Q1 2023 MSC Industrial Direct Co Inc Earnings Call
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Okay and welcome to the MSC industrial supply fiscal 2023 first quarter conference call.
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This president of Investor Relations and Treasurer. Please go ahead.
Thank you Allison and good morning to everyone.
The new year as well Erik Gershwin, our Chief Executive Officer, and Christian Actus 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 Web page.
Let me reference our Safe Harbor statement summary of which is on slide two of the accompanying presentation.
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.
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 our other SEC filings.
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 or on our website, which contain the reconciliations of the adjusted financial measures to the most directly comparable GAAP measures.
I'll now turn the call over to Eric.
Thank you John and good morning, everybody and thanks for joining us today I'll start by wishing everyone, a happy new year and I Hope you have a restful and a happy holiday season.
On today's call I'm going to reflect on our first quarter performance.
I'll offer my perspective on the current demand environment.
And update you on our accomplishments against our mission critical initiatives.
Christian will then provide more specifics on the quarter and our reaffirmed fiscal 2023 framework and I'll, then wrap things up what will open up the line for questions.
Before I get into Q1 I'm excited to announce that we produced our first ever ESG report at the start of our fiscal year in November actually you can do this report in the Investor Relations section of MFC direct dotcom.
Our ESG journey has been one of continual improvement.
And we look forward to receiving your feedback as we enhance our reporting each year.
Unrelated front.
We continue to make progress on our D Eni journey.
By adding diversity to our senior management.
Our board of directors.
Most recently, we welcomed rock held per sale as our newest board member.
And she brings with her more than 30 years of supply chain strategy and digital experience.
And we're very happy to have her on board.
This is the latest and what has been a series of moves to infuse, new energy and new excitement in intensity into our company's leadership.
Turning to our performance.
I'm pleased with another strong quarter.
That continues our string of success in the face of uncertain conditions.
Our primary goals for fiscal 2023 are gaining market share expanding.
Expanding adjusted operating margins in.
And improving adjusted return on invested capital or ROIC.
Our fiscal Q1 demonstrated success on all of those dimensions.
Looking beyond the quarter.
Our five growth levers and the productivity momentum that we're seeing.
Set up to continue achieving our mission critical targets.
Our manufacturing centric end market exposure also provides us with strong resiliency in.
In the event of economic softening.
Manufacturing verticals like aerospace are not yet back to pre COVID-19 levels.
And therefore have plenty of room for continued growth.
Additionally, we stand to benefit from re shoring in the future.
As we are just beginning to see the positive impacts from those activities.
In addition to our focus on market share capture and productivity.
We are pivoting our emphasis within category management.
Since Covid began.
Our priorities were securing product availability for our customers.
And staying ahead of the rapid cost inflation that we all experienced.
And I am proud of our team's efforts on both fronts.
Our inventory position allowed us to service customers keep plants running and drive revenue growth.
And thanks to our strong value proposition.
We were able to keep pricing ahead of purchase costs.
And improved gross margins during a challenging time.
Yeah.
As the World now returns to a more normalized state of moderating inflation and stabilizing supply chains.
We are initiating a fresh look at our supplier an assortment strategy.
Our priorities will migrate towards reducing purchase costs.
Streamlining operational efficiencies.
Improving the customer shopping experience.
And channeling more market share to those suppliers, who partner with us.
We will accomplish these objectives through a formalized category line review process that.
That will begin over the next couple of months led.
Led by our new CLO Martina Mcisaac.
It will cycle through our product lines in waves.
Spanning the better part of the next year.
We expect most of the benefits to accrue in fiscal 'twenty, four and beyond with.
With some benefit hitting the latter portion of fiscal 'twenty three.
I'll now turn to the specifics of the quarter.
Results continued to be aided by strong pricing contribution.
Our recent bolt on acquisitions.
And execution of our growth drivers.
We achieved average daily revenue growth of 12, 9% well above the IP index.
We expanded operating margins by 140 basis points over prior year or 100 basis points on an adjusted basis.
Driven by the continuation of our mission critical initiatives.
Which yielded additional savings of $6 million in the quarter.
We remain on track to achieve our goal of at least $100 million of savings by the end of fiscal 'twenty three.
Our mission critical initiatives and efforts of our entire team on cost containment and productivity.
As also boosted our adjusted ROIC see into the high teens.
And now stands at 18, 3%.
We've now already reached our original fiscal 2023 goal and we aim to continue improving that number over time.
Our growth Formula remains anchored in the five priorities that we've discussed as part of mission critical.
Solidify metalworking expand solutions leverage the portfolio strength.
Grow ecommerce and.
And diversified customers and end markets with an emphasis on public sector.
I'll now update you on each one of those.
Our expertise in metalworking remains the cornerstone of our value proposition.
Driven by the depth and breadth of our product portfolio.
Our large network of technical metalworking experts.
And our focus on innovation as a tool to elevate productivity and lower cost for customers.
In many cases, we also help our customers to reduce waste and energy consumption.
Here's a recent example from the aerospace end market.
One of our customers who was a is a fortune 500 company.
It was using a four step drilling process it took them two and a half to three minutes.
Two machine a certain part that goes into an airplane.
After an in depth review by our metalworking experts.
We were able to take that four step process and bring it to one step.
And reduced cycle time from the two and a half to three minutes to just 10 seconds.
We also improve quality, along the way and by the customer's own calculation.
They are now expecting to save over $4 million annually.
Our solutions growth driver is anchored by our vending and implant programs.
Both of which had been fueling market share capture over the past several quarters.
Vending signings remains strong with Q1 signings comparable to Q4.
Vending machine revenues grew in the mid teens and now represent over 15% of total company sales.
Implant signings also remained strong with Q1 again running at a similar pace to Q4.
Implant customer revenues were up over 20% year over year and now represent 12% of total sales up 100 basis points from the prior quarter.
We will continue to push on this growth driver.
And would expect and plan to be at 15% of total sales.
By the second quarter of fiscal 'twenty four.
Sales to customers with our solutions offering now represent 56% of the company's total sales.
Up over 200 basis points from prior year.
Importantly, our solutions capabilities, we're also bringing us into diversified end markets.
With recent wins coming in industry spanning from medical manufacturing packaging and even the hospitality sector.
The third priority is selling the portfolio.
Which is about increasing share of wallet through ancillary products, especially our Ccs business.
Here, we provide an outsourced vendor managed inventory service for.
For the high margin C part consumables.
To keep plants running.
Momentum in this business continues building.
With Q1 <unk> growth in the mid teens.
Our fourth priority is digital.
Which includes all aspects of M. S sees digital engagement with customers suppliers and associates.
John Hill and his team have completed a comprehensive review of our entire digital offering.
And has built a roadmap for our evolution in this space.
For example in e-commerce.
Recent work has focused on improving the customer experience on our website by enhancing product discovery.
And enriching product data.
This investment is producing early returns.
As ecommerce sales grew mid teens in the first quarter.
On an avs basis, we reached 61, 9% as a percent of total company sales up roughly 150 basis points compared to prior year.
Our fifth growth driver is customer diversification through.
Through our public sector business.
Over the past few quarters I've described significant contract wins, such as the four P. L contract, serving the U S Marine space.
Well, we supplemented that win with others at the state and federal level.
And these have helped to produce continued strong growth.
With Q1, a D S coming in over 20%.
And we expect that momentum to continue throughout fiscal 'twenty three.
Each of our five growth levers are not only powering growth, but theyre positioning MSC is a productivity partner to our customers.
Expanding our historic role a spot buy supplier.
In Q4 of fiscal 'twenty, two we expanded our portfolio through two acquisitions and areas that we consider important to our business.
In June we acquired Ingman Taylor.
Our premier metalworking distributor in the Midwest.
It expands our network of technical experts.
We also boast bolstered our OEM fastener distribution business.
Through the acquisition of tower fasteners in August .
Which broadens our end market exposure.
And increases our geographic footprint in.
In the high touch BMI inventory category.
Both businesses are running ahead of their original case in their early days.
We expect both to produce ROIC.
Above our weighted average cost of capital by the end of their first full year of operations.
Christian will discuss our capital allocation priorities in more detail.
But we remain committed to seeking out bolt on acquisitions that fit our strategic financial and cultural filters.
Turning to the external environment.
The picture remains similar to last quarter.
With sentiment readings declining and IP readings moderating.
The majority of our customers are seeing stable order levels demand.
In general activity.
We are hearing no continued talk of softening among a portion of our customers.
More recently, we experienced a higher prevalence of extended holiday shutdowns, along with weather disruptions during the second half of December .
As Kristin will describe.
This resulted in a strong start to the month.
But a slow finish as.
As activity saw a sharper decline than in the last two weeks of prior year.
Zooming out though.
The need for our customers to find productivity tool.
To offset their cost headwinds is as strong as it's ever been.
And this plays nicely into our value proposition.
So we remain focused on delivering that productivity for our customers.
I'm going to now turn things over to Chris.
Thank you Eric and good morning, everyone on slide five of our presentation you can see key metrics for the fiscal first quarter on a reported basis slide six reflects the adjusted results, which will be my primary focus this morning.
Our first quarter sales were up 12, 9% versus the same quarter last year and came in at $957 7 million.
Our first quarter acquisitions represented roughly three percentage points of the growth and FX was a 30 basis point headwind year over year.
Looking at growth rates for average daily sales by customer type public sector sales increased over 22% fueled by fulfillment under our four P. L contract for the U S Marine bases other public sector spending.
National account growth was low teens and core customers grew high single digits.
Our gross margin for the fiscal first quarter with 41, 5%.
Down 10 basis points on a year over year basis, and up 30 basis points organically driven by increased price more than offsetting product cost inflation.
Sequentially gross margin ticked down as expected due to the ongoing realization of previously incurred product cost increases.
The mix impact from our growth drivers along with a small impact from a full quarter with tower fastener than our numbers.
Looking forward, we continue to see new cost increases from our suppliers.
Though not at the fast and furious pace of last year.
As a result, we anticipate taking a small pricing adjustment within the next month.
Our ability to deliver continual cost savings and tangible productivity gains to our customers continues driving solid realization rates.
Reported operating expenses in the first quarter were 280 million versus last year as reported operating expenses of $257 million.
Adjusted operating expenses were also $280 million or 29, 2% of net sales.
Versus last year's adjusted operating expenses of 257 million or 32% of net sales.
Neil did a 100 basis point reduction in adjusted Opex to sales year over year.
Our reported operating margin was 12, 1% compared to 10, 7% in the same period last year.
Adjusted for restructuring and acquisition related costs adjust.
Adjusted operating margin was 12, 3% as compared to adjusted operating margin of 11, 3% last year at 100 basis point improvement year over year.
That resulted in an adjusted incremental margin for our first quarter of approximately 20%.
Reported earnings per share were $1 45 for the quarter as compared to $1 18 in the same prior year period.
Adjusted for restructuring and current year acquisition related costs adjust.
Adjusted earnings per share were $1 48, as compared to adjusted earnings per share of $1 25 in the prior year period, an increase of 18%.
This continues to reflect strong execution at all level sales performance gross profit and operating expenses.
Turning to the balance sheet at the end of the fiscal first quarter, we were carrying $726 million of inventory up $10 million from Q4 balance.
The inventory build is consistent with our double digit revenue growth advantageous year end buys and continuing inflation.
We are targeting an annual cash conversion rate of at least 100% for fiscal 2023, and we are pleased with our performance this quarter, 94%, despite double digit revenue growth and the related receivables growth.
Our capital expenditures were $26 million in the first quarter and included elevated bending installations, new warehouse automation and continued investments in digital.
Our capital spending is frontloaded this year and we currently expect annual Capex spend in the range of $70 million to $80 million in fiscal 2023.
You can see on slide seven our free cash flow is up year over year at $51 million for the current quarter as compared to $43 million in the prior year quarter.
Note that we also spent about $19 million buying back shares during the quarter.
Over 200000 shares at an average purchase price of $79 60.
We currently have $4 5 million shares remaining on our current repurchase authorization.
Our total debt at the end of the fiscal first quarter was $780 million reflect $15 million decrease from the fourth quarter of fiscal 2022.
As for the composition of our debt roughly 55% was floating rate debt and the other 45% with fixed rate debt.
Cash and cash equivalents were $26 million, resulting in net debt of $754 million at the end of the quarter up slightly from 751 million at the end of the fourth quarter.
Our net leverage at the end of the first quarter was one three times in line with our target range of one to two times.
I'd also like to highlight that subsequent to closing our fiscal Q1, we closed on a $300 million receivables facility, which has a committed senior secured revolving trade receivables facility that we will use to reduce our debt and overall funding rate.
It will bring our leverage ratio to just under one time.
Before updating you on our mission critical productivity goals I would like to spend a few minutes to refresh our capital allocation strategy, which you can see on slide eight.
Our top two priorities remain investing into the business and returning capital to shareholders through our ordinary dividend.
From there our next two priorities, our tuck in acquisition and share buybacks at the right valuation levels.
We are prioritizing use of special dividends as we see higher return prospects in other uses of cash.
Let me now update you on our mission critical productivity goals and I'm now on slide nine.
In our fiscal first quarter, we achieved additional gross savings of $6 million and invested another $1 million.
We're targeting our fiscal 2023 goal to be at least $15 million in gross savings.
Warehouse automation remains an area of focus as evidenced by our recent capital investment, we're extending new automation technology throughout our fulfillment centers to strengthen our operations and mitigate the effects of labor inflation.
For the total program to date, we have achieved gross savings of 91 million and we remain on target to hit at least $100 million of gross cost savings by the end of this fiscal year.
Yeah.
Now, let's turn to the fiscal year 2023 guidance, which is shown on slide 10.
We are reaffirming our 2023 guidance as introduced during our fiscal fourth quarter 2022 earnings call last October .
We are estimating average daily sales growth of 5% to 9% and adjusted operating margin between 12, 7% and 13, 3%.
A few reminders as it pertains to our estimates for the year.
Specific to the Avs growth range fiscal 2023 has 252 days six fewer than fiscal 2022.
The full fiscal calendar can be found on our website.
Our engman Taylor and tower fasteners acquisition acquisitions are included in the guidance and add roughly 200 basis points to our <unk> growth for the year.
When we introduced guidance last quarter forecast indicate a softening economic environment, and we factored that into our annual guidance range.
As of now we would characterize the environment and our growth trajectory as temporary and a bit but still solid.
At the gross margin level, we remain on plan.
Fiscal 2023 to be down 40 to 70 basis points versus prior year, which is inclusive of the 30 to 40 basis point acquisition headwind.
As we think about the cadence of our gross margins for the remainder of the year, we expect the back half of the year to be flat to slightly higher than the first half.
This is due to several factors first the realization of product cost increases in our P&L is expected to peak over the next quarter.
Second freight cost should subside beginning in Q3.
Third we have several gross margin initiatives in play whose contribution built in the back half of the year Eric.
Eric mentioned, one which is a new category of line review process, but there are others with a near term time horizon.
On the operating expense line, we expect a slight increase in operating expense as a percentage of sales in Q2, consistent with our typical seasonal pattern with sequential declines thereafter.
Our mission critical productivity efforts will allow us to continue investing in our growth strategy despite ongoing inflation.
Factoring in those assumptions, we expect adjusted operating margin to be in the range of 12, 7% to 13, 3%.
Excluding the 20 basis point benefit of the extra week from fiscal 2022. This would reflect operating margin expansion at nearly all points within our range.
As a reminder, our fiscal 'twenty two fourth quarter acquisitions, dilute operating margins by approximately 20 basis points in fiscal 'twenty three their first full year with us.
While dilutive to operating margins in the first year, both acquisitions are accretive to EPS and on track to achieve an ROIC above our weighted average cost of capital in their first full year of operation.
Holding fiscal 'twenty three that constant with current levels.
We would expect roughly $8 million to $10 million of interest and other expense per quarter and tax rates and slightly under 25%.
Given our expectations for operating cash flow conversion of roughly 100%, we will have flexibility to deploy free cash flow into debt reduction buybacks or accretive acquisitions.
During our last call we introduced our downturn playbook that we haven't already should we experienced significant demand slowdown we.
We have clearly defined triggers for changes in our actual our forecasted revenue and operating profit that initiate a series of actions, we'll take across the business.
This includes everything from pullback on discretionary spending changes in staffing levels and re prioritization of investments.
In addition, our balance sheet remains strong and when the economy slows we generate high levels of cash flow as working capital becomes a source.
This will enable us to pay down debt and are strategically invest through the downturn.
We are not in that mode as of now and well positioned to navigate a change in the environment if required by enacting these levers to control cost.
I'll now turn it back over to Eric.
Thanks Kristen.
We are pleased with our first quarter performance, which is on the heels of a strong fiscal 'twenty two.
And what remains a complex operating environment.
We remain on track to achieve each of our mission critical goals for the end of fiscal 'twenty three.
And we're seeing momentum build quarter over quarter inside of the company.
This is an exciting time for MSC as.
As we position the company as a partner of choice among our customers.
We see a bright future ahead.
And we will continue to reinvest into the business.
Regardless of the macro environment.
We remain squarely focused on what we can control.
Capturing market share grew.
Growing above IP.
And translating that growth into profit expansion.
I'd like to thank our entire team for their hard work and dedication.
And we'll now open up the line for questions.
Thank you.
We will now begin the question and answer session to ask a question you May Press Star and then one on your touch 10 cents.
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At this time legal costs for amendment to assemble our roster.
And our first question today will come from Tommy Moll with Stephens. Please go ahead.
Good morning, and thanks for taking my questions.
Good morning, Tommy.
I wanted to start by.
Circling back on some of the macro commentary that you both offered Eric I took note of your comment about a pronounced slowdown in the second half of December and Kristen I think the key words from from your prepared remarks were the tempering a bit and just in terms of the macro and growth outlook.
I was I was hoping you could give us any more insight you have there in particular, if theres any difference across some of the end markets that would be helpful. Thank you.
Yeah, Tommy sure look I think the headline in terms of the macro is pretty much more of the same in the last quarter, we talked about some pockets of softening.
In line with some of the readings coming down and I think that's what we're still experiencing so we would characterize the environment is very solid look I mean, we're still talking about nice growth levels. Most of our customers are still talking about solid demand and solid order patterns. There are pockets, though and and you know it tends to be the closer to you.
Get to consumer facing industries, the more the more extensive youre going to hear the pockets of softening.
So in general I think we're not seeing anything that suggests like anything falling off a cliff. The words I think Christie referred to are tempering, which would be unappropriate characterization with respect to December in particular from what we could tell the back half of December as an isolated phenomenon, we saw a really strong.
<unk> start sort of put some context on that you know the first couple of weeks the growth rates would have been better than Q1, the back half definitely.
Slowed and we did hear from our sales team that customer.
Customer holiday related shutdowns were more widespread than the last couple of years.
And then throw in weather that disrupted things that week before Christmas so.
It appears to be what we saw back half of the west of December isolated.
Nothing systemic.
Thank you Eric that's helpful.
A follow up I wanted to touch on the pricing environment. It sounds like you've continued to see some supplier price increases I think you said you've got another one of your own plan for next month. So any context, you could give there and then just thinking through how that.
As to your 2023 outlook for Adi So on my math you.
You saw about a 700 basis point contribution this quarter, presumably the range of expected contributions for the year would be significantly lower than that just given the comps.
But if there's any way you could frame what's reasonable for the full year that'd be helpful as well.
Yes, Tommy sure and I'll I'll I'll start out I'll touch on the environment I can give you a little context on our numbers and Christian can fill in anything I missed so in terms of the environment.
It's an interesting time because on the one hand like the whole world is is suffering from inflation fatigue, and you know our customers our suppliers, we're all not immune from that.
At the same time the reality of the situation is that there is still inflation and while it is definitely moderating.
There is still inflation and there's still cost increases as evidenced by the fact that yes, we were still seeing suppliers coming to us with increases and so that that is what drove what I described is going to be a pricing adjustment coming up in the next months. So it's a reality that we all have to deal with you know theres a bit of fatigue, and you know I think the message for us.
Is we're really focused for our customers and making sure we're generating productivity for them, that's going to offset it.
That's how I characterize the macro.
Yes in terms of our numbers and I'm pretty sure. Yeah. This is all sort of baked into what we gave as the guidance range at the start of the year, we did anticipate that we would lap.
The very high pricing of prior year, and that's going to happen during our fiscal second quarter in the next month or so here. So yeah as a percentage of sales pricing contribution will absent some radical change in the environment pricing contribution will come down because of the math of the comps.
I appreciate it and we'll turn it back.
Our next question today will come from Steve Volkmann of Jefferies. Please go ahead.
Great. Good morning, everybody. Thanks, Eric I noted in your prepared comments that you actually said you were starting to see some of the benefits of reassuring poking their head up can you just expand on that a little bit.
Yeah sure, Steve and good morning, I would say very very early so.
We're not so much yet seeing it in our revenue youre not seeing it in our revenues what we are starting to see from our sales team is lists.
Lists of new construction in projects that are going up buildings being put up and so as you can imagine our business development team.
We're all over that it's fairly widespread in terms of geography and in terms of industry type I would say heavy emphasis on manufacturing, obviously, but the tangible evidence now as it's going from talk into.
New construction, so it's a bit early to see it in our numbers, but if we do our jobs right and we get involved with those customers from the ground up that should translate into into the numbers in the coming quarters.
Okay. That's helpful. Thanks, and then maybe Christine question.
I think you've mentioned 20 basis points is the expectation for operating margin dilution from the acquisitions in 'twenty three.
Historically, I guess I'm still tenant who do you guys. Historically as you go out into 'twenty four 'twenty five would you expect.
That too narrow or even reverse in <unk>.
Ultimately you get margin accretion.
Yeah, we would definitely expect it to narrow and it eventually does become on par with the core business. So 24, I don't think youre going to hear much about the noise from those two acquisitions and then as we run our integration playbook. There are a variety of levers, we're pulling that get those businesses on par with the core MSC overall business.
Great. Thanks ill pass it on.
Our next question today will come from David Manthey of Baird. Please go ahead.
Yes, Thank you happy new year everyone.
Good afternoon, Dave.
Yes.
As it relates to deep prioritizing special dividends, if I look back over the past 10 years, it looks like it's well over.
$1 billion.
And how should we think about the reallocation of capital is that higher capex investments in the P&L.
Or is it just more share repurchase to keep you in that one to two leverage range any any details on what you're thinking would be appreciated.
Yeah, Dave sure I'll take this one so I would say this you know over time, we have had a capital allocation framework that began with two top priorities that are sort of <unk> and <unk> and those are reinvestment into the core business to the extent, we see high return projects and right now were pretty bullish there and then two is.
<unk> steady growth in the ordinary dividend and no change there.
I think the change in emphasis you heard from Chris then is on the next two priorities. The next two priorities are going to be share buyback at the right valuation levels.
And tuck in acquisitions, along the lines of what you saw from us in the last quarter, So tuck ins to existing businesses like a metalworking and OEM fastener and I think.
The reason theyre feeling on why the change is just the return prospects, we've always sort of never been wedded to one tactic, it's more been about where we see deploying the next dollar to its best use and I think we feel good about the prospects for the company and when valuation levels are low in the stock that's a good use of capital.
I think you're also hearing from us our confidence growing.
In the tuck in acquisitions based on our track record in the past few years, we feel good about the.
The businesses, we bought and the results that they're producing and so that makes us more bullish on that as well.
Sounds good thank you.
Could you talk about how the benefits of the deal.
The line review will manifest in your results what should we be looking for.
Yeah, Dave So a little early to say, but in general and maybe what I'll do and Kristen you can fill in any missing pieces, just sort of step back and talk a little more about the strategy. The philosophy here and then that will translate into how it yields benefits, but you know as I mentioned in the prepared remarks, Dave if I think about the focus of our category organization for the past really three years now.
Since cold, but it's been two things number one getting product to make sure we have product on the shelves to keep plants running and number two staying ahead of the <unk>.
Crazy cost inflation that we've all been experiencing from our perspective. It was check check really good job by our team on both of those.
The world is beginning to migrate to a new normal now moderating inflation stabilizing supply chain. This becomes the next natural evolution in the story.
So what we're gonna be looking to do is we're going to be looking at our assortment and youre going to not see us deviate from our idea of having a really broad and really deep product assortment that is very important to our customers, but what we are going to do is look for opportunities for efficiencies.
Thank you can expect to see.
The benefits accrue in the form of purchase cost improvements and that could either be the straight price we pay for products that could be in the form of rebates or other adjustments, but that's certainly one area I would expect to see benefits accrue in the form of operational efficiencies to the extent, we see potential to collapse at the fringe.
At the margin collapse, some product lines or suppliers et cetera that they'd be operation or whether that's inventory savings or some opex and productivity improvements through our supply chain that would be another area, where I would expect to see benefit.
Yeah, David the only thing I'd add to that as we contemplated that process when we set the framework or the guidance ranges.
Alluded to some initiatives coming online in the second half are going to change the sequencing of gross margin throughout the year that would be one of those but attacking a lot of different things across price cost and mix as we think about the second half in particular, but all kind of within that original operating margin framework of 12, 7% to 13 three.
That's great. Thank you.
Thanks.
Our next question today will come from Paul Dircks with William Blair. Please go ahead.
Hi, good morning, and thanks for taking my questions.
Hey, Paul.
So first question for me, Eric reflecting on the supply chain environment and the disruptions we've seen over the last couple of years is there a way you can qualify for US how you think that the tight supply chain that we saw.
You did in your share gains over the last couple of years is there a way to parse out how big of an impact your internal initiatives had and taking share.
Paul what I would say look qualitatively qualitatively, what I would say is the past three years.
<unk> created.
A fairly unique opportunity for large well capitalized distributors that were able to I was talking earlier about getting product on the shelf in a tight supply chain environment. A couple of things happened number one obviously scarcity of product so having product becomes paramount.
And then the second thing is obviously tight supply chain means inflation.
And I think the successful distributors those that fared well through this.
Through this crazy period, we're able to stay ahead of that.
And maintain or improve margins through what was a historic time.
And I feel good about our performance on both of those fronts I think as we move forward and things normalize. If the question is okay does that opportunity the share capture opportunity go away you. Our view on it is that like are our north star.
Has become generating productivity for our customers, because particularly wet weather.
In almost any environment you can think of if they are booming if things get slow productivity and productivity could mean costs down or could meaning increasing manufacturing throughput to allow them to get more products into their customer's hands faster that is becoming paramount and thats, where if you're if you listen to each of our five growth levers I tried to get this.
Point of growth they are not just about.
Increasing dollar volume Theyre intended to all serve a purpose that it's all around positioning MSC as a partner to our customers to generate productivity, that's our north star for the next several years.
Got it that's very helpful. I appreciate that.
The other question from me and I appreciate the color you guys gave on the macro environment.
Are you seeing here in early January any bifurcation in the order rates between some of your larger customers and small customers and maybe if not even on order rates and how they're talking about the year ahead, how would you characterize your conversations with each.
Hey, Paul I'll take that one so nothing different than what we've been experiencing for the last few quarters, we're not seeing any deviation there and we do that is kind of one of the things we tend to watch for any early leading indicators. So.
Nothing nothing notable to report there Eric mentioned kind of the macro sentiment pretty consistent we're looking more for pockets of softening end markets at this point, but generally still feeling good about the year solid about our expectations and within that 5% to 9% guidance range.
Got it I appreciate the help thank you.
Youre welcome Thanks, Paul.
And our next question today will come from Patrick Baumann of Jpmorgan. Please go ahead.
Alright, good morning.
Thanks for taking my question.
Okay.
Good.
How are you feeling about current levels of inventory.
And you talked about supply chain pressures and inflation easing just and then as well as some agitation agitation.
Reputation is buying you've done maybe at year end, but you've probably been doing that all along just curious.
How you think about inventories moving forward do you expect some destock now that the situation is kind of normalized around supply chain inflation any color on that.
Yeah sure Pat I can take that one so as you mentioned at the end of your question, yes. The yearend advantageous buys that's pretty typical for US. We're just it's part of the normal playbook that we would run I think more holistically. If you look at inventory obviously the last.
A few years when we've been in this constrained supply chain environment, we've been flexing the balance sheet and certainly not skimping on inventory is that's been a way that we've been able to support our customers.
Uniquely relative to the local distributors in that time period, but going forward, we're definitely taking a closer look at inventory and we're kind of monitoring levels looking at where it makes sense to adjust things given the environment, but certainly not doing anything that would compromise our ability to support the customer and to support our continued growth.
Based on your standing outlook for Eds growth I mean, what do you do you think current levels of inventory are appropriate or do you think your overstocked or little bit under stocked.
Would you.
I wouldn't say, we're overstocked anywhere and there's definitely been some differences in how we've been seeing kind of inventory levels in certain different product categories.
Like if we think about kind of metalworking inventory versus MRO, but I wouldn't give you a specific range at this point, but I definitely say if you've got if you think about that 100% operating cash flow conversion, there's sort of a range of inventory contemplated within that that we felt confident in.
I'll follow up after the call on that.
Pat maybe another color I'd add on inventory is there is times when you you've followed us for a little while here like when we go into a different mode right now we're still in growth mode and in growth mode. Even if things are moderating whatever the growth percentages were still in growth mode and that means.
Keeping inventory on the shelves for customers.
If there comes a point at some point there'll be there'll be a point at which things change and we go into a different mode and that's a lever we can turn pretty quickly as part of a downturn playback.
We're not there though.
Understood.
Then on next.
Next question is on Opex.
Can you just help me understand the year over year moving parts. I mean, you went from $257 million of Opex in last year's first quarter to $2 80. This year I think acquisitions, maybe add a little bit.
Did you have some gross savings.
6 million like I think you talked about 1 million of investments.
It just seems like a pretty big increase I'm guessing a lot of that is inflation related but any any color on the key moving parts in that year over year dollar number.
It would be helpful.
Yes, sure Pat So few things on the big drivers on a year over year basis, Youre right inflation, absolutely one of the biggest buckets. There that was around around $9 million. We did also have an increase through having those two acquisitions <unk> in towers in the numbers for the first full quarter that was around six.
Year over year, we're still seeing kind of T&D normalized for our associates as we get kind of back to normal on how we've been out in the field that was a couple million dollars of pressure little bit of noise on the variable Opex and then you've got some some things in there around higher DNA.
Some of the investments carrying over from the prior year and then to your point, you've got you've got $5 million in that mission critical savings.
And then 280 like as you think about it.
Moving forward is for the rest of the year or is that kind of how.
How should I think about that absolute dollar number in the second quarter and the balance of the year I guess I am thinking in context of pricing contributions that are probably monitoring would you expect kind of I would expect year over year to moderate on the opex growth as well as that is that the right assumption yeah.
Yes, the second quarter on a dollar basis, probably down a little bit but on a rate basis, it'll still be up a tad from Q from Q1.
And then going forward in Q3, and Q4 kind of given some of the dynamics that you described I think 280 low <unk> is probably a pretty.
Pretty reasonable probably probably range for probably a good range for Q3, and I would say ticking down.
Even a bit there from Q4, the opex rate following Q2 will sequentially decline.
Okay I appreciate the color. Thanks.
Yeah.
Our last question will come from Ken Newman of Keybanc capital markets. Please go ahead.
Hey, good morning, guys.
Good morning, good morning, Ken.
Good morning.
Maybe I'll just dig into the metalworking demand.
Obviously, you talked a little bit about activity being relatively stable within your industrial side of your business, but obviously the GBA has kind of been the metalworking index has kind of been a contraction now for seven months.
Curious have you seen any weakness within that portion of your business and.
How do you view that part of.
The portfolio going forward.
Yes, Ken No question look you look at the MDI you look at the PMI the sentiment indices are dropping considerably.
I would say inside of inside of the company I would characterize metalworking as the <unk>.
Microcosm of what I characterized for the for the overall customer base, which is.
Moderating and certainly some pockets of softening, but not dropping like a rock and not dropping as the indices would suggest I think part of the story, Ken is where a lot of.
If you take some of the end markets that drive metalworking consumption. Many of them several of them had been really beat up during COVID-19 and so they still have room to grow so I mentioned aerospace being one another that drives metalworking consumption through the economy oil and gas.
With oil prices being high activity levels are up so that's sort of booing thing. So I mean, nothing really to speak of out of the ordinary or out of what we've described for the total company as it relates to metalworking.
Okay.
Are you concerned at all about potential lag impact of the of that sentiment index or.
Has there been enough structural changes do you think that you can help to offset that because obviously you've outperformed in the last six months relative to that sentiment index.
Yeah look Ken I mean, I wouldn't say concern we were watching it and if you go back and you run a historic patterns.
Typically there's a pretty good correlation with.
The sentiment it looks like the M. B I N. Our revenues, but really look really that's why you saw when we gave the annual guidance of five to nine that's down considerably from where we were running in Q1 and part of that was there was a little bit of comps in there from the pricing that we talked about and then part of that is contemplating some further softening.
So we think it is going to happen.
So do we watch it absolutely are we are we modeling and planning, yes, do we worry about it.
No because from our standpoint, we can make strides almost no matter what happens in terms of capturing share from local distributors. So.
Yes, that's our assessment.
Got it.
And then my last question is probably more for Christian but.
You mentioned some warehouse automation investments towards the end of your prepared remarks, I'm curious if you could just give a little bit more color of what exactly that entails and maybe the timing of the benefits that you expect to see out of those.
Yeah sure. So we obviously have a lot of automation in the warehouses today, we're looking at kind of extending that further modernizing some thing generally in response to a lot of the pressure that we've seen around labor inflation recently, but certainly always just looking for opportunities to be more efficient and provide better service levels to the customer in terms of when the benefits come on.
In line for those Ken I'd say, it's really not materially until 'twenty for some of those are definitely longer term investments.
But when we think about kind of like the ongoing opportunities around mission critical and what that looks like post 'twenty. Three this would be kind of one of the big rock projects that start to kick up again that deliver savings in operating expenses going forward.
And I apologize if I missed it but did you did you did.
Could you specify how much those investments are.
I did not know.
Okay.
Thanks for the color.
Thank you thanks, Ken.
And at this time, we will conclude our question and answer session I'd like to turn the conference back over to John Corona for any closing remarks.
Thank you Allison as a quick reminder, our fiscal 'twenty three second quarter earnings date is now set for April 4th 2023.
And we will be attending at least one investor conference over the next few months as well as conducting several roadshows. So we look forward to seeing you in person. Thank you for joining us today.
Yes.
The conference has now concluded we thank you for attending today's presentation. You may now disconnect your lines.