MSC Industrial Direct Company, Inc.

Good morning and welcome to the MSC Industrial Supply 2020 fourth quarter and full year conference call. All participants will be in listen-only mode. Should you need assistance, please signal in a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note that this event is being recorded. I would now like to turn the conference over to John Corona, Vice President of Investor Relations and Treasurer.

Thank you, Constantino, and good morning, everyone. Eric Gershwin, our Chief Executive Officer, and Kristen Actis Grande, our Chief Financial Officer, are both on the call with me. As on our last call, we are all remote, so bear with us if we encounter any technical difficulties. During today's call, We will refer to various financial and management data in the presentation slides that accompany our comments, as well as our operational statistics, both of which can be found on the investor relations section of our website. Let me reference our safe harbor statement under the Private Securities Litigation Reform Act of 1995, a summary of which is on slide two of the accompanying presentation. Our comments on this call, as well as the supplemental information we are providing on the website, contain forward-looking statements within the meaning of the U.S. securities laws, including statements about the impact of COVID-19 on our business operations, results of operations, and financial condition, expected future results, expected benefits from our investment and strategic plans and other initiatives, and expected future growth and profitability. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks is noted in our earnings press release and the risk factors and the MD&A sections of our latest annual report on Form 10-K filed with the SEC, as well as in other SEC filings. The risk factors include our comments on the potential impact of COVID-19. These forward-looking statements are based on our current expectations, and the company assumes no obligation to update these statements. Investors are cautioned not to place undue reliance on these forward-looking statements. In addition, during this call, we may refer to certain adjusted financial results, which are non-GAAP measures. Please refer to the GAAP versus non-GAAP reconciliations in our presentation, which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures. I'll now turn the call over to Eric.

Thank you, John. Good morning, everybody. And let me start by saying that I hope everyone remains safe and healthy. We have a pretty packed agenda this morning, so we'll get right into it. I'm going to begin with a brief overview of our fiscal fourth quarter, and I'll then turn it over to Kristen so she can review the financials with you. After that, we're going to look forward, and we're going to look forward to the next three years to discuss what is the next stage of our transformation journey. We've completed the heavy lifting of our Salesforce transformation and are now focused on accelerating market share capture, and improving profitability. This is a company-wide effort that we're calling mission critical. And mission critical is more than just a project name. It's reflective of our business strategy of serving as a mission critical partner to our customers on their plant floors. And it also reflects the fact that accelerating market share capture and improving profitability and doing so with urgency is mission critical for our organization and our stakeholders. A lot more is coming on this shortly, but I'll first turn to the quarter. And we've provided some highlights on slide three. Our fiscal fourth quarter financial results continue to reflect solid execution in a tough environment. Versus the prior year period, overall sales were down 11.3% or 12.7% on an average daily sales basis. Gross margin was down 40 basis points and operating margin was 9.8% as compared to 10.7% in the prior year. Excluding one-time adjustments, our operating margin was 11.2% down just 30 basis points from 11.5% in the prior year due to implementing effective cost controls. This all resulted in solid earnings for the quarter. As we noted in our August sales release, sales of our non-safety and non-janitorial product lines have continued to improve sequentially through the quarter. Sales of safety and janitorial products also continued growing with year-over-year growth of roughly 20% each month on average and for the quarter. Looking at our performance by customer type, national accounts declined slightly more than 20%, while our core customers declined mid-teens and CCSG was down in the low double digits. Government sales, and that's both state and federal, were up significantly due to the surge in large safety and janitorial orders, partially offsetting the declines in the other customer types. As you may have seen in our operational statistics released earlier this morning, September average daily sales declined 8.5%, and our October estimated sales declined 4.6% and benefited from some large orders. All of this shows that sales levels have continued to lift and have seen a slight increase in the rate of improvement over the past couple of months. Most manufacturing end markets, while showing sequential improvement in the quarter, are still soft. Many national accounts are running one shift as opposed to the two or three shifts they were running pre-pandemic. Our job shop and machine shop customers continue carrying smaller than normal backlogs. These customers remain cautious about spending, and they're burning off inventory as much as possible given continued uncertainty. The persistence of COVID-19 and its potential for future surges is certainly playing a role in all of this. and this caution is reflected in recent sentiment indices such as the NBI, which remains negative on a rolling 12-month average. That said, the readings have improved over the past couple of months and actually reached neutral territory in September. Should this improvement continue, it would bode well for our business and should translate into continued sequential lift in our revenues. In terms of end markets, The softness in industrial demand was broad-based, with acute weakness in heavily metalworking-centric end markets, such as aerospace and oil and gas. There are some pockets of strength in certain areas, but not in our core end markets, which remain suppressed. We continue to hear that local distributors are suffering, and the longer that the weak conditions persist, the more pressure they're coming under. This continues to create market share capture opportunities and we're focused on capitalizing on them. Moving now to gross margins, I remain pleased with our performance. In particular, we're executing well on both the pricing and the purchase cost fronts. We're seeing strong realization from our annual price increase and we're continuing to benefit from supplier programs on the purchase cost line. You'll note that our sequential drop from the third quarter to the fourth quarter in gross margin was on the higher side of the typical seasonal decline. This was strictly the result of mix, and in particular, the sale of PPE-related SKUs. Absent this headwind, we maintained underlying gross margin stability. September and October gross margins continued our recent trending. Price and cost are performing well, but we'll likely have continued PPE mix pressure in the first quarter Similar in size to that of our fourth quarter. Looking beyond the first quarter, as we move past the PPE-related mixed noise, we expect gross margins to remain at levels close to or at prior year. Cash flow in the quarter remains strong and allowed us to repay a significant amount of debt. Before I turn it over to Kristen, I want to take a moment to thank Greg Clark for his interim leadership of our finance team. He and the team did an exceptional job over the past few months, particularly during the COVID crisis. We're grateful, Greg, for your hard work, and of course, you continue to be an integral part of our future efforts. And Kristen, welcome aboard. Welcome to your first earnings call, and we're thrilled to have you. So with that, I will turn it over to you.

Thanks, Eric. It's great to be here, and I am looking forward to the work ahead of us. Over the coming months, hopefully I'll have an opportunity to meet those of you on the phone who I haven't met already, although that will probably be virtual, of course. As Eric mentioned, I'm going to run us quickly through the numbers for our fiscal fourth quarter, and then we'll devote time to discussing mission critical. On slide four of the presentation, you'll find key metrics for the fiscal fourth quarter and full year on a reported basis. Slide 5 reflects adjusted results, and those will be the primary focus of my comments this morning. Our fourth quarter sales were $748 million, a decline of 11.3% versus the same quarter last year. Our average daily sales in the fiscal fourth quarter were $11.7 million, a decrease of 12.7% on an ABS basis versus the same quarter last year. Our operating margin was 9.8% compared to 10.7% in the same period last year. Excluding severance and other costs, our adjusted operating margin was 11.2% versus an adjusted 11.5% in the prior year. Within our operating profits, Eric touched on the items impacting our gross margin, which was 41.6% or 40 basis points below the prior year. So I'll go a little deeper now into our operating expenses. Total operating expenses in the fourth quarter were $238 million, or 31.9% of sales, versus $263 million, or 31.2% of sales in the prior year. This also includes about $11.2 million of costs related to severance and the review of our operating model mentioned on previous calls. You'll see a sizable drop in our total company headcount and our operating statistics. This was the result of actions tied to our structural cost initiative and explains the severance costs in the quarter, which were 8.1 million of the 11.2 million. Excluding those costs, operating expenses as a percent of sales were 30.4%. In the prior year, excluding 6.7 million of costs related to severance, Operating expenses were also 30.4% of sales. Our results for the quarter reflect the swift cost containment measures we implemented due to COVID-19, including temporary reductions in variable hours, in executive and management salaries, temporary suspension of our 401 match, a hiring freeze, and virus-related travel restrictions. We've now reversed some but not all of these temporary actions. For example, in our fiscal first quarter, we restored our 401 match. All of this resulted in earnings per share of 94 cents adjusted for severance and other costs. Earnings per share was $1.09. Turning to the balance sheet on slide seven, we achieved strong free cash flow of $171 million in the fourth quarter. A key driver was the $32 million decrease in inventory from last quarter to $543 million. This reflects typical contraction in a soft environment but also maintains levels that support share capture. We also benefited from a large reduction in receivables. We continue to manage our liquidity very closely. Given the stabilizing environment, we paid down over $300 million of our revolving credit facility in August. as well as $20 million of maturing private placement debt. Our total debt as of the end of the fourth quarter was $619 million, comprised primarily of a $250 million balance on a revolving credit facility, $20 million of short-term fixed rate borrowings, and $345 million of long-term fixed rate borrowings. Cash and cash equivalents were $125 million, so our net debt was $494 million. In September and October, we deployed our strong cash flow by paying down another $120 million of our revolving debt. Overall, our balance sheet and liquidity remain very healthy. I'll turn it back to you now, Eric.

Thanks, Kristen. Turning to slide eight, many of you know that over the past couple of years, we've been working hard to reposition MSC from a spot-by supplier to a mission-critical partner on the plant floor of our industrial customers. Our focus now turns to implementing mission critical to deliver reaccelerated market share capture and a step change in improving profitability over the next three years. We plan to do so with the same sense of urgency that we demonstrated during the pandemic. I'll start with reaccelerating market share capture, which is on slide nine. Our target is to outgrow the markets in which we compete by at least 400 basis points over the cycle. This market share growth capture is indexed against industrial production or the IP index. Our analysis shows that IP is highly correlated with our growth rate over a cycle, and it's a good proxy for the relative health and performance of the end markets that we serve. This is shown on slide 10. IP is not perfect over shorter timeframes, as the aggregate IP index includes some of our non-core end markets as well. Nonetheless, we're going to use it going forward as our primary benchmark as it gives us the opportunity to better measure our performance over time. This does not mean that sentiment indices such as the NBI are no longer important indicators to gauge the state of our markets. They are, but they're less indicative of outgrowth or share capture since they're purely sentiment surveys. Competitor and supplier growth rates also remain relevant, but differences in end market and product line exposure result in different levels of market growth for each of us. Spread above IP over a cycle is, we believe, the best gauge for outgrowth of our markets. Looking over extended periods of time, average IP growth is in the 2% to 3% range. So this implies MSC growth of at least 6% to 7% over a cycle. We believe that the actions we've taken recently and those that we're taking now and into the near future build to this level of outperformance over time. At the same time, we think that we can outgrow the market over the nearer term as well. And so our goal is to exit fiscal 2021 at roughly 200 basis points above IP. Most forecasts indicate a return to low single-digit positive growth for IP during calendar 2021. Adjusting for our fiscal calendar and assuming that these forecasts are accurate, it would mean that we would expect to be growing in the mid-single digits in our fiscal fourth quarter. But that would still be slightly down for the full fiscal 21, taking into account the PPE headwind that we will face primarily in our fiscal third quarter. There are five growth priorities that will deliver this above-market growth. And none of these should surprise you given that they're aligned with the work that I've spoken about previously. What you should take away from this discussion, though, is the details within each and the specific actions and investments that we're making to produce measurable returns. Let me spend a moment on each one. First is metalworking. This is the core of our business. a position where we have leadership today and where we think we can widen our lead. We will do this by building on our talented team of metalworking specialists through hiring and training. We've begun this effort in earnest and plan to add about 25% to our metalworking specialist team over the course of the year. We'll also continue adding to our industry-leading product and supplier portfolio and we'll introduce value-added services to our customers, such as MSC MilMax, an exclusive technology that we just brought to market. It's a proprietary product that, with a simple tap on a machine, uses data and analytics to optimize our customers' machining operations. Early customer response has been very good, and more importantly, MSC MilMax is delivering improvements to their operations. We're now making it available to all of our customers. The second lever, selling the strength of our portfolio. This encompasses investing in our CCSG or Class C consumables business, leveraging the cross-selling that results from it, and leveraging the programs that we've put in place with those supplier partners who have recently invested with MSC in stepped-up programs. Our joint opportunity funnels are growing nicely along each of these dimensions, and we are focused on converting those into new business. The third lever, expanding our solutions footprint. And that includes vending, VMI, and our growing in-plant solutions program. We're finding that bringing these solutions to our customers consistently produces higher growth, better retention rates, and Stronger Lifetime Value. As a result, we're increasing investments into each of them and we're raising our performance expectations. Our goal for in-plant solutions program sales is to double them over the next three years. Our fourth lever is digital. E-commerce has long been a strength of ours and represents roughly 60% of our sales today. However, standing still is not an option. and so we're raising the bar on ourselves to produce a better experience for our customers. We have hired a new leader who is staffing a new team with deep digital expertise. Their focus will be on our website and on other digital tools that bring us closer to our customers and build higher levels of loyalty and retention. This will include a new product information system, a new search engine, a new user experience, and the new front end transactional engine. The fifth lever is diversified customer end markets. While the core of the business is selling into durable metal cutting manufacturers, we're also focused on building scale in other areas that are counter cyclical and that still leverage many of our strengths. Government is a good example of this. It's no secret that we had some execution issues there a couple of years back We've worked hard to rebuild our team and our business, and we're seeing the payoff in the form of accelerated growth rates, which of course have been aided by COVID relief. We plan to continue building on this momentum. Towards that end, we'll be adding hunter roles that are specific just to government. I'll now turn to our second goal as summarized on slide 11, to deliver ROIC, return on invested capital, in the high teens within the next three years. This would imply profit growth of at least the high single digits, and it would also imply incremental margins in the high teens. Again, all of this assumes that IP grows in the ranges that I mentioned earlier on. We launched an operational cost and productivity initiative to deliver on this goal back in fiscal 2020. As you've heard me mention, We expect this initiative to deliver about 200 basis points and costs down on an operating expense to sales ratio basis over the next three years. I'm going to now turn things over to Kristin, who will give you more details on the actions that will define our productivity runway.

As Eric mentioned, a significant part of the mission critical program is to reduce operating expenses as a percent of sales. The cost takeout is going to come from an assortment of programs aligned to three separate tracks. So the first is sales and service, the second is supply chain, and the third is general and administrative costs. Eric covered some of the sales and service initiatives, so I'll elaborate a little bit more on supply chain and the G&A tracks. Let me first say that the productivity comes from a number of projects, and we are tracking each of them closely with several already announced or even executed. For example, under supply chain, we recently announced that we will be closing one of our smaller distribution centers located in Dallas and moving the service to the remainder of our distribution network. We are also stepping up our use of automation and robotics at several of our customer fulfillment centers for packaging. This was started last year in Harrisburg and is now being expanded to Elkhart. These moves will improve our productivity and allow associates to perform greater value-added services. We have also renegotiated our freight contracts and will realize significant savings over the next three years. When it comes to G&A, in our fiscal fourth quarter, we completed a process redesign of our talent acquisition function, which resulted in outsourcing that function. This is allowing us to find talent at a faster pace and reduced cost. Another example is the voluntary retirement program we offered in our fourth quarter. The take-up on the program was very good, as is evidenced by the significant headcount drop in our fiscal fourth quarter. While we will likely reinvest some of this cost savings over time into the five growth initiatives that Eric mentioned earlier, the program will still produce meaningful overall cost reduction. We've also revised our travel policy such that a significant portion of the COVID-related temporary travel cost savings will become permanent. And finally, we're renegotiating indirect spend contracts where we'll see an opportunity for further savings. Stepping back from these examples, just kind of thinking about the overall operating expense dollars, in fiscal 20, we reported operating expenses of $993 million. In fiscal 21, the add-back of costs associated with the temporary cost reduction measures roughly offsets the reduction in variable costs from slightly lower sales. As Eric mentioned, mission critical includes growth investment, and that'll be in the range of about $15 million in our first year of the growth program, which is 2021. This will be more than offset by total structural mission critical savings in 2021 in the range of $25 million. And by the way, this is in addition to approximately $20 million of savings that we've already achieved in 2020. Putting all of this together means that we would expect operating expenses to be slightly down if sales are flat to slightly down in fiscal 21. Now let's dig into 2021 a little bit more to supplement what Eric mentioned earlier on the growth line. On gross margin, we expect the full year to be flat to down 50 basis points year over year. An operating margin framework is shown on slide 13 for GAAP and 14 for adjusted figures. Operating margins will naturally vary based on the sales level. If sales are down slightly, on an adjusted basis, we would expect operating margin to be in the range of 11.2% plus or minus 20 basis points. If sales are flat, we would expect operating margin to be in the range of 11.4% plus or minus 20 basis points. And finally, if sales are slightly up, we would expect operating margin to be in the range of 11.7% plus or minus 20 basis points. And I'll turn it back over to you, Eric.

Thanks again, Kristen. Before we open things up for questions, I'll just close with a brief summary here. Over the next three years, we are implementing a change equation that we believe will accelerate market share capture and improve profitability. On the growth side of that equation, we're targeting growth rates of at least 400 basis points above market over the cycle by investing in the five growth levers I described earlier. Our investments will be funded by costs being taken out of the business, and we're looking to grow profits faster than sales. This will enable us to improve returns on invested capital into the high teams. All of this is aligned with our ongoing work to reposition MFC from a spot-by supplier to a mission-critical partner on the plant floor of our industrial customers. The results will not come overnight, particularly given that we're still dealing with the uncertainty being driven by COVID-19. However, you saw some early actions being taken in the fiscal fourth quarter, and more is to come. As we move into fiscal 2021, despite the uncertain environment, we're going to press ahead with urgency. This is going to be a year of taking measurable action to change the course of this business over the long term. It will be a year of investment, investment that will be more than funded through cost savings. 2021 is also going to be a year about recommitting to our values, doing the right thing, being humble, Putting our customers first, embracing differences, being transparent, transforming, and most importantly, delivering results. We'll now open up the line for questions.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from the line of Kevin Marek with Deutsche Bank. Please go ahead.

Hi, good morning.

Good morning, Kevin. How are you doing, Kevin?

Good, good. You noted that a big focus operationally going forward is on share capture. I was wondering if you could talk about some of the customers or end markets beyond government where you feel like you can expand nicely.

Yeah, sure, Kevin. Look, I think the first thing I'll say is the share capture algorithm or formula that we laid out has five levers to it. And first and foremost, look, we are reinvesting into our core business. So that's metalworking, that's some of the solutions programs that I talked about, that's the CCSG business and our key supplier partners who have invested with us. That's all about reinforcing the core. One of the five that I mentioned was diversified end markets. And look, we highlighted what today would be the biggest one of those in government. We've talked about putting a full court press onto it. We've been pleased with the performance to date, and so it's encouraging us to do more. Certainly outside of government, we have our eye on a couple of others. I would say, you know, for competitive reasons, I'll sort of be opaque about which ones. But the nice thing is the ones that we have our eye on fall within the umbrella of where there is some business today. We do have some scale, and it'll be about pressing harder. But it would be areas that fit within our industrial profile but are outside of our core metalworking markets.

Great, thanks. And then just one more before I pass it on. I'm wondering if you could give us an updated color on on kind of customers during the pandemic, kind of government or otherwise, and whether you've seen some of those customers show a willingness to reorder with you or whether you've found over time that most of them are really one-time opportunistic buyers.

So, Kevin, you're referring to some of the PPE where we provided PPE into those customers? Yes.

or even outside PPE if you saw customers kind of come to you because maybe others couldn't service them during kind of the depths of the pandemic. Just kind of an update on that dynamic.

Yeah, look, we certainly, Kevin, there's likely some of both going on, which is to say that a lot of where we served was our core customers who have been with us for a long time. Certainly there were cases where we were able to help companies, organizations that normally didn't do a lot of business with us I would say the majority though and where our focus was helping out our long-term customers the most where we have long-standing relationships.

That's great. Thank you. I'll pass it on.

Thanks, Kevin.

The next question is from the line of Hamza Mazar with Jefferies. Please go ahead.

Hi, this is Mario Cordolacci filling in for Hamza. Just wanted to ask a question on just your Salesforce productivity. And you talked about, obviously, the measurable actions to re-accelerate your market share capture. But I guess, could you give us an idea of how you're measuring Salesforce productivity today, how that has maybe changed, or how has that tracked relative to history? given where we're in in Corona and your headcount reductions. And then also with your optimization, do you expect those productivity measurements to change going forward to reach your goals for 2023?

Yeah, Mario, so you raise a good point. We enumerated five growth levers. One of the areas in which you will see us investing is into the sales force. Investments into the sales force are really an enabler that underpin each of the five. And so if you think back, and obviously from the highest of levels, the easiest way to look at Salesforce productivity is sales per headcount. I think right now it's a pretty deceiving and pretty tricky metric. And I say that because if you think about what's happened over the past couple of years here, Eddie, who's our head of sales, had determined that we were over-indexed to farmers and under-indexed to hunters. And what you saw pre-COVID, you may remember, sales headcount came down pretty considerably. as part of that plan. And the plan was to build it back up by expanding our hunter population. That remains the plan. We had a little diversion there with COVID where we lost the ability to really hire in earnest for two, three quarters. We are back to hiring. What I would tell you in terms of how we're measuring performance is it's going to be getting, it is getting right now, a lot more granular than just looking at sales per head. So for each of those Five levers that I mentioned, what Eddie and the sales management team are building are down to the MSA level performance tracking and scorecards along each of the five. So, you know, for us it won't just be about do we hit a certain sales per head. It's got to be hitting the sales in the programs in which we're investing. And that sort of look is going to allow us to really optimize performance at a grassroots level. The other thing it's going to allow us to do is we realize things change. and so as the three years unfold and there'll be another three years beyond that to throttle up or throttle down the levers based on where we're seeing performance.

Great, and then just one more and I'll turn it over. I think Kristen had mentioned that you guys are, you renegotiated your freight contracts. I just want to know if you could provide more detail on that. Are you able to quantify any of the savings you're expecting over the next few years and then also, I mean, What's your outlook for inflation on freight, and how do you think that's going to impact your gross margin line, again, heading towards your targets?

Yeah, so, Mario, as you can imagine, given our logistics model, which is a centralized model, the majority of our freight costs are overnight, next-day shipping with large carriers, and so we'll What I would tell you without getting too specific or detailed, but it's been improvements in really all areas of the supply chain, but particularly around programs with our carriers where we're able to work out win-win arrangements. I think I probably won't go deeper than that.

Eric, this is John. I would just add to Mario's very last comment. Keep in mind that freight for us, the bulk of our freight freight out that you see in the 10K and in our reporting, that's not in our gross margin. That's part of SG&A. So just to be clear on that. Got it. That's helpful.

I appreciate it.

Mario, I will mention one other thing on the freight line, and this is part of the work that was done with Mission Critical, where with kind of a deeper look using kind of sophisticated analytics, a deeper look into the business, one of the things that we did see, in addition to just was an opportunity to optimize our freight and order patterns with customers. So meaning by aggregating orders as opposed to shipping out onesies, twosies, we could sort of shrink the whole pie for us and the customer and bring freight costs down. So within the footprint of what Kristen was describing, that is another program.

Great. Thank you so much.

The next question comes from the line of David Munthe with Baird. Please go ahead.

Dave, we can't hear you if you're there. You may be muted.

Mr. Muncy, can you hear us? Mr. Muncy, we cannot hear you. Can you hear us? Moving on to the next question. The next question comes from the land of Michael McGinn with Wells Fargo. Please go ahead.

Hey, guys. Good morning. Good morning, Mike. I was wondering if I could switch gears and talk about free cash flow in terms of the investments that you're making. You mentioned vending as one of the drivers for mission critical. Also, digital is a big component. Can you talk about what you're expecting CapEx to be as a percent of sales or maybe dollars over this three-year horizon?

Yeah, yeah, sure. So CapEx for 21 and beyond, we're definitely expecting to see kind of an increase over our historic run rates. I'd say 21 CapEx dollars, you can expect to be about $70 to $75 million range. And if you look at kind of what that represents as an increase over our historic patterns, I'd say about half of that is investment into digital related to the growth levers that Eric described. and the other half is kind of split across the other initiatives we discussed, things like solutions, for example. So we will see a higher sustained level of CapEx for a few years that helps bring those growth levers online and enables the programs that Eric talked about.

Great. And then on the operating margin framework, you guys put up a great Thank you for having me. I'm just curious, why wouldn't this great SG&A run rate stick? You could just, you know, kind of tackle that at a high level.

Sure, sure. So maybe let me start with just gross margin. So I think if things play out favorably for us from a mixed perspective, we've got line of sight to keeping gross margins flat 20 to 21. So I'd say right now mixed is kind of the biggest and so forth. versus the prior year were down about $25 million. So if you kind of like pick apart the pieces of that, about roughly $10 million of it is tied to just variable related costs associated with the revenue decline. About $7 million of that would be some of the upside from the mission critical savings in 2020 that we discussed. And then if you break down the remainder, I'd say about half of that is cost reductions related to temporary cost actions we took. And then the other half is what I'll call kind of just generalized spending delays. You know, we slowed a few things down and we're picking them back up in 2021. So of the 25 million that we were down in Q4, I'd expect about eight to nine of that comes back online in Q1. and is a little bit more indicative of what a run-rated figure could look like for 21.

Got it. Appreciate the time. Best of luck and I'll pass it along. Thanks.

The next question comes from the line of Ryan Merkle with William Blair. Please go ahead.

Hey, everyone.

Thanks for the great details.

Hey, Ryan. How are you?

Good. So first off, the growth programs you mentioned are not new. I think, Eric, you mentioned that. So my question is, what has changed that you're now in a position to structurally drive share gains? Is it mainly that the heavy lifting on the Salesforce optimization is done, or is the investment in digital and on-site solutions equally as important?

Yeah, Ryan, I think you got a couple of things going on that explain why more convictions. Number one, yeah, and I think you called out a lot of it. We went through a lot of heavy lifting, as you know, over the last couple of years to reposition the sales force. It was distracting. Most of that work is behind us. So I think one is moving past the change. Two would be seeing some of these programs in action and gaining conviction around what they do for the customer and what they do for us in terms of growth, I think is two. Three, the other big thing I'll call out, Ryan, is having a structural cost program to take cost out to fund investment in the growth so that the investment isn't simply coming on the backs of the shareholders, but that we're funding it through productivity. So I think what you're seeing is increased conviction in the programs and a mechanism to fund it. And then the last thing I'll add is, you know, Eddie has done a really nice job with the sales team in terms of increasing the level of rigor, inspection, and execution. So I would tell you from my standpoint, Ryan, the confidence is greater in investing into the area because I do feel like, you know, the execution between what he's driving, what Kristen's bringing to the table as our CFO in terms of improving operating performance, the inspection will be greater.

Yep. Yeah, that makes sense, especially funding, you know, the new sales hires with cost takeout. So let me ask about that. I think Kristen mentioned 25 million of costs coming out in 2021. So two questions. Is that all structural? And then secondly, over the next three years, how much cost are you targeting to take out?

Yeah, hey, Ryan. So for 21, the 25 million, yes, I would characterize that as structural cost savings. And then over the course of three years, were targeting about $90 to $100 million of cost takeout related to mission critical.

Yes, so Ryan, just on that one, on that point, realize that for us, too, if we're going to see 200 basis points of OPEX improvement and we're talking about the need to reinvest into growth, then you could imagine, right, the total cost number has to be bigger because of the reinvestment.

Yes, exactly, yes, exactly. As Eric mentioned, this is really about funding growth, investing into those growth levers.

Okay. Super helpful. Thanks. I'll pass it on.

Thank you.

The next question comes from the line of Chris Danker from Longwell Research. Please go ahead.

Hey, morning, everyone. Good morning. I've mentioned doubling the implant sales over the next three years. That's pretty aggressive growth, I guess. Can you just kind of size this for today, how big that is and where we're starting from?

Yeah, sure. And, Chris, what I would say is that that program has been inside the company for a number of years now. It's definitely, I think the change and the reason we're calling it out is for a number of factors, it's picking up steam. So it's been done more reactively or on a case-by-case basis and has built to a point where, you know, currently it's in the range of around 5% of company sales. And so they're doubling it over three years. Yep, that would mean around 10%. And the difference is it's going to become a proactive program and investment area as opposed to being done on a case-by-case basis.

Got it. Got it. Super helpful. And then again, getting back to the high single-digit growth rate target over time here, again, strong goal. I assume that means you've got a really kind of national accounts focus to kind of generate that level of growth. How are we kind of providing some guidelines or benchmarks for the sales goal on the ground to make sure that we're really capturing margin accretive business and not just kind of bringing in stuff that ends up being difficult to really get the return on?

Yeah, Chris, you know, what you're raising has been a big focus of Eddie, of sales team, the sales management team, and specifically around, you know, I think the words he uses are not bringing in empty calories, where we get revenues but don't make money from it. And, you know, what I would tell you is the ways we ensure that are, number one, aligning compensation, rewards, and incentives around not just top-line growth but profitable top-line growth, and we have several ways we do that, and then training and awareness. and also some more intelligence that we're arming our sales team with more analytics, being able to make smarter pricing decisions, using the full power of our database. So I would say all of those dimensions are in play to make sure that the growth is profitable.

Got it. Got it. If I could just dig on that just a tiny bit. As far as incentivizing for profitable growth, are we benchmarking to gross margin? Is it op margin? Just any color there for the actual salespeople on the ground would be great.

Yeah, what I would say with that, you know, sales comp is sort of a sensitive subject. I won't get too specific other than to say a little bit of both of those things.

Understood. Well, thanks so much for the call. I appreciate it.

Thanks, Chris.

The next question comes from the line of John Inch with Gordon Haskett. Please go ahead.

Hi, good morning, everyone. This is Karen Laudaling for John. Hey, Eric, I was wondering in your pillars for the growth pillars for Mission Critical, how or if at all does pricing come into play? I ask because obviously you're a key competitor. years ago took a price down to try to accelerate growth. And looking at some of the initiatives that you're talking about, for instance, expanding into, like, relatively new customer category, I was just wondering, you know, how are you thinking about pricing going forward?

So what I would say, and it's one of the – look, pricing is another one of those enabling initiatives in the company that sort of underpin everything we do. and I think I'll give you two answers that cut in different directions. Number one, of course, we're mindful of being competitive with the market and making sure we're competitive. That's the first thing I'd say. On the other hand, what I'd also say is that we think our value proposition is pretty unique and differentiated. We think we're bringing some new things to market in the way of, you know, one example was that MSC Milmax where we're saving our customers a lot of money. improving their productivity, we want to make sure that we are getting rewarded for that. And so towards that end, we're selling over a million SKUs to hundreds of thousands of customers. There's lots of permutations there, and it's very difficult for a salesperson to price right all the time. So we are bolstering our efforts into pricing to get smarter in how we price, to use more science as opposed to just gut. And so on the one hand, certainly there's competitive Headwinds to price, as there always are. On the other hand, we see a lot of opportunity to price smarter and just be more sophisticated and leverage the data and the science. And I think the proof in the pudding there has been, you know, we've talked about the realization on the summer increase that we just took. It was strong. And we go back, if you go back, you remember, to the midyear that we took during fiscal 20, and we said the same thing, really strong levels of realization. And we think part of that's being aided by just being smarter.

Mr. Inch's line has been dropped. Moving on to the next question. The next question comes from the line of Patrick Bowman with J.P. Morgan. Please go ahead.

Good morning, Eric. Good morning, John, and welcome, Kristen. Good morning. Congrats on getting this out. I just wanted to start with kind of a big-picture strategic question. Can you talk about the September and October monthly sales trends and just the difference between safety, Janssen, and the rest of the business? You mentioned something about large orders in October, I think. Any implication on near-term gross margins from that?

So let me start. I'll give you some more color on the growth trends and then talk gross margin, Pat. So on the growth trend, what we've seen – Safety Janitorial, still hovering in nice growth territory, not where it was during the surge, but roughly in the 20%-ish range year-on-year growth, and it stayed there for now. All other, so everything other than Safety Janitorial, basically what's gone on is if you go back to May was our trough where we were down, all other was down in the high 20s, it's been You know, steadily improving. And I would say the last couple of months, the pace of improvement picked up a little bit. So all other September, October down, low double digits. And then the other part of your question was gross margin. Yeah, the color I'd offer for gross margin for Q1 is probably more of the same-ish with what you saw for Q4. And so the levers there, pricing continues to do well. Costs continue to move in the right direction as expected. So we're pleased with the gross margin performance. I think the one thing is we do see some lingering PPE mix headwinds into Q1 as well. And what I said in the prepared remarks, call it similar impact to what you saw in our fiscal fourth quarter.

And you're talking year over year, though, right? I mean, it should step up sequentially like it normally does.

I would say, you know, we were more similar sequentially.

Oh, so first quarter similar to fourth quarter sequentially.

Similar, yeah. And again, the big driver there is the PPE.

What was the comment on large orders, though? So the rest of the business down, was the large orders, was that in Safety Janssen, or what was that?

Yeah, in October, mostly Safety Janssen.

Okay, got it, got it. And then on the 400 basis points of share gains that you're targeting to get to the 6% to 7% sales growth, I mean, this is another way of asking that investment question, I guess. Maybe it's not price. I don't know if there is an investment. Just curious what's required or what's embedded kind of basically from a gross margin perspective in that high teens incrementals as you think about that, you know, the growth rate. And I assume is that a 2023 target or is that like – over this period, 67%.

So basically, look, we realize from where we're starting, we have work to do to get to 400-plus basis points. And so basically what it's saying is by 2023, that's where we want to be, and we're going to have markers along the way. So we want to exit 2021 at plus 200 over IP and see a steady climb up in terms of the share capture. You know, I think our feeling on gross margins and what we had modeled out was, you know, sort of similar – Degradation year-on-year, that if you took our last few year averages, it's somewhere under 50 basis points, but some sort of primarily driven by mix, that that's our assumption. Hopefully, we can do better and we'd outperform if we really do well on price and cost, et cetera. But that was the assumption.

Yeah, okay. That makes a lot of sense. Super helpful. And then last one for me is the restructuring this year in 2021. Is the adjusted framework and earnings kind of a 2021 thing or you think this is going to be a multi-year program and this will continue for kind of a number of years from a restructuring perspective?

Yeah, on the restructuring, I'd say based on kind of how we've teed things up now, we're likely to see a heavier volume of that in the first year. Thank you, Pat. Thanks, Pat.

The next question comes from the line of Steve Barger with KeyBank Capital Markets. Please go ahead.

Sounds like we may have some technical difficulties. Steve?

Hey, can you hear me?

Oh, yeah, there you are, Steve.

Okay, sorry, yeah. Can you square the centralized logistics model with the push towards more vending, VMI, and implant solutions? I'm just trying to understand how it'll work on the ground. Is this hiring more specialists to get deeper with customers of a type, or hiring more generalists that can work across end markets to drive diversification? Now, are we narrowing focus or expanding focus?

So, what I would say is we are, look, there's five levers here, Steve, and I would say we're focused on each of the five and I would say for the most part it's a reinvestment into the core of the business with diversified end markets being a little bit new but for each of the five there's going to be discrete focus. I do think or we do think and obviously we're pressure testing to your first part of your question we pressure test the logistics model all the time and we do think that the centralized model works fine with vending it works fine with the implant solutions and in fact look it's been A big part of the growth of the company in the past. We think we can do it better, for sure, and that's a big part of mission critical, but we think it works just fine.

Okay. And, Kristen, I know it's early days for you. Were you able to participate in the planning process, and how do you see the finance arm supporting this new focus on share reacceleration?

Yeah, so I was able to participate in some of the planning where I think Thank you, Steve.

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

Thank you, Constantino. A quick reminder that our fiscal first quarter 2021 earnings date is now set for January 6, 2021. Before we get there, we'll be at several equity conferences over the coming months, so we look forward to seeing you there. I want to thank you all for joining us today and please continue to stay healthy and safe. Bye for now.