Welcome to the MSC Industrial Direct second quarter 2014 financial results conference call.(Operator Instructions)Please note, this event is being recorded. I would now like to turn the conference over to John Chironna, Vice President of Investor Relations and Treasurer. Please go ahead, sir..

Thank you, Denise. Good morning to everyone. I'd like to welcome you to our fiscal 2014 second quarter conference call. An online archive of this broadcast will be available one hour after the conclusion of the call and for one month on the Investor Relations homepage at www.investor.mscdirect.com.

During today's call, we will refer to various financial and management data in the presentation slides that accompany our comments as well as our operational statistics, both of which can be found on the Investor Relations section of our website. Let me reference our Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.

Our comments on this call as well as the supplemental information we are providing on the website contain forward-looking statements within the meaning of the US securities laws including guidance about expected future results, expectations regarding our ability to gain market share and expected benefits from our investment and strategic plans including the BDNA acquisition and expectations regarding future revenue and margin growth.

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

Information about these risks is noted in the earnings press release and the risk factors and the MD&A sections of our latest annual report on Form 10-K with the SEC as well as in other SEC filings. These forward-looking statements are based on our current expectations. The Company assumes no obligation to update these statements.

Investors are cautioned not to place undue reliance on these forward-looking statements. In addition, during the course of this call, we will refer to certain adjusted financial results which are non-GAAP measures.

Please refer to the table attached to the press release and the GAAP versus non-GAAP reconciliations on our presentation which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures. I'll now turn the call over to our Chief Executive Officer, Erik Gershwind. Go ahead, Erik..

Thanks, John. Good morning everyone. Thank you for joining us today. Also in the room with us is Jeff Kaczka, our CFO. I'll start by saying that I'm pleased with our execution and our overall performance during the first half of our fiscal 2014.

As I usually do, on today's call, I'll discuss the current environment, where we continue to see positive signs; our recent developments, where despite weather-related disruptions, we produced solid results in Q2; and progress with our infrastructure and our growth initiatives, including the BDNA integration, which continue to grow well.

Jeff will focus on our financial results and provide our fiscal third quarter guidance. I'll then conclude with an update of our full year expectations, which have not changed since our last call. Finally, we'll open up the lines for Q&A. I'll now start with the environment.

Market conditions continued to improve despite some temporary weather-related hiccups in January and February. When we spoke on our last call in January, we had just come off the holiday season and had seen the first winter storm impact our fiscal second quarter.

Those weather-related disruptions continued through January and into February and did, in fact, impact our growth rates. Nonetheless, the weather eventually did improve and the environment returned to the levels that we saw in November and the first half of December.

In recent months, the ISM readings have come down from the high 50%s towards the low to mid 50%s range. At the same time, the Metalworking Business Index, which had been negative for quite a while, has improved with the last reading in the mid 50%s at 55.9%. For the first time in awhile, those two measures have converged to a similar range.

In fact, for the past two months, the MBI has actually been higher than the ISM. We're finally reaching a time when those macro indicators are generally consistent with what we are seeing and hearing from our customers.

The manufacturing environment, particularly the metal working sector, has improved considerably from where it had been during the last 1.5 years. We've moved past the contraction that we were seeing during our fiscal 2013 and are now in what we would characterize as a moderate growth environment.

Customers are reporting slightly more confidence and are seeing steadier order flows and backlogs. To be clear, with some exceptions, we would not characterize the current climate as high growth, as most customers remain appropriately cautious with their spending and their capital investments.

Another noteworthy change in the environment was the improved federal government spending climate. That improvement, along with passing the anniversary of sequestration, is contributing to strong growth which I'll talk about in a minute. So to summarize, we see our core business in metal working manufacturing improving at a measured pace.

We see considerable improvements in the government sector. When put together, these contribute to a positive outlook for the environment in the second half of our fiscal year. I'll now turn to our recent results.

Despite the weather-related disruptions, the improvements in the underlying operating environment along with our continued share gains allowed us to post organic growth of just under 4% for the quarter on an ADS basis.

After the slow start in December and January due to holiday timing and the poor weather, our organic growth rates improved from the 2% to 3% range to the mid 6% range for February.

As I mentioned earlier, the government sector performed well to end our fiscal second quarter and to start out our fiscal third quarter, posting double-digit growth rates in February and March. Our national accounts program has also continued to perform well with growth rates well above the Company average.

This is a testament to our customer focused approach. I had the opportunity last month to attend Ariba LIVE, the largest and highest profile conference for supply chain and procurement executives across North America. I came away from the show feeling stronger than ever about the value that MSC is delivering for our customers.

Our solutions, whether that's technical expertise, inventory management or eCommerce, are helping companies gain visibility and control over their MRO spend. Since the second quarter ended on March 1, we closed the fiscal month of March on April 5.

Keep in mind that our fiscal month of March did not include the Easter holiday this year but did last year. With that in mind, we posted organic ADS growth of just a shade under 10% for the month. The Easter holiday timing will reverse itself in April which is also factored into our Q3 revenue guidance.

I'll now turn to the execution of our FY14 plan and update you on our infrastructure and growth initiatives along with BDNA integration. Our co-headquarters in Davidson, North Carolina has been complete for a couple of quarters. The incremental annual operating expense is now fully in our run rate. We have over 200 associates located in Davidson.

We will begin receiving the related incentives in calendar 2015. Construction on our fifth customer fulfillment center in Columbus, Ohio remains on schedule to begin shipping by the Fall of this calendar year.

As expected, the operating expense impact will continue to grow in the back half of FY14 and into 2015 as we stocked the facility with inventory and staffed it in preparation for opening. Our project to relocate our primary data center is going quite well.

We expect to complete the migration towards the end of our fiscal third quarter or early in our fourth quarter. Now for our growth initiatives, which continue adding to our share gains. The vending program added roughly 4 points to our revenue growth in the second quarter. Vending signings remained strong.

We view this as a function of the program's value, along with our customer's ongoing need to find ways to streamline their supply chain. Excluding BDNA, eCommerce reached 46.8% of sales for the second quarter as compared to 43.1% a year ago and 46% last quarter.

This reflects our customer's increasing interest in conducting business online as part of an integrated solution that includes vending, VMI and other forms of automated sales. As a result, eCommerce remains an important part of our growth investment program.

Sales force expansion is on track to add between 5% to 7% to our field sales headcount for the year. We added 32 sales associates in our second quarter, putting us at 40 for the first half and well on our way to hitting our annual target. While it's still early, we're encouraged by the initial performance of our recent hires. Finally, SKU expansion.

After adding more than 40,000 in the first fiscal quarter, we added another 35,000 SKUs to our web offering in the second quarter and now have approximately 760,000 available on MSCdirect.com. We remain on track to add roughly 150,000 SKUs for the year. As the newly added SKUs mature, the growth contributions from this program will grow over time.

I'll now turn to BDNA. While revenue growth turned positive in our fiscal first quarter, the second quarter saw a drag from weather, currency and market weakness in Canada. As a result, overall BDNA revenues were slightly below prior year. We did however see the very early stages of cross-selling. We remain quite encouraged by new account signings.

As I've said before, we continue to take a measured approach to capturing revenue synergies, as our primary focus, for now, remains on operations integration, achieving cost synergies and setting the customer service foundation for growth. I anticipate that our cross selling efforts will increase in the coming quarters.

For example, we've begun introducing MSC's Big Book offering to the BDNA sales force in pilot mode. We expect to ramp that up over the next few months as we learn from the pilots. Regarding the integration plan, we closed another two distribution centers in the quarter bringing the total closures to three.

We're also on track to close the Cleveland headquarters and move our associates to our new Davidson location by September of 2014. Overall, we remain on track to achieve our targeted cost synergy run rate of $15 million to $20 million by the end of FY15 and to achieve our $0.15 to $0.20 accretion range for this year.

As each month passes, our confidence about the future of this business continues to grow. In line with our original plans, we began ramping up investments for future BDNA growth and started adding sales force headcount. This will begin to show in the form of sequential increases in operating expenses.

We're confident that these expenses will yield payback in the form of improving growth rates and earnings in the quarters to come. I'll now turn things over to Jeff to discuss the financial results in greater detail and provide our third quarter guidance..

the positive impact of our strategic gross margin initiatives; the partial quarter BDNA mix; and our modest mid-year price increase. This is expected to be offset by the mix impact of strong growth in government and national accounts.

We expect adjusted operating expenses will increase at the mid-point of guidance by roughly $10.5 million versus the fiscal second quarter. The increase breaks out as follows. Roughly two-thirds of the increase is the variable expense required to support the sequential increase of about $65 million in revenues.

The rest relates primarily to the investments and infrastructure initiatives in the base business including Columbus, sales force expansion, vending and more, plus some increase in investment spending and to BDNA. This increased spending will drive our future growth and remains on target with the plans we communicated last October.

Our sales force expansion included about 40 hires through the first half of the year. Also, distribution center hiring to support the Columbus CFC and BDNA integration was up roughly 175 associates in the first half.

The mid point of our guidance implies an adjusted operating margin of approximately 14.7%, well within our FY14 annual framework of 14% to 15%. Finally, our adjusted EPS guidance is $1.03 to $1.07 reflecting the current market environment and our increased spending on infrastructure and growth initiatives. It also assumes a tax rate of 38.0%.

Our earnings guidance, of course, includes BDNA operating results and excludes $0.03 in integration costs associated with the acquisition. Also the BDNA business is expected to be accretive by about $0.04 in the third quarter.

So in summary, we were able to overcome the weather-related disruptions and achieve the top end of our EPS guidance for the second quarter despite coming in at the low end of our sales guidance. That reflects both the lift in gross margin and our ongoing expense management.

We're also encouraged with some of the external indicators like the Metalworking Business Index and how we started the fiscal third quarter in March. Our investment programs are going according to plan. That, along with improving demand, will provide us growing leverage into the future. Thanks. I'll turn it back to Erik..

Thank you, Jeff. Before we open things up for questions, I'll summarize for you where we stand midway through our fiscal year. For the first half of FY14, we're on track with the annual framework that we laid out at the start of the year. We've achieved mid single-digit organic sales growth and an adjusted operating margin of 14.3%.

That includes, by the way, the fiscal second quarter which we indicated would be our low point for the year in terms of adjusted operating margins.

Accordingly, at organic revenue growth rates in the mid single-digits, which at this point appear quite reasonable, we expect full year 2014 adjusted operating margins to be within our range of 14% to 15%. As I look beyond FY14, I remain very excited about the story that's building within our Company.

We're setting the foundation with an infrastructure to support a much bigger Company. We're executing on share gain initiatives to fuel top line growth. We're putting in place a new growth platform in the form of BDNA with Class C products and solutions. Most importantly, we continue to relentlessly focus on adding more value for our customers.

All of that is the formula for an exciting earnings growth story in the years to come. I'd like to thank our entire team for their hard work and dedication in executing on this plan. We'll now open up the lines for questions..

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question will come from John Baliotti of Janney Capital Markets. Please, go ahead..

Jeff, just a quick question on gross margin.

Is there a way to quantify what you think the benefit was on the inventory and the rebate?.

Yes, John. There was about 30 to 40 basis points associated with those two adjustments. I'll point out those adjustments were for positive reasons. The inventory adjustment was primarily due to our – more selling of our slower moving inventory. As you know, the rebate adjustments are driven by the calendar year 2013 purchases.

That came in a little bit higher than expected, so we had a little more success there. So that was all reflected in Q2. That's not necessarily a repeat into Q3..

Sure, understood. Regarding March, it's hard I guess for each distributer, the impact of Good Friday, it varies a bit. Any sense what you're thinking that benefit would be? Obviously, because it reverses itself in April..

Yes, we – there's obviously the noise in March and April related to the holiday impact. We would estimate it at 2% to 3%, 2 to 3 points, that swings one way and another. It affects us positively in terms of the comps in March and negatively in April..

Sure. So Erik, to that point, despite that, it's still – you're showing nice acceleration in growth January through March. You obviously talked about a lot of the frustrations of the destocking that started probably all the way in December of 2012 and took a good portion of 2013 to get through.

But based on your comments on national accounts and how they lead the trends and these trends, do you get a feel that customers are now at a new base point and you're going to see a much more inelastic demand with respect to the metal working and ISM?.

John, so I think – yes, generally, what you're describing is consistent with how we look at things, which is – over the past few months, no question what you're picking up from us is generally a more positive tone. We would characterize things as a moderate growth environment particularly within our core business right now.

So you're right to point out, for the last 18 months, metal working, in particular, had really been in contraction mode. That's turned around. We see customers, their backlogs are a little more full, a little more optimistic.

I still would caution you to say, we would not characterize the core business as growing like gang busters in terms of the environment as a high growth environment, but moderate growth environment is how we would describe it.

I think you're also right to note that national accounts are certainly leading the way on Company growth as is the government sector, which has been – the government, by the way, has been a real recent turnaround over the past couple months and is encouraging.

With respect to national accounts, you were right to say that historically that has served as a leading indicator for growth.

What I would tell you is, we're still a little cautious to call the full turnaround – much of our national accounts growth – we're excited by this, is not necessarily coming across-the-board which would be more indicative of a general lifting up of the tide as much as it is from targeted accounts and share gains.

So I think, generally positive but we still characterize things as moderate growth..

Okay, great. That sounds good. Thanks, Erik..

Thank you, John..

Our next question will come from Matt Duncan of Stephens, Inc. Please go ahead..

Good morning, guys. Great execution on what I'm sure was a tough environment..

Thanks, Matt..

So I want to see if maybe we can dissect the growth a little bit more, that you're seeing in March. It sounds like, Erik, the government is really starting to pick up.

Can you talk about how much maybe the government is growing? Is vending still contributing around 4%? Then remind us what's going on with your year-over-year comps right now?.

Yes, Matt. So what I would say is that if you looked at our growth and particularly you're referencing March, the most recent data points, generally – first of all, tough to read too much into any one month. We're looking for trends.

Certainly the trend we would call out is government, we described as solid double-digit growth rates which is really over the past couple of months, February and March and national accounts is the other strong grower well above Company average. So that's pretty much the color.

Then the rest as we described, our core business is moving along and inching up at somewhat steady pace..

Okay.

When you talk about customer backlogs growing and you're hearing a more positive tone out of your customers in general, is that across all end markets? Or are there some that are standing out versus others?.

Yes, Matt. I think when you get under the covers, certainly quarter to quarter there's always variation by end market. What I'm giving you is a general description. Realize that our core is going to be colored by the end markets that we've described as our core end markets of primary metals, metal fab, heavy machine and equipment building.

Yes, I think characterizing them as more optimistic is right. I still, there's still some caution in the tone. So I don't think it's full gang busters mode in the core. Still some caution over how much they're spending, how much investment is being put into capital projects.

But certainly, relative to where we had been for the last 18 months, a very big swing. Relative to where we were even last quarter, I would say a moderate improvement..

Okay, thanks. Last thing for me on the M&A environment, you're about to lap the Barnes acquisition.

You guys still out there actively looking for M&A? What's it look like out there right now?.

Yes, Matt. So I think we always – definitely it's part of the game plan that our growth plan that we've described. On the last call – I'll reinforce the comment I made on the last call.

I think for the next couple of quarters, at least the way I would describe it is that, our M&A hurdle rate in our VAR which normally we set pretty high is higher than it normally is, in light of – we want to execute what's on our plates, what's in front of us.

We're quite encouraged by progress and what we're seeing in results and how we're executing. So we like what we're seeing. We want to focus on what's on our plates for the next couple of quarters..

Okay. Thanks guys..

Thank you..

The next question will come from Ryan Merkel of William Blair. Please go ahead..

Hey, everyone. Nice quarter..

Thanks, Ryan..

So, Erik, I think you said government was up double-digits. Can you just remind us what the comparison was last year? Because I think that's helping a bit. But you also said the federal government is picking up.

I'm just wondering why you think that might be?.

Yes, Ryan. So I don't have handy – we can get to you the last year of growth rates. You are right to point out – so there's two factors going on. Certainly the lapping of – last year, we were in a very much, a contractionary environment when it came to federal government spending because we were on sequestration. So did part of the growth re-cost? Yes.

Part of the growth though is clearly a change in – on an average daily sales basis, we are seeing a change. I think what I would attribute to is two factors, the change in spend. I think first of all, I think we've been really not deviating from plan.

For the last year while the spending environments been soft, we've been heads down, executing on our share gain program. Like for the last year, we felt good about our government position. So we solidified the position. What you're seeing is as the tide is lifting, we're benefiting from that.

In terms of why the tide is lifting, what I would tell you from our discussions with government contacts is – there is at least a little more certainty over spending for the coming Fiscal Year. Their budgets in place, relative to where we had been operating, where they've been operating for the last year or two..

Okay, great. Then I think you said you put through a modest mid year price increase.

So just wondering, what gave you the confidence to do that? Then by modest, can I take that to mean 1% to 2%?.

Yes. So Ryan, modest – so two things. The increase – so I think two things. One is, it's in response to select supplier increases. I would still characterize the pricing environment overall as modest. So I'd say select supplier increases. That was the impetus. So the confidence is in part a function of that.

I think, in part a function of – we feel very good about our value proposition right now and how we are helping customers gain control of their spend and take cost out of their business. So we feel we can get paid for that. In terms of modest, we don't break out the mid year, as you know..

Right..

Here is what I'll say about modest. I'll give you two reference points. Number one would be that by modest the mid year is less than we would typically do with a normal mid year..

Okay..

For those who haven't been following us quite as long as you have, if you referenced it against what we announce each year with our catalog increase, it would be well below those levels..

Great. Very helpful.

Last one for me, maybe just speak to Barnes, why it was down slightly year-over-year? Does weather hurt them more? Or is it an end market issue?.

I think, Ryan, it was more – so three factors we cited, weather, currency and Canadian market. So realize that the currency and the Canadian market are two factors that impact their Canadian business which they have reasonable exposure to, so that was a drag on growth. For North America, we didn't see a huge change in growth from Q1 to Q2.

It came down a bit. We chalked that up to weather. The same way on an absolute basis and that seeing that other distributors were impacted, Barnes was not immune from that..

Got you. Okay. Thank you..

Thanks, Ryan..

Our next question will come from Adam Uhlman of Cleveland Research. Please go ahead..

Hi, guys. Good morning..

Good morning, Adam..

Hey, just to follow-up on that, the earnings accretion was better than expected out of Barnes despite the weather impact.

Can you flush that out a little bit?.

Yes.

So we reported $0.04 – you're referring to the second quarter, Adam?.

Right..

Yes, so what I would say is relative to expectation you're correct that on a softer sales we did a little better. I pointed to two lines. I think we did slightly better on the gross margin line in that business than we had anticipated. We did a pretty good job managing OpEx. So those are the two other lines that contributed to the extra $0.01..

Okay.

Were the rebate and inventory adjustments in there as well? Is that part of it?.

No, that was not. Actually, it's a very small piece of the – inventory adjustment was..

Okay, got you. Then, we're adding all these new SKUs to the website and the offering. It sounds like you're pretty optimistic about the revenue contribution for that. How should we think about that over the next 6 to 12 months in terms of contributing to the revenue growth? Because the numbers are fairly large.

What are your expectations?.

number one, overall we really like the program, it's working well; number two, it's really given us a different approach to product additions. It's a much more data driven way we're going about adding the product offering.

Because they're on the website and not on – in the Big Book, they do not have quite the same pop that an item added to the catalog would. So I bring that up just to say that, if we add 20,000 items to the catalog and we're adding 150,000 to the website, one should not extrapolate that we're getting 7 times the pop.

That said, it's a good growth program. The way I would think about it is, you're seeing some of that benefit in our current growth rate, so some of the improvement that we're seeing is a function of the SKU expansion program.

What I would tell you is that if I look out the next 6 to 12 months, should we execute? I have every reason to believe that we will, the growth contribution from that program should increase. Because what happens is, when you add a SKU to our website, you get benefit in year one. You also see benefit in year two before the SKU matures.

So as we layer on classes, we will get a couple years benefit. So the contribution should lift. You're seeing some of it now. We would expect a bit more in the quarters to come..

The contribution that you're seeing now is that like less than 1%? I mean, it's still big dollars, but – with the Spring?.

Not going to break it, obviously, it's something we do track internally for competitive reasons. I'm not going to break it out. But suffice it to say, it is part of the benefit that you're seeing now..

All right. I had to try. Thank you..

Thanks..

Our next question will come from Winnie Clark of UBS. Please go ahead..

On your guidance for the operating margins for 3Q, it was slightly below what we were expecting. I'm curious, did any of the initiatives, spending potentially slip from 2Q to 3Q? Because 2Q was quite strong. Then the guidance for 3Q seems a bit weaker than we would have thought.

But is it possible that something slipped? Or is it simply some level of conservatism?.

So we had a little trouble hearing you. Let me just replay back what I think you said, which is Q2 was stronger than expected.

I'm not sure what you – your question was around OpEx and whether anything moved from Q2 to Q3?.

Yes..

Okay. So I would say in general, we felt good about Q2 performance. We feel good about Q3 guidance. So we feel like basically, we're on track. In terms of initiatives and spending, basically, right down the middle with what we've been laying out for the year. The one comment I would make is, there was a slight bit of slippage in OpEx from Q2 to Q3.

Believe it or not weather did have a small amount of impact. So then certain project-related spending, where because of the weather, projects got delayed a bit and that got pushed from Q2 to Q3. That's the only item I'd call out..

Is there any way to quantify that?.

investments to BDNA; investment in sales force expansion, so we added considerably to sales force; investment in Columbus, so Jeff described our warehouse headcount up to support the BDNA integration and to support Columbus. So you look at that and we feel like $4 million is right in line with what we would have expected..

Okay, great. That's really helpful.

Then talking about the weather impact, is there any way to quantify specifically what that was during the quarter? Then in terms of the recovery, does your guidance reflect that's fully recovered in the third quarter?.

Winnie, it's Erik. So the weather – it's a good question. It's a really tricky one to answer. So to answer your first point, it's really tough to give you a specific number on the weather impact. The challenge we have is we could look at the day or two when you get the storm and we clearly see the impact.

What's very tough to measure and would be virtually impossible to quantify is how much of that do we see come back. We're quite encouraged by March. It was a relatively stable month. Is it possible that there was some movement and deferral of spending from January and February into March? Maybe. There's a lot of noise right now, so we don't know.

But we felt like what we gave you was our best judgment on what we see coming for Q3..

Great, thank you. Congratulations on solid execution..

Thank you, Winnie..

Our next question will come from Eli Lustgarten of Longbow Securities. Please go ahead..

Good morning, everyone..

Good morning.

How are you?.

A couple of – just some clarification questions.

In your outlook for the third quarter and fourth, I assume the assumptions for government is to continue with the double-digit rate? We do have an assumption of a turnaround and positive growth in Barnes coming in the second half of the year?.

So Eli, we'll give you just Q3 right now because we're not going out with Q4 revenue guidance. In Q3, you are correct on government. So included in our guidance would be double-digit growth given what we're seeing in the environment. On BDNA, included implicit in our assumptions or guidance, roughly flat.

So we grew slightly Q1, down slightly in Q2 due to the factors that I mentioned, implicit in guidance is about flat..

BDNA has those higher expenses in the third quarter, so impact a little bit I guess?.

That's right. That's right and that's why the accretion projection is staying at $0.04 where it was Q2 was slightly higher in spending related to the investment program that we expect to drive future benefit..

As we go toward the summer, I mean, business should get better. But are you guys impacted at all by IMTS coming in September? The big machine trade show will be held this year.

I'm just wondering whether – does that change the profile of the way the summer should look versus what it will be a year ago when there was no trade show?.

No. As you point out, IMTS is every other year. Generally, it's not something that would impact revenues. I will tell you, it's a phenomenal show. We will have a big presence there. A lot of our customers and suppliers are there. So it's a terrific opportunity for us, but shouldn't impact revenue trends..

One of your big suppliers, Kennametal, rolled out this brand new computer program I guess called NOVO to help machining – companies doing machining and teach them what products to use and how to do it.

Are you using that at all? Does that involve any of your products? Or through your business to make NOVO available to help them find out what cutting tools to use?.

I'm actually not familiar with it. I can bet you that my team is. I'm sure I'll be getting an update shortly. What I would tell you is what you're hitting on that to me is the bigger trend right now, is the impact that technology is having in manufacturing. That is right now at the heart of what we see as really a revolution going on in manufacturing.

One that we're, as a distributer, playing a big role in helping use – our customers use technology to get a handle on the spend..

Just one final thing. The price increase that you took was sort of very selective. It wasn't a relatively broad based.

That's correct, isn't it?.

Very correct..

Thank you very much..

Thank you, Eli..

And our next question will come from Scott Graham of Jefferies. Please go ahead..

Hey, good morning. So I wanted talk a bit about Barnes, because one of the objectives that you guys were setting out on a year ago was improving the sales per associate there. Unlikely to get to how efficient your folks are, but certainly a lot of steps up the ladder to be climbed.

I was just kind of wondering where we were there? Because it doesn't appear as if that's necessarily reading through Barnes' sales as yet. Could you also, Erik, talk – maybe link the two together, as you add salespeople to Barnes which I believe is something that you said.

How are they added? Are they fully sort of indoctrinated on the MSM way? How do you train them? How will they enter, recognizing of course that it takes six to nine months for them to get up to speed with others, but will that up to speed be much higher than the current core Barnes sales person?.

Scott, really excellent question. So let me give you the quick answer is you are correct. You are not seeing any improvement in the numbers to date. That's sort of stating the obvious. I would tell you under the surface I'm very encouraged by what I'm seeing in terms of the activities that I'm confident are going to drive the result in the future.

I'm going to call out three things. Number one is customer service. I've talked about this on the last couple of calls, but we are doing a lot of work to improve the service levels in that business, to put them – they were okay, but to put them at MSC caliber service.

By that, I'm talking about the customer service experience when a customer calls in and speaks to a person, our fill rates, the type of sales force coverage we have. So service is point one, we're making significant progress. Number two is, I'll call it, sales force profile and training. So there's a lot of terrific people in that business.

But you're right to point out, as we bring new people in whether some leave and we replace or for the incremental hires, bringing people in with a heavier focus on training, what I would say to you is, it's somewhere in between what BDNA used to do – because there is some nuances. It's a slightly different sales force model.

It's not like we're just taking the MSC model and applying it, but I would characterize it as sharing best practices across the business. So a much more robust focus on ramp up, indoctrination and training. Then point three, that's really going to be one of the drivers of sales force productivity improvement is cross-selling.

The fact that we're giving the BDNA sales force the full MSC offering and as I've said in the prepared remarks that is still in the very early stages. We like what we're seeing so far but we're ramping that up gradually. I would anticipate in the next couple of quarters to see that start to pick up.

So long story short here is I think the activities gone on under the covers make me very encouraged..

That's fair.

But I think what I hear you saying, Erik, is that you have not seen the needle move on any of those though?.

I would say on service, needle, yes. On sales force profile and training, yes. So on the first crew, I am seeing the needle move. On cross-selling, needle not yet moving. But I expect it to –.

Yes, I apologize. I meant in terms of monetization into sales..

That's right..

I know you can see some of the subjective things improving, I get that. But really there's been no monetization of sales as yet.

But you're expecting that, perhaps even this quarter?.

To date very little. We're expecting it to come, absolutely, based on the activities we're driving..

Okay, very good. That was really my only question, thank you..

Thank you, Scott..

Our next question will come from Holden Lewis of BB&T. Please go ahead..

Okay,great..

Thank you very much. Wanted to – if you look at sort of your supplemental data, it seems like you're getting – a lot of the growth is coming from the active client list beginning to rise which is something we actually haven't seen in quite some time.

So the first question, can you just kind of talk about the dynamics there? Is that a natural cyclical behavior? Is that beginning to see some of your initiatives pay off? How could we interpret it and then sort of the legs that it might have?.

Yes, Holden. Interesting you picked up on that. We've said for awhile now that – we didn't point it out. You're right. Active customer count has been growing sequentially for the last few quarters. It did show in year-over-year growth. It's not something we've highlighted, much for the same reason we didn't fret over it too much when it was declining.

We don't celebrate too much when it's growing, because it's not really the biggest driver of the performance of the business, given the size of the active customer base and the runway of potential that we have. That said, of course, all else being equal, we like that it's growing.

What I would say to you to date is, I don't think we've yet really seen the tide rise from the improved environment. I'm hopeful that would have a benefit on customer count. What I think you're seeing is – you've heard me over the last year or so talk about some investments in marketing programs, be those digital or print.

We have some new folks in our marketing team that are bringing some new ideas. We have a strong group in place in our marketing. They're tweaking programs and I think you're seeing some of the benefit of that..

Okay. Then I was also curious about the sequential change in gross margin. You put up a 46.4% in Q1. 46.4% in Q2. You're guiding to 46% in Q3. But it sounds like you've put through a modest mid cycle increase to price. It sounds like – obviously, volumes are getting substantially better. You've made some progress on the COGS at BDNA.

I get that you have some mix stuff that happens, although the sequential change doesn't seem too great. It just seems like guiding to kind of a 40 basis point decline sequentially, it just seems like you should perhaps be making some strides from that 46% boilerplate number.

Are maybe these new accounts lower margin accounts? Or what's the offset there?.

Yes. Holden, it's Jeff. I'll take that. As we mentioned before, there was that noise in Q2 of the inventory and rebate adjustments, which again were done for positive reasons. If you strip that out, the equivalent would be basically 46.0% to 46.0%, so basically flat. We mentioned before, the mix impact. That's the real driver.

So in light of us essentially holding flat after the adjustment for those non-recurring items, we're pretty pleased with that..

Okay, thank you..

Holden, I'll add – I think Jeff hit the nail on the head. If you think about it, really, absent the non-recurring factors that Jeff described in – Q2 came in basically absent those factors right where we thought it would. Relative to where we thought it would, Q3 is right in line.

Basically, you've got the math of a modest increase being offset by the mix of the large count..

Okay, thank you..

Our next question will come from Sam Darkatsh of Raymond James. Please go ahead..

Most of my questions have been asked and answered. I just have a couple of little follow-ups.

Again regarding the mid year price increase, what was the timing of that? When specifically did that go in? Was that related to Tungsten? Or was that related to something else?.

Sam, it went in February. Yes. Really, primary driver, raw materials have been spotty is what I would describe that. Some volatility, but really not moving much in either direction. It was in response to what I'll call, select supplier movement..

Okay. Then final question, I noticed that you had obviously a very heavy share repurchase action last quarter and then none this quarter. Should that be telling? Or what's the general plan? Obviously, the stocks been having a very nice move of late.

How price sensitive are you with your share repurchase activity?.

Sam, as you know, we've done stock repurchases on an opportunistic basis. The one we did in Q1 was actually the largest one I believe we've done actually in several years or perhaps in the history of the Company. We're always evaluating that as a part of our capital allocation. We'll continue to do so going forward..

Okay, very good. Thank you much. Again, congratulations in a very difficult environment..

Thanks, Sam..

The next question will come from David Manthey of Robert W Baird. Please go ahead..

Hi. Good morning, guys..

Good morning, Dave.

First off, you talked a little bit about your customers and their attitude towards capital spending and so forth, but I'm wondering just as an early indicator, if you're seeing any trends at all in your sales of metal working machinery?.

Good question. Off hand, we will follow-up to clarify looking back at Q2. I'm referencing Q2 here, David. I have to be honest I don't have the numbers in front of me on March, not yet on – because you raised a good point. Machinery purchases would be a leading indicator of customers willingness to spend on capital. To date, not yet.

But that might to date was for Q2. I don't have March off hand. We can get you that, but to date, not yet..

Okay. It looked like average order size ticked up ever so slightly. So it's probably not major right now, but clearly would be encouraging if it's starting to be a factor..

Yes, David, the one thing I'll point out and just add on is what we're giving you for our Q3 guidance is a light of what we see in front of us today. There is an encouraging data point out there with that metal working business index, the recent reading of 55.9%. We don't make too much of it because it's one reading.

That is a significant uptick from even where it had been the last couple of months. Should that sort of trend continue for an extended period of time, we would be pretty excited. I think that would be indicative of more customer confidence and likely would lead to more capital spending..

Right, okay. Then the last question is on the competitive landscape, particularly among your larger national account type customers, could you just describe the landscape there? There's this constant thought about the competitive landscape getting more intense or new entrants coming in.

Could you just talk about, is it traditional players? New entrants? Is it pretty steady? How do you see that?.

I would describe the competitive landscape similar to what we've described, really over the past year. So what we see happening here is the early stages of industry consolidation beginning to accelerate. We've described many times what we see as those inflection points. We see that beginning to play out.

So on the one hand, that's really exciting because I think that does provide the potential for a growth tailwind for the Company. On the other hand, we're coming from a place where the Top 50 players in our space have 30% share. This is a story that will play out over a decade or more.

So I would not characterize any ratcheting up of competitive intensity vis-a-vis large players. I would comment that the local distributors are under as much or more pressure than they've ever been. So certainly competitive, intensity, price, discounting pressure from local distributors is as strong as it's been..

Great. All right, Erik. Thank you..

Thanks, David..

And our final question will come from Brent Rakers of Wunderlich Securities. Please go ahead..

A couple of follow-up questions on BDNA. I think the first one, on the last call, you gave out an investment spending number, I think up $1 million sequentially.

Did you comment on what that was? What the guide was for Q3 here?.

Q3 was up a bit more. So we came in slightly under that for BDNA through some expense management and a little bit of timing, implicit in our Q3 guide. So in that $10.5 million walk, it's a little more than that. So it will be greater than $1 million as part of our investment program Q2 to Q3..

Okay, great. Then just the final question, you're obviously at a point on BDNA where you're roughly seeing about $0.04 a quarter of accretion. The 2015 targets, I believe, gets you to about $0.08 to $0.09 accretion on a cumulative basis.

Could, maybe – given that you're three DC closures in now and I think, still have the headquarters closing in front of you, could you maybe do some of – a bit of the walk on the cost side? Or is it revenue side that brings you up to that higher level next year?.

number one, executing on cross-selling; and number two, getting that big business to be growing again through the foundational improvements we're making to service and through the sales force expansion that we're starting to invest in..

Great. Erik, I apologize, one last question on just a different subject. I know you've given a lot of talk about the March month. It seemed like early in the month of March, there was also some weather element as well.

Did you see any differential in performance over the course of the month? Or it was pretty much steady for the stay throughout?.

I want to say it was relatively steady through – it's never quite a perfect smooth line, Brent, there's always noise. Relatively smooth, the only thing I'd point out in March is that towards the tail end of the month, we got the benefit of the weaker comp due to holidays.

But I don't even remember back to the beginning of March, if there was a little bad weather, I'm sure we were impacted a bit. But in general, fairly consistent through March..

Okay. Great. Thanks, Erik..

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to John Chironna for any closing remarks..

Thanks again everyone for joining us today and your continued interest in MSC. I would also add that our metal working specialists – we were contacted during the call and indeed, they are using the NOVO product from Kennametal. The feedback so far has been actually quite positive. They actually like it quite a bit. So that's for you, Eli.

In terms of our next earnings date, it will be Wednesday, July 9. We will probably continue with this timing, so we'll do the morning call, 8:30 to 9:30. We'll send out those invitations. We hope that works for everyone. We look forward to speaking to you over the coming months. Thank you very much..

Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines..