Q4 2023 MSC Industrial Direct Co Inc Earnings Call
Yes.
Good day and welcome to the MSC industrial supply fiscal 2023 fourth quarter and full year conference call.
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I would now like to turn the conference over to Ryan Mills head of Investor Relations. Please go ahead. Thank.
During today's call, we will refer to various financial and management that data and 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, a summary of which is on slide two of the accompanying presentation or comments on this call as well as the supplemental information we're providing on the website contain forward looking statements within the meeting 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 Ryan good morning, everyone and thanks for joining us today.
On today's call I'll reflect on where we are by recapping our fiscal 2023 performance.
And our three year mission critical achievements.
I'll, then pivot to where we're going.
By outlining the next chapter of MFC is mission critical playbook.
Finally.
I'll provide color on the current environment and outlook.
Christian will then provide more specifics on our fiscal fourth quarter financial performance and our initial expectations for fiscal 2024.
I'll wrap things up and we'll open up the line for questions.
Before I dig into our annual performance.
I'd like to thank our shareholders for their continued support.
Earlier this month, we announced the completion of our share reclassification agreement.
And elimination of our dual class share structure.
This was voted heavily in favor of by our shareholders.
And makes M S T shares a more attractive investment.
As it broadens our scope of potential investors.
Enhances our corporate governance practices by limiting the Jacobson and Gershwin families voting power to 15% of shares outstanding.
Transitions us to a majority standard.
Any election of directors that is not a contested election.
And replaces the two thirds voting rule for.
For certain significant transactions.
With a simple majority voting standard.
Additionally.
We'll add another independent board member with the selection.
<unk> process getting underway in short order.
Lastly.
It remains our intention to offset dilution from the transaction.
And Christian will discuss that later on in more detail.
I'll now move on to our recent results.
As you can see on slide four.
We continued the trend of meaningfully outpacing the IP index in our fiscal fourth quarter.
Average daily sales improved nine 3% year over year.
Compared to flat growth for the IP index.
Zooming out in the quarter.
And looking at our fiscal year 2023 on slide five.
We achieved average daily sales growth of 11, 2%.
Which was over 1000 basis points above the IP index.
As a result, we achieved a nice milestone.
With annual sales exceeding $4 billion.
For the first time in company history.
Moving to profitability for the fiscal year.
Our gross margin of 41%.
It was down 120 basis points year over year.
Largely driven by headwinds related to customer mix and acquisitions.
In particular, the outsized effect of the large public sector purchases.
However, due to strong operating expense leverage.
Our operating margin was 12, 1%.
And 12, 6% on an adjusted basis.
Which was only a decline of 60 basis points, and 30 basis points, respectively year over year.
I'll now spend a few minutes on slide six.
Illustrating our successful execution of.
The mission critical priorities.
As many of you recall.
Our mission critical program was based on five growth initiatives.
And here, we showcase our performance across each.
On a three year compound annual growth rate or CAGR basis.
One.
Solidifying metalworking.
Metalworking related sales produced a three year CAGR of roughly 9%.
And beyond the numbers.
We strengthened our metalworking position.
By adding new technologies and capabilities.
She is M. S E mail backs and tool we grinding services.
Two.
Leverage portfolio strengths or what I, commonly referred to as selling the portfolio.
Which focused on increasing share of wallet.
Through adjacent product categories.
This includes class C consumable product sales.
Which improved roughly 9% on a three year CAGR.
Of note class C consumable product momentum continued in our fiscal Q4.
As we sustained our recent double digit growth trend.
Three expand.
Solutions.
Which was primarily geared towards vending and implants.
Our vending installed base has grown 10% over a three year CAGR.
While implant sales.
The strong three year CAGR of roughly 35%.
As a reminder, we achieved record quarterly implant signings during our fiscal third quarter.
And maintained a strong signing rate in the fourth quarter.
Looking forward, we expect strong signings to remain a trend across both solutions.
For digital.
With a particular focus on e-commerce.
E Commerce sales improved roughly 9% on a three year CAGR.
And we see plenty of room for continued improvement.
Which I'll touch on in a moment.
Five.
Diversified customers and end markets.
With a particular focus on the public sector.
Public sector sales grew at roughly 7% CAGR.
Despite a high starting point in fiscal 'twenty due.
Due to COVID-19, driven demand.
And over 20%.
Even without the public sector large orders that occurred in the prior two quarters.
Execution of our growth initiatives enabled us to meet or exceed all of our long term targets associated with the program.
Which can be found on slide seven.
This includes compound as average daily sales growth of seven 7% over the three year period.
Which was over 500 basis points above the IPD index.
And ahead of our 400 basis point target.
And this growth drove strong returns.
Allowing us to meet our goal of a high teens return on invested capital.
Fiscal 'twenty three Rois C <unk>.
Came in at 18, 6%.
Progress was driven by greater than $100 million in cost savings.
Also exceeding our target.
And helped to produce a 220 basis point reduction in adjusted operating expense as a percentage of sales.
Over the three year period.
I'm pleased with the execution of our mission critical program.
And I'd like to thank all of our 7000 plus associates for their efforts.
However, we're.
We're not stopping here.
And we're not satisfied.
We aspire to continuously improve.
And if you take MFC to new Heights.
So with that let's move on to slide eight for <unk>.
Look at the direction, we're heading.
The next chapter in our mission critical journey.
Anchored in three pillars, which I'll now describe in more detail.
Our first pillar.
Beat to maintain momentum on the five existing growth drivers that I just described.
And this includes maximizing the impact of our large account program.
Over the past three years, we've built up a significant backlog of large account signings.
<unk> meaningful implant agreements in fiscal 'twenty three.
Yelling these new wins to their full potential run rate rep.
It represents significant latent revenue growth.
Our second pillar will.
We will be to add a couple of significant and new elements to our growth equation to further our performance.
First we will reenergize core customer growth.
Over the past three years.
Most of our growth initiatives, we're focused on larger customers through penetration of high touch services.
In other words.
We outperformed our growth over IP target.
Without generating outperformance from the largest part of our customer base.
Our core customer.
Our next mission trip mission critical chapter.
Calls for an acceleration in growth of the core customer.
And we're making several critical investments in order to make this happen.
We're improving pricing effectiveness.
Upgrading our ecommerce platform and product discovery functions.
And we're investing an AI based digital capabilities to improve our marketing effectiveness.
Not only do we think this effort will improve our growth formula.
But that it will also serve as a margin tailwind.
Our core customers are associated with gross margins that are higher than company average.
Second we.
We will increase our focus on OEM fasteners.
We have two strong businesses now in a I S empower fasteners.
That form a solid foundation to build from.
We have a cross selling blueprint that was developed and proven out with C. C. S. G.
And so we will take that blueprint.
And apply it to the OEM fastener space.
And they'll OEM sales are currently well under 5% of company revenues.
We see significant potential to scale the business.
We will begin implementing our proven process throughout fiscal 'twenty four.
And expect to see the benefits accrue in fiscal 'twenty five and beyond.
Our third pillar.
Will be to drive productivity improvements.
That continued reducing operating expenses as a percentage of sales.
And increasing ROI see.
During the past three years.
We built momentum by developing a productivity mindset across the company.
We reduced adjusted operating expense to sales ratio by over 200 basis points.
By capitalizing on low hanging fruit.
And making some bold moves such as reshaping our branch footprint.
We see plenty of room for further improvement.
And so our third pillar of the next chapter of mission critical incorporates several new initiatives to accomplish these improvements.
We will leverage investments in advanced analytics to.
To improve supply chain performance in areas, such as freight efficiency network performance and more.
We will build on recent momentum with category of line reviews.
And continuously optimize product and supplier portfolios.
And manage mix to improve profitability.
And we will attack, our order to cash and procure to pay processes.
In a way that we've not done before.
We will upgrade our digital core systems.
And reengineer, our order to cash and procure to pay value streams.
In order to unlock productivity in both operating expenses.
And in working capital such as inventory and accounts receivable.
Looking beyond fiscal 'twenty four.
We see an exciting setup unfolding.
As we leverage these new initiatives.
We target 400 basis points or more of growth above the IP index.
And 20% incremental margins over the cycle.
This yields a clear path to achieve adjusted operating margins in the mid teens.
And ROIC C in the 20% range over the longer term.
I'll now turn to the more immediate.
And discuss the current macro environment and near term trends.
On our last earnings call I.
I describe the tone on the ground is one of leveling.
Which was largely the case to our fiscal fourth quarter.
However, we experienced a deceleration in our average daily sales in September.
A portion of this was expected as the public sector capital purchases wound down at the end of our Q4, so no surprise there.
However, the sequential step down well beyond this and.
Was indicative of further softening.
The softening trend is also not surprising given IP readings sentiment survey results and macro news.
As companies and consumers deal with the effects of sustained higher interest rates and recessionary fears.
However.
Conversations with our sales team suggests that we were more acutely impacted in September and October.
By the extended reach of the UAW strikes.
While we have some direct exposure.
This headwind is magnified when accounting for our indirect exposure, including job shops and machine shops.
Many of whom service the auto industry.
We have since received a steady flow of reports of customers clamping down on spend.
And taking temporary breaks from production.
We see this evidenced in a sequential step down of our sales into auto related end markets in early Q1.
It is considerably larger than what happened in the rest of our business.
This led to September average daily sales growing one 3% over prior year.
One 8% on a sequential basis.
Looking to October.
The reach of the automotive strikes has widened.
And as a result with roughly halfway through our fiscal month.
We're estimating October net sales to be up 1% to 2% over prior year.
Which implies flat sequential performance from September levels.
We estimate the impact of the UAW strike on September and October average daily sales to be in the low single digit range.
And while we expect these challenges to continue throughout our fiscal first quarter.
These headwinds are temporary.
In fact.
History tells us that during times of extended softness with customers.
There's often a bounce back to some degree when normal conditions restore.
In the meantime.
It presents an opportunity for us to take market share from the local distributors, who make up the majority of our market.
Before I turn things to Kristen I'd.
I'd like to acknowledge the efforts of our entire team.
During our first medical mission critical chapter.
We sharpened our focus.
Increase the intensity inside of the company.
<unk> improved our agility.
All of those are on display right now.
We came out of the gates in fiscal 'twenty, four with lower revenue growth than we would like.
But I've been pleased with how the team has rallied in response.
We are moving aggressively to capture market share and we believe will allow us to power through a softer environment.
For instance in the month of September.
Vending signings were up 57% over prior year.
N V M I signings, which are largely attributable to our class C business were up 25%.
Implant signings also maintained recent momentum.
All of this bodes well for future growth prospects as the signings gets stood up.
With respect to profitability.
We've taken several gross margin initiatives that were already in flight and look to accelerate near term returns.
These include discounting disciplines, and our focus on moving product mix to our most profitable supplier partners.
On the expense front, we've moved swiftly to reduce discretionary spending and moderate head count.
We're also embedding a continuous improvement mindset across the company.
Such that all 7000 plus of our associates are empowered to identify.
And act on productivity improvements.
All of these actions will strengthen our ability to navigate.
Through the previously discussed environment.
And drive profitable growth.
I'll now turn things over to Kristin.
Thank you, Eric and good morning, everyone.
Please turn to slide nine where you can see key metrics for the fiscal fourth quarter on both a reported and adjusted basis.
Before I dive into our results for the quarter public sector growth was again, particularly strong this quarter.
This was partially due to greater than expected small capital purchase orders from the contract win discussed during our third quarter call that fall below normal public sector margins.
Digging into the details of our fourth quarter performance momentum across growth initiatives resulted in continued share gains and strong cash generation.
Fiscal fourth quarter sales of 1.35 billion improved 1.3% year over year.
Our year over year improvement was driven by continued volume growth.
More modest pricing benefits as we lap prior year actions and a 150 basis point benefit from acquisitions.
Partially offset by five fewer selling days.
On an average daily basis, we experienced year over year growth of nine 3% and outpaced to the industrial production index by approximately 900 basis points, continuing the trend of significant above market growth.
By customer type on a year over year average daily sales basis public sector sales increased over 60%, while national accounts and core customers improved mid single digits and low single digits respectively.
Looking at our sales through the lens of our mission critical growth drivers, we continued making strong progress.
And metalworking, we continued seeing growth driven by our ability to provide customers outside savings and value through our best in class technical expertise product breadth and service levels.
These competitive differentiators combined with our 150, plus metalworking experts places at the spend all with customers and has us well positioned to further penetrate high growth end markets and address customer needs associated with the skilled labor shortage in North American manufacturing.
Within our vending and implant offerings, we continued capturing share and experiencing favorable levels of growth.
And then Dean Q4 average daily sales improved slightly more than 9% year over year and represented roughly 16% of total company net sales in line with the prior year.
Implant signings remained strong at a rate modestly below last quarter's high watermark and sales improved approximately 13% year over year.
As a percentage of total company net sales in plant revenue represented 13% an improvement of roughly 110 basis points year over year.
It's worth noting that both of these solutions would have accounted for a higher portion of total company net sales, excluding the outsized public sector growth.
In ecommerce, we experienced mid single digit growth year over year sequentially.
Sequentially related sales improved slightly to 61% of total company revenue that was down year over year, largely due to the outsized public sector growth that transact through different channels.
Looking forward, we expect improvement in our e-commerce sales, particularly through MSE direct dotcom as we start rolling out enhanced capabilities, including improved search and navigation functions.
Across our other key initiatives, we continued making strong progress.
And selling the portfolio to increase share of wallet.
Which is primarily our class C consumables ETF growth was in the low teens.
Progress on our diversification initiatives also continued with public sector growth in excess of 60% representing 13% of sales, which is an improvement of 500 basis points year over year, it's worth mentioning that even excluding the small capital purchases public sector growth was north of 20%.
Lastly, and as Eric mentioned, we successfully completed the first chapter of our mission critical program. However, we expect to maintain this momentum in fiscal 2024 and beyond.
Looking ahead this will help us mitigate impacts from the temporary market challenges. We currently face that I'll speak to later on.
Moving onto profitability for the quarter, our gross margin of 45% was down 140 basis points year over year.
The year over year decline was largely driven by a 130 basis point mix headwind, primarily due to the specific products sold in association with the previously discussed public sector contract win which was below typical public sector margins.
Looking forward, we don't expect these lower margin sales to have a meaningful impact in fiscal 'twenty four.
As expected price cost with a larger drag on margin this quarter.
Driven by the combination of more modest pricing benefits and higher cost inventory working through the P&L.
However, this was completely offset by combined benefits of other items, such as rebates and other cost of goods sold adjustments.
Reported operating expenses in the quarter were approximately 299 million and up 9 million year over year.
On an adjusted basis operating expenses were approximately 289 million.
Slight decrease of half a million dollars.
This represents a decline in adjusted operating expense as a percentage of revenue at 40 basis points year over year to 27, 9% of sales.
The reduction in adjusted operating expense was primarily due to one less selling week of year over year.
Excluding the difference in business days adjusted operating expenses would have increased year over year.
This increase was primarily driven by variable selling expenses tied to higher volume.
Labor costs digital investment and increased health care costs, which remain at the elevated level, we experienced in fiscal Q3.
This was partially offset by lower freight expense as well as mission critical savings of approximately 3 million, bringing total programming savings 202 million slightly above our stated three year target.
Reported operating margin was 11, 4% compared to 14, 1% in the prior year period.
On an adjusted basis operating margin of 12, 6% was in line with expectations and declined 100 basis points compared to the prior year.
The year over year decline was primarily driven by the 140 basis point reduction in gross margins with a partial offset from the 40 basis point improvement in adjusted operating expenses as a percent of sales.
We reported GAAP earnings per share of $1 56, compared to $1 86 in the prior year period.
On an adjusted basis EPS was $1 64 versus $1 79 in the prior year.
Turning to slide 10 to review, our balance sheet and cash flow performance we continue.
To maintain a healthy balance sheet with net debt of approximately 404 million representing 0.72 times EBITDA.
We have a strong liquidity position with $50 million of cash on hand, and approximately 550 million currently available on our revolving credit facility.
Looking forward, our balance sheet strength and cash flow generation strongly support both our capital allocation strategy and near term intention to offset dilution from the share reclassification, which I will speak to momentarily.
Additionally, we had strong operating cash flow generation during the quarter of 152% and 204% for the full year, well above our greater than 100% target.
Capital expenditures totaled $28 million during the quarter and approximately $92 million for the full year.
Together this resulted in strong free cash flow generation of approximately $607 million for the full year.
An increase of over $420 million year over year.
Moving to our capital allocation priorities on slide 11, our decision to de prioritize special dividends create significant room for strategic Optionality.
Looking forward this will likely be geared towards organic investment bolt on M&A opportunities and further deployment to shareholders.
As it relates to the ordinary dividend, we will target modest and consistent increases.
And by the recent 5% increase.
As I previously mentioned share repurchases will remain in the pecking order of our capital allocation strategy.
Given our intention to offset dilution from the share reclassification, we detailed our expectations for buybacks in fiscal 'twenty four for modeling purposes on slide 12.
The dilution of shares from the reclassification was approximately $1 9 million.
We repurchased approximately 645000 shares during the fourth quarter.
And an additional 205000 in the current quarter as of October 13, leaving approximately 1.1 million shares remaining to fully offset dilution.
As a reminder, we expect to repurchase the remaining shares by fiscal 'twenty for year end.
Looking forward after completing this buyback initiative, we will have approximately two 4 million shares remaining on our current authorization.
And at a minimum we will look to offset annual stock based compensation dilution.
Now moving to our initial fiscal 2020 for outlook on slide 13.
We expect average daily sales to improve approximately 2.5% at the midpoint with a range of flat to up 5%.
This includes an approximately 160 basis point year over year headwind from non repeating public sector sales.
Underlying assumptions within our sales outlook include more normalized pricing benefits year over year.
As it relates to the current market challenges our outlook assumes the IP index remains roughly flat consistent with recent readings.
And that headwinds related to the UAW strike will begin to alleviate in early fiscal two Q4 before calendar year end.
Lastly, as a reminder, we have the same amount of business days year over year throughout the fiscal year.
Within this sales outlook, we expect adjusted operating margins to be in the range of 12 to 12, 8% or down 62 up 20 basis points year over year.
This reflects lower volume and more challenging price cost expectations in the first half of the fiscal year.
However for the full year, we expect to offset a good portion of these negative factors do category line review savings.
Their gross margin countermeasures and a roughly 50 basis point gross margin mixed benefit from non repeating public sector sales.
Combined effect of these items are expected to result in gross margin for the full year being flat to slightly down year over year.
Depreciation and amortization costs are expected to fall in the range of $85 million to $95 million with the increase representing a margin headwind of 30 to 50 basis points year over year.
This largely reflects the investments made in technology and digital capabilities as well as continued growth in bending.
Other underlying assumptions include in interest and other expense of $40 million to $50 million.
<unk>, including implementation costs for cloud computing arrangements.
$120 million to $130 million and.
And a tax rate between 25 and 25, 5%.
Additionally, we expect strong operating cash flow generation to continue in fiscal 2024 and to be greater than 125% of net income.
I will now provide some additional detail on our expectations for the first quarter and quarterly cadence throughout the fiscal year.
With respect to revenues on a sequential basis, we historically experienced low single digit improvements in our <unk> Etfs right compared to for Q, which isn't expected to be the case in fiscal 'twenty. Four. This is primarily due to the previously discussed market challenges as well as an approximately $30 million headwind related to non repeating pub.
Look sector small capital purchases.
As a result of these factors, we expect average daily sales in the first quarter to be down sequentially in the low single digit range and up slightly year over year.
Looking beyond the first quarter, we expect to slightly outpace historical sequential patterns into Q with stronger sequential performance in the second half.
Under this scenario, we assume the previously discussed market challenges begin alleviating in early Q O Q.
With respect to gross margin, we expect the first quarter to tick up sequentially because of the removal of the public sector large order noise.
That said the first and second fiscal quarters are likely our most challenging due to negative price cost.
As we move through the year that gap should ease due to the cycling of our inventory and the benefits of category line reviews and other gross margin countermeasures.
Finally, with respect to operating expenses Q1 will see a sequential step up in DNA and incentive compensation expense.
That sequential step up will not repeat itself to nearly the same degree in the following quarters of fiscal 'twenty four.
Additionally, our profitability as the year progresses will be supported by the Swift actions, Eric previously outlined in response to the soft start to the fiscal year.
This will come in the form of clamping down on discretionary spending.
A hard look at key expense areas like freight and other productivity initiatives and executing on several gross margin actions, including the category line reviews.
With that I will turn the call back over to Eric for closing remarks before we open the line for Q&A.
Thank you Kristen.
Fiscal 'twenty three was a monumental year for MSC.
As we strengthened our corporate governance.
Successfully closed the first chapter of our mission critical journey.
And surpassed $4 billion in annual sales for the first time in company history.
I'd like to thank our entire team for their hard work in making this possible.
Looking ahead, we will leverage the muscle memory game from the past three years to further strengthen <unk> performance.
Regardless of the macro environment as we enter fiscal 'twenty four.
We will remain focused on harnessing our momentum.
Adding new levers of growth and productivity initiatives.
And executing what is in our control.
Thank you again to our entire team.
And we'll now open up the line for questions.
Thank you we will now begin the question and answer session.
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Today's first question comes from David Manthey with Baird. Please go ahead.
Yeah.
Good morning, everyone.
Yeah, Thanks for that.
Color on margin progression as we look year to year, but I'm, hoping you can bridge us a little more clearly from fiscal 'twenty three to 24 gross margin, we're starting at 41 even.
You said 50 basis points due to the non repeating public sector contract win.
The last time, you did a line review something like 50 basis points. So I'm thinking you probably are getting a 100 basis points of good guys. In there on the gross margin what are the 100 or more basis points of offset that lead you to believe gross margin will be flat to down next year.
Yeah, you've got the the tailwind on the Purifiers right, Dave that's definitely one.
Piece of it and then the second thing I'd point out on the category of line reviews I'm not sure I'd go quite as high as the range that you gave.
But there is a reasonable expectation of course that is helping to offset some of the price cost headwind that we've been experiencing and will continue to experience. So if you're starting at 45 lets just say you build that up to 41 as a kind of revised starting point for simplicity.
I think then you could expect a let's just say somewhere between maybe 50 to 70 on the category line review benefit and then your headwind would be in your price cost spread.
And that would get you back down to roughly flattish now where we're at we alluded to kind of the countermeasures in the script that Eric was talking to so obviously theres a lot of things we're doing within gross margin. Both in terms of transactional price cost, but also trying to affect other things in the kind of the other cost of goods sold accounts.
The of countermeasures, but that's that's kind of the color I'd give you on kind of simple building blocks to get back to that roughly flattish guidance on the G M right.
Shouldn't the Youre starting from 45, but shouldn't we start from 41.0, if we're adding back the 50 basis points for the government business. Yeah. Yeah. That's right. Yeah. So go from 40 45, then put back on 50 bps for the government business. So that would take you to 41.
Point out and then depending on how you want to assume category line reviews go I think we've communicated that we would hope to do at least as good as in prior reviews, so that'd be about 20 million.
I'd say, obviously, we're hoping to do better than that depending on how you want to layer that in I would put in 50 to 70 on category line reviews, if I'm kind of being conservative.
Get you up to 41 five to 41, seven and then to drop you back down to 41 flat, that's where your price cost headwind comes in.
Okay, Alright, we can follow up on that.
And then on the.
On the overall sales growth outlook here, including the 400 basis points of share gain.
If you take out the unusual government sales and acquisitions it still seems like you're assuming industrial recession in most cases here.
So first question is is that the case or are you looking at flatness to down in terms of IP for 24 as a base case and then second you Eric.
Eric You mentioned the bounce back in auto related sales following a period of slowness is that your assumption in the second quarter of fiscal 'twenty four.
Yeah, Dave so on the on the revenue front, what I, what I'd say is you're basically what we're assuming I think Christian alluded to this in going through the framework is a roughly flat IP through the year.
The reason revenues are where there are as you of two things. One is as you mentioned, it's about 150 basis point headwind for nonrecurring public sector orders. So if you take the midpoint of our guidance of $2 50, there's another 150 basis points or so for nonrecurring orders. The other thing I'd say is it's also in recognition, Dave we're coming out of the gate slow slower than.
We otherwise would have because of the UAW situation and in the prepared remarks, we talked about you know low single digits in terms of points to growth impacts. So September and October October were a little more than halfway through here, but September we have under our belt that half of October are going to be lower than the midpoint. So that is factoring into our.
Equation in terms of bounce back that is not factored in so what we are assuming is that the UAW situation released itself before the end of the calendar year and that things restore to more of a neutral or flat IP situation. It does not account for any big bounce back that certainly could happen.
Got it thank you very much.
Thanks, Dave.
And our next question today comes from Steve Volkmann with Jefferies. Please go ahead.
Great Hey, good morning, everybody, Eric you talked about the deceleration in September and October it sounded to me like maybe half of that was due to UAW issues and the other half was sort of more general and any more color you can give us some sort of the non UAW drivers.
Yeah, Steve certainly I'll I'll I'll I'll I'll take a shot here and then Christian can chime in to fill in any dots here, but you know certainly if you look and you go Q4 to September the Q4, and even August at the 9% growth number. It's certainly a big drop I think one thing just to sort of walk you growth rate from where we were tracking.
In Q4 to Q1, you have a couple of things going on so one certainly the non repeating.
Public sector orders were about three points of that so that brings you down to about 6%.
There is a bit of a timing on the lapping of an acquisition, it's a half a point or so but basically you're looking at somewhere in the five five and a half range.
Without those factors down too.
What's in the one three range for September and something similar what we're projecting for October over that what we were saying is in the low single digit range you could add back for UAW. So yeah, I'd say I think your your back of the envelope on saying about the sequential step down about half and half.
Is it reasonable ballpark meeting half related to UAW, and then certainly a little bit of softening, which isn't surprising to us given what's going on at all of the macro indices.
Right and just any sort of end markets or you know themes to call out in terms of that slowing non UAW slowing.
Yeah.
I would I'm, sorry to interrupt you, but I would I would call a general slowing the real interesting thing here is it's hard to find a bright line between what is auto related and what's not and what I mean by that is you know we have some direct auto exposure the bigger issue for MSC of course is what would be coded as a machine shop, a fab shop a lot of.
You know there is a portion of their business that is auto related so theres tentacles to the strike that extend beyond just the direct S. I C codes, if you'd look at auto.
But more broadly I would say general softening you certainly do have some pockets of strength still like aerospace of course.
But you know more general general softening again, I think consistent with what we've been tracking with the VIP and the sentiment readings.
Got it okay. Thanks, and then just a quick follow up Christian or are you assuming that gross price is positive in 'twenty four.
Yes, gross price will be positive in 'twenty for Steve I, just see them about one to two points of growth from a growth from price and 24.
Okay. Thank you.
Youre welcome.
Thank you and our next question today comes from Tommy Moll Stephens Inc. Please go ahead.
Good morning, and thanks for taking my questions.
Good morning, Tommy.
One follow up on the 24 discussion we've been having Kristen I think I heard you say.
In terms of volumes you expect them lower I think that was a first half comment, but I just want to make sure that we've got the right timeframe there.
Yeah, you heard that right Tommy lower in the first half of course Q1, we kind of talked about here with what's going on with the UAW in the general industrial softening and then the expectation that UAW alleviate in early Q2.
So what I would how I would think about kind of what changes first half to second half that is UAW headwind goes away and then we also have as we talked about in the prepared remarks are two key things coming online that drive growth in the second half.
One is some changes that we're making around our pricing strategy and then the second is of course, the changes, we're making to the e-commerce platform and both of those are intended to really reenergized the growth rate in the core customer space, which has been lagging in the growth rate we've seen for the broader company overall.
So that is a that along with just the change in the macro piece drive sequential improvement in the second half we've got a bunch of other growth growth initiatives that we're working on a I'd say, there's a runway on the large account wins that we've had in the past year, particularly in the second half of 'twenty three that provide upside throughout the year.
But those are a few things that I would point to that create the inflection first half to second half that we're expecting.
That's helpful. Thank you I also wanted to follow up on auto.
If you have these numbers it'd be great. If you could provide them just what what you estimate your direct.
And indirect exposures are just in terms of percent of revenue and just any more anecdotes you can you can give a word.
You may be able to discern it it's more just general customer caution. So so maybe not directly quote unquote strike impacted but more just to.
Our sentiment headwind in that ecosystem that you've seen manifest.
Thank you.
Sure Tommy So so to answer your first question direct exposure roughly in the range of 10%, maybe a little bit under 10% indirect exposure as I mentioned.
Tough tough to get our arms around specifically, but it was certainly it would take it would take that number up considerably.
When we were referring to kind of MFC is bread and butter of machine shops, fab shops and job shops.
That's in terms of the first part in terms of the of the color I provided we stay pretty close to the ground with our Salesforce and we're getting regular reports and some of the reports are.
Temporary halt in production, which would be sort of a more direct example of what we're talking about due to a strike either out of a customer or a customer of a customer and then the other is as you said there are customers who are further down in the chain.
In the auto supply chain, who are expressing more caution or just clamping down on spending and we have examples of that where you know some of our vending customers. It's basically buy only what you need and so we're seeing a lot of the district almost like what we described in the MSCI world of clamping down on discretionary spending we're seeing the same thing in a lot of our customers.
Thank you I appreciate it and we'll turn it back.
Okay.
And our next question today comes from Ken Newman of Keybanc. Please go ahead.
Hey, good morning, guys.
<unk> morning.
Good morning.
It touched back onto the UAW stuff, a little bit more here, obviously, you're assuming that.
That strike.
Alleviate by the end of the calendar year I'm just curious just how much visibility do you have there in terms of you know what gives you comfort in making that assumption and you know obviously the range in the guidance is a bit wide for this coming year. So at the lower end.
What are you kind of assuming in.
In terms of a potential impact if that strike last a little bit longer than you anticipate.
Well, what I'd say is you could see I mean, we're tracking towards the lower end of the range through September and our estimate for October right. So that gives you a feel for if this were to continue what would have to be the case for the lower end.
In it now.
And look we had to make some assumptions our visibility is somewhat narrow as limited.
Ltd is like all of US as you suggested that's why the range is slightly larger.
But you know look I think the punchline is if this were extended you youre seeing what it's doing now, but certainly to the extent. This alleviates itself at some point there is a lift to come and then you know as we were talking with Dave earlier, if there were a bounce in response more of a lift in and obviously in the meantime, all the Wildcats were focused.
On share capture and so you know I wish I was encouraged while we can only control so much I always encourage right out of the gates in September despite the lower growth our sales team's execution was strong so vending signings up over 50% BMI signings up over 25%. Those are the things that you know kristian mentioned sort of a build in the back half some of the initiatives.
Coming online in addition to some of the bigger programs just better execution in a tough environment. When local distributors are vulnerable gives us confidence because all of those signings will lead to new agreements, which lead to revenue.
As we move along the physical.
Right now that makes sense.
Yes.
For my follow up kind of following up on that I mean.
You did increase the capex year for some of these digital investments I think Christian you mentioned, a decent amount of that going towards cloud computing.
Just quantify how much of that is contemplated in the new Capex guide and when do you expect to see those benefits start to monetize.
Through the income statement.
Yeah, Ken happy to talk about that so it is contemplated in the Capex range that we gave him I would assume around $35 million of that roughly going to the digital core initiative that we talked about and <unk>.
Maybe let me put a little bit more color around that then we kind of went into in the prepared remarks, but we really see this as being key to ongoing productivity generation and the ability to scale profitable growth. Once it goes live. So this is not not a full scale ERP system just to be clear like we've kind of implemented parts of this along the way.
For the year, So our finance systems Dawn already Pan web pricing, where we're not putting warehouse management and scope for this.
And then a little bit I guess, a little bit more color on this too we brought in a new C. D. I O last year John Hill. He's led several of these implementations before and he's got a dedicated team that's taken us through that so it ends up being about $35 million. This year I think a similar amount than in 25 with the program coming online towards the end of 'twenty five.
I'd expect some productivity benefits to start trickling down a little bit earlier that just related to kind of the business process reengineering on order to cash and procure to pay which is really what the system's targeting.
Some small productivity generation in 'twenty, five, but then material impacts the P&L post twenty-five and of course, that's when the depreciation would start to hit as well.
Understood. Thanks.
Welcome.
And our next question today comes from Ryan Merkel with William Blair. Please go ahead.
Thanks, Good morning, two questions first off.
Morning.
Just around the UAW the impact of down low single digits. How did you. How did you quantify that was that the 10% direct down sort of 20% to 25% or are you, including sort of the indirect impact in there as well.
Yeah, we're including the indirect impact in there Ryan So what we what we've tried to look at was the change that we've been seeing in the IP end markets and auto.
Transportation primary metals and fabricated metals and as Eric mentioned, we've got some direct exposure and auto so when we look at that one that probably a little bit cleaner track, although there's even some things that map in there, which arent sort of perfect representations of our business, but primary metals and fabricated metals would be where we would look to.
Try to gauge the impact that may be happening in the other spaces through like the job shops and the machine shops. So we're basically looking at like what normal sequential trends would look like for ourselves in those spaces and then we're looking at what the IP and the teams are doing to kind of triangulate against that low single digit number that we gave.
Okay.
In the right ballpark, where sort of all auto was down maybe 20%.
I think that's where that that'd be roughly roughly in line with what we were seeing when we did the analysis yeah.
Okay. That's helpful. And then just back to gross margins in the walk just high level. It sounds like first half will be down year over year and second half.
Up year over year is that roughly correct and the reason being in the second half you get benefits from the line review and then you lap the price cost headwind right in <unk>.
Yeah, maybe maybe let me give it sequentially Ryan because you've got the noise from the public sector contract win in the in the second half so what I would think about it if youre starting with Q4 as the jump off point on the 45, you're going to move up slightly sequentially into Q1, I would expect a small inflection again in Q2.
And then Q2 into Q3 with the second half being roughly level that might be a little bit of an easier way to think about it because there is a lot of noise in the year over year comps hopefully that makes sense.
Yeah. It does okay I appreciate it thanks.
Welcome.
And our next question today comes from Chris Dankert with loop capital. Please go ahead.
Hey, good morning, Thanks for taking the questions.
Hey, Chris I guess just.
On the on the digital launch of MFC Dot com kind of revamp here.
Additional detail on timing should we still expect that before calendar year end and then maybe just any kind of contribution to sales growth, we should be kind of assuming in the guidance there.
Yeah, Chris So the <unk>.
Basically the e-commerce improvements in the heavy lifting on this is done so Kristen Kristen mentioned in the DNA of the impact to the P&L, but the good news as to where the work is done the rollout will be occurring really over the next quarter or so.
So customers will begin that's when the customers will begin seeing an impact we're pretty encouraged.
What I would say is it's factored in to our guidance for you know basically what Christian described coming out of the gates here were slow we expect some sequential build in part because of this UAW situation at some point of course normalizing, but in part because of the initiatives and that's a piece of it.
What we expect to happen with ecommerce is it's not going to be a light switch.
This will build over time. It is one of the things, though that gives us confidence beyond this year looking at kind of where the three year lens, a multiyear lens what gets US excited as we look back to the prior three year chapter.
And we achieved our growth targets are we exceeded them growth over IP without really getting the engine of our core customer growing. We think this is a big piece to it. So I don't think it'll be a light switch, but I do think we're going to start seeing benefits beyond the next quarter.
Got it. Thank you that's very helpful. And then just to put a fine point on the cost front again seems that we're moving away from absolute you know.
Cost dollars coming out of the business that $100 that we had in the last mission critical program should we now have just got to keep our eyes on hitting that 20 million or 20% incremental margin and think about that as kind of the target for <unk>.
He was improvement going forward.
Yeah, Chris longer term I would say that's a fair way to think about it 24 is going to be a bit challenging on hitting 20, hitting 20% incrementals and because of what's happening on price cost and margins and then what's happening in terms of fixed costs on the opex step up ex step up.
So longer term, yes, I would agree with that and then I the way I would think about productivity within the year, though and maybe the Saar that just helps us kind of Opex sequencing also as we mentioned in the prepared remarks there'd be a step up in Q1 on opex costs related to DNA and incentive compensation.
I would also factor in the sequential volume change in how we gave that but based on what we're targeting for Q1. If you you know what.
It felt like a mid point on what's happened in September and October.
You stepped down based on volume related costs, and Opex that would be offset by the step up in DNA and incentive compensation expense.
And then I would think about Opex dollar sequencing through the year as basically being roughly flat with the exception of your volume fluctuations. So basically what that means is we're leveraging productivity to cover things like our merit increase fund some of the investments and then it just to kind of size what that work our merit, it's typically around $20 million.
Alone each year.
Got it that's all very very helpful. Thanks, So much and best of luck in the new year here.
Thanks, Chris.
Thank you and then final question today comes from Patrick Baumann with Jpmorgan. Please go ahead.
Hi, good morning, Thanks for taking my questions.
Good morning.
Hey, How's it going.
First one I guess I'm, just a quick clean up from the quarter. I think you said Kristen something about rebates and Cogs adjustments offsetting price cost in the fourth quarter what is that exactly.
Yeah. So we saw favorability in Q4, Chris related to both the vendor rebates and customer rebates and then the other item that we had in there was around us.
Been doing a lot of work I think we've alluded to it on previous calls in terms of countermeasures on working.
Working capital and kind of composition of inventory and some of that work started to yield a benefit in Q4 in terms of requiring a lower inventory provision and we've been seen so that was the other thing that benefited us in Q4 and those items combined allowed us to offset the price cost headwind. So it was a meaningful contribution.
We talk about countermeasures for fiscal 'twenty four that's the type of stuff that we're looking to as well.
What can you quantify what that was in terms of basis points.
That offset.
Yeah. So if you look at Q4, we had about 100, a 130 basis points of impact tied to the public sector contract.
And then price cost was down to 120 basis points and it was totally offset by the improvements in those other cost of goods sold areas.
Super helpful. Thanks, Thanks for the color.
And then my follow up.
Maybe for Eric.
If you could give us more color around the pricing strategy.
The changes youre, making for that for the core core customer like what it entails.
And.
After you're done with this how should we think about gross margin for this group.
Can it remain above the company average by the same spread it is today and can you remind us.
How much higher the gross margin is for core customer versus what your book for large customers I recall in the past.
Number given in the range of like 500 700 basis points, but.
That might have been a couple of years ago. So I just wanted to confirm.
Yeah sure. So maybe I'll touch on the strategy Christian can follow up just on the growth differential, but I'll give you the punch line.
So what we're doing here and look at our pricing strategy has always been around the list a list price as a jump off point to get to a net price for our customer we feel very good about our pricing and first I'd say our value proposition is a high price value prop and we don't intend on changing that we bring a lot of value in the way of technical expertise to our customers we do.
Commands a premium relative to the traditional distributor that's warranted and that's not changing what is going to change is as we look any case, where we're touching a customer consistently with a salesperson and our relationship our pricing is competitive what we have found that I think we've alluded to this before that there's cases, where we're not touching a customer as <unk>.
Regularly with the salesperson it may be a direct marketing relationship and there are times, where our pricing is not competitive.
And with that certainly it's not competitive without jumping through some hoops on discounting and so what we're looking to do is identify and isolate those cases, both in terms of skus and customers and make adjustments. So that were presenting out of the gate a more competitive price.
The work is basically this will be going out to work most of the heavy lifting again is done it will be coming in flight in the next one to two quarters.
And basically we feel we are doing this as we've modeled it out with minimal if any margin dilution because of the way we've structured this and the idea is just bringing a better price to the customer out of the gate.
Our feeling is absolutely that along with the web improvements this will reenergize the core customer and you are correct, we absolutely feel that.
Post this adjustment to core customer gross margin will still be healthily.
Both company average and certainly well above the growth drivers that have been driving most of the growth. So your estimate is certainly not out of the ballpark in terms of basis points, but that's one of the reasons. We're excited as we move past Kristian talked about some of the challenges in the first couple of quarters you get past. The first couple of quarters of 'twenty four into the back half into 'twenty.
$5 it gets to be a pretty exciting picture.
Yeah. So it's a good range that you gave and the other thing I'll just I'll add a little color on what Eric said too in terms of profitability is sort of the air.
Customers were talking about here, it's also a lower cost to serve so really benefit to the P&L on a couple of places.
So if you just a follow up to that I guess, that's embedded in the 1% to 2% price you mentioned earlier for the year.
If you reduce the price for this group of customers in select instances, how do you maintain the same gross margin spread.
That group, having the power.
Yeah, it'll be plus or minus Patrick and and the answer is that in a lot of cases, it's going to be there. There's a lot of discounting that occurs when the list is high and we're not competitive out of the gate, there's a lot of discounting and often times inefficient discounting that happens. So while this is going on there is pretty tight controls around discounting.
Disciplines, because we're bringing a better price to the customer right out of the gate.
And most of our modeling suggests that that will offset one another.
Understood Okay, great. Thanks.
I appreciate it.
Thank you, ladies and gentlemen, I think we lost your battery for thank you.
Ladies and gentlemen, this concludes our question and answer session I would like to turn the conference back over to Ryan Miller for any closing remarks.
Thank you for your time and interest this morning as a reminder, our fiscal 2024 first quarter earnings call date is set for January 9th and we look forward to seeing you in person at the Baird and Stephens conferences in November. Thank you for joining us today Goodbye.
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.