MSC Industrial Direct Q1 2025 Earnings Call Transcript

Quartr
Provided by Quartr
January 8, 2025

There are 8 speakers on the call.

Operator

Please note this event is being recorded. I would now like to turn the conference over to Ryan Mills, Head of Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, and good morning, everyone. Welcome to our Q1 fiscal 2025 earnings call. Eric Gershwin, Chief Executive Officer Martina MacIsaac, President and Chief Operating Officer and Kristin Agnes Grande, Chief Financial Officer are on the call with me today. During today's call, we will refer to various financial data and earnings presentation and operational statistics documents, both of which can be found on our Investor Relations website. Let me reference our Safe Harbor statement found on Slide 2 of the earnings presentation.

Speaker 1

Our comments on this call as well as the supplemental information we're providing on the website contain forward looking statements within the meaning of the U. S. Security 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 are noted in our earnings press release and other SEC filings.

Speaker 1

Lastly, during this call, we may refer to certain adjusted financial results, which are non GAAP measures. Please refer to the GAAP versus non GAAP reconciliation 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.

Speaker 2

Thank you, Ryan, and good morning, everyone. Thanks for joining us today. Let me start by wishing all of you a happy and healthy New Year. On today's call, I'll reflect on our recent results and the progress of our mission critical program. I'll then cover the current operating environment and provide some longer term perspective before turning over the call to Martina and then Christa.

Speaker 2

Before getting into the details, I'll start with a brief state of the company. We delivered a solid Q1 that exceeded our expectations driven by higher than anticipated revenues. While it was a good start to the year, we're mindful that the near term environment remains soft and our company remains in a transition period during fiscal 2025. Looking beyond the near term, we remain committed to restoring growth and to achieving the objectives for market share capture and margin expansion that we outlined at the start of this mission critical chapter. The combination of an improving macro outlook in calendar 2025, longer term secular tailwinds and our slate of growth and productivity initiatives all make for a compelling opportunity for for us to deliver on our mission critical targets.

Speaker 2

Let me now turn to the specifics of the quarter. I'll begin on Slide 4 with an overview of our results and an update on our mission critical progress. Average daily sales declined 2.7% year over year. This came in ahead of our guidance range of a decrease of 4.5% to 5.5%. Growth in the public sector and sustained momentum in solutions were the primary drivers of our top line performance.

Speaker 2

Additionally, it's worth noting that we had a strong November with a return to growth. While certainly a positive sign, we are not viewing November alone as an inflection point as the month benefited from some large orders and the timing of a late Thanksgiving, which shifted a greater amount of shutdown activity into the December holidays. Gross margin of 40.7% was in line with our expectations. Thanks to solid expense controls, we were able to absorb our higher than expected revenues without much incremental expense. This resulted in an adjusted operating margin of 8%, also above our expectations.

Speaker 2

Free cash flow conversion of 179% was also particularly strong during the quarter. And while these results are encouraging, we still have work ahead of us in restoring performance to meet the standards that are set by our mission statement. We have a slate of opportunities under our mission critical program that are well within our control. I'm encouraged by the trajectory of improving execution. As a reminder, our mission critical program is comprised of 3 pillars.

Speaker 2

1st, we continue to maintain momentum in our high touch solutions offering. On a year over year basis, we improved our implant program count by 29% to 369 programs and total installed vending machines by 10% to more than 27,000 machines. 2nd, while core customer growth rates remain suppressed, progress on reenergizing the core customer continues. This begins with enhancements to our e commerce platform and messiedirect.com. During the fiscal quarter, we made further progress on improving overall site performance, the shopping experience, navigation and product discovery.

Speaker 2

We provided customers with digital versions of MSC's marketing suite of materials, including our well known big book on our website. We improved search relevance and streamlined the number of clicks and navigation. These improvements are beginning to make their way into important leading website indicators along with customer net promoter scores. Further improvements will continue to roll out through the balance of our fiscal second quarter. And we plan to launch enhanced marketing efforts during the back half of our fiscal second quarter.

Speaker 2

Re energizing our core customer will also be aided through the sales force optimization efforts that Martina outlined on the last call, And she'll provide a progress update on that in just a bit. Another new element to our growth formula that we introduced this mission critical chapter is accelerating our OEM category through cross selling with the broader MSC portfolio. This is made up of primarily fasteners, but also includes other product lines such as clamps, fittings and more that end up in our customers' finished product. We've seen significant acceleration in cross selling activities and hence our opportunity funnel. And that funnel is beginning to translate into results as the OEM category showed healthy growth year over year in our fiscal Q1 and we expect momentum to continue this quarter.

Speaker 2

3rd, we're making progress in optimizing our cost to serve. This includes the subset of actions from our network optimization initiative and our enhancements to drive productivity in the field that we shared last quarter. Martina will also provide more color on these shortly. Switching to the macro environment, as you can see on Slide 5, the IP readings across most of our top manufacturing end markets continue to contract and weigh on our performance against the overall IP index. Automotive and heavy truck, primary metals, fabricated metals and machinery and equipment continue to be soft.

Speaker 2

Aerospace, while a net positive for us in the quarter, experienced the step down related to strikes that have since been resolved. Additionally, manufacturing and metalworking related softness continues to be reflected in MBI readings, which have now been contracting for 22 consecutive months. These soft demand levels evidence themselves in our fiscal December, which ended on January 4th with average daily sales declining approximately 8%. It's worth noting that the 1st 3 weeks of the month looked consistent with our fiscal Q1 performance. December was heavily weighed down by the last 2 weeks as the timing of the Christmas and New Year's holidays along with the timing of our fiscal calendar proved to be a significant headwind.

Speaker 2

The last week of our fiscal month was particularly weak on a year over year basis. This year with New Year's falling on a Wednesday, the final week performed like a holiday week, whereas last year with New Year's falling on a Monday, the comparison was against the more typical business week. Kristen will provide more detail on what this implies for our Q2 outlook. While we remain in a transition period during fiscal 2025, we are fully committed to restoring our company's growth trajectory as we look past the near term. Let me now provide more specifics behind the factors that give us confidence in our ability to do so.

Speaker 2

First, future prospects for North American manufacturing are promising, driven by increased focus on reshoring and incremental manufacturing investment into the U. S. 2nd, we are well positioned to help our customers navigate any pressures that arise from tariff policy. We see benefits from our lower non domestic exposure. For reference, approximately 10% of our cost of goods sold are sourced from China and we have low single digit exposure in Mexico and Canada.

Speaker 2

Additionally, we have a strong MSC specific made in USA product offering that spans well over 100,000 SKUs across a number of categories. As an example, our AccuPro brand of high performance cutting tools is sourced domestically and represents a great option for customers looking for performance tooling while being shielded from tariff impacts. Beyond our product offering, MSC's technical expertise and ability to drive operational savings on the plant floor are powerful tools helping customers offset cost pressures. We saved our customers over $500,000,000 in our fiscal 2024 and plan to build on that success this fiscal year. 3rd, we see runway to continue growing where we've already been successful.

Speaker 2

This includes our inventory management and implant solutions offering and targeted high growth end markets such as aerospace, medical, Department of Defense branches of the federal government and more. 4th, the MSC growth and productivity initiatives that we outlined for you on these calls are not yet realized in current results and are poised to improve our performance as we move through the fiscal year and into fiscal 2026. And with that, I'll turn things over to Martina.

Speaker 3

Thank you, Eric, and good morning, everyone. As Eric mentioned, we outlined a series of initiatives for this fiscal year during our Q4 earnings call. These initiatives were aimed at driving productivity in our distribution network and selling operations, and I'm pleased with the progress made during the Q1. To start with selling operations, we've launched a series of initiatives designed to maximize the coverage and effectiveness of our sales team. A major element of this work focuses on sharpening the deployment of our highly trained field team through better territory design to maximize seller potential.

Speaker 3

We launched the first changes prior to the start of the fiscal year with a redesign of our public sector coverage, the effects of which are starting to be seen in the Q1 results in that market. For national accounts, we completed this work at quarter end. For our core customers, our territory design is complete and we expect to complete implementation by the Q3. Early findings support our expected results. For example, we estimate that in the 1st 7 weeks of the program, we now have expanded coverage for 20,000 active buying customers or locations.

Speaker 3

In December, we saw an increase of over 2,500 customer touches for those newly engaged accounts. Additionally, where routes have been optimized, we're making better use of our sellers' time by freeing up a minimum of 2 selling hours per week. All of this work is further supported by changes in our training and onboarding processes for all roles designed to maximize hands on learning and accelerate independence for new sellers. Moving on to network optimization, we remain on track with the expected savings of $10,000,000 to $15,000,000 to grow through the the fiscal year and achieve full run rate in fiscal 2026. As a reminder, these efforts are centered on the following three initiatives.

Speaker 3

1st is to streamline the supply chain of our OEM fastener Seapart categories by consolidating demand planning and procurement. 2nd, we're upgrading our use of technology in our system wide inventory planning and allocation function to ensure that we have the right inventory as close to the customer as possible. And lastly, we're optimizing our management of inbound and outbound freight to reduce split shipments and lower reliance on higher cost airfreight. All initiatives are on track to deliver planned savings. As it pertains to our OEM and Seaport consolidation, having this work in progress puts us in an excellent position to navigate the potential impact of tariffs.

Speaker 3

As Eric said, roughly 10% of COGS are sourced from China and this team is already working to consolidate volume for procurement synergies. We began taking proactive measures to ensure that we are well protected. On the larger tariff question, we've taken a series of actions including stocking inventory of our highest turn products that would be impacted by tariffs and developing marketing campaigns of our made in the USA products. We have a cross functional SWAT team in place to oversee these efforts and plan to treat any tariff related costs as a supplier price increase. On the freight and planning initiatives, we continue to make progress adjusting and balancing inventory.

Speaker 3

The work we have done on statistical planning is reflected in the year over year reduction in inventory of approximately 73,000,000 dollars I was especially pleased with the sequential reduction in our inventories of roughly $7,000,000 especially given that Q1 also reflects actions associated with year end buys and early tariff actions. Lastly, I would like to highlight that we continue to strengthen our leadership team. We're happy to welcome Derek Collier as our new VP of Supply Chain Operations. Derek brings over 20 years of experience in distribution operations, including 13 years at Walmart and Amazon. I'm confident that Derek will play a successful part in driving efficiencies throughout our network.

Speaker 3

And with that, I will turn the call over to Kristin to cover our financial results in more detail.

Speaker 4

Thank you, Martina, and good morning, everyone. Please turn to Slide 6, where you can see key metrics for the fiscal Q1 on both the reported and adjusted basis. Fiscal 1st quarter sales of $928,000,000 declined 2.7% year over year and exceeded our prior expectations of a 4.5% to 5.5% decline. Lower volumes were the primary driver of the year over year decline, which was partially offset by benefits from acquisitions. Sequentially, average daily sales declined 90 basis points and underperformed the historical quarter over quarter average as conditions moderated across our primary manufacturing end markets.

Speaker 4

By customer type, we are pleased by the return to growth in the public sector with a 9.8% improvement year over year. National accounts declined 1.6% year over year, while core and other customers declined 5.3%. Sequentially, average daily sales were roughly flat for core and other customers, while national accounts and public sector sales declined a little less than 2%. From a solution standpoint, as Eric mentioned, we continued to expand our footprint in the Q1. However, the average daily sales performance of these solutions reflected the current demand environment as the growth of our installed base was largely offset by lower levels of activity.

Speaker 4

In vending, 1st quarter average daily sales were up 5% year over year and represented 18% of total company net sales. Sales through our implant programs grew 5% year over year and represented approximately 17% of total company net sales. As a reminder, this information can be found in the operating statistics posted on our website. Within the op stats, please note that we reclassified our customer end markets to align with the North American Industry Classification System. Moving to profitability for the quarter, gross margin declined 50 basis points year over year to 40.7% as expected.

Speaker 4

This was driven by higher priced inventories working through the P and L and a headwind from acquisitions of approximately 20 basis points. Operating expenses in the Q1 were approximately $304,000,000 on both a reported and adjusted basis. On an adjusted basis, operating expenses were up approximately $14,000,000 year over year, primarily driven by the combination of personnel related costs, investments and carryover operating expenses from acquisitions, which were partially offset by productivity. Combined with lower sales year over year, this resulted in a 2 40 basis points step up in adjusted operating expense as a percentage of sales for the quarter. Sequentially, adjusted operating expenses were up $7,000,000 as expected.

Speaker 4

This is primarily related to the reset of variable incentive compensation programs entering the fiscal year, other personnel related costs and modestly higher D and A. Reported operating margin for the quarter was 7.8% compared to 10.6% in the prior year. On an adjusted basis, operating margin of 8% declined 2.90 basis points year over year. We delivered GAAP EPS of $0.83 compared to $1.22 in the prior year quarter. On an adjusted basis, EPS was $0.86 compared to $1.25 in the prior year.

Speaker 4

Now let's turn to Slide 7 to review our balance sheet and cash flow performance. We continue to maintain a healthy balance sheet with net debt of approximately $463,000,000 representing roughly 1.1 times EBITDA. Working capital continued to be a favorable source of cash during the quarter. This resulted in another strong quarter of operating cash flow to the tune of $102,000,000 Capital expenditures of $20,000,000 increased approximately $2,000,000 year over year, resulting in free cash flow of $82,000,000 dollars This represented approximately 179 percent of net income. Turning to capital allocation on Slide 8.

Speaker 4

Our priorities remain unchanged with organic investment to fuel growth and operational efficiencies being first in the pecking order. Additionally, we will continue to pursue our strategic bolt on M and A strategy and allocate capital to shareholders. The repurchase of roughly 150,000 shares combined with the dividend resulted in returns to shareholders in excess of $60,000,000 during the quarter. Moving to our expectations for the fiscal Q2 on Slide 9. The timing of holidays and heightened customer shutdown activity resulted in an average daily sales decline of approximately 8% in the month of December.

Speaker 4

Given the slow start to the quarter and limited visibility on trends in the new calendar year, we are taking a wider approach to our quarterly sales outlook and expect 2Q average daily sales to decline 3% to 5% year over year. This range assumes January February average daily sales performed similar to the Q1 at the low end of the range and to November levels at the high end of the range. Additionally, the midpoint of our outlook implies that January February ADS are down approximately 2% year over year. We expect our adjusted operating margin for the Q2 to be largely influenced by our sales outperformance and ultimately fall in the range of 6.5 percent to 7.5 percent under the following assumptions. Gross margins of 40.8 percent plus or minus 20 basis points and within operating expenses, productivity to partially offset sequential increases in personnel related expenses and depreciation and amortization.

Speaker 4

Turning to Slide 10, our expectations on certain line items for the full year remain unchanged. As a reminder, this includes depreciation and amortization expense of $90,000,000 to $95,000,000 or an increase of $10,000,000 to $15,000,000 year over year, interest and other expense of roughly $45,000,000 dollars capital expenditures, including cloud computing arrangements of $100,000,000 to $110,000,000 a tax rate between 24.5% to 25% and lastly, free cash flow generation of approximately 100 percent of net income. To assist in modeling the cadence of sales for the remainder of the fiscal year, the bottom of the slide provides historical quarter over quarter averages and key considerations. And with that, we will open the line for Q and A.

Operator

We will now begin the question and answer session. The first question today comes from Steven Volkmann with Jefferies. Please go ahead.

Speaker 5

Great. Thank you for taking my question. Christian, I'm sorry, I just missed your commentary around gross margin, plus or minus 20 bps. But can you just say that again?

Speaker 4

Yes. Steve, were you referring to the Q2 commentary on gross margin in the prepared remarks? Yes. Yes. So for the Q2 and this really stands for the year, we had said previously, we expect throughout the year gross margin to be roughly plus or minus 20 basis points.

Speaker 4

For the Q2 specifically, I'd expect it to be fairly flat to Q1. In the second half, there is some potential for improvement there, potentially to the top end of that range. What we would be looking for in order for that to happen, A few things, I'd say, 1st, neutral price cost, potentially even slightly positive. 2nd item we're looking at carefully is productivity improvements sequentially through the year. Martina covered some detail on what those programs were.

Speaker 4

Some of that hits OpEx, of course, but some of it also does hit cost of goods sold. Wildcards against that though that we don't have great line of sight to are the mix impact, which as you know has been a headwind lately. There's the potential for that to improve depending on the inflection in core. And then the other thing that's hard to predict is the top line. The stronger the top line, the easier it is to expand gross margins.

Speaker 4

And really beyond the second quarter, if we had better insight on those last 2, we'd be giving more specific guidance. But as Martina mentioned on the productivity initiatives, like we're really focusing the team internally on what we can control within that, which is the price cost management, delivering the productivity, executing on the initiatives that drive the core growth inflection. And maybe last item to point out, Steve, to put a finer point on the end of the gross margin discussion for forward looking, none of this includes impact from tariffs, which if that happens, and of course, we don't know size or timing, we would anticipate moving on price similar to the start of an inflationary cycle. So all of that comment excludes tariff impact.

Speaker 5

Great. Understood. So just pulling on that thread a little bit. Presumably, if we get into an inflation type situation, that should actually be a gross margin tailwind for you normally. Is there any reason that would be different in Please

Speaker 4

go

Speaker 2

ahead. Hey, good morning, guys. Good morning, guys. Good morning, guys. Good morning, guys.

Speaker 2

Good morning. Good morning, guys.

Operator

Please go

Speaker 2

ahead. Hey, good morning guys.

Operator

Hey, Ken.

Speaker 2

Good morning, Ken.

Speaker 6

Morning. Maybe for my first question, Kristen, sorry if I missed this, but can you just remind us how much in savings from the productivity initiatives you're expecting on SG and A dollars in 2Q? And then just a follow-up with that is maybe just some color on how you think about OpEx as we move through the back

Speaker 2

half of the year, just because the

Speaker 6

easy comps start to show up in your fiscal Q3, but I'm just curious that there are some items that we should be aware of on how SG and A levers if that revenue does start to stabilize in the second half?

Speaker 4

Sure. Yes. So Ken, specific to Q2, I'm expecting productivity to improve slightly. We delivered about $5,000,000 of productivity in the Q1 in the OpEx line. So I think we'll do a little bit better than that in Q2.

Speaker 4

Beyond that, what we've said for the year is a range of productivity between $15,000,000 $25,000,000 in operating expense. The initiatives that Martina covered, as we talked about last quarter on an annualized basis, those initiatives specifically are worth $10,000,000 to $15,000,000 but they're going to ramp inside the second half. So not sure if your question was specific to some of that newer stuff, but on a full year basis, if you think about where we're expecting OpEx to land, we're anticipating $15,000,000 to $25,000,000 of productivity.

Speaker 6

Right. I guess the question is, are really kind of driving towards what you think what the core incremental margins could be because again you're down I think ADS is down like high single digits of the comp is starting in the Q3. I know the decrementals don't really make sense this quarter last quarter, but is it fair to assume that you're not necessarily expecting a reverse in those in that operating leverage decremental to incremental here in the second half?

Speaker 4

Yes. I mean, it's really noisy to your point. You look at decrementals and incrementals in the year because of a lot of that is because of actually OpEx level. So I think to answer it differently, Ken, I think how you originally asked it. If you're trying to think about modeling OpEx in the second half, I would still use kind of the general rule of thumb of taking 8% to 10% of variable cost on top of whatever revenue number you're modeling for second half.

Speaker 4

And then we'll get more specific as the quarters roll forward here. But I think if we've got the 40.8% gross margin plus or minus 20 basis points and then you use that rule of thumb of second half OpEx being tied to really just where you're putting your top line based on that variable OpEx rate, that should get you close to what we're what we do have line of sight to at this point. And of course, as we talked about, the revenue is really the bigger unknown for us that we're watching carefully.

Speaker 1

And then I would say that 8% to 10% variable OpEx, that's whatever your growth assumption is in the second half relative to the first half. So first half versus second half is that 8% to 10% variable OpEx we're talking about.

Speaker 6

Got it. That's helpful. And then just my last question here. I understand that visibility is clear as mud right now, but maybe just what you're seeing from your larger customers on the OE Automotive and OE Aerospace side. I know that's about 20% of your sales today.

Speaker 6

Just any color on the pull rates relative to last quarter? And is there any commentary on their visibility?

Speaker 2

Yes. Ken, it's Eric. So good morning. Look, I would say in the prepared remarks, the overarching theme is the conditions in our world of metalworking and heavy manufacturing are still soft. So most of the end markets automotive certainly has been soft, but I would say that word can carry through all end markets probably with the exception of aerospace, which has been strong.

Speaker 2

It remained positive for us, definitely a little choppier over the last quarter because of the residual effects of the strike, which have since sorted themselves out. So, we would expect aerospace, the outlook to be good. That notwithstanding, generally soft conditions. I mean, 2 data points I'll give you that just put a finer point on it. So, if you look, we talked about our vending growth and our implant growth.

Speaker 2

And we feel really good about those 2 programs. But if you parse them out and look at an average daily sales per machine, so if you normalize for signings, vending so these are our best customers, some of our largest customers, vending average daily sales per machine down mid single digits, implant where our penetration and our market share position is perhaps the best, average daily sales per program down in the low double digits. So that'll give you a feel for conditions and customers clamping down on spend. I will say though that there's certainly post election, there is some more optimism weaving into the discussions and the outlooks that we're having we're hearing about from customers. So look, we're cautious.

Speaker 2

As you said, visibility is clear as mud, especially for us. This call is always a tricky one. We're coming off of this was a really wonky holiday period, which I'm sure we'll touch on at some point during the Q and A, and we barely have any window into January. So, we're cautious. But I will say there is some more optimism weaving into our conversations with customers about 'twenty five outlook.

Speaker 6

Really helpful. Thanks, Eric.

Operator

The next question comes from Tommy Moll with Stephens. Please go ahead.

Speaker 1

Good morning and thank you for taking my questions.

Speaker 2

Good morning, Tommy. Hey, Tommy.

Speaker 1

Kristen, one last maybe last item on OpEx just to make sure everyone's on the same page. Can you just bridge us from the $304,000,000 that you just reported sequentially, in the past you've given us some helpful bridging items, just the pluses and minuses on the fixed items that will change and then I assume the $8,000,000 to $10,000,000 variable assumption holds for Q1 to Q2 as well. But anything you can do to provide granularity there is always helpful.

Speaker 4

Yes. So Tommy, Q2 OpEx sequentially from Q1, we're expecting to be roughly flat. Within that, there's a couple of moving pieces. So we do have another step up coming in personnel related expenses, which is typical for us at this time of year. Another small increase coming in D and A.

Speaker 4

And then we do expect that to be offset by 2 things. 1 is a little bit more productivity than we saw in the Q1. And then the second would be the decrease on the top line if you apply that 8% to 10% of variable OpEx on that. That's the puts and takes to get you back to basically flat to Q1.

Speaker 1

And then just going forward from there, Kristen, other than the 8% to 10% variable, which will be a function of revenue in the second half, are there any other personnel D and A, whatever other items you would call out?

Speaker 4

Yes. So D and A does continue to increase sequentially. I think without going into more of a specific number for the Q3 and the Q4, Tommy, maybe what you're thinking of is some color we gave on the full year around sort of certain categories of expenses that we know on a full year basis are going to go up, which is one of the big challenges we're facing in 2025.

Speaker 2

That really weighed on the December growth rate. So in essence, what you're getting for Q2, if you look past December and look at January, February, it isn't much different from Q1.

Speaker 1

Thank you, Eric. I'll turn it back.

Operator

The next question comes from David Manthey with Baird. Please go ahead.

Speaker 2

Yes. Good morning and Happy New Year, everyone. Happy New Year. Happy New Year, Dave. First question, I guess I'm going to go back to the OpEx laundry list here.

Speaker 2

The one thing that hadn't been mentioned was the savings from the Columbus distribution center. Did that $5,000,000 to $7,000,000 accrue to the Q1 as expected? Are the benefits greater in the Q2? Or is that already incorporated in the run rate? And then, and a refining question here on the compensation, I think you said merit increased $7,000,000 I think that's the variable compensation component.

Speaker 2

But then, Kristen, you mentioned higher personnel expenses, which sounded different, whether that's wages or health care or whatnot. Could you talk about those things? And then on that personnel expense, does that also step up? I think you get a full quarter of the merit, so that's going to be a little bit higher sequentially. What about the other personnel costs?

Speaker 2

Thanks.

Speaker 4

Yes, sure, Dave. So first part of your question on Columbus, yes, still tracking comfortably in that $5,000,000 to $7,000,000 range. That was about half of the productivity that we saw in Q1 and that's really at run rate by quarter now. Most of that work was kind of wrapped up at the end of our fiscal Q4. So we see a pretty equal benefit through each quarter of fiscal 2025.

Speaker 4

And then second part of your question on the OpEx, you touched on the personnel related expense. So we're wrapping up a few things in that bucket. And I think the $7,000,000 so we quoted a $7,000,000 sequential increase Q4 to Q1 OpEx, which I think is what you were referring to within that. The largest kind of candlestick in the bridge is a personnel related expense increase of $9,000,000 sequentially. And then to your point, that includes a few things.

Speaker 4

So it does include the merit increase you mentioned, which we have 1 month of incrementally in our Q1. We also had a slight step up from benefits inflation. And then the biggest piece though within that $9,000,000 dollars is the reset of the variable compensation program. That's a little bit more than half of it. And then I think I heard you comment on merit increase in 2Q.

Speaker 4

Yes, you're correct. We would see another step up sequentially in the Q2 of about $4,000,000

Speaker 2

Perfect. Thank you. Then with all of the administration change and the saber rattling, one of the key themes we've heard a lot about is government efficiency. And it seems like if the government is looking at streamlining or consolidating purchasing that might be an opportunity for MSC. I know it's kind of blue sky, but maybe you could comment on how you see that opportunity if at all?

Speaker 3

Sure. Thanks, Dave. Good morning. This is Martina. So when you think about our public sector business, about 2 thirds of it is federal today.

Speaker 3

Now the majority of that is weighted towards military and defense. So we don't see a lot of change or we don't anticipate that the administration would drive a lot of change there. We do see that based on our own public sector restructuring, what we have done is specialized sellers now at all levels of the government and increased our level of investment there as part of our sales effectiveness program. So I think we are poised to take advantage of any change that comes. So we don't really see any downside risk.

Speaker 3

And as you say, we see that there might be some upside.

Speaker 2

Thanks again. Appreciate it.

Operator

The next question comes from Chris Dankert with Loop Capital. Please go ahead.

Speaker 1

Hey, morning. Thanks for taking the questions.

Speaker 2

Hey, Chris.

Speaker 1

I guess just going back to the tariff conversation. I think last time around, a lot of those tariffs were treated as discrete surcharges. You mentioned in the prepared remarks the expectation you can treat that as a supplier price increase. Any reason for the shift in applicability here?

Speaker 2

Chris, I'll take it. No, I think, look, what we wanted to get across was that, I think, well, first of all, there's still a lot of uncertainty. Something is likely coming. We don't know how much and we don't know when. What we wanted to get across is we're prepared.

Speaker 2

We have a playbook. We've dusted off the playbook. A team is ready to go. I think we'll see how it plays out, Chris, but more or less, we would follow a similar playbook. What we were trying to convey was that we would move in whatever form, we will move on price as warranted.

Speaker 2

And remember, Chris, there's sort of like if I think back to last time around, there's 2 inflationary effects on the tariff situation, the direct and then the knock on effect. The direct effect is any imported products going up, and that's where you're referencing surcharges as the more likely means. The secondary effect is more broad based industry wide inflation. So, something like 75% of our sales are through industry branded products, but we're not directly affected by a tariff, but certainly you could imagine tariffs are going to influence list price changes from our manufacturers. And there that would trigger more broad based pricing actions and that's what we're referring to.

Speaker 1

Got it. That's helpful color. Thank you, Eric. And then I guess, when it comes to the enhanced marketing that's going on in the back half of the year, I guess,

Speaker 2

are you able to kind

Speaker 1

of bucket out where that investment spend is going generally? Are we talking about keywords, search? Is it more will there be any kind of discounting in addition to drive traffic? Maybe just kind of help flesh out that marketing investment a bit would be great.

Speaker 2

Sure. So what I'll do and you can imagine this one's a little sensitive competitively, particularly before we're in market, but I'll sort of give you the broad strokes. So the way we're thinking about this is we've got 2 objectives with our marketing efforts. So I'll talk about objectives, with our marketing efforts. So I'll talk about the

Speaker 1

2 objectives and then give you a feel for what sort of programs are we

Speaker 2

looking at to achieve those objectives. So the objectives are basically top of not rocket science, but top of funnel and bottom of funnel. Top of funnel meaning generating more awareness and demand for MSC's product and services. And bottom of funnel would be taking customers who we already have a relationship and increasing retention rates and share of wallet of folks who already know us and come to us. So you can imagine the programs to achieve those are a bit different.

Speaker 2

I tell you that there's going to be a pretty healthy mix in the media used, Chris, and it'll be a combination of digital marketing along the lines you're suggesting. In terms of pricing and discounting, what I would say there is we already have in our arsenal promotional programs and tools that we'll use and leverage more extensively, but it's not like we're making them up brand new. And it'll be a combination of digital, some print, as you know, some heavy focus on website improvements and merchandising and then also some personal outreach between our sales force both inside and outside and prospecting and follow-up calls. So that's the color I'd give you. As we said, it'll be beginning and don't think of this as big bang necessarily.

Speaker 2

It'll more be sort of iterative and incremental in market beginning late in Q2, our fiscal Q2.

Speaker 1

Very helpful color. Thanks so much, Eric, and best of luck to everyone at 25 here.

Speaker 2

Thanks, Chris. Happy New Year.

Operator

The next question comes from Patrick Bowman with JPMorgan. Please go ahead.

Speaker 7

Hi, good morning. Happy New Year. Thank you. Quick one on the sequential daily sales performance in the Q1, it was down 1%. And I think Kristen said core was flattish and national account and public sector was down 2%.

Speaker 7

What surprised you within those customer groups on a sequential basis that drove the upside versus your guidance?

Speaker 2

Pat, I would say I'm not sure I'm going to answer it sequentially. Overall, what I would say is if you look at the exceeding guidance and where it came from, there's a couple of things I'd call out. Number 1, clearly public sector. And public sector looking sequentially is really tricky to do because their fiscal timing is all up, it's end of September. So the sequential view on public sector is not great.

Speaker 2

Look, that team is really performing well. And I give kudos to the leadership team. It's been momentum that's been building for a while. And then add on top of that, Martina touched on some of the early stage seller effectiveness work, sales optimization work that went directly to public sector, just turbocharged what is already a strong team. So we feel really good about that.

Speaker 2

And back to Dave's questions about further opportunities, we feel like strong team well positioned there. The second thing I'd call out is solutions momentum, clearly, vending and implant. So look, while our national accounts growth rate is not where we want it and that number is nothing to write home about, I will tell you under the covers, we feel good about execution there and a lot of that is driven by macro softness. And then look, the third thing I'll say about Q1 and we did mention this in the prepared remarks is that we did benefit. November was particularly strong.

Speaker 2

And there we had some large order activity. We do think the timing of the Thanksgiving holiday being pushed almost a week later in the month probably boosted November and came back to buy us a little bit December. But I would say those are the big drivers behind the Q1 November performance.

Speaker 7

Helpful. And maybe Martina on the selling ops side of things, can you talk about that territory redesign a bit more? You mentioned, I think some things about timing across public sector, national accounts and core in terms of when that redesign would be completed, maybe rehash some of that. And then the 20,000 accounts you referenced that I guess are new because of the redesign, I guess that's across public sector and that's you also mentioned something about 2,700 new touches. Any color on what percentage of underlying accounts this represents for public sector?

Speaker 7

Like how much of an expansion is that on an account basis? And then what is the opportunity across national accounts and core from this redesign in terms of new touches or account expansion?

Speaker 3

Sure. So there's a lot in there. Let me unpack it. Let me pull up the big picture and review what we're doing. And thank you for the question because it's something I'm very excited about.

Speaker 3

So we are basically our goal in the full redesign across all the customer segments, so public sector, national account and core, we want to deploy our sales force as efficiently as possible. So we want to put trained people in front of the best potential. And that obviously has a slightly different flavor in each customer segment, but fundamentally our goal is to look at growth. We believe in the equation that says growth comes from coverage and capacity, which is related to time and competency. So there are pieces of the program that touch on all three for all three segments.

Speaker 3

Public sector was where we moved first and it was fully deployed as we started Q1. So that's where we're sort of seeing the results. But I did not mean to create the impression that those 20,000 accounts were particularly to public sector. That is so far overall what we have done as we've been looking at territory design. So we're trying to design all territories now to cover efficiently, maximize seller capability, maximize customer coverage and some of that results like in the time saving like I shared with you.

Speaker 3

So essentially, we believe that coverage time and touches are going to improve sales development. It's too early yet for me to give you any kind of flavor to forecast impact, but I did want to share those specifics because we're very encouraged with the progress. And as we implement now fully implemented national accounts and implement over the next sort of quarter and a half on core, we'll be able to share more. So design is all done and all things that an implementation is starting now in the others.

Speaker 7

So just to be clear, I just I'm a little confused. So what is the 20,000 accounts represent and what was the 2,700 new touches you mentioned?

Speaker 3

Yes. So the 20,000 accounts have now been pulled into what I would call active coverage. They've been assigned to sellers. And that doesn't mean they weren't actively buying from MSC in the past, but we've designed the territories to include them. Now we haven't maybe implemented in every case the seller change yet, but we know that that design is coming.

Speaker 3

And on the touches, that's in what has been implemented already, we've been able to engage with new customers and new relationships and we do keep track of customer touches and in December we saw that increase.

Speaker 7

Okay, that's helpful. Thanks. I'll leave it there. Appreciate the time.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Ryan Mills for any closing remarks.

Speaker 1

Thank you for joining us on

Speaker 2

today's call. We look forward to interacting with

Speaker 1

you and seeing you guys at investor events and upcoming conferences. And our next earnings call is on April 3rd. Thank you. Bye.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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Earnings Conference Call
MSC Industrial Direct Q1 2025
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