Parthenon-EY Perspectives

Investing in distribution

Scott Orleck, Managing Director

March 2016
Investing in distribution
Summary

US distribution and maintenance, repair and operations

1 (MRO) represent large, growing markets with multiple
value-added niches/segments.

Most segments remain heavily fragmented, leading to

$
2 several interesting acquisition targets and consolidation
opportunities.

Distributors continue to be a critical part of the supply

3 chain and increasingly encounter opportunities to provide
value-added services and earn higher margins.

Acquirers have significant levers to increase

4
business value.

Page 2
Agenda
Distribution industry dynamics
Drivers of profitability in distribution businesses
Parthenon-EY overview and relevant experience

Page 3
 Distribution industry dynamics
Wholesale distribution is a massive market ($5t+) in the US,
with opportunities across many sectors

Total sales of US merchant wholesalers,

by segment, 2014

Total =
$3.0t $2.6t $5.6t
100%
Miscellaneous Miscellaneous
Paper and paper groducts Furniture and home furnishings
Beer, wine, and distilled alcoholic beverages Lumber and other construction materials
Chemicals and allied products Hardware, and plumbing and heating equipmentand supplies
80
Apparel, piece goods, and notions
Metals and minerals, ex. petroleum
Farm product raw materials
Motor vehicle and motor vehicle parts and supplies
60
Drugs and druggists' sundries

Machinery, equipment, and supplies

40
Groceries and related products
Professional and commercial equipment and supplies

20
Petroleum and petroleum products
Electrical goods

0
Nondurable goods Durable goods

Page 4
Source: Bureau of Labor Statistics
 Distribution industry dynamics
Distributors have outperformed the equity markets, corresponding
with a vibrant M&A environment

Distributor stock performance by segment vs. S&P500, Number of acquisitions by

indexed to January 2000 public distributors since January 2000

Num ber of
Com pany name by segment
acquisitions

10X Electrical
ADDvantage Technologies Group Inc. 8
Medical Anixter International Inc. 14
9 (n=3) Arrow Electronics, Inc. 63
Avnet, Inc. 75
8 VOXX International Corporation 25
WESCO International Inc. 24
7 Food
Sysco Corporation 49
6 United Natural Foods, Inc. 13
Industrial/MRO
Industrial/ Applied Industrial Technologies, Inc. 24
5 MRO (n=6) Fastenal Company 4
MSC Industrial Direct Co. Inc. 10
4 IT (n=4)
Law son Products Inc. 2
Food Watsco Inc. 9
(n=2)
3 W.W. Grainger, Inc. 26
IT
2 Electrical Insight Enterprises Inc. 6
(n=6) McKesson Corporation 48
S&P 500 ScanSource, Inc. 13
1 Tech Data Corp. 18
Medical
0 Henry Schein, Inc. 55
June June June June June June June June June June June June June June June June Patterson Companies, Inc. 35
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Ow ens & Minor Inc. 11

Note: Segment lines composed of a sample of public companies that hav e been public since 1/1/2000, equally weighted Page 5
Source: Capital IQ
 Distribution industry dynamics
Profitability varies across verticals, with durables commanding higher gross
margins than consumables

US merchant wholesalers gross and operating margin,

by segment, 2013

Durables Nondurables

40% 40%
Gross margin Gross margin
Operating margin Operating margin

32% 32%
30 30

27%
28% 27%
26%
25%
22% Average GM%

21%

21%
22%
20% (weighted)
20 18% 20
17%
14% Average GM%
(weighted)
14%
10%
10 10 9%

4%

0 0
HVAC

Furniture
and software
Electrical goods

Machinery

Motor vehicles

Misc. durable
commercial

equipment
Professional/

Petroleum
Computer

Metals/minerals

Lumber

Nondurable
Apparel
Misc.

Wine/beer
Paper
Groceries

Drugs

Farm products

Chemicals
Page 6
Source: U.S. Census
Distribution industry dynamics
Profitability is generally driven by a combination of industry and
company-specific factors

Drivers of profitability

Industry specific Company specific

Inventory turns
Distributors are paid to hold inventory; slower-turning
inventory typically indicates higher margins
Product complexity and technical sales requirements
Technical expertise and consultation increase distributor
value to customers and create stickier customer
relationships
Fragmentation of supplier and customer base
High fragmentation typically indicates additional value-add
from distributors
Regulatory environment
Strict regulatory environments can control margins or
require the use of certain products and impact growth
Pricing dynamics
Pricing environment can play a major role in distributor
profits

Page 7
 Distribution industry dynamics
Inventory turns are inversely correlated with profitability, as distributors are paid
for holding inventory longer

Industrial distribution, inventory turns vs.

gross margin, public companies and
representative private companies

60%

Fastenal Commentary
MSC The higher the inventory turns, the lower the margin.
Fire protection and safety
Distributors are paid for holding the inventory because it
Gross margin percentage

40 Grainger needs to be available on demand.

Distribution industry analyst

Fluid power
Retail distributors in apparel or groceries want to turn
Metalworking
their inventory as fast as possible and sacrifice margins
Roofing to do so. Something like complex, heavy machinery parts
have longer sales cycles and shelf lives, so higher
Plumbing, HVAC
20 and utilities margins are earned.
Wesco
Distribution industry analyst
Electrical

0
0 2 4 6 8 10

Annual inventory turns

Page 8
Source: Company CIMs; Barclay s Distribution Industry Chartbook, CapIQ; Parthenon-EY Interv iews
 Distribution industry dynamics
Distribution of more complex products with additional technical
support is associated with higher margins

Machinery and
Fuel
equipment

Average EBITDA margin Average EBITDA margin

1-3% 11-13%
Less complex Technical More complex
products and complexity products and
technical sales technical sales
Food
of products Chemicals

Average EBITDA margin Average EBITDA margin

4-6% 10-12%

Page 9
Source: Parthenon-EY analy sis, industry websites
Distribution industry dynamics
Distributors in traditional hourglass supply chains with fragmented supplier and
customer bases create value by facilitating distribution, and typically earn higher margins

Pharmaceutical distribution dynamics Industrial components

Producers Producers
e.g., Pfizer, Roche, Pumps Instrumentation Valves
GlaxoSmithKline, Novartis e.g., March, e.g., Dynasonics, e.g., Rotork,
Goulds Eurotherm Jomar

Distributors
e.g., Ryan Herco Flow
Solutions, FCX Performance

Distributors Customer base

e.g., Kaiser Permanente, CVS Pharmacy, e.g., Pfizer, Intel, BP, Kraft Foods,
Rite Aid, Mutual Drug, Independent Physicians Kimberly Clark, Weyerhaeuser

More consolidated supplier base Highly fragmented supplier and

leaves less opportunities for customer base creates
distributors to add value in the opportunities for distributors to
supply chain add value in supply chain

Page 10
 Distribution industry dynamics
Regulation can allow distributors in certain industries to command higher
margins and provide technical expertise

Alcohol HVAC/safety equipment

Value-chain position of the distributor is protected
by law as the 21st Amendment ensures that wine,
beer and spirits must move in legally sanctioned
transactions from producer to wholesaler to retailer
or restaurant
Several states have laws that regulate distributors
markup on alcohol; markups can range between
20% and 50%
Building codes require that certain HVAC safety and
energy-efficiency standards are met
Increased regulation and financial grants/incentives
to make buildings more energy efficient have
allowed HVAC distributors to offer higher-quality,
higher-margin solutions

Gross margin: 25-30% Gross margin: 25-30%

Operating margin: 8-10% Operating margin: 5-7%

Page 11
Source: U.S. Census
 Distribution industry dynamics
Distributors can benefit from (or succumb to) the underlying pricing environment
of distributed products

Sustained increase Significant decrease or high

in product prices volatility in product prices

Distributors can stand to benefit (and earn great Conversely, distributors carrying inventory come
profit dollars) from increasing prices of their end under significant or even catastrophic pressure
products when prices fall

Example: The roofing shingle industry consolidation Example: Distributors were severely impacted by
led to sustained price increases and distributor profit precipitous declines in steel
growth
$1,250 Steel price index
$300 Asphalt shingle price index
1,000

200 750

500
100
250

0 0

2008

2009

2010

2011

2012

2013

2014

2015
1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

Higher prices are a win-win for manufacturers and One of the issues with imported steel is that you have
distributors across the value chain as long as to be able to plan much farther in advance, and once
distributors can pass along price increases. you commit your money it is tied up.
Roofing industry CFO Plumbing supply purchasing manager

Note: Steel Price Index comprised of av erage monthly settlement prices f or domestic hot rolled coil steel, rebar steel and wire rod steel, equally weighted Page 12
Source: BLS, Capital IQ,
Distribution industry dynamics
Industry drivers of profitability

Industry drivers of profitability

Fragmentation of
Technical Regulatory Pricing
Inventory turns customer/
expertise environment dynamics
supplier base

Distributors are Highly technical Highly fragmented Regulatory Distributors are

paid at a premium industries require customer and environments vary impacted by the
when they are distributors to supplier bases widely by industry, underlying pricing
required to hold employ provide more sometimes trends of the
inventory longer knowledgeable leverage for the requiring the products they hold
sales reps and distributor continued use of in inventory
account certain products,
managersoften Ability for inspections of Industry
creating sticky distributor to add products or even consolidation and
customer value is more maintaining a commodity pricing
relationships and significant when specified margin are two common
driving higher managing drivers of price
margins relationships variability and
between many distributor margins
suppliers and
customers

Page 13
Agenda
Distribution industry dynamics
Drivers of profitability in distribution businesses
Parthenon-EY overview and relevant experience

Page 14
Company profitability drivers
Profitability is generally driven by a combination of industry and
company-specific factors

Drivers of profitability

Industry specific Company specific

Relative market share (RMS)

High RMS increases purchasing leverage, brand
awareness and pricing power
Private label products
Private label products are generally more profitable,
removing a step in the supply chain
Sales strategy and account management
Many distribution businesses are simply order-takers,
while others aggressively pursue new accounts and
increasing share of wallet
E-commerce
Online sales require less customer service and account
management, and can also can serve as a customer
acquisition tool
Value-added services
(i.e., fabrication, remanufacturing, repair)
Additional services allow for additional revenue streams
and up-selling opportunities

Page 15
 0
20
40
60%
Vehicle parts EBITDA margin Gross margin 55%

Source: Company CIMs

Textiles 50%

Safety equipment 45%

MRO 40%

Alcohol 40%

Educational
40%
products

Automotive parts 35%

Pet supplies 35%

Company profitability drivers

Automotive
30%
engine systems
Aftermarket
30%
consumables

Metalworking 30%

Industrial valves 30%

Safety equipment 25%

Building materials 25%

IT 26%
gross and EBITDA margins
Sample distribution company

Insulation 25%

Plumbing,
25%
HVAC and utility

Tires 20%

Ophthalmic
20%
products
Distribution businesses can have very different margin profiles

Apparel 20%

Electrical 15%

IT 15%

Sporting goods 15%

Food 15%
Page 16
Company profitability drivers
RMS mattersdistribution companies with high relative market shares are
associated with better performance

EBITDA of distribution market leaders Distributor case studies

Vehicle parts Safety equipment

30%

26% Distributes aftermarket Distributes protection and

parts and accessories to safety equipment to those
23% businesses and consumer who inspect, maintain and
markets repair fire equipment

20 ~40% market share ~8-10% market share in

very fragmented market
EBITDA

15%
14%
Auto aftermarket
Other auto parts
Average consumables
(Parthenon-EY
10 sample) Distributes consumable Distributor of automotive
maintenance parts and aftermarket driveline
accessories to oil change solutions to driveline repair
shops outlets, general repair shops,
fleets and auto retailers
15-20% market share
0 7-10% market share
Vehicle Safety Auto Other auto
parts equipment aftermarket parts
consumables

RMS ~3x ~8x ~3x ~1.5x

Page 17
Company profitability drivers
Technical expertise and value-added servicessuch as maintenance, product repair, or in-
house design and engineeringenable some distributors to drive higher margins

Representative industrial distributor profiles Distributor case studies

Fluid power and

Fabrics and textiles
motion control Electrical
technologies
Distributor of fabrics, working with 5,000+ architectural/design
Fluid power and motion Electrical parts firms and 600 furniture manufacturers
control technologies primarily used in
Description 3,500+ SKUs developed by in-house design team and sourced
and solutions to OEMs construction and for
from various manufacturers
and MRO customers industrial applications
Between 2005 and 2010, won 15 industry awards for design and
Inventory innovation
9.2x 9.2x
turns 15% EBITDA

High
Technical Provides value-added Apparel
Low
expertise system design and
engineering services
Distributor of undecorated branded apparel and athletic
accessories
Maintenance/ High Sells 38,000 SKUs from 55 brands to over 24,000 advertising
Low
repair Owns service and companies, promotional products distributors, and screen printers
services repair centers and embroiderers
Little value-add in addition to management of many SKUs,
vendors and customers
EBITDA ~9% ~4%
9% EBITDA

Page 18
 Company profitability drivers
Emphasis on private label products, which typically generate 20% higher gross
margins, can be a tool to expand margins

Gross margins,
private label and branded products Distributor case studies

Educational supplies
80%
Private label
Other branded products Distributes early childhood educational products to schools,
districts, early learning centers and more
63% Private-branded products have increased from ~29% of sales in
61%
60 2008 to 34% in 2010; EBITDA margin grew 200 basis points in
that time

49%
44%

40 37%
Small vehicle parts

Distributes aftermarket parts to businesses and consumer

20 17% markets
Internationally sourced, proprietary products have increased from
~35% of revenues to 50% from 2006-10; gross margins have
increased from 40% to 55%

0
Oil change Small Educational
consumables vehicle parts supplies

Page 19
Source: Company CIMs
 Company profitability drivers
A focused and aggressive sales strategy, such as expanding the account management
program, can significantly improve top and bottom line performance

Total revenue by sales channel,

information technology distributor Distributor case studies

Information technology
$80m
Account
management Distributor of digital data systems, such as product tracking
Tech sales systems (i.e., barcodes, scanners) through a multi-pronged sales
Online approach
Initiated
Online: 20% of sales through e-commerce platform
60 aggressive
account Account management: 40% of sales driven by outbound calling
management/ efforts by 40 account managers to existing customers to sell
sales program additional products
Tech sales: 40% of sales are handled by 25 technically trained
40 phone operators fielding incoming calls from potential customers
seeking consultative advice
Historical investments in customer relationship management
(CRM) and enterprise resource planning (ERP) systems facilitate
metrics-driven culture
20

0
2007 2008 2009 2010 2011

Page 20
Source: Company CIMs
Company profitability drivers
Primary company drivers of profitability

Primary company drivers of profitability

Relative market
Value-added services Private label Sales strategy
share

Market leaders, Value-added services Private label products Many distribution

particularly those with
significant relative
market share, generate
higher margins
High RMS drives
profitability through These services also
increased purchasing
power (often through
volume rebates), more
pricing leverage and
greater brand
awareness
create opportunities for
superior margins
through up- and cross-
selling additional
services
Private label, as well as
tend to create much
stickier customer
relationships
Some distributors have
eliminate a step in the businesses primary
supply chain and have value is in warehousing
become increasingly and logistics
common across many
industries Distributors with a
concerted and
aggressive sales
internally designed or
strategy are able to
manufactured products,
rapidly grow both their
enable distributor to
top and bottom lines
generate higher margins
and create loyal
customers
created industry-leading
brands

Page 21
Company profitability drivers
Successful acquirers have been able to leverage the market structure to
generate superior returns through multiple levers

Potential
Levers Commentary Value driver
impact
Roll-up/ Smaller players have struggled over the last few Roll-up accelerates share gain in a market
consolidation years and have limited ability to grow where relationships are sticky
Larger players are driving consolidation in this Consolidation helps in volume rebates and
market; ~80% of independent MRO distributors getting dedicated regions from key
(facility sub-segment) have been approached in manufacturers
Strategic

the last three years to sell their business

Limited savings on SG&A given the
fragmented nature of the business

Value-added Increasingly becoming an important part of the Wrap-around services such as fabrication
services/ distributors portfolio and engineering services are high margin
partnerships and drive sticky relationships with end-
users and manufacturers

Pricing Broad price changes will cause unsustainable Pricing, if used selectively, can add a few
share, however, selective pricing has the ability to points of margin (customer segmentation,
drive revenue growth bundling, etc.)

Route optimization Regional consolidation allows optimization of Optimized sales and distribution routes
distributions routes, warehousing and sales
Operational

Consolidated warehousing
resources
Optimized sales resources

Cash management Most independent distributors are not sophisticated Optimizing inventory management/turns
managers of inventory and cash cycles
Improving the bill-to-cash cycle

Back-office Fragmented nature of the business provides Consolidation of G&A functions

consolidation limited potential on the G&A, save back-office
(finance, HR, procurement functions)

Page 22
Agenda
Distribution industry dynamics
Drivers of profitability in distribution businesses
Parthenon-EY overview and relevant experience

Page 23
Introduction to Parthenon-EYs Industrials practice
Parthenon-EY has deep experience in helping investors evaluate potential
distribution investments
Key questions
What is the underlying market growth?
How stable is the market and how does
it perform across business cycles?
What is the role of the distributor?
Is the distributor going to be
disintermediated?
How sticky are the relationships
(vendor and end customers)? What are
the platforms for growth?
What are the potential business levers
that an acquirer can use to increase
value?
Parthenon-EY capabilities
Proprietary and customized
econometric demand and market
forecasting
Primary research, including market
participant and sales force surveys, and
industry expert interviews
Market sizing and competitive analysis
Revenue forecasting and full potential
analysis
Representative engagements
Over 100 industry evaluation and due
diligence projects covering many
segments within the distribution and
industrial MRO market (e.g., HVAC,
flow control, janitorial-sanitation, fluid
power, electrical, automotive)
Adjacent market and international
market prioritization analysis
Investment thesis generation and
potential target company identification
Sector scans for investment trends
Identification of acquisition targets for
potential industry roll-up
Page 24
 Introduction to Parthenon-EYs Industrials practice
We have broad experience across verticals

Total sales of US merchant wholesalers, Relevant Parthenon-EY

by segment, 2014
$3.0t
100%
Miscellaneous
Paper and paper products
Beer, wine, and distilled alcoholic beverages
Chemicals and allied products
80
Apparel, piece goods, and notions
Farm product raw materials
60
Drugs and druggists' sundries
$2.6t
Miscellaneous
Furnitureand home furnishings
Lumber and other construction materials
Hardware, plumbing, heating equipment and supplies
Metals and minerals, ex. petroleum
Motor vehicle and motor
vehicle parts and supplies
distribution experience
Total =
$5.6t
100+ commercial due
diligence efforts
Experience across nearly
all relevant verticals
Proven process for integrating
Parthenon-EY toolkit specifically
for distribution businesses

Machinery, equipment, and supplies Market size and segmentation

Macro economic forecasting
40
Groceries and related products Customer and supplier research
Professional and commercial
equipment and supplies

20
Petroleum and petroleum products
Electrical goods

0
Nondurable goods Durable goods

Page 25
Source: Bureau of Labor Statistics
Introduction to Parthenon-EYs Industrials practice
Parthenon-EY background and author contact information

About Parthenon-EY
Parthenon joined Ernst & Young LLP on August 29, 2014. Parthenon-EY is a strategy consultancy, committed to bringing
unconventional yet pragmatic thinking, together with our clients smarts, to deliver actionable strategies for real impact in
todays complex business landscape. Innovation has become a necessary ingredient for sustained success. Critical to
unlocking opportunities is Parthenon-EYs ideal balance of strengths specialized experience with broad executional
capabilities to help you optimize your portfolio of businesses, uncover industry insights to make investment decisions, find
effective paths for strategic growth opportunities and make acquisitions more rewarding. Our proven methodologies, along
with a progressive spirit, can deliver intelligent services for our clients, amplify the impact of our strategies and make us the
global advisor of choice for business leaders.

Learn more about us at parthenon.ey.com.

Contact
Scott Orleck
Managing Director
scott.orleck@parthenon.ey.com
+1 617 478 6382

Follow us for regular updates

LinkedIn | linkedin.com/company/parthenon-ey

Facebook | facebook.com/ParthenonEY

Twitter | @parthenon_ey

Parthenon-EY | Page 26
Introduction to Parthenon-EYs Industrials practice
Industrials practice key contacts

Jim Hsu Brad Kuntz Jamie Bader

Senior Managing Director, Senior Managing Managing Director
Head of Americas Director, Head of Boston
Boston Industrials Practice +1 617 478 4621
+1 617 478 4651 New York
+1 212 773 6774

jim.hsu@parthenon.ey.com brad.kuntz@ey.com jamie.bader@parthenon.ey.com

Terry Bradshaw Matt Fish Nigel Gault

Managing Director Managing Director Chief Economist
Boston Shanghai Boston
+1 617 478 4658 +86 21 3360 7778 +1 617 478 4634

terry.bradshaw@parthenon.ey.com matt.fish@parthenon.ey.com nigel.gault@parthenon.ey.com

Dave Hoverman Greg Miller Chris Ross

Managing Director Managing Director Managing Director
San Francisco Boston Boston
+1 415 486 3611 +1 617 478 4668 +1 617 478 4679

dave.hoverman@parthenon.ey.com greg.miller@parthenon.ey.com chris.ross@parthenon.ey.com

Page 27
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