Q3 2021 MSC Industrial Direct Co Inc Earnings Call
Good morning, everyone and welcome to the MSC industrial supply 2021 third quarter conference call.
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Also note todays event is being recorded.
At this time I'd like to turn the conference call over to John Corona, Vice President of Investor Relations and Treasurer, Sir. Please go ahead.
Thank you, Jamie and good morning to everyone.
Erik Gershwin, our Chief Executive Officer, and Christian Axis Grande, our Chief Financial Officer are both on the call with me.
As we continue working remotely at MSC, Please bear with us if we encounter any technical difficulties.
And before I get into our cautionary language I wanted to highlight that we recently created a micro site dedicated to corporate social responsibility.
For many years the concept of doing the right thing is driven everything we do in all of our stakeholder interactions at MSC.
I invite you to learn more about our community relations diversity, and inclusion corporate governance and environment and sustainability efforts by visiting our website.
This is only the very beginning of our ESG journey, but we are committed to progress and continually striving for excellence.
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 them.
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, a summary of which is on slide 2 of the accompanying presentation.
Our comments on this call.
Excuse me as.
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 statements about the impact of COVID-19 on our business operations results of operations and financial condition.
<unk> future results expected benefits from our investment and 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 these statements.
Information about these risks is noted on 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 risk factors include our comments on the potential impact of COVID-19.
These forward looking statements are based on our current expectations.
And the company assumes no obligation to update these statements except as required by applicable law.
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 reconciliations 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 thank you everyone for joining us I Hope you enjoyed your holiday weekend I'm excited to update you today on our progress this quarter.
We are seeing the benefits of the strategic pivot that's been made by our company over the past few years.
We made significant investments across the organization.
The transition from a leading spot buy provider.
For a mission critical partner on the plant floor.
I've mentored by our spot buy capabilities.
With the bulk of the less visible changes completed.
We outlined our plan to return to historic levels of revenue and earnings growth.
Consistent with the legacy of our company.
Mission critical is our program to translate those investments into superior financial performance.
And we shared with you 2 goals.
That underpin our efforts.
First to accelerate market share capture.
With a target growth rate of at least 400 basis points above IP.
By the end of our fiscal 2023.
Second to.
To return ROIC see into the high teens.
Powered not only by leveraging growth.
But also by structural cost take out of $90 million to $100 million also by the end of fiscal 2023.
This year, our fiscal 2020.1.
On our proof of concept.
With our fiscal third quarter, serving as the latest encouraging data point.
With respect to revenues, we committed to achieve at a minimum of 200 basis points of positive spread versus the IP by our fiscal fourth quarter.
Q3 is muted by P. P E comps.
But the non safety and non janitorial business grew about 21% year over year.
And we expect our total company growth to meet or exceed our fiscal Q4 commitments.
This year with the help of numerous structural cost reductions.
We increased our customer facing sales head count and.
And we'll continue doing so into fiscal 2022.
We've grown share in metalworking through investment and innovation that improve our customers' businesses.
At the tail end of fiscal 'twenty, 'twenty, 1 and into fiscal 'twenty 2.
We're implementing improvements in e-commerce.
We started with a new production information system earlier this year.
We're now rolling out enhanced search capabilities.
User interfaces for both desktop and mobile.
Transactional engine.
And overall improved functionality.
We've committed to maintaining our gross margin through a series of initiatives.
And excluding the write down for PPE, we have done so.
The macro environment is driving price increases and.
And given our inventory turns and innovative merchandising and pricing programs.
We expect strong realization to continue.
Finally.
We've picked up the pace on structural cost take out.
We've already exceeded our 25 million dollar cost takeout goal for fiscal 'twenty 'twenty, 1 for the full year.
Looking ahead.
Fiscal 'twenty 'twenty, 2 it's setting up even better than the current year.
We will build on our momentum and continue making progress towards our goal of 400 basis points or more of market outgrowth as measured against the I P index.
On the gross margin line.
We expect inflationary pressures to continue.
While purchase cost increases are beginning to make their way into our P&L.
They will be offset by ongoing price realization.
Yielding a stable gross margin outlook year over year.
On the structural cost right.
We will deliver roughly $20 million of incremental savings on top of that which has been achieved over the past 2 years.
And that will include benefits from existing initiatives, which will deliver incremental savings during the first half of 'twenty 2.
Plus benefits in the second half from new initiatives that we have yet to execute on.
Along with a handful of more transformational projects.
That will deliver additional savings in 'twenty 3 and beyond.
We will once again reinvest a portion of these incremental savings into our 5 growth initiatives to.
To build upon market share capture.
Nonetheless, we expect incremental margins at or above 20%.
How far North day go will be a function of how high we can get revenue growth.
And how much price realization we see.
With all of this is the backdrop.
I'll now turn to the specifics of the quarter beginning with the external landscape.
The economic environment improves significantly.
Most of our manufacturing end markets turned positive during the quarter.
And this is evidenced itself then I P readings that turned to double digit growth in April and May.
And in sentiment readings, such as the M. B I index, which are at very high levels.
All of this is supported by our customers' outlooks, which are robust.
At the same time, the industrial economy is experiencing very real supply chain shortages and disruptions.
These disruptions are evidencing themselves and product scarcity.
Freight delays and extreme labor shortages.
That are resulting in significant availability and inflationary pressures.
And we are certainly not immune to these challenges and in fact, we're seeing them play out.
That said.
We are very well positioned to navigate the current environment.
Particularly when compared to the local and regional distributors, who make up 70 per cent of our market.
M a c's broad multi brand product assortment.
High inventory levels strong supplier relationships and next day delivery capabilities.
Position us well to accelerate market share capture.
Additionally, the.
The supply chain challenges.
Our resulting in significant and growing inflation.
That is producing the most robust pricing environment, we've seen in years.
Turning now to our performance you can see our reported numbers on slide 4 and adjusted numbers on slide 5.
Revenues were up 2.2% on an average daily sales basis.
We're seeing continued sequential improvement in our sales levels.
Most notably non safety and non janitorial product lines improved through the quarter from mid single digit declines in our second quarter.
21% growth in our third quarter.
Sales of safety and janitorial products as expected given the significant surge during the pandemic last year declined just over 40 per cent for the quarter.
Looking at our performance by customer type and excluding for a moment.
D in janitorial product lines.
All of our customers all types were up strong double digits.
However, including all product lines and given the extremely difficult comparisons government sales declined nearly 40%.
National accounts return to growth by posting a low single digit increase.
While our core customers improved and grew in the mid teens.
C C. S. G grew mid single digits.
June showed continued improvement with total company year over year growth estimated at $15.4 per cent.
Our non safety and non janitorial growth is estimated at roughly 20%.
While safety and janitorial are estimated to be down roughly 10% against last year's continued P. P E search.
We expect strong growth rates and on safety and non janitorial products for the balance of the fiscal year.
On the pricing front, we've seen solid realization of the March price increase that we mentioned last quarter and as a result, we saw a sequential lift in gross margin.
From our fiscal second quarter's adjusted rate of 42 point out per cent.
Since that last call, we've seen continued significant pricing activity from our suppliers.
And as a result, we've implemented a June price increase.
This is earlier than normal, but certainly warranted given the environment.
We will not hesitate to move again, if suppliers continue raising their prices.
Beyond the numbers, we had a couple of positive developments during the quarter.
1 was the recovery of the nitrile gloves impairment, which Christian will touch on in just a bit.
The other was the acquisition of a majority stake in the William Hearst Company in June.
Hirst isn't metalworking distributor based in Wichita, Kansas.
With a heavy focus on the aerospace sector.
And this deal is meaningful to MSC in several ways.
First goes to market with a highly specialized and highly technical sales force.
It fills out a geography in which MSC was underpenetrated.
And more importantly brings.
Brings technical capabilities that we can leverage across the entire MSC business.
Aerospace is roughly 10% of total MSC sales today.
It's an industry that is poised for strong growth coming out of the pandemic.
And the first platform will considerably enhance our effectiveness.
And serving and growing that portion of our business.
First has been led by CEO, John Mullen, who remains at the helm and retains a meaningful ownership stake in the business.
I'll now turn things over to Christian to cover the financials and their mission critical progress.
Thank you Erik I'll begin with a review of our fiscal third quarter, and then update you on the progress of our mission critical initiatives.
On slide 4 of our presentation, you can see key metrics for the fiscal third quarter on a reported basis.
<unk> 5 reflects our adjusted results.
Our third quarter sales were 866 million up 3.8% versus the same quarter last year.
We had 1 more selling day this year in our third quarter. So on an average daily sales basis net sales increased 2.2 per cent.
Erik gave some details on our sales growth and I'll, just reiterate that our non safety and non janitorial sales grew 21 per cent in the quarter, while our safety and janitorial sales declined 42 per cent.
Moving to gross margins execution and realization on our mid year price increase was solid.
Our gross margin for fiscal Q3 was 42, 3% up 30 basis points sequentially. After adjusting out our inventory write down from last quarter and down just 10 basis points from last year.
Looking ahead, we took our summer increase in early June in response to the continuing inflation, we're seeing from our suppliers.
We expect the recent trends to continue and aim to achieve a gross margin for fiscal 2020, 1 that is flat with fiscal 2020.
Operating expenses in the third quarter were $257.3 million or $29.7 per cent of sales versus $242.8 million or 29, 1 per cent of sales in the prior year.
Our third quarter includes just 400000 of legal costs associated with the loss recovery, which I'll discuss shortly.
Opex as a percentage of sales excluding those costs was the same as the GAAP figure or $29.7 per cent.
Let me share a few more details on our third quarter Opex is.
I mentioned on our last call, we expected opex to increase sequentially from our second quarter not only by the variable operating expenses associated with higher sales, but also due to expected higher incentive compensation as well as growth investments related to mission critical.
Recall that our adjusted Opex for Q2 was 244 million.
On $90 million increase in sales means roughly 9 million of variable related opex.
The remainder of the increase was primarily related to higher incentive compensation.
While mission critical growth investments did increase sequentially. This was offset by an increase in mission critical saving which I'll speak to in more detail in a few moments.
As you may have seen in our earnings release. This morning, we had a very positive development regarding the nitrile gloves impairment, we announced in our fiscal first quarter.
Pleased to report that last month, we received a 20.8 million loss recovery of the original $26.7 million impairment loss recorded in Q1.
That recovery is below the operating expense line in the P&L, but it does increase our GAAP operating income.
Such that our GAAP operating margin for the quarter was 14, 8%.
Excluding the $20.8 million loss recovery and associated legal fees as well as restructuring charges during the quarter of $1.3 million. Our adjusted operating margin was 12, 6% down 70 basis points from the prior year.
GAAP earnings per share were $1.68.
Adjusted for the lost recovery as well as restructuring and other charges adjusted earnings per share were $1.42.
Turning to the balance sheet and moving ahead to slide 7 on.
Free cash flow of $3 million in the third quarter as compared to 49 million in the prior year sales.
Largest contributors were our increasing inventory and accounts receivable balance as our sales picked up significantly in the quarter.
I would also note that we repurchased 47 million of stock during the quarter or about 507000 shares at an average price of $92.92 per share.
This underscores our ongoing commitment to a balanced capital allocation philosophy, and our goal to maximize total shareholder returns.
In fact, the day in our fiscal Q4, we repurchased another 229000 shares at an average price of $89.7 pence.
Lastly, when it comes to cash flow. Please note that the $28 million loss recovery was received in June and will therefore, therefore be reflected in our fiscal fourth quarter cash flows.
As of the end of fiscal Q3, we were carrying $598 million of inventory.
$66 million from last quarter.
We're actively managing inventory levels to ensure we can support our customers that sales continue accelerating.
Therefore inventory levels are likely to continue climbing in the fourth quarter.
We still expect capital expenditures for the fiscal year of approximately 55 million and we still expect our cash flow conversion.
Operating cash flow divided by net income to be above 100 per cent for fiscal 'twenty 'twenty 1.
Our total debt at the end of the third quarter was 759 million, reflecting a $75 million increase from our second quarter.
Roughly 2 thirds of that increase was used to repurchase shares under our ongoing share repurchase program.
As for the composition of our debt 187 million was on our revolving credit facility about 200 million was under our uncommitted facilities $20 million on short term fixed rate borrowings and $345 million with long term fixed rate borrowings and cash and cash equivalents for $27 million, resulting in net debt of 732 million at the end.
End of the quarter.
Let me now provide you with an update on our mission critical productivity goals.
On slide 8 you can see our original program goals of 90 to 100 million of cost take out for fiscal 2023 and that is versus fiscal 2019.
Our cumulative savings for the first half of fiscal 'twenty, 1 or $17 million and we saved another 12 million in our third quarter, bringing our year to day savings from 29 million against our goal of 25 million by the end of this year.
We also had invested roughly to 7.7 to 8 million in the first half of fiscal 'twenty, 1 and we invested another $7 million in our third quarter, bringing our total year to date investments to $15 million, which compares to our original full year target of $15 million.
Given the success of the program through the first 3 quarters, we now expect to achieve savings for fiscal 'twenty 'twenty, 1 of roughly 40 million regarding total investments for fiscal 'twenty..1 we now expect roughly $25 million, which would result in net savings of 15 million for this year.
Before I turn it over to Erik Let me leave you with some broad expectations for the coming quarters.
With respect to sales the difficult safety and janitorial comparisons will ease in our fiscal fourth quarter and into fiscal 'twenty 2 weeks.
We expect double digit growth rates for the total business in our fiscal fourth quarter and continued strength into fiscal 'twenty 2.
For fiscal 'twenty, 1 we expect a low single digit total company growth and we aim to achieve gross margins that are flat with fiscal 'twenty.
In terms of adjusted operating expenses sequentially from our third and fourth quarters, we will see a decline due to volume based expenses from sequentially lower sales dollars and lower incentive compensation.
With that in mind, we remain on track with our adjusted annual operating margin framework for fiscal 'twenty 'twenty, 1, which you can see on slide 9.
Furthermore, and as Erik mentioned earlier, we expect to achieve 20 per cent or higher incremental margins in both fiscal 'twenty, 2 and our fiscal 2023 and I'll now turn it back over to Erik.
Thank you Kristen.
Fiscal 'twenty 'twenty, 1 is finishing on a high note.
And we expect that momentum to continue into fiscal 'twenty 2.
We are gaining steam internally.
Our end markets are strengthening as evidenced by I P readings.
The inflationary environment, along with our ongoing price realization should continue to support gross margins.
On the structural cost front.
We've made strong progress on our mission critical program.
And will deliver further savings over the next 2 years and beyond.
All of that should translate into incremental margins at or above 20%.
For the next 2 years.
I. Thank our team for all of their hard work and dedication and we will now open up the line for questions.
Okay.
Ladies and gentlemen at this time well begin the question and answer session.
Once again to ask a question you May press Star and then 1 to withdraw your question you May Press Star 2.
At this time, we will pause momentarily to assemble the roster.
Yeah.
And our first question today comes from Tommy Moll from Stephens. Please go ahead with your question.
Good morning, and thanks for taking my questions.
Hey, Tommy how are you.
Doing great doing great.
Erik I wrote down 1 of your comments and I think Oh.
I'm getting is about right you talked about this being 1 of the most robust pricing environment you've seen in years. So I wanted to dig in on that.
Talked about another increase in June.
Possibly.
The book, we'll see another 1 before the end of your fiscal year.
Any way you could frame for us what the June increase looks like a co.
Quantitatively.
And if you play this out longer term.
Beyond the next quarter or 2.
And this kind of inflationary environment.
Is this a net benefit net neutral to your platform.
How does this play out.
So on me. So yeah look I think let me, let me start with the macro and the environment and you did capture the my comments accurately you know if you go back and for those who have been studying our space for a long periods of time, you know you go back to different areas than we've experienced for the past 10 or 15 years and <unk>.
Generally strong robust inflation is a distributors friend and so if you looked at MSC as gross margin performance in.
In the 2 thousands versus what it's been the last several years you'd see on.
Noticeable difference and we've talked about our gross margin formula consisting of 3 things price cost and mix.
We've talked about the fact that there's generally a mixed headwind in the business of somewhere 30 to 50 basis points.
So to the extent price and costs were a wash.
We would see erosion of somewhere 30 to 50 basis points and not surprisingly over the past few years, that's about what you've seen from us in a very low inflation environment I think unusually low 2 thousands may have been unusually strongest is unusually low certainly you know some of the supply chain issues that we discussed.
On scarcity are leading to more inflation than we've seen than I've seen in at least a decade.
You know price increases coming from suppliers fast and furious Youre right you know for us to take 2 moves.
In a matter of a few months, we haven't done that in a while and that's in response to the environment net net Tommy we view this as a positive typically what you would see from US is the early stages of an inflation cycle price would outpace cost.
And we believe that's where we're at right now you know certainly in the later stages things can flip around book you know to the extent that this inflationary cycle has some legs to it as it appears.
We would expect price to outpace cost. So you know if you look at the proof in the pudding will obviously be in our numbers, but you know you think about yes, we're going to begin to start seeing cost in our P&L, yes, that'll begin to happen as early as this quarter, but you know you sort of zoom out and say, okay fiscal 'twenty 'twenty, 1 we're calling to.
B, you know plus or minus flat with prior year and as best we can tell now and of course will come back next quarter with a framework as we normally do but as best we can tell now we're giving you sort of look ahead to 'twenty 2 and say you know, we're seeing a roughly flat picture that would imply positive price cost in each of those years to offset mix and you know then you take it a step further and all.
Stop talking telling me, but if this business can produce roughly flat gross margins.
And I P does what it is it is forecast to do to do and we continue to build on our internal momentum and outpaced the IP youre looking at strong topline growth roughly flat gross margins enhance that with some cost take out and we think we have a really compelling picture.
Thank you Erik that's all very helpful.
I wanted to follow up with a question on the inventory, which you provided some helpful comments on in the script.
What has the philosophy changed at all and in the appropriate level. There I mean, you've got potential supply chain issues that you may want to protect against.
I think you referenced in the script the opportunity to.
To deploy.
Or to put your balance sheet to work with some inventory to to take market share.
Has anything.
Changed in your mind about how to how to manage that or what what do you want us to know about how youre thinking about inventory right now. Thank you Tommy I would say this no change in philosophy, some change in tools and tactics and keeping up with the times, but in terms of philosophy, no change and again going back being in this business now over.
2 decades times of growth in times of products scarcity create really compelling opportunities for distributors like MSC bottom line is if you have stuff on the shelf you're going to capture share. So I think what you're seeing the big building inventory youre seeing it over the past quarter. We telegraph, we expect it to continue we would have liked it to.
Even bigger if it weren't for scarcity issues.
We're going all in on making sure that we have product on the shelves for our customers at a time when product is scarce and it's critical as the economy now ramps back up the industrial economy that our customers keep their lines running so we are going all in on inventory and it's sort of it is a reflection of our view on the outlook of the economy.
And our view on the importance of having product to capture share.
Thanks, Erik I'll turn it back.
Our next question comes from on the Missouri from Jefferies. Please go ahead with your question.
Hey, this is actually Ryan gunning on filling in for Hamzah.
Could you just talk about your current vending initiative.
How much of your customer base or what percentage of revenue is vending and what kind of growth you're seeing there.
Yeah sure good morning, Ryan and and what I'll do is just you know connect back to you know if you recall, where we are right now laser focused on restoring the kind of market share capture rates that this business had become accustomed to and so we put our our our first marker out there 400 plus basis points by 'twenty 3.
The first sort of goalpost in in getting there is going to be our fiscal fourth quarter at least 200 basis points and then if you recall, we outlined 5 growth initiatives that are going to get US. There..1 of those is what we refer to as solutions and in solutions, specifically, it's 3 things it's vending, it's vendor managed inventory and it.
Our implant program all of which are aimed at bringing us closer to the customer.
And embedding us on to the plant floor. So what I would say is vending is picking up steam we definitely saw not surprisingly Ryan we saw a lull in our new account signings on the growth rate of course, the growth rate of the installed base came down with Covid and its bounce back as the business has the new signings.
Took a lull during the pandemic because of the inability to get into plants. We are seeing it come storming back so we're measuring <unk>.
Size of funnel dollars in funnel close rate all of those are doing what we wanted to see happen as the years gone on they've gotten stronger and stronger. So what I would say is remains an important growth driver along with be a mine and plant as part of this.
Solutions initiative.
Got it debt. That's helpful. Thank you and then I guess kind of switching gears can you talk about.
What youre seeing in terms of metal working markets from a growth perspective, and just competitive dynamics there.
Yeah. So so I think from a market standpoint a.
What we're seeing is in particularly Ryan this quarter you know if you think about metalworking.
And our end market exposure, there theyre very tightly coupled and so not surprisingly nearly half of our sales are tied into 5 heavy manufacturing end markets that are the bulk of where the metalworking consumption happens those.
Those heavy manufacturing end markets went down deeper than most of the economy and quite frankly has been a little slower to recover we saw that start to flip in the past quarter on it. So if you take a look at below the I P. Reading you can see some of the sub indices. We are starting to see the heavy manufacturing markets come back and we think that's a great.
Opportunity for us.
In terms of share capture we're still sitting on.
So leadership in metalworking, but still sitting in the neighborhood of 10% market share. So we've got a big runway ahead of us in terms of share capture and.
The end markets that we think have legs to them in terms of this recovery. So we're excited by our our metalworking outlook and what I would say is to capture that share. There's a few things that are paragon investment into people. So you see our head count ticking up that investment into metalworking talent, we did it both organically and in the past quarter through our App.
We're really excited about her joining the family we're doing it through technology.
With initiatives like MSC no Max on a combined with our people are really helping customers take cost out of their operations and then I mentioned earlier to Tommy's question sort of the old fashioned way of just having product on the shelf when others don't we think that really matters as well. So all of those sort of feed into what we think is an exciting metalworking outlook.
Great. That's all Super helpful. Thank you very much.
Our next question comes from Adam Uhlman from Cleveland Research. Please go ahead with your question.
Hi, guys good morning.
Hi, good morning on them.
Hey can we go back to the the the price increase discussion we were having earlier I guess in the operational stats. It looks like there was a million dollars attributed to price, which seems kind of low.
I understand there are some some other offsets that you call out in there like customer mix and product mix and discounting.
Can you maybe.
Parse that apart between what were the headwinds that offset the price increase from March and then as we put this price increase through in June.
You know, how how should we be tracking that contribution to the total sales growth guidance.
Maybe you could just dimension it sort of it sounds like low single digits, but maybe you could clarify that.
Sure so going back to the first part of your question. The first thing I'd say is price realization.
I think as Eric touched on it is solid and we're pleased with what we're seeing around realization and then the second metric that you mentioned on which is what we see in the growth decomposition composition on the op stats.
And that has about 1 per cent of growth assigned to both price and mix to your point. It's a combination of things that are in that metric normally that's a pretty good indicator on for how you could think about price growth in the business, but what's happening in the second half of this year in Q3 and Q4 is if you look at the large amount of P. P E volume net.
We had in the base so in in second half of 'twenty.
It's really making it a not a very meaningful metric to think about how price is impacting the business and so that's kind of what you see near term I think if you if you zoom out and you look at what's happening sequentially. We did grow margins from Q2 to Q3 and so that's an indicator.
That we're seeing on the price benefit that we had expected to see coming into the numbers and then beyond that like Eric Eric touched on we're seeing about flat margins 'twenty to 'twenty, 1 which is not something we typically see in the business that means we're offsetting the costs coming out of the P&L and that traditional mix headwind on.
That we see in the business and we're expecting to do the same thing again in 2020 'twenty 'twenty 2.
Okay got you. Thanks, that's helpful and then.
For mission critical on gas, there's $40 million of gross savings remaining over the program for the next couple of years could you dimension some of the bigger buckets.
That you expect those savings to come.
Come from and then have you changed your thoughts at all on your reinvestment appetite of those savings.
Yeah, so for the future debt for the following 2 years on the program 'twenty 2 and 'twenty 3 we got programs. We've got programs that are working across all areas of the P&L I think where do you think about kind of the transformational work that we have ahead of us sort of like the bigger.
Longer term projects to execute you'll probably see us pivoting a little bit more to the operations side of the business. You know we did a lot of work around the sales side of the business that you saw us execute in 'twenty, 1 so there'll be a bias towards operations on the transformational work, but on the pipeline of projects really touches.
Every part of the P&L on theirs.
There's a lot of small things that are going to deliver benefits, particularly in kind of 'twenty..2 second half of 'twenty 2 will that carry over in the beginning of 'twenty 2 from what happened with that but in particular, the sales program or the sales restructuring.
You saw us execute in fiscal 'twenty, 1 and then those transformational projects are going on kind of position us on for 'twenty, 3 and beyond and then in terms of the reinvestment I'll give you guys from firmer guidance on that next quarter. When we published the framework on but 1 of the things that we're looking at right now, it's kind of on which projects they want to bring online and 1 on the growth.
Syed.
And we're really committed to delivering that incremental margin of greater than 20%. So we'll probably adjust the investment schedule accordingly based on our other assumptions to make sure we're delivering on that incremental.
North of 20 that we committed to for fiscal 'twenty, 2 and 'twenty 3.
Okay. Thanks.
Youre welcome.
Yeah.
Our next question comes from David Manthey from Baird. Please go ahead with your question.
Yeah.
Hi, good morning, everyone.
Good day.
First off it's Christian.
Your discussion there on price mix, if we set mix aside it sounds like you had solid.
Price realization on the March increase and with the glide path from that increase in addition to the new June increase.
In light of the current inflationary environment.
Should we be reading that you or your expectation for price realization alone might be on the higher end of low single digits or even in the mid single digits in the coming quarter.
No I think I I'd say, a lower single digit is a reasonable expectation day, then I think what's starting to happen to in Q4 is.
As the costs are all the inflation, we're seeing passed on to us from suppliers are starting to roll on to the P&L on so it is dampening a little bit on the price cost spread we might've been hoping to see when we looked forward last quarter, but generally still really pleased at being able to offset the macs cover on the cost and keep the margin flat for the full year.
Okay.
I know you've always been hesitant to talk about price realizations, specifically, but.
If based on your comments it sounds like.
From your price realization forgetting about mix and forgetting about the cost side. It sounds like youre seeing good realization, which might imply a little bit higher than low single digits is that in the ballpark.
We were seeing our realization come on line as expected yes.
Okay fair enough and Dave just just to put color on that is as Christian mentioned, so the metric that's the public metrics. She mentioned because of last year. The P. P. E surge the mixed component of that metric is so distorted compared to what it typically is a normal time that will correct itself in the quarter or 2 as you can imagine inside the company or pricing.
Team has 10 ways till Sunday in which they're looking at more micro price realization metrics and yeah, We're where we're seeing just this Christmas day, just as we would have expected in terms of outcomes.
Okay sounds good.
And second on the E Commerce front it.
It seems like that metric lost momentum during the pandemic and has since reaccelerate. It I think trailing 12 months you're back over 60% E Commerce.
What does that tell us about the trends in the business if anything as we come out of the downturn here.
Yeah, Dave So I think important to understand you know just true what makes up sort of the buckets under that 60 per cent E. Commerce, obviously, there's a big chunk.
Over half of that is MSC direct dot com.
And that's the part right now I mentioned investments into digital most of the investments are directed there to take MSC direct dotcom to another level and certainly I would expect over time that portion of the business to grow as a percentage of revenues. The total 60% includes other buckets like vending things flowing through events.
Machine, you procurement with large accounts, which so there was sort of a mixed dynamics going on underneath the covers because as you can imagine I mentioned earlier vending dropped considerably during the pandemic and is now climbing back up for us what I'm gonna be looking at is the quality of the experience on MSC direct.
On a comp gonna be looking at retention average order size and somebody sort of micro measures and then yes, I think for you over time seeing at 60% growth.
Will be the way to look at it and evaluate it.
Great. Thanks Erik.
Our next question comes from Ryan Merkel from William Blair. Please go ahead with your question.
Hey, everyone nice job on gross margins this quarter.
Hey, Ryan Thank you.
So my first question is on SG&A leverage I know you expect strong leverage in 'twenty, 2 but should we expect SG&A leverage in the fiscal fourth quarter.
Yes, if the fiscal fourth quarter.
It's going to we're going to come down sequentially, Ryan relative to where we were in Q3, a little bit of that coming.
With the decline in sales and then we're also going to see a bit of a normalization on the sales.
Excuse me the sales incentive compensation.
So we will see a more favorable opex rates are coming in in Q4, better leverage coming in Q4, and then for the year are feeling confident that we'll land inside that low single digit framework.
Probably on the lower end of that given where we think revenue is going to land and kind of given what we see happening in the inflationary environment.
Really we've talked a lot about kind of what's happening on the cost of goods sold with inflation, but we're also seeing some costs start to creep into the business on the SG&A side around things like labor inflation and wage increases things like that.
Alright, so it sounds like SG&A leverage will improve in <unk> and then it'll improve more so in 2022 is that right correct.
Okay.
And then my second question June average daily sales growth, but that was a nice number I know, you're not giving guidance, but I'm hopeful to get your view on what inning of the macro recovery. We're in and then if sales growth can accelerate from the June level.
So so Ryan I look I think from our perspective, we are encouraged I think you know from me Judy on the sort of 1.1 data point, we're looking at a sort of a bigger story here and I am encouraged by the momentum, we're seeing and I think that goes for macro but also sort of from bike.
Meaning how is the company doing relative to IP.
We had a pretty good quarter in Q2, obviously P. P E noise here, but we are starting to see progress.
In terms of the macro recovery.
Again, Ryan we're coming from a fairly slanted view, where we're heavily exposed to heavy manufacturing, which had been hit hard at the later stage. So we think there's plenty of room here, we're kind of hitting a speed bump as a as an economy and industrial economy with the supply chain and labor constraints right now no question impacting growth.
With our customers anyway, but.
But we think there was a nice recovery here.
Particularly in certain end markets, where we think theres on ways to go to answer your question early innings, and then I feel the same about you know in internally.
We still feel like we're in the early innings. We think this year has kind of been a.
On a proof point that we're on the right track, but we have sight set high in terms of share capture and spread above IP and still feel like we're early innings there too.
Sounds good Erik thanks.
That's right.
Our next question comes from Michael Mcginn from Wells Fargo. Please go ahead with your question.
Hey, everyone. Good quarter, I was hoping to get a little more color.
I was hoping to get a little more color on the recent acquisition is there can you frame for us what aerospace is like round about percentage of your business today is there ever a point from a portfolio management standpoint, where you think it.
You cap yourself.
Mike So so we're sitting at around <unk> and I'll touch on on on what <unk> brings to us so aerospace roughly at 10% of MSC as revenues.
We think that it is a really good fit in terms of an end market for MSC for a number of reasons first and foremost of which we can really moving the needle per our customers' productivity using metalworking, our metalworking experts metalworking technology like mill, Max our product portfolio et cetera. So we think it's a good fit.
In terms of capping it at some point that will be a very high class problem. We think we have a ways to grow in penetrating that market, we really like the timing of Hearst because you know on aerospace obviously has been on its back and we think has a long way to go and recovery.
And what really excites us is the team there.
<unk> is really technical and really focus so so so they're bringing something in some sense expanding our metalworking capabilities for sure, but they're really bringing something that we don't have organically in the business, which is a metalworking focused specific to aerospace.
And we think that's a capability not just the build out and cross sell into their customer base, but for John and his team. We think we can leverage that team across MSC is broader aerospace customers to increase penetration so we see them.
Bottom line is we see a ways to go.
With aerospace and at some point will be in the high class position to have to try to cap it but we got along no pun intended but runway in front of us there.
Got it.
And then going back to the earnings algorithm you outweighed earlier on the call mentioning if we can get flat gross margins.
Just in terms of that.
How back to know how how much runway do we have to get back to normal in terms of gross margin rebates and in terms of the local core customer catching up to that national account.
So here's here's here's what I'd say, Mike. So so let me break apart gross margin into 3 buckets price cost and mix.
What I would say is we still see yeah. So over the past few years price and costs are more or less been a wash on what youre hearing is that price is now outpacing cost and we think that as long as the inflation cycle continues and by all measures given product scarcity labor scarcity et cetera et cetera. It does feel that.
We're in the early stages of an inflation cycle.
The extent that continues while costs are going to creep into the P&L. We think we can you know state stay ahead of it with price debt.
That brings us to mix.
Mix has a lot on you mentioned a couple of moving parts, Mike There's a lot of moving parts to mix.
In terms of which product lines are growing faster, which end markets are growing faster size of customers. You said national accounts et cetera, net net when you put it in the wash and you put all of the mix components in the wash, we still see a negative you know sort of a headwind coming from mix.
And and we do still see it somewhere in the 30 to 50 and it's tough to give you a precise number it moves around but somewhere 30 to 50 bps per year. So the way, we get to sort of announce the way we get to flat and take 21 is it for instance is some mix headwind, yes, but price outpacing cost and I was being a wash.
Got it appreciate the time thank you.
Okay.
Our next question comes from Kevin Matt from Deutsche Bank. Please go ahead with your question.
Hi, Good morning, Thanks for taking my question good morning.
A lot has been asked I guess maybe.
Maybe I'm wondering if you could give some more color on some of the supply chain constraints. You know what are you seeing in terms of labor product availability and.
I think it's gotten better or worse for you and for your customers and kind of how are you managing that.
Yeah, Kevin So let me talk about I'll talk about sort of broad marketplace, which would include customer and supplier.
I would say over the past quarter, the supply chain issues have become more acute not less.
And I think that in particular, the 1 that is just white hot is access to labor everybody I'm talking to is feeling the pinch and what that means is it's really at this point constraining growth.
The exciting thing is.
To the extent this is a speed bump the long term prognosis outlook is really good.
But what what it means for our suppliers and inability to hire people who are needed to produce stuff and ship stuff to distributors like MSC for our customers. It's much the same there they're their order backlogs are massive and they can't keep up with it they can't get product out the door.
I think from our standpoint, Kevin we think we're really well positioned to navigate this first of all it should be it should be temporary I mean, who knows how long it takes to believe but it should be temporary.
The second thing is we think we're well positioned number 1 is that whatever issues, we're facing and we are facing I mean, we mentioned, we would like inventory levels to be even higher than they are we're facing issues from our suppliers, but whenever we're facing.
Remember 70 per cent of our market is made up of local distributors, who really struggle in gaining access to the product.
So we think there's a tremendous market share capture opportunity and then the second thing I'd say is that all of these constraints and scarcity are what is fueling the inflation that has been fueling is fueling the ability to take price. So.
Yeah.
We think we're well positioned to navigate this we think the outlook is really good.
To be clear absolutely the issues that are acute and in labor is at the top.
Got it. Thank you that's really helpful. Maybe just 1 more getting back to some of the mission critical commentary is.
Is there is there scope to by the time, we get through fiscal 'twenty 3 to be above $90 million to $100 million given that you're executing on a chunk of that kind of faster than originally anticipated I'm.
I'm wondering if there are other things or other initiatives that maybe you didn't make the first round of planning for mission critical that you now feel like you may have the ability to pursue.
Yeah, I think we're definitely optimistic that that's possible.
Really at the higher end of that $90 million to $100 million range right now and 1 of the things we've talked a lot about internally is that you know we communicate mission critical as a kind of time fence between 19 and 2023, but.
Really what we're doing here is changing the culture of the company to make this idea of driving these costs out of the business and ongoing an ongoing part of what MSC does your after a year. So we do have a long pipeline of projects.
I think its always possible, we shuffle timing on some things pulse on thanks for that could provide the potential to go above that.
But 1 of the things we are thinking through for 'twenty..2 is are you you've got some big projects executed in 'twenty, 1 that carryover from the smaller new things, we're going to execute that help us in 'twenty, 2 and then youre going to see us really reload and kind of recharge on the transformational projects that'll hit in 'twenty, 3 and beyond so to the extent that we can bring those big transformational things on.
Faster or maybe to a greater extent on where originally contemplating that would be the path to going above that $90 million to $100 million range right now.
Yeah.
Got it understood. Thanks, a lot I appreciate it.
And our final question today comes from Patrick Baumann from Jpmorgan. Please go ahead with your question.
Patrick is it possible your phone is on me.
Hello, sorry about that can you hear me now.
It was on mute I'm apologize for that Erik.
Wondering if you could talk some more about what you're doing to the website and why is this this is just basic upgrades or is it something more transformational.
Day, you interact and then on on this front like how would you benchmark yourself to the website capabilities I guess MSC direct person who's kind of leaders in the industry at this point.
So Patrick what I would say on I'll answer your question on E. Commerce, So to do it I just wanted to underscore something Christmas and then it was in relation to mission critical and that was about a cultural change happening inside the company and I bring this up in the context, you asked me about ecommerce because what what Kristin described happening in Michigan.
Critical with it becoming a way of life and kind of like constantly raising the bar on ourselves. The same thing is happening everywhere in the company across.
Our commercial organization across marketing across structural cost you name. It. So I you know I think whats happening here and the investments being made is we're raising the bar on ourselves and it's certainly we benchmark.
Peers inside and outside of the industry for capabilities, but I have to tell you the north star for US that's driving these changes is the customer.
How we can make their lives better how their expectations with with a younger millennial influence workforce growing as a percentage of total work force like we did this is about raising the bar on ourselves and doing better for customers. So what we're doing is and I'd call. It somewhere between an upgraded transformational but really changing.
The technology stack, we use.
And what that means is moving I'm certainly more cloud based where we can capture changes that happen.
Overnight as opposed to needing to do.
Upgrades, we're talking about using capabilities like AI powered inter.
Intelligence and logic that allows our.
Our search engines, our website, our whole digital experience with the customer to constantly improve so I think some of this is around technology.
And then some of it is flat out just around customer experience and reducing friction and creating a better experience stickier experience from the customers. So that's really what's going on and it'll happen. So we're beginning to put things into market in flat this quarter.
That will continue so we will continue to launch sort of iterations along the way it won't be big Bang into the first couple of quarters of 'twenty, 2 and obviously won't be watching carefully for performance, but I think this all goes back to the idea of raising the bar on what we expect out of ourselves and for our customers.
But what do you what do you use to track kind of the progress is it it.
It sounds like some voice of customer maybe cause you gotta be some metrics you mentioned stickiness like.
Site visits at sales metrics as revenue per visit I don't know what do you use yeah. So 1 of the things that are new and we've really upgraded our digital team. That's a strong group and 1 of the things they've implemented as a weekly business review process, where they're managing through a whole bunch of metrics a cup.
All of them you've mentioned you know, whether that's average order value whether that's number of unique visits whether that's conversion from the top of the funnel, meaning people coming to the site to the bottom of the funnel ordering and looking at all points along the funnel. So there's a bunch of metrics there they're meeting weekly.
And literally when they see metrics moved 1 way or another they are adjusting.
By week, so if its going into doubling down on it if they see sort of a negative break in trend getting to root cause and then making adjustments in real time.
So that's happening on a weekly basis.
Great help helpful color, Eric maybe go on for Christy really quick on a follow up on Opex.
You mentioned variable comp incentives as positive sequentially from the fourth quarter do you also expect any sequential net savings from from the various programs debt that you have in flight and then also on what about freight costs any update on what youre seeing in the P&L there going into year end.
So sequentially from mission critical no impact from investments and savings on a net basis it'll be flat sequentially and then oh on the freight side sequentially not really seen any headwinds freight is a bit more of a story for us on a year over year basis.
That really has more to deal with on a.
Lower freight rates that we saw in the second half of 'twenty last year due to how we were shipping the P. P E out to our customers, where the customers were taking possession of that product on.
So we are seeing a bit of freight inflation creep in sequentially, it's not an impact.
It's maybe a million or $2 million on a year over year basis in the fourth quarter on but we feel like freight is relatively well controlled given what's happening on the macro environment.
We do a lot of small parcel shipment on.
And that is on.
That's sort of in terms of how we pay for that are pretty well bound by our contract and expect to see a little bit more pressure coming in from our L. T. L shipments next year, but on.
Think given what could be happening with freight from what we know of the macro environment. We're in a pretty good position.
Great helpful color. Thanks, Thanks, a lot I really appreciate your time and best of luck. Thank.
Thank you Patrick.
Yeah.
And ladies and gentlemen, with that we'll conclude today's question and answer session I'd now like to turn the floor back over to John Corona for any closing remarks.
Thank you Jamie before we end the call a quick reminder, that our fiscal fourth quarter and full year 2021 earnings day. It is now set for October 20th 2021.
I'd like to thank everyone for joining us today, and we certainly hope you enjoy a fun healthy and safe summer.
Take care everyone.
And ladies and gentlemen, with that the conference call has now concluded we do thank you for attending today's presentation. You may now disconnect your lines.
Yeah.