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Text: These risk factors include our comments on the potential impact of COVID-19.
I hope that everyone remains safe and healthy.
As we cross the halfway point of our fiscal 2022, I'm excited by the growing momentum inside of our company to accelerate market share capture and improve profitability.
Each passing quarter is another proof point that the extensive repositioning of MSC is now firmly taking hold.
As our performance improves, we continue raising the bar on expectations across the organization.
And I'm pleased to see how our team is rising to the challenge.
With respect to market share capture, we're sustaining growth rates that are at or above our long range target of growth, at least 400 basis points above the industrial production index.
Our fiscal second quarter average daily sales growth rate of 7.9%, does not do justice to the momentum that we see developing.
This year included two sales days around the holidays that carried minimal sales, whereas last year we were closed due to the timing of those days.
Therefore, the absolute sales growth rate of 11.4% is more indicative of underlying performance.
January got off to a very slow start, as a result of widespread absenteeism due to the COVID surge throughout the supply chain.
In fact, our growth rate in January actually started out negative.
We saw an inflection during the last two weeks of the month of January, and we've sustained double-digit growth rates since that point.
February was particularly strong at nearly 18%, with a catch up from the soft January.
And March has continued our double-digit growth pace.
You'll hear from Kristen that we now see double-digit growth for fiscal '22 as a likely outcome.
In line with our strategy, growth is being fueled by the five growth levers that we've been describing for you.
And those are metalworking, solutions, selling the portfolio, digital investments, and customer diversification with an emphasis on the public sector.
Within these five levers, today I'll highlight our implant program, e-commerce, metalworking, and the public sector.
Implant continues its strong momentum and now represents approximately 9% of company sales.
We're tracking ahead of plan, which targeted 10% of total company sales by the end of fiscal '23.
Our recent investments in e-commerce are also starting to pay dividends.
E-commerce reached 60.7% of total company sales, up 150 basis points from prior year and 30 basis points from the prior quarter.
This is being driven largely by improvements to mscdirect.com.
Our technical metalworking expertise, including MSC MillMax, is particularly powerful in the current environment.
Our customers are experiencing rapid inflation, labor shortages, extended lead times and more.
As a result, the need for productivity on the plant floor is higher now than it's ever been.
And MSC is uniquely positioned to address these challenges, as the largest national metalworking distributor offering multiple brands, robust technical expertise, and the ability to document cost savings and productivity improvements on a continuous basis.
A recent example demonstrates how our approach is helping customers find the needed productivity.
Our technical experts were brought into one of our aerospace customers to analyze their cutting tool consumption.
We were able to save the customer over $1.2 million on an annualized basis, by recommending alternate tooling that yielded faster metal removal rates, shorter lead times, and increased productivity with a more cost effective tool.
These savings are allowing our customer to bring some of the outsourced production back in-house, adding volume for our customer, and leading to greater opportunities for MSC.
Examples like these are happening regularly across our business and they are fueling new customer wins as well as greater wallet share at existing customers.
Finally on the growth front is the public sector.
Our team is performing well.
You may have seen that we were recently awarded a five year contract to service 10 U.S. Marine Corps bases across the continental United States, Hawaii, and Japan.
Implementation across the bases is underway, and we expect to see revenue build through the balance of fiscal '22 and into fiscal '23.
Turning now to profitability improvements.
Our long range goal is to -- restore return on invested capital into the high teens by the end of fiscal '23.
And we said we would achieve this by leveraging growth, by executing on gross margin initiatives, and by delivering structural cost takeout of at least $100 million, helping to reduce opex as a percentage of sales by at least 200 basis points from our fiscal 2019 baseline.
I'm encouraged by progress on each of these fronts.
Let me start out with a few words about gross margin.
You'll recall that we were not pleased with our gross margin performance in our fiscal first quarter.
We began addressing it aggressively with countermeasures during the latter portion of Q1.
As part of those countermeasures and in response to the massive purchase cost inflation coming from our suppliers, we implemented a significant price increase in late January.
Price realization thus far has been strong, and as a result, Q2 gross margins came in at 42.5%.
This gives us added confidence that we can keep gross margins flat or better for fiscal '22 versus prior year.
We also generated strong operating expense leverage and reduced adjusted opex as a percentage of sales by 80 basis points versus prior year.
This is largely the result of our Mission Critical initiative.
We delivered $6 million of savings in the second quarter and remain on track for $25 million in expected cost savings for the fiscal year.
And we remain on pace to achieve our goal of at least $100 million in total cost savings by the end of fiscal '23.
All of this is translating into improving adjusted returns on capital, which is well on its way into the high teens.
Turning now to the external landscape.
The story remains largely unchanged.
Strong underlying demand, tight supply chain constraints, even tighter labor constraints, and rapid inflation.
All of this is evidenced in public indices such as IP readings, which remain at mid-single digit growth levels.
Sentiment surveys like the MBI and feedback from our customers.
[Audio gap] with limited exceptions like automotive, the order backlog and outlook for most customer segments remains robust.
Relative to last quarter, headwinds from COVID have eased dramatically.
They reached a fever pitch during December and the first half of January.
But if subsided considerably as the virus has waned.
Like everyone will watch the developments with the latest variant, of course.
Here at MSC, we reopened our customer support centers in Melville and Davidson, with a hybrid work environment.
We've received positive feedback from our associates and our operations are running smoothly.
Angst related to COVID has been joined by broad based concerns related to the Russia-Ukraine situation.
Our direct exposure to the region with respect to sales and purchasing is insignificant.
The indirect impacts, though, will likely play out in the form of further inflation, and more supply chain disruption.
While these conditions create some challenges for us here at MSC, they also provide opportunities to take additional market share from the 70% of the distribution market that's made up of local and regional distributors.
MSC's brought in deep inventory, a good better best brand assortment, and our logistics capabilities, enable us to service our customers at high levels when many cannot.
We've used recent market conditions to accelerate share capture and will continue doing so.
Kristen will now take you through the details of our performance, the financials for the quarter and our outlook, which includes a revised annual operating margin framework with a low double-digit sales growth scenario.
Kristen, over to you.
Our second quarter sales came in at $863 million.
As Erik mentioned, given the extra two days this year coming with minimal sales, the total sales growth of 11.4% over the prior year period is more reflective of our real growth.
On an average daily sales basis, Q2 growth was 7.9%.
Our non-safety and non-janitorial product lines grew just over 10% on an ADS basis, and sales of safety and janitorial products declined roughly 3%.
Looking at ADS growth rates for our sales by customer type.
Government sales declined roughly 11%, due to the difficult janitorial and safety comps.
This is a large improvement from Q1's decline of nearly 30%, and we expect the comps to ease further in the back half of fiscal 2022.
National account growth with low double-digit and core customers grew high single-digit.
We're continuing to see strong execution and growth initiatives with vending and plant and mscdirect.com, each growing roughly 100 basis points or more, as a percent of total company sales versus the prior year.
As Erik mentioned, our fiscal Q2 gross margin was 42.5%, up 90 basis points sequentially from our first quarter, and up 440 basis points from last year's fiscal Q2.
As you may recall included in last year's Q2 gross margin was a $30 million PPE related write down.
Excluding this write down, our prior year Q2 adjusted gross margin was 42%, 50 basis points below the current year quarter.
We're very pleased with this result and we remain on track to hold the annual gross margin for fiscal year 2022 flat or better in fiscal 2021.
Reported and adjusted operating expenses in the second quarter were $266 million, or 30.8% of sales.
Last year reported operating expenses were $245.1 million, and adjusted operating expenses were $244.4, or 31.6% of sales.
This represents an 80 basis point reduction in adjusted opex to sales.
It's worth noting that this includes an increase to our incentive compensation accrual this quarter, including a year-to-date catch up that will not repeat.
We incurred approximately $3.1 million of restructuring and other costs in the quarter, as compared to $21.6 million in the prior year quarter.
Last year's Q2 charges primarily included operating lease impairment, and other related costs associated with our move from physical sales branches to virtual customer care hubs.
Our operating margin was 11.3%, compared to 3.6% in the same period last year.
Excluding the restructuring and other costs and the PPE related inventory write down in the prior year, our adjusted operating margin was 11.6% versus an adjusted 10.4% in the prior year period, a 120 basis point improvement.
On the adjusted incremental margin front for second quarter came in at just over 22% ahead of our initial fiscal 2022 goal.
Earnings per share were $1.25 as compared to $0.32 in the same period prior year.
Adjusted for restructuring and other costs, as well as the prior year's PPE related inventory write down.
Adjusted earnings per share were $1.29 as compared to adjusted earnings per share of a $1.03 in the prior year period, an increase of 25%.
This is a result of our execution at all levels, sales performance, gross margin, and opex leverage.
Turning to the balance sheet, you can see that as of the end of our fiscal second quarter, we were carrying $658 million of inventory, up $35 million from Q1 balance of $623 million.
The inventory build is fairly typical with historical periods of high growth, with the added element of ongoing supply chain disruptions.
Accounts receivable are also rising as expected with the current sales growth.
As a result of this increased use of working capital, our second quarter cash flow conversion or operating cash flow divided by net income was slightly negative.
Our capital expenditures were $16 million in the second quarter.
Moving ahead to Slide 7, you can see the uses of working capital also impacts our free cash flow, which came in slightly negative for the second quarter as compared to $4 million in the prior year quarter.
We do expect cash conversion to improve in the second half of fiscal 2022, and for the fiscal 2022 full year to come in at approximately 70% to 80%, roughly comparable with historical periods of Southwest.
Our current expectation for strong sales growth for the year, continuing supply chain challenges, and the recent government contract win are all increasing our working capital and affecting our cash conversion for this year.
Our total debt at the end of the fiscal second quarter was $835 million, which reflects a $72 million increase from our first quarter.
As for the composition of our debt, $285 million was on our revolving credit facility, about $200 million was under our uncommitted facilities, approximately $300 million with long-term fixed rate borrowings, and $50 million were short-term fixed rate borrowings.
Our cash and cash equivalents were $42 million, resulting in net debt of $794 million at the end of the quarter, up from $700 million at the end of the first quarter.
Let me now provide an update on our mission critical productivity goals.
You may recall that our updated cost savings goal for fiscal 2023 is a minimum of $100 million versus our fiscal 2019 cost base.
As you can see on Slide 8, our cumulative savings for fiscal 2021 were $60 million, and we also invested roughly $22 million over that same period.
For the full year fiscal 2022, we expect additional gross savings of $25 million, and additional investments of $15 million.
We've made excellent progress toward this goal in the first half, as we've achieved $16 million of gross savings and invested $11 million.
We remain on target to hit at least $100 million of cost savings by fiscal 2023.
We're encouraged by the momentum building across all three lines of the P&L, revenue growth, gross margins, and operating expense leverage.
Our current growth momentum creates the potential for a higher tier on our annual operating margin framework provided to you on Slide 9.
You can see that we added a low double-digit scenario in that growth range.
We would achieve an annual adjusted operating margin between 12.5% and 13.1%.
Should the current trends continue, we would expect to move into that range.
At those levels of adjusted operating margin, our incremental margins will be around 25% in the back half of this year and north of the 20%, we originally envisioned for full year fiscal 2022.
We've now crossed the halfway point of fiscal '22 and momentum is picking up steam.
With each passing quarter, our repositioning is taking hold.
We're accelerating market share capture, capitalizing on our ability to add value in a unique pricing environment in order to improve gross margins, and we're generating operating leverage through our mission critical efforts.
As we look to the back half of the year, we will continue raising the bar, targeting double-digit sales growth, strong price realization, and incremental margins in the mid-20s.
They are the driving force behind our improved performance for all stakeholders.
All 6,500 of us will remain restless until we achieve our mission to be the best industrial distributor in the world.

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q2 adjusted earnings per share $1.29.
q2 earnings per share $1.25.

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