MSC Industrial Direct 2Q17 Earnings Call Notes

Erik Gershwind – Chief Executive Officer

Conditions improved as manufacturing firmed

“Conditions steadily improved through the quarter as manufacturing continued to firm up. This was reflected in the most recent MDI readings with May reaching 57.1, the highest reading in more than 5 years. June’s reading came in last week at 56.2. Feedback from customers who is consistent with the theme of continued and steady improvement and this is reflected in their order volumes, backlogs and general sentiment.”

End markets were strong

“From an end market perspective, aerospace, fabricated metals and machine jobs continued to improve as did oil and gas related business. While automotive was still strong, it wouldn’t have been spottier than it has been over the recent past. Other end markets like heavy truck and agriculture have appeared to bottom and showed some improvement. As customer sentiment continues to be positive and the industries hold at their current levels, we should continue to see improving sales trends.”

Prices haven’t really moved yet

“what I would say there so we track a number of commodities, okay, a bunch. You could imagine given our exposure to metal working, we will look at the materials in particular that make up cutting tools whether that’s steel or carbide and tungsten and such. What I would say though is the vast majority of our sales as a percentage are connected to branded manufacturers. And so unless manufacturer moves I mean generally what we are going do is mirror where their list prices are and not get out ahead of their list price. And so unless the manufacturer moves it’s – even if the commodities have moved and to be honest that’s something that surprised a bit over the last call it 6 months to 12 months these commodities certainly for a while have firmed up and there wasn’t as much manufacturer movement. Now, that could change. We are hearing bits and pieces that that could change as capacity starts to get fueled out by the manufacturers. But really for us the trigger is seeing a manufacturer move their list prices.”

Core customers are paying up for performance because of competitive threats

“I actually see different dynamic happening, particularly look, we realized our sweet spot called a medium size manufacturer and what we find with most of our customers right now they are facing competitive threats, they need more productivity, they need to get product to markets faster, etcetera, etcetera. They are starving for productivity. And in a lot of cases the productivity – if they can move the needle on their productivity, their manufacturing process, it dwarfs the savings they can get on the product itself. And so what’s actually – what’s interesting and what’s happening like if you take our cutting tool portfolio, it’s actually migrating up in quality of products, because in a lot of cases they are going to spend more for the product if they are going to get a much better length of cutter, the length of the tool life and the productivity coming out of the tool. And it’s actually moving the other way towards high performance. So I think our core customers anyway the big lever for them is productivity and getting more output for less dollars.”

MSC Industrial Direct FY 2Q17 Earnings Call Notes

Erik Gershwind

Conditions remained positive

‘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.”

Growing optimism

“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.”

Orders have begun to turn the corner

“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.”

Hearing more an more conversation about future price increases

“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.”

We are coming out of a prolonged industrial recession

“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.”

Building optimism, not just cautious optimism

“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.”

Broad based improvement in sentiment

“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.”

Even oil and gas is stabilizing

“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.”

Tools are getting used

“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.”

Price increases would come in the August/September timeframe

“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.”

MSC Industrial Direct FY 1Q17 Earnings Call Notes

Erik Gershwind – President and CEO

Environment stabilizing

” I’ll begin this morning’s discussion by covering the environment which is showing potential signs of stabilizing. We’ve also seen increased optimism from our customers over the past couple of months.”

Return to growth in December

“While conditions remain difficult throughout the quarter we did see a better than expected November as well as a return to growth in December, the start of our second quarter. The improvement in growth rate was across all of our customer types. MDI readings that had risen above 48 back in August continued above the 48 level through October and then ticked up to 49.7 in November and 49.8 in December bringing the rolling 12 month average to 47.2. The most current readings imply essentially stable metal working end markets, and are a significant improvement over the trends of the past year. Remember that December of last year was at a reading of 44.”

Marked improvement in optimism driven by

” there is also a market improvement in optimism about what the future may bring. This optimism is being driven by a couple of things, first there is an expectation that increases in infrastructure spending, lower corporate tax rates, and a more business friendly regulatory environment will provide a stimulus to the industrial econom”

Still need to see sustained increased optimism

” All of that said we caution that these are not yet sustained trends and increased optimism will need to translate into sustained increases in demand and order activity before we declare that the environment has turned.”

Price activity is not yet broad based

“I’ll now turn to the pricing environment where it remained soft in the fiscal first quarter and continues to be so. Commodity prices are still fairly low relative to historical levels despite improving over the past year. While we have seen some supplier price increase activity, we characterize it as selective and not broad based. That said any activity at all is more than we’ve seen over the past couple of years. If we continue to see increases we anticipate taking a very modest price increase sometime in the next month or two.”

Potential for a spring loaded effect when the economy returns to a stronger foot

“Many of our customers businesses have been depressed by the difficult environment. And this has created the potential for a spring loaded effect when the industrial economy returns to stronger foot. ”

If the recovery comes we have a great earnings leverage story

” we are now seeing signs that a potential recovery could be coming. If in fact it becomes a reality we will benefit from a tremendous earnings leverage story.”

Distribution is winning in the marketplace

“. I would say we are seeing a trend among some of our suppliers with many already do all or virtually all of their sales through distribution. I would say there is more of a trend of laid towards putting more of sales through distribution. And I think the reason that’s the case is because distribution is winning as a channel in the marketplace. So I think it’s a response to what’s happening with customers making choices about where they want to buy and that’s through well performing distributors. ”

We are seeing a clear improvement in growth rate

“look no question when you hold back. We are seeing an improvement in the growth rate in the business, okay plain and simple because you’re right you point to its start in November being better than expectations, December certainly better. What we wanted to do though is give you a realistic picture that I would say in terms of December it was a pretty strong month across the Board obviously.”

We did see capital related purchases

“Now our belief there Matt is we did see a spike in what we call Capital related purchases. So these — it could be a machine. It could be a tool holder, it could be a tooling package, let’s think of that like a start up kit of cutting tools when a customer purchases a machine. Or all of those things tend to imply optimism about the future obviously if they are investing in the business.”

Optimistic end of year buying probably wont continue into January and February

“Our assumption right now and again Rustom mentioned limited visibility, we’re sitting here very early in the month of January is that a lot of what we saw was end of the year buying because customers are more optimistic and that won’t continue in January and February. Which kind of gets us to more or less flatter January and February.”

It’s been at least three years since we’ve seen anything resembling this

” it is at least three years because the last two years there’s been really low confidence among our customer base. It has been at least three years since we’ve seen anything resembling this””

The stabilization has been pretty broad based

” This stabilization has been pretty broad based Adam. So across most of our core customer types that we referred to was our typical core customer types of the machine and equipment folks, primary metals, metal fabrication. All of those are seeing an improvement over the last couple of months. I think some of that is driven by oil and gas, no question Adam because we’ve said the indirect effect on all these job shops. And again what we’re hearing is more stabilization than it is a strong rebound even with oil and gas

Rustom Jilla

Probaby 40% of our goods are ultimately foreign sourced

“Look, I mean yes, our federal tax rate is pretty much we pay our full federal tax so any reduction whether it’s 20% to 25% to 15% any reduction will be a positive for us, right. The ultimate EPS benefit to us and we definitely expect it will depend on what the offsets are and whether there are any offsets. I mean that could be with foreign tariff, cross border taxes, interest, a whole bunch of different factors which might or might not come into play. So it’s hard to quantify. I mean since you did ask the question it was foreign tax related but I will sort of make the point on the — on our cost of goods sold as well in there and that is that remember that about 12% to 15% of our cost of goods sold comes directly from outside the U.S. And we believe that — and we believe, we don’t have the exact number with the U.S. purchases that are actually foreign source it’s roughly about 40%.”

We are ultimately expecting a net benefit

“So remember many suppliers have multiple countries of origin and alternatives as we do also. And in any case inflation is historically good for distributors but it’s a bunch of different factors here that mean it’s hard to quantify exactly how much of the benefit will flow through but we clearly are expecting a benefit. ”

What we would do with extra cash: dividends and M&A

” Now part B of your question is what will we do with that. So I mean, look I mean in general we believe in steadily increasing our ongoing ordinary dividends. I mean we’re very, very Erik and I have been very consistent in terms of communicating that. There’s no reason to think that will change. And we have also demonstrated over the years that if we do have excess cash flow over and above requirements, we are balanced and opportunistic in terms of capital management and if we do have excess cash at the end of the day that we can’t deploy in the business, that we can’t deploy you know for ordinary dividend increases, and if we don’t have attractive M&A we are absolutely not averse to returning it by way of open market by banks or even tender type things.”

MSC Industrial Direct FY 4Q16 Earnings Call Notes

MSC Industrial Direct (MSM) Q4 2016 Results

Erik David Gershwind

Conditions remain very difficult

” Conditions remain very difficult throughout the quarter, much as they have for the past few quarters. Low oil prices and the strong U.S. dollar continue to weigh on manufacturing activity. While we did not see the more extensive summer plant shutdowns that some of our customers were talking about back in late June, demand levels remains depressed particularly in metalworking and heavy manufacturing.”

MBI readings have ticked up, bode well for the future

“As you may have noticed, MBI readings have ticked up over the past two months posting over 48 for both August and September. While these levels still denote contraction in metalworking end markets, the readings are nonetheless a significant improvement over the trends of the past year. If they sustain, it would bode well for our future prospects and indicate a potential leveling in the metalworking industry. That said, for now we remain cautious.”

Conditions continue to be extremely soft

“Visibility remains extremely low with some customers taking a wait-and-see approach as is typically the case in a presidential election year. With respect to the pricing environment, conditions continue to be extremely soft”

Example of services provided to customers

“So how are we achieving this better than market growth? I’ll give you a simple real-life example. For a number of years, we were doing a modest level of business with a metalworking company in the southeast. This manufacturer had a strong relationship with a local distributor that was providing good service and high levels of technical expertise, so the company didn’t see a reason to change. However, as conditions softened and its business started coming under pressure, this company became more receptive to hearing about our inventory management program in order to reduce cutting tool inventories, our high service levels that shrink lead times, and our metalworking experts who produce documented cost savings on the production floor. Fast forward two years and we have now more than quadrupled our business with this customer.”

Not really seeing much material change in the environment

“So if you look back over the last few months, you’d say, oh August looks like things are getting better, September ticked down, October back up, and the reality is it’s moving around. We don’t see, at this moment, material changes than what we did for November was took the average of the two.

A lot of our customers are telling us they want to wait and see what happens after the election

“I would say for the most part, and what you heard from our comments was more of the same. With the one added dimension, so you know, generally pretty soft, low backlogs, low order flows, some pockets of activity as we pointed to, oil and gas continues to weigh, we have not seen that pick up; heavy machinery, infrastructure continues to weigh. I think the one added thing that I would add in as we have gotten closer to November to the election is, from many of our customers, we’re hearing wait-and-see and that’s pretty typical in an election year. I mean, that’s the one new thing I’d call out over the last quarter and it’s typical that it builds as you get close to November. So, I don’t make much of it either way. I don’t think any of our customers have a sense of what it’s going to mean for after. The only thing I think it means is that, we always say our visibility is low, it’s probably even a bit lower just because of the cautious perspective that many of our customers have.”

MSC Industrial Direct FY 3Q16 Earnings Call Notes

Erik Gershwind

Conditions weakened

” Conditions remained quite difficult and in fact grew even more challenging as we progressed through our fiscal third quarter and into June. On our last call, we described a tough environment. And in talking to our customers and looking at the macro indices, commented that we saw the potential for some stabilization on the horizon. Unfortunately, that did not materialize and in fact things weakened.”

Continues to be driven by low oil and strong dollar. Brexit could create further headwinds

“On a rolling 12-month average, the MBI currently sits to 45.3, which implies the continued and significant contraction in metalworking manufacturing activity levels. This is consistent with what we are hearing right now from customers who are describing short backlogs, soft incoming orders and low visibility. It’s also consistent with what we are hearing from suppliers who were seeing very much the same thing. The root causes for this prolonged downturn remain the same, the ongoing effects of low oil prices and the strong U.S. dollar. The uncertainty around the impact of Brexit could serve to create further headwinds on U.S. manufacturing exports, given the stronger dollar as well as the potential slowing of underlying European demand.”

Hearing more about furloughs, time off and even layoffs

” the sense that the industrial economy may have been stabilizing has given way to more belt tightening and less optimism among our customers. We are hearing more talk about furloughs, time off, and even some layoffs. And while our visibility remains very limited, we are beginning to hear about distributors laying off sales people, which we have not heard much of until very recently.”

Pricing environment remains soft

“Turning to the pricing environment, it remains extremely soft. While there has been some upward movement in many commodities during the calendar year, it has not yet translated into the manufacturer list price increases that are needed to trigger distributor pricing moves. ”

Low interest rate environment means good time to return capital to shareholders

“As we have done periodically throughout our history, we see now is a good time to return capital to our shareholders, particularly given the extremely low interest rate environment. At a size of roughly $390 million, this repurchase will put our leverage ratio at about 1.4x, giving us plenty of flexibility for future opportunities, including acquisitions or additional share repurchase.”

stabilization has not materialized

” The weakness is pretty widespread within manufacturing. I would say it is acute within our sphere of the world within metal cutting manufacturing, so many of the segments that we pointed to before heavy machinery, metal fabrications such as job shafts and machine shafts, etcetera. So really, not much of a change, I think you are right, from our perspective a quarter ago, our sense was that there was a chance of may be stabilization. I wouldn’t have called it an uptick, but stabilization. That is certainly not materialized.”

June was a really bad month

“I mean I can just anecdotally tell you that for the month of June, what we heard from customers and particularly, what I heard from some of our key supplier partners that June was a really bad month. So, what you see – the one caution I will give you is it’s always tough for us to sort out this time of year, how much of this as I said is a material step down that’s ongoing versus softening as we get into the summer and customers taking advantage of summer slowdowns in a more serious way”

We have scratched our head at recent ISMs

” The ISM, I would tell you that it’s been – to be honest we sort of scratched our head at the latest reading. But I think we have been – we and the rest of the industry have been scratching our head at the readings over the last several years, so really not surprising. And just if you ran regression analysis against our average daily sales levels in the ISM, you would find over an extended period of time and you would find virtually no correlation, very different from if you ran the regression analysis against the MBI on the rolling 12-months average. So not much do I make of that. I think more relevant with respect to June as you pointed out is we certainly look at the MBI, we will look at other indices and most relevant to us, is talking to customers and talking to suppliers. ”

It’s pretty acute in metalworking

“I think the softness is fairly widespread, but of course, we are coming from a world, Ryan, where our front porch is metalworking end market. So, it’s pretty acute in the metalworking end markets.”

Customers are scratching their heads on Brexit, probably a net negative

“Yes. I think post Brexit, what I would say is again, going back to the comments I made earlier on the UK, uncertainty. I mean I think like everybody else, our customer suppliers kind of scratching their head, not sure exactly what to make of it, so a lot of uncertainty. Look I think the general sense though is net-net a negative, not a positive and that it creates a headwind given both the potential for the stronger U.S. dollar, which hurts exports and then the potential for weakening underlying European demand that would also hurt exports. So, I think the sense would be net negative, but uncertain as to how big of a headwind and how much to make of it.”

MSC Industrial Direct FY 2Q16 Earnings Call Notes

Erik Gershwind

The environment remained difficult and root causes haven’t changed

“As expected, the environment remained difficult and the root causes have not changed. Sustained low oil prices and the strong U.S. dollar with its negative impact on export demand continued to be a drag on manufacturing activity. While macro indicators have improved since our last call, they still reflect a significant slowdown in manufacturing with US factory activity continuing to contract.”

Prevailing sentiment is that business will possibly improve

“we just completed a survey of our customers and the prevailing sentiment is that business will at least stay the same and possibly improve in the months ahead. We would certainly like to see a bit more time pass before forming our own conclusions. ”

Pricing environment conditions remain extremely soft

“With respect to the pricing environment, conditions remained extremely soft due primarily to the lack of commodities inflation and a high degree of competitive intensity that comes with a prolonged downturn.”

I wouldn’t say explosive growth, I’d say stabilization

“to me the outlook is less about any sort of explosive growth. The word I would use is potential for stabilization. So things have been at a low level.”

Deflation is causing pricing pressure

” I mean if you look at what’s happened deflation in commodity, so lack of any inflation in this case deflation has resulted in no ability to take pricing. So that’s in these overwhelming headline number one. I guess it depends on your take. From my standpoint that is cyclical, we’ve got decades and decades of history to say that that ebbs and flows.”

Did see aerospace soften a bit mid march

“Anything heavy equipment machine related, infrastructure related, really tough. Aerospace has obviously been a bright spot. We did see, as Rustom pointed out particularly in that mid-March period, we did see it soften a bit.”

There was a softening in March, but we think it’s just timing

“Look, in speaking to customers and government by the way, what we would say is, we also saw really softening in March. As best we can tell, a lot of that has to do with timing. End of March is their quarter end and then there was a squeeze. As best we can tell and we just pulse checked our customers, general sentiment would be things stabilizing. If we looked out to next few months, most felt like stable, maybe some signs of life. Certainly there were some we felt further erosion, but majority not.”

Rustom Jilla

March saw considerable mid month softness

“March started out quite strongly, but we then saw considerable mid-month softness driven by confluence of factors. In terms of end-markets, the extreme pressure in oil and gas and continued challenges in heavy equipment and machinery. Then we also saw some weakness in aerospace driven by a push out in orders of commercial aircraft and in government, the timing of quarter-end budget crunches. Some customers also used spring break to take time off. Finally, if our own recent inventory actions are indicative of the broader supply chain then there was some potential drawdown as well.”

MSC Industrial Direct FY 1Q16 Earnings Call Notes

MSC Industrial Direct (MSM) Erik Gershwind on Q1 2016 Results

The environment continued to deteriorate as expected

“The environment continued to deteriorate as expected. The root causes for the slowdown remain the same. The rapid and sustained drop in oil prices, the strong U.S. dollar with its negative effect on export demand, and foreign exchange headwinds, are all negatively impacting broader manufacturing activity.”

Conditions remain extremely soft in the pricing environment

“With respect to the pricing environment, conditions remain extremely soft, due primarily to the lack of commodities inflation. Supplier pricing activity, the primary driver of distributor pricing movement continues to be minimal. As such, we’ve not implemented a mid-year price adjustment and don’t anticipate doing so absent to change in conditions.”

Have gained share despite negative growth rates

“Despite negative growth rates in the quarter, the macro industries industrial distributor surveys and supplier feedback all confirmed that our share gains have continued.”

Visibility is low right now

“It’s pretty much I have described as a very challenging environment but now both on the demand side and on the pricing side and really no surprises, I’d say visibility is quite low right now so tough to identify a catalyst at this moment although with low visibility who knows. So that’s on the environment side.”

Small benefit in December from holidays on Fridays

“So, net-net what we saw in December was similar level I would say of shutdown activities prior years that along with the benefit of the holidays being on Friday counted for roughly 250 basis points or so we have to peg it of benefit in December, but net-net I think for us big picture in terms of outperformance. ”

Our results don’t have the same correlation with PMI that they once did

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

Rustom Jilla

The majority of segments are down and have deteriorated

“I think the overwhelming majority of segments are down and down and have deteriorated over the past few months. There’s pockets like commercial, aerospace that have been reasonably strong. There’s pockets of automotive that have been reasonably strong and again, probably no surprise to you.”

Energy indirect exposure has taken everyone by surprise

“But on the energy front really no change and just a reminder, our direct exposure to energy is really low, meaning, well under 5%. The indirect exposure is I think what’s taken everybody by surprise not only in MSC but in the broader economy. And it’s ugly. I mean, this is a way to say and I think in the past we’ve shared that when we look at our manufacturing end markets, as there what would be traditional saw that metalworking markets in areas that are energy exposed, i.e. Texas, Oklahoma et cetera. The results are really, really poor and not surprisingly.”

Weather hasn’t been a factor either way

“Nothing majored report on weather that would have been a factor either way. We didn’t set anything big there. With respect to shutdown activity, we would characterize the shutdown activity as relatively similar to last year.”

The bigger headline than inventory destocking is that demand is coming down

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

MSC Industrial Direct FY 4Q15 Earnings Call Notes

MSC Industrial Direct (MSM) Erik David Gershwind on Q4 2015 Results

Deteriorating and quite difficult demand environment

“I’ll begin by covering the deteriorating and quite difficult demand environment.”

Conditions worsened as the quarter progressed

“We remain in a difficult environment where conditions worsened as the quarter progressed. The root causes for the slowdown remain the same. The prolonged impact of the rapid drop in oil prices, the strong U.S. dollar and its impact on export demand, and foreign exchange headwinds, all of which are negatively impacting broader manufacturing activity.”

Outside of aerospace and automotive, customers have seen significant slowdowns

“indicators confirm a considerable slowdown in metal working activity as the quarter progressed. They’re also very much in line with what we heard from customers and other industry participants. With the exception of pockets like Aerospace and Automotive, customers have seen significant slowdowns in their volumes, their backlogs and their quoting activity.”

We’re beginning to hear about layoffs for the first time in a while

“visibility remains extremely low. We’re now beginning to hear of layoffs for the first time in quite a while. We also believe that some of the slowdown can be attributed to destocking of customer inventory levels, although this is very difficult to quantify.”

Pricing remains extremely soft

“With respect to the pricing environment, conditions remain extremely soft, due primarily to the lack of commodities inflation. Supplier or manufacturer pricing activity, which is the primary driver of distributor pricing movement, remains well below historical levels.”

Economic slowdowns are a time for us to take share

“economic slowdowns are the times when MSC makes its greatest strides and we expect to do the same this time. While the 70% of the market that’s made up of local and regional distributors is on its heels, we are on our toes. While others are cutting inventories and receivables to preserve cash, our strong free cash flow generation allows us to invest and to provide customers with industry leading service.”

It’s be easir to find where it’s not getting worse than where it is

“I would say the answer is more about where it’s not getting worse. It’d be easier to find where it’s not getting worse than where it is. Seriously, I think, we’re seeing pretty much, with the exception of a couple of pockets that I mentioned, it’s pretty broad based. It’s particularly acute within our core metalworking-related markets, heavy equipment and machinery, primary metals guys, machine shops, and I would say, it’s also more acute in the mid-size and small customers than it is at the larger customers. But, it’s pretty broad-based everywhere. And it’s just more acute in pockets.”

Visibility is really low

“our visibility is really low. So, it’s tough for us to look out beyond a month, let alone a year.”

Non-manufacturing has slowed more than manufacturing

“let me talk customer segment, first, manufacturing, non-manufacturing. What I would say there is both have slowed, but in terms of the absolute growth delta, you are right. Non-manufacturing slowed more. ”

An exciting thing about a downturn is the opportunity to acquire strong talent

“one of the most exciting things, if you could call it exciting, about a downturn is the opportunity to acquire some great talent, to make some great investments that really juice the returns coming out of the recession, and we’ve said this time will be no different.”

MSC Industrial Direct 3Q15 Earnings Call Notes

Tough environment but earnings exceeded expectations

“growth rates were in line with guidance, reflecting the challenging demand environment. Second, that gross margin stabilization continued, despite the extremely soft pricing conditions. And third, that strong expense management led to earnings exceeding expectations.”

Drop in oil prices, softening export demand, foreign exchange headwinds

“Root causes for the slowdown included the impact of the rapid drop in oil prices, softening export demand, and foreign exchange headwinds all of which were impacting broader manufacturing activity. At the time, I said that it was unclear as to whether we had moved out of a moderate demand environment and into a low one.”

Low demand environment

“With another few months under our belts and with the same headwinds persisting, it’s now clear that we are in a low demand environment. In speaking with customers, while things have not continued to deteriorate, they have essentially remained at low levels in what is a sluggish environment.”

Activity has at least leveled

“However, most customers are suggesting that their activity has at least leveled, meaning they’ve not seen further significant declines. The macro indices we track confirm what we’re hearing from customers.”

Significant slowdown in metalworking activity

“The ISM has generally trended downward over the past six months, despite a slight improvement in May and June. It remains well below October’s peak, as well as below the 12 month average.

As for the MBI, after an up-tick in March, the index fell below 50 in April, and continued to tick down below 48 in both May and June, suggesting a considerable slowdown in metalworking activity.”

Pricing conditions extremely soft

“With respect to the pricing environment, conditions remain extremely soft, due primarily to the lack of commodities inflation. Supplier pricing activity, which is the primary driver of distribution pricing movement, remains well below historical levels.”

Moderating sales force expansion

“With respect to sales force expansion, we continued moderating as we had started to do last quarter. This is in response to the softening demand environment, as sales force paybacks lengthen when growth rates slow. We now anticipate sales force expansion to be roughly 2% for the fiscal year.”

Things have stabilized but at a very soft level

“I think what we would describe right now is, you hit it on the head. It’s a very sluggish environment, it’s soft demand. What we did want to get across in the prepared remarks is it’s not – we haven’t seen a continued dramatic deterioration within the last couple of months that things have sort of stabilized, but stabilized at a very soft level.”

We look at a few things and triangulate to try to get a sense of where we are in the market

“What we do is we triangulate a number of things. We look at the macro sentiment indices like ISM, like MBI. We look at some of the distribution surveys that are produced by your community. We talk to suppliers, which is a great source for us to get at point of sales growth for distribution, and then we triangulate. I think as we triangulate, the story continues to be that we’re growing well above market.”

Metalworking has been particularly hard hit

“I think you are right to call out the fact that our core business, metalworking, cutting tools, have been particularly hard hit. You could see that evidenced in a number of places, but most notably the MBI has been under 50, indicating contraction for three months in a row.”

You have seen inventory stabilize as a result of changing conditions

“You have since seen that inventory number stabilize. That is the result of certainly changing our approach. As a result, correlating you are seeing free cash flow generation really improve.”

Local distributors are fighting for survival

“what we’re seeing is very typical with what we’ve seen in past cycles, where guys like us, the national players, get hit certainly. We get affected when there’s a slowdown. The local distributors that make up the 70% of the market get disproportionately hit. And what we see in times of slowdown is competition. They will get very – the local distributors will get very competitive.

So I would say price competition is very high right now. And a lot of that, I mean, that’s really being driven off the local distributors doing what they do when things get slow, which is fight for survival. So that’s the biggest headline.”

MSC Industrial Direct FY 2Q15 Earnings Call Notes

We have seen a swift and significant change in demand conditions

“I will now turn to the environment. We’ve seen a significant and swift change in demand conditions since the start of the calendar year. We heard this in a change in tone from many of our customers and saw it in sentiment indicators like the ISM and MBI, both of which trended down through the quarter. Root causes included the impact of the rapid drop in oil prices and softening export demand. As you know, our business has very little direct exposure to the oil and gas sector. There is little doubt, however, that the dislocation in this sector and the resulting uncertainty is currently impacting broader manufacturing activity, particularly in energy producing states. Softening export demand is also impacting manufacturing and heavy manufacturing in particular as exchange rate headwinds have become more severe.”

Weather was a small factor but there was more going on

“In addition, while weather was certainly a factor in the quarter, we believe the broader weakness that we’re seen is more than a temporary disruption. With respective to the pricing environment, conditions remain quite soft due primarily to the lack of commodities inflation. A number of our suppliers did implement small price increases, and we were successful implementing a modest mid-year price adjustment of our own at the beginning of January.”

Growth rates dropped significantly in February

“Turning to our results, the slowing demand environment resulted in lower than expected organic growth which came in at 6.8% for the quarter. As you can see from our monthly numbers, growth rates were solid in December, improved in January, before dropping significantly in February as the environment deteriorated.”

We’re still adding headcount but at a slower pace than previously projected

“As of now, our trajectory is to increase sales headcount by around 6%, a bit below the 8% to 10% range we previously provided and that could change further either up or down as we assess changes to the environment.”

The indirect exposure to oil and gas is larger than we expected

“the direct exposure is 3% or less to the oil and gas sector. Where it gets trickier and what we’re now seeing where the impact is much broader based is all of the tiers of that supply chain and particularly in our core manufacturing base that are actually influenced by oil and gas. So we are seeing pretty pronounced changes in growth rates and in conditions in manufacturing, and particularly when we go to manufacturing and look at our numbers and look at manufacturing activity in states that have an oil and gas influence, it’s really pronounced. So it’s pretty clear to us that while the direct exposure is small, the indirect exposure is pretty broad based.”

In one quarter things moved pretty quickly

“I would say in general if you look at what’s happened with the indices, the sentiment indices, I mean they’ve been trending down. So the drop you’re referencing in Chicago, the ISM in general what’s happened with the MBI I think is indicative of what’s happening on a broader base, less about one area like Chicago more about what’s happening across the board is — look, in one quarter this thing moved pretty quickly where you can tell our tone on this call is quite different from just a quarter ago we see that as pretty broad based and not specific to our region.”

Heavy manufacturing has been particularly hard hit

“manufacturing is a very broad umbrella. We have seen over the past quarter so the slowdown has been broad based on the factors we describe. If there is an area that we call out it would be heavy manufacturing, heavy durables. As you could imagine given our strong metal working position and but that’s a significant percentage of our total company sale, heavy manufacturing has a big influence on our growth rates and you are right, there has been a double whammy in heavy manufacturing because of oil and gas and then being particularly hit hard by the change in the export environment. ”

The inventory build is in fast moving stuff, also higher inventory can be acompetitive advantage if this is a sustained softness

“Few things on the inventory, number one is that, the build is in fast moving inventories that we can turn quickly. We’ve shown — I have complete confidence in our team that it’s been really changed, we can bring inventory levels down quickly. The other thing I’d say is, in times of — if this becomes some sort of sustained softness having inventory on the shelves customers are not going to want keep inventory what will distributors are going to be forced to bleed down inventory levels. This becomes a really big advantage for us and I talked in the prepared remarks about this. Times like this of dislocation being an opportunity for us to accelerate share gains having product in stock and getting it next day is absolutely critical. So I feel very good about our inventory investment.”

We do think long term lower oil prices are good

“whether it’s the back half of ’15 or not or it’s ’16 we don’t know, but longer term we think that what’s happening with energy prices actually bodes quite well for manufacturing in the US. Number one it makes us more competitive and then number two you’re right that lower oil prices that are going to put more dollars in consumers’ pockets and that’s more money, more disposable income to spend.”

We’re hearing more caution than excitement

“I would say the answer is right now no, we are not hearing that, I think we’re hearing more caution than we are excitement for the near term. That said I give a caveat that if I went back a quarter, a quarter and a half ago our customers also weren’t talking about what was coming with oil and gas. So certainly who knows, it’s possible but right now we’re not hearing a lot about a coiled spring for the back half of the calendar year.”

March did not bounce back

“I think the bigger story with March is the fact that growth rates did not bounce back which I think is more supportive of the case that the Q2 factors were a lot deeper than just weather”