Good morning, and welcome to the MSC Industrial Supply 2020 First Quarter Conference Call. [Operator Instructions]I would now like to turn the conference over to John Chironna, Vice President of Investor Relations and Treasurer. Please go ahead.

Thank you, Melisa, and good morning everyone. I'd like to wish everyone a Happy New Year and welcome you to our fiscal 2020 first quarter earnings call. With me are Erik Gershwind, our Chief Executive Officer; Rustom Jilla, our Chief Financial Officer; and Greg Clark, our Vice President of Finance and Corporate Controller. As you all know, Greg will become our Interim CFO when Rustom leaves the Company at the end of the next week.During today's call, we will refer to various financial and management data in the presentation slides that accompany our comments as well as our operational statistics, both of which can be found on the Investor Relations section of our website. Let me reference our Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Our comments on this call as well as the supplemental information we are providing on the website contain forward-looking statements within the meaning of the U.S. securities laws, including guidance about expected future results, expectations regarding our ability to gain market share and expected benefits from our investment and strategic plans, including expected results from acquisitions.These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks is noted in our earnings press release and the Risk Factors and 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 this call, we may refer to certain adjusted financial results, which are non-GAAP measures. Please refer to the GAAP versus non-GAAP reconciliations in our presentation, which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures.I'll now turn the call over to Erik.

Thank you, John and good morning everybody. Thanks for joining us today. I'd also like to reiterate a happy and healthy New Year to everybody. As our fiscal 2020 is now in full swing. I'll begin this morning's call with some strategic context before getting into the usual specifics of the quarter. Over the past several years, we've repositioned MSC from our historic role as a spot buy-only supplier to a mission critical partner on the plant floors of North American manufacturing and industry. We undertook this journey, primarily because we saw an opportunity to partner more closely with our customers, who have been calling out for help in running their businesses better. And MSC is uniquely positioned to fill that void.We also foresaw increasing pressure coming over time on our legacy spot buy-only model mainly from increased pricing transparency in this more transactional side of the business. Over the past several years, we've taken a number of steps to realize our vision. First, we focused on building trust with our customers. The kind of trust that allows us to play a bigger and deeper role in their business. We've done so by developing a new sales model and new tools to facilitate trust building such as robust cost savings documentation, which we recently patented. While the implementation of our new sales plan has taken time, we're seeing the early results pay off in higher levels of customer satisfaction and loyalty. And this is important because, our data shows that higher loyalty leads to higher growth over time.Second, we doubled down on product and service categories that are technical and high-touch in nature bringing us closer to the center of our customers operation. We've invested in our traditional core of metalworking through a further build out of technical specialists, new…

Good morning, everyone and thanks Erik. Before discussing the numbers, let me start by thanking Erik, not only for his kind words but for a great four plus years of partnering closely with him and my heartfelt thanks to Board and to my fellow associates, especially those in finance for a host of good memories.Now to the financials. First, let me remind you that we provided Q1 guidance both with and without the severance and separation charges we expected to incur. As such, I'll speak first in terms of our reported results and then in terms of our adjusted results, which reflect the exclusion of those costs. Our first quarter total average daily sales, ADS was $13.3 million, a decrease of 1% on an ADS basis versus the same quarter last year. This was slightly better than the negative 1.5% midpoint of our guidance range. Versus fiscal 2019, our MSC Mexico business which was not in the prior comparative period contributed roughly a 100 basis points of growth for the first quarter sales. Our Q1 reported gross margin was 42.2% at the high end of our guidance range as a result of lower inventory provisions and higher vendor rebates and credits.Versus prior year, our gross margin was down roughly 80 basis points with Mexico accounting for roughly 20 basis points of the decline. Total reported operating expenses in Q1 were $256.9 million, slightly better than expected as a percent of sales. As such our reported operating margin was 11% versus the guidance of 10.7%. Our tax rate for the quarter -- for the first quarter was 25%, slightly better than guidance and the prior year due to the favorable impact of stock compensation expenses. So all of this resulted in reported earnings per share of $1.18.Now let me move to…

Thank you, Rustom. We remain focused on repositioning MSC from spot-buy supplier to mission critical partner to manufacturers and industry. In fiscal 2020, our focus remains on three initiatives. One, completing the sales effectiveness refinements, position our business to capture market share aggressively. This includes ramping up growth investments in areas that are delivering early returns. Two, implementing the new supplier program which when combined with an -- improving purchase cost trend and mid-year price action will continue to close the gross margin gap; and three continuing to streamline our cost structure and transform our operating model to be leaner. Recent progress on these priorities represents the beginning and at the end of our journey to fulfill our mission to be the best industrial distributor in the world.We'll now open up the line for questions.

We will now began the question-and-answer session. [Operator Instructions] The first question today comes from David Manthey with Baird. Please go ahead.

Yeah. Thank you. First off, Rustom congratulations and best of luck.

Thanks very much, Dave.

Sure. And then Erik, can you broadly compare the shifting model here from the spot-buy to the shop floor solutions business. You noted an expectation for better sales and return on capital trends. But specifically, can you talk about the P&L and how you view secular gross margins and operating margins under the new paradigm?

Yeah, sure Dave, look -- I think you're hitting at the heart of the opening this morning, which was about how the Company has been repositioned to the -- sort of the new model this mission critical model, which as you said is a higher mix of recurring inventory management related technical business. So, a couple of attributes that you're highlighting that come from -- so, number one, is what we're seeing is higher retention. And the reason that becomes so important as we model out over time customer lifetime value as you could imagine small movements in customer retention, small increases in retention when you blow that out over a number of years, yields significant increases in lifetime value.So we are encouraged there and it's one of the reasons why sort of reinforcing that this is the right strategy. Not surprisingly, probably one of the other attributes is that at least for many of the revenue streams. So some of the more technical related metalworking and vending being two examples come with lower gross margin percentages. And that's one of the reasons, of course, why over the past few years you continually hear us talk about a mixed headwind, we share today how we move the business. So if you think about an 1,800 basis point movement toward solutions business over the past -- six years or so with lower margin percentages on vending and technical metalworking that will come with a headwind. What that does is it leads to particularly as we now have some scale in these businesses that tees up the other opportunity that we talked about this morning, which is to take a broader more holistic end-to-end look at as we referred to with the operating model, recognizing that -- look, the supply chain -- the supply chain and the whole operating model for a spot-buy business is of course going to be a higher cost model than the model for a planned managed Inventory model, because spot-buy comes with a very high premium level of service and with the scale now built up, we see considerable opportunity to take cost out, quite frankly.

Okay. So, but no change in the secular operating margin expectation of the Company, used to be in the high teens, is that still achievable under the new paradigm?

Yeah, look what I'd -- Dave, what I'd say there is for me, one step at a time, which is what we want to see right now is stabilization and then return to op margin expansion. Certainly we see those things as part of the formula, so no change there. Talking -- once we start getting some traction, I'll return to you and talk about high teens, how about that?

Okay. Thanks for that Erik. And then second on the guidance, if you triangulate the variables that you gave us, it looks like SG&A is expected to be roughly flat from the first quarter to the second quarter, which is fairly typical for the Company, but given the severance actions, you've got one fewer day versus typically flat or higher. The sales are flexing down. I just would have thought we would see a decline in SG&A sequentially. Any color that you can provide on operating cost trends into next quarter?

So sequentially it's interesting, but when you -- the way that the holiday works out, right in December, we keep our staff online during that period because we don't want to take out the people and then have to hire them again from the next quarter. And that's come the next month. And that's a big contributor to that actually, we are seeing savings, we are seeing close on $2 million of savings from the cost take-outs of Q4. Of course not sequentially because we saw that in Q1 as well, but compared to last year.

Dave, the other color, I'll add, I think -- you know I think Rustom is right in that we -- we feel like, I think you're right to note this because clearly, it does stand out why would not the X be down when sales were down sequentially as the total revenues were down as they are. Q2 is a bit of an outlier. So, Rustom mentioned one reason, which is the variable factor, we typically in Q2 for the holiday issue that Rustom described and also because we generally see higher sales in Q3. We won't bring staffing levels down in Q2, the way we would in another quarter with sales dropping that was one factor. But the other to hit on is we do have a couple of investments that we're making in Q2 that are not necessarily permanently embedded costs, i.e., they're not headcount, I mean you could see headcount coming down but discretionary type of investment specifically around aimed at growth and productivity. I'll kind of leave it there. But that are non-permanent in nature, but that are making the OpEx higher in Q2.

And that was the roughly $2 million that I had mentioned.

Alright helpful. Thanks guys.

Your next question today comes from Hamzah Mazari of Jefferies. Please go ahead.

Good morning. Happy New Year and best of luck to you Rustom.

Thanks, Hamzah. Happy New Year to you too.

Happy New Year, Hamzah.

Thank you. Erik, my first question is, you spoke about a lot of change, a lot of repositioning at the Company. Why -- what's your level of confidence that this restructuring will be successful relative to others you've had. Has the culture changed internally, is there more employee buying, I know you have -- you had a new Head of Sales from outside the Company. Just any thoughts there would be helpful.

Yeah, sure, Hamzah. So what I would say is my confidence is high. Let me start with that. We have done. So let me talk specifically because I talked a little about the operating -- let me talk specifically about what's happening in sales and the refinements being made where my confidence is high. So over the last two years, we have done a lot of heavy lifting that you alluded to in changing the sales model and this morning I tried to articulate why we went through those changes, which is about articulating the new value proposition that ties to this new strategy.The heavy lifting is primarily behind us and as you said, we have a new Head of Sales, Eddie Martin, who's come in with a fresh look and basically concluded that the plan is right and the implementation needed to be tweaked. And the tweaks are happening now and is basically, when I say tweak, two refinements being made. One is that there were a couple of areas in which he observed with data and intuition that we were over allocated and by over allocated and then over staffed and there's two areas and that's where you saw the headcount results in Q1. So one would be management to lean things out and increase spans of control a bit were reductions in management. And the second is to identify areas in which portfolios were undersized and so what you saw happen with headcount going down was a consolidation of some portfolios.The flip side of that. And this is part of why the confidence is areas in which were under allocated and particularly we highlighted a couple of them where we've already made some investments into the hunting function or the BD roles where we're pleased with early progress. Obviously, it's still early but pleased with progress so and that area for instance in the new business area, we're seeing new signings, up 27% year-on-year. Last year we talked about hiring a bunch of people that were new that would need time to get up to speed we're seeing that happen. So the productivity per person year-on-year was up about 45%.So just as we suspected now it's still early, it's still a small percentage of total we like what we're seeing there. And so the other side of the refinement here what you saw in Q1 was the drop in head count it will come back up in areas like this, where we're seeing returns and that's how we see throttling up share capture. To get to the last point before I wrap is -- is your point about culture. I think it's a good one. What I would say is it's a Company that has become more adept and responding to and adapting to change. So I think as time has gone on in more and more changes we have become better at managing the change.

Actually I'll add one final point, if you think about the restructuring actions of Q4. I mean the dollar benefits of what we expected and the actions that we expected the execution is going pretty much as planned. And we are seeing that. So from that perspective that is growing successfully too.

Great. Very helpful and my follow-up question and I'll turn it over is. You talked about market outgrowth as a milestone to watch for success. You talked about retention rate. Any thoughts as to what that outgrowth is today. Are you growing under the market and you know historically I guess you outgrew the market by 300 bps to 400 bps. Is that the right metric to look at going forward one sort of the restructuring is behind us?

Yes, Hamzah, I think you honed in. Look -- what I -- what we would say today based on triangulating all the different metrics, the surveys, the growth rates, etc, etc, is we're somewhere growing in line with market right now given our exposure. We see really good things happening as I mentioned, on the BD side, but it's still early and it's still small as a percentage of total, it's a couple of areas that we're pleased with progress. But overall, roughly in line, certainly what we're seeing of late is softening conditions which are more acutely soft at metalworking are weighing down. So the water levels coming down across the business quite frankly and is sort of muting or masking some of the progress we see happening in these investment areas. But roughly in line and then looking forward, yeah, certainly, Hamzah sort of minimum table stakes this to say how do we get back to the kind of share capture or outgrowth that we've seen. And, yes, you're right, what we've talked about the 300 basis point and 300 basis point to 400 basis point range.I mean, sort of that would be table stakes for us, and being able to do it more effectively and efficiently than we've done with the past. And we got three things, we are just head down focused on in order to restore that gap. One, as I mentioned, ramping up investment into the growth areas where we're seeing early returns. Two is going to be improving government performance, which for the past year depending on the quarter has cost us somewhere around a point of growth and a lot of progress happening under the covers in government. And the third is continuing to focus on growing solutions as we've done with our core customer to lift retention over time. So that's where we're focused.

Great. Thank you so much. Best of luck.

Thanks, Hamzah.

The next question today comes from Robert Barry of Buckingham Research. Please go ahead.

Hey guys, good morning. Happy New Year.

Hey, Rob, Happy New Year to you.

Thank you. So you mentioned that it sounds like the last week in December was pretty noisy with holiday timing some extended shutdowns. Curious how things were tracking before that last week?

Yeah, Rob. So a good question. December was a really, really funky month, I'll call it. So let me start by saying it was actually so acute softness, the last two weeks. So, and we actually track back, so the last time we saw this was, it was actually our fiscal 2014 was the last time when the Christmas and New Year's fall on Wednesday, what we typically -- what we've seen is basically two weeks that our last weeks. What I would say this year, that was different from on top of the holiday timing, we heard from our sales team a lot more customers using it and I think it's because things have been soft to begin with, it's not just the holidays. But because customers were soft they were using the two weeks to do more extended shut downs than what we've seen for the past several years. So you sort of have a double whammy there.I'll now get to your question. Interestingly, it's a good question about the first portion of December was certainly stronger than the last two weeks on a relative basis, but not as strong as we would typically see and there was. So one or two theories going on it again this will prove itself out in January. One is as crazy as it sounds, the late Thanksgiving may have made November, a little better and December a little worse interestingly, we usually see the first post Thanksgiving week to be not quite as strong. So that this year moved into December. So the first week was a little softer than we thought the other two weeks, pretty much in line. But the big headline being holiday timing and more shutdowns. And then for us Rob, the real question will be what happens in January that will sort itself out as to whether this was all noise or whether we've hit a different point in terms of economic activity.

Right. Right. That's very helpful. So just to be clear, whenever you set the guidance for the sales, for the quarter which of the weeks did you choose? And we have the base off of which to kind of build the seasonality improvement?

We went back to November. We actually based January, February of November of the typical sales movement that we would see from November. So we actually -- gave December a pass, we put the actuals, you know the estimate of the actuals we have it's actually fully finalized the numbers with the estimate of the actuals and then we moved on.

Got it. Got it. And then just I guess for me lastly on gross margin quickly, I think you're guiding down at the midpoint 70 bps in the second quarter, which I think would account for the pressure from Mexico and sources of growth, right, which I think reach about 20 bps and 40 bps to 50 bps respectively. But does that mean that everything else is kind of neutral like price cost is neutral in 2Q?

The price cost remains negative, but that sequential drop from Q1 to Q2 is well within our normal range. I mean 20 basis points and particularly when you think about how I talked about Q1, some of the drivers of that being inventory and when the rebates and credits and all the rest of that, there is actually we're not too worried by that. Gross margin we think is performing as planned. But let me look beyond Q2 and there is two other factors that should buffer the typical downward trend, right? One is the mid-year price increase, which as Erik said is coming late, right, it's pretty much going to come in from into Q3 and onwards, right, the benefits.And second is the supplier program benefits, which we talk about, right? We say it's $10 million in the back half of the year. Yes, it's mostly in Q4 as we communicated but you definitely see it coming in from Q3 onwards. And so you combine all those things and that's -- so that's our gross margin outlook.

Got it. Just to clarify in 1Q was price cost? What was price cost to gross margin?

It was about 90 basis points, I mean, when you look at the moment, if you looked at our decomps which we usually use in there, the earnings decomp, that probably gives you the best sort of price/mix estimate of what's in there. Now, the price costs, what we go is also, yeah, it's also the movement on the margin. It's fundamentally being impacted by the fact that we took our price increases earlier. And then from that point, until you get your next price increase you have -- the price end of it keeps rolling whereas the cost end of it is just average cost system -- average going through our system.

Yeah, sorry just of the 90 which was the total decline, how much was due to the dynamic between price and cost? The whole thing?

Well we shared Rob, so just to be clear, Rustom's 90 basis points, I believe is -- he's referring to the price contribution in the growth decomposition. I think you're talking price cost -- look we've generally talked about. So if you think about the way we've talked about gross margin price, cost, mix, three factors right. And what we've said is, over time what we saw is price, cost, kind of a wash and we're left with a mix. There is a mix headwind in the business that's somewhere in the 40 basis point to 50 basis point range --

Typically.

Okay.

Typically, right, moves around quarter-to-quarter. That we don't -- and for all the reasons we talked about earlier on with how we're moving the strategy, we don't see going away. What Rustom is describing is the dynamics of price cost, we've been negative price cost, it feels like as it should Rustom said, we've -- what's happening is sort of what we would expect to happen, that price cost dynamic is beginning to improve.

Yes.

For all the reasons you described.

I gave you the number that's out there in the public domain and then I described how the price cost curve is moving for us. You see it looking better in the second half for sure.

The next question today comes from John Inch of Gordon Haskett. Please go ahead.

Thank you. Good morning, everybody. Happy New Year.

John, Happy New Year.

Thank you. And Rustom, we'll miss you. Erik, I just want to square, so just want to understand the kind of the guide here. Are you assuming that business average lift from November, but then daily sales for the quarter anticipated are going to be worse than December. So is that compares issue? Or is that just because obviously the -- I guess at the second quarter is seasonally soft, but then it's I mean year ago.

John, You got it. You're hitting on it. So what we did, Rustom described, so we basically didn't know what to make of December and so to Rustom's point, his team basically -- if you model November to Jan, Feb and go back a whole number of years, we're using more or less an average lift and you're exactly correct. What happened was, we saw a larger than average lift last year, which is why the growth rate in Jan, Feb is worse than it was September, October, November in Q1. The reason, it was larger, we saw last year a number of large orders --

Right. Okay.

That we're not anticipating repeat themselves this year. Hopefully, they do, but that's not baked in. Right now we don't see it.

Right. And Eric, is there anything you could say on the Phase 1 trade deal. I asked because there is a little bit of anticipation of some tariff roll back. Do you have to give up price, I mean as you guys are thinking about your price increase. Is this going to be contingent on sort of what you're seeing with respect to kind of tariffs and costs and other things or I mean how does this all play in and are your customers saying anything about it?

So let me -- let me cut in there and there still remains uncertainty of course on tariffs, right. But for us, as we pointed out before, the impact was fairly small. We've made that point before and then so we've looked at the tariff, the more recently the list for tariffs and we've calculated 4A and 4B and we've looked at that and the impact is really small on our numbers. How many inventory that we actually have right now -- you know that's come through at the higher tariffs and the amount of the annual spend, that will be impacted by this. So we're not really seeing it as having -- as having any material impact on our GM.

Got it. Then just I guess lastly, Erik, how do you interpret our wisdom, how do you interpret sort of the flat trend of e-commerce sale. It's sort of been decelerating throughout the year. I'm just curious how you are thinking about your performance in e-commerce kind of flat year-over-year versus the structural transparency kind of growth of e-commerce generally in industry and then obviously your attempts to move to more and more of a high-touch model is. I mean, are you encouraged by that trend? Or is it, do you expected to rebound or like -- how do you think about it?

Yeah, John, it's an interesting question, because certainly, yes, what we've seen is that the e-commerce as a percentage, it's flattened. Honestly don't make too much of it either way, I think it's been lifting in part because of our focus on e-commerce in part just because of sort of the landscape and how customers are buying. I don't make too much of it either way. To be honest, right now we are more focused on the other metric of how much of our business is going through solutions, inventory management solutions as a percentage of revenues, how much is coming from customers with the solution. And then, yeah, how much of our business is flowing through product categories, product and service categories that our technical and high touch. So that's where the focus is, less concerned either way to be honest about the e-commerce percentage.

Okay. So given the new sales head, all the restructuring, kind of the strategic shift of the Company, it sort of sounds like you're not necessarily expecting e-commerce as an outcome to get a lot better necessarily it's versus the overall Company? Or is that I don't want to put words in your mouth.

Yeah, I think that we're going to continue investing John in e-commerce for sure. It's an -- customers want to buy electronically having a strong digital marketing presence is important, having a great transactional e-commerce experience is important. So it's an underpinning of the value proposition, no question. I think what you're not hearing is -- an outright focus in full court press on lifting that percentage of total.

Yeah, understood. Thanks very much.

Sure, John.

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

Hey, good morning, everyone.

Hey, Ryan, how are you?

Good. So first I want to put a finer point on this idea of transforming to a leaner operating model. So two questions. So first, what are the major changes versus the prior cost structure. And then secondly, can you just give us a sense of sizing the opportunity, Erik? I know it might be a little bit early, but maybe just the range of basis points in terms of OpEx of sales that you're thinking about?

Yeah, sure, Ryan, maybe I'll start and then turn it over to Rustom. In terms of the changes. Look, I think, as I mentioned, this is about the move to the new strategy and aligning the operating model to it. What does that mean and what are some of the specifics. I think the biggest opportunity, I'll call out and Ryan, I'll start by saying we're going to be taking an end-to-end look at the business. So every nook and cranny of the business on, are there ways for us to be more effective. Now, in some cases, that's going to mean cost out. In other cases, it may mean investment into the business to fuel growth, the key metric here for us as we look at effectiveness efficiency is OpEx the sales ratio. So it will mean some cost out some investment.A prime example would be supply chain for sure, in the sense that, as you could imagine if you're servicing spot-buy business which is you're getting an order at 8 o'clock tonight and shipping it out the next morning in small quantities. Looking at everything from the way goods flow into our distribution centers from our manufacturers. How they are put away, how they are managed in a facility and then how they get shipped out, how we manage free, it's a different equation then when we're managing inventory for our customers to a vending machine where the replenishment may be periodic and not every day and it can be planned out and it's not emergency in nature.You would imagine that optimally one, the spot-buy model would be higher cost model given the premium services the other one -- within that is an umbrella. There is a bunch of opportunities and it's still early, but a bunch of opportunities that quite frankly, we're now teasing out to say how do we look at the way goods flow? How do we look at our business process? And how we manage freight? How we manage bulk purchases, etc, etc, to -- and the nice thing here is an opportunity to not only improve cost and efficiency. But in a lot of cases, improve the customer experience too. So that would be a little bit more color and I'll let Rustom to touch based on the size.

So Ryan, yes. As you know that it is too early to set a target on this, but look the benchmark suggest a couple of hundred basis points of potential for improvement.

Okay. So that's meaningful. All right. That's helpful. And then secondly, just going back to the ramping of the growth investments. Erik, you hit on this, you're going to ramp the investments that are seeing early returns. Can you just spike out the one or two that you're going to invest in more heavily and then how much you're going to invest this year in growth investments?

Yeah. Ryan, so good question. So I gave a little color. So basically, what we're doing and again, going back to the sales refinement, step one was where we were over allocated in those two buckets -- take them down, which we did. Step two was look and say where are the areas that are not only critical to strategy for the new strategy, but that are showing early returns. And so the hunting function in the BD role is sort of one poster child for that that will be probably one of the biggest areas of drivers of the increase. We mentioned CCSG which is showing some nice traction is another area. There's a couple of others that behind that as well. In terms of sizing and timing, Ryan, what I would say is look, obviously, we took a big count a big chunk down in Q1. You can expect the number to lift in Q2 again in Q3 and again in Q4. Given the nature of hiring and head count management in attrition, it's hard to be precise. What I would offer is that we would expect that by the end of Q4 Ryan, sales and service headcount to be above where it was when the year started. So it will be a meaningful rise from here. And again, it will be driven in areas with better showing returns.

Okay. Very helpful. Rustom best of luck. Great, working with you.

Thank you. Likewise.

The next question comes from Michael McGinn of Wells Fargo. Please go ahead.

Hey guys, thanks for the time.

Hey good morning.

Good morning, Rustom, best of luck.

Thank you.

I just wanted to hone in on, if I heard you right, it sounded like CCSG was growing mid single digits, but metalworking was down, is that correct?

That is correct.

So, -- basically my working assumption of gross margins would have been you know in mix sort of been you guys need -- what it needed to grow in both those categories for maybe hit the top end of your gross margin guidance. Can you just, on the end market fundamentals seem a little similar. Can you just talk about the dichotomy between those two businesses and why that is?

Yes, absolutely, Michael. Look, the biggest factor, and by the way on the gross margin, the 20 basis points over the midpoint been in top of the range. Rustom gave a couple of the drivers there. But in terms of the fundamentals, look, the biggest thing I'll point to Michael is that metalworking products are sold into metalworking manufacturing and metalworking manufacturing is acutely soft right now. So if you look at most of the surveys and then look at the end markets where there is weakness, they tend to have strong metalworking presence. So examples would be automotive, heavy truck, ag, oil, gas weak. And so metalworking is being influenced by really end market exposure.

Okay. And then just switching gears to capital allocation. I think the last time you did, you did a special reverse tender now we're going back to the special dividend. Is there a rhyme or reason to that and is that the path going forward for you guys after you delever from the 1.5 times I think you mentioned?

So maybe I'll take a crack at that Mike and then Erik can add more if he wants to. So look what we have is a balanced capital allocation strategy. So we've used -- we've -- we worked, we try to increase shareholder returns using various means. And so we've done a lot of buybacks in the past that doesn't mean that they won't happen again at some point, I mean it's Dutch auction tenders, open market purchases all of that. But this special dividend is, it basically returns funds to our shareholders and improve total shareholder returns and importantly with the -- with our balance sheet remaining -- and our cash at balance sheet being as strong as it is and our cash flow generation as strong as it is. I mean you know you're talking about 1.5 times leverage that will reduce as time goes on, if nothing else happens, right? So plenty of opportunity to do more going forward to.

Yeah. And just to add on that in terms of the go forward. What I would say is -- look, we've -- Rustom had it -- we've had a balanced approach over time. I think we're focused on right now as we've said, while we're going through all of these changes in the business, the bar is pretty high for us on any meaningful M&A. So right now, as it -- when it comes to capital allocation, we're not necessarily tied to anything other than saying we're going to return cash to shareholders as appropriate in a way that's going to enhance shareholder returns and the special dividend we think checks both those boxes.

Great. Very helpful. And if I could just sneak one in -- more and more in on the growth initiatives. Obviously you don't want to run the business -- you want to run the business for long-term success. But is there a point where you step back and say, hey, to your segment leaders what's drive margin, fixed cost improvement and funded internally before we step up head count here. Is there -- where is the breaking point for that where you're forcing managers hand to show that improvement before maybe starting that hiring again?

Yeah, Michael, look, it's a good question. I think as we taken headcount down nicely over the last couple of quarters and we're talking about it going back up. To be clear, the biggest, there'll be some selective rehiring and one example where the selective rehiring is, it was a pretty heavy focus on increasing performance management intensity inside the Company and we feel it's important that the message is if you're going to manage out somebody that's not performing that you can replace that person with somebody who is performing it creates a good incentive to keep doing it.So that will be that's one example where headcount would come back in. But the big driver is going to be in sales and service, which is customer facing and we think really critical to capturing share. Look, this is still a hand-to-hand combat business, very fragmented, street based. We do to share -- to capture share over time, do need to increase sales headcount. The goal of course is to do it more efficiently and that's why we're adding back heads in sales, it's an areas that is selling returns so that we can do it more efficiently.

All right. I appreciate the color. Thanks for the time.

And our last question today comes from Blake Hirschman of Stephens. Please go ahead.

Yeah, good morning, guys.

Good morning, Gentlemen.

Real quick on auto, you call it out as a little soft again, how much of that do you think was due to the GM strike and did you see things pick back up after that ended?

Some look at -- what I would say Blake is the -- is auto has been soft notwithstanding the GM strike, I think it's bigger than GM. So early to say right now, I mean, I'm thinking of the numbers auto is still pretty soft for us. So look I would expect certainly, it will help a bit, but I think the headline is more than auto was soft, notwithstanding the strike.

Got it. All right. I'll leave it there. Thanks and good luck to you Rustom.

Thanks, Blake.

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

Thank you everyone for joining us today. Our next earnings date is set for April 8, 2020 and we look forward to speaking with you over the coming months. Again I wish each of you a great start to 2020. Thank you.

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