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Edited Transcript of MSM earnings conference call or presentation 10-Apr-19 12:30pm GMT

Q2 2019 MSC Industrial Direct Co Inc Earnings Call

MELVILLE Apr 11, 2019 (Thomson StreetEvents) -- Edited Transcript of MSC Industrial Direct Co Inc earnings conference call or presentation Wednesday, April 10, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Erik David Gershwind

MSC Industrial Direct Co., Inc. - President, CEO & Director

* John G. Chironna

MSC Industrial Direct Co., Inc. - VP of IR & Treasurer

* Rustom F. Jilla

MSC Industrial Direct Co., Inc. - Executive VP & CFO

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Conference Call Participants

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* Adam William Uhlman

Cleveland Research Company - Partner & Senior Research Analyst

* David John Manthey

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Evelyn Chow

Goldman Sachs Group Inc., Research Division - Research Analyst

* Hamzah Mazari

Macquarie Research - Senior Analyst

* John George Inch

Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials

* Robert Douglas Barry

The Buckingham Research Group Incorporated - Research Analyst

* Robert Scott Graham

BMO Capital Markets Equity Research - Analyst

* Samuel John Darkatsh

Raymond James & Associates, Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the MSC Industrial Supply Co.'s Fiscal 2019 Second Quarter 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.

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John G. Chironna, MSC Industrial Direct Co., Inc. - VP of IR & Treasurer [2]

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Thank you, Nicole, and good morning, everyone. I'd like to welcome you to our fiscal 2019 Second Quarter Conference Call. With me today are Erik Gershwind, our Chief Executive Officer; and Rustom Jilla, our Chief Financial Officer.

During today's call, we will refer to various financial and management data in the presentation slides that accompany our comments as well as our operational statistics, both of which can be found on the Investor Relations section of our website.

Let me reference our safe harbor statement under the Private Securities Litigation Reform Act of 1995. Our comments on this call as well as the supplemental information we are providing on the website contain forward-looking statements within the meaning of the U.S. securities laws, including guidance about expected future results, expectations regarding our ability to gain market share and expected benefits from our investment and strategic plans, including expected benefits from recent acquisitions. 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.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [3]

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Thanks, John. Good morning, everybody, and thank you for joining us today.

To kick off this morning's call, I'll provide a brief overview of our fiscal second quarter results. I'll then offer specifics about the environment and our recent performance before turning it over to Rustom, who'll review the details of our second quarter and provide third quarter guidance. I'll then wrap up before we open up the line for questions.

Our fiscal second quarter earnings per share came in slightly below our midpoint due to a lighter-than-expected top line, particularly in February. Gross margins were as guided and, in fact, slightly ahead for the base business. And operating expenses were also in line. Included in our total company results this quarter was our expansion into Mexico. While it was not material to our overall results, it did mute our gross margins by roughly 10 basis points. And more coming on these subjects in just a bit.

Turning to the environment. Conditions generally remained solid in the industrial economy, although the last couple of months were softer than we've seen in recent quarters. Sentiment indices like the MBI remain in positive territory but have come down from previous levels. The last 2 months' readings for February and March were identical at 53.6. The rolling 12-month average for the MBI is now 56.2 which is still very healthy. However, a combination of some weather, destocking, softness in automotive and oil and gas and some ripple effects from the prior government shutdown were factors.

To be clear, nothing we see indicates a dramatic step-down, but demand moderated at least for those 2 months. Customer sentiment generally confirms this picture. Things have gotten off to a slower start than expected in the beginning of calendar 2019, but the outlook remains generally positive.

With regard to the pricing environment, things have remained stable, providing a solid backdrop as we implemented our midyear price increase. The tariff landscape also remained stable with no indications that we're headed towards the 25% level. As a reminder, our own tariff exposure is relatively small at roughly 5% of cost of goods sold.

I'll now turn to our performance within this environment. While our overall growth rate came in below our expectation, it's important to understand what's happening under the surface. Our core customers maintained growth rates in the high single digits. This is particularly important because core is where most of our sales transformation efforts have been aimed and demonstrates ongoing traction of our changes. National Accounts also remained in the high single digits. And as expected, Government was negative in the quarter, weighing down our overall growth rate.

As you'll hear from Rustom in greater detail shortly, we're projecting our third quarter growth rate to tick down, and this is primarily a function of 2 things. First, the slower growth rates from February continued into March when factoring out the Easter holiday benefit. To be clear, we're not seeing acute weakness in specific accounts. If we were, it could point to competitive movement or change in share. However, neither one has changed meaningfully.

Instead, we saw lower growth across the board, particularly towards the end of the calendar quarter. A good example of this was in our highly penetrated National Accounts where our relationships are strong. Many of these accounts saw lower spending levels in March even as compared to December. This is consistent with softening demand or inventory destocking.

I should note that the last week of our fiscal March, which was the first week of calendar April, or the calendar second quarter, rebounded and was much stronger. Should that sustain, it would suggest the February and March softness was just temporary. Our fiscal third quarter guidance does not anticipate that this strength continues for the rest of the quarter. If it does, it would mean upside to our guidance.

The second factor impacting the third quarter revenue guide is Government which, as we anticipated, will hit its peak headwind in the third quarter with a low double-digit decline projected. This is a function of year-over-year comparability as both of our previously communicated contract losses is hardest this quarter. As I've shared with you in the past, we've been making significant changes in Government. And as a result, our pipeline of new opportunities has improved considerably. Keep in mind that moving past this comparability issue will reduce a headwind of at least 1 point of growth, and this is before the changes that we've made bear fruit.

Despite the lower projected third quarter growth rate, my conviction in our sales transformation remains high. I base this on several data points. First, our core customer growth rate remains solid, and given that core is where the bulk of our sales changes were aimed, this is important.

Second, the sales changes have freed up our sellers to engage in more growth activities, and we're seeing the positive impact of this in inventory management signings and, in particular, vending. Vending signings are up over 50% for the year. And while it takes time for signings to turn into revenues, they are a good indicator of future growth prospects and share capture. As a point of reference, vending did contribute 280 points of growth in our second quarter.

Third, we have stepped up our focus on new business generation considerably. Most of our sales force hiring has been aimed at business development. Our hunters have gone from just a handful a few years back to about 100 associates today as part of our sales transformation efforts, and this number has nearly doubled just over the past year. These hunters are beginning to hit their stride, and we are seeing a robust new account funnel that continues to build each month. They are not yet moving the needle on our growth rate, but they will as they move to implementation.

We believe that our business generation efforts, including what we're seeing in vending, will add 1 point or more of growth over the next couple of quarters, and it will build from there. As you can see from our operating statistics, we added another 16 net sales and service additions this past quarter and we'll continue on our moderate hiring pace given the success of the program.

A fourth proof point, we continue generating considerable cost savings for our customers through our technical expertise on the plant floor. These cost savings are an indication of the value that we're bringing to customers and they help build loyalty.

Finally, feedback from our sales team, from customers and from suppliers is consistent with the quantitative data and is telling us that we're on the right path with our plan.

I'll now turn from the top line to our pricing actions. Since our last call, as expected, we implemented a meaningful price increase of 2% to 3% in February. We are pleased with the high realization rates that we're seeing, which are due to the solid efforts of our sales and marketing teams. It's also a testament to our strong value proposition as we're delivering the type of cost savings and productivity to our customers that justify the increase.

A moment on AIS which has generally performed in line with expectations over the course of the past 3 quarters since our acquisition of this OEM fastener business. This past quarter, however, we did see some softness coming primarily in the automotive sector in the Midwest. As AIS supplies OEM fasteners, they will feel changes in automotive production rates acutely, and that is the case now with just a handful of customers driving the bulk of the softness. The team continues making early inroads with cross-selling and we expect that to build over time.

Before wrapping up, I'll talk about Mexico which is an exciting development for the company. We've established a majority-owned business, MSC Mexico, working with an existing Mexican distributor, TAC, or TAC. We view Mexico as a strategic foothold for us and a critical component of presenting ourselves to National Accounts as a North American supplier. A direct presence there allows us to not only support current U.S. customers with Mexican plants but also opens up the Mexican market for us which is a meaningful long-term growth opportunity.

We've been looking for the right expansion opportunity for quite a while and we were excited to find an excellent partner in TAC, whose cofounder is now MSC Mexico's CEO. They built a strong value proposition as a VMI provider of MRO supplies into various industries within Mexico and we're very much looking forward to a bright future ahead.

I'll now turn things over to Rustom.

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [4]

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Thank you, Erik. Good morning, everyone.

Before getting into the details, let me remind you that we had provided Q2 guidance for both our total company results and our base business or total company excluding the impact of the AIS acquisition. In addition, on February 1, MSC Mexico commenced operations, which Erik just spoke about. Our guidance did not include this business, in which we have a 75% controlling interest, but 1 month of actuals are included in our total company results.

We will exclude MSC Mexico along with AIS when discussing our base business.

Our second quarter total average daily sales were $13.3 million, an increase of 8.8% versus the same quarter last year, just below the 9% midpoint of our guidance. AIS contributed 230 basis points of growth and MSC Mexico contributed 40 basis points of growth. Our base business growth was 6.1% versus the 6.5% midpoint of our guidance.

Our reported gross margin was 42.7% for the quarter. This was in line with guidance as the 10 basis point difference from the midpoint of guidance was entirely due to our MSC Mexico business which of course was established post-guidance.

Our total company gross margin was down roughly 120 basis points from last year, with about 30 basis points coming from AIS and another 10 basis points from MSC Mexico.

Our base business price contribution remained positive and, in fact, improved due to the price increase. Although as expected, purchase cost continued to increase and mix remained a headwind.

Our OpEx to sales at 31.1% was flat versus the last year's Q2 and in line with guidance. Total OpEx was $256 million, up $17 million from last Q2, with about $5 million of this coming from the acquisitions. Just under $4 million of the increase was attributable to volume-related variable costs, such as pick, pack, ship, freight and commissions. Another $6 million related to growth investments, including additional field sales and service personnel and stepped-up marketing. Cost inflation and all other expenses net of productivity added nearly another $2 million.

Our fiscal second quarter operating margin was 11.7%. That's down roughly 110 basis points from the prior year with roughly 20 basis points of this due to AIS. Our base business operating margin was 11.9%, down almost 90 basis points from the same quarter a year ago and due to lower gross margins as noted earlier. Total company and base business operating margins were both in line with guidance. Our total tax expense on a percentage basis for the second quarter was 25.1%, also in line with guidance.

So all of this resulted in reported earnings of $1.24 per share, $0.01 below the midpoint of our guidance. AIS and MSC Mexico had no impact on reported EPS after rounding. Last year's reported EPS was $2.06 which included a onetime tax benefit related to Tax Cuts and Jobs Act of roughly $0.72. Also included in last year's Q2 was the catch-up of the lower tax rate on our year-to-date income. As noted in January, perhaps the simplest way to normalize EPS for tax benefits is to apply the current quarter's tax rate of 25.1% to fiscal 2018's Q2. And if we did this, Q2's EPS was $0.01 below last year.

Turning to the balance sheet. So our DSO was 54 days, flat with fiscal 2018's Q2 and down roughly 4 days from our fiscal first quarter of 2019 which is broadly in line with our typical seasonal pattern. Our inventory increased during the quarter to $573 million, up $45 million from Q1 as we continued to take advantage of calendar year-end rebate opportunities, build safety stocks ahead of possible tariff-related disruption and also to get ahead of impending supplier price increases.

Total company inventory turns remained at 3.6x. With tariffs looking less likely, we have slowed purchasing and expect inventory levels to decline in our third fiscal -- in our fiscal third quarter.

Net cash provided by operating activities in Q2 was $22 million versus $36 million last year. Our capital expenditures in the second quarter were $13 million versus last year's unusually low $8 million. And after subtracting capital expenditures from net cash provided by operating activities, our free cash flow was $9 million as compared to $28 million in last year's Q2.

We paid out $35 million in ordinary dividends during the quarter and bought back 275,000 shares for $21 million at an average price of $76.02. In last year's second quarter, we paid out $33 million in dividends and spent $18 million on buybacks.

Our total debt at the end of the second quarter was $593 million, comprised mainly of $281 million balance on our credit facility and $285 million of long-term fixed-rate borrowings. Our leverage increased slightly to 1.2x as compared to 1x at both Q1 and last year's Q2.

So now let's move to our guidance for the third quarter of fiscal 2019 which you can see on Slide 4 and is shown with and without acquisitions. Please remember that DECO is in the base, while AIS and MSC Mexico are included in the total company deals. Please also note that Easter is later this year and this artificially inflates our March growth but then suppresses our April growth rate. For the fiscal third quarter, of course, the anticipated impact is a wash.

So overall for Q3, we expect total company ADS to increase by approximately 5.5% to 7.5% versus the prior year period. This includes 3% to 5% of organic growth and around 250 basis points from acquisitions. Note that AIS was acquired on April 30 last year, so 1 month of sales was included in last year's Q3. And MSC Mexico is now included for the full quarter. You can see on the website op stats that March's total average daily sales growth is estimated at 9.5%. We estimate that this includes about 350 basis points from the acquisitions with Mexico contributing about 100 basis points of that. We also estimate that the month was boosted by about 200 basis points from Easter falling into April this year.

As Erik mentioned, our fiscal March was softer than expected for most of the month with a nice rebound in our final week, which is the first week of calendar April. Our guidance forecast assumes daily sales rates above the first few softer weeks in March but not at the levels we saw in the last weeks' rebounds.

Our Q3 operate -- our Q3 reported gross margin is expected to be 42.7% plus or minus 20 basis points. This is inclusive of a roughly 60 basis point negative impact from the acquisitions, and roughly 30 of this comes from the new Mexican business. Our base business gross margin is expected to be 43.3%, up 20 points sequentially from the second quarter and bucking the trend of a seasonal decline. Year-on-year, our total company Q3 gross margin is expected to be down almost 90 points with roughly 40 basis points due to acquisitions.

On our last call, we flagged price realization as the key gross margin driver for the second half of the fiscal year. So far, price realization has been strong. However, higher purchase cost and mix are continuing gross margin headwinds as higher sales growth coming from vending and direct ships comes at gross margin below the company average but they do contribute to our operating profit.

Operating expenses are expected to be around $262 million, up $17 million over last year's third quarter, with AIS and MSC Mexico accounting for roughly $5 million of this. Variable expenses associated with higher base sales are expected to account for another roughly $3 million. And an additional roughly $2 million comes from inflation net of productivity.

And finally, our growth investments including the higher field sales and service headcount are expected to be up roughly $7 million on the prior period. Recall that we added 35 sales and service associates in our fiscal fourth quarter, 34 in our fiscal third quarter and 16 more in our fiscal second quarter. We also added to our inventory management an implementation team to support accelerated vending signings. Sequentially, our base business OpEx is expected to be flat after allowing for the roughly $5 million of higher volume-related variable expenses.

So year-on-year in percentage terms, we expect our total company third quarter OpEx to sales ratio to be unchanged at 29.7% despite the higher growth investment spending. We expect the third quarter's total company operating margin to be approximately 13% at the midpoint of guidance, a 90 basis point decline over last year's 13.9%. The driver is a roughly 90 basis points gross margin decline with roughly 40 of this coming from acquisitions. The additional sales and service headcount added since fiscal Q4 2018 also contributes, but the impact is minor. Assuming the midpoint of our total company Q3 operating margin guidance, we would remain in the lower-left quadrant of our 2019 annual op margin framework through the first 3 quarters.

You might have noticed that we modified Slide 6 in our deck, and that's the operating margin framework. And this is including acquisitions. This is strictly to reflect the Mexican acquisition which dropped the [GM] ranges and the operating margins in each quadrant by 10 basis points.

Before turning to taxes, I would like to briefly cover incremental margins. In fiscal 2018, we delivered base incremental margins of over 22%. In fiscal 2019, we have taken a step back. Our first half base business operating profit only grew slightly as the decline in gross margins cost us around $2 million or 50 basis points of operating margin, and we invested around -- about $11 million for growth, mostly in field sales and service personnel.

Q3 is expected to show a similar picture. Our gross margins will be sequentially higher because of the February price increase but down year-on-year. And as Erik noted before, where OpEx is concerned, we intend to continue investing in field sales and service personnel through this fiscal year.

Our full year 2019 incremental margin picture implied by our annual operating margin framework was already slightly below 20%. Assuming the midpoint of our fiscal Q3 guidance for the total company, our 9-months year-to-date incremental margins will be only marginally positive. The primary driver of this is revenue growth. Sales have been softer than anticipated over the past couple of months, and our guidance assumes that this will continue in our fiscal Q3. At the same time, our higher growth investments, namely sales and service, with operating expenses as a percentage of sales, also slightly above what we had anticipated at this point in the year. As we look ahead, we remain confident that our investments will continue to yield payback and that we will achieve leverage on the step-up in investment spending.

Now turning to our estimated tax rate for the third quarter. It is 25.1%, in line with the first half of the year. Our guidance also assumes a weighted average diluted share count of roughly 55.4 million shares.

So our fiscal third quarter EPS guidance range is $1.46 to $1.52 per share with a midpoint of $1.49. This includes AIS and MSC Mexico which together are expected to have a roughly breakeven impact on EPS.

I'll now turn back to Erik.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [5]

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Thank you, Rustom. Before closing, I'll provide some perspective on our performance and our path forward. Over the past few years, we've repositioned MSC from a spot buy supplier to a mission-critical partner on manufacturing plant floors. This journey has included several important initiatives: migrating our product portfolio to technical and high-touch product lines; expanding our inventory management footprint through vending and VMI; creating a new value proposition anchored in producing cost savings and productivity improvements for our customers and reengineering our sales force to support the new value proposition.

As we entered this fiscal year, our plan called for improving revenue growth relative to the market, particularly in our core customers, moderating gross margin pressures through price realization and achieving operating expense leverage on our growth despite a step-up in sales investments.

Halfway through the fiscal year, the biggest difference in financial results compared to our expectations comes from revenue growth. While starting out in the right direction, top line growth has not maintained momentum, at least not over the last 2 months. Whether the moderation that we've seen continues or it proves to be just a blip is still unclear. In either case, we like what we're seeing from our growth investments. We therefore remain focused on our growth plan and we are confident that it will deliver the anticipated benefits as we move forward.

We'll now open up the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Evelyn Chow of Goldman Sachs.

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Evelyn Chow, Goldman Sachs Group Inc., Research Division - Research Analyst [2]

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I just want to start on your fiscal 3Q growth guidance and the deceleration you embed. Helpful to hear a few of the things you posited: Inventory destock in the National Accounts, maybe some potential share shifts, your government contract headwinds peaking next quarter. It seems like April is a step in the right direction, but from what I gather, a lot of the headwinds you cite don't really seem like things that resolve in the short term. So maybe Erik or Rustom, could you elaborate a bit on what you're seeing here? And also what factors could actually get better as you go through the fiscal year.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [3]

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Yes. Sure, Evelyn. I would say with respect to the deceleration in the growth rate, and we're referring to of course the base business, really 2 things to talk about. One is that, look, we did see softer conditions in February that continued into March. And what we've done with our guidance is assume that basically those conditions hold. In terms of color on that, I would say it was no one thing, a combination of a whole bunch of things. I mean some weather, particularly in February, I would say weather. Destocking which, what I'd say on destocking, hard to quantify but a lot more anecdotal evidence than we've heard about in the past. We saw some pockets of softness in automotive and oil and gas and a little bit of ripple effect from the government shutdown that occurred on some of our core customers who did government work. So that was the macro. I would say hard to say for sure, but a good chance that -- there's a case to be made that some of that lingers on, and there's a case to be made that says some of that is temporary and doesn't. Reasonably encouraged to see the start of the calendar quarter, second quarter or the first week of April, bounce back. So I think that's what we'll see. The second thing that I want to hit on is essentially what we're seeing. What you're hearing for me is despite the tick-down in growth, a lot of confidence in what I'm seeing from our growth initiatives. And essentially, what's happening is there is a lag between what we're seeing on the ground in terms of progress on initiatives and how that progress is translating into numbers. So during the prepared remarks, I commented on 2 of those: one being vending; and the other being business development or as I referred to as hunting, in other words, new account generation. So just to put some color on new account generation, we're seeing -- I talked about the growth in the size of the team, but that is translating. So new account signings had doubled in recent months, and these are signings per month, and we're seeing a pipeline that continues to grow. And most of that progress is being driven by the core team of hunters that have been in place for a while. Nearly half the team is new, meaning they've only been hired in the last year and haven't hit their stride yet. So we expect that pipeline to keep growing. Again, still early, but we're seeing a lot of positive indicators there. So as we look out, let's put the macro to the side and who knows what happens there. We do see a couple of things in our control that should positively impact growth rate. So one is just the math of Government lapping Government over the next couple of quarters which the headwind abates based, and that's worth roughly 1 point. And then between vending and new business generation, as we talked about, we see -- again, you can never pinpoint timing precisely, but over the next couple of quarters, at least 1 point there. So we do like what we're seeing on the ground and what's in our control.

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Evelyn Chow, Goldman Sachs Group Inc., Research Division - Research Analyst [4]

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That's all really helpful. And then maybe just touching upon something you raised just now. As you've been folding new salespeople into your organization, have you gotten a better sense of when they become productive, and when you feel like they get past that ramp phrase -- phase and start to produce?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [5]

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Yes. That's a really -- oh, you want to go ahead, Rustom? Go ahead.

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [6]

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Sure. I mean, it was the -- yes, Evelyn. Well first of all, they're different, right? There's some of the hunters are all the way from [trading] sales hunters to the large enterprise hunters. But the early economics of these hunters, I mean, that we're seeing they're producing, as Erik said, significantly more revenue per head and that gross margin's lower than company average but better than National Accounts. And most importantly, it's still early but the initiative is already breaking even from a P&L perspective overall.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [7]

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One thing I'll highlight just to underscore Rustom's point about early signs being positive. And just -- I have the benefit of being here since the "old days". Relative to -- and it is early, as Rustom said. But relative to the "older model", the one size fits all model before all these changes, we are seeing, for the base of sellers that have been here for a bit now, considerably higher revenue per head than what we saw under the old model. So very early, but encouraging.

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Evelyn Chow, Goldman Sachs Group Inc., Research Division - Research Analyst [8]

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And if may, just sneaking in one more in here on the fiscal 3Q margin. Rustom, I know you said it will probably stay in that lower-left quadrant of the guide, i.e., around 12.8%. Just thinking about typical seasonality, I think your fiscal 3Q margins tend to be up quarter-over-quarter 100 to 200 bps. Pricing should improve. So are you -- do you just think that particular quadrant looks especially good to you? Or are there other headwinds to margins that I'm not really thinking about?

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [9]

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No. I mean, the fiscal -- I mean, sequentially, I mean, between Q2 to Q3, I mean, there's normally a downward drift. So in this time, it's actually bucked it, the base margins. And that's due to strong price realization. It's net of the normal seasonality that with the price increases have been gone through earlier and then going through and then reflecting, but also increased purchase cost. But also don't forget that Mexico pulls down our Q3 and this is going off the base. Mexico pulls down our Q3 gross margin by roughly 30 basis points. Because remember, there's a clean 1 month in the first -- in the second quarter. And were you talking about gross margins? Or were you focusing more on op margins?

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Evelyn Chow, Goldman Sachs Group Inc., Research Division - Research Analyst [10]

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I was looking more at the EBIT margins, Rustom.

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [11]

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Oh, sorry. So look, I can give you that as well. I mean, the -- so the EBIT margins, I mean, we've -- and maybe I'll actually take it in terms of incrementals. I mean, we do expect incremental margins in the second half to be in the lower-left quadrant of the framework and we expect slightly positive incrementals for the second half. But it's too early really to be definitive beyond Q3.

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Operator [12]

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Our and our next question comes from Robert Barry of Buckingham.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [13]

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Just to maybe clarify, were you able to quantify how much these factors impacted the quarter: The weather, the government shutdown impacts?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [14]

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Rob, it is so tricky. So the short answer is no. I mean, what I would say though is what you saw from the base business, Rustom mentioned in the prepared remarks, we were off from the midpoint. So if we go February in particular, we were off from the midpoint of our guidance by about 40 basis points on the base business on the top line. That was -- the driver behind that were these factors that I saw and it was particularly in February, which quite frankly didn't surprise us all that much, based on what we were seeing in terms of weather and other reports and surveys about February. What surprised us a bit is that it extended into March with the exception of that last week of our fiscal month. But tough to quantify other than to say that, that gap between the midpoint of our revenue range and where we landed would be the difference.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [15]

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Got it. Got it. So kind of marginal, I guess, is the best estimate.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [16]

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It's certainly -- look, nothing we saw or we point to would indicate that any sort of major step down here. And certainly, that jives -- what we're hearing from customers, things did get off to a slower start for all of those reasons. But outlook generally remains pretty good. So nothing we're talking about here appears to be dramatic.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [17]

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Got it. And sounds like you put through the price increase, it went as expected. So on the base business, do you expect -- or does the gross margin forecast assume that you're net positive on price/cost in 3Q?

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [18]

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So the answer is no. I mean, because we have a very strong positive contribution coming back on realization on our pricing, but we also have a long lag coming through in our cost as we've explained before. And so think about our last quarter. If you think about the last quarter of fiscal '18, when we got pricing earlier than the cost coming through, we saw the positive benefit of that. Because we have an average costing system, because we buy ahead, because we defer increases, all the rest of that, it takes a while for cost to come catching up with us. And so we are seeing that, I mean, we are seeing that in our numbers. And for instance, in the first half, Robert, I mean, most of the P&L impact was from calendar 2018 cost increases, the costs that we saw coming through.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [19]

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And just to tag on to what Rustom's saying. If you're looking, Rob, to say, "Where's the pricing benefit?" Take a look -- the answer to that, Rustom sort of hit this in his remarks, that essentially, we bucked what has been -- if you look over our last few years, what you'd see is margin, absent any action, will tick down Q2 to Q3. It ticked up, that's basically price.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [20]

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Got it. I mean, do you think in 4Q, you'll be neutral? Or is there line of sight to being at least neutral on price/cost?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [21]

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Look, I'd say early to say, so many moving parts. The one thing I'd say, just the caution there will be generally if we follow a seasonal pattern as we do most years, you'll see Q4 generally will drop from Q3 primarily due to seasonality. That would be the typical pattern. But obviously, we'll give more color next call.

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Robert Douglas Barry, The Buckingham Research Group Incorporated - Research Analyst [22]

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Got it. I guess just lastly, I wanted to follow-up on the comments about all these sales efforts adding about 1 point to growth. I think a few quarters ago, you talked about the kind of sales realignment causing you guys to underperform the market by maybe it was 200 or 300 basis points. And as you kind of ramp the salespeople, that you could close that gap. And I don't know if that's taking longer or if I'm not remembering it correctly, but now it sounds like you're only talking about all the efforts adding 1 point to growth versus where we are now. So could you just clarify that, please?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [23]

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Yes, absolutely, Rob. So in terms of gauging progress, first thing I'd say is take a look. I think it's important to isolate Government in the story here because we've been pretty transparent about a couple of contract losses and Government changes we've been making. But when pulling out Government, if you look at our core business, which is where most of the changes were aimed, Q1, Q2, even into March, which granted March was helped by Easter, the core business is up high single digits, okay? So part of the changes -- part of the benefits are being seen in the performance of the core. The core is outperforming the company average right now. The comment about the 1 point was related specifically to one aspect of these changes, which is the new business generation. So from where we sit today, first of all, realize that our Q3 guide is contemplating some unexpected softness continuing. That may or may not continue. But regardless of the environment, what I'm isolating is the new business generation, we anticipate adding, and what I said was at least 1 point, and then building. So realize the way this works, Rob, is we've hired a lot of hunters. As you heard, the numbers went from a handful up to 100. And it takes roughly -- what we found is it takes a hunter somewhere, 3 to 6 months, to sort of build their funnel and be able to start hitting their stride. As they do, each month that goes by, they are -- we are seeing new account signings add. These new account signings are going to layer on top of each other. And so what I was describing in the 1 point was, looking out over a couple of quarters, getting at least 1 point. I absolutely expect, if we continue to execute, as the early signs indicate we will, that builds because these account signings layer on top of each other.

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Operator [24]

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Our next question comes from Scott Graham of BMO Capital Market.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [25]

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I was wondering -- I know, Erik, you commented that the more moderating sales in manufacturing in particular in February and March, that in fact, you saw a little bit of a snapback in early April, that the moderation was broad-based. I'm wondering, was the snapback similarly broad-based?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [26]

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Yes. And the only caveat is snapback, I wanted to -- so what we saw was a week. And granted, it was an important week, we felt, because it was the start of the calendar quarter. So if the destocking hypothesis had held, we felt it was an important week, but only a week. To answer your question, yes, it was broad-based. So very much the way softness was sort of broad-based, what came back was broad-based.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [27]

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Got it. Rustom, I was hoping that you could maybe shed a little bit of light on your thinking around third quarter free cash flow. Obviously, this quarter was impacted by some of the working capital build that you've talked about here. Does the lack of sort of pre-purchasing as well as the sales allow you to have -- should third quarter be a really strong free cash flow quarter, up year-over-year and all that?

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [28]

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Yes, Scott. And the answer is yes. We do expect the third quarter to be significantly better than the second quarter.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [29]

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And working capital would be a source of funds in the third quarter?

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [30]

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Well inventory for sure would go down. We expect inventory to go down. I mean, as sales grow and we continue -- I mean, I'm not sure if receivables will be a source of funds, they're not going to be an aberration-ally high use of funds, but they're not -- that's really a source. So the drivers are going to come from -- and also remember in the second quarter, we pay -- we have -- the way it works, we have 2 tax payments. That happens every single year. So that alone sort of gives us a ton of cash.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [31]

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Yes, fair. And my last question is you guys are kind of, the last couple of years, just give us sort of this price/mix net of discounts within your supplementary data, supplemental data. What I'm wondering is it's been positive now for 5 straight quarters. One of your competitors started, I guess a little over a year ago, to kind of say what they estimate mix is each quarter. Essentially, they wake up in the morning and they have certain -- negative mix is a certain range of basis points. Is that something that you guys might to be prepared to talk about, what you would -- you sort of your wake up in the morning negative mix, whether it's large customers, vending, other, e-commerce? Is that something that you could maybe give us a little more detail on?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [32]

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Got it. So I think a fair point. And look, we have pointed to ongoing that there is a mix element to the gross margin equation, a negative mix element. You're right, we haven't specifically [colored] it. Let us take it back and chew on it. Part of the reason, by the way, when you see our decomposition, you're right, what you is price/mix together. And look, the fundamental reason is, in a business with 1 million-plus SKUs, several hundred thousand customers, there's a lot of permutations. Getting at price realization, there's multiple ways we look at it. It's, in many cases, very hard because a lot of our customers are not buying the same items every quarter every year, they're random purchases. It's very hard to disaggregate mix from price, which is why you see them together. Let us see if there's something we can do to give you some more and point you in the right direction.

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Operator [33]

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Our and our next question comes from Hamzah Mazari of Macquarie.

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Hamzah Mazari, Macquarie Research - Senior Analyst [34]

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My question is largely around operating leverage for the company. It feels like, post the Barnes deal, that took longer to integrate, we had a sales force strategy shift and now it feels like some of these growth investments are just late in the cycle. Do you think, longer term, the company can get op leverage in a slowing macro? Meaning, do you think that the share gain in a slowdown, given these growth investments, will materialize? Or we just have to wait for the next cycle to see these growth investments pay off?

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [35]

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So, Hamzah, so maybe I'll take that and then take it in terms of incremental margins and maybe bring the conversation back to that. So we've talked about achieving a 20%-plus annual incremental margins. And we said to do that, we need a mid to high single-digit organic revenue growth, flat or modest erosion in gross margin and OpEx productivity offsetting inflation, okay? So right now, we're seeing greater than modest gross margin erosion. Our stepped-up growth investments are not yet producing payback. I mean, you've heard me mention that on the business development people, we've come to break even, but we're at that point. So as a result, we're going to be well below the 20% level this fiscal year. But looking beyond, I mean, our current growth investments will abate and then it comes down to gross margin erosion. If gross margin erosion remains at current levels, we will need low double-digit sales growth to get it and we go from there. And probably the only other point to mention is OpEx productivity. I didn't cover that. But if you saw the last 2 quarters, we talked about it, I mean, on a $3 billion-plus business, I mean, if you look at the -- our productivity has offset, in Q2 and in the projections of Q3, all but a couple of million dollars of inflation. So we continue to focus on that, too. Does that give you enough of a...

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Hamzah Mazari, Macquarie Research - Senior Analyst [36]

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No, that's helpful. I was just wondering, are these growth investments just coming too late in the cycle? Or do you think structurally, these investments just take longer to pay off than some of the investments maybe you've made in the past cycles?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [37]

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Hamzah, I mean, from our perspective, when we look at growth investments, really, we try to do it in a cycle-agnostic sort of way and say, "Are these good return on investments? Are going to get high payback from the investments over cycles?" Because it's very hard to run the business throttling up, throttling back. Now certainly at the margin, we can temper based on environment. But we look at over a cycle saying, "Are these investments going to produce payback?" We're confident in these investments. And I would say so far, while I understand all of us would like it to happen faster, no question, relative to past investment -- growth investments that we've made, I'm not necessarily seeing that it's going to take that much longer. I think we -- all the signs point towards improved growth. So the only last comment I'd make it is right now, I understand your point about late in the cycle. But just to be clear, nothing we're seeing indicates that the macro is going way down. It may be moderating. But even in a moderate economy, there's an opportunity for us, as these investments yield payback, to improve our growth rates and produce the kind of growth rates that you're used to seeing from us.

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Hamzah Mazari, Macquarie Research - Senior Analyst [38]

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That's very helpful. And just a follow-up and I'll turn it over. I may have missed this, but did Easter have any impact in sort of the first week of April pickup that you're seeing? Or it's just -- it didn't really have an impact?

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [39]

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Easter helped our March number -- our estimated March numbers by a couple of hundred basis points. But it will get wiped out completely in April. So by the time we finish the quarter, net 0.

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Operator [40]

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Our next question comes from John Inch of Gordon Haskett.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [41]

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So I want to start with the gross margin guidance for the third quarter. I guess we've got AIS and Mexico kind of 40, 50 basis points. The core, right, the 42.7% shows sort of no benefit from the sequential volume improvements. So I'm assuming this is the -- Rustom, what you've talked about, the gross margin degradation. But we've got price, I guess, with 80 basis points of realization, should be a lot more this quarter. What's the -- is there anything else you can comment on with respect to why there's not better gross margin leverage given the volumes and the price increase put through?

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [42]

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John, sure. So the 42.7% is the total, is the total, right, which includes all the acquisitions and everything, all the negatives and everything from there already in that number. If you looked at the -- if you looked at our base number without even AIS, so if we're comparing complete apples to apples, so I mean, that number was -- is still up 20 basis points. And so we're seeing sequential rise coming through. It's fundamentally the same thing that we -- that I tried to explain earlier, which is that the price increases are going through, right, but you're having the lag effect of costs coming through. And that's coming, right? We build that. And then finally, there is, of course, a mix element when we do more vending and certain things so that they come to at a lower gross margin for sure. I mean, vending is about minus 40 basis points compared to -- it's pulled us down about minus 40 basis points a quarter, pretty consistent with what we've seen. And then finally as you said, there's the 60 basis points also coming from the 2 acquisitions.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [43]

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John, the only thing I'll add to Rustom's comments is takes books -- so if you go sequentially, and what I would suggest you do is put Mexico to the side, and I say that because Mexico was in one period and really essentially not in the other. And if you compare Q2 to Q3, plus 20, take a look at our last few years and look at it without a meaningful price increase because we really haven't had a meaningful midyear price increase in the past few years, and look at the gross margin performance over those -- from Q2 to Q3. And when you compare this year on those, you'll see a pretty sizable difference, that's effectively pricing net of costs.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [44]

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So the core growth in March, I think, ex Easter and acquisitions, was about 4%. But you talked about core -- I'm sorry, the organic growth. But the core account growth was high single digit. That almost sounds as if it was holding up throughout. So was it the large accounts that stepped down, if you were to parse that out? Or was it the drag from Government got even worse? Just because you talked about the core stuff being pretty resilient, what actually happened ex those other moving parts?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [45]

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John, so you're -- and you're talking about specifically March?

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [46]

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Yes. That seemed to be kind of the big month here.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [47]

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So to be clear, I want to make sure I'm transparent. So core was high single digits in March. That was relative to the 6% for the company. You have to take off -- that's inclusive the Easter effect, okay? So we're estimating the Easter effect had about 200 basis points, which brings the 6% down to an effective 4%. It would bring core down also.

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John G. Chironna, MSC Industrial Direct Co., Inc. - VP of IR & Treasurer [48]

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So also, it's John, sorry. But also Government, as we have indicated, was going to be down double digits for the quarter and March is the first month for the quarter. So yes, Government took a step down from the Q2 levels.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [49]

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Right, with 3Q being the worst inflection. Do you think there was any kind of -- considering you guys were raising prices, do you think there was any kind of a pull-forward if you go back to the fiscal second quarter as you looked at sort of the trends within your accounts, Erik, that maybe have accounted part of the step-down versus the broader economy or maybe disruption from your sales force initiatives or something that's more idiosyncratic to MSC?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [50]

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John, it's a good question. Generally, with price increases, given the percentage -- of one of our customers, if you look at the stuff we supply, industrial MRO supplies, as a percentage of their total spend, it's not that big. It's not the kind of thing where they would be buying in advance because it's just not that big dollars. Look, what is possible, because we did hear some destocking, as I said, anecdotes, tough to quantify. But more anecdotes than we've heard it in recent quarters, is more of being macro buying, I guess, because of tariffs or whatever late in calendar 18, that's possible. I don't know. I don't think it would be, to your -- like, idiosyncratic, MSC-specific on price increase? Don't think so. Nor do I think, by the way, that there was any sort of price -- connection between pricing and volume. We look at that pretty carefully as part of our price realization and saw no difference between where prices were raised than they were in terms of units.

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John George Inch, Gordon Haskett Research Advisors - MD & Senior Analyst of Multi-Industrials [51]

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Got it. A couple more quick ones. Rustom, is the 30 basis points from Mexico, is that kind of onetime based on step-up of inventory and amortization? And then Erik, how are you thinking about maybe firepower to do a larger deal? It was announced that Kaman's exploring a sale of -- that would be a very large deal. But I'm just curious about your own thought process now that you opened Mexico, AIS seems to be under your belt, what are you thinking going forward?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [52]

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So I'll let -- Rustom will hit...

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [53]

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Right. So I'll go first. So not a major inventory step-up over there. But yes, when they -- in the go-forward quarters, we'll expect Mexico to be, rough, closer to 20 basis points of downward. Erik?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [54]

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Yes. And John, to your question on M&A, I mean, I'll even take it up a notch on capital allocation. Our approach pretty much the same, this idea that we refer you, inside the company, of think like an owner which means spend the next dollar of free cash flow where we see the highest risk-adjusted return. I would say a couple of things of note right now, two factors. And certainly, we have a robust M&A funnel, no question, but 2 factors I'd point out. Number one, we're seeing valuations as being pretty high right now, pretty robust. And number two, look, you've heard we've got a bunch on our plate. We're heavily focused on our organic growth investments and seeing the early signs of progress translate into results, and that's where we're putting most of our focus. So certainly, M&A, there's always a funnel, but I would say right now the bar would have to be pretty high to do a large deal.

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Operator [55]

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Our next question comes from David Manthey of Baird.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [56]

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First off, could you give us your specific definition of what a core customer is and approximately what percentage of your sales are to core customers today?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [57]

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Yes. Very fair, David. So I'll give you a definition, and by subtraction here, which is a sense -- I mean, the cleanest definition is if it's not National Accounts and it's not Government, we're referring to it here as core. But when it gets that -- and as a percentage of revenues, look, it's over -- we've given you National Accounts, we've given you Government, so look, it's over half the company's sales. And it is reflective, when you look at what makes that up of -- could be anything from small, medium to even some large. But our sweet spot of manufacturing customers, that is where you see that most strongly.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [58]

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Okay. And the remainder, I guess, beyond end market would primarily be a transactional type customer. Is that fair?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [59]

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Sorry, not following, Dave.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [60]

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Well, rather than having a National Account relationships, some sort of a vending solution, integrated supply, VMI, sort of what you would consider not in that core group, would be more of a simple relationship with MSC, maybe more transactional in nature. Is that correct or no?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [61]

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I see your point, Dave. So what I would say is within that core bucket, there are different types of relationships. So even within core, even for a customer that's not a National Account, there may be a very formal relationship in place with a program a la National Accounts, just not at the size and scale of National Accounts. There may be something that's a program but a little simpler, an inventory management solution that's in there. Or it may be a small customer where the relationship is through telesales or even through our direct marketing channel. So that core can span anything from a small transactional relationship with our -- through our direct marketing channel, through a program.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [62]

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Okay. And then last question in terms of your strategy to target that noncore customer, I think you've clearly outlined with sales force effectiveness how you're going after the core. But I'm not sure I'm clear on how you're targeting the rest of the customer group in terms of that transactional customer, your sort of web pricing, catalog pricing. Can you just give us any kind of color, Erik, on the strategy that you have for the rest of the business that's not really focused in this sales force effectiveness initiative?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [63]

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Absolutely, Dave. So we have, within that core bucket, are many customers who don't have a formal relationship with a salesperson. They go through what we refer to as a direct marketing channel. And what we've done, interestingly, as part of the sales transformation effort, is we've taken pieces of it. Not the sales force, but pieces of particularly around the value proposition, and we've applied it to those small customers who are doing business with us through the web, through marketing campaigns, through inbound call centers. And what we've done, and it's actually translated, Dave, and it's one of the things we didn't talk about today, but we have over the last couple of quarters, is seeing considerable pickup in the growth rate in that small direct marketing channel. We've moved it from being a more transactional relationship to focusing more on some of the value-add, ways to help with cost savings, and just doing it without a person.

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Operator [64]

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Our next question, it's from Adam Uhlman of Cleveland Research.

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Adam William Uhlman, Cleveland Research Company - Partner & Senior Research Analyst [65]

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I was wondering if we could just step back and talk about the Mexico business, maybe if you could give some more insights and -- on what your plan is over the next year or 2. Some specifics about the size of the business and kind of the margin profile, customer profile, would be helpful.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [66]

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Sure, Adam. So look, I think the core, the essence of that strategy here was twofold. One, reinforce the core business. And by core business, what I'm talking about here is the business in the U.S. Many of our customers, be it a National Account or otherwise, have plants or contemplating a plant in Mexico. And being able to present ourselves, we now have Canadian presence through the CCSG business, this gives us a footprint to present ourselves to those customers as a North American supplier. We think that's important. The second piece to the strategy is that Mexico, over time, we still see as a growth market for manufacturing and it's an opportunity to have a direct presence to a growing manufacturing market. It's something that we've had our eye on for a while. And really, it was about waiting until we found the right partner, which we did. Size of the business is small. As we said, it's immaterial. But really, this is about a foothold and a foundation for growth.

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Adam William Uhlman, Cleveland Research Company - Partner & Senior Research Analyst [67]

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Okay. Got you. And then just from a high level, as I think about kind of price versus cost going forward. Is it a fair assumption that the company is going to be maybe pushing more on trying to reduce the growth in product costs? Or should we expect maybe a pull-forward of the catalog increase earlier in the year to offset this lag of product cost? I understand the mechanics of how it moves through your P&L, but which one of those do you think you're looking greater at? Is it trying to reduce your cost growth? Or do you think you have to pull forward that price increase you normally do on Labor Day?

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [68]

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Adam, I would say yes and yes. We're looking at price and cost. It's a silly answer but it's sort of the truth. But I would say on -- look, on the cost front, yes, there is going to be some focus on -- particularly if conditions moderate, yes, there's going to be a focus inside the company. We have a meeting coming up with us some key suppliers and that's going to be part of an ongoing dialogue. Yes. So we will step up our focus on purchase cost, particularly if things soften. So you will see that from us. In terms of pricing, I'd say it's too early to tell. I mean, that's usually -- that's a decision, Adam, we'll make based on market conditions and customer willing to accept as opposed to just the number. So I would say TBD on the pricing.

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Operator [69]

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Our next question, it's from Sam Darkatsh of Raymond James.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [70]

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A couple of quick questions. First, the total e-com platform sales were about, what, 6.5% year-on-year, which is real similar to your ADS organically, excluding acquisitions. And that's the first time in recent memory the total platform sales haven't been a growth driver. I'm trying to reconcile that with the fact that, obviously, vending was still a significant driver to organic growth and vending is included within total e-com platform sales. So I'm trying to reconcile what that meant, also why it wasn't a driver this quarter.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [71]

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So Sam, the one caveat, and let us take a look at the numbers, but I do know that a lot of times that e-com as a percentage of total could be influenced by acquisitions.

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John G. Chironna, MSC Industrial Direct Co., Inc. - VP of IR & Treasurer [72]

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Yes, exactly. Exactly right, Erik. So Sam, those acquisitions are coming in at -- they're in the denominator, but they're 0 e-com. So that's why you're not seeing the same growth that you've seen historically.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [73]

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Right. But I'm comparing the e-com sales to your ADS excluding acquisitions. I would think that's an apples-to-apples comparison. Isn't it?

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [74]

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Then I'll have to double-check that. But I'm not sure. I'd like to see how you do that, but okay.

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Erik David Gershwind, MSC Industrial Direct Co., Inc. - President, CEO & Director [75]

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Let's assume it's the case, though. If so, so 2 things I would caution. One is realized vending, you are correct. Vending is growing. We're actually excited to see it really taking off last year. The growth -- the kind of growth we're seeing this year in signings, of these 50% growth, is not yet making its way to the numbers. I think that's a really important point. Another one of those examples of kind of seeing it on the ground and not translating into numbers yet. So the second thing about vending is that realize when we sell vending to a customer, only a portion of those sales will run through the vending machine. We see a lot of pickup in sales we're seeing outside of the machine that may or may not be electronic.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [76]

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Last question for me. The share repo activity was a little bit lower this quarter versus the prior couple of quarters despite the fact that the stock and the valuation was lower than in prior quarters. Was that because of your internal visibility with the Mexican deal? Or is that -- does it have to do with the slowing trends you saw in February and March? What was the reasoning behind the share repo activity moderating?

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Rustom F. Jilla, MSC Industrial Direct Co., Inc. - Executive VP & CFO [77]

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Well, if you look at the last 3 fiscal years through '18, right, just sticking with the fiscal years, we've done $515 million worth of buybacks. And then we had some pretty -- sort of pretty decent buybacks in Q1 and then the smaller number, as you pointed out, in Q2. So yes, we continue to buy back shares. I mean, no, there's nothing specific. I mean, Erik kind of talked about this earlier, so I'll just repeat very quickly. We are balanced and opportunistic. We continue with this. We focus fundamentally on our organic investment and then on steadily growing our dividends. And we're not really driven. We don't have a target per se that says we'll go out and buy back shares, buy x or something [better]. Because we're also quite willing to just build up cash. And so it's just a function of how it's played out there.

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Operator [78]

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This concludes our question-and-answer session. I would like to turn the conference back over to John Chironna for any closing remarks.

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John G. Chironna, MSC Industrial Direct Co., Inc. - VP of IR & Treasurer [79]

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Like to thank everyone for joining us today. Our next earnings date for the Q3 is set for July 10, 2019. We'll be out on the road and at various conferences over the coming quarter, so we look forward to speaking with you over the coming months. Thank you.

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Operator [80]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.