Q1 2021 MSC Industrial Direct Co Inc Earnings Call
[music].
Good morning, and welcome to the MSC industrial supply 2021 first quarter conference call.
Participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing the star key followed by zero. After todays presentation, there will be an opportunity to ask questions. 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, Jason and good morning, everyone.
Eric Gershwind, our Chief Executive Officer, and Kristin Act the screen day, our Chief Financial Officer are both on the call with me today.
As one of our last call. We are all the remote so bear with us if we encounter any technical difficulties.
During today's call, we will refer to various financial and management data in the presentation slides that accompany our comments as well as the operational statistics both.
The 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 summary of which is on slide two of the company presentation.
Comments on this call as well as the supplemental information we are providing on the website cash.
Forward looking statements within the meaning of the U.S. securities laws, including statements about the impact of COVID-19 on our business operations results of operations and financial condition expected future results expected benefits from our investment of strategic plans and other initiatives and expected future growth and profitability.
These forward looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by the statements.
Information about these risks the as noted in our earnings press release, and the risk factors and the Mdna sections of our latest annual report on form 10-K filed with the FCC as well as in other SEC filings.
These risk factors include our comments on the potential impact of COVID-19 the.
Forward looking statements are based on our current expectations and the company assumes no obligation to update the statements investors are cautioned not to place undue reliance on these forward looking statements in.
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 the Erik.
Thank you John and good morning, everybody thanks for joining us.
I'll begin by wishing each of you a happy healthy and especially of safe new year.
I'll start the call. This morning, with some perspective on our journey and our recent progress.
I'll, then review first quarter results and take a deeper dive into our growth initiatives.
From there.
Instead, we will review the financials in more detail.
And provide color on our structural cost program.
I'll then wrap up before we open up the line for questions.
As we enter the middle of fiscal 2021.
Momentum on our mission critical initiative is building.
This is evidenced in part by improving numbers.
More importantly, Mike.
Hi progress against our key initiatives.
And by the increasing pace with which we're operating the business.
As a reminder.
Several years ago, we decided to reposition MSC.
From a spot buys supplier to.
<unk> mission critical partner.
We captured this in our new brand promise.
To make you better.
And we did so in.
In order to secure the next decade plus.
NFC success.
The deepened the moat around our business.
Since that time.
We have recreated MSC its value proposition.
The modeled our supply chain with an elevated presence on the plant floor.
Reshaped MSC sales force.
The new platforms for growth such as the C.C.S.G.
And we've accelerated the pace of innovation.
Well the advancements like MSC nomex.
We built new digital capabilities like ecommerce to improve customer retention in the loyalty.
And the new pricing function.
To improve price execution and realization.
And finally, we've.
We've taken steps to create a more agile culture.
In order to drive change faster.
On our last call we outlined mission critical.
Where our pathway to translate these changes into improved performance.
We share true three year targets.
And those were accelerated market share capture.
And improving ROI see.
We share of five growth levers.
That will deliver at least 400 basis points of outgrowth above IP.
By our fiscal 2023.
We also share the structural cost initiative.
It will yield the at least 200 basis points in operating expenses the sales ratio improvements by fiscal 2023.
Powering ROI see.
Back into the high teens during that time.
While we're encouraged by progress.
We have our sights set high.
And we're just getting started.
We're making inroads on the five growth levers.
And we're moving aggressively on the structural cost from.
To achieve our one year and three year targets.
With the robust project pipeline.
And the steady drumbeat of changes being implemented across the company.
Looking outside of our company.
All of this is happening against the backdrop that remains challenging.
But of showing some positive indicators.
The good news on the vaccine front.
And the recently passed stimulus package.
Will likely improve the outlook over the coming quarters.
I'll now turn to our fiscal first quarter financial results, which you can see on slide four.
Overall sales were down 6.3%.
Gross margin was down 30 basis points versus the prior year period.
Our operating margin on a GAAP basis was 7% and was significantly influenced by a nonrecurring asset impairment charge.
Which I'll describe in greater detail shortly.
As you can see on slide five.
Excluding this impairment charge and adjustments related to severance and cost associated with mission critical.
Our adjusted operating margin was 11.0%.
Down 30 basis points from the prior year.
Despite lower sales.
And supported by mission critical.
All of this resulted in earnings per share of 69 cents for the quarter or a $1.10 on an adjusted basis.
We're seeing continued sequential improvement in our sales levels.
Most notably.
Our non safety of non janitorial product lines improve.
The improved through the quarter.
Declined low double digits.
Sales of safety in janitorial products anchored by our PPD program.
Continued growing at over 20 per cent for the quarter.
The.
Moving trends extended into the December.
The total company sales growth estimated at 2.4%.
Well aided by some large p. orders the.
The December is nonetheless encouraging.
As the rest of the business excluding safety in janitorial.
Was down in the low single digits year over year.
Looking at our performance by customer type.
Government sales continued to grow significantly year over year.
Due to the surge in large safety in janitorial orders.
National accounts declined in the low teens, while our core customers declined low double digits.
And C.C.S.G. was down mid single digits.
As you can see on slide six.
Industrial production remained in the negative single digits range, but.
But did improve over the prior quarter.
Most of manufacturing end markets behaved consistent with this trend although.
Although metalworking centric end markets did continue to lag the broader IP index.
More importantly.
We have seen the gap between the IP and our growth rate begins.
Begin to compress as expected.
We plan to build on that momentum.
And as a reminder, we target exiting fiscal 2021 with at least the 200 basis point positive GAAP above IP.
For our fourth quarter.
I'll now turn to our growth initiatives.
On the last call I am.
Line five levers that will drive our improved growth over the next three years.
And those are metal working.
Solutions.
Selling our portfolio.
Digital.
Diversified end markets.
Today, I'll discuss and focus on a couple of the.
First metal working.
We're investing heavily in our core business in order to widen our lead.
One way, we do so it's by capturing new customers from local distributors, who are under tremendous pressure in the current environment.
We track, our funnel of opportunities and win rate by market.
And both are progressing according to plan.
We expect that process to progress the build as the locals come under more and more pressure.
With each passing month.
And that's the meal Max is aiding our efforts to capture market share.
[noise] milling is one of the most significant cutting tool applications.
Cutting tools represent roughly 30% to 40% of.
Of the $12 billion to $15 billion metalworking market.
MSC meal, Max not only provides opportunities to capture share within cutting tools.
But it opens up access to our customers broader MRL purchases.
Which are multiple times the size of their cutting tool spend.
We're seeing strong early reception to the new technology.
Our funnel of opportunities is building quickly and it's starting to produce new wins.
As we do with vending.
We're offering M.S. seemed on Max as the service in exchange for incremental share of wallet.
The second initiative all features government.
Which is right now our largest diversification play.
We've been working hard over the past two years to turn our government business from an underperformer to an outperformer.
And while we're benefiting from a P.P. tailwind we.
We are nonetheless pleased with our progress in the fiscal first quarter.
As the business grew over 35%.
Beyond the current momentum.
We're investing in this area to build for the future income.
Including adding hunter rolls dedicated the creating new opportunities for us.
Third Oh.
I'll highlight our sales force build out.
Growing and reshaping our sales force is an important enabler.
The towers each of the five initiatives.
In recent years.
We've taken sales head count down in.
In order to reshape the salesforce consistent with our new strategy.
For the first time in several years.
We're now poised to expand the sales force.
We had a delayed due to the pandemic, but we've now restarted those efforts.
In our fiscal first quarter, we increased our sales head count by 50 income.
Including roles such as business development.
Or hunting.
Total working specialists and government.
This effort has been aided by the redesign and outsourcing of our talent acquisition function.
Which was one of the mission critical projects the Christian mentioned on the last call.
We are hiring faster and at a lower cost.
Before turning things over to Kristen.
I'll now discuss our PPD program.
And the related impairment charge for the nitrile gloves.
From the outset of the pandemic, we have worked hard to source critical p. supplies to support our customers the need.
And to keep the front lines of industry and government workers safe.
Despite the widespread scarcity of certain products and well documented supply chain issues.
We've been successful in this effort across a wide range of items.
Nigel gloves have proven to be more challenging.
Over the past several months.
A number of our large customers approached us in dire need of the scarce product.
Our normal channels of supply could not produce sufficient quantities as the nitrile gloves global supply chain is under extreme pressure right now.
As a result in September our team turned to new sources of supply.
We used free payments to secure priority status.
Which has been a standard market practice through the pandemic.
And it's been an effective tool for us and securing scarce product during the stock.
As of today, we have not yet received the gloves.
And in light of the growing uncertainty over our ability to secure deliveries.
We recorded an impairment charge for the full amount of the prepayments.
We are of course pursuing all possible paths to either secure the gloves.
From a refund of our prepayments.
Pulling back from the specific issue.
We're quite pleased with our PPD program.
Which is consisted of hundreds of global supply transactions, leading to substantial revenues and most importantly, the ability to keep our customers safe.
I'll now pass it over the Christa.
Thank you Eric let me start with the review of our fiscal first quarter and then I'll update you on the progress of our mission critical initiatives for reference on slide four of the presentation, you'll see key metrics for the first quarter on a reported basis flight.
Slide five reflects the adjusted results, which will be my main focus this morning.
Our first quarter sales were 772 million or 12.5 million on an average daily sales basis, both the decline of 6.3 per cent versus the same quarter last year.
Moving to gross margins, our first quarter gross margin was 41.9% a decline of 30 basis points compared to the first quarter of last year the.
Well actually gross margin improved 30 basis points compared to fourth quarter 2020, despite the headwind from from large P cells that we mentioned on our last call we.
We continue to see solid performance due to the traction of our initiatives.
Our execution on both the pricing of purchase the in front of has been strong with solid realization from our annual price increase as well as improvements to our supplier programs.
December gross margins continued the trend of solid execution on the price and cost fronts. We.
We can however, see increased headwinds in gross margins due the P.E. related skews the over the next couple of quarters.
Total operating expenses in the first quarter were 243 million.
Were 31.4% of sales versus 257 million or 31.2 per cent of sales in the prior year.
This includes about 4 million of costs related to severance and the review of our operating model both related to mission critical.
The severance made up about one third of that amount.
Excluding these costs operating expenses as a percentage of south of were 30.9%.
In the prior year.
Excluding 2.6 million of cost related to severance.
Operating expenses were also of 30.9% of south.
We were able to keep the adjusted op ex the sales ratio of flat. Despite the decline in sales of our mission critical initiatives continue to deliver savings.
I'll go into more details on the progress of our mission critical initiatives and the minute.
Including the asset impairment charge that Erik mentioned earlier all of this resulted in GAAP operating margin of seven per cent compared to 11% in the same period last year.
Excluding the impairment charge, the severance and other related costs, our adjusted margin was 11% versus an adjusted of 11.3 per sand in the prior year.
GAAP earnings per share were 69 cents adjusted for the impairment charge as well of severance and other related costs adjusted earnings per share were dollar 10.
Turning to the balance sheet and moving the had the slide seven we achieve free cash flow of $95 million in the first quarter as compared to 72 million in the prior year.
The improvement was driven by our accounts payable management and the deferral of payroll taxes under the current act.
As of the end of fiscal Q1, we were carrying $521 million of inventory down 22 million from last quarter right.
Roughly $60 million of that is related to P. P products and over half of that of specific the disposable masks.
As of ample plot the supply should the virus search continue.
During the quarter, we continued to manage our liquidity very closely and we paid down 130 million of our revolving credit facility in Q1.
Our total debt as of the end of the first quarter with 490 million comprised primarily of a $120 million a balance on our revolving credit facility.
20 million of short term fixed rate borrowings and free hundred and 45 million of long term fixed rate borrowings.
Cash and cash equivalents were 53 million, resulting in net debt of 437 million at the end of the quarter.
Since then in December we paid a special dividend of approximately 195 million, which we funded primarily from our revolver.
The special dividend reflects our long standing commitment to returning capital to our shareholders as part of our balanced capital allocation philosophy, while maintaining a conservative balance sheet.
Before I turn it back to Erik let me provide an update on our mission critical of productivity goals.
On slide eight you can see our original program goals of 90 to 100 million of cost take out through fiscal 2023.
And as versus fiscal 2019.
On our last call we share that we had taken out 20 million of cost in fiscal 2020 and that our goal for fiscal 21 with the take out another 25 million to achieve cumulative savings of 45 million by the end of fiscal 21.
I'm pleased to report that we achieved an additional 8 million of savings in the first quarter, bringing our cumulative savings the 28 million against our goal of 45 million by the end of the fear.
This is gross savings and does not reflect investments of roughly two to 3 million in the first quarter and 15 million expected in fiscal 21.
While one quarter does not make a year and we did capitalize on some low hanging fruit and I'm encouraged by our fast start to the year and our continued momentum in executing our mission critical of productivity programs.
In addition, the some of the initiatives I mentioned last quarter, which are proceeding as planned. We also signed an agreement to sell our Melville New York facility. This 170000 square foot facility on 17 acres served as one of our co headquarters we.
We will be relocating late the spring to a smaller 26000 square foot space nearby which will accommodate our new hybrid working model once.
Once the sale of our current location is complete we will save roughly 3 million annually in operating expenses.
We will continue to review, our real estate footprint for additional opportunities.
And I'll now turn it back to Erik.
Thank you Kristen.
Last quarter, we outlined our mission critical initiative.
It's aimed at turning the hard work, we performed over the past several years.
Into improved financial performance.
Our company's sites are firmly set on two goals referenced on slide 12 day.
To be achieved by the end of our fiscal 23.
First growing at least 400 basis points above IP.
And second returning the ROI see back into the high teens.
We have five growth initiatives powering our market share aspirations.
And we are executing significant structural cost reductions that.
We expect to improve operating expenses as a percentage of sales.
The at least 200 basis points.
As we move into the middle of our fiscal year.
We're encouraged by the momentum that's building inside the company.
This is evidenced by improving numbers.
By improving execution of the projects behind them.
Most significantly there.
There's an energy building inside the four walls of MSC.
And with each passing quarter.
We expect that energy to growth.
We will not rest until we've achieved our mission of being the best industrial distributor in the world as.
As measured by all four of our stakeholders.
Thank you and we'll now open up the line for questions.
We will now begin the question and answer session. Just a question you May Press Star then one on your Touchtone phone. If you are using the speakerphone. Please pick of your handset before pressing the keys to withdraw your question. Please press Star then to.
The first question is from David Manthey from Baird. Please go ahead.
Yeah, good morning, and happy New year, everyone, Hi, Dave afternoon, the Hi, Dave Yeah.
Hi, So the first question kind of Big picture could you outline the role of technology in the mission critical effort or the if you're cutting costs.
And you hope to maintain or improve the productivity and customer service of the mass. The how how're you doing that can you give us a couple of examples.
Yeah, Dave I I think it's so good question of what I would say is just the way on the growth side. We described sales force as an enabler of the expansion of the sales force, it's something that was or enables each of the five initiatives. You know technology is underpinning everything we're doing and that's that's on the call.
Outside it's on the growth side, so on the growth side of it and I'll get to your question on costs on the growth side heavy investment into digital as we had talked about as one of the five levers heavy investment into pricing analytics that we're beginning to see translate in the form of improved price realization on the gross margin line and then of course.
Yes, a heavy emphasis on using technology its of power some of the structural cost initiatives and I think what's the most significant there is the cost take out here. This is not an exercise of just the stripping cost out of the business. This is an exercise is the improving how we do things. So you know a perfect example of that is what Kristen.
I just mentioned with with our moving Melville, Yes. It was the downsizing of the building, but really what we're doing is rethinking the way, we work and using technology to do it. So it's moving to a hybrid work model and obviously for all of US a technology. It's been at the core of that and you know not only does that open of productivity gains.
It's the allows us to shrink real estate footprint of it allows us to rethink travel and how often we need to get together.
But but it opens up the talent pools in new locations that were not wed to you know Melville for instance that we can recruit especially in certain functions in other areas. So that would be an example, Dave but I think what you'd see if you go project by project across the three big buckets sales and service supply chain and G and H technologies underpinning a lot of.
Okay. Thank you for that and then just to clarify one thing on slide number five where you say that lot of the safety sales were down year to year, but improved sequentially. Each month, we say improved the you're talking about dollars. There is the average daily sales growth rates what is the improvement you refer.
Moving to.
That would be improvement in our average daily sales right Dave.
Perfect all right. Thank you very much.
Our next question is from John inch from Gordon Haskett. Please go ahead.
Thank you good morning, everyone happy new year.
The New York.
Thank you.
So let me start Erik and president of raw material costs have been going up have you seen that reflected in the prices of your purchase products and how Erik are you thinking about the annual price increase the maybe you could talk about you know just supplier pricing actions and trends in general.
John So you're right, what you're pointing out of something we have our sourcing folks have their eyes on closely particularly as it relates to metals. What I would tell you is today, it's been a little early to see it translate as as you know in following us for a while one of the real triggers for US is seeing the commodities movements translate into.
The supplier.
The supplier list increases, which have not yet come in earnest, we do it we do expect though that that's going to build should the inflation sustain.
As of now our thinking is we would expect to implement a price increase you know timing wise, it's still a little early but figure roughly end of Q2, beginning of Q3 is kind of what we're thinking now and John the only other thing I'll point out is I think if you. If you look at our growth the composition you will see.
We're seeing improved price realization of the most recent increase we took was back over the summer. It was in the 1% range. So it was pretty modest given the low inflation at the time. So we're encouraged the we've invested a lot into price.
You know sort of price execution price analytics, and we think we're starting to see that's the flow.
From of improved realization.
So just based on your answer it's too soon to tell if the right. The raw material costs are going to translate into higher product costs like what what's traditionally the lag and and are your competitors raising prices yet are they also kind of waiting in the.
So generally there is a lag and it'll depend on how soon you know we you know it's it's it's usually a several month lag it depends on exactly when the depends on how fast they snapped back and of course I think it would have to be sustained for a bit of time before a manufacturers.
Pass it along the way, we watch pricing carefully I would say to date, we've not seen a lot of movement, but history would suggest that if what we're seeing now in the inflation does hold that it would yield increases coming from our suppliers.
And as a matter of zone and no that makes sense and then just of the follow up question, Eric I'm of the 400 basis points of targeted market growth does your plan provide for a more granular break down say by targeted industries. So some aspects of government might be more than 400, some less and the if so I'm assuming that's the case could you give us any details.
The the kind of square up the 400 target yeah. So if you look inside the company John we have the 400 broken out a few ways certainly by customer type we have the look.
We also have the look by product and service category and we have another look that's you know literally down to the geography. The ZIP code. So the level of buy initiative of our five big levers. So we have multiple cuts at it certainly you know there's going to be industries, the grow faster than others of what I would say.
There's a couple of things one is you're going to see us it's for US. It's the balance on the one hand, you're going to see us continue to invest in our core our core as metal working and metal working gets sold into those heavy you know heavy.
Heavy manufacturing sectors that have been hit pretty hard. So if you look at the IP numbers they've been lagging goes heavy metal working centric end markets have been lagging at some point when there was a recovery of a real recovery of those.
The will snap back and we think we'll benefit in an outsized the way by staying focused on that segment of.
The second piece would be you know the balance is sort of the fifth lever. If you will is the diversified end markets and the biggest focus for US right. Now is the one you touched on John <unk> government. Certainly you know we're encouraged by momentum there that would be one that we would expect to outpace the 400 for sure of given.
Its relative size of our portfolio size of market and the level of investment were putting the.
Yeah, you mentioned now the work in the last call Erik as the continued focus so does metalworking grow faster than 400 or is it kind of around the 400.
The new plan, you know look I'd say I think it will move around John and obviously it will be a function of how we execute how much share. We capture I think you know the way we look at it is given our relative our relative size in metalworking and market share that we have if we were growing at 400 basis points above IP in metal working that would be a pretty good result, and would allow us.
The widen the lead given the size of the base, we're starting with the.
Makes sense. Thank you. Thanks.
Our next question comes from Hamzah Mazari from Jefferies. Please go ahead.
Hey, good morning, happy new year.
Uh huh.
Hey, So some of my question is just around the.
The reacceleration of market share and you mentioned does the new energy of building inside the company you don't maybe you could talk about sort of you know how is this restructuring the different from out of cultural bias perspective, [laughter] and then and then how how conservative.
Our the numbers you've put out there the 400 basis points, the ROI see sort of mid teens.
How hard we think of of those two items.
Hamzah. So let me let me start with the <unk>. The energy you know the CWIP. The question around the energy and there is I mean, if you're inside the company and right now by large measure that's inside it virtually you would feel a change of.
And what I would say is I'd go back to say look if the if you go back over the life of this company are particularly our life as a public company. We're going on 25 years now the DNA of this company is a growth company and one that always stretched and so I've sale.
Having goals that were much bigger than where it was at the time and look over the past few years, we've been through a lot of changes.
<unk>, we're coming out the other side of the changes and are reconnecting with that legacy and the idea of thinking begun setting stretch goals I think that's one of the sort of the biggest things. It's the reconnection with that idea and the leadership team that's embracing the embracing the idea of stretching from.
And you know I think thats beginning to true way from.
Through the organization you know so to your point about how conservative are the goals.
Look as as you could imagine.
You know like like most things inside the company, we are stretching and you know for any goal that we're talking to you about you could imagine net for the group inside of sales is there a higher aspiration sure where the group on the it's focusing on the cost side by area is there a higher aspiration sure of because we are true.
Thank the build the mentality into the company of stretch and think big.
Got it and then just on the on the gross.
The cost savings target of 90 to 100 million [laughter] do do you have a sense of how big of the reinvestment you're thinking you're into growth will look like and where you're going to reinvest I know you've talked about sort of rebuilding the sales force and the hunters.
You know 50, I think you started the as a number of.
Bart, but just order of magnitude of how much of those gross savings you know would be reinvested and is there going to be all in sales or the the areas.
Yeah. So for this year, we're looking out of $15 million reinvestment that would be for fiscal 21.
Oh for 22, and 23, you can definitely look for that annual number to step down and we're going to continue to invest.
I don't think we've given a specific range from I'd say you could probably look from 778 million of of reinvestment in 22 and 23. That's always change you know as we continue to add more at the pipeline look at the prioritization of when things come online.
As far as the where the investment go as you know we're focused on the three areas cost out in GNS day supply chain and sales and service. It isn't investment really underpinning all three this year is a bit more focused on the sales and service areas, particularly but the of digital initiative ramping up very quickly.
But you're going to see investment across the board as Erik mentioned a lot of the stuff. We're looking out on the cost side is really transformative do and requires the investment.
So it will be across the board nearer term debt more weighted to sell from service.
Got it very helpful. Thank you so much you're welcome.
The next question is from Kevin Mirek from Deutsche Bank. Please go ahead.
Hi, good morning, it wrong.
Good morning.
Can you just update us on what happened in sales in terms of safety versus non safety performance like how the trend by month through the quarter and then obviously you know through December.
Oh, Yeah sure we can get your specific numbers I mean, what I'll do Kevin is just give you sort of the general.
Picture as to what's going on is you know, it's it's consistent with what we're seeing in the indices like IP. We are seeing the sequential build in the performance, particularly of the base business and by base I mean non safety non janitorial. So if you look at safety in janitorial, which is a great.
Proxy for our PPD program.
Through the first quarter that was growing in the low twentys or December stepped up to the high Twentys close the 30, but I think the real story is what's been happening in the non safety Slas janitorial you know the other day the core of the business, which has been a steady climb up so you.
Go back to the teeth of the pandemic, Yeah, we were talking down I believe it was mid twenties I mean, you know in the depth of the Sting and we've been on sort of a gradual a gradual climb up and then you know obviously look we got a nice pleasant surprise in December.
Where the all I'll do the base business was down low single digits. So one month does not a trend make it was an encouraging sign we got some benefit of some some cares act spending is as that was expiring, but it's been a steady climb up in the base business.
Got it. Thank you. Another follow up you know is there any gross margin implication that you would call out from the trends you've seen the December as far as Q2 expectations are concerned not the typical seasonality maybe doesn't call from much of the change here of a Q.
Yeah, Let me touch on gross margin and I'll put it back in the context of kind of the guidance the gave last quarter around the operating margin framework.
So what we what we told you last quarter on gross margin range thinking about the year is you can expect us to be flat to maybe down 50 bat the.
The biggest variable there is really a mix driven by the P. P headwinds.
So since then we've seen a couple of things happened I'm, one of our price and cost execution has been really strong like we alluded to for December I'd say, it's as good or better than we had envisioned.
Two we see a higher chance of larger P headwinds for a quarter or two and and what's behind that is one the got a large inventory position on the asks you know the virus the surging when they end up selling through a lot of those at the same time, it's no surprise the share of that mass pricing has come down over the past couple of quarters, but really given the.
The strong price cost performance, the will still likely fall within that flat to down 50, Bips range, even with the larger PB had when I think of the P. had when word to book I'm really large of its possible we could strout side that that down 50, that's range if that happened I think what you'll see us do as a net countermeasures whether it's.
You know on the gross margin line or or elsewhere on the p. and all the mitigate that risk as much as possible, but really trying to still protect that investments that are going to drive the growth both in 21 and beyond you know.
Regardless of what happens the P. It is the temporary headwind thinking a couple of quarters the underlying price cost dynamic that's of we're most focused on and we're really pleased with what we see there.
Ah you know I'm more broadly we're still very committed to the two overall mission critical targets around the market type growth capture and ROI see improvement.
Got it understood. Thank you happy new year to have you here.
The.
The next question is from Michael begin from Wells Fargo. Please go ahead.
Hey, good morning, everybody great quarter, the money, Thanks, Mike happy New year EPS.
The New York, well I wanted to touch on your annual margin framework. Historically your financials have seen a slow start given the first half seasonality of the business.
But you were able to meet the low end of your full of your framework on a mid high single digit revenue decline.
So assuming mix is normalizing and price building momentum to the benefit of your gross margin I was just curious what are your bad debt assumptions for SGN day in terms of cost out opportunity and maybe what would what factors would push that the the high end of the annual framework share.
Sure sure so sort of drilling in the bed on assets DNA in terms of the op margin framework that.
That we laid out last quarter I'm, our thinking on on the operating expenses still holds really if you. If you end up seeing revenue flat to slightly down you can look for the opex expense to be slightly down.
Well and we are on target for that still I. If you. If you think about kind of what would drive us to the upper end of the overall op margin of framework.
I'd say you could have one potential where you're looking at potentially over driving the productivity programs. You know, we're always looking to be more aggressive on on things and that the apartment on the gross margin side again, we are seeing strong underlying price and cost performance I'm not sure that I would say the the mix headwind is behind us the yet because we still do have P.E.
Volume moving through and you know, especially in the next couple of quarters I'm, it's still likely that P mix could be a headwind.
But I'd say the the operating expenses largely still in line with the framework you know gross margin we feel confident we're in that flat down 50 depth range. So if you saw anything advantageous against either of those those could pick us up to the of the upper end of the range.
Okay I appreciate that and then.
You mentioned, some nice trends within milling and the mill backs initiative you have.
I'm, assuming that's catering to your core customers walls from government can you remind us what milling and maybe see CSG combined as a percentage of your revenue is.
So let me, let me talk a little bit and Mike what I'll do is maybe frame for you know Max which is really you're right no no Max is powering the core business. The interesting dynamic though is its powering it in the metalworking category, but we see an opportunity to power through other ancillary MRO products.
Within the heavy manufacturing sector. So let me explain a little bit. So you know metal working in the U.S., we sized the 12 to 15 billion and it fluctuates based upon what's happening in the market you can imagine right now with spending being down the economy being soft the to the lower end of that cutting tools as the whole represents 30 to 40.
The set of metal working.
That's been the company's bread and butter for a long time within the coding tool universe milling is one of the biggest out of applications within cutting tool, that's where MSC nomex is designed to show productivity and looked at the results in terms of improving customer throughput productivity has been really really encouraging.
So you know the frame there we believe there's you know roughly around 45000 locations customer locations in the U.S.
That would be candidates for MSC mail backs and those are the that's basically the universe of you know where we see the right fit of heavy manufacturing that's doing billing applications. The opportunity for US is to go in there and it's not just it's to improve the customers productivity and then as we described we're really providing a service.
Yes, and then in exchange for the service, we're asking for incremental market share capture in many cases, so far and obviously, it's still very early what we're seeing though is the market share capture may or may not happen in cutting tools. It may happen in the customers' ancillary spend so if you go into a typical manufacturing operation generally for every dollar of.
Cutting tools, they're spending they're going to spend some multiple of that on an MRO purchases and sort of thats the bigger opportunity for us and all of this obviously is the power the 400 basis point outperformance that we're giving ourselves towards.
Alright, if I.
If I could dig into that a little further can you.
Maybe touch upon why no back in.
Important to have the may hand of the distributor versus maybe in the OEM because my perception is you're going in you are providing these services.
And you're finding the fast and right solution. So how did that work with your maybe supplier relationships and you're able to provide you know the bass.
Product that you know works versus favoring Warner or another.
Of product, where an OEM bite you.
Yeah, Mike So that's the it's a great question and look I think I I really I as much as I love the mill Max technology and about what its doing I think we are perfectly positioned to be the one to bring this to the market for a couple of reasons. One is the technology by itself is a piece of the parcel the end here is about.
Finding productivity and helping customers improves throughput reduce wasted materials et cetera to do that you need the check this technology is unique but by itself its not enough you actually need the technical person alongside to interpret the data somebody who understands machining of metal working which obviously we've got the larger.
The national.
Footprint of of of metal working tech specialist in our field and in our current customer care centers and then on top of that Mike and this gets to your question about the suppliers look suppliers are manufactured our suppliers of the manufacturer to do this the challenge they face ultimately what this tool does is it brings objectivity and it.
The moves brand preference because its of it moves the two performance and so the.
The the benefit that a customer has by doing business with MSC is we're going to give them. The right. We're going to use the interpret the data and then we're going to give them the right answer to their problem in the you know the nice thing there is MSC has the broadest the deepest metal working portfolio in the industry. So I think all three of those components together or what's needed to really maximize value of the.
The thing that I think what you know in a fortunate position to have all three.
Thank you appreciate the time of I'll pass it along.
The next question is from Adam Allman from Cleveland Research. Please go ahead.
Hey, guys. Good morning, happy new year to all the I'm not one of your.
Yeah. It was wonderful good start with the discussion about your hiring plan for the sales force for the rest of the year I'm wondering if you'd be willing to dimension.
Just how many folks you or looking to add to the sales force and then or maybe more of this reinvestment the the $15 million for the year is sort of you think of the that is going forward as being more digital investments and non head count related.
Okay. So so Adam I'll I'll start you look we let me start with the bigger the the bigger question on investments you know growth investments. We are really focused on this three year.
I haven't set of enough the 400 basis points, plus and building momentum along the way we've got five growth levers. We believe all five of critical to hitting the 400 basis points plus a net underpinning that is the sales force expansion, which I'll get you, but the again no slide metalworking solutions selling the full for the portfolio digital.
Oil and diversified segments, which right now is government, you're going to see investment where the growth investments going its going directly into those five and then into the sales force that's kind of power of those five.
In terms of the sales force, particularly look we've been it's been a few years now since we've expanded the sales force you know Adam you Youve been following our story for a while we have been through this whole repositioning of the business and we need it to reshape the sales force in order to bring this thing to life and what that meant was over the last couple of years under.
Eddies watch we've taken headcount down because what we found was that we were over assorted in in certain roles I'd and farmers did not have enough in hunters and some other key roles in metal working that went out of throttling up. So we're reshaping the sales force you saw us at 50 in the first quarter look if if if we can continue hiring the right people.
Plus we're doing.
We could see that continue what sort of that rate and pace of.
The.
For the balance of plus or minus for the balance of the fiscal <unk> you know, we we'd like to get it well we're back to 2019 levels of.
On what we published in our sales and service that by the end of the fiscal and look obviously the idea is one of the funding that growth investment you know that's the head Count addition of the sales force, we're gonna be funding that through the productivity work that of the Christian described.
Okay, Great. That's very helpful. Thank you and then secondly, Christian could you provide the magnitude of the ppt headwind. The gross margin. This quarter was in that 30 basis point decline, then and just given what you're seeing so far here in December and what the.
The the surge in pp orders did I hear you correctly say that the similar headwind in the second quarter is that still still up in the air Yeah, I'd say second quarter is likely to be higher we didn't we're not seeing it yet in December but based on what we think is going to happen with the inventory moving out the door.
Do you see a larger P. had one for Q2, probably also for Q3, and then I think I heard you mention or something in there on on Q1, we did see some P. P mix headwind in Q1 that was really driven by some large orders that went out the door, which is a a similar on the reason that we would expect the.
The increased risk in the second and third quarters as well.
So do you think your gross margin was closer to the flat with the positive pricing and purchasing that you had at the word of back that out yes, I'd say, we were closer to flat.
Yeah, Adam maybe just the true chime in a little bit with a couple of two cents on gross margin and go of Kristen hit this I want to underscore a couple of points that I think what we're seeing since we you know, we basically said hey for the year, we see ourselves slapped the down 50 basis points since the since last quarter of two things right. So one is we like what we're seeing on price.
Execution, and we like what we're seeing on the purchase cost side on the sourcing side I think that's a net positive I think what we are saying, though is we do see the potential in the next quarter or two from more pronounced P. P headwinds based on the factors that Kristen describe you know you got a big mask inventory flow.
The researching no secret prices have come down on masks. So there is the potential for a more pronounced ppt headwind of.
For the next quarter or true than we've seen in the last quarter of two where there has been some that weve absorbed but not as much as what we may face in the next quarter or two I think from me, what what I want to underscore the.
What I'm looking at is saying hey, the P.P. stuff, we're talking about a once in a generation.
The kind of episode here, that's really hard to predict was really hard to predict months ago is really hard to predict now from me again sights set on the three year goals on the ROI see improvements the real underlying value creation drivers for us are gonna be price and cost that's where we like what we're seeing.
Okay. Thank you.
The next question is from Steve Barger from Keybanc capital markets. Please go ahead.
Thanks, Good morning.
Uh huh.
Just a couple of follow ups of just first for the impairment you said the ability to get the gloves is increasingly in question is that just based on how long it's been or is there something more specific and really I'm trying to understand if we should be worried about inventory risk for other pandemic stuff as cases, hopefully slow down as 21 progressive.
Yes, Steve So look the <unk>. This is a yeah. This was a really unique situation with with nitrile gloves, and we followed not only of unique but a really difficult situation that is isolated to the Nigel gloves in terms of a prepayment and the exposure of the size you know the accounting rules are pretty clear that when.
The reach a certain point of uncertainty and without going through all the details you can imagine we're pursuing every path possible, but we reached a certain point of uncertainty. It was clear we of impair the asset which is a prepayment what I'd say is we have used the prepayment tool many times over during this pandemic and it's been it's become a fairly standard industry.
Practice actually through the pandemic to secure scarce product. It's worked out most of the times. This case to trade. It hasn't worked out of what I would say, though is in terms of prepayment exposure, if that's where you're going no. We don't see another case like this. This is this is this is pretty unique.
So truly a one off and you don't see inventory risk for other pandemic related products.
We certainly what I would say is we don't see any prepayment risk I mean, you know look obviously <unk>. It's Chris. The described we're sitting on a lot of mask inventory that will be a function of how it moves is the risks there sure of course, depending upon how the virus moves but.
But you know what we're talking about the set of facts with the nitrile gloves, where the prepayment isolated to that.
Got it and the of the 50 people added did you break out how many were metal working specialists versus the the hunters and how long does it take a new metal working specialists to reach the level of productivity you want versus that new salesperson.
So you we didnt know that Steve just the FERC of competitive sensitivity, we don't break out specifically what I can tell you is we gave you the three sort of primary buckets of the 50, which are the BD hunters metalworking government at the three big areas of focus of what I would say with metal working as we generally find.
A faster ramp up because they are coming with the industry expertise you know the <unk>. The one caveat in most cases, when we're hiring of metal working specialist they don't necessarily have their own book of business, what they're doing is they're support so the way we see the benefit in the metal working specialist number one we're going to see it certainly INOMAX installations, but we'll Vince.
The lift in their geography for our metalworking salespeople, who are out there generating sales because of the technical expertise the individual.
Brings and per.
Jim we that's a really fast ramp to get them up to speed on mill Max to get them in the door to hopefully leveraged to other MRO products. There is the ramp on the original ramp on nomex. The we've been super aggressive about rolling it out there was a little bit of a ramp on mail backs I mean, it's not you know, it's not rocket science, but certainly it's a new it's a new trick, it's a new technology and that's the case not just for a new person but.
For all of our metalworking experts of Christians mentioning pockets of investment that's certainly been one area of investment where we've been rolling out the sample kits and testing tools and doing training for our.
Our metal working folks at a pretty fast rate and that's that's a piece of our investment and we'll continue that.
And just to be clear that that mill Max program is unique to you.
Yes.
That's great. Thanks.
Thank you.
Our last question comes from Patrick Baumann from JP Morgan. Please go ahead.
Hi, good morning, everyone. Thanks for taking my questions.
Hi, I'm just kind of quickly you talked about investments NSG day of 15 million incrementally this year, the and I forgot what you said annually beyond this year, but Mike.
My question is on Capex expectations, and if you expect the Capex to go up over time as well as the result of the initiatives and by how much.
Yeah. So for this year of Capex, we're estimating the range of 70 to 80 million, which is the step up of our historical run rate.
And then in the future years for the program of 22, and 23, I'd expect where we're seeing more of a sustained the level over where weve been assets. There historically, probably not as high as the top end of that range, but you're not going to see a sustained increase for the next three years.
So that 70 to 80 is is going to be more of the sustained level. Then for those years of that what you are saying I'd say the lower end of the range, maybe think 60 to 70 for 22 and 23, but we're you know we're still working through a lot of the detailed planning on that it's kind of be dependent on how we prioritize different projects in the pipeline what the us.
Specific investments are the we bring online at what time, but you know we can give you some clear guidance on the as you get closer to 20 to 20 assets.
Got closer to 2022.
Got it and then and then.
Yeah on the longer term kind of Earl I see target can you kind of remind us of the components of that like how much of that is sales versus margins.
And.
I guess the invested capital side of the equation are you assuming like.
You know the.
Changes in that you know by that time the weather with.
Working capital investment or or I guess, maybe you're assuming you're using debt and equity as the denominator smitti buybacks I don't know how just trying to understand the components of of the high teens number yeah.
Yeah. So we haven't broken that out specifically yet on a what kind of the the the drivers are of the components of getting the the high teens ROI see I would say everything is on the table right now we've been talking a lot of course, the about the growth and the operating expense side of things, where we see gross margins going on but really everything is on the table for us as far as opportunities GAAP and <unk>.
The touch last call I'm on the <unk>, turning our sites more aggressive way of looking at working capital opportunities on the not something that we'll be getting into I threw out 21.
And just last one from me on the on the unit growth remind me of the gross margin dynamics annually through that time or what do you expect.
Sure so for the for the Op margin framework for 21, you can think of flat to down 50, bips as the as well as the guidance, we've been giving and then for the out years. We haven't commented specifically on what we expect to happen margin, but we're seeing very strong price cost, we're investing heavily in the pricing analytics and I'm not sure what the inflation dynamics are going to look like that.
The driving costs, yet and 22 and 23, but.
You know we'd be looking to to cover that exposure and to continue deliver strong realization.
Is there still the mix headwind, though that you have to deal with over that time. The mean that that's been kind of the story. The last yeah. Yeah. So there's there's always the mix is the biggest unknown right and where we fall on those kind of range is on gross margin right now you've heard us talk a lot about the p. pressure, which as Erik mentioned, that's really specific the 21, it's kind of a unique.
And given the you know the pandemic dynamic, but mix could remain of fluctuating <unk> factor from where we land in that range from 22, and 23, but I'd say, it's more about where the growth comes from in terms of the products, where we're growing on the parts of the business, where we're growing and then the how fast each of those five growth levers comes online back of definitely influence the margin range.
Yeah.
[noise], yeah patch under the maybe add a little perspective on gross margin sort of if you think about our formula overtime. What you know what's the sort of what's going on is what we've talked about it let's put it this year the funky year with P. P E and wild swings.
X.P.P.E. just the ordinary course of business you know somewhere between 30 and 50 Bips has been where we fluctuated in mix headwind and you know so the assumption Weve had and what we've seen from while is the price cost are flat then you're looking at or you know modest gross margin. The Rosen your year on year and you know that's sort of what the thinking.
He has been what I would tell you is this year in particular, what you're hearing from me and Kristen is we may have outsized of mix headwind, specifically because of P. P. But looking beyond that yeah. What you are hearing I was encouraged by our price realization in the execution there.
And the work happening on the sourcing side and if those things continuing the momentum continues the could create positive price price cost spread which could eat into that mix headwind and create a little bit different dynamic for us the better one. So obviously it's to be determined and were early but you know one of the price cost front, we're encouraged by momentum.
Yep Yep sounds good okay, well thanks for the color really appreciate it and best of luck of thank you.
Huh.
This.
You sort of question and answer session I would like to turn the conference back over to John Corona for any closing remarks.
Thank you Jason for me on the call today, a quick reminder, that our fiscal second quarter 2021 earnings day is now set for April twin sorry April 7th 2021.
And I'd like to thank you for joining us today, and please stay healthy and safe take care everyone.
[noise]. The conference is now concluded. Thank you for attending today's presentation you may now disconnect.
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