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Text: Most of us continue to work remotely at MSC, so bear with us if we encounter technical difficulties.
These risk factors include our comments on the potential impact of COVID-19.
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 generalists to specialists.
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-buy supplier to mission-critical partner on the plant floor.
Like the other ones that came before it, this pivot was done to deepen the moat 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 reengineered 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 reaccelerate 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 million 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 cost 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 toward the higher end of our $90 million 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 writedown on PPE of roughly $30 million.
The writedown 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 writedowns 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 4 and adjusted numbers on Slide 5.
Overall sales were down 1.5% for the quarter.
We're seeing continued sequential improvement in our sales levels.
And most notably, our nonsafety and nonjanitorial 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 6, 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 nonsafety and nonjanitorial 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 nonsafety and nonjanitorial product lines for the balance of the fiscal year.
Due to the PPE writedown, our GAAP gross margin was 38.1%.
But excluding that writedown, adjusted gross margin was 42%, down just 10 basis points versus the prior year and up 10 basis points sequentially from the first quarter.
Looking ahead, we took our midyear 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 outside lift -- an outsized lift, excuse me.
I'll now turn things over to Kristen to cover the financials and overall progress on our Mission Critical program.
I'll begin with a review of our fiscal second quarter and then update you on the progress of Mission Critical initiatives.
Slide 5 reflects the adjusted results.
Our second-quarter sales were $774 million, or $12.7 million, on an average daily sales basis, both a decline of 1.5% versus the same quarter last year.
Moving to gross margins.
Our second-quarter gross margin was 38.1%, a decline of 400 basis points compared to the second quarter of last year.
As Erik mentioned, this was primarily the direct result of the roughly $30 million PPE writedown we recorded during the quarter, which was primarily related to masks.
Excluding this writedown, our second-quarter gross margin was 42%, a 10 basis point decline from the prior year and a 10 basis point increase sequentially from our first quarter.
Our pricing realization has remained strong, and solid execution of our supplier programs has continued.
I'll add two points here.
One, we don't expect any further impairments going forward.
And two, our midyear price increase had no impact on our fiscal second quarter as we implemented it in March, the first month of our fiscal third quarter.
Operating expenses in the second quarter were $245.1 million, or 31.7% of sales, versus $251.4 million, or 32% of sales in the prior year.
This includes about $700,000 of legal costs associated with the nitrile glove prepayments we impaired in the first quarter.
Excluding these costs, operating expenses as a percent of sales was 31.6%, a 40 basis point improvement from the prior year in which there were no operating expense adjustments.
With regard to the nitrile glove impairment we announced in our fiscal first quarter, we're pleased to report that an arrest for suspicion of fraud has been made, and we've been notified that bank accounts holding a substantial portion of the impaired value have been frozen.
The legal process is going to take some time to resolve this matter, and we will provide you with updates as developments occur.
Moving back to our fiscal second-quarter results.
We incurred approximately $21.6 million of restructuring costs, primarily related to the move to virtual customer care hubs and a review of our operating model, both related to Mission Critical.
Execution of our Mission Critical initiatives continue to deliver savings, and I'll go into more detail on that in a minute.
In Q2 of last year, we incurred $1.9 million of restructuring charges, and that was primarily related to consulting costs.
All of that led to operating margin on a GAAP basis of 3.6%, but that was significantly influenced by the PPE writedown and the restructuring charges related to the virtual customer care hubs.
Excluding this writedown, as well as the restructuring and other related costs, our adjusted operating margin was 10.4%, up 30 basis points from the prior year due to our progress on Mission Critical and despite lower sales.
GAAP earnings per share were $0.32.
Adjusted for the inventory writedown, as well as restructuring, and other charges, adjusted earnings per share were $1.03.
Turning to the balance sheet and moving ahead to Slide 7.
Our free cash flow was $4 million for the second quarter as compared to $58 million in the prior year.
The largest contributor was our increasing inventory and accounts receivable balance as our sales picked up in January and in February.
As of the end of fiscal Q2, we were carrying $533 million of inventory, up $12 million from last quarter.
This is net of the $30 million inventory writedown during the quarter.
We're actively managing inventory levels to ensure we can support our customers as sales accelerate in the second half.
Therefore, inventory will likely continue to be a use of cash.
We now expect capex for the fiscal year of approximately $50 million to $60 million.
We still expect our cash flow conversion or operating cash flow divided by net income to be above 100% for fiscal '21.
As we mentioned on our last call, we increased our debt to fund the $195 million special dividend paid in December.
Our total debt as of the end of the second quarter was $684 million, comprised primarily of a $115 million balance on our revolving credit facility, about $200 million on our uncommitted facilities, $20 million of short-term fixed rate borrowings, and $345 million of long-term fixed rate borrowings.
Cash and cash equivalents were $20 million, resulting in net debt of $664 million at the end of the quarter.
Let me pivot now and provide you on an update on our Mission Critical productivity goals.
On Slide 8, you can see our original program goals of $90 million to $100 million of cost takeout through fiscal '23, and that's versus fiscal '19.
On our last call, we shared that we had taken out $8 million of gross savings and invested roughly $2 million to $3 million in the first quarter.
During our fiscal second quarter, we achieved additional gross savings of $9 million, bringing our cumulative savings for fiscal '21 to $17 million against our goal of $25 million by the end of this year.
We also invested roughly $5 million in Q2, bringing our total investments to $7 million to $8 million, which compares to our full-year target of $15 million.
We're ahead of plan on savings, and our investment program is also progressing very well.
In fact, these results are such that we anticipate making some additional growth investments to capture more of the opportunities that we're seeing.
On balance, this means that our net savings target for Mission Critical remains roughly the same or slightly larger for the full year.
The most significant initiative during the quarter was, of course, our move to virtual customer care hubs, including the closure of 73 sales branches.
The gross savings related to that move are expected to be between $7 million and $9 million in fiscal 2021 and reach an annualized level of approximately $15 million to $18 million starting in fiscal 2022.
With respect to revenue growth, as Erik described, we expect to turn nicely positive in our nonsafety and nonjanitorial business this quarter, and assuming these trends continue, should see healthy growth rates for the total business in the fiscal fourth quarter.
For the year, while still early, it is likely that we will be flat to positive for total company growth.
We expect our gross margins to remain at levels where they've been running, excluding the writedown.
In terms of adjusted operating expenses, you can expect to see a step-up sequentially from volume-based expenses, increased incentive compensation, and increased growth investment.
Where we fall within that framework will primarily be a function of how quickly revenues accelerate and how much gross margin tailwind we see from price.
As we move to the back half of fiscal 2021, momentum is building both inside and outside of the company.
On the outside, the environment continues to firm.
On the inside, we're accelerating progress with respect to growth investments and structural cost takeout.
And while we're ju -- we're just getting started, we are encouraged by the progress that is beginning to evidence itself.

user
compname posts q2 earnings per share $0.32.
q2 adjusted earnings per share $1.03.
q2 earnings per share $0.32.
q2 sales $774 million versus refinitiv ibes estimate of $779.8 million.

assistant