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Text: Erik Gershwind, our chief executive officer; and Kristen Actis-Grande, our chief financial officer, are both on the call with me.
As we continue working remotely at MSC, please bear with us if we encounter any technical difficulties.
For many years, the concept of doing the right thing has driven everything we do in all of our stakeholder interactions at MSC.
I invite you to learn more about our community relations, diversity and inclusion, corporate governance, and environment and sustainability efforts by visiting our website.
This is only the very beginning of our ESG journey, but we are committed to progress and continually striving for excellence.
Let me reference our safe harbor statement under the Private Securities Litigation Reform Act of 1995.
These risk factors include our comments on the potential impact of COVID-19.
I hope you enjoyed your holiday weekend.
I'm excited to update you today on our progress this quarter.
We are seeing the benefits of the strategic pivot that's been made by our company over the past few years.
We made significant investments across the organization to transition from a leading spot-buy provider to a mission-critical partner on the plant floor augmented by our spot-buy capabilities.
With the bulk of the less visible changes completed, we outlined our plan to return to historic levels of revenue and earnings growth, consistent with the legacy of our company.
Mission Critical is our program to translate those investments into superior financial performance.
And we shared with you two goals that underpin our efforts: first, to accelerate market share capture with a target growth rate of at least 400 basis points above IP by the end of our fiscal 2023; second, to return ROIC into the high teens powered not only by leveraging growth, but also by structural cost takeout of 90 to $100 million also by the end of fiscal 2023.
This year, our fiscal 2021 began our proof of concept with our fiscal third quarter serving as the latest encouraging data point.
With respect to revenues, we committed to achieve a minimum of 200 basis points of positive spread versus the IP by our fiscal fourth quarter.
Q3 is muted by PPE comps, but the non-safety and non-janitorial business grew about 21% year over year, and we expect our total company growth to meet or exceed our fiscal Q4 commitment.
This year, with the help of numerous structural cost reductions, we increased our customer-facing sales headcount and will continue doing so into fiscal 2022.
We've grown share in metalworking through investment and innovation that improve our customers' businesses.
At the tail end of fiscal 2021 and into fiscal '22, we're implementing improvements in e-commerce.
We started with a new production information system earlier this year and are now rolling out enhanced search capabilities, new user interfaces for both desktop and mobile, a new transactional engine, and overall improved functionality.
We've committed to maintaining our gross margin through a series of initiatives, and excluding the writedown for PPE, we have done so.
The macro environment is driving price increases.
And given our inventory turns and innovative merchandising and pricing programs, we expect strong realization to continue.
Finally, we've picked up the pace on structural cost takeout.
We've already exceeded our $25 million cost takeout goal for fiscal 2021 for the full year.
Looking ahead, fiscal 2022 is setting up even better than the current year.
We will build on our momentum and continue making progress toward our goal of 400 basis points or more of market outgrowth as measured against the IP index.
On the gross margin line, we expect inflationary pressures to continue.
While purchase cost increases are beginning to make their way into our P&L, they will be offset by ongoing price realization, yielding a stable gross margin outlook year over year.
On the structural cost front, we'll deliver roughly $20 million of incremental savings on top of that, which has been achieved over the past two years.
And that will include benefits from existing initiatives, which will deliver incremental savings during the first half of '22 plus benefits in the second half from new initiatives that we have yet to execute, along with a handful of more transformational projects that will deliver additional savings in '23 and beyond.
We will once again reinvest a portion of these incremental savings into our five growth initiatives to build upon market share capture.
Nonetheless, we expect incremental margins at/or above 20%.
How far north they go will be a function of how high we can get revenue growth and how much price realization we see.
With all of this as the backdrop, I'll now turn to the specifics of the quarter beginning with the external landscape.
The economic environment improved significantly.
Most of our manufacturing end markets turned positive during the quarter, and this evidenced itself in IP readings that turned to double-digit growth in April and May and in sentiment readings, such as the MBI index, which are at very high levels.
All of this is supported by our customers' outlooks, which are robust.
At the same time, the industrial economy is experiencing very real supply chain shortages and disruptions.
These disruptions are evidencing themselves in product scarcity, freight delays, and extreme labor shortages that are resulting in significant availability and inflationary pressures.
And we are certainly not immune to these challenges.
And in fact, we're seeing them play out.
That said, we are very well-positioned to navigate the current environment, particularly when compared to the local and regional distributors who make up 70% of our market.
MSC's broad multi-brand product assortment, our high inventory levels, strong supplier relationships, and next-day delivery capabilities position us well to accelerate market share capture.
Additionally, the supply chain challenges are resulting in significant and growing inflation that is producing the most robust pricing environment we've seen in years.
Turning now to our performance.
You can see our reported numbers on Slide 4 and adjusted numbers on Slide 5.
Revenues were up 2.2% on an average daily sales basis as we're seeing continued sequential improvement in our sales levels.
Most notably, non-safety and non-janitorial product lines improved through the quarter from mid-single-digit declines in our second quarter to 21% growth in our third quarter.
Sales of safety and janitorial products, as expected, given the significant surge during the pandemic last year, declined just over 40% for the quarter.
Looking at our performance by customer type and excluding for a moment, the safety and janitorial product lines, all of our customers, all types, were up strong double digits.
However, including all product lines and given the extremely difficult comparisons, government sales declined nearly 40%.
National accounts returned to growth by posting a low single-digit increase, while our core customers improved and grew in the mid-teens.
CCSG grew mid-single digits.
June showed continued improvement with total company year-over-year growth estimated at 15.4%.
Our non-safety and non-janitorial growth is estimated at roughly 20%, while safety and janitorial are estimated to be down roughly 10% against last year's continued PPE surge.
We expect strong growth rates in non-safety and non-janitorial products for the balance of the fiscal year.
On the pricing front, we've seen solid realization of the March price increase that we mentioned last quarter.
And as a result, we saw a sequential lift in gross margin from our fiscal second quarter's adjusted rate of 42%.
Since that last call, we've seen continued significant pricing activity from our suppliers.
And as a result, we've implemented a June price increase.
This is earlier than normal but certainly warranted given the environment.
We will not hesitate to move again if suppliers continue raising their prices.
Beyond the numbers, we had a couple of positive developments during the quarter.
One was the recovery of the nitrile glove impairment, which Kristen will touch on in just a bit.
The other was the acquisition of a majority stake in the William Hurst Company in June.
Hurst is a metalworking distributor based in Wichita, Kansas with a heavy focus on the aerospace sector, and this deal is meaningful to MSC in several ways.
Hurst goes to market with a highly specialized and highly technical sales force.
It fills out a geography in which MSC was underpenetrated and, more importantly, brings technical capabilities that we can leverage across the entire MSC business.
Aerospace is roughly 10% of total MSC sales today.
It's an industry that is poised for strong growth coming out of the pandemic, and the Hurst platform will considerably enhance our effectiveness in serving and growing that portion of our business.
Hurst has been led by CEO, John Mullen, who remains at the helm and retains a meaningful ownership stake in the business.
I'll now turn things over to Kristen to cover the financials and our mission-critical progress.
I'll begin with a review of our fiscal third quarter and then update you on the progress of our mission-critical initiatives.
Slide 5 reflects our adjusted results.
Our third-quarter sales were 866 million, up 3.8% versus the same quarter last year.
We had one more selling day this year in our third quarter.
So on an average daily sales basis, net sales increased 2.2%.
Erik gave some details on our sales growth, but I'll just reiterate that our non-safety and non-janitorial sales grew 21% in the quarter, while our safety and janitorial sales declined 42%.
Moving to gross margins.
Execution and realization on our midyear price increase was solid.
Our gross margin for fiscal Q3 was 42.3%, up 30 basis points sequentially after adjusting our inventory writedown from last quarter and down just 10 basis points from last year.
Looking ahead, we took our summer increase in early June in response to the continuing inflation we are seeing from our suppliers.
We expect the recent trending to continue and aim to achieve a gross margin for fiscal 2021 that is flat with fiscal 2020.
Operating expenses in the third quarter were 257.3 million or 29.7% of sales versus 242.8 million or 29.1% of sales in the prior year.
Our third quarter includes just 400,000 of legal costs associated with the loss recovery, which I'll discuss shortly.
So OPEX as a percent of sales, excluding those costs, was the same as the GAAP figure or 29.7%.
Let me share a few more details on our third-quarter OPEX.
As I mentioned on our last call, we expected OPEX to increase sequentially from our second quarter, not only by the variable operating expenses associated with higher sales but also due to expected higher incentive compensation, as well as growth investments related to Mission Critical.
Recall that our adjusted OPEX for Q2 was 244 million.
A 90 million increase in sales means roughly 9 million of variable-related OPEX.
The remainder of the increase was primarily related to higher incentive compensation.
While mission-critical growth investments did increase sequentially, this was offset by an increase in mission-critical savings, which I'll speak to in more detail in a few moments.
We're pleased to report that last month, we received a 20.8 million loss recovery of the original 26.7 million impairment loss recorded in Q1.
That recovery is below the operating expense line in the P&L, but it does increase our GAAP operating income such that our GAAP operating margin for the quarter was 14.8%.
Excluding the 20.8 million loss recovery and associated legal fees, as well as restructuring charges during the quarter of 1.3 million, our adjusted operating margin was 12.6%, down 70 basis points from the prior year.
GAAP earnings per share were $1.68.
Adjusted for the loss recovery, as well as restructuring and other charges, adjusted earnings per share were $1.42.
Turning to the balance sheet and moving ahead to Slide 7.
Our free cash flow was 3 million in the third quarter, as compared to 49 million in the prior year.
The largest contributors were our increasing inventory and accounts receivable balance as our sales picked up significantly in the quarter.
I would also note that we repurchased 47 million of stock during the quarter or about 507,000 shares at an average price of 92.92 per share.
This underscores our ongoing commitment to a balanced capital allocation philosophy and our goal to maximize total shareholder returns.
In fact, to date in our fiscal Q4, we repurchased another 229,000 shares at an average price of $89.07.
Lastly, when it comes to cash flows, please note that the 20.8 million loss recovery was received in June and will therefore be reflected in our fiscal fourth-quarter cash flows.
As of the end of fiscal Q3, we were carrying 598 million of inventory, up 66 million from last quarter.
We're actively managing inventory levels to ensure we can support our customers as sales continue accelerating.
Therefore, inventory levels are likely to continue climbing in the fourth quarter.
We still expect capital expenditures for the fiscal year of approximately 55 million, and we still expect our cash flow conversion or operating cash flow divided by net income to be above 100% for fiscal 2021.
Our total debt as of the end of the third quarter was 759 million, reflecting a 75 million increase from our second quarter.
Roughly two-thirds of that increase was used to repurchase shares under our ongoing share repurchase program.
As for the composition of our debt, 187 million was on our revolving credit facility.
About 200 million was under our uncommitted facilities, 20 million was short-term fixed-rate borrowings, and 345 million was long-term fixed-rate borrowings.
Cash and cash equivalents were 27 million, resulting in net debt of 732 million at the end of the quarter.
Let me now provide you with an update on our Mission Critical productivity goals.
On Slide 8, you can see our original program goals of 90 to a hundred million of cost takeout through fiscal 2023, and that is versus fiscal 2019.
Our cumulative savings for the first half of fiscal '21 were 17 million, and we saved another 12 million in our third quarter bringing our year-to-date savings to 29 million against our goal of 25 million by the end of this year.
We also had invested roughly to 7 to 8 million in the first half of fiscal '21, and we invested another $7 million in our third quarter, bringing our total year-to-date investments to 15 million, which compares to our original full-year target of 15 million.
Given the success of the program through the first three quarters, we now expect to achieve savings for fiscal 2021 of roughly 40 million.
Regarding total investments for fiscal '21, we now expect roughly 25 million, which would result in net savings of 15 million for this year.
With respect to sales, the difficult safety and janitorial comparisons will ease in our fiscal fourth quarter and into fiscal '22.
We expect double-digit growth rates for the total business in our fiscal fourth quarter and continued strength into fiscal '22.
For fiscal '21, we expect a low single-digit total company growth, and we aim to achieve gross margins that are flat with fiscal '20.
In terms of adjusted operating expenses, sequentially from our third to fourth quarters, we will see a decline due to volume-based expenses from sequentially lower sales dollars and lower incentive compensation.
With that in mind, we remain on track with our adjusted annual operating framework for fiscal 2021, which you can see on Slide 9.
Furthermore, and as Erik mentioned earlier, we expect to achieve 20% or higher incremental margins in both fiscal '22 and fiscal 2023.
Fiscal 2021 is finishing on a high note, and we expect that momentum to continue into fiscal '22.
We are gaining steam internally, and our end markets are strengthening as evidenced by IP readings.
The inflationary environment, along with our ongoing price realization should continue to support gross margins.
On the structural cost front, we've made strong progress on our Mission Critical program and will deliver further savings over the next two years and beyond.
All of that should translate into incremental margins at/or above 20% for the next two years.

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q3 earnings per share $1.68.
quarterly adjusted diluted earnings per share $1.42.

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