MSC Industrial Direct Company, Inc.

Good morning and welcome to the MSC Industrial Supply 2021 second quarter conference call. All participants will be in listen-only mode. Should you need assistance, please signal conference specialists by pressing the start key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I'd now like to turn the conference over to John Corona, Vice President of Investor Relations and Treasurer. Please go ahead.

Thank you, Jason, and good morning to everyone. Eric Gershwin, our Chief Executive Officer, and Kristen Actis-Grande, our Chief Financial Officer, are both on the call with me today. Most of us continue to work remotely at MSC, so bear with us if we encounter 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 statements is noted in our earnings press release and the risk factors of the MD&A sections of our latest annual report on Form 10-K, followed with the SEC, as well as in other SEC filings. These 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 obligations to update these statements except as required by applicable law. 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. I hope this call finds you doing well and staying safe and healthy. As we enter the second half of our fiscal year, I wanted to focus my opening remarks this morning on our company's mission. Since the inception of MSC over 80 years ago and through our last 25 years as a public company, our mission has stayed the same, to be the best industrial distributor in the world as measured by our four stakeholders. And we've not wavered from this. Two concepts underpin our pursuit of this mission. The first is reinvention. We believe in the need to continuously reinvent ourselves in order to remain relevant and secure our future. Our history demonstrates this, and it can be captured in chapters, each one of those chapters being defined by a different reinvention. From a storefront to a cataloger, from a regional metalworking distributor to a national broadline MRO distributor, from catalog to digital, from direct marketing to field sales, from generalist to specialist. The second concept that underpins our mission is growth, which is the lifeblood of this company throughout its history. Growth has enabled us to attract and retain great associates, better serve our customers, produce market share capture for our suppliers, and generate returns for our shareholders. Historically, and up until the past few years, we produced a revenue CAGR in the double digits with an organic revenue CAGR in the high single digits. And these results were a product of continuous and focused investments. This growth produced strong incremental margins, which allowed for reinvestment back into the business, thus creating a virtuous cycle. Our most recent reinvention has been one we've talked about, the repositioning of MSC from spot by supplier to mission critical partner on the plant floor. Like the other ones that came before it, this pivot was done to deepen the mode around our business and to secure our next phase of growth. This reinvention was complex, the moves took time, and they impacted growth while changes were made. We redesigned our value proposition and we reshaped our sales force from one size fits all to a more segmented one. We re-engineered our supply chain to move from the four walls of our distribution centers onto the customer's plant floor. And we sharpened our culture to move faster and more readily embrace change inside our business. While we did all of this, we reduced growth investments in areas like field sales in order to complete the reshaping into our new model. We are now emerging as a stronger company and are poised to re-accelerate growth. We've strengthened our value proposition with still more to come, and further strengthened and extended our leadership in our core business of metalworking. History shows that market leaders capture the largest portions of an industry's profit pool, and we will do so. Five levers will fuel our growth, and we're investing into them in order to produce market share gains. Market share capture will lead to growth, which leads to more reinvestment back into the business to further strengthen our core and to add more adjacencies over time. We've also focused on structural cost takeout, with a portion of the savings being reinvested back into growth even more aggressively. We've captured both of these elements, growth and structural cost improvements, in the two mission critical goals that we laid out at the start of the fiscal year. And as a reminder, those goals are reaching 400 basis points of market share capture by the end of fiscal 2023 and returning return on invested capital into the high teens by improving our operating expense to sales ratio inclusive of a 90 to $100 million gross cost takeout target. We're in the early innings of this journey but the proof points so far are encouraging. You saw our commitment to these goals evidenced with the recent announcement regarding the move to virtual customer care hubs. We are redeploying costs from back office, from management roles, and from rent, and putting it into growth. We eliminated 110 positions, and we're adding 135 positions that are customer facing and that will drive growth. This will represent the largest year-over-year increase in customer-facing sales role that we've seen in years. The recent announcement was also about talent. By moving to a virtual customer care network, we retain our local one-to-one connection with our customers while knocking down geographic boundaries. We're now able to recruit technical talent wherever it resides. The improving economic outlook makes our story even more exciting. With the vaccine rollout picking up steam, we're seeing significant positive signs from our customers, such as building backlogs and activity levels. All indications suggest the continued firming of the environment. At the same time, the speed of the recovery coming on the back of significant economic disruption is leading to supply chain shortages and disruptions. and we are well positioned to help address these for a couple of reasons. First, the local distributors who have been struggling for the past year and from whom we focused on market share capture will struggle even more during a snapback due to working capital constraints, limited product offerings, and limited delivery capabilities. The market share capture opportunity will only accelerate. Second, while we all face supply chain disruptions and shortages, MSC's broad and deep product assortment, our multiple brand choices, including exclusive brands, and our next-day delivery capabilities position us very well against the 70% of the market made up of local and regional distributors. The speed of the recovery, commodity scarcity, and supply shortages are also leading to commodities inflation. we typically benefit in the early stages of an inflation cycle and should see a gross margin tailwind as we capture price earlier than realizing cost. As we look ahead to the latter part of 2021 or fiscal 2021 and into our fiscal 2022, assuming the economic recovery continues on its current pace, here's what we expect. We anticipate improving average daily sales levels with strong growth rates in our non-safety and non-janitorial business. This will be fueled by the investments that we're making and their contribution will grow over time. Keep in mind that we'll see high PPE comparables in our fiscal third quarter and this will mute our overall growth rate. However, this moderates by our fiscal fourth quarter and we should see strong overall growth rates. We anticipate a bounce back in gross margin from the Q2 anomaly, which I'll talk about in a bit. We should return to at least the levels at which gross margins have run over the past year with some potential upside due to the early stages of an inflation cycle. We also expect a continued stream of structural cost work that is moving us towards the higher end of our 90 to $100 million cost takeout range. All of this should yield healthy growth that translates into expanding operating margins as we look ahead to fiscal 2022. It's an exciting time for our company, and we remain heads down, focused on executing so that we can capitalize on the opportunity in front of us. I'll now turn to our second quarter performance. Before getting into the details, I'll start by addressing the obvious issue in our second quarter that impacted results, which is the inventory write down on PPE of roughly $30 million. The write down is exclusive to PPE inventory and is primarily comprised of disposable masks. It's no secret that we moved aggressively in the early stages of the pandemic to acquire large quantities of PPE and specifically disposable masks. At the time, we were selling millions of masks per week, inclusive of some very large quantity purchases for several of our large customers. Some of these customers were not only buying large quantities at the time, but also committing to even more large quantity buys in the coming weeks and months. As a result, we bought big in order to ensure we could keep these customers safe and keep their operations up and running. As time went on, These customers found that their consumption was not as great as anticipated. When that happened, we decided to play the long game. Even in cases where agreements were in place, we decided not to impose them. We wanted to support our customers through the pandemic, knowing that what's really important is securing long-term loyal customers and keeping them safe. As a result, we took on the extra inventory. Pricing on these items has come down considerably. And at the same time, demand slowed even through the winter months when the virus surged. And so we were left with the exposure that we addressed in our fiscal second quarter. This was an extremely unique set of circumstances. And if you look back, we've not had any meaningful inventory write downs over the last decade. Putting the PPE inventory aside, our fiscal second quarter reflected solid execution in a choppy but clearly improving environment. You can see our reported numbers on slide four and adjusted numbers on slide five. Overall sales were down 1.5% for the quarter. We're seeing continued sequential improvement in our sales levels and most notably our non-safety and non-janitorial product lines improved throughout the quarter from low double digit declines in our first quarter to mid single digit declines in our second quarter. Sales of safety and janitorial products continued progressing nicely, growing in the low teens for the quarter. Looking at our performance by customer types, government sales continued to grow significantly year over year due to large safety and janitorial orders. National accounts improved sequentially and declined in the high single digits, while our core customers also improved sequentially and declined in the mid single digits. CCSG finally improved to declines in the low single digits. As you can see on slide six, industrial production through the IPI or industrial production index continued improving, though it did remain negative through our fiscal second quarter. Most manufacturing end markets behaved consistent with this trend, although metalworking-centric end markets did continue to lag the broader IP index. Notably, the gap between IP and our growth rate flipped to positive. Recall that a 200 basis point spread was our target for our fiscal fourth quarter. So while it's still early, we are encouraged by our recent performance. March showed continued improvement. Our non-safety and non-janitorial business turned positive growth for the month, as did CCSG, both of which grew in the mid-single digits. Safety and janitorial, on the other hand, were down roughly 20% against last year's PPE surge. We expect strong growth rates in our non-safety and non-janitorial product lines for the balance of the fiscal year. Regarding gross margin, due to the PPE write-down, our gap gross margin was 38.1%. But excluding that write-down, adjusted gross margin was 42.0%. down just 10 basis points versus the prior year and up 10 basis points sequentially from the first quarter. Looking ahead, we took our mid-year price increase in early March in response to the early stages of the inflation cycle, which again are generally a nice tailwind for gross margins. So we expect the recent trending to continue into the back half of the year. In terms of our mission critical growth initiatives, We're particularly pleased with our metalworking market share capture from local and regional distributors. We track new customer market share wins by MSA or metropolitan statistical area and have seen strong performance through this downturn. We're just now scratching the surface in terms of the revenue contribution from these wins, primarily because metalworking customer spend has been suppressed to now due to the soft conditions. As things rebound, we should see an outsized lift. I'll now turn things over to Kristen to cover the financials and overall progress on our mission-critical program.