John Chironna - VP, IR and Treasurer Erik Gershwind - President and CEO Rustom Jilla - EVP and CFO.

Matt Duncan - Stephens, Inc. Ryan Merkel - William Blair & Co Scott Graham - BMO Capital Markets Equity Research Hamzah Mazari - Macquarie Adam Uhlman - Cleveland Research Co Paul - Raymond James. David Manthey - Robert W. Baird & Co., Inc. Andrew Buscaglia - Credit Suisse Justin Bergner - Gabelli & Company Steve Barger - KeyBanc Capital Markets.

Good morning. And welcome to the MSC Industrial Supply 2017 Second Quarter Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. [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..

Thank you, Denise, and good morning to everyone. I'd like to welcome you to our fiscal 2017 second quarter conference call. In the room with me are Chief Executive Officer, Erik Gershwind; and our Chief Financial Officer, Rustom Jilla.

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, 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 in the MD&A sections of our latest Annual Report on Form 10-K filed with the SEC as well as in our other SEC filings. These forward-looking statements are based on our current expectations and the company assumes no obligation to update these statements.

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

Please refer to the GAAP versus non-GAAP reconciliations in our presentation, which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures. I'll now turn the call over to Erik..

Thanks John, and good morning, everybody. Thank you for joining us today. I'll begin this morning's discussion by covering the environment which continues to show improvement as the momentum that began a quarter ago sustained.

I'll then discuss second quarter business developments which was highlighted by sales growth above the high end of guidance, gross margins in line with our expectations, and earnings per share above the top end of our guidance range. Rustom will provide additional detail on our financial results and will share our third quarter 2017 guidance.

I'll conclude with some additional perspective on our performance. And then we'll open up the call for Q&A. So I'll begin with market conditions, our second quarter and an early look at our third quarter. Conditions remained positive during our fiscal second quarter with January building upon December's return to growth.

While February reflected difficult comparison for the same period last year, March's growth rate picked back up to start the third quarter. We estimate March growth to be around 4% which is inclusive of the benefit of Easter timing.

Keep in mind that our fiscal March does not close until April 8; and as a result, our final monthly sales results could have greater variability than in prior quarters. MDI reading that were at 49.8 back in December, surpassed 50 for the first time in two years in the month of January reaching 53.8.

February lifted further to 56 and March's reading came in as 56.4, which brings the rolling 12-month average to 49.3. Given our historical four-month lag to the rolling 12-month average, that data point points the higher growth in our metalworking end markets and consequently higher sales growth in the quarters to come.

Customer sentiment generally matches what we are seeing from the macro industries across a broad range of manufacturing sectors. The growing optimism in the industrial economy has continued as the outlook has turned noticeably more positive over the past two quarters.

While order volumes are not yet as robust as sentiment, they've begun to turn the corner for most of our customers, and this is true despite the lack of further clarity on policy topics such as infrastructure spending, lower corporate tax rates, and a more business friendly regulatory environment.

Last quarter, we were cautious not to call December's improvement a sustained trend. Today, we would. If the indices hold the current levels, we should continue to see improving sales trends for our business. Turning now to the pricing environment.

As we mentioned on our last call, we had seen some supplier price increase activity, but it was very select and not broad based. As such, we did implement a very modest mid year increase in February. Given how small it was, it is not material to our overall results nor do we expect it to be so for our fiscal third quarter.

We are, however, hearing more and more conversation about potential future more meaningful price increases from suppliers. And this bodes well as we look ahead. Moving on to our revenues. Our growth rate against the markets in which we operate reflects continued share gains.

Our average daily sales growth for the quarter is consistent with the rise in the MDI and given the correlation of our sales trends on a fourth-month lag to the MDI's rolling 12-month average, this also bodes well for continued growth.

Taking a look at our various customer types, the improvement in growth rates has been fairly widespread across our customers. Government business was up slightly year-over-year in the second fiscal quarter which was the small improvement over the first quarter. National Accounts grew nicely in the mid-single-digit range and above the company average.

We had mentioned on our last call that our funnel for large customers remained strong. Some of these national accounts growth was new business but our existing customers also lifted their buying levels. Our core customers grew in the low-single digits for the quarter.

This is a significant improvement and is reflective of the improving manufacturing environment. CCSG sales growth also turned positive for the first time in more than two years. E-commerce was 59.8% of sales for the second quarter, basically flat from last quarter and up from 57.8% a year ago.

Sales of vending customers contributed roughly 300 basis points of growth in the quarter, and we added approximately 25,000 net SKUs in the second quarter. Our total active saleable SKU count remains over 1.5 million, and our SKU expansion program remains an important contributor to growth.

With respect to our field sales and service teams, we continue to focus on increasing selling hours by improving sales force effectiveness. As such, we ended the second fiscal quarter at 2352 associates, flat with last quarter.

Looking forward, we expect that number to decline slightly over the next few months as our sales effectiveness programs gain traction. We also continue to focus on gross margin stabilization and our result for the fiscal second quarter was 44.7%, just slightly above the midpoint of our guidance. I'll now turn things over to Rustom..

Thank you, Erik. Good morning everyone. So let’s turn to our fiscal second quarter in greater detail. Our average daily sales in the second quarter increased by 2.9% versus last year, with sales to manufacturers up 2.6% and to non-manufacturers 4.5%.

So overall ADS growth came in slightly above the high end of our guidance range of 2.5% and this was a very nice turnaround after five quarters of ADS decline. As Erik mentioned, our Q2 gross margins at 44.7% was slightly better than the midpoint of our guidance and down roughly 40 basis points from last year.

Product and customer mix, including capital related sales were basically in line with our expectations. In mid February, we did take a small mid-year price increase in some select product categories. However, it was too late to have an impact on Q2 gross margin and too small to have much of an impact on gross margin for the rest of fiscal 2017.

As always, we continue to tightly manage our operating expenses and despite approximately $20 million in higher sales year-over-year, our OPEX declined slightly. Of course, there are number of pluses and minuses. Last year's Q2 had high medical expenses, re-transition to a new medical plan and the amortization related to J&L acquisition.

This year we had volume related variable cost, SAP finance project expenses, a higher bonus accrual and higher salaries due to merit increases, all partially offset by productivity saving. So this resulted in roughly 100 basis points of leverage as operating expenses as a percentage of sales decline.

Now versus our guidance midpoint Q2 OPEX is about $3 million higher, roughly a $1 million was due to higher sales volume and the remainder was a combination of payroll and payroll related expenses primarily additional sales commissions and bonus accruals.

Our second quarter operating margin was 12.3%, slightly better than the guidance midpoint of 12.2% but up a solid 50 basis point from last year's Q2. Our operating margin improvement versus guidance came from higher sales volume and gross margin performance while the improvement versus last year came from expense leverage.

Operating income itself grew 8% on 3% growth illustrating the potential for leverage in our business model as the industrial economy returns to greater growth. Our fiscal second quarter EPS was $0.93, $0.03 above the high end of our guidance range. $0.03 of EPS was attributable to our lower effective tax rate.

Our effective tax rate came in at 36.1%, well below our guidance of 38.2% and this was due to the early adoption of the new accounting standard on stock compensation, which requires excess tax benefits and deficiencies resulted from wasted or exercised stock based compensation to be recognized in the income statement.

Our early adoption resulted in net excess tax benefits which were previously been recognized through additional paid and capital on the balance sheet but are now recognized as reduction of income tax expense during Q2. So Q2's EPS was up 16% from last year's Q2 of $0.80.

Broadly, operating income growth contributed $0.05; the income tax benefits about $0.03 and a lower number of shares outstanding another $0.05. Turning to balance sheet, our DSO's were 51.5 days, up over the prior year and slightly down from the last quarter.

Our inventory turns at 3.4 were up from last year and also up slightly from last quarter's 3.3 and this was despite inventory is increasingly sequentially by roughly $10 million. You may recollect that we signaled Q2 inventory growth on our last call.

Likewise in Q3, we expect inventories to be slightly higher as we want to remain well positioned for an upturn in sales. Our free cash flow which is cash flow from operation less capital expenditure was $8 million in the second quarter. This compared to roughly $50 million for the same quarter last year.

So the major drivers of this change were higher inventories and accounts receivable which can be expected in a growth environment, offset partially by higher accrued liabilities. Our capital expenditures were $13.2 million in the second quarter, up $2 million from last year's Q2.

Note that our fiscal 2017 CapEx is now expected to be around $55 million to $60 million. And we continue to expect fiscal 2017's operating cash flow conversion which is net cash from operating activities divided by net income, to be about 100%.

At the end of the second quarter, we had roughly $549 million in debt, mainly comprised of $184 million revolving credit facility balance, $163 million on our term loan and $175 million of private placement debt. We had $36 million in cash and cash equivalent and so our leverage ratio remains at 1.1x.

Now to our guidance for the third quarter of fiscal 2017 which you can see on slide 4 of our presentation. We expect Q3 sales to be between $734 million to $748 million, up from the prior quarter's $727 million despite one less work day this quarter.

So our guidance therefore assumes average daily sales of $11.6 million in Q3 and ADS growth of roughly 3.5% at the midpoint. We expect gross margin to be 44.6% plus or minus 20 basis points in Q3. And that's down 40 basis points from the prior Q3's 45% and virtually flat sequentially. And this is consistent with what we anticipated on our last call.

We expect Q3's operating expenses to be above $230 million or roughly $9 million higher than the prior year. Three buckets here broadly. Variable expenses related to higher sales should amount to $1 million; the second bucket is spending on our key initiative and other items net of productivity and J&L amortization account for another $2 million.

And I should point out you that both of our two large projects SAP finance and telephony peak in Q3 as they are currently being implemented. And expenses were begun to subside in Q4.

The single largest driver of Q3 is increase in OPEX is roughly $6 million of bonus accruals versus last year's third quarter, which we have been talking about since last year's third quarter. If the bonus accrual and last year's extra day were normalized between the two years, Q3's OPEX as a percentage of sales would be below last year's.

This is obviously at midpoint of guidance. Looking forward to Q4, at these levels of sales growth and after backing out the extra four days in last year's Q4, we expect further leverage meaning that OPEX as a percentage of sales will be below prior year. So all of this result in Q3 operating margin of about 13.5% at the midpoint of guidance.

Last year's Q3 was 14.5% but if the bonus accrual and the one extra working day are normalized -- last year are normalized out then Q3's operating margin is slightly up on last year, with the mix driven lower gross margin offset by OPEX leverage.

Furthermore, if Q3 ends per our guidance then year-to-date with virtually flat we'd be at an operating margin of 13%. This would be slightly ahead of the expectations contemplated in our framework which is on slide 5 in the presentation. We are assuming an effective tax rate of 36.3% for Q3.

While it's difficult to predict how many stock options will be exercised in Q3 and our share price, we have estimated in our guidance that under the newly adopted accounting standard to share based compensation, there will be $0.01 EPS benefit.

In addition, we've assumed the $0.02 EPS benefit from R&D tax credit mostly associated with the investment in our SAP finance implementation. So finally our EPS guidance for our fiscal third quarter of 2017 is a range of $1.05 to $1.09. I'll now turn back to Erik..

Thank you, Rustom. For the past two years, we've been operating in a deep and prolonged industrial recession. We view that time to capitalize on opportunities that present themselves only during downturns, to focus on the fundamentals of the business and to improve this company.

Along the way, we've delivered solid financial results given the environment. We are now seeing things start to turn positive as momentum in manufacturing is building. Our business is performing in fiscal 2017 as we would expect.

Revenue growth rates are improving and we are generating leverage in the form of earnings growth, particularly when considering the roughly 40 basis points of bonus expense headwind that we described at the start of the year. More exciting to me, however, is the story that is building with each passing week.

As I look out at couple of quarters, here is what I see. I see revenue growth rate that should continue to improve as we've not yet fully benefited from the recent spike in MDI readings based on our historic four months lag. I see gross margins that will likely benefit from the early rumblings of inflation that is yet to make its way to market.

I see operating expenses that will certainly include ongoing investments but will no longer be weighed down by a bonus step up the size we are experiencing in fiscal 2017. I see a strong a balance sheet that can be used to enhance returns by effectively deploying capital be that through acquisition, share repurchase or other cash returns.

When I put all that together, I see an exciting growth story right in front of us. One that we've been preparing the company for over the past few years. I'd like to thank our entire team of associates for their dedication and commitment to our plan, to our customers, our stakeholders and to our mission. And we'll now open up the lines for questions. .

[Operator Instructions] Our first question will come from Matt Duncan of Stephens. Please go ahead. .

Hi, good morning, guys. Doing great, Erik, thanks. So wanted to just talk about sort of what you are hearing from your customers.

Are you seeing a building of optimism here? Are we still in maybe more of a cautiously optimistic environment where you are not quite seeing them ready to ramp yet? And I know that the healthcare decision is not that far in the rearview mirror at this point, but do you feel like that has changed sentiment in anyway?.

Matt, so I would say in general we are seeing a building optimism in our customers. So I would describe it more is building optimism than I would cautious optimism. Look, certainly like everybody else in the country there is somewhat of a wait-and-see approach with respect to the various policy reforms, no question about it.

But in general, more and more strengthening, more and more confidence and I think a couple of proof points I’d point to, one would be at the turn of the calendar year, we talked about capital related purchases that generally happens when customers are feeling more optimistic in their business.

This quarter, this past quarter Q2, I’d point to you may have noticed, our vending growth contribution spiked up. A lot of our vending is metalworking, production related metalworking items. That started to ramp up.

So those are indications to me sort of proof points to support the anecdotal evidence we are hearing from customers that there is building optimism, yes. .

Okay. Very helpful. And then the other question I've got, you talk about a return to more meaningful growth a couple of quarters out.

And so, conceptually if we do see some inflation return, let’s say it’s a point or two that you are getting in growth from inflation, what level of revenue growth do you think maybe the current MDI reading would translate to for you guys?.

Matt, good question. So look you can do the math and the current reading, so by the way the current lag, the way we look at it again is on rolling 12 month average because what we find with the sentiment indices, they can move around a lot. The rolling average tends to smooth that out. So right now that rolling average is still at 49.

However, if you believe the leading indicators here are 56, hypothetically let’s say that 56 were to continue for a period of time and net rolling 12 months inches up higher and higher.

Look, if you look back over history at minimum that would support growth that looks much more like the historical average organic CAGR that you are used to seeing out of the company, and then look if you put you are hitting on sort of another element of what gets me excited which is if inflation does come to be which we are not seeing yet but are seeing some leading indicators.

If that comes to be, it certainly enhances the leverage story and the growth story. But I think punch line is you should start to see if these levels sustain, the most recent readings growth, organic growth looks more like what you used to out of our historical CAGR. .

So you would say that's high-single digits, perhaps better. .

I would. .

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

Hey, good morning, everyone. So first on sales guidance. The midpoint implies average daily sales in April and May remaining at March's $11.6 million level. And you mentioned the building customer optimism, so it seems to me that will imply a little bit more of a lift.

So I'm just wondering if this is typical conservatism or is there anything to call out?.

So, Ryan, let me try that. It's actually -- it is averaging $11.6 million for the two months, but April with Easter would be a little bit lower. The Easter impact in there and then the May number, so you’ve got to -look at it that way. .

Got it. Okay. .

Ryan, by the way just a little more color. Typically what we do as is we'll aways say, our window into the future is pretty short no matter what the environment.

We will take a look at what we are seeing in the business, and with March there was a portion beginning of March and the end of March have been particularly strong, a little soft during the middle and what we do is averaging it out. And to the best of our ability apply that average going forward unless we saw some radical change.

And at this point, we didn't see enough radical change to model it in as part of forecast. .

Yes. That make sense, okay. And then secondly one of your big peers is reducing list prices to be more in line with the market.

And I am wondering if this is something that your customers even noticed and could there be any impact to your pricing?.

Yes, Ryan, so what I would say -- let me start by saying, look, pricing environment to be clear even if things pick up, competition remains fierce, and the pricing environment remains challenging. That said, Ryan, the vast majority of what we are hearing, when I described a tough pricing environment, that is really coming from the local distributors.

We are not hearing a whole lot and certainly not seeing a whole lot from our customers in regards to any of the movement. What we hear more about is local distributors getting aggressive.

And then, look, as it relates to pricing, the other thing I'll point out and as I look to the future, if conditions continue to get better and you got two factors there that I think could abate some of the pricing pressure if they work according to plan.

So one being as demand picks up generally look when our customers are busy, they have less time to price shop and what they really value is getting product in their door fast which we can do, and that's why Rustom pointed out we are building up inventory to keep our value proposition really strong, so pricing pressure tends to abate when customers are really busy.

And they really value the next day delivery. And then the second thing would be inflation would also help soften pricing pressure. But, look, as of now, it remains pretty intense but really coming from the locals more than anything. .

Got it, and well, your answer is consistent with history so nothing has really changed. All right. And lastly CCSG turning positive is nice to hear and nice to see.

I am curious if you can give us an update on the EBIT margin performance and the progress you've made in that business? Because I recall when you bought it I think it was high-single-digit margins..

Yes. So, Ryan, we really can't give you -- we've essentially integrated that business particularly the back end of that business such that -- I can't give you an EBIT answer because we don't have a view as the EBIT because the back end have been integrated. What I can tell you is, look, on the top line encouraging like the rest of the business.

Some encouraging sciences of progress and some sciences of life. We are really focused on the two ways cross selling opportunities that are continuing to gain traction. And are part of our sales force effectiveness initiative but that's really the degree to which we manage that business given that the back ends now together. .

The next question will be from Scott Graham of BMO Capital. Please go ahead..

Hey, good morning. And nice job and the quarter. So help me square something here. So we have a really good amount of large account growth yet you still have manufacturing which improves obviously markedly but for the non-manufacturing to have been up more than the non-manufacturing.

Can you -- my understanding was that most of your large accounts were sort of in your core metalworking business and so could you help square that and what that means from mix going forward?.

Yes, sure. Scott, it's actually really good observation. So what happened is, interestingly, you are right to note that the non-manufacturing is pretty high. Normally when that happens what you see is a really strong performance in government which we shared, makes up a healthy chunk.

This quarter we happened to note that government was up just slightly.

What we saw in non-manufacturing was a couple of pockets of end markets that are connected to our national accounts when that are outside of core manufacturing but where we had some real success and you can imagine for competitive reasons I am going to be a little sensitive about pointing out where those are.

But they were one or two in particular that has big growth that were tied to national account wins that make up --.

Because intuitively that doesn't normally happen that way right?.

Normally when non-manufacturing grows faster the biggest driver there is government. So this was a little bit different I would agree.

And I would say mix wise, I wouldn't read too much into it with the bigger mix element that you point out is the large accounts growth is a customer mix headwind to gross margin as Rustom mentioned but not so much to manufacturing. I wouldn't read into the manufacturing, non-manufacturing, Scott. .

So if the -- let see even pull out these couple of isolated situations. It still looks like the large accounts I am guessing was still a nice pop. I mean that was big number right on the increase.

So is that may be a little bit more of a headwind that you were thinking within your framework or in line?.

A framework or talking headwind to gross margin, operating margin right?.

That's correct, yes. .

Right. So, Scott, the way with larger accounts I mean quite clearly the national accounts, quite clearly they adversely impact our gross margin. But if you take into account cost to serve and all the rest of that they wouldn't necessarily have that effect on operating margin.

But, yes, I mean part of what you saw and it comes back to lot of the large accounts and lot of those vending sales that Erik referred to earlier also actually have a negative impact on our gross margin. .

I am with you; I got that, thank you. Last question is within manufacturing again that was a really nice pivot there. Could you talk about to the extent that you know which specific vertical-- actually there are lot of verticals that do metalworking.

Which one specifically within manufacturing or the ones that you maybe call out as the reason for why it's now up after however many quarters down?.

Yes, Scott, the good news here is that the improvement we are seeing in the numbers and in customers sentiment is pretty broad based. So we are finding it across most of our customer types and most of our end markets things are improving.

Look, so within that some of your -- if you wanted to call out whether MSC's core metalworking related segment, metal fabrication is a big one which is essentially job shops and fab shops. Heavy equipment and machinery would be another one that's a big and primary metals would be a third that are big.

Metalworking end market for us all of which are showing improvement. And then look I think another influence here that I wouldn't underestimate it is oil and gas stabilizing. Not boom but stabilizing so relative where this economy has been in the last two years. The fact that it's stabilized and showing signs of life now is a big change. .

The next question will be from Hamzah Mazari of Macquarie. Please go ahead..

Hi, good morning. Thank you. How are you? The first question is if you could just give us a sense of the potential for increased online competition to your business? And any changes you maybe seeing there.

I know you have a higher metalworking component so there is more technical support requirements but any color you can sort of frame as to how you are thinking about higher online competition to your business model?.

Yes. Hamzah, I think that's been an ongoing trend of some of the digital model. I would say sequentially here quarter-to-quarter not much new to report. Look, it remains a presence the whole digital competition remains a presence. It remains a threat.

And I think what you are seeing from MSC, what you have seen and what you can expect to continue to see is a move of our business towards technical, high touch product line services such that the MSC value proposition becomes way deeper than just price and transact. So you brought up metalworking, you are absolutely right.

We have metalworking experts that are in there with our sales people helping the customer improve their production process. That's pretty sticky and that's something that's hard to sub out just because you could find a products you put online.

We talk about our class C business and the high service element to the small consumable nuisance items that we essentially take over ahead for customer. So you are going to continue to see MSC migrate our business towards those types of categories and services.

And look I think the proof has been in the putting that for the most of the day it has been working. .

Great. And just to follow up. You mentioned broad based improvement in manufacturing. Could you maybe outline your exposure to the auto market? The SAR has been weak lately and just curious to see what your exposure to that end market is? Thank you. .

Yes, Hamzah, auto it's funny, it become -- if you remember couple of years back we were getting questions about oil and gas exposure and on first glance it was small and the same would be true with auto.

It's small as a direct -- the challenge is where it becomes difficult to say whether oil and gas is the indirect exposure is much difficult much bigger than the direct and it's much more difficult to quantify. So specifically if you went and you visit to our core customers particularly those in a mid west to the south east they are job shops.

And so they have customers from all different end markets one of which would likely be automotive. So very difficult to quantify but look in general Hamzah to me the general takeaway here is most segments are moving in the right direction in terms of outlook..

The next question will be from Adam Uhlman of Cleveland Research. Please go ahead..

Hi, good morning.

Yes, I guess I am wondering what magnitude of price increases that the company would be to see that would really start to turn the gross margin story around, work through some of the mix headwinds that we are seeing over the next 9, 12, 18 months that something we need to see 3%- 4% type price increases or to really move the needle on gross margin and revenue or is it small enough to just a couple of points would really change the outlook for MSC?.

Adam, what I would say there is that if you look ahead that getting back to what we want to see to really move the needle is something in line with historical averages for our increase. And I say that we haven't had a historical average increase in the last few years here.

But you mentioned something 2%, 3% range that would be more in line with historical average certainly. And we've been there in the last couple of years. So if you ask me if hypothetically there were 2.5% -3% increases should that move the needle for the company I think the answer would be yes. .

May be Adam, may be another way to think about this is if you look at the last couple of quarters, our mix and price combined, mix and price variance has run it about 1.3% each right.

And into negative and in those quarters I mean we basically coming in with -- we talked about vending and all the rest of it but like 40 basis points of compared to prior year. So if you look at that that gives another way of perhaps triangulating back to that answer. .

Okay. Thanks for the color.

And then could you talk to what you are seeing in act of account growth, new national account wins maybe your ship to location, traction of, return to corner on bringing in new customers and maybe any kind of magnitude you could put around that?.

Yes. Look, Adam, as you know we stop reporting on that quarterly. So I'll certainly give you the color and by the way the reason we stop reporting on it quarterly was because it really -- we didn't find it to be a metric that was particularly meaningful having look back over the last couple of years and seeing it was remarkably stable.

Look, I think we are seeing is the trend remains more or less stable. So I don't think any major changes over the last quarter from the numbers that you've seen to talk about either direction.

Look, within that total number realize there are a lot of new accounts coming in new high potential accounts and we've called out the national accounts there for instance is one where we are pretty encouraged about the funnel of new opportunities. .

The next question will be from Sam Darkatsh with Raymond James. Please go ahead..

Good morning, guys. It's Paul on for Sam. Just a quick question. So you talked about selling hours and sales associated being down in the next few months.

At what point would you have to actually increase sales, sales associate count based on end market conditions? Or what would you have to see out of your end market to really increase that number?.

So, Paul, I mean let me help on this. It's to do first of all with productivity and what we are doing. I mean all the technology and the things that we are using to try and increase the productivity of our people. So hard to give you a call and say exactly at what point we would expect it to pick up.

But certainly we had actually expected to go down over the next couple of quarters so -- little bit.

Hard to say when it will pick up but clearly Paul at some point as we go forward and absorb productivity and as a business has grown significantly with those kind of numbers that Erik is talked about, at some point we would start to add some sales and service people because whenever we add two together, field, sales and service.

And service is part of our high touch that differentiates ourselves. So a lot more volume. There will be some headcount at some point..

Paul, the only other thing I would add I think right now if you talk to our sales management team, they would tell you they see -- and I think we have some good program in pilot load and in flight on the sales effectiveness front. They see a decent size runway to extract growth without adding headcount so Rustom is absolutely right.

This does last forever but I think for a little while here this growth to be having without adding people. .

Got it.

And are you hearing anything or seeing anything yourself or hearing anything out of your customers in regards to problems with labor constrains and tightness in the labor markets in terms of getting jobs done?.

I would say I am not hearing anything new, Paul. What's come out -- I'll tell you that in general particularly in the manufacturing world access to qualified talent is a hot topic and but that's been a hot topic for a couple of years. I haven't seen much change in the last quarter in that regard. .

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

Thank you.

Hi, Rustom, could you repeat what you said about DSOs and describe how you calculate that ratio?.

Yes. I mean it's -- I said our DSOs were up versus last year right and I think when you are talking about how you calculate the ratios I mean that's just a standard calculation of sales, divided by sales and multiplied by the number of days.

So what we are seeing however and what we are seeing I guess probably what you are trying to get to is what's happening with our DSOs and so you are seeing two things. One thing is the impact of national account growth with typically longer term. And David as well we are also seeing the extension of terms that we are seeing in there.

So this has been an ongoing trend and it's likely to continue, okay, as we continue to grow this side of the business. But the good news is that our aging remains stable and write-offs remains low. So perhaps that was way you are trying to get to. .

Yes. By my calculation if you look at net instantaneous DSO it is the highest I basically ever seen and if you look at AR, net AR just as a number I think it exited call at 4.30 and that have been running 3.88 to 3.95 in the five quarters preceding and it just seems like a pretty big increase.

And given the February was not that strong it seems out of character.

So any additional comments on that?.

No. We've seen it steadily increasing month on month on month. I mean obviously it's not one of the metrics that we like as we see it going up there. It's just a fact I mean it has been going up pretty steadily.

But if you look at aging which is another way of looking at it, I mean if you compare aging I mean our aging is actually down on the last year comparison of the aging. So it's the quality of our debt remains decent. .

Okay..

It really comes down, if you think about it just took the big increase in national accounts. And so you got the big mix plus the factor that being sort of giving longer term and the combination of those two is what you are seeing in that. Now --.

Dave, I would say this one too similar to the gross margin discussion earlier where you could imagine look negotiating terms much like at all terms with a large buyer who is doing a lot of business is different from a small company.

And so just like as national accounts grow there is a gross margin impact, you are seeing something similar here and I think to Rustom's point what we are focused on is number one, are we getting value back in return if terms are longer? And then number two is the quality of -- how are we doing managing those terms? How are we managing risk and by all measure on that front we are managing it well.

But you are right to point it out that it is growing much the way gross margin has been headwinds. .

But let me cut in there, add one more point I mean we will take those sales any day of the week because even if we go $100 million, we got $100 million more in sales and even if we sort of added $25 million to our working capital or something some number like that, net of course inventory everything, and that's one time sort of addition but then the cash flow that we get from that consistently and ongoing it would be like $20 million a year right.

So the trade off is pretty good. But --.

Okay. And just as a follow up here. It sounds like it has been a change and maybe you could talk about when that happen in terms of extending terms to your customers.

The national accounting has been sort of a secular trend and the trend to longer DSOs is happened over time and this seems like a pretty significant change just quarter over or like I said it is up 10% versus a last five quarters. It seems like a pretty big increase. .

So, first of all, no, it is not -- there is no change. It has been steadily increasingly if you look at our numbers. I think you made the point too. So no there isn't a sea change in this quarter at all. But there has been a steady movement on this. I look at our numbers by month obviously and then look back.

And you can see this pretty steadily evolving and actually when we dive when we cut into the components it is in the national account fees. And you can see that steadily -- it has been steadily increasing pretty much as long as I can remember anyway. .

Okay.

Just last question if I could get one more in here, your next opportunity to raise prices in a meaningful way, does that happen in the fall?.

Dave, what I would say to that is so we are sitting in April. There have been cases where we've raised prices sooner if the market got really hot. So I wouldn't rule out, what I would tell is that the more weeks passed and the closer we get to the kind of historical cycle are on August, September timeframe, the more we would be likely to wait.

So at this point it is not impossible if we could do something but with every passing week more likely to wait..

The next question will be from Andrew Buscaglia of Credit Suisse. Please go ahead..

Hi, guys. Just looking at that gross margin line again. Can you talk about last quarter you talked about pickup in capital goods? I was thinking that would help you guys going forward however we are getting into Q3 and it looks like there is nothing material there I guess.

And you didn't have a lot of commentary on those capital goods ramping, spending and ramping. Can you just talk about that what you are seeing this quarter and then how it translates into the gross margin? And I have one more point. .

Sure, Andrew. So we talked about capital goods in the context of December when we had capital and capital related by the way we shouldn't include tooling packages and stuff like that. So for the entire quarter I mean there was nothing discernibly out of line in terms of the mix of capital.

However, we did see the vending and if you look at our vending sales which went up so much and the impact that they have on us. I mean that's production metalworking. So as that continues that's nothing but a good sign. It shows gross margins -- it shows metalworking continue to go.

Erik can you add?.

Yes. Andrew, so I think what you are seeing here is a fairly typical cycle of what happens and when things starting to improve. So end of the year, around the December -January time is the year end tends to be time when if there is more optimism customers will put in machine orders. We saw that and that was the capital related purchases.

Once the machine get delivered they need to get tooled up and then they start running so they get tooled up with what Rustom refer to as tooling packages which think that is like a starter kit of tooling, large purchase but tends to be lower gross margin. And tooling accessories like holders and things that hold the tools.

Once that happens then presumably these machines are going to start running. And they are going to start consuming tools consumables. And so what you are seeing is so when Q2 it was a spike in capital related purchases. Encouraging sign I mean customers are investing in capital.

What you are now seeing and we are seeing it in the spike up in the vending growth contribution is tool starting to get used. Now these are production tools.

Production tools tend to get a lot of scrutiny and we've talked about the tools that run in the vending unit, tend to come in at slightly lower gross margin because they are part of the production process and that's definitely what you are seeing.

And Rustom said good thing is because this is seeing a cycle play out that is indicative of increasing customer confidence now turning into machine starting to run..

Okay. All right. That makes sense. And on the pricing side I mean you guys are optimistic last quarter.

It sounds like you got a price increase but it just wasn't all that meaningful but can you talk about where that price increase is? Like where that was exactly and if they do transpire I mean it sounds like in your comment earlier if you don't get something-- if you don't -- if you are not pushing it by August it is not going to happen in the fall? Is that correct?.

Yes. So, Andrew the increase which we saw was very small. We generally don't break out mid year increases. But it was small; it was select meaning that it tied primarily to some select suppliers that took their list prices up. But the list price increases were quite moderate and they were sparse. So it averaged out to a small increase.

I described this being encouraging.

What we are hearing more and more from suppliers, look, they are all seeing what we are seeing which is commodity is recovering from a two year low period, they are building almost all commodities now on a 12 year -- a 12 months basis or up and suppliers also looking at and saying demand environment is getting better.

So commodity is up, demand environment is getting better. There is more and more talk from our suppliers that they are entertaining increases. Those of have not yet come to market but if they do as we suspect they will that could mean a more robust increase in the future.

And that look hypothetically I said on the earlier question could be sooner than the catalogue increase, the typical catalogue increase August-September but more likely than not would be then and if this trend continues it would be a healthier increase. .

The next question will be from Justin Bergner of Gabelli & Company. Please go ahead..

Good morning. And thank you for taking my questions. First off I wanted to just follow up on the vending topic. I think you had mentioned earlier the vending contributed 300 basis points to overall company growth. So that would mean that it was essentially driving all of the growth in the quarter and growing perhaps double digit in isolation.

Is that a fair conclusion?.

It would be fair to say that vending customers, so we haven't done as broken out, so we give you the growth contribution, yes, I mean so the growth contribution is 300 basis points factually you are correct that vending customers accounted that absent 0:52:22.0 vending the growth would be flat.

I mean I think what you are seeing is vending customers tend to represent where we put focus and where our value proposition is really coming to live. And they also tend to be manufacturing oriented and you are seeing that start to pick back up. .

Okay. That's helpful.

And so I mean if I look out to the third quarter given that there might have been boost from sort of initial vending orders in the second quarter, would you still expect vending to be a strong would you expect it to taper a bit given sort of the transition from buying the initial machine and stocking to buying the consumables?.

Justin, I would say if the environment stays strong as the MDI indicates it would and as what we are hearing from customers supports then no reason that should back down.

I mean so we would think what that should translate into is stronger manufacturing activity, stronger manufacturing activity should translate into more tools being consumed and that should stay strong. .

That's what results by our gross margin guidance which is pretty much in line sequentially. And indicative of what we expect from vending and the same sort of product/customer mix going forward, Justin in Q3 and Q3 anyway. .

Okay, thanks.

And then finally does that all must fall in the national account customer group or is it spread across customer groups to vending?.

Spread, it is much more widespread than national accounts. .

The final question this morning will be from Steve Barger of KeyBanc Capital Markets. Please go ahead..

Hi, good morning, guys. I am good. Thanks for getting me in.

I am curious is there a general rule of thumb for revenue growth or gross margin contribution trends for new SKUs relative to existing products? And is the decision to add new SKUs primarily driven by customer request or you evaluating relative cost and margin opportunity?.

Yes, really good question and we noted look that program remains ongoing growth driver. Steve, what I would tell you and I'll describe the program a little bit. Punch line is what you can't do is simply model out and say; SKUs are up 8% or 10% that means revenue should be up 10%.

We do find that the reason is that the baked business has very mature SKUs that tend to produce higher revenue per SKUs you could imagine in most of the new SKUs which take time to build up. What we do with the program is we are leveraging a few pieces of insights, one is our supplier intelligence.

So what products they bring, what they are seeing selling what's not. Two is a whole lot of our analytics around what customers are looking for based on we mine a lot of data from our website on sales searches, on what gets requested in branches.

So we gotten smarter and smarter about the SKUs that we add meaning that we are adding things that we are pretty certain have some built-in demand. And that is help to improve the program to where it's really become a growth driver. What we typically do is not add those so gross margin I would say not a huge difference.

So the company from an inventory standpoint we will tend to have them earn their way in. So that we don't -- it's not a ton of speculative inventory until we have a little bit of history with the item. So hopefully that helps to give you a sense of how we run the program..

Definitely, thank you. And one more just in response to the digital question earlier you talked about the move towards more technical products and class C inventory management.

How much of that has been done with existing customers or is that early in the process? And how much of that is prospecting new customers to take share from someone else?.

So the answer Steve is it sell above, what's interesting is even within existing customers though, so the share gain don't only have to come from a new customer. One of the beautiful things about this industry is it is just so darn and fragmented so $160 billion in the US, the top 50 distributors have 30% share.

70% of the shares sits with the local and regional and that plays out when you get on to the ground and you go into an account, very few accounts of ours or any distributor for that matter have all their eggs in one basket. So typically there are many distributors selling into a given customer.

So the interesting thing is in a lot of cases our best share catcher opportunities are on existing customers where we may have a small percentage of their spend, we may only have one product category or be at one plan to one area of the plan.

And that tends to be a really effective way of capturing share, the share of wallet and it certainly as you point out new customer acquisition and in particular we called out the national accounts area as one example also becomes a good mechanism. .

And ladies and gentlemen, this will conclude our question-and-answer session. I'd like to hand the conference back over to John Chironna for closing remarks. .

Thank you, Denise. And thank you to everyone for joining us today. Our next earnings day is for July 12, 2017. And we look forward to speaking with you over the coming months. Thanks again and have a good day. .

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