MSC Industrial Direct Co., Inc. (MSM) Earnings Call Transcript & Summary

Good morning, and welcome to the MSC Industrial Supply Fiscal 2026 Third Quarter Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Ryan Mills, VP of Investor Relations and Business Development. Please go ahead.

Thank you, and good morning, everyone. Welcome to our fiscal 2026 3rd quarter earnings call. Martina McIsaac, President and Chief Executive Officer; and Greg Clark, Interim Chief Financial Officer, are on the call with me today. During today's call, we will refer to various financial data in the earnings presentation and operational statistics document, both of which can be found on our Investor Relations website. Let me reference our safe harbor statement found on Slide 2 of the earnings 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. 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 are noted in our earnings press release and our other SEC filings. Lastly, 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 or on our website, which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures. I will now turn the call over to Martina.

Thank you, Ryan, and good morning, everyone. On today's call, I will briefly cover our fiscal third quarter results, and we'll provide an update on the progress of our initiatives and the current demand environment. I will then turn the call over to Greg to provide greater detail on our fiscal 3Q performance and our outlook for the fiscal fourth quarter. Starting with our results on Slide 4. Average daily sales exceeded expectations with year-over-year growth of 7.8%, underpinned by continued strength in the daily sales of our core customer and noticeable improvement in national accounts. Adjusted operating margin of 10.6% also performed better than expected, resulting in an incremental operating margin of 32% in the quarter. Since becoming CEO earlier this year, I have spent a portion of my time getting to know our external stakeholders at conferences and roadshows. This time has been well spent as it allowed me to ensure that the high-level KPIs we're using to drive urgency and performance in the business are aligned with the way our shareholders will evaluate our results and hold us accountable to progress. To summarize here, we are focused on sales per rep per day and sales per total headcount, year-over-year volume improvement, adjusted operating margin expansion and adjusted incremental margin. And lastly, ROIC, which will improve naturally when the KPIs I just mentioned are firing on all cylinders. We are fully committed to restoring MSC to a mid-teens operating margin, a goal which is understood and driving action across the enterprise. While we aren't hitting any home runs yet with these KPIs as of the third quarter, I am encouraged by the singles and doubles we are producing, which I will now discuss in greater detail. Starting with sales per rep per day. we are making progress on our goals. As you recall, our sales force optimization initiative was completed in December with actions taken to streamline and professionalize our service organization which in turn resulted in some noise in our 2Q. This headwind is largely behind us, as evidenced by the improving ADS of impacted customers and the inflection seen in national accounts during the quarter. sales per rep per day has improved high teens year-over-year, suggesting that at this point in time, we are fundamentally doing more with less with 225 fewer heads in the fields, we're targeting the right customers and meaningfully increasing customer touches through disciplined sales execution. As you can see on Slide 4, average daily sales to our core customer once again outperformed total company with volumes beginning to improve. A portion of this improvement is being driven by daily sales growth in the double-digit range on mscdirect.com. As we look at the business today, in process for new sellers. We expect this will accelerate growth, reduce attrition and strengthen our ability to quickly add new sales head count where we see potential in the market. We've also instituted new sales management processes throughout the selling organization, guided by our sales leadership, sellers now operate to new standards with new tools and a supportive pipeline review process. Early benefits of this work and our initiatives over the last year resulted in improved cross-selling that helped contribute to OEM fastener growth of more than 15% in the quarter, as sellers are guided to sell MSC's full value proposition. Added to this work, we continue expanding our vending and implant footprint. The growth of our installed base is showing the benefits of an improving macro environment that should result in higher sales across existing locations, an effect which we commonly refer to as the coiled spring. We started to see early signs of this in the third quarter with daily sales trends on a per unit basis showing volume improvement. I'm also pleased that the company continues making strides to improve its cost structure as demonstrated by the 150 basis point reduction in adjusted operating expenses as a percent of sales in the quarter. This is being driven by several factors, including our recent head count actions, our new sales structure, which eliminated duplicative commissions being paid on the same dollar lowering our selling costs by reducing commission expense in the quarter and lower freight expense compared to the prior year despite elevated fuel costs as a result of benefits from our various optimization initiatives. Acting on our productivity pipeline and optimizing our cost structure will be at the forefront of our strategic focus as we progress towards our long-term targets. As we have said, we intend to challenge MSC's cost structure to restore the company's operating margins to the mid-teens. Our own competitive benchmarking on sales per total head count suggests that at today's revenues, we are relatively heavy by 1,000 heads. To close the gap to that benchmark, we will have to grow and aggressively target changes in the way we work with a focus on AI and automation. That focus is already being recognized. Just this month, MSC was awarded Verint's Global Customer award and accelerated insights with AI that recognizes efforts in pushing AI beyond pilots and into real-time use. Switching to the macro environment, we are seeing further signs of an industrial recovery taking shape with positive IP readings across most of our top manufacturing end markets and 5 consecutive months of MBI readings above 50. Turning to Slide 5. Average daily sales outpaced the IP Index for the fourth consecutive quarter and was above our target of 400 basis points in the fiscal third quarter. though still primarily price-driven, I'm encouraged, however, by the trend of volume improvement in April that has continued through June and suggest that our initiatives are beginning to take hold. While there is plenty of room to further improve, when I consider our financial results, the improvements made to strengthen our performance-based culture, increasing engagement scores from our associates, and the tangible evidence of progress achieved in the quarter across our focused areas of improvement, I'm confident that MSC is headed in the right direction to enhance our long-term profitable growth algorithm and create meaningful value for shareholders. And with that, I will now turn the call over to Greg to cover our financial results in greater detail and expectations for the fiscal fourth quarter.

Thank you, Martina, and good morning, everyone. Please turn to Slide 6, where you will find key metrics for the fiscal third quarter on both a reported and adjusted basis. Fiscal third quarter sales of $1.047 billion came in above our expectations for the quarter and improved 7.8% year-over-year. Price was the primary driver of the improvement and contributed 720 basis points to growth followed by volumes that contributed another 50 basis points. Sequentially, average daily sales outperformed historical averages and improved 12.3% compared to the fiscal second quarter. Looking at our sales performance by customer type, we see some signs of encouragement. Core customer daily sales continued the trend of outperforming total company with year-over-year improvement of approximately 8% in the quarter. National accounts, we were pleased by the improving trend and compared to the first half of the year with the growth in the third quarter of approximately 7% -- and lastly, in the public sector, daily sales improved roughly 8% and primarily driven by increased defense activity in the quarter and a lower comparison in the prior year. In solutions, we remain pleased by the continued expansion of our footprint in 3Q. In vending, the number of machines installed at quarter end increased 7% year-over-year to approximately 30,800 machines. The number of customers with an implant program improved 7% year-over-year to a total of 426 programs. As you recall, at the start of the fiscal year, our implant program count growth began to moderate as we strengthened financial discipline in the field and sharpen the quality of our decision-making. This is prompting us to transition certain existing implant programs with suboptimal returns to more cost-effective service options that are better scaled to customer needs. As was the case in the first half of the fiscal year, signings in the third quarter were higher than the sequential increase in total program count. Looking at the sales through these solutions, -- average daily sales through ending were up 15% year-over-year and represented approximately 20% of total company net sales. Sales to customers with an implant program were up 16% year-over-year and represented approximately 21% of total company net sales. Moving to profitability for the quarter. Gross margin of 41.1% came in slightly ahead of our expectations and improved 10 basis points year-over-year. Operating expenses in fiscal third quarter were approximately $324 million on a reported basis. On an adjusted basis, operating expenses of $319 million increased approximately $9 million year-over-year or $11 million quarter-over-quarter. However, we saw a sizable improvement in adjusted operating expenses as a percentage of sales with declines of 150 basis points year-over-year and 310 basis points quarter-over-quarter. This performance was better than expected as sales growth meaningfully outpaced expense growth driven by our productivity and headcount actions taken over the year. Reported operating margin for the quarter was 10.2% compared to 8.5% in the prior year. On an adjusted basis, operating margin of 10.6% exceeded the high end of our outlook for the quarter and compared favorably to 9% in the prior year. We delivered GAAP EPS of $1.44 compared to $1.02 in the prior year. On an adjusted basis, we delivered EPS of $1.43 compared to $1.08 in the prior year, an improvement of 32%. Turning to Slide 7 to review our balance sheet and free cash flow performance. We continue to maintain a healthy balance sheet with net debt of approximately $433 million, representing roughly 1x EBITDA. Capital expenditures of $21 million were down slightly year-over-year, and we achieved free cash flow conversion above 100% despite the step-up in AR related to the increase in sales. This is resulting in free cash flow conversion of 94% fiscal year-to-date, keeping us on track to achieve our updated target of 95% for the fiscal year. Looking at our capital allocation strategy on Slide 8. Our highest priorities remain organic investment to fuel growth and advance operational efficiencies across the business. Returning capital to shareholders also remains a priority with approximately $49 million returned to shareholders in fiscal 3Q and $160 million fiscal year-to-date in the form of dividends and share repurchases. Moving to our expectations for the fourth quarter on Slide 9. To reflect quarter-to-date trends, including daily sales in fiscal June that are expected to grow approximately 7% and more difficult comparisons with prior year this quarter, we are anticipating average daily sales improvement of 6.5% to 8.5% compared to the prior year, gross margins to follow the historical 3Q to 4Q sequential decline of 40 to 50 basis points and the continuation of profitable growth demonstrated by the midpoint of our adjusted operating margin range of 10% to 10.8%, implying adjusted incremental operating margins in the mid-20s. As we approach the end of the fiscal year, we have updated our expectations for some line items that can be found at the bottom of the slide. We now expect depreciation and amortization expense to be approximately $100 million for the fiscal year versus our prior expectation of $90 million to $100 million. We're also reducing our CapEx assumption from $100 million to $110 million to approximately $100 million. This is resulting in our expectations for free cash flow conversion to increase from 90% to approximately 95% for the fiscal year. Our expectations on the other line items for the fiscal year remain unchanged and include interest and other expenses of approximately $30 million, including the $5 million employee retention credit benefit we recognized in Q3, which is excluded for adjusted EPS and a tax rate between 24.5% to 25.5%. And with that, we will open the line for Q&A.

[Operator Instructions] Your first question is coming from Chris Dankert with D.A. Davidson.

I guess, first off, maybe just as we look at the fourth quarter guide, can you just kind of help us right size how much of that is kind of underlying core volume improvement versus pricing? Obviously, the pricing comp is a lot deeper here. Just kind of update us on that front.

Sure, absolutely. I mean I think we obviously had the beginning of some of our pricing actions impact the fourth quarter last year. But we do see continuing volume improvement. We're up against tougher comps in the fourth quarter. Ryan, maybe you want to share some for modeling purposes.

Yes. Chris, welcome back. The way I would think about volumes and price in 4Q is price was about 7.3%, 7.2% year-over-year in 3Q. As Martina mentioned, we'll begin lapping some of our more meaningful price actions related to tariffs in 4Q last year. We did put some price in May related to what we're seeing in the metalworking and other product categories. I would think about price being in that 6.5%, 7% range but definitely implying volume improvement at the midpoint. And I'll remind you, it's against a tougher comp as well. Our volume comparison in 4Q is about 300 basis points tougher relative to the third quarter. So we feel good about what we're seeing.

Got it. That's extremely helpful. And I guess just kind of as a follow-up here, on the sales force realignment and the efforts on that front, can you just kind of give us a sense for how did the execution there sort of tracked through the quarter to your expectations? Are we continuing to see things move in the right direction there? Are you pleased with kind of how sales growth and coverage have kind of moved as we got into June? Maybe any kind of additional commentary there to make that would be very helpful.

Absolutely. We're exactly where we thought we would be. So you want to think about this in 2 phases. So first, thinking about the structure and the analogy that I use with the team is you want to get wet if it rains. So you want to be in the right place at the right time with the right opportunities, with the right programs and put it into our context, able to take advantage of the tailwind that we're seeing in some of the industrial trends, and that's happening. So proof points, you look at the volume through our vending units, we've got vending and implant up mid-teens ADS in the quarter. We've got vending per unit up high single digits, which is clearly a volume driver. That's that coiled spring we've been waiting for. So the structure piece is behind us, and we're happy with our segmentation and our coverage. Now the next piece, which is really more exciting is you want to make it rain as well. And that's what we're talking about around the sales excellence side of things. So we've compressed our time to hire. We have filled the vacancy. We're onboarding and training people differently. We've got new sales management processes. So now you start to drive growth and volume through your day-to-day activity and your day-to-day sales management. So we're exactly where we thought we'd be. This is a long game that we're playing, and you'll start to see it as the volume improves in the next quarter and beyond. To this point.

Your next question is coming from Ken Newman with KeyBanc Capital Markets.

On the nice quarter. Martina, maybe for my first question, maybe could you help us level set on how to think about us from the outside tracking your progress on your productivity initiatives into next year? I know you mentioned being about 1,000 heads heavy at current revenue levels, but how do you view that evolving as the volumes in the cycle inflect into next year?

Yes. Ken, thank you for the question because that -- I think it is important that we're all on the same page. So let's take one step back and say, where did this benchmark come from? We committed -- we're committed to that mid-teens operating margin or beyond in terms of a turnaround for the company. And we needed an internal benchmark. We needed something to anchor ourselves against and to shoot for. And so we did all of this benchmarking to say, today, to deliver $4 billion in sales, it takes us 1,000 more people than it would take one of our public peers. And that's the measure of efficiency then that we're looking at internally. So if you quickly do the math, you're talking about 570,000 ish per head, that's what we generate today. We want that number to be $100,000 more, right? That's what the 1,000 heads turns into. So then the team takes that target and says either, a, I need to be able to grow without adding heads or I need to take heads out to make my process more efficient. And it's a combination of both because we want to improve associate experience and take manual work out and build up the foundation that can absorb growth without needing new headcount. And in doing so, we want to improve customer experience. So there's a whole set of interconnected factors that we're looking at. So we have a road map today. I mean, if you think about it, we're almost at the end of our fiscal year. So we've already mapped out the target for 27 that gets us closer to that benchmark, but that's the number that we want you to be tracking. So you can look at absolute headcount progress if you look at total head less the sales headcount, but it's really that ratio, I think that's the more important measure of progress. And the other thing I'll say is based on the road map, we're not going to share a lot of details upfront for competitive reasons and honestly, to support the strong momentum and morale that is within the company around this benchmark. But as we log the wins, we will share them. But you'll see them in those 2 numbers. And it's not going to be linear. This quarter, for example, we didn't see a lot of movement. Some projects are small, some are much bigger, some are short term, some take a little longer, but those are the 2 places you should look.

And then maybe for the follow-up, just thinking about operating leverage from 3Q to 4Q, I think the midpoint of the incremental margins is in the mid-20% range. You did low 30s this most recent quarter. Maybe any color on just why the operating leverage may step down sequentially despite the ADS growing? Is there a mix headwind that we should be aware of? Or is there anything else kind of onetime that we should kind of be aware of thinking about that fourth quarter guide relative to maybe what's maybe more baked in as conservatism?

Ken, this is Ryan. Not overly concerned about the increase in -- I mean, the decrease in the operating leverage. It's mainly just driven by the timing of some actions and some moving pieces in the prior year. For instance, if you look at freight, year-over-year in 3Q is about a $3 million good guy. We will start to lap some of our network optimization savings in 4Q. That will be a bad guy year-over-year just because of what we're seeing in fuel costs. Another one would be, if you think about our headcount actions we took at the end of last fiscal year, we'll start to anniversary them. So the way I think about it is, yes, it's a step down, but there's some moving pieces. But I'd say our profitable growth algorithm still remains intact. Mid-single digits incremental margins should be at least 20%. As we near high single, low double digits, incremental margins should be at the upper end of 20%, closer to 30%. So just some onetime moving pieces in the quarter. That's how I view it, Ken.

Your next question is coming from Ryan Merkel with William Blair.

Martina, I wanted to start on the comments you made about the industrial recovery. You're starting to see that. I'm curious what inning do you think we are in for the industrial recovery? And then have you seen customers adding more shifts yet to plants and restocking inventory? Or might that be a future tailwind?

So thanks for the question, Ryan. I think we're probably in sort of third inning if I -- that might be conservative, but we are starting to see changes in behavior. So the most notable now that we haven't sized yet, but we're watching closely is summer shutdown patterns are changing significantly. So whereas we would have had preplanned shutdowns, particularly in automotive, those are being canceled. Those are not -- or they're not being announced as they would have been. So it's still spotty, but it's real. And so I think that's probably the best indicator that we have.

And Ryan, I'd just add, in 3Q, our top 5 end markets saw strong growth in 4 with the exception of automotive. As we head into June, we saw automotive turn positive, which is another good sign. And then going back to Martina's earlier comments in Q&A, if you look at the average daily sales in vending and implant on a per unit basis, we were up high single digits, that implies volume improvement. I think that's a good gauge on industrial demand. So we're starting to see it, and I hope that continues.

Yes. That's really helpful. Yes, 1% volume, I imagine we will get a lot better if this continues. So that's kind of what I'm focused on. And then on pricing, 7% price was a little better than I think we expected. Just talk about why that was. And then just on tungsten, are you done seeing price increases from suppliers on that now? And I'm curious how much of tungsten carbide prices up year-over-year in 3Q because I imagine that's a decent tailwind.

We're not done, Brian. Thanks for the question. So tungsten is still the largest driver of our inflation. And I think we're not done. Suppliers' reaction depends on their own -- the nature of their own supply chain. We will plan for a price action in the fourth quarter. And I mean, tungsten overall is up over 50% -- so we haven't really seen a slowdown yet. We are -- we haven't seen a lot of prebuying. -- cutting tool volume is still growing for us, which is an important metric that we're tracking because we want to make sure there's no demand destruction yet. There aren't a lot of substitutes for carbide cutting tools. So we're still seeing inflation, but we're still seeing growth. And yes, we don't see the end.

And Ryan, just going back to your first question on pricing in the third quarter, yes, it came in a little bit better than anticipated. A couple of things driving that is we saw cutting tool volumes inflect positively. If you think about the inflation there, that contributed. And then we talked about being more strategic with pricing in certain categories and streamlining some discounting templates. -- that occurred more later on in 3Q, so not too much of an impact in the quarter, but pleased with the pricing, but more encouraged that we saw volume inflect positively in the quarter.

Your next question is coming from Nigel Coe with Wolfe Research.

I just wanted to follow up on that pricing question. First of all, can you maybe just comment on how kind of that price cost gap is trending in kind of 3Q into 4Q? And then when we look at the monthly sales performance, I know that month-over-month can be volatile, but May was weaker, June was stronger. It looked like a bit of a prebuy ahead of price increases you said, Martin, that didn't happen. So just curious, any comments on that?

Yes. It does. I can see how if you look at our April, May, June, you're kind of wondering, is this going in the right direction. We had a couple of, of course, structural things impacting that. So remember, Easter moved, which inflated our April. And then June, typically for us is a 250 basis point drop because of our 5-week month and the holiday timing. Actually, this year, it's about a 50 basis point increase. So we've seen just some shifting, but no real concern. We're pretty happy with where sales are. And price/cost positive contributed 20 to 30 basis points to margin in the quarter.

Okay. And does that still look similar in 4Q, Martina? And then I'm just wondering maybe if you could just break out SG&A between payroll, freight, et cetera, in light of the freight inflation, especially. And then just wondering in '27, how we should think about SG&A growth relative to sales. And I know you guys don't tend to look much beyond the quarter, but any thoughts on '27 in light of third innings of, hopefully, a cycle recovery here?