MSC Industrial Direct Co Inc (MSM) 2013 Q4 法說會逐字稿

Good morning and welcome to the MSC Industrial Direct fourth quarter of FY13 earnings conference call.

(Operator Instructions)

Please note, this event is being recorded.

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

Please go ahead, sir.

Thank you, Denise and good morning everyone.

I'd like to welcome you to our fiscal 2013 fourth quarter conference call.

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

During today's call, we will refer to various financial and management data included under the section operational statistics, as well as presentation slides that accompany our comments, 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 plans including the BDNA acquisition, and future revenue and margin growth.

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

Information about these risks is noted in the earnings press release, and the risk factors in the MD&A sections on our latest quarterly report form 10 Q 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 reconciliation of the adjusted financial measures to the most directly comparable GAAP measures.

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

Erik, please go ahead.

Thanks John.

Good morning and thank you for joining us today.

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

On this morning's call, I will start with the discussion of the current operating environment, our recent developments, and progress with key initiatives, including BDNA.

Jeff will take a deeper dive into the financial results for the quarter, and provide our fiscal first quarter 2014 guidance.

I'll then provide you with a framework for thinking about fiscal 2014 in its entirety and discuss our longer-term outlook.

And finally we will open up the call for Q&A.

Let's begin with the market environment in the fourth quarter, which remains consistent with the outlook that we provided on our last call and that of the last several quarters.

The weak demand environment persisted, and this was particularly true in metalworking, where spending on cutting tools remained depressed.

Nonetheless, the success of our share gain programs and customer penetration initiatives continued.

Looking ahead, I'd characterize the indicators as mixed, with some signs of possible improvement on the horizon.

Recent ISM readings of 55 plus suggest improvements in the future.

You will remember that there is a lag of roughly four to five months historically, between ISM trending and our results.

You may also have seen the recent analysis published by the US Cutting Tool Institute.

It showed that US cutting tool spend was down over 8% for the first six months of 2013, but the most recent reading for July indicated a spend that was roughly flat with the prior year.

Customer feedback also remains mixed and fairly cautious.

While most are not seeing large declines, they are not seeing significant growth or increasing backlogs, either.

There are pockets of strength in certain markets, such as aerospace and automotive, but in segments like primary metals, metal fabrication, and machine and equipment building, which represent a much greater percentage of our revenues, conditions remain pretty soft.

MRO inventory levels continue to come down, albeit at a slower pace, as customers employ lean and productivity tools to streamline their operations.

I'll turn out to our performance since the quarter ended, and we are encouraged by improvement in our September and October organic average daily sales growth rates, which are trending to approximately 3%.

This is a testament to our continued share gains.

The improvement is a function of growth in our national accounts program and core business, along with the realization of our big book price increase which I'll touch on in a bit.

I'm particularly encouraged by some recent wins in the national accounts arena.

Not surprisingly, the federal government segment muted some of the improvements, due to the shutdown and more general clamp down on spending due to sequestration.

We estimate the impact of the shutdown to be roughly 1 percentage point of growth in Q4 and are anticipating another 1 percentage point in our Q1 guidance.

We also implemented our price increase in August, and it averaged roughly 3% across our various product lines.

Price realization has been strong, thanks to good execution and the high value add that we bring to our customers.

I'll now turn to our investments for the future.

We continued our actions to strengthen our infrastructure and enhance our growth engine.

On the infrastructure side, we completed the construction of our co-headquarters in Davidson, NC.

All of the 120 associates who we expected to relocate to the Charlotte area have done so, and they are thriving in their new environment.

We had our grand opening in late September, and the buzz around the building and the community was sensational.

We also broke ground on our fifth customer fulfillment center in Columbus, Ohio during the quarter and it remains on schedule to open late in fiscal 2014.

As I mentioned earlier, our growth initiatives continued fueling share gains.

Our vending program added roughly 3 points to our growth in the fourth quarter, and e-commerce reached 44% of sales for the full year as compared to 41% a year ago.

Those programs, as well as other inventory management capabilities like VMI, will add significantly to our recurring revenue stream over time.

Additionally, as I've alluded to on prior calls, we've been investing in SKU expansion on our website.

We added a total of 100,000 SKUs during fiscal 2013, bringing our total web-based SKU offering to around 700, 000.

We have plans to add an additional 150,000 SKUs during FY 2014.

That will also contribute to growth and share gain in the quarters to come.

Turning to our integration of the BDNA business; I'm extremely pleased with the progress made thus far.

Conversations with customers, suppliers, and our new associates continue to reinforce the potential that BDNA brings to us, whose business model is very sticky, lending itself to tremendous up-selling opportunities over time.

Sales were trending down versus prior year, in the low to mid single digits for the past few quarters, but revenue growth is starting to show some improvement.

September average daily sales growth was up in the low single digits, and October will also finish up over the prior year.

This is the result of improved execution, and focus on customer service.

We're also encouraged by new account signings and how that bodes for the future.

With respect to the integration plan, we remain on track.

Moving quickly on backend integration, and methodically on the front end.

We are in the process of closing the first three distribution centers between now and early calendar 2014.

We'll also be moving the Cleveland headquarters to our new Davidson location by September of 2014.

Additionally, realization of purchase cost and contract synergies is progressing as expected.

Overall, we remain on track to achieve our targeted cost synergy run rate of $15 million to $20 million by the end of FY 2015, and to achieve our $0.15 to $0.20 accretion range for fiscal 2014.

I will return shortly to discuss our fiscal 2014 framework and our longer-term outlook.

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

Thanks, Erik, and good morning everyone.

We're very pleased that we were able to exceed our EPS guidance, even though the soft environment continued in the fourth quarter.

We did it through a lift in our gross margin and effective management of our expenses.

The BDNA integration is going well and their fourth quarter results were better than expected, and as Erik mentioned, September and October improved somewhat, and this gives us greater confidence going forward.

But let's go through some of the detail of our fiscal fourth-quarter results just as we've done throughout the past year, I'll speak in terms of our reported results and our adjusted results, which reflect the exclusion of Davidson relocation costs as well as BDNA integration costs.

Our reported sales growth on an average daily sales basis was 12.7% compared to the same period last year.

This includes a full quarter of BDNA sales.

Excluding BDNA, our organic sales growth on an average daily sales basis was relatively flat.

In terms of total sales, there were also four fewer sales days in our fiscal fourth quarter this year, as compared to the same period last year, which became virtually a week, given that the 4th of July holiday fell on a Thursday this year.

While our overall organic growth was flat, customers within our vending program contributed roughly 3 points of growth.

Excluding BDNA, sales from our manufacturing customers were flat, while sales from our non-manufacturing customers were up 1%.

Within non-manufacturing, our overall government sales declined, showing the continuing impact from sequestration that started during the second quarter of the year.

Our state business, on the other hand, continued to grow.

In regard to gross margin, we posted 45.6% for the quarter above the midpoint of our guidance of 45%, primarily driven by BDNA.

As compared to the same period last year, the margin was up by approximately 40 basis points, also driven by BDNA's higher margins.

Our reported EPS for the quarter was $0.89 or $0.95 on an adjusted basis, which excludes roughly $0.04 for BDNA transaction and integration costs and about $0.02 for the Davidson relocation.

The $0.95 was well above our guidance of $0.87 to $0.91, and reflects not only sales in gross margin above the top end of our guidance range, but also our tight management of operating expenses.

Finally, the tax provision came in at 38.3%, above what we had expected, due to a slightly higher than anticipated overall date tax rate.

Turning to the balance sheet, our metrics remain strong, DSOs were 45 days and inventory turns were 3.39, a slight improvement from fiscal third quarter levels.

From a cash flow perspective, we continue to generate significant levels of cash.

This allowed us to pay down over $40 million of debt, including all of the remaining balance of our revolving credit facility.

The only debt we have from the BDNA acquisition is the remaining balance on the $250 million term loan.

And we closed the year with $56 million in cash and cash equivalents, and our current cash balance now stands at $103 million.

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

Consistent with last quarter, this guidance will include the impact from the BDNA operating results and exclude the nonrecurring items like BDNA integration costs, as well as the relocation costs associated with our Davidson facility.

We expect revenues to be between $662 million and $674 million.

On an organic basis, the expected ADS growth is about 3%, reflecting our assumption of a slightly improving demand environment.

This guidance is consistent with what we saw in September and much of October, the first two months of the quarter.

We expect gross margin to be in the range of 46.5% plus or minus 20 basis points.

It will be enhanced by higher gross margin BDNA products and tailwinds from the recent price increase, as well as strategic programs like private brand and discount management.

These tailwinds will be partially mitigated by the usual headwinds of purchase cost escalation, which is moderating, and vending.

We also have a new headwind from the higher relative growth rates in national accounts, which carry lower gross margins.

We expect adjusted operating expenses will increase at the midpoint of guidance by approximately $4 million versus fiscal fourth quarter.

This increase primarily relates to projects like Davidson, as well as growth initiatives like sales force expansion and our vending program.

We expect our tax rate to be about 38.2%.

Finally, our adjusted EPS guidance is $0.92 to $0.96, reflecting the current market environment and our increased spending on infrastructure and growth initiatives.

This of course includes BDNA operating results and excludes the integration costs associated with the acquisition and Davidson relocation costs.

This impacts EPS by a total of approximately $0.06.

Also, the BDNA business is expected to be accretive by about $0.04 in the fiscal fourth quarter.

Before I close, let me touch on capital expenditures.

We finished fiscal 2013 at approximately $89 million, lower than we originally expected.

This was due to the timing of our Columbus-related CapEx which moved into fiscal 2014.

We expect CapEx to be slightly over $100 million for fiscal 2014, with nearly half of this associated with the infrastructure projects, primarily the Columbus CFC and the completion of Davidson.

So in summary, we were able to exceed our EPS guidance for the fourth quarter despite the soft market conditions, thanks to a lift in gross margin and continued effective management of expenses.

In fiscal 2013, we began laying the foundation for the future success of the company with the BDNA acquisition and the Davidson co- location along with other key investments.

We've also begun to see a slight pickup in sales growth in the first quarter, which is somewhat encouraging as we begin the new fiscal year.

Finally, I would like to note that last week we announced a 10% increase in our quarterly dividend.

Thanks, and at this point I will turn it back to Erik.

Thanks, Jeff.

I'll now on now turn to 2014 and beyond.

Typically, we provide guidance for one quarter at a time, and at the start of the new fiscal year, we offer you a framework for thinking about incremental margins for that year.

Today I'm going to give you a more granular picture of what we expect in fiscal 2014 and in the years to come.

I'm doing so because I recognize that fiscal 2013 and 2014 are unusual relative to our historical performance.

We are in the midst of building a foundation that will support the next leg of our growth story.

We're taking actions to ensure that we not only continue to outgrow the market, as we have in a tough environment, but accelerate our growth through share gains no matter the market conditions.

As we execute on this plan, I want you to have the same picture that I do, so that you can feel as confident as I do about the payoff that we expect as we leverage our current priorities.

Let me explain our framework for fiscal 2014, starting with three organic growth scenarios; high-growth, which we define as double digits; moderate growth, which we define as mid to high single digits; and low growth, which we define as low single digits.

And now we will take a look at how we expect adjusted operating margins to perform under each of these scenarios.

In either the lower the moderate organic growth scenarios, we expect operating margins for the full year to be in the range of 14% to 15%.

The further we move up the curve from low to moderate growth, the closer we get to 15%, and on the other hand, the operating margin moves towards 14% for the year in the low growth scenario.

As we move into the high organic growth scenario, operating margins move above 15%.

When it comes to the quarterly development of operating margins, during the course of fiscal 2014, there are three factors to consider; one, the growth environment; two, the pricing environment; and three, the ramp in spend that we expect over the year.

Assuming the expected conditions in the fiscal first quarter continue, i.e., modest pricing and low growth environment, we expect the second quarter of our fiscal 2014 to be the low point for operating margins in the year.

For FY 2014, in the low and the moderate growth scenarios though, adjusted operating margins are down in the neighborhood of 200 basis points compared to fiscal 2013.

So let me explain why.

The single largest factor is that we will now have a full-year of BDNA in our results, which by itself contributes to roughly half of the 200 basis point GAAP.

Embedded in our assumptions is BDNA top line growth in the low single digits, and accretion consistent with our guidance of $0.15 to $0.20.

Of course, substantially higher growth from BDNA would change the overall mix of the company and impact operating margins.

The other half of the gap in FY 2014 is due to operating margin suppression in the base MSC business, and there are two factors that are driving this.

First, we project roughly $12 million to $50 million in infrastructure-related expenses.

The impact on operating margins of some of these infrastructure-related expenses is temporary in nature, and will moderate into 2015 and 2016.

The rest are an increased level of spend that get leveraged with additional growth.

And behind this plan infrastructure spend there are primarily three drivers.

Number one is the new Davidson building.

While the cost of operating Davidson will be offset by the payroll tax incentives that we receive from the city in the state, they don't start kicking in until during FY 2015, creating a gap before generating cost savings.

Those incentives extend for a decade.

Number two was the new Columbus customer fulfillment center.

In order to prepare for the opening in late fiscal 2014, we are staffing up the building to receive inventory, train our associates, and get ready to ship products.

At the same time, since the building is not operational, we're maintaining headcounts in the other distribution centers to handle current volume levels.

The full switch to Columbus will happen during fiscal 2015 creating a temporary increase in expenses as we transition.

Of course, some expenses, depreciation in particular, will not step down once we ramp up Columbus.

Those expenses remain in our P&L on an ongoing basis, but get leveraged with revenue growth.

Keep in mind that Columbus will support our next leg of growth, and we don't see the need for another one through at least $4 billion in sales.

And number three, we are outsourcing our data center and are incurring upfront project-related fees to do so.

This move will provide us with ample room for growth and reduce the risk of a potential outage.

This was a decision that was coming in the near future anyway, and the BDNA acquisition pushed us to address it now as we increase our volumes.

In addition to the infrastructure expenses, the other factor accounting for the temporary operating margin suppression in the base business is growth investment.

Our plan is to continue our programs from fiscal 2013 including vending, e-commerce, private brand, SKU expansion, and marketing investments.

In addition, as I mentioned earlier, we will accelerate our sales force expansion.

This is in comparison to most of fiscal 2013, when we held sales headcount flat.

As we shared with you last quarter, our plan was to begin expanding our sales force as the environment stabilized, and we began doing so in our fiscal fourth quarter by adding roughly 2% to our sales force.

Barring any significant downturn in the environment, we anticipate expansion in the range of 5% to 7% over fiscal 2013 levels.

Given the nature of our sales force investment, this means incremental spending and some dilution in fiscal 2014.

However, we are highly confident that restarting this expansion will contribute to improved growth as we approach fiscal 2015.

Let me now turn to how this operating margin framework translates into EPS performance.

Our inflection point for EPS growth falls right in the middle of our moderate growth scenario.

Mid-single digit organic revenue growth is the break-even point for EPS growth where adjusted EPS is essentially flat with FY13.

Below mid-single digit organic growth levels, we expect EPS would decline, and above that level EPS would grow.

Double-digit EPS growth would occur as we get into the high growth scenario of double-digit organic top line growth rates.

Once again, we are assuming that BDNA produces low single-digit top line growth and $0.15 to $0.20 of accretion.

Should BDNA outperform those assumptions, it would further enhance the overall EPS picture for the year.

In addition, should commodity inflation add significantly to the current pricing environment, that would also enhance the EPS picture.

Let me now turn to fiscal 2015 and beyond, a growth story that I'm very excited about.

I'll begin with an update on our revenue goals of $4 billion by the end of fiscal 2016.

We set this goal call at the close of our fiscal 2011 as we hit $2 billion in sales.

That goal implied a 15% compound annual growth rate inclusive of organic and acquisitive growth in a moderate growth environment, with the majority of the growth being organic as it had been in the past.

We're now just over two years into that plan, closing fiscal 2013 at around $2.7 billion on a run-rate basis inclusive of annualized BDNA sales.

Our organic growth rate since fiscal 2011, though, has been lower than anticipated due to the impact of softness in the metalworking sector this past year.

Clearly we have not been operating in a moderate growth environment.

Nonetheless, achieving our $4 billion goal requires a CAGR of just under 15% over the next three years.

So we remain on track, although we will need to see an improvement in our organic growth rates to achieve the goal.

Assuming that the metalworking and the manufacturing environments return to growth, we anticipate strong organic growth for three reasons.

First, we'll continue to take advantage of our share gain programs which should benefit from incremental growth spending.

Second, we see the potential for accelerated industry consolidation, which should serve as a growth tailwind.

And third, we are encouraged by the prospects of a renewed manufacturing renaissance in North America, which would create a new and additional tailwind that we have not yet experience.

M&A remains an important part of our growth story as well.

However, we'll not acquire growth simply to hit the $4 billion target, or to hit any other metrics, for that matter.

We will maintain the same rigor that we always have.

Any acquisition will have to be a strong strategic fit, cultural fit, and meet our financial hurdles, including long-term returns on capital.

Now, the question we've been asked most frequently with respect to our growth plan is about operating margins, and specifically what happens to them as we march towards $4 billion and beyond?

The answer to this question is central to our confidence in the plan.

Let's focus on the profitability of the base business, which includes MSC and BDNA, as timing and mix are uncertain when it comes to future acquisitions.

We see and FY 2014 as the low point for our operating margins.

Assuming a moderate growth scenario, we would expect the fiscal 2015 increase in operating margins to be modest, and then pick up steam in 2016.

Should we see a higher growth environment, the operating margin recovery accelerates.

Over time, we see the base business operating comfortably at operating margins in the high teens, and we'll reach that level when the base business, meaning the combined MSC and BDNA, reaches around $3.5 billion in revenue.

That's about a 30% increase over the end of FY 2013 annualized revenue run rate.

How quickly we get there is a function of the trajectory of our organic growth.

Before we turn to your questions, I'd like to thank our entire team for their continued hard work and dedication.

I'm very excited about the future of our company.

A lot of hard work has gone into the plan, and now it's all about execution.

With the experience of this team and our history of prudent management, I remain very confident that our actions in laying the foundation for growth will pay off in the form of exceptional returns.

And we'll now open the lines for questions.

(Operator Instructions)

Ryan Merkel, William Blair & Company.

So, a lot in the call there.

Let me just start with I think what you said was you expect 2015 would be more of a modest increase in the operating margin, and that would accelerate in 2016.

So if you could just walk through why would be more modest in 2015 if growth spending is falling off?

Yes, sure, Ryan, my pleasure.

I'm going to answer you in a second.

I do want to take a second, though, in talking about 2015, 2016, and looking at the whole picture here to step back and talk about the context in which we're operating, because I think that is very relevant to the story that I just laid out.

We are operating in a market right now that is in the early stages of the consolidation story.

And we believe that as the industry consolidates there is going to be clear winners.

And those winners are going to be defined by those who capture market share, who achieve scale, and therefore as a result, who capture the majority of the profit pool.

And the steps -- what I outlined in this multi year plan here, are the steps to ensure that MSC is positioned as a clear winner.

So, what you're hearing is that we are investing in growth drivers to accelerate our share gain, we're building the infrastructure now that is going to support this next leg of growth and that is going to give us the scale that we need, and hence allow us to achieve the kind of profitability that we want.

So, that is really why we are taking a more moderated approach to this op margin acceleration, particularly in FY15.

Now, to answer you specifically with respect to 2015, it is really a story of two issues, Ryan.

One is that the infrastructure spending that is being put in, that $12 million to $15 million I referenced through 2014, much of that carries through 2015.

And so the story is about leveraging that fixed investment.

And that happened as we achieve growth.

The second piece of the story is that the growth investments that were accelerating take a little bit of time before they kick in with the higher returns and the accelerated growth.

So we need to see returns on those growth investments.

So those are the two factors that are driving the more what we consider to be expect to be a more modest pick up in 2015 that accelerates and 2016.

Okay that make sense that we should think about it in terms of you're going to see accelerating share gains are going to boost the top line and then a lower level of SG&A growth that we've seen, that's more a 2016 story than a 2015 story about a little bit in 2015 as well?

You got it.

Okay and then I just wanted to talk about vending, continue to add nicely to growth.

But you haven't initiative I think to improve vending margins and I'm wondering how that is going, first of all.

Second of all, do you have any machines that are in their third year of operation that are doing close to the MSC Company level EBIT margin?

Yes, great question.

So let me start, Ryan, by saying vending, you heard the update continues to go well, you are exactly right.

We've talked about programs that are actually in the rollout phase right now and the execution phase in terms of improvements.

So the headlines on vending continues to be a key growth contributor, continues to appeal to customers in this environment who, really what we are hearing is a heavy emphasis on productivity and lean from our customers.

This is a great match and that's why I think you're seeing the growth, the high customer retentions.

As we've called out the area that we wanted to improve as productivity and profitability.

So to answer you directly, yes, we do have machines in their third year.

We've reached the point where the third year -- so the profile of the third year vending account is now right around the Company op margin.

Total program margin when you combine all the classes is still below as we've described, but we expect that to reach Company average within the next couple of years.

Excellent, thank you.

David Manthey, Robert W. Baird & Co.

First off, yes, a lot to digest here, but I'm thinking about the progression here.

And thanks that's a lot of information.

If we look at that down 200 basis points year-over-year in the second quarter of next fiscal year, I guess there's a typical step up from 1Q to 2Q just because of payroll and salaries and benefits and that sort of thing and usually a couple $3 million.

And then of course there's variable expenses as the sales reaccelerate.

But I'm coming up with that would be something along the lines of maybe $9 million of sequential first quarter to second quarter meeting that maybe the initiatives or the spending -- the incremental spending is $5 million or $6 million, does that sound about right?

And are you saying that's going to peak -- those dollars going to peak in the second quarter and they continue to moderate from 2014 into 2015?

Yes David it's really good question let me go back and explain to you what -- here's what I can tell you.

What we wanted to make clear is that the framework we gave you is an average for the year.

So here's what I can tell you.

For the year, in a low to moderate growth environment, we expect op margins to be at all in between 2014 and 2015 that is one.

Two, we expect that to move quarter to quarter.

Okay?

Three is that the movements quarter to quarter are a function of three things.

One is what happens in the demand environment, two is what happens with the pricing environment, and then three is the sequential increase in spend that you're talking about.

So the other thing I can tell you is that if the demand environment and the pricing environment remain as they are now, what we'd expect is that Q2 would be the low point of op margins for the year.

And it's very much for the reasons that you described, which is -- you're very well aware, there is typically is a seasonal pattern to the business, both in terms of revenues and some expense step up in the second quarter.

Okay, thank you.

Yes, we will spend some time going through that.

I did want to ask a broader question, a more secular question.

As your customers are demanding more of these higher-end supply chain Solutions, and clearly that is what is driving a good portion of the Company specific growth year, how do you define MSC's competitive advantage, particularly in vending?

I think it's pretty clear on the e-commerce site that you are one of the best in class companies.

But when you think about vending, what it you go in with your competitive advantage when you're selling that customers?

David, it's a great question, and I would step back and say, the way we sell to a customer, our value proposition is much more than just about vending.

So the advantage that we are bringing to the table is not so much lining up one vending program against another, it is the total package of what we can do for a customer.

And fundamentally, our customers want to save time and they want to save money.

When you clear out the noise out they of have two objectives.

And we believe in the industrial distribution world, we are best positioned to save our customers time and we do that through the broad SKU offering, or an excellent web experience, through great service and through terrific logistics for next day delivery.

We also believe we can save our customers money like nobody else in the space and that comes in a number of ways.

It comes by streamlining inventories and freeing up cash, i.e., inventory management solutions.

It comes with product choices and exclusive brand alternatives that are at attractive price points, and it also comes with generating productivity savings right on the plant floor which we do with technical metalworking capabilities.

So I think you've got to think of our value proposition of the total package that is unique and different.

Particularly for a manufacture.

Right, okay, Erik, thanks very much for the information.

John Inch, Deutsche Bank.

Jeff, why were -- just remind me if we go back to the quarter for a second, why were the gross margins so much higher given that the volumes were flat all-in on a daily sales basis?

Did you get the benefit of -- was it program rebates or something unexpected?

I'm just curious because you normally don't exceed your gross margins by that much versus expectation.

You are right, John, it wasn't related to rebates.

The gross margin was actually 60 basis points above the midpoint of our guidance and that was a significant reason why we were able to exceed the EPS guidance and BDNA with the driver there.

I think you will recall that we had said that BDNA we expect it to drop from the low 50s to -- or from the high 50s to the low 50s, in fact it dropped to the mid 50s.

Two things there, the inventory valuation adjustment was slightly less than we had expected, and the business performed better operationally that we had estimated.

We expect it to return to the high 50s in Q1.

Right, so on that, just to pick on them point then.

Shouldn't the high 50s we were coming up with the back of the envelope with BDNA just over 10% of your revenues, it should be driving gross margins higher by about 1 point, but that is not really your guide in the first quarter, it's below that.

So is there some reason why the gross margin isn't an a little bit higher?

Are you talking -- from quarter to quarter you would have to look at BDNA's increase from the mid 50s to the high 50s, so that -- (multiple speakers)

I was actually thinking year-over-year right?

So BDNA is not the first quarter a year ago you did 45.9 you add 1 point that is 46.9 your saying 46.5.

So many headwinds and tailwinds from last year, John, including the price increase -- or the lack of the midyear price increase and then the headwinds and tailwinds.

The normal headwinds from things like purchase cost escalation and vending and things like that and then the tailwinds from the programs that we're are implementing.

So we are going to see a 90 basis point sequential lift and we think that's pretty meaningful in the soft environment that we have today.

So that is coming from certainly the price realization, the BDNA margins returning to the high 50s.

But again we have tailwinds and headwinds and one of the additional headwinds we have, which I mentioned, is the higher relative growth rate in the national accounts.

Yes, with the price at 3%, was that normally what you would've expected?

Just a little bit more than what other distributors typically get in the catalog.

Just remind me again did that help the margin that all this quarter -- or prospectively in the first quarter?

Yes, absolutely.

So it's only, like, 2%, right?

John, I would say, this is Erik, and I'll touch on how this fits in.

I would say 3% is somewhere in the range of quote, unquote normal.

So it's -- we've been higher, last year was higher, there's years we've been lower but remember that we didn't do a midyear price increase this year.

Yes.

So that was part of the thinking in terms of the 3%.

We would still characterize the pricing environment as pretty modest right now.

But you didn't do a price increase, Erik, because the business conditions, [while] I'll think were pretty early competitive, particularly metalworking.

So I'm just wondering now that you've done this 3% -- which sound like it's a little bit above average or maybe back towards normal.

Does that just imply that business -- forgetting about your September/October result, is that just also implied?

Business is getting better because you are now able to raise pricing where before you are not?

Has anything changed at that point I guess?

John, the way I characterize it, I think we feel very good about the price increase we've put in place.

When we look at what we did over the course of the year, we feel very comfortable relative to the value of bringing customers and the cost savings we're generating.

We feel comfortable with it.

I think view that more as a function of, this was the cycle and the time in the year when which we do it as opposed to a dramatic change in the external pricing environment.

Okay, that's fair.

And maybe just one more.

E-commerce, which I believe includes vending, I realized there is 4 fewer days in the quarter and you did have tougher compares, but with vending -- which you said was 3 points of contribution same as last quarter, it's only 2% year-over-year growth.

So, I guess my question is, it's two part really, is e-commerce on a daily sales basis with vending?

Has this picked up sequentially if you strip that out?

And then are you, as part of spending initiatives, Erik, into next year are you talk about sales but maybe if you could get the e-commerce piece of this back to more of an elevated trajectory?

Because that seems to be an area you could be an area you could be taking some share gains, right?

Because smaller players don't have e-commerce capability, are you at least spending incrementally more in 2014?

What is your thought there?

You are absolutely right, e-commerce is a huge portion of our growth plans and the share gain story, your absolute right.

I would tell you that I think the best way to look at e-commerce and its growth trajectory, is e-commerce as a percentage of total Company and that's continued -- I don't have the numbers handy, we can get them to you.

But that's continued -- I gave you the number on an average across the year of 44%, but sequentially quarter-to-quarter, that's gone higher as a percentage of total which indicates that it's growing -- well outpacing Company average.

I think the story there, a piece of it is vending, although realize that vending, it's only what is actually going through the vending machines.

The bigger piece of the story on e-commerce is our website and it's the new platform that we put in place which is working well, quite well, getting great customer feedback.

And to answer your other question, yes, it is -- we do envision more incremental spend.

We don't view e-commerce as a one and done meaning you put the site up there and stop investing, we think that would be a big mistake.

So, we anticipate and part of our plans and the OpEx, there is a portion of that, that's going into continual enhancements to our e-commerce efforts.

Finally just how much of the 3% price increase do you think you realized in the first quarter -- I'm sorry in the fourth quarter?

In terms of your total revenues, how much of that would've been price?

In Q1?

Q4, the fourth quarter.

Price is much more of a factor in Q1 than it was in Q4.

Realization was -- we'll tell you the realization has been strong.

But more of a factor in Q1 than in Q4.

Okay.

Great, thank you.

Matt Duncan, Stephens Inc.

Just want to try and dig in a little bit more on the operating margin ramp in FY15.

So, it sounds like, Erik, just to make sure I understood you correctly, the all-in operating margin, which would include the integration expense at BDNA is 14% to 15%, and FY14, if we've got low- to mid- single-digit organic growth, is that correct?

One correction, so let me restate it.

The all-in operating margin for the Company in a lower moderate growth scenario is 14 to 15 points that's adjusted operating margins.

So that excludes one-time integration expenses, severance pay outs and things of the sort, that is adjusted operating margin, okay?

So at the middle of that range what we had referenced is that is around 200 basis points down from FY13 levels, about half of the 200 basis points is strictly the math of bringing BDNA into the total, because we only had a stub period in FY13 of BDNA results.

We have the full-year result in FY14.

The other half of that 200 basis point is coming from the temporary suppression in the base business, and that 100 basis points, think of it as two prongs.

Prong one in is the infrastructure investments, prong two is the accelerated growth investment.

So then if we were to add in the integration costs from BDNA, what should be all-in operating margin then be?

I don't know Jeff if you have any -- if you could give us some help on the impact on operating margin from the stuff that's going to be adjusted out on EPS?

Yes, Matt, what I can tell you is that the total nonrecurring integration and transaction cost for BDNA is $25 million to $30 million most of that at incurred in FY13 and '14.

And I think, if I remember correctly, you got $15 million or $20 million of that left, correct?

After Q1, right?

Yes.

Okay.

So then as we look out to FY15, obviously the flow-through of those expenses is going to decline, and when you're talking about moderate operating margin expansion, you're talking about the adjusted operating margin.

So I'm trying to think through in terms of how many basis points of operating margin expansion we should translate that to?

Is it 50 to 100 basis points, plus then the extra leverage because the BDNA integration costs are going down?

I just want to make sure we don't get carried away with how to translate moderate into the amount of operate leverage you can get.

Yes, Matt, for now, I'm going to stick with the characterization of modest.

And the reason is there are so many -- going out another year is -- it becomes very difficult to pinpoint a specific op margin expansion because so much of it is tied to what happens in the revenue environment, what happens in the pricing environment.

The further we move out the more variables [you] are.

What we did want to do, though, is give it to a sense of how wraps up into high teens and I think the relative point is that 2015 we expect to improve, but not to improve to the degree to which it does in 2016.

So, Matt, just a little more color on what's happening and why.

Take the infrastructure expenses, okay, something like Columbus, which -- so 2014, what we described as Columbus opens up at a very tail end of 2014 and we have this -- there's two factors going on with Columbus.

One is a temporary build in headcount.

And that temporary build in headcount is because we are not yet shipping out of the new distribution centers.

As we move through the course of FY15, that temporary headcount build will come down.

But for a good part of 2015, that will remain a headwind.

The other factor on Columbus is depreciation will kick in.

So Columbus alone, when you combine those two things for 2015, Columbus could be in the neighborhood of a 30 to 40 basis point drag on op margins in 2015.

So that's just give you a little color on why it is that we think it's going to be a modest recovery in 2015.

And what happens is, certain things in and 2015 into 2016 drop off and we also anticipate generating grow that is going to leverage the fixed cost.

Okay that's helpful.

Sorry for getting so granular there.

And the last thing I just want to make sure we understand the monthly sales patterns that you guys are seeing.

Were the organic revenues down through the quarter until maybe August and then they flip positive?

Can you give us some help with that month-to-month trend?

And then talk about what end markets specifically you are seeing improvement in.

As you talk to customers, what is the general feel on customer outlook for their own businesses, as we move into calendar 14?

Just to help us think through what growth might end up looking like for you guys?

Good question, Matt.

So, let me start with the sequential revenue trending.

I don't have the numbers handy, we can get them for you on June, July, August.

I think I've noted we didn't see a significant ramp up in the quarter.

So the ramp really started in -- there was a difference, a significant difference between August and September.

So what we said was September and October were both in the 3% territory and that's what our guidance implies on an organic basis.

But don't think of it as Q4 there was this progressive ramp for the quarter.

There was not, it was roughly flat.

Your other question was around customer outlook.

The word I would use right now, Matt, is mixed, is probably the best way to put it.

When we put together this whole mosaic of what we're hearing from our customers directly, what we're seeing in terms of the macro indicators and how that all plays out, it is very mixed.

There are certainly pockets of growth in the economy, and it's no rocket science I'm sure to reveal that aerospace and automotive are two of the people we're citing.

But there's also pockets in more general industrial.

The sectors that I called out, the primary metals, the metal fabs, the big chunk of our base, that's still pretty soft and still pretty cautious.

Then you go to the macro indicators and on the one hand, the ISM would be quite encouraging at 55%-plus.

And yet you look at some of the metalworking specific indicators that we'll look at -- and we referenced one of them in the cutting tools, that has been soft and in fact considerably down for much of the year.

So it is really a mixed bag right now.

Okay, that is helpful.

Thank you, guys.

Hamzah Mazari, Credit Suisse.

The first question, Erik, is just a little bit more big picture.

You talked about September and October seeing improvement.

I'm just curious if that growth does stall out over the next 12 months, at what point do you start pulling back some investment spend?

Or is the view that we should go full speed ahead to take shares longer-term?

Hamzah, maybe I'll take that, this is Jeff.

I will tell you, one of the things we do is manage our operating expenses very closely from quarter-to-quarter.

We've done that for years, and we are stepping up the investments, we're committed to that, we think that will drive the growth in the future and also provide the infrastructure.

We are committed to the framework that we provided in terms of the operating margin and we do have levers.

We don't anticipate the revenue growth rate being below that low to moderate, but we don't have a fixed point of a fall [up].

Obviously, if the conditions deteriorated, very significantly, we would take some steps.

But at this point we feel comfortable we'll fall in that low to moderate range.

Great, and just a follow-up.

On the Barnes deal, you talked about taking a more prudent approach on front office rationalization in order to avoid disruptions.

Could you maybe add some color on where the risk may be in that process?

And any sales force compensation changes you are making as you bring in Barnes or is that too early?

Or that's been done?

Hamzah, it's a great question and what I would say is that when you think of the notion that we are moving methodically on the front end, I wouldn't think of it in terms of that translates into risk.

Really this goes back -- the philosophy we're applying to BDNA is very much the philosophy that I described at the outset in terms of how we are looking at this business.

We are looking at creating something here that is built to last and that is going to sustain growth for a long period of time.

And what we want to avoid is rushing to jump on revenue synergies only to find -- any time you are into something new, there is going to be unanticipated things, there's going to be pitfalls.

We want to hash all of that out.

Certainly you raise sales force compensation, I'm not going to get too much into the detail on that one for competitive reasons, but certainly that's one factor we want to consider.

Shared accounts, product pricing, there's a the whole number of factors that aren't necessarily a matter of risk, but a matter of making sure that, when we move we like to move in the right way and get it right.

And we are going to take our time on the front end and pilot it, recognize that it is a different business, and recognize that will be scale it is done right.

Great, thanks a lot.

Eli Lustgarten, Longbow Securities.

Can we talk a little bit about supplier incentive of buy?

One of things we're starting to hear the marketplace is that there is some attractive pre buys being offered by suppliers, better cost or something going on that may help the result of the next couple of quarters.

Are you seeing any of that and taking advantage of any of that?

I just had another call where somebody was making a pre buy, particularly when you need to have a little bit higher inventory because of Columbus?

Eli, I would say there is a bit.

So when Jeff describes the gross margin picture, is rebate piece of it, yes.

But I would tell you that when we work with our suppliers, we're really focused on sell-through and share gain.

So, yes, too some extent, there is the occasional buy opportunities, and we try to be entrepreneurial and there is win-win cases where we take advantage.

But the real focus with our supplier partners is on share gain in sell-through.

Yes, so at this point you're not -- it's normal incremental, whatever it is, it's nothing material taking place in the first half of the year?

That's right.

You threw so much at us, I want to make sure I understand this.

The basic premise is that with the 3% comparisons going on at this point.

You need to have that, plus some in the middle to have -- not to have 2014 be a challenge to match 2013 results, with the difference being the investment being made in the core business.

Is that a fair way to contrive?

Eli, I would say yes.

So I would say another way to stay at is mid-single-digit organic revenue growth is the breakeven point for adjusted earnings per share relative to prior-year.

And the drivers of that suppression are, one, growth investment, two, infrastructure expense that leveraged with growth.

John Baliotti, Janney Capital Markets.

Erik you give us a lot of information to chew on and a lot of different scenarios.

And I was thinking maybe the market seems to be still digesting it because the stock is kind of bouncing all over the place.

And I'm just thinking maybe if I took a high-altituded summation of what you're talking about.

Is it fair to think that, you guys are obviously investing as you point of the long-term, this is not about the next 12 months of the next 24 months.

But you got some plans, long-term plans that you want to continue, with some obviously subjectivity if things fall apart.

But in a traditional distribution sense, if volumes pick up, you don't have a corresponding variable cost to service that.

And therefore the more efficient MSC going forward would deliver better margins than what you have in the past?

Is that fair?

Yes, John, yes I think it is a fair characterization.

I think if there were two headlines here.

Headline one, is the fact that you are right that we are looking at the big picture here, and looking at operating in a market that is in the early stages of consolidation and with knowledge that there is going to be clear winners.

And the winners are going to be driving share gains and they are going to achieve scale and be able to generate leverage, thereby -- and therefore profitability.

We are taking the steps now to ensure that MSC is a winner.

I think that is headline one.

I think headline two would be that we're really confident in our plan, and one of the things that gives us the confidence is history.

We've been at this for decades, and we've been through cycles like this.

We have been through step functions before.

We were in one as recently as right around the 2000s and saw what happened as that played out and the kind of returns and the leverage that we generated in the decade to follow.

Because it seems like -- and you don't benefit from some of the SKU mix that some of your competitors have in terms of the tailwinds to gross margins.

But you do have some pretty significantly -- you have very high margin to start with, I know it's on a nominal basis.

But it seems like the benefits you are getting from BDNA and the obvious strategic benefit of BDNA and what it can do for customers and consolidating their spend, layered onto the fact that you've got a good infrastructure to support that, seems that you are far from maxed out in terms of your profitability.

Yes, for sure.

That it was why we wanted to make the point that we do see this business comfortably in the high-teens in operating margins.

I think that is absolutely right.

Brent Rakers, Wunderlich Securities.

Just wanted to follow back up on the catalog price increase announcement.

I think 3% is what you said earlier, Erik.

I think last year the number, if I recall, was about 3.5% to 4%.

And I guess by this fourth quarter it had faded away to about 30 BPS in price realization.

If you just maybe could talk us through what that would not occur again in the current fiscal year, and maybe even think ahead about -- talk ahead about midyear price increases and what you're seeing out there on that front.

Yes, so Brent, what your getting at is the outlook for gross margins as we move through the year.

A little early, a little early to tell, because so much of it as you pointed out -- look, in the base business there is a natural progression to our margins which you're familiar with which says, that Q1 absent any additional pricing action, tends to be the high point through the year and there is a series of headwinds that will then gradually bring that down during the course of the year.

The big variable is pricing, certainly, I would say that another variable this year, which is BDNA, which high gross margins to the extent that, that business outperforms our assumptions, that would be another tailwind.

And, look, we have in the tailwinds in terms of our strategic programs on the exclusive brands in the discount management.

So, I would say a little early to tell on the pricing environment.

If you asked me if the rest of the year looked like it does now, how would I characterize that?

I would characterize the pricing environment as modest.

Does that mean, Erik, that by the time we get to second, third, fourth quarter we think the Company will still be realizing 2% to 3% price increase contribution?

I think two separate issues in terms -- the price realization, even through fiscal 2013, was quite good, Brent.

So what happens is during the year, is, absent pricing action, there are headwinds that will bring that down, but the price realization in terms of getting price still good.

The one other thing I should mention, we saw in fiscal 2013 pretty significant headwind in terms of purchase cost escalation.

And that is a result -- we talk about there is always of delayed effect from the time there is an inflationary environment and we get the purchase cost to when it works through P&Ls.

We do see the headwind of purchase/cost escalation.

Jeff had pointed out, we see that moderating through this fiscal year.

So at least one of the headwinds should be a little less than it was during FY13.

Okay and then, one last question.

I think you talked about seeing some improvement in September/October month.

I guess if you could talk on that frame in terms of more sequential patterns, because when you go back and look at September to August, October to September the patterns look very similar to 2010, 2011.

If you could, maybe comment directionally as opposed to the year-over-year change?

Yes, I think you are right.

The sequential change in daily sales is pretty consistent.

I guess if anything we would view that is encouraging, because 2013 was not consistent with that pattern.

So, to the extent that it is consistent with the 2010 or 2011 we view that as encouraging.

In terms of putting color on it, as we said, obviously federal government is quite weak, so that's muting some of the results where we are seeing strength.

The first place I'd call out is I think we are doing well in our national accounts program.

A lot of the larger companies, in particular, in this difficult environment are heavily focused on lean and on productivity and I think our value proposition plays really well there.

Which is part of the reason why we are seeing success and then some success in our core business.

Sam Darkatsh, Raymond James & Associates.

The formatting of this call was terrific, sometimes the message is not always as exuberant as we would like to see from an earnings stand point, but the formatting and the information flow was excellent.

Thank you, Sam.

Most of my questions have been asked and answered.

I noticed, and this may be apropos of nothing, but your direct mail pieces were up year on year for the first time in I can't remember how long.

And that seems a little counterintuitive based on what some of your growth initiatives may prescribe.

Was that just a funky thing with the timing or is that indicative of some sort of initiative that you are also looking at over the next year or two?

You're pretty good, Sam.

You got to get up pretty early to pull one over on you.

So, the answer is -- no, you are right.

What you are seeing is some increase in marketing investment.

So there's, and I'm not going to get into too much detail for competitive reasons, but there is some marking activity, some of which involves print.

If you look at the total pie of marketing activity, the heavier weighting is still digital, no change there and no surprise.

But there are some programs that did -- part of our growth investment that did involve some print pieces that are working quite nicely.

And then my last question, and you've talked around this a little bit, Erik.

When we are looking at out year leverage.

You've talked in the past about pennies OpEx leverage on sales or at what point do you begin to leverage sales on an OpEx standpoint?

How should we look at that in terms of, what would you have to grow top line in excess of in order to begin to leverage OpEx in the out years?

And maybe that could help us for modeling purposes.

Well, so what we said was, for 2015, assuming a moderate environment, so the moderate environment as we described mid- to high-single-digits, we expected op margins to improve, albeit modest.

So by 2015, that means earnings should be growing faster than sales, assuming that environment or better.

And basically what happens as you know, given how high the incrementals are when we're growing.

As our revenues move from the moderate mid- to high-single-digits into the double-digits, the ratio between earnings and revenue growth starts to really improve considerably.

But the idea is, beginning in 2015, earnings should grow faster than sales, assuming our assumptions hold.

So the thinking then would be, let's say if you only grow low-single-digit, you don't leverage OpEx, but over a certain low-single-digit rate, maybe OpEx grows at maybe half the rate of sales something like that, would that be unfair?

I don't know that I'd get that specific in terms of 2015.

But what I would tell you is you've got pretty good experience with us over time for knowing how we generate leverage.

The one caveat I would offer, Sam, is just going back to this theme about the early stages of a consolidating market, we want to make sure that as much is we want to get op margins up quickly that we are not doing it at the expense of the needed growth investments that are going to ensure share gains and ensure our position is a winner.

Very helpful again, thank you both.

Scott Graham, Jefferies & Company.

I definitely have to second on that previous caller, great transparency, thank you.

Thank you, Scott.

So, I might've missed this in everything that you said, Erik.

Did you give the MSM-only operating margin?

For what period?

For the fourth quarter.

For the fourth quarter, the operating margin for the fourth quarter (multiple speakers).

No I we didn't -- I was going to say, the one thing we did provide that the expected impact throughout the year for BDNA would be about 100 basis points dilution to the operating margin.

And there's no reason to believe that it was any different this quarter, right?

I would say it is fairly consistent this quarter, yes.

Got you.

When you guys put out that it's $0.04 accretive, and I noticed that you paid for this all with cash, do you impute an interest expense within that $0.04?

Yes, we do.

You do, great.

Last question is private label, you've heard me ask about this before.

What is the percentage of total Company sales that's private label right now and directionally, what you thinking?

I know the answer is going to be up of course.

But maybe, as these investments take place, a portion of them are going toward improving your private label program.

Could you talk about where we're at today, and where we will be tomorrow?

Yes, sure, Scott.

So what we have given you is the percentage of products that the private brand products represent of our total offering and we said that is roughly comparable to revenues.

And figure that is in the 13% to 14% range as a percentage of total.

That number is continuing to climb year-over-year by pretty nice clip.

And obviously, as you would imagine of course, higher-margin great customer value.

It is going up year-over-year by a pretty nice clip.

If you asked, without giving a specific target, if you asked me over time, could that number get to 20%?

Would I think that is possible?

I think that is possible, but I'm hesitant to give you a specific time.

But that gives you a sense of runway.

And would you be willing to tell us how much that's worth -- how much every point is worth to the operating margin?

Scott, we don't breakout -- for competitive purposes, what we don't do is break it -- to do that we'd have to share the margin differential, and we don't do that.

Suffice it to say, it's a needle mover.

It's needle mover to the point where it's getting significant amount of investment, because the differential is very real.

Okay and will the spending behind expanding private label increase on a year-over-year basis like everything else is?

Is there as much going toward private label pro rata as the other programs?

Yes, and it's very similar.

So the answer is yes, Scott, that is part of the increment in the growth spending is diverted to private brand, and it's a fantastic investment.

But much like a salesperson is, there's parts there is part of the investment into private brands that are dilutive near-term.

So there is some dilution to the spending.

So just to give an example, if part of the investment is to marketing program, it will take time for the marketing program to gain traction, generate buzz, and get incremental business in before we start seeing the margin benefits, but a highly, highly accretive investment over time.

Very good, thank you for your time.

Ladies and gentlemen, this will conclude our question-and-answer session.

I would like to turn the conference back over it to Mr. John Chironna to run for his closing remarks.

Thanks everyone again for your continued interest in the Company.

Our next earnings date is set for January 8 and we certainly look forward to speaking with you then or over the coming months.

It's a little early, but we would like to wish you and your families a safe and happy holidays.

And look forward to speaking to you then again.

Ladies and gentlemen, the conference has now concluded.

We thank you for attending today's presentation.

You may now disconnect your lines.