Q1 2024 MSC Industrial Direct Co Inc Earnings Call
Yeah.
Good morning, and welcome to the MSC industrial supply 2024 first quarter conference call.
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I would now like to turn the conference over to Ryan Mills head of Investor Relations.
Ryan Mills: Thank you and good morning, everyone welcome to our first quarter fiscal 2024 earnings call Erik Gershwin, Our Chief Executive Officer, and Chris Synaxis Grande Our Chief Financial Officer are both on the call with me today.
Ryan Mills: During today's call, we will refer to various financial data and the earnings presentation and operational statistics that accompany our comments 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 earnings 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 security laws.
Ryan Mills: 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 and.
Ryan Mills: 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 will now turn the call over.
Ryan Mills: The error.
Speaker Change: Thanks Ryan.
Ryan Mills: Good morning, everybody and thank you for joining us today.
Ryan Mills: I'll begin by wishing everyone, a happy and healthy new year.
Ryan Mills: As we look back on the first quarter of our fiscal 'twenty 'twenty four.
Ryan Mills: Which is the first step in our next mission critical chapter.
Ryan Mills: The headline that comes to mind.
Ryan Mills: A strong execution in a challenging environment.
Ryan Mills: On today's call I'll provide more color on both our execution.
And the environment.
Ryan Mills: Christian will then give more specifics on our financial results and expectations for the year.
Ryan Mills: And I'll, then wrap things up before we open up the call for questions.
Ryan Mills: I'll now begin with the environment.
On our last call, which was midway through October we.
Ryan Mills: We describe the sequential softening in demand that began in September.
Ryan Mills: The causes included reduced spending due to sustained high interest rates.
The ripple effects of the UAW strikes.
Ryan Mills: Inventory burn down.
Ryan Mills: And then overall caution among our customer base.
Ryan Mills: Following our call.
Ryan Mills: We experienced an even softer back half of October.
Ryan Mills: Resulting in another sequential step down in our growth rate.
At the time of our last call.
Ryan Mills: Which again was roughly halfway through our fiscal month.
Ryan Mills: We estimated October sales growth of 1% to 2% over prior year.
Ryan Mills: As you can see on the op stats, we ended the months down over 1%.
Ryan Mills: Which demonstrates just how soft demand was.
Ryan Mills: In the back half of October versus our expectation.
Ryan Mills: That softness carried into November and as you can see on the op stats into December as well.
Ryan Mills: The root causes were largely the same as identified last quarter.
Long with belt, tightening and inventory burn down heading into the holidays a calendar year end.
Ryan Mills: While the U a W situation did resolve itself Mo.
Ryan Mills: Of our customers were slow to bring spending back on Libert line excuse me back online.
Ryan Mills: Due to high finished goods inventories.
Ryan Mills: December was compounded by a slightly higher than normal holiday shutdown schedule.
Ryan Mills: Which is typical when demand is soft.
Ryan Mills: All of this has been evidenced in I P readings distributor surveys and most acutely in metalworking related end markets.
Ryan Mills: As demonstrated by recent M B I readings.
Ryan Mills: As we look ahead to calendar 'twenty 'twenty four.
The outlook on the ground from customers suppliers and our own sales team is more encouraging.
Ryan Mills: Particularly after the first calendar quarter.
Ryan Mills: End user demand.
Ryan Mills: While light has remained fairly stable.
Ryan Mills: We've not seen the precipitous drops that many had feared.
Ryan Mills: We're hearing that automotive related customers.
Ryan Mills: Should ramp up early in calendar 'twenty 'twenty four.
Ryan Mills: At the same time straw.
Ryan Mills: Stronger end markets like aerospace and defense should remain strong.
In addition.
Ryan Mills: The prospect for stable or even lower interest rates is giving customers more confidence in future capital spending.
All of this bodes well for a more positive view of the back half of our fiscal 'twenty 'twenty four.
Ryan Mills: And into fiscal 2025.
With respect to pricing.
Ryan Mills: The environment has remained stable.
Ryan Mills: We did see some select supplier cost increases.
Ryan Mills: Which go into effect early in calendar 'twenty four.
Ryan Mills: As a result.
Ryan Mills: We'll be taking a small price increase during our fiscal Q2 to pass these along.
Ryan Mills: I'll now turn to our execution.
Ryan Mills: I am pleased with our team's ability to remain focused on what's within our control.
Ryan Mills: And to make progress in any market scenario.
Ryan Mills: Focused execution has been a theme for the past three years.
Ryan Mills: With progress spanning our strategic growth pillars.
Ryan Mills: Our productivity initiatives.
Ryan Mills: And now our sustainability efforts as well.
Ryan Mills: As this progress continues.
Ryan Mills: It sets us up for a strong rebound when the macro environment improves.
Ryan Mills: And it makes for a better world in which to operate.
Ryan Mills: I'll show you what this looks like on the next few slides.
Ryan Mills: And I'll start with our sustainability progress on slide five.
Ryan Mills: In December we just reaffirmed mlc's commitment to environmental social and governance principles with the release of our 2023 ESG report.
Ryan Mills: Within this document we.
Ryan Mills: We demonstrate how I met C is enabling a better world.
Ryan Mills: And a better tomorrow.
Ryan Mills: For example.
We've recycled over 20000 pounds of carbide since 2021 through our re grind surfaces.
Ryan Mills: And we've recycled one and a half thousand tons of corrugated packaging just in 2023 at our Cfcs.
Ryan Mills: We're also creating a better world by providing sustainable products and services to our customers.
Ryan Mills: As we reached over 20000 environmentally preferred products within our offering.
Ryan Mills: Additionally, our metalworking solutions enabled customers to reduce electricity consumption.
Ryan Mills: By 32 million kilowatt hours during the fiscal year.
Ryan Mills: On the social and governance front as Youre aware, we strengthened mst's corporate governance practices through the elimination of our dual class share structure.
But we did more than that.
Ryan Mills: Our community Relations program is a vibrant part of our culture.
Ryan Mills: We support many not for profits across the country.
Ryan Mills: Examples of which can be found in our ESG report.
Ryan Mills: In summary.
Ryan Mills: We're proud of our ESG achievements in fiscal 'twenty three.
Ryan Mills: And we're focused on building on this momentum in fiscal 'twenty four.
Ryan Mills: I'll now turn to progress on the three strategic pillars, we outlined for this next mission critical chapter.
Ryan Mills: Maintaining momentum of existing growth drivers.
Ryan Mills: Adding a couple of new elements to our growth formula.
Ryan Mills: And driving further improvements.
Ryan Mills: Through three productivity initiatives.
Ryan Mills: I'll now take you through performance against each of these.
Ryan Mills: First on slide six maintaining.
Ryan Mills: Momentum on existing growth drivers.
Ryan Mills: We continue gaining traction in the public sector with high single digit growth during the quarter.
We saw a similar level of growth in our Ccs business.
Ryan Mills: Which primarily consists of class C consumable products.
Ryan Mills: And we did so despite a softening demand environment.
Ryan Mills: Metalworking, while soft due to manufacturing conditions made important strides for future progress with the formal launch of the machining cloud relationship.
Ryan Mills: Extending our reach to tooling engineers, who are configuring new machining jobs.
Ryan Mills: Despite our metalworking market leadership.
Ryan Mills: We continue to see ample opportunities to expand in various regions across North America.
Most significant was our solutions performance.
Ryan Mills: During the quarter, we achieved vending signings growth of more than 25%.
Ryan Mills: While our installed base grew 10% year over year.
Ryan Mills: For implants, we achieved a record rate and signings and grew our program count by more than 35% compared to prior year.
It's also worth noting that via my installations were up year over year in the low teens as well.
These numbers are indicative of market share gains.
Ryan Mills: And bode well for our future growth outlook.
Ryan Mills: As a reminder, signing.
Signings take roughly three months to convert to revenue generation, depending upon the solution and the size of the wind.
Ryan Mills: As a result, the costs associated with these wins.
Ryan Mills: Before the revenues too.
Ryan Mills: I'll now discuss progress on the two new elements to our growth formula which are shown on slide seven.
Ryan Mills: First is re energizing our core customer growth.
Ryan Mills: On the last call.
Ryan Mills: I highlighted two foundational priorities for unlocking the growth.
Ryan Mills: Realigning, our public facing web pricing.
Ryan Mills: And implementing the new product discovery functionality on our website.
Ryan Mills: With respect to pricing.
Ryan Mills: Our goal is to provide market competitive prices to smaller core customers.
Ryan Mills: While remaining roughly gross margin neutral.
Through better discounting disciplines.
Ryan Mills: We are currently 30% of the way through the realignment.
Ryan Mills: And we're on track to achieve that goal.
Ryan Mills: In addition.
Ryan Mills: We're seeing encouraging early indicators such as improved web conversion rates.
And more favorable levels of growth compared to non piloted skus.
Ryan Mills: We plan to complete the balance of the portfolio.
By the end of our fiscal second quarter.
Ryan Mills: With respect to the new product discovery platform.
Ryan Mills: It is now in market in the form of a pilot program.
Ryan Mills: And will be fully deployed before the end of our fiscal second quarter.
Early indicators are also promising for search.
Ryan Mills: We're watching conversion rates and other performance measures carefully.
Ryan Mills: And we're pleased with what we're seeing.
Ryan Mills: More exciting is what's yet to come in the following quarters.
Ryan Mills: As we build on the base functionality being launched now with significant enhancements such as new table views and schematics cut.
Ryan Mills: Customer self service analytics and.
Ryan Mills: And AI driven personalization.
Ryan Mills: We will more aggressively market the pricing and the web improvements in the back half of our fiscal year.
Ryan Mills: After both projects are complete.
The other new element to our growth strategy is.
Ryan Mills: He is building on our OEM Fastener foundation of Aaas and tower.
Ryan Mills: We plan to do so by capitalizing on the cross selling blueprint that we've proven out with C. C. S. G.
Ryan Mills: Well, we're still in the early innings.
Ryan Mills: Initial indications are promising.
Ryan Mills: With the build out of a large funnel and several early wins.
Ryan Mills: These efforts will allow us to significantly expand our share of wallet across our customers.
Ryan Mills: Yeah.
I'll now touch on our third mission critical priority.
Ryan Mills: Improving profitability.
Ryan Mills: Through productivity.
Ryan Mills: And here, we highlighted three initiatives.
Ryan Mills: Improving category management.
Ryan Mills: Accelerating supply chain efficiencies.
Ryan Mills: And upgrading our digital core systems.
Ryan Mills: And business processes.
Ryan Mills: Our category management efforts.
Ryan Mills: Which include line reviews.
Ryan Mills: Portfolio optimization.
Ryan Mills: And product mix and margin management.
Ryan Mills: Us to exceed our first quarter gross margin expectations.
Ryan Mills: As you may recall.
We shared on the last call that gross margins for the year should be flat to slightly down versus fiscal 2023s, 41.0%.
Ryan Mills: We also felt that Q1 and Q2.
Ryan Mills: Would be the most challenging.
Ryan Mills: Due to the worst of the price cost dynamics.
Ryan Mills: So we were pleased to come out of the gate strong at 41, 2%.
Ryan Mills: Each provide some potential upside for the year.
Ryan Mills: Supply chain improvements.
Ryan Mills: Our noteworthy and are just getting started.
Ryan Mills: Martina has built a strong team with a mix of existing MFC performers.
And some new talent from the outside.
Ryan Mills: This team is bringing a fresh perspective to many areas within supply chain.
Ryan Mills: During Q1, we saw improvements in freight expenses.
Ryan Mills: Both in absolute terms and as a percentage of revenues.
Ryan Mills: And in inventory efficiency.
Ryan Mills: As inventory levels dropped $17 million.
Ryan Mills: Despite end of calendar year buying for re bid opportunities.
Ryan Mills: We anticipate more improvements to come.
Ryan Mills: As the team is conducting a thorough review of our supply chain end to end.
Ryan Mills: Finally, with respect to our digital core systems upgrade.
Ryan Mills: The project is on time and on budget.
Ryan Mills: We expect to launch sometime around the end of fiscal 2025.
Ryan Mills: Which will unlock further productivity gains across the order to cash and procure to pay value streams.
Ryan Mills: All in all despite.
Ryan Mills: Despite the subdued growth rate in our fiscal first quarter.
Ryan Mills: Our execution remains at high levels.
Ryan Mills: And supports future profitable growth.
Ryan Mills: I'll now pass things over to Christian to discuss our first quarter performance and annual outlook in greater detail.
Christian: Thank you Eric and good morning, everyone. Please turn to slide eight where you can see key metrics for the fiscal first quarter on both a reported and adjusted basis.
Christian: Fiscal first quarter sales of 954 million declined 4% year over year with the same number of business days in both periods.
The year over year decline was mainly driven by lower volumes due to the demand softness experienced in the second half of the quarter that Eric mentioned earlier.
This was partially offset by ongoing momentum in our mission critical growth drivers as well as more modest tailwind from price and acquisitions.
Christian: Foreign exchange was also a slight top line benefit to the tune of 30 basis points.
By customer type, we experienced 9% growth in the public sector as we continue to further penetrate that portion of the market.
Christian: Sales to national account customers improved 4% compared to the prior year period, while core and other customers declined approximately 5% year over year.
Christian: As it relates to national accounts, and core customer base impact from the UAW strike and acute demand softness in metalworking related end markets at quarter end were the primary drivers to the step down.
Christian: From a solution standpoint, we continue to take share during the quarter.
Christian: In vending Q1 average daily sales improved 5% year over year and represented approximately 17% of total company net sales an improvement of roughly 80 basis points compared to the prior year.
Christian: Sales to our implant program continued growing in the double digit range with 10% growth.
Christian: An improved more than 200 basis points year over year to 15% of total sales.
Christian: Signing rates across both solutions remained healthy during the quarter.
Christian: Especially in in plants, where we achieved quarterly signings at a record rate.
Christian: Moving onto profitability for the quarter, our gross margin of 41.2% declined 30 basis points year over year.
Christian: As expected price costs, a larger drag on margin during the quarter, which will be the case for QQ before leveling off in the second half of the year.
Christian: That said I'm pleased with our gross margin countermeasures, which offset the majority of price cost headwinds during the quarter.
Christian: Okay.
Christian: Reported operating expenses during the quarter were approximately $291 million up $11 million year over year.
Christian: On an adjusted basis operating expenses were approximately 289 million up $10 million year over year.
Christian: Find yourself being essentially flat year over year. This resulted in adjusted operating expenses, increasing roughly 115 basis points as a percentage of sales.
Christian: This step up in operating expenses was largely driven by elevated costs associated with our strategic investments of roughly $10 million.
Christian: To give some perspective more than half of this investment was associated with payroll related costs to support implant growth.
Christian: When price realignment initiatives.
And upgrades to our digital core.
Christian: Outside of cost associated with strategic investments payroll and payroll related costs were up primarily due to merit and higher health care costs, which were largely offset by productivity.
Christian: On a sequential basis Q1, adjusted operating expenses were roughly flat with Q4 levels.
Christian: Revenues were down in the neighborhood of 50 million sequentially after backing out the nonrecurring public sector orders, which came with very little operating expense.
Christian: All else being equal one would have expected Q1 operating expenses to flex down by a few million dollars the gap and the reason they did not was primarily the investments I, just described which support solutions growth web price realignment initiatives and upgrades to our digital core.
Christian: We are pressing on with those investments because our confidence in their ability to create long term value for stakeholders and our constructive outlook for the back half of the fiscal year, which I will describe in just a bit.
Christian: Reported operating margin was 10, 6% compared to 12, 1% in the prior year period.
Christian: On an adjusted basis operating margin of 10, 9% declined 140 basis points compared to the prior year.
Christian: The year over year decline was primarily due to the previously mentioned step up in operating expenses combined with lower sales volumes.
Christian: GAAP earnings per share was $1 22, compared to $1 45 in the prior year period.
Christian: On an adjusted basis EPS was $1 25 versus $1 48 in the prior year.
Christian: Turning to slide nine to review, our balance sheet and cash flow performance. We continue to maintain a healthy balance sheet with net debt of approximately 513 million representing nine four times EBITDA.
Christian: Share repurchases during the quarter to offset share with classification dilution was the largest contributor to the sequential increase in net debt.
Christian: We made progress on our working capital during the quarter, including roughly $17 million inventory reductions.
This resulted in first quarter operating cash flow conversion of 117% keeping us on track to achieve our target of greater than 125% for the full year.
Christian: Capital expenditures during the quarter of $18 million declined approximately 7 million year over year.
Christian: Together this drove free cash flow generation of approximately $63 million compared to 51 million in the prior year.
Christian: The strength of our balance sheet and cash generation supports our capital allocation priorities shown on slide 10.
Christian: As you can see our decision to deprioritize special dividends continue creating significant room for strategic Optionality such as the investments currently being made this fiscal year.
Christian: Looking forward this will likely gravitate towards other organic investment opportunities.
Christian: Bolt on M&A with a focus on metalworking and OEM fasteners and further deployment to shareholders.
As it relates to the ordinary dividend, we will target moderate and consistent increases.
Christian: Moving to slide 11 for an update on our repurchasing efforts I am pleased to announce that we repurchased all of the dilution from the share repurchase a vacation, which was approximately one 9 million shares.
Christian: This was achieved by approximately 1.4 million shares repurchased during the first quarter.
Following the 650000 shares repurchased in fiscal Q4.
Christian: With this buyback initiatives complete we have approximately two 4 million shares remaining on our current authorization.
Christian: Looking forward, we will look to offset annual stock based compensation dilution and look for windows of opportunity to be more aggressive.
Christian: Turning to slide 12, we are maintaining our outlook for the fiscal year. Despite the slow start.
Christian: As a reminder, this entails average daily sales growth of zero to 5% and adjusted operating margin in the range of 12 to 12, 8%.
Christian: I would like to provide additional color on the expected cadence of our performance for the remainder of the fiscal year.
Christian: Starting with revenues the midpoint of our outlook assumes that average daily sales improve meaningfully as we move through the back half of the fiscal year.
Christian: This expectation is based on the following assumptions.
Christian: First improving macroeconomic conditions beginning in early calendar 2024.
Christian: Rick described earlier.
Christian: Second the recent surge in solution signings continued to produce a growth tailwind as it takes roughly three months to convert to revenue generation, depending on the solution and the size of the wind.
Christian: Third our strategic investments such as the pricing realignment and new web search platforms will begin yielding benefits as we move through the back half of the fiscal year.
Christian: On the profitability side, our gross margin performance during the quarter was better than expected and at a rate higher than our annual assumptions.
Christian: We expect second quarter gross margin to be similar to the first corner with some potential upside later in the fiscal year, given easing price cost headwinds.
Christian: Increasing contributions from category line reviews, and the small pricing actions during fiscal Q O Q.
Christian: As it relates to adjusted operating expenses, we expect to see the typical seasonal lift in dollar terms for QQ related to the timing of merit increases.
Christian: From there we would expect any step up in adjusted operating expenses to be more modest with the increase is being driven by variable costs associated with volumes as strategic investments begin to ease.
Christian: As a result, we would expect to see strong operating leverage in Q3 and Q4.
Christian: With that I will now turn the call back over to Eric for closing remarks before we open the line for Q&A.
Eric: Thank you Kristen.
Eric: I'm proud of our team's execution in a challenging environment during the fiscal first quarter.
Eric: We demonstrated high levels of performance throughout our previous three year mission critical journey.
Eric: And that is carrying into this next chapter.
Eric: We're focused on maintaining momentum on existing initiatives.
Eric: Investing into new ones that will accelerate performance.
Eric: And creating new productivity levers to drive margin expansion.
Eric: The work, we are doing now will yield dividends, particularly as macro conditions improve.
Eric: Our board and our management team are confident in our people our plan and.
Eric: And our future.
Eric: I'll close by thanking our entire team of 7000 plus associates.
Eric: Their hard work and commitment to our mission.
Eric: And we will now open up the line for questions.
Speaker Change: Thank you.
Speaker Change: To ask a question. Please press Star then one on your telephone keypad.
Speaker Change: It's a question that's already been addressed we would like to remove yourself from queue. Please press Star then two.
Speaker Change: Once again, ladies and gentlemen, the stores I'm wondering if you have a question.
Speaker Change: Today's first question comes from Tommy Moll with Stephens. Please go ahead.
Tommy Moll: Good morning, and thank you for taking my questions.
Speaker Change: Morning, Tommy Tommy.
Speaker Change: I wanted to start on the on the demand environment and you've both provided some helpful context on how you see the year shaping up and improving as we go forward.
Speaker Change: But there were two points I wanted to circle back on a first is just on the macro improving as we get into the first calendar quarter.
Speaker Change: Any additional insight you can provide there on what you're seeing or assuming in that and then the related point, you're you've described some of the benefits from strategic investments in the second half.
Speaker Change: You've got a slide today that provided a lot of positive early updates, but what confidence or visibility do you have that when you continue to lean in there that will really move the needle in terms of the ETS. Thank you.
Speaker Change: Hey, you're telling me, it's Eric I'll take Oh, I'll, let you take both so let me start with the demand environment and you know you heard in the prepared prepared remarks, what we've seen over the past.
Eric: Three months or so, particularly since the call and you know really in speaking to customers you got a few things going on certainly high interest rates catching up with.
Eric: The industrial economy in terms of lower capital spending and we saw that evidenced in some.
Eric: Some acute softness in certain of our product lines that would be more akin to a capital type purchase very typical.
Eric: The second thing certainly the UAW situation, which while the situation itself resolved itself our customers were slow to come back online and then the third factor the closer we got to the end of the year the calendar year.
Eric: The more we saw what we described this belt tightening and inventory burn again pretty typical in a slow environment that customers would use ended year to take more than typical time off. So you saw that in our December numbers as we look forward.
Eric: What informs our outlook is pretty much the same process that we go through on a normal basis, we'll look at macro indicators look at what's going on around US and then leaned heavily on what we hear on the ground and what we hear on the ground is from our customers from our sales team who are interfacing with our customers every day and from our supplier community and you know I I would see.
Eric: In general a couple of things one is we would expect that part of what happened at the year end here with the belt tightening the holiday schedule and the burn down that sort of falls off as we move into the calendar year, but as particularly what we're hearing on the ground as we move past the first month or two of the calendar year that with interest rates stable.
Eric: Coming down confidence is building among our customer base.
Eric: And again, we're hearing this from our reps our customers and our suppliers.
Eric: All of that feeds into your you look to the back half of our fiscal year and into 25, which seems like a more encouraging constructive environment.
Eric: So that would be the first thing I'd say on the demand side, telling me and yeah, you're right. If you look at our framework for the back half the back half of the year certainly it's back end loaded now given the way the slow start we came out of the gate. So some of that is environment and then some of that is initiatives and that was the second part of your question with respect to the initiatives I sort of break it into two.
Pieces as we did in the prepared remarks on the slide the first tranche is the stuff that's already been in motion, that's maintaining momentum on existing growth drivers.
Eric: So that would particularly what we call out there was the solutions performance, where we have seen a nice step up in the growth rate.
Eric: Some of these growth drivers and as Christian mentioned, we see a lag somewhere plus or minus three months from the time that we get a new signing whether it's a vending or implant to the time that we start to see meaningful revenue contribution so that would be one of the things that gives us confidence and then the other is the newer growth initiatives and particularly the <unk>.
Eric: Two foundational elements that we highlighted.
Eric: Directed at Reenergizing, the core customer you know what I'd say on both as well it's still relatively early stages on both particularly on the web pricing.
Eric: You know realignment, we do have enough experience there under our belt to feel pretty good about the metrics that we're seeing.
And that it's doing what it's expected to do so certainly that factors in to our constructive outlook for the back half of the year as well.
Speaker Change: Thank you that's all helpful and for my second question I wanted to follow up on gross margins Christian maybe two.
Speaker Change: So just make sure that I heard you correctly, and then give you an opportunity to give any additional insight here, but what I would I think I heard you say.
Speaker Change: First quarter was better than you would expected second quarter should be roughly similar to first quarter in terms of the margin rate.
Speaker Change: And then second half versus second quarter potentially higher.
Speaker Change: So if you could just step us through all of those make sure. We're tight and then any of the driver if she'd like to call out would be helpful. As well. Thank you.
Speaker Change: Yeah sure.
Speaker Change: Start with Q1 and to your point, we were definitely pleased with where we saw gross margin land in the first quarter I'll break it down on a year over year basis, we did see a sizable headwind from price cost as expected and that was offset by a combination of things the largest being the gross margin.
Speaker Change: Countermeasures that we've been working on them to think about things here like inventory efficiency driving improvements in our variances.
Speaker Change: Rebates influencing favorable product mix and then we also starting to get a better benefit from the category of line reviews in Q1.
Speaker Change: Then if we think about Q2 to your point expecting that to be roughly flattish.
Speaker Change: A slight easing in price costs into Q2, but not really notable until the second half.
Speaker Change: And then as we think about the second half in addition to price cost easing, we see additional benefit from category line reviews coming online in the second half and that's really the combination of those things is really what's giving us confidence.
Speaker Change: And gross margin for the full year and that's what you are hearing reflected in our talent and our time being a little bit more bullish about that for the year.
Speaker Change: Thank you I'll turn it back and appreciate the insight.
Speaker Change: Thanks Tommy.
Speaker Change: The next question comes from Ken Newman with Keybanc capital markets. Please go ahead.
Ken Newman: Hey, good morning, guys.
Ken Newman: Good morning, Ken.
Speaker Change: Good morning.
Speaker Change: Sorry, if I missed this in the prepared remarks, but I'm curious if you could just quantify what the UAW headwind wise to Ats. This quarter I think you mentioned last quarter. It was a low single digit impact.
Speaker Change: And you know any color you have on how we think about that volume normalizing here into the you know the second fiscal quarter.
Speaker Change: Yeah, Ken so that first quarter impact from UAW hard to precisely pinpoint it but what we did similar to what we had looked at a in the Q4 call. When we share what we're seeing in September we're really looking at the end markets that.
Speaker Change: We now are either directly auto related or are kind of adjacent to honest with things like primary metal fabricated about all the places, where we see machine shops and job shops selling into and when you look at the growth rate that we saw in those end markets kind of relative to the broader business.
Speaker Change: The impact that kind of the high end of low single digits and that would that would be both on a sequential and a year over year basis.
Speaker Change: Okay.
Speaker Change: And maybe just a clarification there.
Right.
Speaker Change: Sorry go ahead Ken.
Ken Newman: Yeah, maybe if you could just also just talk a little bit about the normalizing here.
Speaker Change: Thank you.
Speaker Change: Yeah. So we had originally indicated in early two Q pick up related to the UAW, we did the guidance Ken and while we were pleased that we saw the strike resolved earlier than we had expected we really didn't see a snapback at all in the customer base a lot of that our understanding of that had to do with the high inventory positions are and and then.
Speaker Change: And our resulting inventory burn down at the end of the calendar year and so what we're hearing on the ground from.
Speaker Change: From our customers and from the field from our suppliers that we expect that to start to improve and calendar Q1, not sure how much of it in the media in January or maybe kind of second half of calendar Q1, but that's definitely that improvement is definitely contemplated in our full year guidance.
Speaker Change: Okay.
Speaker Change: And then just a clarification question. There is is there any good way to parse out how much of auto is at the core customer versus the national account, because obviously the core customers, where you're kind of seeing the the big volume headwind here this quarter.
Speaker Change: There's not there's not a great way to do it I mean generally what I'd say is we see we see a lot of our core customers map into fabricated metals primary metals and machinery and equipment.
Speaker Change:
Speaker Change: So what I would probably feel confident saying core is more weighted in those end markets. The national account, but theres no perfect kind of rule of thumb, it's hard to think about that.
Got it.
Speaker Change: That's helpful.
Speaker Change: My second question here is you know I think your prior guide suggested you know call. It one to two points of price in fiscal 'twenty four it sounds like you're expecting another price increase here into the second quarter.
Speaker Change: You know high level are there any real change to the pricing outlook as we think about the top line and how do we think about the contribution to price and price cost as we move through the year, obviously back half will be a little bit easier on the price cost side.
Speaker Change: Yeah. So I think we will see a very slight improvement in price expectations for the year kind of like within that one to two point range that we gave for the contribution to growth from price I'd say, we're feeling more comfortable in the upper end of that range because of the pricing action that Eric had discussed.
Speaker Change: Here in calendar Q2.
Speaker Change: That is one of the things within price cost, that's given us more confidence and I'm, pushing up and being a bit more bullish on the gross margin projection for the year.
Speaker Change: Okay.
Speaker Change: Understood.
Speaker Change: I'll get back in line.
Speaker Change: Thank you and our next question comes from Stephen Volkmann with Jefferies. Please go ahead.
Stephen Edward Volkmann: Hi, good morning, everybody I'm, sorry to be a little bit annoying with a short term question here, but Christian you gave some sequential thoughts around how the year progresses.
Stephen Edward Volkmann: But you didn't really comment on second quarter sales relative to first usually that's kind of flattish, but I know you have a bunch of growth kind of initiatives that maybe start to kick in and just any thoughts on sort of how the year progresses on the topline.
Speaker Change: Yes, Steve I'll take that one so for the for the second quarter, what I would say if you look in the opt out.
Speaker Change: You'll see that December we were below our historical month over month decline, which is which is typically about 8% from November to December so we're off.
Speaker Change: To a slower start in the second quarter, and that's driven by the things Eric highlighted in his prepared remarks, particularly the extended shutdowns and the clamping down in Japan that we really saw accelerate in December.
Speaker Change: That storage really if you look at Q1 to Q2 sequentially. We are down slightly and then I'd say given what we saw in December it's likely that that would be the case, but I'll say, it's really too early to tell at this point it really depends how fast that ramp comes back online in early <unk>.
Speaker Change: Under Q1 like this time last year, we saw sort of a supply dynamic with December and then we felt really nice snap back in January so how quickly that comes online is probably the biggest variable.
Speaker Change: Point.
Speaker Change: Don't know exactly what that's going to look like look like.
Speaker Change: What is in our control when we look forward is the growth that we can drive, particularly in the second half tied to the strategic initiative, we're very.
Speaker Change: Optimistic about that and then obviously any tailwind we're getting from macro the earlier that started the better.
Speaker Change: Okay, Great and then sort of longer term is there any way to ballpark.
Speaker Change: Maybe on a D S basis, or something but the kind of business wins that you think you have for the second half. So that we can get some sort of comfort in how that progressive.
Speaker Change: I wanted to I wanted to size it specifically, Steve what I can what I'll give you a call or two maybe when we look at the strategic initiatives progress on the second half and how we pressure test that internally, we're basically looking at all of what what I'd call kind of call our core growth initiatives, our existing growth initiatives in one inflection opportunity we see.
Speaker Change: So we are pressure testing the wins that we already have the growth that we expect in our largest customers.
Speaker Change: What inclusion opportunities, we see that could come online and then we're looking at where we think public sector sales will sustain and then we're like our class b cells will sustain that were pressured checking all of that and then within the newer things that Eric touched on in the prepared remarks like what kind of benefit do we think we will see from the web enhancements.
Speaker Change: Or the list price repositioning what we're really looking at is a range of outcomes, particularly in our core customer segment and how quickly we could see an inflection in that slice of the business and so obviously you went into the pilots with some assumptions on what that would look like and we're proving those things out through the pilots. So it's still early days, but we are on.
Speaker Change: We are reassured by what we're seeing where we're happy with how the pilots are going and that's giving us confidence in the second half.
Speaker Change: Fair enough, we'll see how that goes thank you so much.
Speaker Change: Thank you and our next question today comes from Chris Dankert with loop capital. Please go ahead.
Chris Dankert: Hey, good morning, Thanks for taking the question I guess.
Chris Dankert: Yep.
Chris Dankert: I guess to kind of pull a thread on that last question a little bit more here is it too early to give us a glimpse that's kind of what level of sales acceleration, you're seeing on those reprice skus versus those that haven't been repriced yet.
Speaker Change: Chris Good morning, I would say so look as Christian described is it and maybe just zooming out for a second looking you know what we're seeing now versus back half obviously when you do the math on what has to happen to a D S and growth rates in the back half. It's a significant step up I think you're looking at sort of three buckets, one is economic improvement.
Speaker Change: Two is the existing overlaying the existing growth drivers, which do have a proven path to them in terms of implant in vending and their contribution to growth and then three what youre hitting at now which is some of the newer ones I would say you know look we're on the on the web price realignment, where 30% of the way.
Speaker Change: Through the process. It's look it's it's still I would say a bit early and I say, it's a bit early Chris, particularly because one thing I did want to highlight we really weren't expecting I mentioned in the prepared remarks that until we're through the entire offering we're not really marketing this actively to customers because it's hard to market.
Speaker Change: <unk> realignment for some skus and not others.
Speaker Change: And so the expectation out of the gate wasn't to see a massive lift I think in the early going with the hypothesis. We were proving out here was particularly around the ability to be margin neutral, which is proven out. So I think the fact that we're actually seeing a discrepancy in performance and it's a couple of areas. One is just in general.
Skus that have been touched versus the ones that had been I would call that a modest difference, but a difference but you know.
Speaker Change: It's a difference and the second thing being some more operational metrics like web conversion rates, which just give us a sense as to how customers are responding to the changes when they see them.
Speaker Change: So I would say the results that we're seeing now are encouraging but still relatively small compared to where we anticipate them going once we actively market. This in the back half would be or the other thing Chris I would say is we're not hinging the entire back half.
Speaker Change: On this initiative by itself because our expectation is this pricing combined with the product discovery on the web will take time and we'll continue building.
Speaker Change: So it's a combination the back half improvement that we need to see that we're assuming in our outlook is based on all three of those factors I've mentioned economy, plus current growth drivers that had been accelerating plus these new ones, but then build as we move through 'twenty four 'twenty five.
Speaker Change: Okay.
Speaker Change: Got it that's really helpful. Thanks, so much Eric.
Speaker Change: And then just touching on the property.
Speaker Change: The ability of improvement what kind of opportunity wrapped up in mission critical here I know, we're getting away from a specific dollar targets, but maybe you can just kind of walk us through some of the initiatives.
Speaker Change: The profitability improvement piece, there and just kind of a confidence level and driving SG&A leverage at kind of hitting the incremental margin target nearer term.
Speaker Change: Yeah, Chris I, you know in in so in the prepared remarks, we hit on story.
In terms of the productivity and what I would say is a mission critical one that over the last three years was capitalizing on some of the low hanging fruit that we saw and that led into the productivity target I would say, we feel at least as good.
Speaker Change: As we did for the last round as we do for this round in terms of productivity. It's just it's different kinds of stuff and so the three anchors are number one is category management. So the category management improvements you know we hit on over the last few quarters. We've talked about line reviews, but line reviews are really just one tactic in what is a bigger objective.
Peer to improved category management performance and excellence and we mentioned a few of the other factors like looking at margin mix management.
Speaker Change: And portfolio optimization kind of all feed into category management most of the benefit we're going to see there is going to be on the gross margin line more so than the Opex line and look I mean, obviously it was one quarter Q1, but we were encouraged because you know we had telegraphed Q1 was kind of the depths of the price cost negativity based upon timing at all.
Speaker Change: Average costing so the fact that we could come out of the gate strong as we did we felt good about and we track back to category management. So I think that that one youre going to see play out on the gross margin line for the most part the second one is the supply chain area.
And you know it's it's it's it's long been a strength of M. S. CS, particularly in the spot buy arena supply chain that is in and what I'm excited about is is the team that Martina has assembled that's now taking you know just a fresh look and it's a combination of some people that have been here a long time and know the ropes at MFC with some new people, bringing fresh thing.
Speaker Change: And fresh ideas and yeah, we had two data points on the supply chain front.
Speaker Change: This quarter freight expense as a percent of sales that came down as it should given given rates, but we saw a nice improvement there and then the second being inventory efficiency.
Speaker Change: I think youre going to see more from us in the quarters to come on the supply chain front I mentioned the team is really doing an end to end look at everything from how we're operating inside the buildings to how we move things across the buildings. So that would be the second one and then third this digital core the systems project, which is really beyond the systems project. It is.
Speaker Change: Going to unlock for US, we we mentioned order to cash and procure to pay which are two would be just the core value streams, how things move through MFC that theres a lot to unlock there that one will be in the later stages of this next chapter I mentioned that the launch of the new system will be sometime around the end of fiscal 'twenty five so that would be.
Speaker Change: Fiscal 'twenty six event for the back half of 'twenty four and 25, you can expect category management to influence gross margin and supply chain on the Opex line.
Speaker Change: Yeah.
Speaker Change: Got you. Thanks, so much for the color there I don't I'll jump back in queue here.
Speaker Change: Thank you and our next question comes from David Manthey with Baird. Please go ahead.
David J. Manthey: Yeah, good morning, everyone and happy new year.
David J. Manthey: Good morning, Dave.
Speaker Change: First off could you give us your mindset head.
Speaker Change: Cow for fiscal 'twenty four.
Yeah sure Dave I, you know, what we've talked about.
Dave: So far is you know we saw the softening beginning last quarter and that we were going to temper hiring.
Dave: And that's essentially what you saw from us.
Dave: In the first quarter. So if you look head count in total is up.
Dave: More than 100% of the increase came in sales.
The rest of the business head count in support functions head count was actually down.
Dave: Up in sales and being up in sales is really a function of two things one was supporting the growth in the vending and the implant signing specifically.
As you can imagine the more of those we have the more support there is so we viewed that as a good thing and the second was some some other select basically investment opportunities on the front end of the business to drive growth. The rest of the business was down I would say the M. O. We're following right nowadays is reflective of the environment, which in which we.
We are operating so we were viewing the current step down in growth as fairly shallow.
Dave: And fairly temporary as evidenced by our outlook for the back half of year and so we're taking an approach to head count that's moderating and certainly I think you'll continue to see that temper, but not a dramatic drop I think you know if we were operating in a different sort of environment you'd see a different playbook.
Speaker Change: Got it and then.
Speaker Change: Could you discuss your thoughts on growth versus IP, this quarter and related to that.
Speaker Change: You clearly are expecting some economic improvement as we move through the year, but does your outlook also assumes we established 400 basis points of outgrowth later this fiscal year.
Speaker Change: Yeah, Dave that that is certainly yes. The short answer is yes, and and definitely we saw it compress here from.
Speaker Change: From everything we can see Dave we don't see a change in relative market share position in terms of what's behind the compression in growth relative to IP.
Speaker Change: And a lot of it was a function of some spend contractions of inventory burn.
Speaker Change: Things beyond just output.
Speaker Change: That disproportionately affected us so the short answer is yes, our expectation and our focus is still on outgrowing IP by at least 400 bps.
Yeah.
Speaker Change: Thank you very much.
Speaker Change: Yeah.
Speaker Change: Yeah.
Speaker Change: Thank you and our next question today comes from Patrick Baumann with Jpmorgan. Please go ahead.
Patrick Baumann: Oh, Hi, good morning, Thanks for taking my questions.
Patrick Baumann: What is that.
Patrick Baumann: I'm just on the web pricing realignment.
Patrick Baumann: Okay.
Patrick Baumann: Can you talk program and what it entails.
Patrick Baumann: And the reason I'm asking is I just remember in the past you had some pilot programs you had done for things like sales force changes you had made.
Patrick Baumann: And then when it rolled out more broadly the impacts were different than what you had seen on the pilots.
Speaker Change: Just wanted to check your confidence on the accuracy of the read on the sales lift in the in the neutral margins versus the control group.
Speaker Change: Yeah, Pat sure. So what I would tell you is you know the.
Speaker Change: First of all what we're doing the goal is to present.
Speaker Change: We've had web pricing for a while.
Speaker Change: But for customers that don't interact with us often and have a structured escape discount program, there's cases, where those arent competitive. So the goal is to create a market competitive price for any customer that wants to come to us. So that's the objective.
Speaker Change: I mentioned worth 30% of the way through it and I think where you're going is how accurate read is the 30% look I think it's it's it's pretty good it's not 100% for sure. So there's still it's certainly is there uncertainty of course, but I would say that in terms of the degree to which we're managing this project.
Speaker Change: The the rigor that we're bringing is really sound. So this fits with Martina and her team I can tell you that we're getting Kristian mentioned some.
Speaker Change: Some some expenses related to that most of that is getting some outside expertise from folks who have a.
Speaker Change: Specialists in this but our team has met with a combination.
Speaker Change: Of our own team and some help managing this on a daily stand up basis. So the visibility there transparency is really high and so my confidence is high.
Speaker Change: And so what what percentage of the.
Speaker Change: Of the business is is actually going off it at that.
Speaker Change: The printed what price these days.
Speaker Change: It's still a relatively low percentage, but it's not something that we are you can imagine competitively sensitive, but it's not something we do.
Speaker Change: Probably.
Speaker Change: In terms of the price changes on the 30% of the Skus was it.
Speaker Change: Timing wise that that happened late in the first quarter and is the net price on those skus negative. After the changes are there an equal or is there like an equal number of SKU price increases and decreases.
Speaker Change: So what I would say is yeah. It happened a little more than halfway through our fiscal first quarter.
Speaker Change: And in terms of there was a balance so you can imagine there were some prices that went down somewhat up I would say there were more that went down.
Speaker Change: That went up but along with that came you know in the past that the pricing were higher our salespeople are inside salespeople would really have to jump through hoops with the customers. So along with that came some discounting guardrails.
Speaker Change: And that's how you get to a margin neutral outcome.
Speaker Change: Got it Okay, and then and then it seems like.
Speaker Change: Given the 1% to 2% price outlook that youre, maintaining and seems like tracking favorably to they're there isn't much.
Speaker Change: Drag from this initiative.
Speaker Change: That you expect and then there also isn't much deflation coming through it seems like.
Speaker Change: Maybe you could provide some color on are there any product categories, where you're seeing customers push back on pricing at all.
Speaker Change: Or is it just that.
Speaker Change: Is it basically just kind of a stable outlook.
Speaker Change: Further pockets of cost increases.
Speaker Change: Sorry to interrupt you I I would describe the environment.
Speaker Change: And the word I used in the prepared remarks is stable it's been unusual in our history to see meaningful price deflation on our products and I would say, we're not seeing it now you know if anything there's more going up than.
Speaker Change: And then anything but it's relatively stable I mean, the price increase is not going to be a major event, but we did want to share. It is noteworthy because I think you know and you're concerned about price deflation, we're not we're not seeing it.
Speaker Change: In terms of the price drag from the web pricing initiatives, you know again, our goal for the whole program beginning with the first tranche was roughly margin neutral. So what that means is any drag from where they were more prices down coming up gets buffered by improvements to discounting disciplines, we made and that's what we saw.
Speaker Change: Understood. Okay. Thanks, so much for the color best of luck.
Speaker Change: Thanks Pat.
Speaker Change: Thank you and ladies and gentlemen, this concludes our question and answer session.
Speaker Change: I'll turn the conference back over to Ryan Miller for closing remarks.
Ryan Miller: Thank you for your time and interest this morning as a reminder, our two to fiscal 'twenty four earnings call date is set for March 28, we look forward to seeing you in person at conferences and other investor events in the coming months again. Thank you for your time. This now concludes our call.
Speaker Change: Thank you ladies and gentlemen, you may now disconnect your lines and have a wonderful day.