Q3 2022 MSC Industrial Direct Co Inc Earnings Call
[music].
Good day and welcome to the MSC industrial supply 2022 third quarter conference call.
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After todays presentation, there will be an opportunity to ask questions.
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Please note today's event is being recorded.
I'd now like to turn the conference over to John Corona, Vice President of Investor Relations and Treasurer. Please go ahead Sir.
Thank you and good morning, everyone.
Erik Gershwin, our Chief Executive Officer, and Kristin <unk> Grande our Chief Financial Officer are both on the call with me today.
During today's call, we will refer to various financial and management data in the presentation slides that accompany our comments as well as our operational statistics both.
Of which can be found on our investor Relations webpage.
Let me reference our Safe Harbor statement under the private Securities Litigation Reform Act 1995, the summary of which is on slide two of the accompanying presentation.
Our comments on this call as well as the supplemental information we are providing on the website contain forward looking statements within the meaning of the U S Securities laws.
Statements about the high inflationary environment and global economic conditions on our operations results of operations and financial condition expected future results.
The 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 in our earnings press release, and the risk factors and the MD&A sections of our latest annual report on Form 10-K filed with the SEC as well as in our other SEC filings.
These risk factors include our comments on the high inflationary environment and global economic conditions.
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 reconciliation.
Inflation or on our website, which contains a reconciliation of the adjusted financial measures to the most directly comparable GAAP measures I'll now turn the call over to Eric.
Thanks, John .
Good morning, everyone and thank you for joining us today.
I hope you remain safe and healthy.
On today's call I'll reflect on our recent performance.
Provide color on Q3.
And also share our perspective on the current environment.
Christian will provide more specifics on our financial performance and outlook.
And I'll, then wrap things up before we open up the line for questions.
We're now three quarters of the way through fiscal 2022.
And our drive to improve execution and financial performance is in full swing.
Each passing quarter is another proof point of progress on our mission critical journey.
During our fiscal third quarter, we achieved revenue growth of roughly 500 basis points above the IP index.
We demonstrated continued gross margin expansion, both sequentially and year over year.
And we translated the growth into.
Strong operating leverage.
Adjusted incremental margins for the quarter were just over 33%.
And adjusted operating margins expanded 200 basis points.
Our fiscal third quarter represented the highest revenue in the history of our company.
And the lowest operating expense to sales ratio.
Since fiscal 2013.
While we're encouraged with progress.
We are far from satisfied.
On the growth front.
We're seeing historically high contribution from realized price in light of the inflationary environment.
And so we still expect more growth above IP.
We're focused on capturing it.
On the profitability front operating margins are improving but we strive for consistent margin expansion before we declare victory.
Turning now to our performance I'll begin with revenue growth.
We remain focused on the same five growth levers that have had our attention all year.
And those are metalworking solutions.
Selling the portfolio.
Digital.
And customer diversification with an emphasis on the public sector.
Today, I'll highlight metalworking selling.
Selling the portfolio and the public sector.
Metalworking remains the cornerstone of our strategy.
We use our expertise to bring productivity and profit improvement to our customers.
These efforts are driving customer satisfaction.
New wins.
And the strong price realization rates that we've been seeing.
A recent example, underscores the power of our metalworking team.
One of our experts recently consulted with a customer who produces machinery for the food processing and consumer goods industries.
He recommended numerous process improvements to both their drilling and milling operations.
Those recommendations reduced cycle times and milling in the customer's milling operations from nearly three minutes.
Down to just 10 seconds per part.
Similar improvements were made in their drilling operation.
Taking cycle times from over two minutes.
Yeah, I want to just 15 seconds.
In total this translated into increased capacity and reduced energy consumption.
You'll think $700000 in annual profit improvement for the customer.
For MSC.
This has resulted in a several fold increase in share of wallet.
In order to bolster our metalworking leadership.
We acquired Ingman Taylor.
Premier metalworking distributor.
Headquartered in Wisconsin after the quarter end.
We have long admired the company.
And are excited about the combination of our two businesses.
England Taylor brings to M. S C. A deep bench of metalworking expertise are.
A great reputation with customers and suppliers.
And a culture that aligns with ours.
CEO , Rick Star will continue running the in England tailored business.
And I'm thrilled to welcome him and the entire team and I see.
Next I'll touch on selling the portfolio.
Which is about cross selling additional product lines.
Most notably our sea parts consumable offering of C. C. S G.
This business is particularly important because it solves a big challenge for our customers.
Through an outsourced via my model.
And at the same time creates high degrees of loyalty and stickiness for M C.
High margin category.
We have sharpened our focus on this business and.
And we're seeing performance improve as a result.
Growth has been pacing ahead of company average with Q3 coming in the mid teens.
We view this as the early stages of our plan and.
And we expect momentum to build.
Finally on the growth front.
I'll update on the public sector.
While sales remained down in the quarter.
I'm encouraged by progress.
During the course of Q3, we completed.
<unk> implementation across the entirety of marine bases for the four P L contract.
We've begun to see revenues build.
And we're on pace with our initial expectations.
Partially as a result of this we.
We saw the public sector and flat during the quarter.
March and April were slightly under 20% negative.
Whereas may flip to growth and.
And we expect double digit growth in our fiscal fourth quarter.
Turning to gross margin.
I remain quite pleased with our performance.
Following a strong output in our fiscal Q2.
Gross margins lifted sequentially, another 40 basis points in Q3.
This is largely the result of the late January price increase.
And supplier rebate upside due to higher purchase volumes.
Realization rates remained strong against the backdrop of severe inflation.
Our value proposition is resonating with customers during these extreme times.
Our customers are plagued with rapid inflation labor shortages and extended lead times.
The need for product availability and potential productivity gains are paramount.
M. A C is delivering on both fronts.
As evidenced by the example, I shared earlier.
I'll also mention that in response to continued supplier cost increases.
We implemented a low single digit price increase towards the end of May.
Finally, I'm, particularly.
Excited by our progress this quarter on operating profit improvement.
Thanks to our mission critical initiative.
And to the efforts of our entire team on expense control and productivity gains.
We reduced adjusted operating expense to sales ratio by 140 basis points.
And hence expand expanded adjusted operating margins by 200 basis points.
These efforts are pushing adjusted ROIC see into the high teens.
We are ahead of schedule with our original 2023 golf.
Turning to the external landscape.
Where you are in interesting times indeed.
On the one hand, there are several yellow or red macro indicators, such as high inflation rising.
Rising interest rates.
And ongoing supply chain shortages and challenges.
On the other hand.
We are experiencing a more encouraging picture.
Order levels backlogs and overall activity remains strong.
Most segments of the industrial economy are still seeing robust demand patterns.
As evidenced by the industrial production index.
That said many of our customers are feeling the effects of extreme inflation in all lines of their income statement, along with the ongoing labor and supply shortages.
Resulting in the need for productivity and process improvement.
Despite supply chain constraints easing gradually we are nowhere near back to a normal environment.
And while all of this continues to put pressure on our customers.
We are not seeing any evidence of an imminent recession.
As suggested by the headlines.
As a result.
We remain in growth mode.
In fact, we expect double digit organic average daily sales growth to continue in fiscal Q4.
As evidenced by our June meeting.
If however, we were to see a change in environment at any point.
We're prepared to adjust quickly.
Through the pandemic, we've become more agile.
And we've improved our ability to course correct.
In addition, our balance sheet remains strong and.
And our cash generation will continue improving leaving.
Leaving us well positioned to capitalize on any opportunities that would emerge.
I'll now turn things over to Kristin.
Thank you Eric.
I'll begin on slide four of our presentation, where you can see key metrics for the fiscal third quarter on a reported basis.
Slide five reflects the adjusted results, which is where I'll focus most of my comments today.
Our third quarter sales were up 10, 7% versus the same quarter last year and came in at 959 million.
Our non safety and non janitorial product lines grew nearly 13%.
And sales of safety and janitorial products improved sequentially.
Looking at growth rates for ourselves by customer type government sales declined nearly 10% due to the difficult janitorial and safety pumps.
The comps have begun to ease and we do expect the government sales to return to growth in Q4.
National account growth was high teens and core customers grew low double digits.
Moving to more technical and solutions oriented business remains an integral part of our mission critical strategy.
Sales to customers with solutions now represent roughly 55% of total company sales.
Within that solutions umbrella, our implant program moved to nearly 10% of total company sales in Q3.
You may recall that our goal was to reach 10% by the end of fiscal 2023.
Progress is accelerating faster than anticipated.
The remaining approximately 45% of company sales solutions customers.
Are made up primarily on our vending and vendor managed inventory channels.
As Eric mentioned, our gross margin third quarter with 42, 9%.
40 basis points sequentially from our second quarter and up 60 basis points from last year's Q3.
Reported operating expenses in the third quarter were $271 million.
Last year's reported operating expenses of $257 million.
Adjusted for acquisition related costs, adjusted operating expenses were $271 million or 28, 3% of net sales.
First last year's adjusted operating expenses of $257 million or 29, 7% of net sales.
This represents a 140 basis point reduction in adjusted Opex to sales year over year.
We incurred approximately $3 3 million of restructuring and other costs in the quarter.
As compared to 1.3 million in the prior year quarter.
Our reported operating margin was 14, 3% compared to 14, 8% in the same period last year.
And you May recall included in last year Q3, operating margin was 28 million impairment loss recovery.
Adjusted for restructuring and acquisition related costs.
As well as the prior year impairment loss recovery adjusted operating margin was 14, 6% as compared to adjusted operating margin of 12, 6%.
A 200 basis point improvement year over year.
And as Eric mentioned earlier that resulted in an adjusted incremental margin for our third quarter of just over 33%.
That puts us at a year to date incremental margin of 24%.
So we feel confident we will exceed our original fiscal 2022 incremental margin goal of 20%.
Reported earnings per share were $1 78.
As compared to $1 68 in the same prior year period.
Adjusted for restructuring and acquisition related costs as well as the prior year's impairment loss recovery adjusted earnings per share were $1 82, as compared to adjusted earnings per share of a dog.
<unk> 42 in the prior year period, an increase of 28%.
This is a result of our execution at all levels.
South performance gross margin and Opex leverage.
Turning to the balance sheet, you can see that as of the end of the fiscal third quarter, we were carrying $680 million of inventory up 22 million from Q2s balance of $658 million.
The inventory build is consistent with our double digit revenue growth.
Ongoing supply chain disruptions and the continuing inflation.
Accounts receivables are also rising with the current cell approach.
As expected we saw sequential improvement in our cash flow conversion or operating cash flow divided by net income.
Q3 cash conversion was 78%.
<unk>, just slightly negative cash conversion last quarter and 22% conversion for last year's Q3.
Our capital expenditures were 14 million in the third quarter.
Moving ahead to slide seven you can see the usage of working capital also impacted our free cash flow, which came in at 64 million for the core current quarter as compared to 3 million in the prior year quarter.
As discussed last quarter, we expect cash conversion to continue improving.
And we remain on track for the full year fiscal 2022 cash conversion to reach approximately 70% to 80%.
Our total debt at the end of the fiscal third quarter was $790 million, reflecting a $45 million decrease from our second quarter.
As for the composition of our debt roughly 56% was floating rate debt and the other 44% with fixed rate debt.
Cash and cash equivalents were 29 million.
Jumping in net debt of 761 million at the end of the quarter.
Down from $794 million at the end of the second quarter.
I will now provide an update on our mission critical productivity calls.
You may recall that our updated cost savings goals for fiscal 2023 is a minimum of 100 million person as our fiscal 2019 cost base.
As you can see on slide eight our accumulative savings through fiscal 2020, one for $60 million and we had invested roughly $22 million over that same period.
In our fiscal third quarter, we achieved additional savings of $4 million and invested another $2 million that brings our year to date savings and investments to $20 million and $13 million respectively.
We fully expect to achieve $25 million in grossing games and reached $15 million of investments for it.
Fiscal 2022.
And we remain on target to hit at least 100 million of gross cost savings by fiscal 'twenty three.
Before I turn it back to Eric Let me share a few comments on our fiscal fourth quarter expectations.
Keep in mind that this fiscal year includes a 50 <unk> week. So there will be an extra five selling days in the quarter.
That extra week of sales is expected to carry a roughly 20% opex to sales ratio.
On an ADR basis, we expect to continue growing at a double digit pace for the quarter.
Sequentially, we anticipate gross margins will likely see the typical seasonal headwind as the benefit of the latest price increase well more or less be offset by a lower rebate accrual and increased purchase costs.
We also expect to continue leveraging our strong growth such that incremental margins well not at the level of our Q3 should still be in the mid twenties.
All of that should get us comfortably into the top tier of our fiscal 2022 annual operating margin framework.
As you can see on slide nine.
Last point on Q4.
The numbers I just referenced are on an organic basis, excluding the impact of England Taylor.
Let me provide some color on EM and Taylor.
With annual sales of roughly 60 million the business will be about 30 basis points time, we'd have to our gross and operating margins in the fourth quarter.
Roughly neutral to EPS in fiscal 'twenty, two and accretive to EPS thereafter.
More importantly is expected to achieve an ROIC above our weighted average cost of capital in the first full year of operations.
One final area I'd like to discuss.
As Eric mentioned and we are all aware.
Many are concerned about the economy.
First let me reiterate that we currently do not see signs of a slowdown.
But if a slowdown were to occur we are well positioned to weather the storm.
Our balance sheet remains strong and as we've shown numerous times historically when the economy slows, we generate strong cash flow and working capital becomes a source of funds.
It's enabled us to strategically invest through the downturn.
In addition through mission critical we have already built momentum removing structural costs from our business.
And plan to continue doing so.
Finally, our growth initiatives are still ramping and should continue to fuel growth above the IP index under any economic scenario.
All of these reasons, we feel well positioned regardless of the environment.
I'll now turn it back to Eric.
Thank you Kristen.
Our company remains firmly in growth in execution mode.
With each passing quarter, we're gaining traction.
We look forward to closing the fiscal year strong.
With double digit top line growth.
Gross margin expansion.
And adjusted incremental margins in the mid twenties.
I want to thank our entire team for their dedication and their hard work.
And we'll now open up the line for questions.
Thank you.
During the question and answer session to ask a question you May Press Star then the one touch tone phone.
If youre using a speakerphone, please pick up a handset before pressing the keys.
Your question. Please press Star then two.
First question comes from Tommy Moll with Stephens. Please go ahead.
Good morning, and thanks for taking my questions.
Hey, Tommy good morning, how are you.
Doing well thanks, I had planned to ask if you had seen any sign of a slowdown in the business, but now having.
Eric and Christian on the record that you're not I will oh, instead of asking a third time I'll I'll go a different direction.
And ask have you seen anything change.
So compared to last quarter, when we had this conversation.
Have any of your end markets gotten better or worse has the tone of conversations with customers changed at all you highlighted Eric somebody I think you referenced inflation fatigue.
Maybe that's a little bit different than it was before but just anything that's changed would be helpful.
Tommy I would say that for the most part most of the factors you just referenced so demand outlook inflation. The shortages the lead times are fairly similar to last quarter.
I think in some ways. The change is that these do these headwinds at our customers and suppliers are feeling continue and I think what that's doing is just sharpening the focus on need for productivity and need for help and our customers. There was a drumbeat for sure about hey, we understand our price increases, they're coming fast and furious from.
And every line of the P&L, we need help offsetting them with productivity.
We need help offsetting the labor shortages were facing which have not abated either.
And there was still despite some of the headlines on our supply chains easing theres still real shortages and lead time delays. So we need products. So I think all of those are playing well into our favor.
Because we can deliver on some of those things for customers, but I think it's it's it's more or less a lot of the same things that are just kind of sharpening this need for the customer.
That's helpful. Thank you.
Following up on mission critical you're ahead of plan currently.
If we if we.
Think this through as it continues to evolve.
Do you do you end up with a more.
Run rate repeatable kind of operating framework I mean mission critical was a very specific plan for a very specific starting point.
But do we evolve into a more repeatable.
Yes.
And in future years, and and if the answer is yes, and you can sketch any of the contours.
Is there a implied incremental.
ZIP code that you end up in you know hypothetically if you have an operating framework and.
Industrial production grows low single digits in a given year is there a rough range for an incremental margin framework might employ.
And I'll break it down to a few parts I think first part of your question on mission critical so we.
We've got a the official start of originally stated mission critical goals ending in fiscal 'twenty three and that's the guidance that we gave back in kind of the beginning of this journey, where we're going to deliver great if not greater than 100 million.
Cost savings so absolutely on track to meet and exceed that target. So you can kind of assume at least 15 million more of savings in 'twenty three kind of bring us across the finish line for the originally stated mission critical balls, but then to your point, it's not really gonna end and twenty-three what mission critical as it ultimately.
[noise] about is kind of changing the culture changing the mindset in the company to generate continuous productivity.
How much productivity I think you kind of asked about how to think about that in the context of a framework I'd say a lot of it has to do with how much. We think we need to offset in terms of what's coming out of from an inflationary perspective and also how much do we want to be able to invest every year. So no specific guidance at this point beyond 'twenty, two we'll give them a little.
More color on our fiscal 'twenty three framework that will come up next quarter and at that point, hopefully, we'll have a little bit more of an understanding of what might be coming at us from a macroeconomic perspective, but generally we feel really well poised for next year. We're on track for all the mission critical targets not just the cost out.
So feel very confident about continuing to grow at least 400 basis points above I T.
We feel very good about delivering the opex savings and we're already on track and ahead of schedule on the ROI see improvement so.
I'm feeling very good about where we are its closeout 'twenty, two and right now feeling feeling optimistic about 23.
Thanks, Christian will stay tuned and I'll turn it back for now.
Thank you and our next question today comes from Ryan Merkel with William Blair. Please go ahead.
Hey, good morning, everyone nice quarter.
Thanks, Ryan good morning.
So my first question was on inflation I'm curious do you think prices are starting to peek here or is that not clear yet.
Ryan.
I'd say not clear yet certainly to date, we continue to see you know we mentioned in the prepared remarks that we took an increase as recently.
Late in May in response to what we're seeing from suppliers.
So you know I would say, we have not yet seen a slowdown in the rate and pace of increases coming from our suppliers. We're trying as you know it was sort of for us the leading indicator and I think that's not that's because disinflation wave is driven beyond just commodities, it's driven by so many other factors you know oil and fuel wage rates and whats going.
There's multiple variables here, so so far no slowdown.
Okay.
Kind of what I thought you'd say and then turning to gross margin how much did price cost helped gross margin in the quarter the increase year Euro 60 bps.
Yeah, so year over year, the way to think about the margin improvement of 60 bps. This attribute about half of that to favorable price offsetting purchase cost inflation than any mix headwind and then about the other half from increased vendor rebates.
Okay. So I'm just trying to get a sense for this year, how much price cost is helping your gross margin.
Could you help us there and should we view that as one time 'cause Cogs will eventually catch up so it might be a little give back because we look out to 'twenty three is that the right framework.
Let me let me take you maybe Q3 to Q4. So you can kind of cap how to think about fiscal 'twenty two.
So if you're if you're thinking about sequential gross margin from Q3 to Q4. The first thing I'd tell you is you've got to account for the seasonal mix headwind that we typically see at this time of year and it has to do with the product mix of summer goods.
About 50 to 60 basis points roughly of headwind from that dynamic.
Then you've got pricing, which we do expect to remain positive and we'll get a little bit of a boost from that small may increase that we took but then you have offsetting that increase purchase cost inflation and a decrease sequentially and vendor rebates.
And so that's kind of the organic Q3 to Q4 changes and then on top of that I would layer in a headwind from England Taylor about 30 basis points approximately.
Okay.
Or did one three I'd say, it's too early right now to guide Brian I mean like Eric just commented, we don't know what's going on with inflation, yet and really of all the variables that we're looking at to understand how fiscal 'twenty three might shake out price cost is definitely one of the biggest one and much of that is contingent on what happens with the timing of the inflation cycle.
Okay, no that all makes sense and I was I was really just trying to get a sense of my feeling is prices helped the business, but not maybe as much as we've seen in the past. So is that the right. It's been sort of a modest boost not not something that was overly impactful to gross margins.
Well I think organically, if you think about being able to improve margins fiscal 'twenty two versus fiscal 'twenty. One we're going a few years now actually with keeping flat or slightly up.
Again and that is a change in trajectory from what we've seen the business do in the last several years and to be able to do that it basically means we're getting enough of a favorable spread from price cost that it offsets that mix headwind that we've kind of been seen in the business steadily over the past several years as some of our growth initiatives, which are.
Margin headwinds as those continue to grow so we're often we're getting enough price cost that it's covering that mix headwind. So in that regard I would say, we do feel really good about the price contribution to the business.
I don't know how far back you'd have to go to really see price, maybe doing better than that I don't know if Eric wants to add any context for that you know kind of Ara before I got here, but you know, we're really pleased with the price cost outcome.
I think the only other thing I'd add Ryan is there. This time around there is look obviously, we're benefiting from a macro environment deflation that's out of our control, but I would say relative to past cycles. There is more work going on in the company to control. Our destiny. So you know we've talked about there's a big pricing initial.
Inside the company to sort of build up the muscle in our sales organization on how to have that discussion with customers and how to sell through price. So that even if in some point inflation is going to slow how do we still make sure. We're extracting value because we are delivering the goods for the customer in terms of productivity and product availability. So.
That's one initiative C. C. S. G. You know we mentioned in the prepared remarks, it's getting amped up focus under Kim and the team in the field.
That is a margin accretive.
The piece of our business that we're starting to see momentum there's focus going on private brands inside the company and end and moving the mix of business. There. So there are things on the self help front.
I think probably more so than I would've said during the past pricing cycle right.
Very helpful. Thank you pass it on.
And our next question today comes from David Manthey of Baird. Please go ahead.
Thank you and good morning, everyone.
I was I was wondering if you could give us some insight into your thinking.
As you're developing the fiscal 'twenty three framework potentially I know, you're not going to give us details, but is the plan regardless of what you see out in the market you'll have a category for sales declines or will you just base the buckets on how youre budgeting and then adjust later if conditions change like you did.
The upside this year.
Yeah, and I should say I think it's hi, Quinn not hide it.
So for sure there is no let's say it stays with us right.
It sounds like you.
Yeah, It's me sorry.
Okay.
My might be that my that'd be that my.
Me and my theory.
So physical placement framework, Dave a couple a couple of thoughts.
We're obviously going to be modeling a lot of scenarios. There's a lot of uncertainty out there right now we talked a little bit about now what happens with the inflationary cycle and price cost being one of the biggest.
Factors that could move the needle for us in 'twenty three but generally we're trying to understand you know what is going to happen with the industrial production index now being representative of what we would say is market growth and then what's our ability to gain share and take price on top of that and so that that's like some of the really big buckets that we're modeling and thinking through.
And we have a lot of momentum heading into 'twenty three that we feel really good about allowing us to capture share regardless of what happens to the market. So we're very focused on controlling our own destiny and delivering that at least 400 basis points of growth above IP, regardless of what the I P index actually does and obviously if we.
Were to head into a down scenario some of our ability to continue expanding margin gets a little bit harder than if we get some favorable IP growth, but generally again very optimistic right now with what we see the momentum in the business and definitely committing to hitting those mission critical goals for 'twenty favorite regardless of the circumstances.
Okay. It sounds like your base the buckets on some outlook for IP and then adjust from there is sort of the view.
Yeah, Yeah, Big building blocks I P. As a benchmark for market. What do we think is going to happen on price cost share gain and then productivity and inflation.
Yep, Okay, great and then.
As it relates to two mission critical in some of these cost savings in a recent general Investor deck. You cited that you still have 26 branch locations and I'm wondering is does that number gravitate to zero over time and if not could you talk about why if so could you talk about the timeframe and then if the.
The savings from those closures is included in your your mission critical targets.
Yeah. So Dave the 26 now we feel pretty good about that number we would imagine that a stay stable I'm. Obviously, we did a lot of big work around the branch restructuring last year, which took out you know many of our branches. The ones that are left behind are really supporting some of the different kind of businesses with NMFC.
And we feel like 26 is the right number so not contemplating any more savings from any kind of material branch restructuring or branch closures.
Perfect Alright, thank you.
And our next question today comes from Chris Dankert.
Capital. Please go ahead.
Hey, good morning, Thanks for taking the question.
Good morning, I wanted to get.
You've mentioned you know there's ongoing you know lead time extension supply chain issues kind of continuing a pace here I guess, how do we translate that for M. S. C kind of what's the fill rate today look like versus you know that you know near 98% level, we were seeing kind of pre pandemic.
Yeah, Chris what I would say is there's definitely still supply chain issues were seeing a difference in our.
It compared to sort of pre COVID-19 fill rates, but the difference for us.
Is very marginal.
Whereas compared to the local distributors, it's it's a really wide gap between pre pandemic and now.
So we actually feel in some ways like on a relative basis. The advantage has grown although yeah. When we look at our fill rate in our service metrics, which you could see the difference we're still not back we're up from where we were at the low as a few quarters ago, but still not back to pre pandemic I will point out one nuance, which is when we look at it a couple of different way.
What we called first pass and second pass. So first pass would be is the product located in the location that is closest to the customer.
And there we see a pretty sizeable difference the second metric would be second pass, which is do we have the item anywhere in our network.
And for that second pass measure the difference is very marginal and this has been the case through COVID-19. So while theres some freight expense to be borne by moving things around we're generally more often than not able to deliver for the customer.
Got it and that's certainly been such an issue with that you know having product on hand in terms of market share conversion. So I'm glad to hear that that kind of continues to recover but we're not quite there yet and it just kind of a point of clarification I didn't see it in the deck implant growth in the quarter I assume that's still kind of a one 9% of total sales were still seeing.
Yeah, you know near 70% growth not that business today.
Is approaching 10% of sales actually this quarter.
Oh perfect Yeah, that's all I had thanks.
So much guys really appreciate the color.
Yeah no problem.
And our next question today comes from.
Whereas Jefferies. Please go ahead.
Hi, This is Hans Hoffman filling in for Hamzah Mazar I know you guys touched on it a bit in your prepared remarks, but could you just talk about what youre seeing in metalworking markets from a growth perspective, and then just maybe talk about some of the competitive dynamics there.
Yeah sure so.
In terms of end markets you know the general comment I would say is where we're seeing pretty much broad based strength across most of the verticals that are metalworking related certainly you can imagine with oil and oil prices being high that area of the business is doing a lot better than it was years ago auto and aero or are certain.
Really on their way back and growing and we still feel like there's plenty of room.
Both of those general machining strong so environment is good and then in terms of competitive dynamic metalworking. Its a lot like the rest of it.
The industrial supplies and the MRO market space, which is that its highly fragmented. So you think about it across this is now beyond metalworking, but across the entire industrial landscape. The top 50 distributors have roughly 30% share.
It would be the metalworking would sort of be an analogue to that and so it's fragmented and there's a lot of market share to be had.
From local and regional distributors that aren't faring quite as well right now.
Okay. That's helpful and I know you guys you know you mentioned.
Taylor acquisition, but could you just talk about your M&A pipeline going forward and if you're seeing any changes to private company valuations and then how you're thinking about capital allocation going forward.
Yeah sure. So on the M&A front I would say in terms of our outlook and you know we've been pretty consistent for a while now which is that are you know.
Typically as it relates to anything really big and really sort of outside of our core business. The bar would have to be really hard that we are focused on our pipeline within our core business here Oh, we have a couple of things that we consider to be at our core.
One change I would call out as it does feel like the pipeline and the degree of conversations are more robust I think there's probably a lot of private owners.
Just thinking about life about the future of the business et cetera. So I think the pipeline is pretty robust again, they would be over the more or less of the smaller variety inside of our core I mean in England tells a great example, it's a great team. It's in a in an MSA, where we'd like to see more penetration.
Been a leading competitor for a long time the values lineup between Rick and M. S City. So a great example of what we would hope to find and continue to build on them.
And in terms of capital allocation look we're sitting now.
Now at about one five times leverage which is a very comfortable place to be particularly as you know Christian had mentioned, we would expect to start to see cash generation really picking up as working capital kind of stabilizes.
So so we think we have plenty of dry powder here.
We're going to stay pretty disciplined you know first priorities for us are organic reinvestment into the business to the extent you know we like what we see in terms of the return prospects of late.
Confidence is really building based on the performance.
Closely close second would be you know the ordinary dividend and then from there. We look at M&A, We will look at return of cash to shareholders I E.
Buyback on a risk adjusted basis, and you know the only other comment I'll make is we are mindful of rising interest rates. So from our standpoint in a high interest rate environment.
Doesn't change anything other than that the hurdle the hurdle rate effectively goes up if we're going to deploy cash.
Got it thanks, I'll turn it back over now.
Thank you and our next question today comes from Ken Newman with Keybanc capital markets. Please go ahead.
Hey, good morning, guys.
Good morning, Ken.
Good morning.
So first question you know Eric I appreciate the comments about the macro uncertainty and in your ability to adjust quickly if the environment changes.
We've talked a little bit about I think there was an earlier question about what structural incremental margins could look like just given all the work you've done in mission critical but I'm also curious if you have a viewpoint on what structural decrementals could look like relative to past the past down cycles.
Yeah, Ken I can take that one so at this point, we're not even modeling a scenario, where we need to worry about decrementals for next year I mean, if things were to really erode before we have the framework for 'twenty three we would provide some guidance on that but right now it's not something that we're even looking at.
But I guess to the point, though you would expect that even in a downturn or an eventual downturn in the cycle you would expect those decrementals to be better than what you experienced in the past right just giving them a structural cost out of the last two or three years.
Yeah, absolutely Yeah, I think that's where we'll really see a benefit from all the mission critical work that's been done over the last couple of years already in terms of structural cost take out.
We're at 85 million roughly at the end of as of the end of this year approximately that will certainly help us and then Eric also mentioned before just a lot of things that we're doing differently inside the business now that aren't going to allow us to weather that storm differently than MFC has in the past. So I think the big one that we're really excited about Eric brought up.
Earlier, but just the work we've been doing around capability development in the field things that benefit our ability to add value of that customer kind of regardless of what the macro environment is that would that would definitely make a down cycle look quite different for us than it has in the past.
Is there any way that you can maybe just provide just a little bit more color as to.
Maybe give us a framework of its decrementals were just making up a number here in the 20% is that more of like a mid teen type of range or is there still kind of doing work on that.
We will give you a look at that next quarter.
Gotcha.
Okay, and then for my follow up here.
I know inflation is still a very real impact of the market today, and obviously you're already putting in some some pricing.
Dressed out here.
I do think we've seen some pullback in raw material costs for some key materials, though like steel and copper.
Any color on how you think about decisions on inventory and you know how do you think about the potential price cost realization when inflation does roll.
So you.
You know I can look at some point.
Inflation, obviously, we track commodities very carefully and well.
That that is part of the buying formula as we look our buyers are tracking commodities and indexes. What I will say is as I mentioned earlier relative to prior cycles. There's other factors beyond just the commodities that are influencing our suppliers raising prices for now you know look at some point no question the music.
It will stop.
And the inflation cycle that that could be next quarter. It could be next year it could be in three years five years.
I have no idea at some point that will stop and certainly price cost will come under more pressure than it is now and I I look I think it's why you know one of the comments, we made earlier, whereas we're focused on initiatives in our control, but even in an environment, where we're not capturing as much in price that we have the.
Ability to offset more pressure on price cost were own initiatives as I mentioned, a few of those earlier.
Understood.
Okay.
At the time.
And our next question comes from Pottebaum and J P. Morgan. Please go ahead.
Good morning, Eric Good morning, Christian Congrats on the strong quarter.
Oh, Hey, good morning, Thank you.
Eric I'm just.
Our first question is on a price.
When you look in the fourth quarter I think you said you put through late May increase I'm, just curious what what do you expect that price contribution to be to sales will be up from the 6% you just.
You put up in the in the third quarter given that increase and then as you look into next year, what's the carryover now based on kind of what you've announced and then I'm. Sorry. This is kind of a little bit of a long question just along those lines as you think about next year.
Is there some bucket of your product offering that you could see pricing move down to.
To that last question if commodities the fleet from here or is.
You know all of that price you put through you considered by you to be kind of sticky such that you wouldn't give any of that back in that scenario sorry for the long question.
So okay. So it looks like an a b C. So let me start with the New York.
It didn't it doesn't go near term how about so near term you first question Pat was about Q4. It looks so you could do the math on and what we show you in the op stats, we give you a sense of price and we always call. It price mix, because it's tough to be coupled with two all the time, but it's in that growth decomposition and in our Q3 I think it was in the five.
5.5% something like that range, you know where does it go for Q4, it's hard to predict precisely because mix does play into it. Yes. It's this is sort of a living organism here and things things change, but that being said all else being equal sure. Yeah. We took so the increase we took in.
Lately with low single digit so it's not like it was huge but yeah. If if realization does what we think it should do.
One would expect the price contribution in Q4 to be all else being equal slightly higher than it was in Q3. That's right. So I think that was the first part of your question. The second part is the carryover I think the way to think about that is we will get.
A part of a year or so for the larger increase we took in January we're going to get that for the first sort of carry over the first part of fiscal 'twenty three.
And then for the late May increase we will get a carryover for roughly three quarters of fiscal 'twenty three and then of course, the other contribution would be any additional price increases that happen, which will be a function of what we see between now and September or quite frankly through the course of fiscal 'twenty three.
I think that was the second one the third one on was about deflation and that's certainly commodities are going to come down I will say, Pat and you never say never right, but if I look back over the course of my history in this industry.
Because the finished goods the parts that we sell the raw materials generally are a relatively small percentage of the finished product we have not really seen cases, where deflation leads to mass price reductions.
Which is to say generally pricing is sticky I think what certainly what happened is if you know prices commodities come down.
The prospect of further price increases goes away.
But it would be.
Unlikely and certainly it would be a break in pattern from the past to see prices in mass comes out.
Understood. That's helpful color. Thanks for accommodating all those questions.
I have one follow up and then this one is on gross margin I.
I guess, what what surprised you in the quarter. It just seemed to me like sales were kind of in line with how you thought they would play out.
You know in the quarter.
So I guess I'm curious why did volume rebates come in.
Is it or maybe you had maybe that was planned to be where it was and I guess, that's the question what what surprised you because you you called out price costs, you called volume rebates, but I feel like the gross margin was better sequentially than you.
You know maybe internally or <unk>.
Maybe externally people thought maybe internally as well I was just curious what surprised you and then.
I think you said at one point recently you saw enough momentum that gross margins could be flat next year I may have that wrong. If I'm wrong. Just tell me you never said that if I'm right I guess I'm just curious is that still the case.
So Pat I can take the first part I sort of start and then I'll turn it over to Christian.
That's good of you know I think what.
Apprised as look I think.
If you go back when we were thinking at the time last quarter. When we were coming off of a strong sequential lift from Q1 to Q2, we felt good about that and we felt like Hey, you know gross margins should be up a little bit from Q2 to Q3, but not a lot.
So I would say you are correct. The 40 bps was a little more probably a little more than we expected.
I'd say two things one is you know look we I had mentioned we have this initiative in the field on pricing to improve realization the results have been quite good.
So I think that's one and then two is yeah look we did.
A heavy amount of purchasing.
That resulted in outsized rebates and to some degree we expected it but we probably did even a little bit better there.
Is the two things I'd call out and then the other point was about.
Twenty-three Christian you want to jump in.
Sure, Yes, I don't believe we've we've commented on that specifically pad I think we're looking at a variety of potential outcomes for.
And next year and obviously the length of the inflation cycle would be a really big driver of the guidance. We would provide for gross margin next year, but I'd say given.
Given what we know of for 23, it would be on a very good outcome. If we were able to hold margins flat, there's certainly a set of conditions under which that could happen but on it.
That would be a really good outcome for us for next year, I would say and we will give some more guidance on some ranges and kind of what would affect that on the margin side. When we head into that outlook for next year, but you were you were you kind of a specifically on gross margins to be clear about that.
Yeah, you got it that's exactly right yeah.
So that's what your answer was in response to your right.
Yes, just checking as I kind of thought it was like I'm not really sure that was the gross margin.
[laughter], great Great and then.
One little modeling one too just on the fourth quarter, you said opex to sales on that extra week is is 20% what do you expect the extra week the curry four absolute sales contribution.
Related to the extra week.
Yeah, just just roughly whatever you whatever you are modeling for Q4 is whatever five five days is worth.
I just thought the easiest way to do it and then just implied 20% opex on that typical gross margins.
Perfect. Thanks, so much I appreciate the time.
No problem thanks for that.
Ladies and gentlemen, this concludes our question and answer session I'd like to turn the conference back over to John Croteau for any closing remarks.
Thank you Rocco before we end the call a quick reminder, that our fiscal 'twenty two fourth quarter earnings date is now set for October 20th 2022.
We plan to attend several investor conferences, and perhaps a few road shows before then so we look forward to seeing you in person thanks for joining us today.
Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.
Yeah.