MSC Industrial Direct Co., Inc. (MSM) Q1 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the MSC Industrial Supply Company’s First Quarter 2016 Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note today’s event is being recorded. I would now like to turn the conference over to John Chironna, Vice President of Investor Relations and Treasurer. Please go ahead.

Thank you, Aldol [ph], and good morning, everyone. I'd like to welcome you to our fiscal 2016 first quarter conference call. With me in the room is Erik Gershwind, our Chief Executive Officer and Rustom Jilla, our Chief Financial Officer. During today's call, we will refer to various financial and management data in the presentation slides that accompany our comments, as well as our operational statistics, both of which can be found on the investor relations section of our website. 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 U.S. 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 in the MD&A sections of our latest annual report on Form 10-K filed with the SEC, as well as in 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 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 CEO, Erik Gershwind.

Thanks, John. And good morning everybody thank you for joining us today. I’ll start by wishing everyone a Happy New Year and also thank you in advance for bearing with me as I muddle through a New Year’s head cold that I contracted. So I’ll now get into the remarks and I’ll begin by covering the macro environment which remains extremely challenging. I’ll then turn to our recent performance which I’m quite pleased with in the face of difficult conditions. Rustom will then provide additional detail on our financial results and share our second quarter 2016 guidance. I’ll then conclude with some additional comments on our expectations for the year and reinforce the opportunity that we see going forward. And finally, we’ll open up the call for Q&A. So, let me begin with market conditions and then our performance against the challenging backdrop. The environment continued to deteriorate as expected. The root causes for the slowdown remain the same. The rapid and sustained drop in oil prices, the strong U.S. dollar with its negative effect on export demand, and foreign exchange headwinds, are all negatively impacting broader manufacturing activity. Macro indicators continue to reflect the sharp and extended slowdown in manufacturing, with U.S. factory activity extending the more than two year low that I mentioned last quarter. The ISM continued its decline in December and has now been below 50 for the past two months. The MBI also continued falling and remained below 50 for eight months in a row. The October and November MBI readings came in at 43.2% indicating a significant contraction in the metal working sector. These readings are consistent with what we are hearing from our customers, which includes shrinking backlogs and order flows, and very low visibility. With respect to the pricing environment, conditions remain extremely soft, due primarily to the lack of commodities inflation. Supplier pricing activity, the primary driver of distributor pricing movement continues to be minimal. As such, we’ve not implemented a mid-year price adjustment and don’t anticipate doing so absent to change in conditions. Let me turn to our performance in the face of this challenging environment, and it’s highlighted by three things. First, continued share gains as indicated by growth rates well ahead of the market, second, sustained gross margin stabilisation from solid execution on both the buy side and the sell side and third, continued strong expense controls and realization of the benefits from our productivity initiatives. I’ll start with revenues. On an average daily sales basis, our net sales for the quarter were in line with our guidance and down 3.3% from last year. The monthly trend deteriorated through November as anticipated. Growth rates by customer class came down across the board. Our large account business comprised of government and national accounts grew at a low single digit pace for the quarter. Our core and CCSG customers lagged the company average reflecting the extreme softness in both the metal working and the mining end markets. The combination of these factors meant that customer mix remained the gross margin headwind. Despite negative growth rates in the quarter, the macro industries industrial distributor surveys and supplier feedback all confirmed that our share gains have continued. This is a function of strong execution of our growth initiatives, vending, SKU expansion, sales force productivity, eCommerce, digital marketing and more along with delivering excellent service in a difficult environment. Availability of product is paramount to our customers, particularly now when they are reducing inventories on their own shelves. Customers continued leveraging our vending and eCommerce technology platforms. eCommerce reached 57% of sales for the first quarter, up from 56.7% last quarter and 54.5% a year ago. Sales to vending customers contributed roughly 50 basis points of growth. We also added approximately 70,000 SKUs net of removals to our web offering. We now have nearly 1.1 million SKUs available online and continued growth in these areas bodes well for future sustained share gains. Regarding sales force expansion, our net head count for the quarter was basically flat. I will note that beginning this fiscal year we are including field sales and service associates in this calculation. Given our increasing penetration of inventory management solutions such as vending and VMI this adjustment better reflects the way we go to market as both the sales and a service organization. Field sales and service expansion remains an important growth lever, and we still anticipate increasing headcount in the low single digit range for the year absent of change in conditions up or down. We continue to execute well on our gross margin stabilization counter measures, including purchasing and selling initiatives. As a result, gross margin reached the high end of our guidance range for the quarter, and continued to trend of sequential stabilization over the past few quarters in the face of current market conditions. Finally, I want to note the continuing focus on expense control in the quarter. Operating expenses are significantly below the prior year and that reduction is beyond the volume related declines despite ongoing incremental spending on growth initiatives. And this reflects our teams cost on mentality and strong execution in this difficult environment. All of this resulted in earnings per share at the top end of our first quarter guidance. I’ll now turn things over to Rustom.

Thanks, Erik. Good morning everyone. As Erik noted we executed nicely at both the gross margin and operating expense levels so let me jump right into our fiscal first quarter results in greater detail. So sales have already been covered, but just to recap the decline in average daily sales in our fiscal first quarter of 3.3% versus last year was within our minus 2% to minus 4% guidance. With regards to gross margin, we posted 45.1% for the quarter, at the high end of our guidance and virtually the same as in the first quarter last year. Make no mistake, the headwinds from customer mix and the soft pricing environment remained significant but the execution of our gross margin counter measures such as discount optimization, freight initiatives and supplier cost reductions has been strong. And as I mentioned last quarter, supply of cost reductions should also have an increasing impact as we move through fiscal 2016 and you will certainly need them to offset those headwinds. We continued to make steady progress on reducing overall operating expenses. At fiscal 2016 first quarter, OpEx was roughly 7.6 million lower than in the same period last year. However, as you may recall last year’s first quarter included $3.6 million of non-recurring costs so that apples-to-apples improvement was approximately $4 million. This came from headcount related savings, various cost reduction initiatives and lower volume related expenses. These gains were partially offset by higher medical costs, making the savings from our cost down efforts effectively even greater than the $4 million just mentioned. The temporary spike in medical cost is partially due to MSC transitioning from our self insured medical plan to a fully insured private health care exchange which will not only provide our associates with more choices but will also help us better manage and reduce the volatility of healthcare costs over the long run. Finally, the Q1 tax provision came in at 38.2% slightly better than our guidance of 38.4% and this was mostly due to the favourable closing of the state income tax audits. Our EPS for the quarter was therefore $0.89 at the high end of our guidance range due to continued expense reductions and gross margin stabilization. The $0.89 compares to an adjusted $0.95 last year as OpEx savings could not fully offset the negative impact of lower sales volumes. Turning to the balance sheet, our DSO was 51 days, up from last year's 49 days in the first quarter, reflecting continued growth in the national accounts. Our inventory turns were down to 3.11 from the prior quarter level of 3.19, though inventories actually declined by roughly $14 million over the three months. As I noted last quarter, these lower turns are a function of the 13 point average turn calculation we use and should begin improving in the second half of this fiscal year. Our free cash flow which is the cash flow from operations less capital expenditures was $107 million in the first quarter, so this compared to $44 million for the same quarter last year and reflects improvements in working capital. Please note that while cash generation was quite strong in Q1, some of this such as cash taxes paid is timing related and free cash flow in our fiscal second quarter is expected to be just slightly positive. Nevertheless, for fiscal 2016 we expect free cash flow to be in excess of last year’s $198 million. Capital expenditures were approximately $16 million for the quarter versus $13 million in last year’s Q1 and full year 2016 CapEx expectations remained in the $60 million to $70 million range. With regard to other uses of cash, we paid $1.70 [ph] million of our revolver net of borrowings, paid our approximately $26 million in dividends and bought back roughly 97,000 shares in the first quarter for about $6 million. So we ended the first quarter with $38 million in cash and cash equivalents and $354 million in debt, mostly comprised of $206 million on our term loan and $118 million balance on our revolving credit facility and a leverage ratio of just 0.71 times. Now, to our guidance for the second fiscal quarter of 2016, and please note that our visibility is very limited in the current environment. Normally this is our most difficult quarter to forecast in any case coming so soon after the holidays and it’s been compounded this time by the challenging environments. With that said, we expect second quarter revenues to decline on an ADS basis by roughly 2% to 4% versus the prior year period, while December’s sales decline was only 1.5%. This included the favourable impact of the holidays falling on Friday this year as opposed to last year when they fell on a Thursday. So including this favourable impact, we are projecting something similar for January and February. In the second quarter we expect the gross margin of 44.9% plus or minus 20 basis points and that’s flat to down -- slightly down sequentially and down versus the same quarter a year ago. Our gross margin will be impacted by headwinds and tailwinds that will roughly neutralize each other. The headwinds will be the impact of the soft pricing environment including high competitive intensity particularly from local distributors, customer mix and lower supplier rebates. The tail wind will be the benefit from our gross margin stabilization initiatives including buying and discounting improvements, along with longer term strategic program such as growth in private brands. We expect fiscal Q2 operating expenses at roughly the same level as our first quarter. Our expense controls remain strong and however the second quarter will include the seasonal increases in payroll related expenses due to the calendar year reset, continued spending on growth initiatives, and the need to remain ready for a seasonal Q3 volume growth which we typically see. As such, in the second quarter, we expect an operating margin of about 11.6% at the midpoint of guidance. As many of you know, our fiscal second quarter is nearly always the one with the lowest operating margin and we expect 2016 to be no different. Clearly our annual framework implies the second half improvements in operating margin. However, this is not because we are assuming an improved environment, rather it reflects the following. First, sales comparisons get easier as we reach March and move through the back half of our fiscal year. Second, absolute sales should increase sequentially from fiscal Q2 onwards simply due to the number of effective sales days providing increased leverage, third, we expect the execution of our various cost down measures to only add to the leverage opportunity in the back half of the year. We’ve also received a number of questions on the impact of the 63rd week on our fiscal 2016 operating margin framework, so let me clarify. The framework in the accompanying presentation is based on a novel 52 week year, but we will also benefit from the 53rd week this year. This should add roughly 15 to 20 basis points to our fiscal 2016 operating margin in each quadrant of the framework with the full benefit coming in the fourth quarter ofcourse. Finally, completing our fiscal second quarter guidance, we expect EPS in the range of $0.76 to $0.80 and hope that this assumes the tax rate of 38.4%. I’ll now turn back to Erik.

Thanks, Rustom. Before we open up the lines to your questions, I’ll make some closing comments. I’m pleased with our execution during the start of our fiscal 2016 in the face of an extremely challenging environment. We’ve started the year as expected and remain in line with our annual operating margin framework. Looking beyond 2016, I remain confident about our business and its future. Economic slowdowns are the times when MSC makes its greater strides. These are the times when the local and regional distributors that make up 70% of our market suffer disproportionately. History tells us what will happen to local distributors if this downturn prolongs. Reducing their inventory leaves customer service vulnerable. Clamping down on receivables disrupts long standing customer relationships. Laying off people creates hiring opportunities to acquire industry talent not typically available. We are just starting to see the very early signs of these things occur in the market place. The pace will accelerate the longer these conditions hold. We are pleased with our share gain performance to date and would anticipate it to continue or even accelerate the longer these conditions last. And that will lead to disproportionate top line growth when the environment does improve. We are also using this time to improve our cost structure through productivity initiative and tight expense management, and that should create significant earnings leverage when revenue growth returns. 2016 marks an important milestone for us. It represents MSCs 75 year anniversary. I’d like to congratulate our MSC associates for this achievement and thank them for their hard work during our first quarter. I have great confidence that they will do the same in the coming months and years. And we’ll now open up the lines for questions.

Thank you sir. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Matt Duncan of Stephens, Inc. Please go ahead.

Good morning, guys.

Hey, Matt good morning.

Matt.

Nice job in a tough environment this quarter.

Thank you.

So the first question I have got is just on the sales trend. You know not surprised that things got worse as the quarter progressed given what we’re seeing from the economic data points just end markets are getting tougher. Was a little surprised by how much things got better in terms of that decline in December versus November and Rustom, you pointed out that there is a little bit of a holiday benefit there, but is there anything else going on because it was 4.4 points better in terms of the sales decline in December versus November given what -- metal had to say any of the extended holiday shutdown for a lot of manufacturers were planning, I think that’s a little bit of a surprisingly decent data points. So is there something you guys did to help the sales there in December is there anything you’d call out Erik?

Matt, so I would say -- what I’d say is sort of two -- I’d pars [ph] out two parts to the question. Part one, what’s happening in the environment, part two being our execution and what’s happening with our growth rate. With respect to environment, look, I think it’s difficult. It’s pretty much I have described as a very challenging environment but now both on the demand side and on the pricing side and really no surprises, I’d say visibility is quite low right now so tough to identify a catalyst at this moment although with low visibility who knows. So that’s on the environment side. With respect to our growth rates and performance I think as we look at it, we don’t make too much of the month to month movement we are looking over broader tranches of time quarter by quarter and what we’re seeing is in a deteriorating lousy environment pretty stable performance that we feel quite good about. I would note that December and Rustom mentioned the holiday impact, so just to give a little more color there and explain what was going on. The holidays this year both Christmas and New Year, and remember New Years actually falls within our fiscal December. So both of those holidays fell on a Friday, last year on Thursday and the difference being when the holidays fall on a Thursday effectively, that Friday for us count as a business day, but you could image a lot of businesses take long weekends. So, net-net what we saw in December was similar level I would say of shutdown activities prior years that along with the benefit of the holidays being on Friday counted for roughly 250 basis points or so we have to peg it of benefit in December, but net-net I think for us big picture in terms of outperformance. We feel really good about it and really good about our share gain performance in a lousy environment.

Okay, very helpful. And then last question from me just Rustom you’ve been there about six months now, as you’ve looked at the business and you’ve tried to identify cost savings opportunities, are you to a point where you can quantify how much more expense you think you can take out of the business to drive better profitability?

Matt, six months, you’re right. Look, it’s an ongoing process. I mean, we’ve been taking cost sale as across of all range of areas, I mean, headcount, freight initiatives, minimization of discretionary expenses, stuff like that. So, that will continue. I mean, we’ll continue doing that, and it’s been done bottoms up through the organization with everyone focusing on productivity. So won’t quantify but certainly we’re using all that, and that’s spark the reason why we are guiding to be able to hold operating expenses flat right in Q2.

Sure. Okay. Thank you.

Yes. Matt, just to chime for a second, give Rustom a little bit of props here, because to Rustom we did start some of these costs moves before he came on board of the organization, but I will say that since he’s joined I think the pace has accelerated and he and finance team are bringing very strong leadership to the organization and this is going to be an iterative process that he’s introduced of increasing discipline, increasing an intensity and focus on execution and taking cost out, one cost center at time at a very as he said grassroots level, so I think the momentum will only increase over time.

Okay. Thanks. Appreciate the color guys.

And our next question comes from Ryan Merkel of William Blair. Please go ahead.

Thanks. Good morning, everyone.

Hey, Ryan.

Nice job on gross margins and costs.

Thank you.

So, I want to start with price and it’s and I guess a two part question. So first, how would characterize the big box price realization. And then secondly, what is your outlook for sort of price realization for the year?

So, Ryan, as you know with respect price, first of all, our big book price increase we shared last quarter was quite low at 1%. So as you can imagine realization off 1% was going to be low. I would say in general we feel good about how we're doing managing price discounting discipline in a very difficult environment and the evidence there is if you look at our growth decomposition on the offset, what you've seen now for a number of quarters is plus or minus price being essentially flat as a contributor to growth which again I think in what is effectively deflationary environment is a testament to execution and to the strength of the value proposition so we feel good about that result.

Yes. And then price for the year? I mean should we be assuming just flattish is that a fair assumption?

Look, I think what I would do there, Ryan is point you more to how we're looking at gross margin. I think price is one piece of the gross margin formula and I think holding price plus or minus flat is what's allowing us to achieve the sequential stabilization, so our Q2 guidance on the margin side is more or less continued the trend of sequential stabilization. If we were to look around the corner we see something similar in Q3 and then as we move to Q4 we have seasonal factors that usually come into play that will take gross margin down in Q4, but overall I think we feel pretty good and all of that by the way is baked into the framework in each quadrant that we provided, so, in the current environment, more or less more of the same absent change in conditions.

Right. Okay. And then I guess just maybe a bit of end market color. Manufacturing customers down about 5% which I think is a pretty good in this environment. I think its evidence of share gains as you said. Can you just list a couple of the end markets that are doing more poorly versus some that are doing a little bit better, I think that would be helpful?

Yes, Ryan, I guess I can add color. It's probably going to be no great surprise relative to what you've heard and seen from others. I think the overwhelming majority of segments are down and down and have deteriorated over the past few months. There’s pockets like commercial, aerospace that have been reasonably strong. There's pockets of automotive that have been reasonably strong and again, probably no surprise to you. The other color I would offer is as it relates to size of Company you've heard us talk about large account even in a negative environment still growing albeit in low single digit range so larger companies seem to be faring better than smaller companies and again I think no great surprise there.

Right. Okay. Thank you very much.

And our next question comes from Sam Darkatsh of Raymond James. Please go ahead.

Good morning, Erik, John, Happy New Year to you.

Happy New Year to you too.

Couple of questions. First off, a follow up on the pricing question, and at the risk of – I don’t mean to imply that this is a zero sum game, but clearly your pricing over the last three quarters has been flat to up mildly and Granger in the U.S. has been showing pricing down 1% or 2%. In the SKUs that you overlap Granger, are you seeing pricing down 1% or 2% and therefore the difference might be the metalworking breadth and depths and the value prop that you give, or is it something else entirely? Just trying to get a sense of why you’re seeing different pricing than let’s Granger might?

Sam, so good question. Tough for me to compare, that’s a tough one for me to answer. I’m not sure is it relates to Granger. To be honest we are really focused on how we’re executing in a tough market and while we certainly pay attention to the competitive landscape much more focus is given to how we’re executing for customers. What I would say, I wouldn’t make too much of pricing, you’re right, its slightly positive, I think net-net as we looked over the past several quarters the trends has been flattish, plus or minus and we feel like that’s a really good result. I think there’s a couple – I think there’s two things going on. I think one is execution and one is value proposition. I think execution we’ve been talking about counter measures on the buying and selling side and certainly on the selling side that’s been maintaining discipline. Its very easy to in a soft environment when customers are shopping, give price away and we’re being careful to maintain discipline in this tough environment. So that’s the execution side of things. As it relates to value proposition, look, I think one of the things that we’ve been talking about is, really paying attention and being mindful about our portfolio of business that we want to be in businesses that have a lot of value add and where we think we bring lots of equation beyond price. So metalworking, you bring up metalworking as a good example where our specialists are bringing cost savings on the plant floor outside of the price of the product. So I would say I think those are the two reasons behind what I think it’s been good execution in a really tough pricing market.

Two more quick questions if I might. The vending growth contribution two, three quarters or so might have been four points; it went to two points last quarter, now its 50 basis points. That might suggest that the vending initiative is approaching or is at maturation. Is that an unfair characterization?

Yes. Sam, it is. I think the bigger there is the water level coming down on everything, so the 50 basis points is now relative to a minus three. The 400 basis points was relative to like plus seven, plus eight. Effectively what we’re seeing is because the slowdown is occurring virtually everywhere, remember what that represents is sales of the customers with vending machines, those businesses are being affected just like every other. So from our standpoint the fact that those businesses that we’re still showing growth in businesses that are coming way down is a good sign. I don’t think we’ve reach at all that that indicates reaching the end of the line of vending.

Last question, CCSG, what was the drag of that CCSG provided on overall sales comparisons and is that drag moderating, expanding, if you could help us with that? Thank you.

Sure. So CCSG, I would say – we say CCSG and metalworking both being below company average. Honestly, both in the similar ranges. Certainly, I’d like to see CCSG growing fast, so I’d like to see metalworking growing fast, so I’d like see the business growing faster. I think the overwhelming headline there is they are being impacted by the macro like everybody else. Execution at CCSG remains focused on the three levers that we talked about which are service improvements, core customer service improvement which are going quite well, cross-selling which is really picking up traction and then sales force retooling and transformation, which I would say, remains the work in process., have a lot of confidence in the team and the plan there.

Thank you, gentlemen.

Thank you.

And our next question comes from Adam Uhlman of Cleveland Research. Please go ahead.

Hi, guys.

Good morning, Adam.

Happy New Year and congrats on the numbers in a tough environment.

Thank you, Adam.

I wanted to dig more into the market share capture because that’s a point that I agree with you on, but the average order sizes were kind of flattish and customer count was flat or down a little bit from last quarter. We’ve talked about this a little bit, but maybe could you flush out some other metrics that you used, track your penetration with customers. Could you talk about maybe like are you seeing growth in the ship to locations versus maybe just overall customer count or maybe you can talk about productivity with the new SKUs that you’ve added to the book? Maybe just help us, put to more flesh around that aspect?

Yes, sure Adam. Let me start, when we look at share gains we begin with the bottom line, so we look top down to evaluate overall company performance and then in a very granular way we look bottom up at a ton of different metrics. The bottom line for us when we look top down is how does the company’s growth rate compared to industry, and as you know we triangulate and by the way your work is an excellent piece of work along with some others on distributor surveys, we triangulate data including your surveys, including supplier feedback, including macro indices, peer comparisons to get out what we believe market is growing at and assess our growth relative to market. At the end of the day that is the bottom line and that’s what we can’t out run. Our assessment is that our gain performance remains quite strong as measured along that dimension. I think what you’re then getting at is, hey, where is it coming from? Where is it coming from? There is two things I’m going to cite. One is program execution and that program execution is both directed at shared wallet penetration and new account acquisition. And the other is the strength of the wallet going back to the strength of the value proposition and the customer service particularly what we find in times like this. When times are tough and customers really need to lien out their operation, they need to rely more heavily on supplier partners whether that’s helping them in the plant, whether that’s getting them product quickly. So we see the MSC advantage really being widened when times get difficult, so I think that’s part of the story. The other part of the story is program execution, again directed at share of wallet penetration and account acquisition. I’ll touch on one of the thing you mentioned, piggybacking on the account acquisition piece and that’s customer count. Not surprising to us here, it’s a metric that we’ve said for awhile, not top of mind for us, its really been sort of left over, its more of a Direct Marketing metric, not surprising to us that would flatten now. If you look back at other periods of economic difficulty that number tends to in and flow with the economy, in fact in the last downturn [ph] it was significantly, its now flat, so not particularly surprising results to us.

Okay. Got you. And then Rustom, you’d mentioned when you’re going through the margin drivers for the quarter, the discount management, the freight, supplier cost reduction, I was wondering if you could maybe quantify the savings that you’re getting from each of those buckets or rank them out or help us better understand the drivers there? Thanks.

No. I couldn’t and I mean, for obvious competitive reasons and the fact that we work with our suppliers and just to compare the reasons, I couldn’t. But those are the main drivers and they are just the drivers, Adam, that we keep working on.

Okay, great. Thank you.

And our next question comes from Robert McCarthy of Stifel. Please go ahead.

Good morning, everyone. Congratulations on some nice execution this quarter.

Hey, Rob.

Thanks, Rob.

I guess a couple of questions, one, not to drill down on December again, but I understand the comparison and you kind of highlighted the 230 basis points, but could you comment on what you’re seeing maybe with respect to your energy phasing or derivative markets and association with energy. Whether you saw any signs from a comparison standpoint or any kind of stabilization there vis-à-vis December or recent trends that may explain some of this – I don’t want to say stabilization, but this better performance in the months?

Yes, Rob, so let me start with two things there. I’ll start with energy and then get to the December number. But on the energy front really no change and just a reminder, our direct exposure to energy is really low, meaning, well under 5%. The indirect exposure is I think what’s taken everybody by surprise not only in MSC but in the broader economy. And it’s ugly. I mean, this is a way to say and I think in the past we’ve shared that when we look at our manufacturing end markets, as there what would be traditional saw that metalworking markets in areas that are energy exposed, i.e. Texas, Oklahoma et cetera. The results are really, really poor and not surprisingly. So, no sign of life there, I would not read anything into that. With respect to December as I’ve said, I mean, the holiday impact call it roughly 250 basis points, when we look months to months there can be noise in the growth rate, we’re really focused on what’s happening on an average daily sales level in absolute dollars and what we’re seeing there over the past couple of quarters going into our Q2 guide is effectively average daily sales stabilization and I think that’s really where we’re focus because the growth rate is strictly a function of how it lines up to comparisons prior year. And again I think we feel pretty good, I mean, what we’ve seen average daily sales stabilization in the phase of a deteriorating environment.

Now, clearly, I mean, you look at the counter metal preannouncement, coupled with kind of the whole investor tenor around shutdowns for year end December, expectation are zero, so it’s a pretty surprising result. Obviously I think you’ve guided to something a little more conservative, we wouldn’t want to extrapolate from that data point, but turning to the comparison kind of I think you cited that comparison gets significantly better in the kind of the March timeframe. Do you have some sense whether you could return to positive growth in the back half of the year or is that possible given how the compares layout? How do you think about how back half can play out from the topline perspective?

Well, if you just continue to assume that we have sales per day running at more or less the same level as we’re running today, and we don’t have the visibility to be able to tell you any different to that, right?

Yes.

But if project at that, I mean, the back half of the year would be close to breakeven, varies slightly, maybe call it, you can do the math yourself, but close to breakeven.

Right. I prefer you to do the math Rustom, but I appreciate that. And then, the final point or question I guess, is just looking – is there an opportunity here to maybe do more kind of larger cost take out or restructuring across metalworking or CCSG or whatever case maybe, just given the prevailing environment? Is there a potential plan be here to just say you know what, this maybe a real opportunity to take a lot of cost take out or really rethink kind of the cost structure of the business. How do you think about wrestling with that?

Well, I guess, first of all, I mean, we are sort of – we prefer the approach of working through very bottoms up, very collectively with the team and trying to see how we can improve productivity and doing it without sort of trying to take costs out purely reactively to market conditions, right? I mean, that’s one of the reasons why MSC bounce back so strongly from 2008, 2009 as well. So right now we’re not really seeing the environments where we need to do that. If things gets much worse than obviously we’ll respond accordingly, accelerate cost actions that we’ve taken and do stuff, but as of now, no I think we continue to solve this in a very way, focus and execute and let the team sort of runaway with it.

Anything to add there, Erik.

No, I think, Rob, I think Rustom is really leading us through the approach to expense management and productivity in a very effective way and it’s not going to be about a big bang and a massive transformation. The transformation is happening one cost center at a time. We’re just doing thing smarter. One productivity initiative at a time, and I think its working. I will tell you I think there is still a lot of runaway, that’s the exciting part, it just not going to be in a big bang. The only other thing I’ll add to Rustom’s first comment and your question on the back half of the year end. Look, we are squarely, one think I want to reiterate. We are squarely in that lower left quadrant. So that the demand quadrant that we called slightly negative, but I think we said, it was zero to minus four, I mean, right now what everything we see and grant that our visibility is extremely low, but we would characterize it as right smack in that quadrant.

Thanks for your time, guys.

And our next question comes from David Manthey of Robert W. Baird. Please go ahead.

Thank you. Happy New Year, guys.

You too, David.

First, I guess, I have to ask the requisite December question. Would you characterize the impact of the mild weather across the entire U.S. as either a positive or negative? And then second, lot of the questions have referenced the year-end shutdowns, the holiday shutdowns, what do you see from your customer base specifically as it relates to those shutdowns?

Yes, Dave, good question. Nothing majored report on weather that would have been a factor either way. We didn’t set anything big there. With respect to shutdown activity, we would characterize the shutdown activity as relatively similar to last year. So, if you take a similar level of shutdown activity combined with the benefit of the Thursday versus the Friday holiday effect, we think that’s what helped us in those last couple of weeks. And I’ll attempt to hard to pars out the shutdown activity from the Thursday, Friday phenomenon because again going back to the analogy when the holiday fall on Thursday its unlikely that a business is going to come back up for that Friday, so effectively losing a selling day twice, one for Christmas, one for New Year. So, hard to pars those out, but I would call it similar to last year.

Okay. And clearly some of your customer carry some amount of safety stock and the product that you sell them, do you any comments either anecdotal or statistics that will help you and us understand where we are in the inventory destocking cycle?

Yes. I wish I had something quantitative, it’s a tough one to get precise on Dave, what I would tell you is certainly like what MSC is doing, once you see inventory levels have come down, our customers are doing the same thing. However I would say I want to draw your attention to what we see as the bigger headline which is the results we saw and others have seen in terms of the macro for the back half in the last few months. The primary driver there is a reduction in incoming orders in demand in backlogs, not in destocking and I think that’s a bigger headline.

Okay. And then, somewhat related to that and final question, your sales historically have somewhat track the ISM, PMI was maybe a two or three months lag. And do you look at that relationship differently today or the reason I ask is it seems that the ISM has fallen since mid-year, last year and your average daily sales growth and your guidance is basically the same in the second quarter what you saw on the first at the midpoint. So, I’m just wondering if you could square those two things or are you thinking about that relationship differently?

Dave, I think the honest answer is, we’re thinking about the relationship differently. I think if you go back and you probably you have seen the same thing with other distributors, but the correlation or historically the correlation with PMI was quite tight and over the past couple of years I think not just for us but for peers it’s not been nearly as tight. So, we certainly look at it, but we look at a bunch of other factors as well in forming judgments. We introduced for awhile now the MVI, which seems to have a tighter correlation. So again, we’ll look at PMI but not with same degree. I don’t think it has the degree of predictive correlation at it did years ago.

All right. Thanks a lot, Erik.

And our next question comes from Ryan Cieslak of KeyBanc Capital Markets. Please go ahead.

Hey, guys, good morning and Happy New Year.

Hey, Ryan, Happy New Year to you.

Lot of my questions has been answered, but I just wanted to ask the share gain question one more time in a different way. And Erik, is there way of thinking about maybe where you’re seeing the greatest share gains right now from the segment or your business where it’s a core metalworking business or vending or CCSG. Is there one area that you think you maybe garnering greater share gains and other or you pretty much across the board?

Yes. Ryan, I think what we try to do is highlight for you and there is sort of three dimensions by which we look at the business by customer type, by product type and by channel, the highlight for you where what we think is driving. And I think we’re doing well in the lot of areas, but certainly what we’ll do during the prepared remarks is highlight where we think we’re doing particular well. So, by customer type we’ve been calling out the large accounts as an areas that’s done particularly and that’s not just national accounts but we think that its an area where technology is allowing for supplier consolidation to happen at our customers in an accelerated pace and we think we’re benefiting quite nicely from that. Along the product dimension, look, we’ve talked about metalworking, it’s the key area focus, it’s an area where leadership where we feel like we’re doing quite well, we’ve talked about the Class C areas and area focus. And then along with channel dimension you know these two that we’ve highlighted that we think we’re doing quite well vending and eCommerce, so those are the ones that we call most attention to.

Okay. Fair enough. And then on the – you been taking about the gross margin counter measures particularly some benefits you guys are getting with your suppliers in terms of how your buying right now. Just you can maybe give some more granularity on the cadence of that benefit as we go into the other quarters. Is it something you see or you expect really pickup in the back half or do you see a gradual incremental benefit quarter by quarter?

I’ll take that. I do see – we do see that gradually beginning to accelerate as we go on. And that’s we’ve been working with our suppliers and the suppliers who see us as the value-add driver of growth, brand building platform, they are investing in us and obviously we’re focusing more on them. And we kicked off lot of work on this back in November and with the second round pretty much rolling out now. And so, we’ve seen some of these benefits come in as we go into the back half of the year. And then some of them will actually flow into F 2017.

Okay. And then Rustom is there a percentage or way you thinking about, are you working with a target – a certain percentage of your supplier base or is it sort of a broader initiative with all your suppliers that you’re really looking to target?

Broader, we started with our key strategic suppliers and clearly and focus on that, but definitely broader, its working across the whole base.

Okay.

Ryan, the one comment I’ll add on the supplier front is this is been ongoing, it’s not a one and done, its ongoing discussions, its ongoing actions and look, to some degree it has to be a win-win situation. So it’s not just a matter of us going back and beating the supplier over and saying, give us more money. That’s not going to be sustainable and in long term not good for both sides. So it’s been about dialogue certainly with strategic suppliers as Rustom said, going broader, but also about not just what the suppliers going to do for us, but what can we do for them to make it work their investment in us.

Okay, great. And then, just a housekeeping question. Rustom, if I heard you right, you said that there was some higher metal core cost in the quarter and I think you said, part of it more were temporary. I just wanted to make sure that was a case. And is there a one time in nature sort of headwind that was in the core that rolls off going forward or how should we been thinking about medical core cost going forward?

Sure, absolutely. But you know, we’ve been self insured through the end of calendar 2015, and so we’ve always had variability in our quarterly medical cost, right. And this year’s Q1, which for us end of the end of November, remember, so it’s been compounded by the introduction. The Q1 peak that we haven’t seen was compounded by the introduction of our private health exchange. So then probably see based on what we’ve seen anyway so far we have some reasonably high medical cost so far coming through December, right. But going into Q3 and Q4 then you’ll start to see the benefits of a steadier sort of run rates of medical costs and certainly a lower run rate than what we’ve had in Q1.

Is there a way of quantifying you know what type of headwind that was in the quarter?

I mean in this particular quarter, I mean medical costs were almost 4 million higher sequentially compared to the quarter before. But like I said, I mean you don’t really take away too much from that because they do vary quite a bit, they bounce around quite a bit.

Got you, okay fair enough. Good quarter guys.

Thank you, Ryan.

And our next question comes from Charles Redding of BB&T. Please go ahead.

Hi good morning gentlemen. Thanks for taking my question.

Hi, Charles.

Hi. Just wondering if we could chill down a little bit on government national accounts, you mentioned the low single digit growth expectations here and certainly the benefits from technology, but where else do you see strength here and maybe how do you prioritize large accounts here over the coming quarters?

Charles, really it’s been an area of focus and remains an area of focus and I think it’s been -- I think what you are seeing is slight positive. It’s again going back to the two drivers of performance right now in terms of execution and the strength of the value proposition and I think both are at play with respect to national accounts and with respect to government. So I mean, both of those segments have been pretty soft so we feel good about positive results as being indicative of strong share gains and I think that’s been an ongoing area of focus and it will remain an ongoing area of focus.

Okay, great thanks. Maybe how do we think about the opportunity for M&A in the current environment? I guess we are coming up on three years here post Barnes and can you give us any color on changes in the market and maybe how you think about current consolidation in the industry just given the ongoing headline pressures?

Yeah sure Charles. I would say despite the significant changes in environment not a significant change in our approach here and what we are seeing and how we are thinking about M&A, which is where we certainly keep our ears and eyes wide open have not seen a radical change in activity levels and you know certainly M&A part of the equation and as I’ve said in the last couple of quarters and I would reiterate is you know at the moment certainly we are open to it, but the bar is a bit higher than it normally is just given everything going on inside the company and outside of the company and quite honestly the nice traction that I think we are seeing on the topline and gross margin and on expense controls I feel like the company is executing well and so to divert attention to an acquisition we would do it for the right acquisition but the bar is just a bit higher.

We certainly, we certainly have the capacity to make acquisitions as well, because remember that under our debt covenants we can go upto 3x if you would and we are at 0.71

Excellent. Thanks again.

Thank you Charles.

And our last questioner for today is John Inch of Deutsche Bank. Please go ahead.

Thank you. Good morning everyone.

Hi, John.

Hey, Rustom. So if just hypothetically if we were to loose two days Christmas and New Year right on the 23 day month that’s about 89% is the 89% a benefit right if you don’t loose them, is the reason it’s only 2.5 because they were into slower days of the months anyway or you still get some business so you can kind of cut it in half or just trying to understand the 2.5, is that -- have an extra day or something is it always sort of 1.25, is that the way to think about it?

John you got it. It’s just that it’s a partial day. It’s not that it’s you know there is some business coming in, but it’s another day. So that’s it, it sets us apart, it’s not, those days are not the equivalent of a full day.

Okay. So then to get it down three for the quarter, I think you have to go from your down one and a half, you have to go down four the next two months. So that almost implies right that if you are down to 2.5 to the 1.5 that’s 4, are you assuming then Erik that January, February are also down 4 to get to the down 3, is that in other words it’s simply a continuation of the run rate of the apples-to-apples down 4, does that make sense?

Yes, it does. And I think that’s when I look and I couch it by saying as Rustom said our visibility right now is extremely low. This is always a tough quarter for us John because we come off of the holidays and really don’t have any peak into how things bounce back. It’s compounded the low visibility this year by the environment. But yeah, I mean essentially you are right. If you do the math you’re right it averages about 4% down January, February and our assumption is more or less a continuation of what we are seeing in the environment.

Okay, Federal Government was, well at least generally government was source of strength right? Now government fiscal year ended in September in your quarter. Did you see any kind of an anomaly around that time Erik and Rustom that you'd call out maybe some sort of a buy in advance or buy after the September period because you did call out that the growth rate had de accelerated which I guess is natural because it had been so strong. I'm just wondering if there's any other anomaly associated with the year-end fiscal that might have accounted for some of that?

John, good catch on government. Not so much an anomaly. Generally there’s a seasonal pattern with the government. You're right; their fiscal year ends in September. So as you can imagine there's a lot of spending leading up through September and then a big drop off as people spend their final budget dollars. That happens every year so no big surprise there. We've been really pleased with the performance in government. I think that has been a very strong growth for us. You were right to note that the growth slowed down. The big factor there and it wasn't so much ADS, it was more a function of the ongoing lack of budget resolution within the Federal Government that did not get resolved until late December and most certainly had an impact on spending environment in government. We did see a change there. We're hopeful with resolution and hopefully that bodes well for the back half of the year but like everything else visibility is low and to be seen but that was the big driver.

That makes sense. Just lastly, so you called out Erik you added 70,000 SKUs to the online catalog so you're at a million one. I guess, I've got a two-part question. Did that materially impact growth in the quarter, the 70 on the million before that you saw like is there an initial fill or something like that and then the second part is like where do you think the 1.1 can go to, because in theory right that could be a good buffer or stabilizer to a tough market if you can just keep adding these SKUs to broaden your product line and then maybe take a little bit of market share.

Yes John, I think -- let me take your questions in reverse order. Look, I do think there is still some runway there left and we've been adding them at 100,000, 150,000 clip to the last few years. We do still see runway there, and I do think it’s been a piece of the market share story has been capture of new products. No question. To answer your question, the 70,000 would not have a material impact on the results to date. Think of these in waves that kind of hit the beach, so the impact actually happens cumulatively over a couple of years but the 70,000 would not yet have a material impact on the current results.

So in other words, potentially a benefit in fiscal 2017. I mean, let’s say you add another 50% SKUs, at some point do you have to add another warehouse because there’s sort of no freeze lunch you just can't keep adding SKUs without having to stock them because your advantages actually being able to stock product when mom and pop can’t in a downturn? Do you know what I mean?

At some point I hope so because it means we’ve grown so much but we’ve talked about on the warehouse side is that what we see right now Columbus should take us to 4 billion assuming the next billion looks like the first three and that’s factoring in on what we’re doing on the SKU front. The other thing I'll call out that we talked about is we are trying to be smart about these that they get added to the web. They don’t immediately get added to stock until we see them trip certain thresholds, so we’re trying to be sort of inventory and capital wise about how we do it.

Got it. Thanks much, appreciate it.

Thank you, John.

And this concludes our question and answer session. I’d like to turn the conference back over to Mr. Chironna for any closing remarks.

Okay. Thank you everyone for joining us today. Our next earnings date is going to be April 6, and we certainly look forward to speaking with you over the coming months. Take care.

Thank you sir. Today’s conference has now concluded. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.