MSC Industrial Direct Co., Inc. (MSM) Q1 2014 Earnings Report, Transcript and Summary

Good morning, and welcome to the MSC Industrial Direct First Quarter 2014 Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to John Chironna, Vice President of Investor Relations and Treasurer. Please go ahead.

Thank you, Amy, and good morning to everyone. I'd like to welcome you to our fiscal 2014 first quarter conference call. An online archive of this broadcast will be available 1 hour after the conclusion of the call, and for 1 month on our homepage at www.mscdirect.com. During today's call, we will refer to various financial and management data in the presentation slides that accompany our comments, as well as our operational statistics, both of which can be found on the Investor Relations section of our website. Let me reference our Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Our comments on this call, as well as the supplemental information we are providing on the website, contain forward-looking statements within the meaning of the 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 BDNA acquisition and expectations regarding future revenue and margin growth. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks is noted in the earnings press release and the risk factors in the MD&A sections of our latest annual report on Form 10-K filed with the SEC, as well as in our other SEC filings. These forward-looking statements are based on our current expectations and the company assumes no obligation to update these statements. Investors are cautioned not to place undue reliance on these forward-looking statements. In addition, during the course of this call, we will refer to certain adjusted financial results, which are non-GAAP measures. Please refer to the tables attached to the press release and the GAAP versus non-GAAP reconciliations to 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, and thank you for joining us today. Also in the room with us is Jeff Kaczka, our Chief Financial Officer. I'll begin by stating that I'm very pleased with our progress over the past quarter and with our performance against the plan that I laid out on the last call. This morning, I'll cover the current operating environment, where we're seeing some positive signs of stabilization; our recent developments, where we're seeing solid results; and our progress with key infrastructure and growth initiatives, including BDNA, where we remain on track. Jeff will focus on our financial results and provide our fiscal second quarter guidance, and I'll then conclude with an update of our expectations for the year, which are aligned with what I shared in detail on our last call. We'll then open up the call for Q&A. I'll now turn to the environment. Over the past quarter, we've seen definite signs of stabilization and potential improvement in the manufacturing economy. While not near the strong growth levels indicated by recent ISM readings, feedback from our manufacturing customers confirms the current theme of stabilization and gives us some cause for greater optimism about 2014. This sentiment is reflected in recent metalworking-related surveys such as the Metalworking Business Index. Readings for the past 3 months have hovered around 50. While only indicative of a flat metalworking environment, it's nonetheless a significant improvement over the below 50 readings through most of last year and it's consistent with what we're hearing from customers. Current order flows and inventory levels are steady, and the prospects exist for improved order flow and growing backlogs as we move through the new calendar year. In addition, a budget resolution in Washington should hopefully reduce uncertainty for our commercial customers and those directly impacted…

Thanks, Erik, and good morning, everyone. The stabilization in the market environment and our sequential sales growth improvement throughout the quarter are encouraging developments that contributed to our earnings per share exceeding our guidance. We continued executing our various growth and infrastructure initiatives, and we're pleased with the progress made thus far. The BDNA integration continues to go well and its first quarter results are slightly better than expected. So let me go through the fiscal first quarter results in more detail. I'll continue to speak in terms of our reported results and our adjusted results, which reflect the exclusion of nonrecurring Davidson relocation and BDNA integration costs. Our reported sales growth on an average daily sales basis was 17.5% compared to the same period last year. This includes a full quarter of BDNA sales. Excluding BDNA, our organic sales growth on an average daily sales basis was roughly 5%. And that growth rate continued to benefit from customers within our vending program, which contributed roughly 4 points of growth. On the website this morning, you hopefully saw the footnote to our November sales figure which stated that we refined our accrual for direct ships this quarter. The impact of that change increased our organic sales growth for November by 2.3 points, and for the fiscal first quarter, by 0.7 percentage point. This was a onetime catch-up that will have no future impact on our growth numbers. The change had an immaterial impact on the first quarter's earnings. In regard to gross margin, we posted 46.4% for the quarter, just below the midpoint of our guidance of 46.5%. This primarily reflects 2 dynamics at play and both are positive for the business. First, our national accounts program is growing faster than the rest of the business, putting some pressure on…

Thanks, Jeff. Before we turn to your questions, I want to confirm the framework that we shared with you on our last call, and I want to emphasize that we're on track with our commitments. Let me highlight a couple of key points that we made. We expect full year 2014 adjusted operating margins to be in the range of 14% to 15%, should organic revenue growth be somewhere in the single-digits. The further we move up the curve from low- to high-single-digits, the closer we would get to 15%. We expect the second quarter to be the low point for the year with respect to adjusted operating margins. And finally, with respect to earnings, mid-single-digit organic revenue growth is about the breakeven range for EPS growth. Double-digit EPS growth would only occur if we moved into the high-growth scenario of double-digit organic growth. Our first quarter performance and our second quarter guidance put us right on track with what we laid out last quarter. In the first quarter, we achieved adjusted operating margins of a shade over 15% on 5% organic revenue growth. Adjusted op margins will decline in the second quarter on slightly lower revenues, and we continue to see the second quarter as the adjusted operating margin trough for the year due to the seasonal effect of the holidays, weather disruptions and the anticipated ramp in our spending. Pulling back from the near-term and looking at the bigger picture, I remain very excited about the story that is building here. We're putting in place the infrastructure that sets us up for the next run of growth. We're executing on the share gain programs that will fuel top line growth, particularly as manufacturing recovers. We're executing on the BDNA integration and growth plan, which creates a new platform of growth to complement our base business. All of this makes for a story of tremendous earnings leverage as we move beyond the near-term into fiscal 2016 and beyond. I'd like to thank our entire team for their hard work and their dedication in executing this plan, and we'll now open the line for questions.

[Operator Instructions] Our first question comes from Sam Darkatsh at Raymond James.

This is Josh filling in for Sam. I wanted to get the assumptions for share counts straight with the guidance. Could you break out what the guidance is for share count and also tell us how much is remaining on the buyback authorization?

Do we have the share count total?

It was -- actually, the share count -- the share count -- the share repo authorized program was 4.3 million shares before the buyback. So subtract from that the 1.45 million shares. So that would give you your outstanding amount, what is that, like, 2.5 million, 2.3 million -- what's that? Sorry, 2.9 million, sorry. And as far as the share count, most of the shares were bought back in November. So -- and we do it on a weighted average basis, on a daily basis. So there wasn't a huge impact in the Q1. In fact, the impact was about $0.005. I can get you the exact share count afterwards, Josh, if you want to follow-up with me.

Okay. That all makes sense.

Actually, we assumed 62.1 million shares within our [ph]...

There you go.

For Q2.

Okay. And then, I know there's a lot of moving parts in December. But if maybe we back away from the last week or so when there was noise with weather and holidays, can you give us a sense of how pricing is looking now that you're a few months into the last Big Book price increase and what some the puts and takes have been as it relates to price and volume?

Sure, Josh. It's Erik. So let me just -- I'll give you a perspective on both, sort of what we're seeing from a demand standpoint. And I'll touch on the pricing environment. I think, from a demand standpoint, what you sense from us is we're encouraged by the sequential improvements we saw through the back half of calendar '13, the beginning of our fiscal year. Our perspective is our share gain momentum continues and the only difference that you saw from Q1 to prior quarters was an improvement in the manufacturing, and particularly, metalworking manufacturing environment. And as we described, it's not like it's booming, and we don't see it as the ISM would indicate. But certainly, the environment went from what was a pretty negative environment over the past 12 to 18 months to one of stabilization. In terms of the holidays, the weather, yes, I mean, hopefully, you also sensed from us that this is a really, really tricky time to be interpreting growth rates in December. I will tell you that for much of -- the first part of December looked an awful lot like October and November from a growth standpoint, and the back half of the month, and particularly the end of the month, you had 2 things going on. One was the holidays of Christmas and New Year's Day falling on a Wednesday, is the most extreme negative impact we could see from a holiday effect. And then number two, add on top of that really lousy weather in several parts of the country that was widespread. So you saw effectively a combination of holidays plus weather pulled growth rates from what was in the 5 neighborhood down to the 3 neighborhood. Okay. So that's the story on demand environment. But absent that factor, we feel pretty good about what's building, and what we did moving forward is baked into our guidance forecast, is January and February returning to the 5-ish range that you saw in October and November, which is consistent with our characterization and our customers' characterization of the environment as stable. So that would be the demand environment. With respect to pricing, I would tell you that the Big Book price realization was solid. It was consistent with what we've seen over the past few years. I would still characterize the pricing environment as modest. And as you know, we -- the way we look at pricing, there's 2 primary drivers that we use to assess a pricing environment. One being what's happening on the supplier front. Two being what's happening on the customer front and sensitivity to pricing. Right now when we put those together, we would still characterize the Q1, Q2 period as modest.

Our next question comes from Ryan Merkel at William Blair. Ryan Merkel - William Blair & Company L.L.C., Research Division: So first off, I wanted to dig into the drivers of the improving growth. Certainly, vending continues to be a driver. But were there any end markets or product categories that are standing out as where you're seeing the biggest improvement, or is it broad-based?

Ryan, what I would say is from an end-market perspective, I think the color I would add is in general, as we described, metalworking -- our core end market, the metalworking end markets, are still lagging the broader industrial economy. So I think that dynamic holds. I think what you've seen is the water level come up and certainly, it's an improved picture but still lagging. In terms of bright spots, I point you to a couple of areas by channel. Certainly, vending and e-commerce are the shining stars and I think that's a function of the value add that those programs are bringing to customers in a time when customers are really looking to streamline supply chain. And then from a market perspective, I'd point to our national accounts program as what's been sort of disproportionately outperforming the business. And I would tell you there, I think, 2 things going on. Primarily what we're seeing is, I believe, improved execution. And that's both with respect to account penetration and new account signings. I will tell you, historically, national accounts have served as somewhat of a leading indicator for us of what will happen across the broader customer base. So I think we're hopeful that, that's the case here. Right now though when we dig in on our national accounts performance, I think it's weighted to date more towards execution than it is to market. But that does give us some cause for -- the historical correlation gives us some cause for optimism. Ryan Merkel - William Blair & Company L.L.C., Research Division: Okay, that's helpful. And then I want to dig into the price again because by my math, price added a little less than 0.5 point year-over-year to the growth rate. And I thought price was running at kind of 3% in October or November. So what am I missing?

Yes, Ryan, are you referring to -- in the West side stats, the growth decomposition? Ryan Merkel - William Blair & Company L.L.C., Research Division: Yes.

Yes, okay. So one thing to realize there is that is a -- that's -- so if you're looking at that $1 million roughly, that's the combination of price plus discounting plus mix. So that's customer mix, that's product mix. There's also sorts of movement up under the covers. What I would tell you is that the way -- we have some detailed measurements on price realization. And we're seeing strong realization consistent with what we've seen over the last few years. Ryan Merkel - William Blair & Company L.L.C., Research Division: Okay. So just mix is an offset there, and then you said discounting is in offset, too. Wouldn't that hurt the realization?

It would. I'd tell you that mix is a big part of what's going on as well though. Ryan Merkel - William Blair & Company L.L.C., Research Division: Okay. So more mix. Okay. And then last question. You said expenses will ramp more modestly. This is outside of variable expenses in the second half. So of the $12 million to $15 million in infrastructure growth spending planned for the year, what annual run rate are you running at, are you assuming for the fiscal second quarter?

Ryan, it's Jeff. Let me just give you a sense maybe going down the infrastructure investments and you could get a sense. We had said it would be an additional $12 million to $15 million in the year during the last call associated with the infrastructure. Davidson is at full run rate right now. In terms of the CFC for Columbus, we've begun ramping there. There's where we'll see a little bit more of a ramp in terms of infrastructure expenses as we go out. And a good deal of the IT data center expenses have already been incurred and will be incurred through Q2 and then that will subside as we go out. As far as the growth investments though, we will continue to ramp in areas like the sales force expansion and a lot of that will take place in Q2 and continue in the second half of the year, and then SKU expansion, vending and so forth. But it will be a more modest increase sequentially from quarter-to-quarter, again excluding the volume-related increases.

Our next question comes from Matt Duncan at Stephens Inc.

So, Erik, I'm wondering if we can maybe dive a little bit more into the increased -- improvement in your tone that, I think, you're purposefully making sure you get across here. How much of what you guys are seeing that's making you more positive is sort of just end-market stabilization versus talking to your customers, their optimism and what you're hearing from your customer base on their expectations going forward?

So, Matt, here's what we're trying to get across. It's not booming. It's not great, but it's better than it was for the last 12 to 18 months. And I think that's very consistent with when you look. So there's still a big divergence between the ISM and the metalworking market. So if you look at the metalworking indices, there's still a wide gap. When we speak to customers, there's still a big gap between what customers are saying and what the ISM readings suggest. So what you're hearing is improvement relative -- we've been, for the past 12 to 18 months, in a manufacturing market where, with respect to our core end markets and metalworking, things are pretty soft. So it's better. It's stable. And I think that's the way our customers would characterize things. Are there -- there's a couple of things that give us signs -- pause and signs of optimism for '14? Sure. The budget resolution is one that we mentioned that we're hopeful will add more certainty, both to government and commercial customers. But in general, the more positive tone that you're hearing is more along the lines of: things are stable and not declining.

Okay. And so following up on the month-to-month progression, and I get that this is a little bit guesswork, but is there any way to try and quantify the impact that you're seeing from the weather? Can you look at December in a way that you can look at how many below locations, how many sales offices you had that were down for so many days or customers that were down and try and break out? If I look at the 5% drop in daily sales growth, excluding the benefit you had in November from the accrual change, how much of that do you think you can attribute to weather versus other things like holiday timing?

Matt, it's almost impossible for us. In fact, I'd say virtually, it's impossible to split out. Because of the timing of the weather, and that we don't have enough days under our belt post-holidays, post-weather now to see how things rebound. Hopefully, weather calms down a little bit across the country. It's really impossible for us to parse out. So the way I think about it is, the difference between the 5 and 3 is a combination of holiday plus weather disruption. And it's tough for us to break it out any further.

Okay, understood. And then last thing for me on the buyback, is that something you guys would see yourself continuing to do? Is that -- Jeff, you did say that was sort of an opportunistic action. Your stock is obviously up a bit from where you made those purchases. So would it be safe to assume that, that was probably something that you did that one time and we're likely not going to see it again? Or do you still feel like there's a good opportunity to buy more of your stock here?

It's one of the elements of our capital allocation and return to shareholders. And you could see, we've always said that we take a balanced approach in terms of where we put the capital. And just look at the past year, we did the largest acquisition in the company history. We followed it up with a dividend increase. We just did the share repurchase. And of course, we're investing significantly in the organic growth of the business. And I would expect a balanced approach going forward and an opportunistic approach to the share repurchase.

Our next question comes from Adam Uhlman at Cleveland Research.

I guess, my first question was a clarification on the pricing environment. Did you happen to take your normal December price increase?

We did not. No. We took no pricing action other than what we disclosed about our Big Book increase.

Okay. Got it. And the idea there is just there's not cost push from the suppliers?

Yes, we had talked about, Adam, the -- so in terms of the P&L impact, the purchase cost headwind realized through our P&L has certainly mitigated. And then looking out the windshield, again we're characterizing the environment as modest still.

Okay, got it. And then as I think about the inventory additions for the rest of the year, you're adding a lot of SKUs, you're getting better turns. It sounds like there's some more to come. Could you help me understand how you think about the inventory dollars as the year progresses or your turn goals?

Yes, sure, Adam. It's Erik. So I think what you're seeing on the inventory front is, and you're rightfully pointing it out, a scenario where, I think, we're executing well and what you're seeing is the result of some operations improvements that we've made within our purchasing area to drive turns up. What I would tell you, if you're looking forward, the only significant factor -- the SKU additions, I made a point of mentioning that the inventory -- the way the program is designed, I think, is done very smartly where we're bringing inventory in only when we have a very high degree of confidence in the sales activity of the SKUs. So I wouldn't see a major headwind there. The only headwind you really see going forward that would impact turns at all would be the build we're going to do for Columbus which will, overtime, work its way out of the system. That will be a temporary spike. Other than that though, pretty much steady as she goes.

Our next question comes from Brent Rakers at Wunderlich Securities.

I wanted to follow-up on the last question. I guess, the lack of a mid-year price increase, and maybe if you could talk about what the ramifications would be for gross margin trends during the second half of the year?

Yes, Brent, it's Erik. So again, pricing environment is modest. No mid-year to date. Remember, we can do a mid-year pretty quickly. So I wouldn't rule anything out for the back half of the year. All we're giving you is what we see right now. It's certainly possible that we could take some modest pricing. You've got the sense of what we're guiding for in the second quarter. And I think we would characterize the sequential erosion from Q1 to Q2 is pretty moderate, all factors considered. Right now and obviously, we'll give you guidance on the next call about the next quarter, but gross margins, but if you asked us right now, if we peeked around the corner and looked at Q3, Q3 would look relatively stable with Q2 down slightly but relatively stable. And I think the key thing to remember is, all of this is sort of factored into our perspective on the op margin range of 14% to 15% for the year.

Okay, great, Erik. That's helpful. Maybe on Barnes or BDNA for a second. When you look through the outlook there, could you maybe talk about where the headcount is now before you start reinvesting in the business? And maybe where the headcount was at closing date?

Sure. And are you talking about -- Brent, are you talking about sales, field sales headcount, total headcount?

Total headcount, please, Erik.

Total headcount, I'm going to have to get back to you. We're going to have to get back to you. We'll follow up, Brent. I don't have it offhand. Generally -- so without the numbers, let me just give you sort of a directional sense of where we're at. Obviously, one would expect that support-related noncustomer facing headcount is going to come down over time. That is part of the cost synergy number that's in the model, okay? And directionally, where we're at, field sales headcount, which is really the growth driver portion of the business, is a shade under 700 now, not materially different than it was. That's the number that, over time, we're going to expect to see grow. I think, like we see on that MSC-based business, we see a lot of runway for sales force expansion. So that's the number that I expect to grow and that will begin to tick up in the second quarter, albeit slightly.

Okay, great. And then, I guess, just, Erik, one follow-up on that last question. Related to the $1 million of additional investment spending targeted for the second quarter on the BDNA is, can we assume that, that's almost exclusively additional sales force adds?

No. It's actually divided. So let me touch on BDNA, Brent, give you a high-level walk on BDNA. So $0.05 accretion Q1 down to $0.03 in Q2. The $0.02 is essentially $0.01 of that is the lower sales volumes in Q2 that are seasonality, they see the same thing we see on the MSC side. And then $0.01 of that is the money that you're referencing that's reinvestment into the business, along with we're also anticipating higher sales levels in the back half of the year. So there's a small piece of the money that's supporting volume support for the back half of the year, a piece of it is beginning stages of sales force expansion, although I tell you that's early. And then the other 2 are the pieces that I mentioned, which are marketing investment and investment into some of their value-added offerings.

Our next question comes from David Manthey at Robert W. Baird. David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division: Maybe if you guys can address well-run BDNA here. Could you talk about functionally what's been done to date there, and what's on the docket for 2014? The reason I'm asking is, on the last call, you had mentioned that the better-than-expected performance at BDNA was one area of potential upside for the numbers. I'm just wondering what that might look like, where that outperformance might come from, so that you can help us with what you've done and what you're going to be doing in 2014 will be helpful.

Sure. It's Erik. So right now, David, I think, the headline is, BDNA basically on track. So I would say the $0.15 to $0.20 accretion range, the $15 million to $20 million synergy run rate in '15, right now assume that's on track and will be -- we expect to fall within those ranges on both as planned. In terms of what's happening with the business, there's really a few components going on. I would call step 1 around improving execution and improving customer service in that business. Step 2 -- and these are not sequential necessarily, but 3 sets of things. That's initiative 1. Initiative 2 would be integration, which would be integration of the distribution centers as described. And integration of the headquarters location into Davidson as described. And initiative 3 would be growth planning. And so I think it's -- to characterize where we are now, we're well underway on initiative 1, which is improve customer service, improve execution, which is servicing existing accounts and signing new accounts. Integration plans are also underway, and that's both -- that's what's driving the synergy realization, both on the cost side and the very early stages on the revenue side. And then just entering now sort of initiative 3, which would be growth planning, which was what I just described on the $1 million growth investment. So I think with where we're at, we're encouraged. The business, if you look back, had been trending for the last year or so as a decline -- a mid-single-digit decliner. That's moved to a low-single-digit grower. And I think the gap there is essentially the first 2 things. It's the customer service and execution and very beginnings of cross-selling synergy. David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division: All right. And just finally, in terms of these SKU additions that you're making, are you targeting your existing or similar customers with these products or are there new verticals you can go after? And I'm wondering, does the number of customers you have, the number of active customers, does that go up or does the mix of nonmanufacturing, for example, does that change materially as we go forward based on the SKU additions?

David, I would say -- so philosophically, these SKU additions are not all that different in terms of how we viewed prior SKU additions is which -- they're targeted. For the most part, they're targeted at both, largely at share, while a gain, and account penetration is sort of priority 1. And certainly a lot of these SKUs do give us the ability to move into new end markets. But I would tell you, first and foremost, on share of wallet gains, and as I described, I think we're using some very smart techniques in how we're harvesting and mining some of our transactional data, historical data, customer data, to get high-performing SKUs into the mix.

Our next question comes from Eli Lustgarten at Longbow Securities.

Just one clarification to the -- I think you gave the guidance. Did you say 62.1 million shares basic was what you're assuming for the year, was that the basic number you had?

Diluted.

That would be diluted.

62.1 million diluted?

Correct. 62.1 million diluted shares in our assumption for Q2 guidance.

Okay. Can we talk about the operating expense? You said it will be up $7 million X, so whatever happens to sales numbers in the second quarter and then it moderates. But with depreciation coming on to the expenses next year, are we looking at roughly $3 million to $5 million per quarter of incremental expenses for the next couple of quarters, as you go into 2015? Can you give us some guidance, not just second quarter, but looking third, fourth, and into '15 of what the sequential operating expense number goes up, excluding the volume change?

Are you speaking in terms of depreciation associated with the CFC?

Well, you gave us $7 million in the quarter, but only $1 million of that is depreciation, and then you give $2.5 million from the payroll and $3.5 million from growth in manufacturing. That's a sequential number. I'm trying to get is what is that sequential number in third, fourth and into '15. Depreciation goes up, payroll sort of disappears for a while and you still have the rest of the base equipment [ph]. I'm just trying to get the idea, what should we figure the incremental operating expense numbers are in the second half of the year into '15 grow at, excluding the volume number?

Eli, it's Erik. I'm going to jump in for a second. So I think the way to think about it. We're not yet prepared to give you a specific sort of quarter-by-quarter OpEx walk, because there are variables on timing, on what happens with volume. What we did want to get across is, number one, the annual framework that we gave you in terms of an op margin is intact. Number two, the Q2, Q2 is going to be the low point in op margin for the year and in part because it's the highest OpEx build. And what we were trying to get across is the fact that don't take the plus $7 million in sequential OpEx and assume that Q3, Q4 are each then a plus $7 million, that if you look from Q2 to Q4 and drew a line, that we expect, absent volume increases, which we hope come in spades. But that absent that, that it would not be a straight line taking the $7 million trend and running it out.

No, right. But would it essentially stay flat or slightly up from the 2Q run rate? Is really what I'm looking at.

We still expect it to go up.

Okay. Most of the commentary you have prior really set up 2014 as a modest earnings decline for the year. You're now sounding a lot more optimistic, particularly with the organic growth potential that you're seeing of that. Does that give you more confidence that you should be looking more to flat to probably modestly up here in 2014?

I think, Eli, what we want to get across on the call is we're on plan. I mean, I think the framework we laid out in the last call, we still feel like we're intact. We felt like from an earnings growth standpoint, mid-single digits, somewhere in the mid-single digits is the breakeven range for where earnings growth are flat. We still feel that's the case. And depending upon how optimistic one wants to get about what the revenue trajectory in the environment, you could draw your conclusions on where you take that with earnings. But from our standpoint, on plan.

Our next question comes from Hamzah Mazari at Crédit Suisse. Flavio S. Campos - Crédit Suisse AG, Research Division: This is Flavio, I'm standing in for Hamzah today. Most of my questions have been answered already, but if you just could give us a sense or comment a little bit on how the OEM side is tracking relative to the MRO side, especially as manufacturing seems to be doing better recently?

Yes. We gave you -- so, Flavio, for our first quarter, and this is sort of consistent trending, but for Q1, manufacturing was up a shade over 5. Nonmanufacturing, a shade under 4. And remember, nonmanufacturing is way down a little bit by one of -- of the 24%-ish that's nonmanufacturing, about 8% of that, or 8% -- 8% of the 24% is government that's the negative. Flavio S. Campos - Crédit Suisse AG, Research Division: That make sense. And within manufacturing, has OEM started to give signs of recovery as well or is it more on the MRO side?

Yes. So we did see -- that's a good point. The 5 did grow sequentially through the quarter. So we're certainly encouraged by that. But as I said, I would still characterize the sort of hard -- heavy manufacturing environment as stable and not certainly as a straight line up right now. What you're hearing from our tone is stable this quarter is a lot better than negative what it's been for the last year or so.

Our next question -- I'm sorry, and our last question comes from John Inch at Deutsche Bank.

Erik, were you alluding to -- when you were describing pricing, were you alluding to a third quarter expectation on gross margin that was comparable to the second quarter? I wasn't quite sure what you were suggesting with respect to margins in the third quarter based on what you were describing earlier in the call.

John, what I was -- yes. So let me just -- I'll make sure I'll get it straight for you. So what I was responding to was the question has to do with pricing, lack of mid-year, influence on Q2, and then looking to the second half of the year. And obviously, you know our drill. We give -- we tend to give the gross margin guidance one quarter at a time. What I said was if you ask me right now to peek around the corner at what I saw for Q3, probably a slight decline. But relatively stable slight decline with where we are in Q2 would be what we see right now. All subject to change, but that would be the look around the corner.

Okay. So that's sort of what I thought. Now to get to the 14% to 15% kind of your expectation for the year, if we go from 15% down to 13%, how do you -- like, how does third quarter and fourth quarter fill in? Like is it an expense control or you're just assuming the volumes -- volumes drive gross margins. So I guess, is the rest of this to get to your own op margin guidance, Erik, is that because expenses come down? It's a little bit of a point around Eli's question.

Yes. Good question, John. So what I would tell you, last call when we gave you the framework, our implicit assumption was that gross margins are plus or minus relatively stable. Not a big difference versus prior year. And I'm talking about even versus prior year, not a big difference. The big change going from Q2 to Q3, for instance, is going to be the revenue levels. And particularly growth rates certainly, I mean, a lot more growth would help a ton. But there's a seasonality impact. So Q2 is the low -- from an absolute sales dollar standpoint, Q2 is the absolute low point. Q3, it tends to be historically is a higher absolute number that gives some leverage. So even if OpEx were to go up the same as it did in Q2, we get more leverage based on the sales being higher.

But historically, some of the seasonal pattern is driven, if I'm not mistaken, by the price dynamic. So if you're not able to take a -- if you didn't take a price increase and you did do the 3 but your realization is sort of -- it's flat based on your disclosure, doesn't price traditionally, Erik, kind of fade over the course of the year? Meaning you start up with a catalog and you kind of get that initially. But then, for lots of different reasons, mix or national accounts or whatever, kind of the price fades over the course of the year. I'm just curious, if that's not really an expectation set, are you banking on something else perhaps like maybe incremental -- significant incremental BDNA contribution or something like that?

So, John, 2 elements to the question. I think, one thing I'd get across is that we do -- even absent price, we would anticipate seeing a lift in absolute sales Q2 to Q3. Market conditions remaining constant, we would expect that. And the same thing we would expect to happen on the BDNA side, similar seasonal pattern there, which is you could imagine would help improve the contribution from BDNA. So that would be the volume story. On pricing, look, we're still hopeful that we can capture some, even if it's modest, some mid-year pricing if it's modest. But are not anticipating, in order to achieve the 14% to 15%, you are correct that our normal seasonal pattern is margins will peak in the first -- absent pricing, peak in the first quarter, and then the headwinds will take over through the course of the year. So 2 things I'd point out. One is, look, we're hopeful that maybe there is an opportunity for some modest mid-year this year. Two would be, we -- the purchase cost headwind that we were calling out last year, there was a sizable to the sequential headwind is not there the way it was last year. And we talked about it was going to work its way through. It has. So that leads us to believe that it should be a more stable picture than maybe it was in prior year.

Okay, that's very helpful. Maybe one more. I appreciate the timing of holidays, but do you guys -- I mean, given this winter weather, don't you actually sell winter sort of seasonal products that -- I know certainly Grainger does, they sell summer and winter products that are prospectively maybe getting a boost to offset some of the Midwest weather disruption in other areas of the country or is that less a factor given your metalworking mix?

Good question. And yes, you're correct. The answer is both. We do. I mean, so we -- our rock salt and so there are certain items that will sell like crazy. So there is a little bit of a tailwind there. That generally is more than offset by the headwind given our customer and product mix, we're selling into manufacturing and what we lose is more than what we gain.

Okay. So I'd like to thank everybody for joining us today and for your continued interest in MSC. Our next earnings date is April 9, and we look forward to speaking with you over the coming months. Thank you.

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