MSC Industrial Direct Co., Inc. (MSM) Q2 2016 Earnings Report, Transcript and Summary

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

Thank you, Keith, and good morning, everyone. I'd like to welcome you to our fiscal 2016 second quarter conference call. 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 plans. 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 of 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 everyone and thank you for joining us today. I’ll begin by covering the macro environment, which remains quite challenging, but is showing some signs of potential stabilization in the months to come. I’ll then turn to our performance, which I continue to be pleased with in light of the difficult conditions. Rustom will then provide additional detail on our financial results and share our third quarter 2016 guidance. I’ll conclude with some comments on our expectations for the year and reinforce the opportunities that we see going forward. We’ll then open up the call for questions. So, I’ll begin with market conditions and our performance against the challenging backdrop. As expected, the environment remained difficult and the root causes have not changed. Sustained low oil prices and the strong U.S. dollar with its negative impact on export demand continued to be a drag on manufacturing activity. While macro indicators have improved since our last call, they still reflect a significant slowdown in manufacturing with US factory activity continuing to contract. The two sentiment indicators, ISM and MBI, both halted their downward trends in January and improved slightly in February. March then showed further improvement in each to 51.8 and 49.7 respectively. The manufacturing economy has however contracted significantly versus the same period last year as supported by the 12-month rolling average MBI reading of 45.6. So demand remains quite weak. But there is a sense that the industrial economy may be stabilizing albeit at low levels. This can be seen in the March MBI reading, which if sustained would indicate a leveling in metal working in the months and quarters to come. Also, we just completed a survey of our customers and the prevailing sentiment is that business will at least stay the same and possibly improve in the months ahead. We would certainly like to see a bit more time pass before forming our own conclusions. However, should the uptick in the MBI sustain and confirm what we are hearing from our customers, this would bode well for future quarters. As a reminder, we historically see roughly a four-month lag between movements in sentiment indices and our growth rates. With respect to the pricing environment, conditions remained extremely soft due primarily to the lack of commodities inflation and a high degree of competitive intensity that comes with a prolonged downturn. As expected supplier price increases were minimal and we did not implement a mid-year price adjustment. Let me now turn to our performance for the quarter. It’s highlighted by the same three things that I noted last quarter. First, continued share gains as indicated by growth rates above the markets we serve. Second, sustained gross margin stabilization from solid execution on the buy and sell side. And third, continued strong expense controls and realization of the benefits from our productivity initiatives. Let me start with revenues where the quarter played out essentially as expected. On an average daily sales basis, our net sales for the quarter were in line with our guidance and down 3.2% from last year. Growth rates by customer types remained low 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 customers lagged the company average reflecting the acute softness in metal working end markets. CCSG, on the other hand showed sequential improvement in its growth rate and were slightly ahead of the company average. Net net, when all of this is combined, customer mix remained the gross margin headwind. Despite our negative growth rates, macro indices, surveys and supplier feedback indicate that our share gains continued in the face of difficult conditions, particularly in the metal working sector. This is a function of delivering excellent service in a difficult environment. Availability of product continues to be paramount to our customers, which is why our broad offering and next day availability is a competitive advantage during these times. Customers continued leveraging our vending and eCommerce technology platforms. eCommerce reached 57.8% of sales for the second quarter, up from 57% last quarter and 55.4% a year ago. Sales to vending customers contributed roughly 20 basis points to our growth rate. We added approximately 5,000 SKUs net of removals to our web offering during the quarter, which although lower than in recent quarters, maintains our momentum and we are on track to add roughly 150,000 for the fiscal year. Regarding our field sales and service personnel, net head count for the quarter was down slightly. The base MSC field sales and service team was more or less flat for the quarter. CCSG field sales and service head count accounts for virtually all of the drop. We are pleased with the success of our CCSG sales effectiveness efforts that are allowing us to design more efficient sales portfolios and call reps. As a result, we reduced field sales and service headcount through attrition. As you may recall, we have been focused on three growth levers for the CCSG business, and those are service enhancements, cross-selling and salesforce improvements. As noted before, though we have seen significant progress on the first two, but have said that the salesforce remained a work in process, so it’s good to see our progress here begin to accelerate. Looking forward, we expect total sales and service headcount to be up a bit from Q2 levels for our third and fourth quarters sequentially and flat to perhaps slightly down for fiscal 2016 as compared to prior year. This reflects increases in MSC sales and service headcount along with some further attrition on the CCSG side as the sales effectiveness program builds momentum. Looking beyond fiscal 2016, field sales and service expansion remains an important growth driver for the company. We continue to execute well on our gross margin stabilization counter measures, including both purchasing and selling initiatives. As a result, gross margin once again reached the high-end of our guidance range for the quarter, and continued the trend of sequential stabilization seen over the past several quarters. Finally, I want to note the continuing focus on expense control. Operating expenses for the quarter were significantly below the prior year and that reduction is well beyond volume-related declines despite ongoing spending on growth initiatives. This reflects our team’s cost down mentality and strong execution. All of this resulted in earnings per share at the top-end of our second quarter guidance. I’ll now turn things over to Rustom.

Thanks, Erik. Good morning everyone. Erik covered the drivers of our sales results quite comprehensively, so I will move straight to gross margins and operating expenses. With regards to gross margin, we posted 45.1% for the quarter, at the high-end of our guidance and down about 30 basis points from the second quarter of last year. Considering that we took no mid-year price increases and the headwinds from customer mix continued we owe this good outcome to the execution of our gross margin countermeasures and those are pricing discipline, discount optimization, freight initiatives and supplier cost reductions. As noted on previous calls, the supplier cost reductions should have an increasing impact as we move through the second half of fiscal 2016 and into fiscal 2017. But as I have also said before, we will need all of these countermeasures just to keep gross margins stable if the tough pricing environment persists. With respect to reducing operating expenses, we continued executing well as our fiscal second quarter OpEx is roughly $6.8 million lower than in the same period last year. This came from headcount related savings, various cost reduction initiatives, lower volume related expenses and in general, from a heightened focus on productivity. In addition, the tax provision came in at 38.2%, slightly better than our guidance of 38.4% mostly due to change in the estimates of state tax liabilities. So our diluted EPS for the quarter was $0.80, at the high-end of our guidance and this compares to an adjusted $0.84 last year. Turning to the balance sheet, our DSO was 48 days, flat from last year's second quarter. Our rolling 12-month inventory turns were 3.13, slightly up from the prior quarter’s level of 3.11. We expect turns to continue improving in the second half of the year. Our free cash flow, which is cash flow from operations less capital expenditures was $50 million in the second quarter. This compared to a negative $22 million for the same quarter last year. Our free cash flow was much stronger than we had expected as looking at this assumes [ph] reduced inventories by $28 million. Capital expenditures were $11 million for the quarter versus $12 million in last year’s Q2 and $27 million year-to-date. We continue to expect fiscal 2016 CapEx to be within the $50 [ph] million to $60 million range we have been providing with one potential exception. We are now exploring the purchase of our Atlanta distribution center, the only major CFC that we do not own. To provide some context, the Lasso [ph] which is owned by the Jacobson family, recently notified the company of its intent to sell the site, which they have owned since before our 1995 IPO. The lease provision give MSC the right to buy the facility instead of letting it go to a third-party. As with our other major CFCs, we prefer to own them outright as they are core strategic assets. The purchase price, while not yet agreed upon, will be determined by the appraisal process and we expect the purchase could add around 50% to our fiscal 2016 CapEx if an agreement is reached. Turning again to our strong cash flow in Q2, we paid out approximately $27 million in dividends, bought back roughly 238,000 shares for about $13 million at an average price of just under $0.57 per share and repaid $25 million of debt. We enter the second quarter with $24 million in cash and cash equivalents and $328 million in debt, and that’s mostly comprised of $200 million on our term loan and $99 million balance from our revolving credit facility. So we ended with a leverage ratio of 0.7 times. Now, to our guidance for the third fiscal quarter of 2016. We expect third quarter ADS to decline by roughly 2% to 4% versus the prior year period. March’s sales decline was about 4.8%, so we are assuming roughly 1.7% declines to April and May as a result of lower comparisons, along with an improvement in ADS to $11.4 million, the same level as the past two quarters. March started out quite strongly, but we then saw considerable mid-month softness driven by confluence of factors. In terms of end-markets, the extreme pressure in oil and gas and continued challenges in heavy equipment and machinery. Then we also saw some weakness in aerospace driven by a push out in orders of commercial aircraft and in government, the timing of quarter-end budget crunches. Some customers also used spring break to take time off. Finally, if our own recent inventory actions are indicative of the broader supply chain then there was some potential drawdown as well. Following the slowdown in mid-March, we saw a slight pick up late in the month, all of this netted out to an ADS of $11.2 million for the month. So looking at our guidance range, we would hit the lower end, if April and May only return to the ADS levels of mid-March. However, should our ADS for April and May get back to the higher levels of February and early March, we would expect Q3 to come in at the top-end of our guidance range. In the third quarter, we expect the gross margin of 45%, again plus or minus 20 basis points, which is essentially flat with Q2 and continuing our trend of sequential stability. Gross margin headwinds come from the soft pricing environment including high competitive intensity, particularly from local distributors, customer mix and then also from lower supplier rebates. The tailwinds are the benefits from our gross margin stabilization initiatives, including better buying discount optimization and the others that I covered earlier. We expect fiscal Q3 operating expenses to be just slightly higher than in our second quarter, despite an additional roughly $50 million sequentially in revenues. This demonstrates our team’s focus on strong expense controls as we are offsetting nearly all of the increase in variable expenses and investments with productivity and savings. With stable gross margins and flat operating expenses, we expect strong sequential incremental operating margins. As such, in the third quarter, expect an operating margin of around 13.8% at the midpoint of guidance. This is 20 basis points lower than last year, but that’s despite the 3% decline in ADS. At the high-end of our guidance range, operating margins would be about 14% same as last year. And on an annual basis, we remain in line with our operating margin framework and we continue – we currently anticipate annual operating margins coming in at the high-end of the lower left quadrant. Finally, completing our fiscal third quarter guidance, we expect EPS in the range of $0.98 to $1.02. Note that this assumes a tax rate of about 38.2%. I will now turn back to Erik.

Thank you, Rustom. I’m pleased with our execution during the first half of our fiscal year in the face of the continued challenging environment. We remain in line with our annual operating margin framework. We worked hard over the past several quarters to hold gross margin stable in the face of adverse commodities and pricing conditions. We focused heavily on improving productivity and the cost structure of the business. All the while, we have maintained our focus on taking share and outgrowing the markets in which we operate. Should the industrial economy once again return to a moderate growth and/or a moderate pricing environment, we are positioned for strong earnings growth and operating margin expansion. And even in an environment with no price, and low revenue growth, we still expect to grow earnings and expand operating margins. I’d like to thank our entire team of associates for their hard work and dedication to our mission. The progress that we are making would not be possible without the team’s continued focus. And we will now open up the lines for questions.

Thank you. [Operator Instructions] And the first question comes from Matt Duncan with Stephens, Inc.

Hey, good morning guys.

Hey, Matt, how are you?

Good. Thanks, Erik. So I want to start just by looking at sort of the monthly sales progression. March, it looked like ticked down sequentially, despite a little bit easier comp and I was hoping you might could kind of walk through what happened around mid-month, it sounds like that caused things to slow a little bit? And then taking that a step forward, it sounds like you guys did a customer survey recently that makes you feel like maybe things could tick up a little bit here and I was wondering if you could give us a little bit more detail about what that survey told you?

Yes, sure, and it’s Rustom. Look, I mean we’ve started strongly, okay, quite strongly and the continuation of February actually. And in the middle, I mean it was just the confluence of those factors. I mean, everything the aerospace, the continued or perhaps even notch down in weakness in oil and gas and then as we came towards to the end of the period, it started. We saw a slight pick up again as we went through. And now of course the MBI and the customer surveys which Erik can cover I guess suggest the potential leveling and that should improve ABS going forward, but usually with a lag right, four month lag.

Yeah, Matt, and I will touch on sort of the outlook. And I think Rustom covered the mid-March period that was a bit of a surprise to us pretty well which is when we dug in it was really a series of things from end markets to a little spring break and folks who weren’t busy using a take time off, some potential inventory draw down, a few things hit at once. As we said, we did see things pick back up a bit at the end of the month and essentially that's what’s factored into guidance for April and May. In terms of outlook, yeah, I mean we did do a customer survey and I would say from what we saw more or less consistent with recent MBI movement which I would say less about - to me the outlook is less about any sort of explosive growth. The word I would use is potential for stabilization. So things have been at a low level. We didn’t hear anything that would indicate a dramatic pick up, but we also heard a stabilization as potential beyond the horizon and certainly if that were the case and by the way that’s consistent. If you think about MBI reading of 49.7 for March, if that holds, essentially what that says is month-over-month conditions were flat, more or less, okay. So that would be consistent with the stabilization theme. So, I mean if that were to carry through, I don’t want to leave you with the impression that we're hearing things are going to explode, but certainly from relative to where we've been that would be an improved condition and we would expect improved performance in the quarters to come.

Okay. So basically things are stabilizing, but not improving yet is the way we should read that?

Yeah, I would say the headlines are still very challenging right now, some potential signs on the horizon here that stabilization could be coming.

Okay. So looking forward then, if you were to see the sales growth pick up, I mean you guys seem to have been doing a lot of good things to set yourselves up for pretty meaningful operating margin expansion once things get better. I mean you’ve got I would think a pretty good outlook there. So if you were to see sales growth go to call it the mid-to-high single-digits, over the following twelve months if we were to stay there, what kind of operating margin expansion should we expect out of the business?

Yes, Matt, look, I think what you're hitting on there is to me one of the most exciting parts of the story and what I'd try to close with which is, I look back at the work done over the past year or two and yeah, look on the gross margin line in the face of a no price and arguably deflationary environment, pricing has held stable, gross margins have held stable. So I'm pleased with the work there and then very pleased with the expense, the job on expenses when you look sequentially Q2 to Q3 as a proof point. So if we were to return to some sort of normalized demand environment, you are right, if you look at our historic track record and no reason for me to think it would be anything different, mid-to-high single digits, we would see significant earnings growth and significant margin expansion at those levels. Look, then if you were to make the case for any sort of a pricing, so that’s in a no-price environment, any sort of pricing to return, the picture gets accelerated.

Yeah, so with no pricing, is 100 basis points of operating margin expansion doable at that mid-to-high single-digit revenue growth rate? Is that something that you think you could achieve?

Matt, I am going to hold off - I don't want to – what we will generally do. Look, I don’t want to go out, so we've given you the margin framework for the year, so you could see for this year in 2016, if you go to the upper right quadrant, which would be if memory serves me, a better demand environment, you could see some margin expansion, right, I think 13.7 was the upper right quadrant. That will give you sense for '16. I’m going to hold off on – we will come back with a 2017 outlook that will give you more specifics, but suffice it to say, look, if revenue growth got into the mid-single-digits, mid-to-upper single-digits historic, we would expect some healthy growth op margin expansion.

Okay, great. Thanks, Erik. I will hop back in queue.

Thank you. And the next question comes from Hamzah Mazari with Sterne Agee.

Good morning, guys. Just had a question on pricing. Any sense of how much of the pricing degradation you believe is cyclical versus structural? You mentioned a much more competitive environment with local smaller players, but we all know inflation is weaker. Just trying to get a sense of how you think about that.

Yeah, Hamzah, it’s Erik. I will take that. First of all, welcome back, Hamzah.

Thank you. I appreciate it.

Look, I think the answer to the pricing question, our perspective on this is that it is primarily cyclical. I think we’ve got two things going on. Number one is and it’s the two things I highlighted in the prepared remarks. So first of all, the headline number one is commodities. I mean if you look at what’s happened deflation in commodity, so lack of any inflation in this case deflation has resulted in no ability to take pricing. So that’s in these overwhelming headline number one. I guess it depends on your take. From my standpoint that is cyclical, we’ve got decades and decades of history to say that that ebbs and flows. With respect to competitive intensity, what I would tell you is, the primary driver here is a cyclical factor, not a structural factor and what I mean by that and in my career now which is just about 20 years, I go back and look at periods where there is prolonged softness in the environment and this is very typical of what happens. So what happens is our customers are squeezed competitively and they start ratcheting up focus on price much more than they would in a normalized demand environment. And on top of that you've got local distributors that make up the 70% of the market who are fighting for survival and price is one of the primary weapons that they will use and get very aggressive. So we have seen this. We saw it before in 2009, I’ve seen it earlier in my career. I will grant you that this has been an extended period or prolonged period of slowness. I think it’s been a while, but to me that’s still largely a cyclical phenomenon. Did I leave you speechless Hamzah?

Just had a follow-up question. One of your competitors seems to be moving to a higher service driven model with onsite and vending and then there is another competitor that seems to be moving towards a lower service driven model targeting a small or medium customer. I am just curious whether you see your distribution or go to market strategy evolving over time or being pretty consistent with where you are today?

It’s a very good question. I would say that our go to market approach continues to evolve, so I think the answer is, it’s going to evolve, it has. If you look back at the company 10 years ago and how we went to market versus today, it’s evolved quite a bit and I think if you look 5 to 10 years, it will evolve quite a bit more. I think what we try to do is pursue our own path. And if I looked at our investment approach sort of over the past several years, I think it’s kind of our own unique blend when we look at our investment portfolio as to how we go to market. That’s a balanced approach that it involves heavy touch with sales force expansion, it involves inventory management services where we embed ourselves into customers. It also involves broad product offerings, SKU expansion, e-commerce and marketing. So I think it’s been a healthy balance. And I think for now we continue to see that working as evidenced to us the bottom line is how are we doing in outgrowing the markets in which we serve. We feel good about that. So, yes, I think you could expect it to continue to evolve for now along the dimension of a balanced portfolio.

Good to be working with you guys again. Thank you very much.

Thanks, Hamzah.

Thank you. And the next question comes from Sam Darkatsh with Raymond James.

Erik, Rustom, good morning. How are you?

Good. Hey, Sam.

Hey, Sam.

Couple questions regarding gross margin, if I could. Based on your commentary that for the year your overall margin should now be closer to the higher-end of the lower left quadrant as well as a lot of your gross margin internal initiatives the fact that they ramp going forward, might this mean that in the fourth quarter the typical seasonal pressure on gross margin might be much more limited and we might see flattish gross margin sequentially Q4 over Q3?

Sam, yeah, I will take that. Yes, we are certainly with the supplier initiatives that we have in mind, we are looking at, at this point, somewhat flattish in our projections and that’s what will enable us to ramp operating margin as you alluded to down in that lower end. Look, with gross margins, I mean Erik has made this point and I will make it again, I mean this is a very – it’s tough pricing environment, it’s a long, prolonged tough pricing environment that we are seeing. But then also it goes both ways. So when you’ve got this long, touch sort of environment then it also means that suppliers are not putting up prices, it also means that suppliers are looking to identify distributors with whom they feel they can partner and work together to increase sales. So it goes out on the one hand, it comes in on the other and that’s what the focus in on keeping ourselves around. We’ve said quite often that if we can stay at the 45 range there, if we can do that, then with what we've done in terms of cost cutting and all, then you get the leverage that even Matt asked about earlier.

And, Erik, you mentioned CCSG now trending above company average which is really encouraging for us to hear. Can you talk about CCSG’s gross margin in and of itself? What does its pricing and gross margin look like either sequentially or year-on-year? I mean, are you gaining traction because of price or is it because of something else?

Sam, so, yeah, let me -- I will sort of start with you on the more backwards. I think we feel good about progress on CCSG as well. It was slightly above company average, so certainly not yet where we wanted given the company average was a minus 3, so I will have to say, look, from our standpoint, still very much a work-in-process. But if I point to where are we seeing the progress, going back to those three growth levers that we’ve outlined, I feel good for a while about the service enhancements that we're making, so just core execute – basic blocking and tackling improve customer service. So certainly I think it could be part of the benefit here is the sustained improvements that we've made. And the second one cross selling and what we've talked about is the primary focus on cross-selling to start had been bringing the MSC product offering into the Class C customer base. We have described that being slow out of the gate, but having built momentum. So that we are also doing quite well and I think it’s also contributing to success. Probably the biggest change I’d point to is we are - the third lever is one that I’ve said has been very much a work in process and the sales force effectiveness efforts where we are seeing some traction there. I'm encouraged by - you saw it in the – I described it in the net headcount reductions there which was just a matter of attrition, but increasing confidence and understanding optimizing portfolio sizes, call routes and so forth. So we feel good there. I will circle back, on the pricing front not much to speak of in that business in either direction. The gross margins as we’ve said are accretive to company average. The margins in that business I think we’ve shared it are well north of company average and has been relatively stable, so not much to speak of there.

And if I could sneak in one last question and your quarterly cash flow benefit from inventory if it’s not a record, it’s got to be real close to it, real impressive. Where did it come from specifically the inventory benefit where were you able to draw inventory out and what are your expectations for inventory by year end?

Okay, specifically I mean it came with – if you are talking about in terms slow moving, fast moving or the rest of that, it was mostly from inventory that was turning over reasonably rapidly, but we did make some improvements in taking down our slow moving as well. I actually think that we’ll probably go up a little bit by year end from where we are and that’s a combination obviously of the sales as well as the fact that we use – we view and we use inventory as a competitive tool to help us keep up those strong service levels.

Sam, the one add I will make to Rustom’s comment, he is absolutely right, is that I think our purchasing team, our supply chain folks have done a very good, have a lot confidence in them. And one of the things that they've done is, we've been in this declining revenue mode in this tough environment for a little while. We are relatively slow to turn off the faucet for exactly the reason that Rustom mentioned which is that – having inventory on the shelf is critical when customers get slow and they don’t want to keep things on their own shelf. So we’ve moved sort of slowly, but what you are seeing is the benefits of reacting to the environment and I think that’s the biggest reason. I think Rustom is right, sort of moving forward I wouldn’t expect more continued decline.

Very helpful. Thank you, gentlemen.

Thank you. And the next question comes from Ryan Merkel with William Blair.

Thanks. Good morning, everyone.

Hey, Ryan.

So first question from me is back to gross margins. I'm curious how much runway is left on the gross margin counter measures? So if inflation were to stay at zero percent into 2017, due you think you could hold margins flat again or would that be pushing it a little bit?

So that would certainly be the objective. Now if inflation stayed flat, Ryan, we’d continue to not get price increases coming through from our suppliers, right. We would continue in fact to work with strategic suppliers that sort of see us as a value-added partner to see how we can look for further improvements, gain share, who just basically sell more of their products. So that will be an ongoing initiative. And countering on the hand, we still have customer mix and so that will intangibly – so I have to call how customer mix would role in there, right, but all things being equal, certainly our objective would be to try and hold gross margin and then saying that Ryan, you’ve heard me say this before, I mean it is a battle clearly and it’s an ongoing battle that we face. It’s a combination of out in sales, it’s discount optimization, pricing discipline, it’s do with our buying and then basically it’s – Erik I don’t know if you want to add anything there.

No, I mean I think the only thing is, as Rustom pointed out, lot of the benefits from the actions that we’ve taken on the buy side actually do help us in ‘17, so tough to say precisely do we hold it flat, as Rustom said, that’s the goal. But I think we feel that absent any major change in mix that it would say in relatively narrow band.

Okay, fair enough. And then second question, aerospace, auto, government, I think those have been better end markets for you the past couple of quarters, but when you look at the recent growth rates and you talk to customers, how are you feeling about the near term outlook for those markets?

Yeah, Ryan, so I will just give you sort of a quick snapshot from an end market perspective, what I would say in general, anything that is oil and gas related will sort of trickle down in that supply chain, it’s still really touch,. And as you know this is a big segment for us. Anything heavy equipment machine related, infrastructure related, really tough. Aerospace has obviously been a bright spot. We did see, as Rustom pointed out particularly in that mid-March period, we did see it soften a bit. Look, in speaking to customers and government by the way, what we would say is, we also saw really softening in March. As best we can tell, a lot of that has to do with timing. End of March is their quarter end and then there was a squeeze. As best we can tell and we just pulse checked our customers, general sentiment would be things stabilizing. If we looked out to next few months, most felt like stable, maybe some signs of life. Certainly there were some we felt further erosion, but majority not.

Okay. And maybe I can sneak in one more and this is kind of back to Matt’s question about long-term margins. Just let me ask it a different way. Long-term, what level of incremental margins can you do and maybe give us a different sale scenarios, but I'd like to assume that price is sort of zero to up one, so we are still in this low pricing environment. Under what circumstances can you do incremental margin let’s say 20% to 25%?

Ryan, a fair question and our perspective on that, if you look past the near term noise and say, at least in a normalized demand environment, okay, where you look in the historical, in a normalized demand environment we are growing mid-to-high single-digits. We feel like we're in a position where incremental should be in the 20s, somewhere in the 20s for the business. And what we’ve also said is that where – I mean that’s a pretty broad range, where in the 20s that would fall would be largely a function of what happens in the pricing environment. So if you told us that the assumption was the current pricing environment holds, there is no inflation at all, obviously that’s going to bring it down to the bottom end of the range. If you told us that it would return to historically normalized pricing environment that would obviously push it up in the range. So all else being equal, sort of, if we took a multi-year view of that, that’s how we’d see it.

Right. So, not a lot of change there based on what you’ve said in the past?

Yeah.

Yeah. Look, I was just going to add there, Ryan, I mean, if you actually had sales without price up in the high single digits, okay, which is something this company has done many times in the past, there is no reason that you couldn’t see double digit EPS growth, even without price.

Thank you. And the next question comes from David Manthey with Robert W. Baird.

Hi, good morning, guys. First off, you mentioned in your preamble here that you believe you’re gaining share. Could you tell us what gives you confidence that you’re gaining market share versus your competitors and on that, what customers or segments where you think you’re gaining the most share?

Yeah. Sure. Dave, so what I would say is, look, the way we measure share, it really hasn’t changed that much, which is, we triangulate across a series of things. So we’re going to look at what’s happening with the indices and the indices that are most relevant to our end markets. So most specifically for our core segment, which is largely metalworking expose. The MBI has proven to be the highest correlation over the past several years. So for starters, we’re looking at indices. The second thing we’re doing is we’re looking at industry surveys. The third thing we’re doing which is proven to be one of the more objective sources of feedback for us is going to our supplier community and checking specifically point of sales. So look, I would tell you that when we triangulate all those, not much has changed for us. When we look at share by the way, we’re looking over periods of quarters, years at a time and we feel quite good about the performance. I would tell you we feel, in terms of where, I mean, there is a couple of things I’d call out, number one is our core metalworking business. When we look at our growth relative to market, we feel very good about the performance and that’s confirmed most specifically from our suppliers. And I’d also call out the large accounts area, which continues to be an export national accounts and government area where we’ve continued to feel that we’ve won.

Okay. Thank you. And Rustom, is it correct that Good Friday was in both March of fiscal ‘15 and ‘16?

Yeah. It didn’t have much of an impact, yes. Yeah. It’s just the Monday falling, the tiny difference of the prior year versus this year. Easter Monday falls in April this year for us. So it’s a small difference. It’s so small.

But Good Friday was in March of both years?

Yes.

Okay. And then I believe you mentioned previously, the 53rd week in the fourth quarter this year adds 15 to 20 basis points to annual EBIT margins, is that correct?

Yes, it is David.

Okay. And then the final question, other income popped up a little bit, it’s been typically net 0 and it was, I don’t know, 0.75 million, was there anything in there that unusual we should know about.

Sure. It was FX transaction gains and losses amongst our UK and Canadian businesses. So the big swing came from volatile foreign currency rates. And that’s really what it was, it was about 600,000, 700,000 I think and it’s also [indiscernible] but that’s really what it was, it’s not something that we think you could count on going forward, maybe it’s something that’s impacted by FX rates.

Thank you. And the next question comes Ryan Cieslak with KeyBanc Capital Markets.

Hey, good morning, guys. Erik, I wanted to see if you can maybe provide some color, you guys announced a really nice win with an electrical supplier in early February. Maybe just some sense of how that might have, if anything, impact the top line going forward here and then also talk a little bit about the genesis of that win and if there is any additional opportunities you see in the pipeline going forward?

Yeah. Sure, Ryan. It’s an exciting one for us. What I would tell you is, I think long term, very, very significant prospects for growth for the company. It’s certainly one that we’re going to take our time and build the right for the long term. I mean, from our standpoint, Square D is really one of, if not the premier, electrical brand and helps us an awful lot. I think from Schneider Square D’s perspective, MSC is going to bring something to their distribution network that really wasn’t getting served before, which was particular the sweet spot, where we can play for them is tapping into manufacturing accounts and in particular, tapping into smaller manufacturing accounts that they otherwise couldn’t reach to their existing distribution channels. So one of the things, if I’m cautious is only because, one of the things that we’re going to be very careful with Square D to do is to make sure that as this thing takes off and it will grow, that it’s a win-win and that means that in specific, we’re really not going to be focused on targeting where their current distribution network plays, so which is highly technical, electrical business is not going to be where we’re focused and where we’re going to focus is more on the spot by replacement MRO in the manufacturing segment. So I think huge prospects for the future. I think it will take some time to build, but very exciting. And in terms of pipeline, look, I mean, product expansion is a very important driver and as part of that, one of the things we’ve done and we’ve used the difficult time, difficult environment is to try to forge new supply relationships and that’s something that we hope is an ongoing process for us.

Okay. Good color. I appreciate that. And then my other question is, obviously still a very challenging pricing environment, although we have seen I think steel prices stabilize here over the last month or so. I just would be curious to know what is maybe the outlook for pricing from you from a standpoint if we were to see steel price may tick up a little bit, maybe what’s the lag in the move in commodity prices, particularly on the steel side and when you actually would see that flow through to your pricing in that at the end of the day?

Yeah. Ryan, I would say, so you pointed out a couple of indicators there that if sustained or built upon, could be encouraging. But there is a lag. In specific, what we would need to see, Ryan, is that the manufacturing community sees enough price increases on their end where they take pricing to market. That would be the trigger. Until that happens, we’re going to be fairly cautious about any pricing move. So that would be the event if you will.

Okay. And then last one for me is thinking about use of cash going forward, it looks like you guys had used a little bit more this quarter versus last to repurchase shares. With where the stock is at today, any change in the strategy there of just thinking about how you guys look to deploy cash here going forward?

Let me take that. Look, we have a balanced approach to capital allocation, right. I mean, organic investment, dividends, opportunistic share repurchases and M&A. And basically, what we try to do is maintain flexibility while using capital allocation to enhance total shareholder return and so buybacks are definitely appealing. And so really, I mean, if you think about Q1, we bought back 97,000 shares, Q2, 238,000 and we have 1.3 million authorized remaining on our buyback authorization. So buybacks remain on the cards, but we’re going to continue to have a balanced approach and build cash.

And Rustom, would it be fair to say if you guys were to go through with the purchase of the DC in Atlanta that maybe the buybacks would slow down a little bit or how do you think about that just from a cash management standpoint?

Actually, I don’t think, they wouldn’t impact the other. I mean, luckily we happen to be in a company with such strong cash flows and such a strong balance sheet that the Atlanta purchase is worth noting obviously and flagging as early as we had indicated, so we’ve done that. But it wouldn’t color our buyback decision one way or the other.

Thank you. And the next question comes from Scott Graham with BMO.

Hey, good morning, Erik, Rustom and John. I do have two questions and maybe one for the more math challenged, I guess that would be me. Rustom, could you go over again your sort of low end versus high end EPS versus the ADS numbers, you did a really nice job there and I don’t think I got that correctly?

No worries, Scott and I’m happy to do that. So in our assumption, first of all, we’re basically kind of looking at our gross margin and saying 45 plus or minus 20 basis points, right. So if you just assume that the gross margins are going to stay constant and that the additional sales at the high end or the low end were going to have very, very little incremental OpEx associated with them, okay, so then it comes down completely to sales growth, right, how the range moves. So if April and May average daily sales come in at mid-March levels, okay, for April and May, then we’d be at the low end of our guidance range, right. If on the other hand, April and May come in at early March levels, we’d be at the high end of our guidance range. And if April and May come in such that we do 11.4 for the quarter, which is what we’ve been doing for a while, then we’ll be in the middle.

Understood. The idea of course is that the March number is worse in the middle of April and better in the beginning of April obviously, off of those comments that you’ve made that happened, some things that happened in the middle two weeks there, yes?

In the middle two plus weeks, yes.

Yeah. Got you. But on that, it just seems to take not just a few, with your competitors also, so little to disrupt sales of these days, I mean Spring break, I get it and I’m sure that that was the reason, but just in yesteryears, that was never an issue or a certain end market weakening, destocking, what have you. How do you go about and identify, maybe even proactively if possible, what could potentially disrupt your thinking for the next two months?

Yeah. Scott, it’s Erik. Look, so let me start by saying that, I think what you’re sensing from us and from others, it’s really challenging environment and I think we’ve been pretty consistent that while there may be some signs of stabilization on the horizon, it is very difficult environment. So I think it’s a fair observation. What I’d say about Spring break, we certainly, I wouldn’t shock up this whole thing to Spring break. I think what we saw happen is we really dug in, is that there was a series of things happening at once, one of which was customers were slow and using it as the time to take a little bit more time off than they would have done in a prior year, but by any stretch, don’t be up with the impression that that’s the whole story, but I think the bottom line is, the environment has been extremely challenging. In terms of sort of what colors our outlook, I mean, look, we certainly look at the indices, but the most valuable source of feedback for us, for me is getting directly to customers, our sales people and our customers directly. We do that all the time in a very robust way and that’s what sort of colors our view and that’s how we build our sense of what’s happening and also our outlook.

That makes a lot of sense. My second question very simply is, there has been for a long time, there was a gap in the growth of your ecommerce sales and the rest of the business and that gap has narrowed considerably. Could you maybe talk about what is kind of keeping the ecommerce business maybe a little, what’s the delta there other than the obvious, it’s just that the differential, that gap seems to be almost gone?

Well, if you look Scott, if you look year over year, okay, so just as a reference point, so obviously on an absolute level, on an absolute basis, growth for the ecommerce channel was slow like everything else, but the way we look at it is on a relative basis as a percentage of total, ecommerce is up year-over-year in excess of 200 basis points. So we still feel like it’s gaining traction and we still feel like there is ways to go. I’ll remind you that the ecommerce definition for us includes a number of things. So it includes the website, it includes our vending business in particular, product sales that go through the machines, it includes EDI, so some of the more sophisticated kind of account integrations that we have. But from our standpoint, that’s still moving north and we would expect that to continue moving north.

No. I understand that, I guess what I was getting at maybe, is there another round of upgrade spending to your portals or anything within ecommerce that we might need?

I got you, okay. So I think what I would tell you there Scott is their technology investment is such a core part for us, I think for any distributor in this business right now that I view investments into our digital channels as ongoing in nature. But what I would tell you is they’ve been ongoing, so certainly they’ve been in our run rate for the past few years. So I wouldn’t call out anything that would be a major step up in CapEx specifically around web or ecommerce, but I would tell you that it’s in the run rate and that we plan to continue investing.

Thank you. And the last question comes from Justin Bergner with Gabelli & Company.

Good morning, everyone. Thank you for taking my question. In regards to share gains, I think you’re not willing to put out sort of a magnitude in terms of your degree of share gains that you’re seeing but maybe you could speak to sort of your level of confidence that you’re gaining share versus a level of confidence maybe looking back a few quarters, do you have higher level of confidence today that you’re gaining share versus a few quarters ago?

Justin, I would say our level of confidence remains pretty high and I don’t think it’s changed much over the last few quarters. I think first of all, one thing I’ll say is we look, we tend to look over increments of time in quarters and years. Our premise is that it’s very difficult to start looking month-to-month at movements and drawing major conclusions because you’ve got so many factors going on including comps, including end market exposure, et cetera, et cetera that they can produce some wild swings. So we will tend to look in at least quarter increments, and as we do that, we feel pretty good. I mean, there is no perfect science here. I want to reiterate what we do. We triangulate a few different ways. Just to give you one reference point if you wanted a grasp on to something, we shared where the MBI is at on a rolling 12 month basis, which is sort of the best gauge for year-over-year what’s happening in the metalworking markets and at 45.6 that implies close to 9% declines in the metal working market and relative to our performance, our performance is considerably better by several hundred basis points.

Thank you. That’s very helpful. One more if I may, every day, I seem to see a small private deal being announced in the distribution space, have you noticed a pickup sort of in deal activity on sort of the smaller private level, how does that sort of effect your view of small bolt on acquisitions going forward or perhaps what’s driving that increased level of deal activity since activity is occurring?

I’ll touch on the level of deal activity. I would say we’ve not seen, Justin, to be honest a significant change one way or another in private deal activity. I mean, obviously we keep our fielders out, we keep relationships with a lot of folks, but I wouldn’t call out a major change either direction in terms of the private deal activity that we’re seeing at least.

And Justin if I could just add, I mean we consider ourselves primarily an organic grower, right, if you look at the company’s track record over the last 20 years even, right, but I mean M&A is expected to play a role in our growth strategy as we move forward. I mean, we keep our eyes and ears open and we certainly have the financial flexibility to be able to do those bolt-ons.

Thank you. And that concludes the question-and-answer session. I would like to turn the call back over to management for any closing comments.

Thank you everyone for joining us today. Our next earnings date will be on July 6 and I certainly look forward to speaking with you later today and in the coming months as we’re out on the road.

Thank you. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.