MSC Industrial Direct Co., Inc. (MSM) Q3 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the MSC Industrial Direct Third Quarter of Fiscal Year 2013 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. John Chironna, Vice President of Investor Relations and Treasurer. Please go ahead, sir.

Thank you, Denise, and good morning to everyone. I'd like to welcome you to our fiscal 2013 third quarter conference call. An online archive of this broadcast will be available 1 hour after the conclusion of the call and available for 1 month on our homepage at www.mscdirect.com. As many of you know, we filed our 8-KA with the SEC this past Monday, July 8, which covers the completion of our acquisition of the Barnes Distribution North America business. The filing includes historical financial statements for the BDNA business and pro formas to illustrate the combination with MSC on a historical basis. Since today's call is to cover our earnings, if you have any technical questions regarding the 8-KA filing, we would ask that you contact me after this call. During today's call, we will refer to various financial and management data included under the section Operational Statistics, as well as presentation slides that accompany our comments, 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 the Barnes Distribution North America acquisition. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks is noted in the earnings press release and the risk factors and the MD&A sections of our latest quarterly report on Form 10-Q 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 will refer to certain adjusted financial results, which are non-GAAP measures. Please refer to the table attached to the press release and the GAAP versus non-GAAP reconciliations 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 our Chief Executive Officer, Erik Gershwind. Erik, please go ahead.

Thanks, John. Good morning, everyone, and thanks for joining us today. With me, along with John, is Jeff Kaczka, our Executive Vice President and CFO. On this morning's call, I'll discuss our current results and update you on the status of the BDNA acquisition. I'll then provide you with an updated strategic perspective on the company's performance and our future. Jeff will provide details regarding our financial performance for the quarter and our Q4 guidance and then I'll wrap things up. Our near-term performance remains consistent with our expectations and with the assessment that we've shared with you on recent calls. We continue our share gain momentum through organic programs, like vending, e-commerce and other customer penetration initiatives. At the same time, we continue to tightly manage the business through expense control. That said, a combination of a weak demand environment, particularly in metalworking manufacturing, a soft pricing environment and the timing of our significant infrastructure investments is producing a picture that's remained consistent over the past few quarters, basically flat organic revenue growth yielding a slight erosion in earnings. I'll briefly touch on each of these elements and I'll start with the demand environment. Over the past several months, we had cited a disconnect between many macro indicators and the micro indicators that we consider when managing our business, like more specific metalworking indices, along with customer and supplier feedback. When we all experienced ISM readings of 53 and 54, we shared with you at the time that we simply didn't see them as reflective of our business environment, particularly in the metalworking-related sectors such as primary metals, metal fabrication and machinery, among others. So we shared with you other metalworking indices that have continued contracting over the past 9 months. More recently, we've seen the macro catch up with what we've been describing. For example, the last 2 months of ISM readings have averaged 50 and are more reflective of what we continue to see and hear from customers. They've indicated that there's been no catalyst for increased demand. And that in the meantime, while their business remains sluggish, they're tightly controlling metalworking and MRO spend. On the supplier side, channel checks confirm the same and validate our share gains. Regarding pricing, we've received questions from you about our decision not to implement the midyear price increase. Our pricing decisions are based upon what we see from manufacturers and from our customers in the way of pricing behavior. Neither of those supported the midyear increase. However, we will launch our catalog in August and we'll implement a normal size price increase. Finally, regarding our investments, we continue to forge ahead on key initiatives that are diluting our near-term margins through incremental operating expenses. Those include infrastructure investments like Davidson, the Columbus Customer Fulfillment Center and other growth-related investment priorities, such as e-commerce, private brand and vending. While many of these are creating near-term pressure on margins, particularly in a low growth and soft-pricing environment, we're making these investments based on their significant future payback and are confident that the strategy and timing behind them are sound. Davidson remains on track and on budget for an August opening. Roughly 120 or so of our Melville-based associates will be relocating in the weeks to come. Our tight controls and ongoing training are helping to ensure a smooth transition. Columbus also remains on track for a late 2014 opening. With respect to our growth initiatives, our momentum continues on vending. Signings remain strong and Q3 growth contribution was around 3 points. e-commerce is also moving along nicely with the rollout of our new site, which is receiving favorable customer feedback and that's reflected in our e-commerce growth. Excluding BDNA, as a percentage of sales, it was 43.5% for the first 9 months of fiscal 2013 versus 40.5% for the same period a year ago. I'll now turn to an update on BDNA. With it now a part of our business, we feel even better about the vision for this platform, especially after talking to customers, suppliers and associates since closing. I'm even more confident in the positive impact that BDNA will have on our growth rates and our profitability. The rationale for the deal is squarely on point with our strategic plan. We're adding a high-margin product line adjacency to bring in to MSC's manufacturing customers. We're bringing the MSC product offering next day delivery and web capabilities to the BDNA customers, including the transportation and natural resources sectors, among others. We're gaining a platform into Canada that had previously been lacking from our portfolio. And finally, we're gaining a foothold in a category with loyal and long-standing customers. Let me know talk a bit more about how we view the economics of the deal. When we evaluate acquisitions, we look at cash-on-cash returns. In this case, by virtue of realizing more than $100 million in net present value cash tax benefits and by executing on the cost synergies that are right in front of us, we rather quickly earn above our weighted average cost of capital. In other words, the deal makes economic sense even without growth. But this is ultimately a growth play for us. The returns start getting incredibly attractive as the business grows. We ultimately see the potential for this business to be at or even above MSC's operating margin levels. At today's revenue rate of around $290 million annually, the business is doing around 9% in EBIT margins. If we execute on our cost synergy range between $15 million and $20 million, we'll add between 500 and 600 basis points to EBIT margins, already bringing the business in the neighborhood of MSC levels. And then because of the high gross margins, the incremental margins in the business are quite high even when factoring reinvestment back into the business. And finally, we see the opportunity to improve the current levels of BDNA sales force productivity by bringing the MSC offering to their customers and by bringing MSC sales management practices to the table. Ray Rutledge and his team have gotten to know the BDNA organization quite well and are excited by the excellent talent will make great additions to our team. We're moving through our integration process and have reached a few significant decisions that I'd like to share. First, regarding the distribution network, we'll be folding 5 of the 9 BDNA locations into MSC's over the next 18 months. Customers will receive even better levels of service from our combined teams. Three of the locations will consolidate sooner, while 2 will wait for our Columbus facility until it's up and running to absorb the incremental volume. The 4 buildings that will remain include our 3 Canadian locations and the repackaging center, which brings added capabilities to our network and which we plan to leverage for improved purchasing. Second, we've decided to close the BDNA corporate headquarters currently located in Cleveland and merge it into our new Davidson location. There are many in the Cleveland building who'll make the move to Davidson, with a small number of associates remaining in a satellite Cleveland presence. Third, we continue to work aggressively with our suppliers to improve our cost position. Step 1 is rationalizing our deals across the 2 businesses; and step 2 is working with those suppliers who see the incremental growth and share gain opportunities to invest incrementally in the combined businesses. On this point, we've heard from a number of suppliers who view the combination of MSC and BDNA very positively. As a result of our work to date, we have even greater confidence in the economics that we laid out previously, including the cost synergy run rate of $15 million to $20 million by FY '15. As you can see on Slide 4, we're reaffirming the other BDNA-related guidance that we have provided. I'd like to now pull back from the details and provide you with an updated strategic perspective on the company's performance. We're in the midst of an important infrastructure build-out, which happens to coincide with a slowdown in growth. As you've seen, our investment spending has put pressure on our FY '13 earnings and I would expect some of that pressure to continue into FY '14, independent of the business environment. As we typically do, we'll provide greater detail regarding our FY '14 outlook on our next earnings call. Looking beyond the near term, we're building towards the picture that gets us very excited about the future. Here's what I see. We're laying the infrastructure to carry us through the next phase of growth. For example, the new Columbus CFC will support our next $2 billion in growth and we're not going to need another Davidson. The anticipated payback from our productivity projects is significant. That includes Davidson, which will generate cost savings over the coming years and begins producing returns in FY '15. It includes our vending improvement program, which aims to improve productivity and service levels for our customers and take vending program operating margins up to company average over the next 2 to 3 years. It also includes several other productivity initiatives that we have in the works throughout the company. We will benefit from the share gains that we're currently executing through vending national accounts, sales force execution, e-commerce and more. While today the results of those share gains are muted by soft customer activity levels, we would expect to grow disproportionately when the manufacturing economy rebounds. And when it does rebound, we'll also benefit from pricing and rebates. Today, those 2 elements of our gross margin formula are headwinds as we're in the late stages of a deflation cycle. When we enter the next cycle, they'll quickly turn to tailwinds. We're going to also benefit from secular tailwinds of the manufacturing renaissance that we expect to follow in the years to come. More and more, my discussions with supply chain executives that are a key customers give me growing confidence that significant manufacturing growth is likely for North America over the next decade. As the focus of supply chain moves from strictly a low cost country sourcing mindset to one centered on supply chain speed, flexibility and proximity to customers, the premium is high to keep the manufacturing supply base local to the North American market. And finally, we'll benefit from the consolidation story that we see building in the years to come with an industrial distribution. If all of this sounds familiar and like a look back at our past, well, you're right. Just the way our infrastructure build-out in the late '90s and early 2000s was followed by a decade of explosive growth and operating leverage, I see the same potential latent in the company as we move through our current build-out. With that, I'll turn things over to Jeff to discuss the financials in greater detail and provide you with our Q4 guidance.

Thanks, Erik. Good morning, everyone. As Erik mentioned, this is our first call since we closed on the largest acquisition in company history and the integration is going quite well. I'll take you through the financials, both the reported and adjusted Q3 results, then I'll go over the Q4 guidance before turning it back to Erik. As John mentioned in the opening, we provided slides on our website. And given the complexity the quarter, we hope that they will help clarify our comments. And we look forward to your feedback on the slides as we consider whether to continue their use in future calls. So to start, I'll go through the reported results, then I'll share with you the adjusted results, which exclude the nonrecurring relocation cost associated with our Davidson facility, as well as nonrecurring transaction and integration costs associated with the BDNA acquisition. That's exactly how we've been discussing the results with you in the past few quarters. And to facilitate the comparison of our Q3 results to our Q3 guidance, we'll also exclude the BDNA operating results as we had not included them in our guidance provided last quarter. We call these our comparable adjusted results. You can see how we define these terms in the presentation on Slide 3. Let me start with an overview of the reported results. Our reported sales growth on an average daily sales basis in the third quarter was 5.7% compared to the same period last year. This includes roughly 5 weeks of business for BDNA as we closed the transaction on April 22. Additionally, our reported gross margin was 45.5% and our reported EPS was $0.98 per share. Our adjusted results eliminate roughly $0.06 for BDNA transaction and integration costs and about $0.01 for Davidson relocation, and this becomes an adjusted EPS of $1.05. Perhaps the most relevant measure when comparing to the guidance are the comparable adjusted Q3 results. And these exclude the nonrecurring Davidson and BDNA transaction and integration costs and also exclude BDNA operating results, which were not in our original guidance. And because BDNA was $0.02 accretive, our comparable adjusted EPS was $1.03. And the EPS walk for Q3 on Slide 6 should help clarify this. Okay. Now let me drill down on the comparable adjusted Q3 results. First, I need to mention there was one less sales day in our fiscal third quarter this year as compared to the same period last year as the Memorial Day holiday fell into the fiscal third quarter this year. Our sales growth on an organic and average daily sales basis came in flat. Sales from our manufacturing customers were also flat, while sales from our nonmanufacturing customers were up 1%. Within nonmanufacturing, our government sales overall in Q3 declined, showing the impact from the sequestration that started during Q2. Our state business, however, grew significantly in the third quarter. Nearly 3 points of organic growth came from customers within our vending program. The offsetting decline is a direct result of the soft demand environment, particularly in the metalworking manufacturing sector that Erik mentioned earlier. Our gross margin for Q3 was 45.0%. And as you can see on Slide 5, this was just above the midpoint of our guidance of 44.9%. As compared to the same period last year, the margin was down by approximately 70 basis points, driven by 50 basis points of the dilution from our vending program and the remainder primarily due to purchase cost increases without the benefit of the midyear price increase. As a reminder, while current supplier increases are few, the impact of last year's increase is still lingering due to our average costing inventory method. Lastly, as I mentioned earlier, our comparable adjusted Q3 EPS was $1.03, which was well above our guidance of $0.95 to $0.99. The primary reason we were able to exceed the top end of our EPS guidance was our tight management of operating expenses. In fact, our operating expenses came in roughly $4 million better than we had guided. And through the first 3 quarters of fiscal 2013, our comparable adjusted operating expenses as a percent of sales were 28.1% versus 28.3% last year despite the lower growth environment. Finally, the tax provision for Q3 came in at 37.1%, below what we had expected. We did close our federal tax audits for 2009 and 2010 during the third quarter, which we previously anticipated would come in the fourth quarter. This resulted in approximately $0.015 positive impact to earnings per share. Turning to our balance sheet. Our Q3 metrics was strong. DSOs were 46 days. Inventory turns were 3.35, a slight improvement from Q2 levels. And from a cash flow perspective, we converted 177% of our net income into cash flow from operations. This compared to 101% for the same period last year. The increase was the result of our successful working capital management, where particularly in view of the soft demand environment, we worked hard to reduce our inventories and manage our receivables. Now that we have debt on our balance sheet as a result of the BDNA acquisition, free cash flow is even more important as it allows us to pay down our debt and reduce our interest expense. As you may recall, we incurred $370 million of debt at a spread of 100 basis points over LIBOR when we closed the acquisition. Not only did our strong free cash flow enabled us to pay down our debt to $290 million by the end of the fiscal third quarter, but as of today, we brought the revolver balance down to 0, leaving only the term loan of $250 million outstanding. We had approximately $58 million in cash and cash equivalents at end of Q3. And our current cash balance now stands at $50 million. In regard to capital expenditures, our Q3 CapEx was approximately $22 million. This included an increase in vending and approximately $8.5 million associated with the Davidson facility. As we've mentioned on earlier calls, we expect CapEx in fiscal 2013 to be elevated due to infrastructure investments of nearly $40 million in Davidson and Columbus combined in addition to increased investments related to our vending program. We now believe fiscal 2013 CapEx will be in the $90 million to $100 million range, driven purely by the timing of certain capital expenditures moving into fiscal 2014. Now let me turn to guidance for Q4. This guidance will now include the impact from the BDNA operating results, but consistent with prior quarters, exclude the nonrecurring items like BDNA transaction and integration costs, as well as relocation costs associated with Davidson. In addition, please note that our Q4 will have 4 less selling days, which becomes virtually a week given that the Fourth of July holiday fell on a Thursday this year. With all that said, we expect revenues to be between $661 million and $673 million. On an organic basis, the expected ADS growth is flat, reflecting our assumption of a continued soft demand environment, particularly for the metalworking-related sectors. This guidance is consistent with what we saw on June, the first month of Q4, excluding the holiday impact. We expect gross margin for Q4 to be in the range of 45.0%, plus or minus 20 basis points. The Q4 gross margin will be impacted by headwinds from the vending program and the seasonally lower gross margin mix of products sold in the fourth quarter. These headwinds are mostly mitigated by our strategic programs, like private brand and discount management, as well as the BDNA higher gross margin products. I would note that the BDNA gross margin includes a charge resulting from the typical inventory valuation step-up required by acquisition accounting. The charge effectively reduces the BDNA gross margin from the high-50s to the low-50s through the end of the fiscal year. The BDNA gross margin level will return to normal levels beginning in Q1 of fiscal 2014. This, of course, temporarily suppresses operating margins in the fourth quarter. In Q4, we expect adjusted operating expenses will increase at the midpoint of guidance by approximately $26 million versus Q3. BDNA operating expenses account for roughly $21 million of this increase and the remainder primarily relates to strategic investment projects. We continue to manage tightly in this environment, but we will also continue investing in key growth initiatives. And regarding our tax rate, we expect the fiscal Q4 tax rate to be about 37.5%. Finally, our adjusted EPS guidance for Q4 is $0.87 to $0.91, reflecting the low growth market environment and our continued tight expense controls. This, of course, includes the BDNA operating results and excludes the transaction and integration costs associated with the BDNA acquisition and the relocation cost associated with the Davidson facility, each approximately a $0.03 impact on EPS. The BDNA business is expected to be roughly breakeven in Q4 and accretive thereafter. So with flat organic ADS growth, our adjusted EPS at the midpoint of guidance is $0.89. This is down from $1.09 last year, as you can see on Slide 8. And almost all of this is due to 2 factors: the extra week in fiscal 2012; and the lack of the midyear price increase. In summary, the soft market conditions continued, so we were able to exceed our Q3 EPS guidance through effective management of expenses. The BDNA integration is going well and the results were slightly better than expected. In the fourth quarter, after adjusting for the complexities, it's expected to be similar to the previous couple of quarters. At this point, I'll turn it back to Erik to wrap things up.

Thanks, Jeff. While we face some near-term challenges due to the demand environment, I remain very excited about our future for 3 reasons: first, we're strengthening our business through the infrastructure build-out that we've undertaken. We're making moves now to support our next wave of growth, giving us leverage on the next billion dollars of revenue. Second, we're investing in growth priorities, such as e-commerce, private brand, sales force expansion and vending. These are initiatives that will enhance our organic growth rates, particularly as the metalworking sector rebounds. And third, BDNA adds a new growth platform to the road map that we've described for you. These initiatives are energizing the company. History tells us that the macro demand and pricing environments will once again improve and our growth initiatives will take hold such that we'll return to a much stronger growth trajectory, one that not only gets us to our goal of $4 billion in sales by the end of 2016, but one that we can leverage into significant earnings growth. I'd like to thank our entire team for their continued hard work and dedication. And I'd also like to -- to wish my best to our pioneers making the move to Davidson in the coming weeks. I'll now open up the lines for questions.

[Operator Instructions] The first question will come from Ryan Merkel of William Blair. Ryan Merkel - William Blair & Company L.L.C., Research Division: I guess, as John requested, I'll save the 8-K technical questions for offline. So let me just start then with the guidance. I think you're calling for Barnes to be neutral to EPS in the fourth quarter, but I think it was $0.02 accretive in the third quarter. So can you kind of walk us through that?

Yes. We were pleasantly surprised that we were actually $0.02 accretive in that stub period, which included the results from April 22 on. There's a little bit of an interesting phenomenon there which benefited us, Ryan, and that is that the sales at the tail end of the months in Barnes are traditionally very strong, so we had the benefit of the higher sales week in the last week of April without the proportionately higher expenses. And so that was the primary reason we were actually accretive in April. We'll have more of a normal quarter in the fourth quarter with the exception that we have -- and this is associated with normal acquisition accounting, a step-up in the inventory which suppresses the gross margins, as I said in my prepared comments. And that will run through our gross margin through the end of the year. We haven't spiked that out separately as a transaction or integration cost. It runs through the operation, so therefore, we expect to be roughly breakeven in Q4. And then as we head into next year, we don't have that impact and we start realizing the benefits of the synergies. Ryan Merkel - William Blair & Company L.L.C., Research Division: Okay. That makes sense. And then, I guess, it was nice to see that you reiterated the accretion for the next couple of years on Barnes. I guess as it relates to next year, the $0.15 to $0.20 of EPS accretion, how much of that is operational versus synergies kicking in? Just trying to get a sense of how quickly those kick in.

Yes, Ryan, it's Erik. I would say on the synergy front, as you heard in the prepared remarks, we feel very good about the range that we provided. You can hear, we wanted to give you the -- sort of the breadcrumbs of how we're going to go about achieving those, but what you could also imagine is that most of those take time to realize. So from a synergy standpoint, most of that number will take some time before it kicks in to the P&L. Ryan Merkel - William Blair & Company L.L.C., Research Division: Okay. That's what I figured. And then just last one real quick. You probably won't want to answer this question, but you mentioned in the prepared remarks that spending on growth initiatives will continue into fiscal year '14. Can you just give us a sense, is it stepping down? Is it half? Just give us a little bit of a sense there, because I think a lot of us were assuming that some of that will start to fall off in '14 and then the margin will start to improve quite a bit.

Yes, Ryan, it's Erik. So I know what you're grasping at there, which is kind of a framework for thinking about '14. And as I said, we're in the middle of doing our work right now and we're going to come back to you with more of what we typically give you as a perspective for the year. Let me say this. I'm going to start by stepping back to what we talked about at the start of fiscal year '13. And we gave a framework. And that framework basically outlined that we were entering a period of accelerated investment. And that was growth investment and that was infrastructure investment. And then as a result of that, at any given level of revenue that you pick, incremental margins were going to be lower than historical. So what we talked about was at the time, it was a little bit of a frothy environment and we were looking at around 10% top line growth. And what we said was that around 10% growth, you could expect mid teens incrementals from us. And that it wouldn't be until what we called healthy double digits, which, to us, was 12 or higher before you'd see out margin expansion. And that then as revenue growth, if it were to step down from the 10, incrementals would get proportionately lower until we'd reach a point somewhere in the low to single -- mid-single digits where we wouldn't be able to grow earnings due to the step-up in investments. And then we overlaid that by saying, look, the wild card on top of all of this is pricing. So that was our outlook on '13. And I'll tell you, I think what's played out in '13 is entirely consistent with that framework. Of course, would we have liked to have seen a stronger demand environment which would have led to higher revenue growth? Of course. But I think what you've seen is consistent. What I would tell you is for now, that framework still holds. And you're seeing it in our Q4 guidance. And I think not much changes in our perspective. Of course, we still -- there's a lot of work going on right now on '14 and we'll be back with more detail.

The next question will come from John Inch of Deutsche Bank.

I want to ask you about the fourth quarter guide in the context of the sequential. I appreciate the walk and, by the way, I do think these slides are very helpful so I would continue them. I understand your year-over-year walk and lacking the week. But if I look at sort of the third quarter to the fourth quarter, each has 64 days. And if you -- I think, Jeff, you said that BDNA was neutral to EPS. So you're kind of going from a walk of $1.03 down to $0.89. And in a flat environment, I'm not quite sure why that's actually happening if you've got the same number of days and if you look historically, right, your third quarter to fourth quarter walk, it doesn't go down that much. So what -- is there anything else going on here? It's just not clear. It's sort of like down 12%. It doesn't seem to jive with the flat environment and the cost cutting that you've been successfully invoking.

In regard to the sequential walk, I think you will normally see, John, the decline and primarily associated with the drop in the organic gross margin in the fourth quarter due to the lower margin mix of product we generally sell in our fiscal fourth quarter.

How much is that, Jeff? What's the magnitude of the sequential?

Well, the magnitude over the last several years, John, has been in the range of 50 to 125 basis points. A lot will depend on whether or not there's fourth quarter actions in pricing. As you recall last year, we did accelerate some of our pricing actions. So in that range of gross margin decline, yes.

Okay. So I'm assuming that's probably coming in at the high end, just to be conservative. Is there anything else on the sequential that you would call out other than pricing and flat environment that's maybe tweaking some of this? I see what your tax rate is, but is there anything else?

You see the tax rate and then you see also the fact that sequentially, our operating expenses, as I mentioned, are going up $5 million, excluding the impact of BDNA. And those are some strategic investments that we're choosing to make. That will benefit us going forward.

Okay. Then the -- Erik, you called out the price increase that you're expecting in the catalog. Well, I'm curious because obviously you traditionally put through a price increase. Are you expecting sort of the impact of this price increase to be the same order of magnitude as a year ago? Or perhaps a little bit higher or lower? Because obviously that will have, in turn, kind of a run rate in terms of the impact of pricing as you get past this quarter into kind of future quarters.

Yes, John. We'll come back -- I mean, our practice, as you know, our practice is we wait until after we release the catalog. So on next quarter, we'll give you the specifics. Not trying to be coy, but just for competitive reasons, we're going to wait until after to give you the increase. Yes, I used the word "normal." And basically, what I mean by that is if you go back and you've tracked us for a while, if you took the low end of what we've done in catalog increases and the high end of what we've done, it's going to -- we've done, it's going to fall somewhere in the middle.

Right. Well, that makes sense. Just lastly, I think you said you've had -- you've got about $20 million left of integration transaction cost for BDNA based on the demand you've done thus far in the $25 million to $30 million guide. Does that all conclude in '14? And how does that, Jeff, kind of delineate over the coming quarters? Is it relatively linear?

Yes, John, what we said was that the majority of that would be complete by the end of FY '14, but it will continue, to some extent, into '15. And linear is not a bad look at it. Probably a little bit more heavier weighted in the first half of the year.

The next question will come from Hamzah Mazari of Credit Suisse. Hamzah Mazari - Crédit Suisse AG, Research Division: I was just wondering if you could maybe comment on how investors should think about execution risk and your ability to manage that given the weak demand environment, given the largest acquisition you've done in your history, given the investment spend as well. Maybe just walk us through how folks should think about that.

Hamzah, it's Erik. I think it's an excellent question and I'll tell you that -- and I tried to hit this in the prepared remarks. I feel very good about the plan that we're executing on right now. We have a bunch of heavy lifting going on, but I'll tell you, we have a really strong management team here. We have a deep team. And it's a team that has a lot of experience here working together. So many of the initiatives -- certainly, Davidson is something that's new for us. We've gotten a lot of help and it's been very hands-on and actively managed. When you look at things like acquisition, the opening of Columbus facilities, these are things that we've done before, we have a playbook on. We have a lot of the same people, the same leadership that was here for the last ones that are overseeing the projects. So I feel very confident. Hamzah Mazari - Crédit Suisse AG, Research Division: Great. And just a follow-up. Post the Barnes acquisition closing, how are you guys thinking about sales compensation metrics? Is that going to change at all? And then how much of your business do you define as true MRO business?

So let me start with -- I'll start with your first question. So sales compensation, are you referring specifically, Hamzah, to the BDNA business? Hamzah Mazari - Crédit Suisse AG, Research Division: Yes.

Okay. So let me say this and, hopefully, you've got a sense of it in my opening. With respect to BDNA, our approach to integration, think of it in 2 prongs. On the back end of the business, support functions in the back end, we're moving aggressively and we're moving swiftly as you can see by some of the decisions that we've made and how that's fueling the synergies. On the front ends of the business, there's some differences. We knew this going in and we found it to be true. There's some differences in the value proposition, some differences in the sales models, some differences in sales force compensation. And for that reason on the front end, we're moving very methodically in terms of how we think about integrating these businesses on the front end. So it's a much more measured approach. I would tell you, in the meantime, why we go through taking very measured steps. We do still see opportunities to capitalize on some near-term revenue synergies, but we're going to be methodical about it. Hamzah Mazari - Crédit Suisse AG, Research Division: Great. And then just how much of your business is true MRO? How would you define that?

Yes, I mean, when you say "true MRO," I mean, by some measures, all of it is MRO. If where you're going is what's not Metalworking, what we've described as Metalworking, it's roughly half of our business, so the other half would be MRO.

The next question will come from Matt Duncan of Stephens Inc.

I've got a couple of quick numbers questions and then take a step back and look at the bigger picture. Jeff, on the gross margin going forward, can you size for us the impact of a normal price increase? And when you get into a more normal pricing environment, remind us what that means for gross margin expansion. And then also, BDNA returning to a normal gross margin level, it sounds like it's somewhere in the order of 600 to 800 basis points that you'll see moving from 4Q into 1Q. How does that flow through?

Yes, let me take the second piece of that. That's correct, Matt. We have this normal inventory valuation adjustment, which will run through our P&L associated with BDNA and that effectively reduces the gross margins. On an apples-to-apples basis, we would expect the gross margins for BDNA to return to the upper 50s. And that is how we would essentially flow through our P&L. As Erik mentioned before, we're talking about $290 million in annual sales. So you can break that down for the quarter and see what the relative impact would be on our overall company gross margins. And regard to the second question, Erik was...

Yes, Matt, on the price increase, so what I would say is we're going to hold off from giving you any numbers only because, obviously, the impact's going to be a function of the size of the increase and we're going to share that next quarter. What I would tell you is that we would expect realization on the price increase to be strong. It's been strong in recent years. That's been an area of focus for us in some programs we've put in place to improve it. So we would expect it to be typical realization with what you've seen over the past few years. But, of course, on an absolute level, it's going to be a function of the size of the increase.

Okay. So then taking that a step further, obviously, you ought to have a pretty nice sequential gross margin improvement from 4Q to 1Q, because Barnes is over 10% of the revenue flowing through, probably going to help you 70 to maybe 90 basis points. Plus you get the benefit of the price increase. So is it unreasonable to expect a pretty good jump, then, from 4Q to 1Q?

Not unreasonable at all. That's right, Matt.

Okay. And then the last numbers question before I move on. On SG&A cost, you guys have obviously done a very good job controlling the operating expenses. Jeff, you commented that there's an assumption of $5 million of gross spending sequentially. Could we also expect there might be some offset to that, though, from cost control actions that obviously did help in the third quarter?

Yes, those cost control actions have helped each quarter this year. We'll keep those in place, Matt, but the net impact of the 2 is the $5 million.

Okay. And then last thing for me, just bigger picture, maybe, Erik, if you could share your thoughts sort of on what you guys are seeing in the trenches. Do you have any reason to be more pessimistic or optimistic at this point on the outlook for the general macro? Obviously, you've been in a pretty flat environment for a while now. So what do you guys see unfolding there over the coming year?

Matt, I think the message that I'd share with you right now is more of the same. What we're hearing from customers, what we're seeing in terms of confidence levels and then just activity levels like incoming orders, order flows, activity levels, very consistent with what we've described the last couple of quarters, which is in our core. So in the metalworking manufacturing sector in particular, it's sluggish. So it's not like activity levels have dropped off a cliff, this isn't '08, '09, but very sluggish. And what's happening is, with sluggish activity levels, customers are clamping down on spend. So spend is down. In terms of the outlook, our view is always fairly limited and relatively short time horizon. I would tell you that with what we see and hear today, we don't see anything changing. I think the ISM and kind of historical correlation would support that, but I'd also give you the caveat that our line of sight is not all that far into the future.

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

This is Josh filling in for Sam. Just on the Big Book price increase, I know historically, at least, the Big Book prices have been easier for you to pass along. Could you talk about whether the pricing environment in general has changed much over the recent months?

Josh, good question. In general, my answer is no. I think what you're seeing is, you're absolutely right, it's an easier bar for us in terms of passing an increase along with our new catalog. In general, what I would tell you is that raw materials have stayed relatively flat and at depressed levels from where they've been. I would point out that in the last quarter, we've seen, in pockets, tungsten being one example, which is a big ingredient that goes into carbide, a little more volatility than we had seen earlier on in the year. And I think it's way too early to say anything. I think should that volatility continue, that could lead to more pricing opportunities. So too early to say. For now, I would say consistent with maybe a little bit of spark of hope should the volatility continue.

Our next question will come from John Baliotti of Janney Capital Markets.

Erik, I think the last quarter, we talked about you had illustrated the fact that the average transaction size had grown a little slower in last quarter versus the quarter before. I think that was obviously reflective of the core growth. But you made a comment about within that, that there was a higher lines picked. And I was just curious to see if you saw that similar trend in this fiscal third quarter.

Yes, John, good memory. You're right. The answer is we did not. Lines picked were -- had flattened down a smidge. And when I say "a smidge," I mean a smidge, virtually flat with the -- sequentially with the prior quarter. So we did not -- I would say, on the average order side, it really tracks back to what we're seeing in the macro with our customers. I'd point out 2 other things. So if you look to like on our history there, at the last couple of years, you've seen sequentially, in the back half of the year, is a slight pick up in average order size. So in addition to economy, 2 other factors I'd point out, one is the lack of the midyear pricing. And we keep going back to this, but certainly, you could imagine that has an impact on average order size. The other thing is Jeff mentioned the impact in terms of federal government spending, the sequestration. Generally, in the back half of our year, we see average daily sales build in the government as they move towards their fiscal year end spend. That's been slow and that drives up average order size. Those tend to be larger orders. That build is slower than it's been in prior years due to sequestration. And I think you're also seeing that play out in average order size.

Okay. That makes sense. And just where do you think, Erik, where do you think you are with respect to the integration of the product lines of Barnes and the traditional MSC product lines with customers? Is that -- where do you think you are in terms of getting that all rolled together?

Yes, John, I'd go back to the framework that I laid out earlier, I think it was for Hamzah, on think of our integration as following 2 tracks on the back end. We're moving quickly on the front end. And that one, by the way, I'd categorize as part of the front end. We're moving in a measured and methodical way. So I would say the answer is very early.

Okay, good. So I mean, even though you're getting -- even though you've had some positive feedback from customers and suppliers and Barnes' employees, you still have a long runway ahead of you?

Yes. John, our approach is we bought this business and our vision is to achieve a leadership position that's going to last and sustain. We want to get it right. We want to build the foundation right and not just rush. I think at the same time, we're going to find some quick-hit ways to capture revenue synergies, in a way that still allows us to move along in a measured way, getting the foundation right. But yes, very early in terms of runway.

Our next question will come from Brent Rakers of Wunderlich Securities.

I guess I wanted to start with just a clarification, again, on the Barnes gross margins. Are you saying that the valuation issues were kind of equally present in Q3 and the Q4 numbers, so the gross margins will be relatively the same there?

Yes, yes, that's correct, Brent. But remember, for the period of time in Q3, we -- it was 5 weeks that we owned the company. So we have a full quarter's worth of that, of sales and similar gross margins for BDNA.

And I guess the second question related to the same topic, you keep referencing moves to the high 50% kind of level. But the pro forma suggests 55% numbers. So can you explain, maybe, what the disconnect would be there?

I'm aware of it being in the high 50s. I don't -- I'm not familiar with the 55.

Brent, I'd say let's get together after the call and go over that calculation. But when you re-class the freight and account for it the way we account for it, you should get into the high 50s.

Okay. Great. And then on the core gross margins, looking back at kind of couple year numbers, looks like you're down, give or take, a couple hundred basis points from about 2 years ago. I was hoping maybe you could dissect that kind of on a generic basis between the drag from the acquisitions that were lower margins, the drag from vending and the drag from pricing. How big of an influence have those 3 items been?

Brent, it's Erik. Yes, I would say the biggest of the 3 would be the pricing differential. That if you look to 2 years ago, we've talked about it, it's over time, the margin has moved within a relatively narrow band. But in any given period, it could move up or down. Certainly, you pointed out a couple of the growth programs that are going to be drags. And those are the vending and the branch-based acquisitions, absolutely were headwinds to margin. We have strategic programs, private branding and discount management, that are serving to mitigate those drags. And then the biggest change in the factors is 2 years back, we had early-stage inflation. And what that means is aggressive sale price moves without the purchase cost realizing kind of reading through the P&L. And we're now at the tail end of that. And it's flip-flopped where it's modest price increases with the high purchase cost leading to the P&L.

Okay. And then -- that's perfect. And then just, I guess, the last question on some of the Barnes-related synergies. It sounds like you're talking in terms of later rather than sooner. I guess I wanted to get a clarification on the headcount. The headcount, I think, was up under 1,300 sequentially, but Barnes initially was acquired with about 1,400 employees. I was wondering if maybe you could give me a bit of a reconciliation on why the headcount wasn't up more sequentially.

You got 2 things going on, Brent. The primary one is headcount is down, and I know we didn't break this out, but headcount on the base business, the organic business is down quarter-to-quarter. So you saw the field sales number, which is roughly flat quarter-to-quarter, our support headcount is down. So that's one factor. And then there's been some attrition, particularly in noncustomer facing support functions at BDNA. And part of that is by plan given that those are some of the duplicate functions.

The next question will come from David Manthey of Robert W. Baird. David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division: First off, in terms of the guidance, you're saying that the midpoint of the range is based on flat daily sales in the core business. I'm wondering if you could talk about your revenue expectation for BDNA?

Yes. BDNA, we expect to be in the low- to mid-70s millions. David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division: Low- to mid-70s. And what does that represent year-over-year?

Actually, that actually contributes about 11% to 12% of our reported top line growth. David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division: Okay. And then just if you did a look back what year-over-year would that be, is that business growing today? Is it flat, like the core business?

For our core business, it's roughly flat. For the Barnes business, as best we can tell, it's down slightly from their previous year. David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division: Okay. And then finally, not to get in the weeds on this, but I'm -- in looking at the supplemental data and the pro formas, could you just talk about the D&A related to the Barnes acquisition? And maybe just as simple as quantifying Barnes' EBITDA margins. I think we were assuming they're sort of in the low teens. I just wanted to clarify that.

I mean, the EBITDA, David, is we came out there roughly around 37 on a $300 million business. So and that's basically the EBIT you'll see add back to corporate allocations. And you add back the D&A of $7 million or so. So rough ballpark, that's what you get.

The next question will come from Adam Uhlman of Cleveland Research Company.

And I'd chime in on the slides, they're very helpful, so please continue. I guess my first question, Erik, that's sort of what we were talking about adding to the sales force a bit on the core MSC business. And with a lot of the work that's happening right now with Barnes and integrating the sales forces or work there, is there still an expectation that we're going to ramp up hiring on the outside sales guys?

Yes, Adam, good memory. And you're right, we came in flat. That's more of a timing difference than anything else. I think you can expect we -- I think what I said on the last call was 2% to 3% increase in sales force in the back half of the year. It's more of just a timing issue on the recruiting front. And you can expect the sales force headcount to be up slightly in Q4. So yes, that continues. And the reason it continues is it's a really proven growth driver for us. A sales person adds growth, it adds customer retention and customer value and satisfaction. So we think it's a growth -- an important growth driver. And the way we're running the business, given that it's still separate from BDNA in terms of how it's being run, we're able to, from a bandwidth standpoint, add to our MSC sales force while we integrate BDNA.

Okay. Got it. And then it's somewhat related, but over the last year, the company has been cautious with pushing through price increases and there's a certain customer set that would like that. And I'm just wondering, within the active account base, if MSC has picked up any large account wins that as manufacturing economy starts to come back, we might see some of those new wins pour through at an accelerated pace, or if that just really doesn't quite add at all?

Adam, yes, the answer is yes. And I talked about it in the prepared remarks and I used examples like, certainly, vending, national accounts program, some of our other customer penetration initiatives. And what we see happening is we have -- I mean, for competitive reasons, we don't like to call those out publicly, but a lot of wins that get me -- either new account wins or share of wallet wins that get me really excited. What's happening right now is because -- so customer activity levels are really sluggish, they're clamping down on spend. So their spend on indirect, on MRO and Metalworking is down. So as a result, the share gains, the activity levels are being muted by the customer sluggishness. That's what I was referencing. I do see a built-in -- when Metalworking rebounds, I see a built-in gain there that's going to occur by virtue of the share gains that we're experiencing. So the answer is yes.

If the market remains flat, how big do you think that can help your revenues?

I hope a bunch. But you could imagine internally, we -- it's not something we're going to share publicly. But internally, you can imagine we do track it carefully.

And ladies and gentlemen, our final question this morning will come from Holden Lewis of BB&T. Holden Lewis - BB&T Capital Markets, Research Division: The -- I'm just -- I noticed you're not giving guidance on fiscal '14. I'm not asking you to. I'm trying to just get a little bit of a framework about the size of the increase that you might expect to see in gross margin. I think earlier, that kind of got discussed, what the mixing up effect of Barnes would be. And then you should have the pricing from the Big Book. Could you -- without giving us what you plan on doing in '14, if you didn't cover it already, what is sort of the historical bump that you've typically gotten from the Big Book? Can we sort of think about it by framing it in historical terms?

Yes, Holden, let me step in for a second. So we're in the middle of doing the work. As I said, we'll come back and give you more color on '14. Net-net for now, if you're trying to look at right now for the foreseeable future, how will the business perform, I would take you back to the framework that we laid out at the beginning of '13, that incremental margin's still lower than historical at any given point of revenue. And what you're pointing out is, yes, we see some nice tailwinds that we didn't have in '13. We also see a couple of other headwinds that we didn't have in '13. Jeff talked about one of them being a rebate headwind due to the fact that purchases are down due to the sluggish environment. So net-net for now, I think use the framework that we've already laid out for you. And we'll come back with more detail as we complete our planning. Holden Lewis - BB&T Capital Markets, Research Division: Okay. And the other thing I wanted to ask about, you've been breaking out the expenses related to Davidson. You haven't been doing so for Columbus. Have those expenses just been relatively immaterial to this point? And then, I guess, the sort of the second part of that is, and I guess Davidson's going to be about a $0.05 drain this year. What do you expect the overall sort of impact going forward from Columbus to be relative in that $0.05 from Davidson?

Yes, we haven't spiked those out separately. Thus far, it's been immaterial, Holden. And we'll evaluate how we talked about those expenses going forward, okay?

We barely just broke ground on Columbus a few -- a month or so ago, I think, so... Holden Lewis - BB&T Capital Markets, Research Division: Okay. But do you expect, for your modeling purposes, are you expecting the cost related to Columbus to be similar to Davidson? I would think that they would be greater in '14 than...

No. Well, the thing is, Holden, we've been spiking out separately for Davidson, were the relocation costs. And we said that would be in the $7 million to $10 million range when that was ultimately complete. We don't see the -- that type of expenditure associated with Columbus. We'll move some associates there, but not a significant amount. Holden Lewis - BB&T Capital Markets, Research Division: Okay. So it's mostly capital, it's not much OpEx?

It'll be capital and some startup operating expenses.

Yes, Holden, there is -- there'll be some OpEx build in '14 related to Columbus. And yes, we talk about headwinds, that's one of them. And we'll come back with more detail on a future call.

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

Thank you, Denise. Well, we'd like to thank everyone for your continued interest in MSC. If anyone has any additional questions, of course, you can reach me in our -- in my office here in Melville the rest of the day and tomorrow. And I would alert everyone to our next earnings date, which is set for October 30. And we'll certainly look forward to speaking to you then or over the coming months. Thanks again and have a good day.

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