MSC Industrial Direct Co Inc (MSM) 2021 Q1 法說會逐字稿

Good morning and welcome to the MSC Industrial Supply 2021 First Quarter Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to John Chironna, Vice President of Investor Relations and Treasurer. Please go ahead.

Thank you, Jason, and good morning, everyone. Erik Gershwind, our Chief Executive Officer; and Kristen Actis-Grande, our Chief Financial Officer, are both on the call with me today. As on our last call, we are all remote, so bear with us if we encounter any 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 2 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 in 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 risks is noted in our earnings press release and the risk factors in the MD&A sections of our latest annual report on Form 10-K filed 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 obligation to update these statements. 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 Erik.

Thank you, John, and good morning, everybody. Thanks for joining us. I'll begin by wishing each of you a happy, a healthy and especially a safe new year.

I'll start the call this morning with some perspective on our journey and our recent progress. I'll then review first quarter results and take a deeper dive into our growth initiatives. From there, Kristen will review the financials in more detail and provide color on our structural cost program. I'll then wrap up before we open up the line for questions.

As we enter the middle of fiscal 2021, momentum on our Mission Critical initiative is building. This is evidenced in part by improving numbers, but more importantly, by progress against our key initiatives and by the increasing pace with which we're operating the business.

As a reminder, several years ago, we decided to reposition MSC from a spot-buy supplier to a mission-critical partner. We captured this in our new brand promise, Built To Make You Better. And we did so in order to secure the next decade plus of MSC's success and to deepen the moat around our business.

Since that time, we have recreated MSC's value proposition; remodeled our supply chain with an elevated presence on the plant floor; reshaped MSC's sales force; built new platforms for growth, such as CCSG; and we've accelerated the pace of innovation, with advancements like MSC MillMax; we've built new digital capabilities like e-commerce to improve customer retention and loyalty; and a new pricing function to improve price execution and realization; and finally, we've taken steps to create a more agile culture in order to drive change faster.

On our last call, we outlined Mission Critical or our pathway to translate these changes into improved performance. We shared 2 3-year targets, and those were accelerated market share capture and improving ROIC. We shared 5 growth levers that will deliver at least 400 basis points of outgrowth above IP by our fiscal 2023. We also shared a structural cost initiative that would yield at least 200 basis points in operating expense-to-sales ratio improvements by fiscal 2023, powering ROIC back into the high teens during that time.

While we're encouraged by progress, we have our sights set high, and we're just getting started. We're making inroads on the 5 growth levers, and we're moving aggressively on the structural cost front to achieve our 1-year and 3-year targets, with a robust project pipeline and a steady drumbeat of changes being implemented across the company.

Looking outside of our company, all of this is happening against the backdrop that remains challenging, but is showing some positive indicators. The good news on the vaccine front and the recently passed stimulus package will likely improve the outlook over the coming quarters.

I'll now turn to our fiscal first quarter financial results, which you can see on Slide 4. Overall, sales were down 6.3%, and gross margin was down 30 basis points versus the prior year period. Our operating margin on a GAAP basis was 7% and was significantly influenced by a nonrecurring asset impairment charge, which I'll describe in greater detail shortly.

As you can see on Slide 5, excluding this impairment charge and adjustments related to severance and costs associated with Mission Critical, our adjusted operating margin was 11.0%, down 30 basis points from the prior year despite lower sales and supported by Mission Critical. All of this resulted in earnings per share of $0.69 for the quarter or $1.10 on an adjusted basis.

We're seeing continued sequential improvement in our sales levels. Most notably, our non-safety and non-janitorial product lines improved through the quarter and declined low double digits. Sales of safety and janitorial products, anchored by our PPE program, continued growing at over 20% for the quarter.

The improving trends extended into December with total company sales growth estimated at 2.4%. While aided by some large PPE orders, December is nonetheless encouraging, as the rest of the business, excluding safety and janitorial, was down in the low single digits year-over-year.

Looking at our performance by customer type. Government sales continued to grow significantly year-over-year due to the surge in large safety and janitorial orders. National Accounts declined in the low teens, while our core customers declined low double digits, and CCSG was down mid-single digits.

As you can see on Slide 6, industrial production remained in the negative single digits range, but did improve over the prior quarter. Most manufacturing end markets behaved consistent with this trend, although metalworking-centric end markets did continue to lag the broader IP index.

More importantly, we have seen the gap between IP and our growth rate begin to compress as expected. We plan to build on that momentum. And as a reminder, we target exiting fiscal 2021 with at least a 200 basis point positive gap above IP for our fourth quarter.

I'll now turn to our growth initiatives. On the last call, I outlined 5 levers that will drive our improved growth over the next 3 years. And those are: metalworking, solutions, selling our portfolio, digital and diversified end markets.

Today, I'll discuss and focus on a couple of them. First, metalworking. We're investing heavily in our core business in order to widen our lead. One way we do so is by capturing new customers from local distributors who are under tremendous pressure in the current environment. We track our funnel of opportunities and win rate by market, and both are progressing according to plan. We expect that progress to build as the locals come under more and more pressure with each passing month.

MSC MillMax is aiding our efforts to capture market share. Milling is one of the most significant cutting tool applications. Cutting tools represent roughly 30% to 40% of the $12 billion to $15 billion metalworking market. MSC MillMax not only provides opportunities to capture share within cutting tools, but it opens up access to our customers' broader MRO purchases, which are multiple times the size of their cutting tool spend.

We're seeing strong early reception to the new technology. Our funnel of opportunities is building quickly and is starting to produce new wins. As we do with vending, we're offering MSC MillMax as a service in exchange for incremental share of wallet.

The second initiative on feature is government, which, is right now, our largest diversification play. We've been working hard over the past 2 years to turn our government business from an underperformer to an outperformer. And while we're benefiting from a PPE tailwind, we are nonetheless pleased with our progress in the fiscal first quarter as the business grew over 35%. Beyond the current momentum, we're investing in this area to build for the future, including adding hunter roles dedicated to creating new opportunities for us.

Third, I'll highlight our sales force build-out. Growing and reshaping our sales force is an important enabler that powers each of the 5 initiatives. In recent years, we've taken sales headcount down in order to reshape the sales force consistent with our new strategy. For the first time in several years, we're now poised to expand the sales force. We had a delay due to the pandemic, but we've now restarted those efforts.

In our fiscal first quarter, we increased our sales headcount by 50, including roles such as business development or hunting, metalworking specialists and government. This effort has been aided by the redesign and outsourcing of our talent acquisition function, which was one of the Mission Critical projects that Kristen mentioned on the last call. We are hiring faster and at a lower cost.

Before turning things over to Kristen, I'll now discuss our PPE program and the related impairment charge for the nitrile gloves. From the outset of the pandemic, we have worked hard to source critical PPE supplies to support our customers in need and to keep the frontlines of industry and government workers safe. Despite the widespread scarcity of certain products and well-documented supply chain issues, we've been successful in this effort across a wide range of items.

Nitrile gloves have proven to be more challenging. Over the past several months, a number of our large customers approached us in dire need of the scarce product. Our normal channels of supply could not produce sufficient quantities as the nitrile glove global supply chain is under extreme pressure right now.

As a result, in September, our team turned to new sources of supply. We used prepayments to secure priority status, which has been a standard market practice through the pandemic and has been an effective tool for us in securing scarce product during this time.

As of today, we've not yet received the gloves. And in light of the growing uncertainty over our ability to secure deliveries, we recorded an impairment charge for the full amount of the prepayments. We are, of course, pursuing all possible paths to either secure the gloves or a refund of our prepayments.

Pulling back from this specific issue, we're quite pleased with our PPE program, which has consisted of hundreds of global supply transactions leading to substantial revenues, and most importantly, the ability to keep our customers safe.

I'll now pass it over to Krista.

Thank you, Erik. Let me start with a review of our fiscal first quarter, and then I'll update you on the progress of our Mission Critical initiatives.

For reference, on Slide 4 of the presentation, you'll see key metrics for the first quarter, on a reported basis. Slide 5 reflects the adjusted results, which will be my main focus this morning.

Our first quarter sales were $772 million or $12.5 million on an average daily sales basis, both a decline of 6.3% versus the same quarter last year.

Moving to gross margins. Our first quarter gross margin was 41.9%, a decline of 30 basis points compared to the first quarter of last year. Sequentially, gross margin improved 30 basis points compared to fourth quarter 2020 despite the headwind from some large PPE sales that we mentioned on our last call. We continue to see solid performance due to the traction of our initiatives. Our execution on both the pricing and purchasing fronts has been strong, with solid realization from our annual price increase as well as improvements to our supplier programs.

December gross margins continued the trend of solid execution on the price and cost fronts. We could, however, see increased headwinds in gross margins due to PPE-related SKUs over the next couple of quarters.

Total operating expenses in the first quarter were $243 million or 31.4% of sales versus $257 million or 31.2% of sales in the prior year. This includes about $4 million of costs related to severance and the review of our operating model, both related to Mission Critical. The severance made up about 1/3 of that amount.

Excluding these costs, operating expenses as a percent of sales were 30.9%. In the prior year, excluding $2.6 million of costs related to severance, operating expenses were also 30.9% of sales. We were able to keep the adjusted OpEx-to-sales ratio flat despite the decline in sales as our Mission Critical initiatives continue to deliver savings. I'll go into more details on the progress of our Mission Critical initiatives in a minute.

Including the asset impairment charge that Erik mentioned earlier, all of this resulted in GAAP operating margin of 7% compared to 11% in the same period last year. Excluding the impairment charge, severance and other related costs, our adjusted margin was 11% versus an adjusted 11.3% in the prior year. GAAP earnings per share were $0.69. Adjusted for the impairment charge as well as severance and other related costs, adjusted earnings per share were $1.10.

Turning to the balance sheet and moving ahead to Slide 7. We achieved free cash flow of $95 million in the first quarter as compared to $72 million in the prior year. This improvement was driven by our accounts payable management and the deferral of payroll taxes under the CARES Act. As of the end of fiscal Q1, we were carrying $521 million of inventory, down $22 million from last quarter. Roughly $60 million of that is related to PPE products, and over half of that is specific to disposable masks. This is ample supply should the virus surge continue.

During the quarter, we continued to manage our liquidity very closely, and we paid down $130 million of our revolving credit facility in Q1. Our total debt as of the end of the first quarter was $490 million, comprised primarily of a $120 million balance on our revolving credit facility, $20 million of short-term fixed rate borrowings and $345 million of long-term fixed rate borrowings. Cash and cash equivalents were $53 million, resulting in net debt of $437 million at the end of the quarter.

Since then, in December, we paid a special dividend of approximately $195 million, which we funded primarily from our revolver. The special dividend reflects our long-standing commitment to returning capital to our shareholders as part of our balanced capital allocation philosophy, while maintaining a conservative balance sheet.

Before I turn it back to Erik, let me provide 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 2023 and as versus fiscal 2019. On our last call, we shared that we had taken out $20 million of cost in fiscal 2020, and that our goal for fiscal '21 was to take out another $25 million to achieve cumulative savings of $45 million by the end of fiscal '21.

I'm pleased to report that we achieved an additional $8 million of savings in the first quarter, bringing our cumulative savings to $28 million against our goal of $45 million by the end of this year. This is gross savings and did not reflect investments of roughly $2 million to $3 million in the first quarter and $15 million expected in fiscal '21.

While one quarter does not make a year, and we did capitalize on some low-hanging fruit, I'm encouraged by our fast start to the year and our continued momentum in executing our Mission Critical productivity programs.

In addition to some of the initiatives I mentioned last quarter, which are proceeding as planned, we also have signed an agreement to sell our Melville, New York facility. This 170,000 square foot facility on 17 acres served as one of our co-headquarters. We will be relocating late this spring to a smaller 26,000 square foot space nearby, which will accommodate our new hybrid working model. Once the sale of our current location is complete, we will save roughly $3 million annually in operating expenses. We will continue to review our real estate footprint for additional opportunities.

And I'll now turn it back to Erik.

Thank you, Kristen. Last quarter, we outlined our Mission Critical initiative. It's aimed at turning the hard work we've performed over the past several years into improved financial performance. Our company's sights are firmly set on 2 goals, referenced on Slide 12, to be achieved by the end of our fiscal '23: first, growing at least 400 basis points above IP; and second, returning ROIC back into the high teens.

We have 5 growth initiatives powering our market share aspirations, and we are executing significant structural cost reductions that we expect to improve operating expenses as a percentage of sales by at least 200 basis points. As we move into the middle of our fiscal year, we're encouraged by the momentum that's building inside the company. This is evidenced by improving numbers and by improving execution of the projects behind them.

Most significantly, there's an energy building inside the four walls of MSC. And with each passing quarter, we expect that energy to grow. We will not rest until we've achieved our mission of being the best industrial distributor in the world, as measured by all 4 of our stakeholders. Thank you.

And we'll now open up the line for questions.

(Operator Instructions) The first question is from David Manthey from Baird.

Happy New Year, everyone. So first question, kind of big picture. Could you outline the role of technology in the Mission Critical effort? I mean, if you're cutting costs and you hope to maintain or improve the productivity and customer service of MSC, how are you doing that? Can you give us a couple of examples?

Yes, Dave, I think it's -- so good question. And what I would say is just the way, on the growth side, we described sales force as an enabler. The expansion of the sales force as something that powers or enables each of the 5 initiatives.

Technology is underpinning everything we're doing. And that's on the cost side. It's on the growth side. So on the growth side, and I'll get to your question on cost. On the growth side, heavy investment into digital, as we had talked about as one of the 5 levers, heavy investment into pricing analytics that we're beginning to see translate in the form of improved price realization on the gross margin line.

And then, of course, yes, heavy emphasis on using technology to power some of the structural cost initiatives. And I think what's most significant there is the cost takeout here, this is not an exercise of just stripping cost out of the business. This is an exercise in improving how we do things.

So a perfect example of that is what Kristen just mentioned with our move in Melville. Yes, it was a downsizing of the building. But really, what we're doing is rethinking the way we work and using technology to do it. So it's moving to a hybrid work model.

And obviously, for all of us, technology has been at the core of that. And not only does that open up productivity gains, it allows us to shrink real estate footprint. It allows us to rethink travel and how often we need to get together. But it opens up talent pools in new locations that were not wed to Melville, for instance, that we can recruit, especially in certain functions in other areas.

So that would be an example, Dave. But I think what you'd see if you go project-by-project across the 3 big buckets, sales and service, supply chain and G&A, is technology is underpinning a lot of it.

Okay. And then just to clarify one thing. On Slide #5, where you say that non-safety sales were down year-to-year, but improved sequentially each month. When you say improved, are you talking about dollars there? Is that average daily sales growth rates? What is the improvement you're referring to?

That would be improvement in our average daily sales rate, Dave.

Our next question is from John Inch from Gordon Haskett.

Happy New Year. So let me start, Erik and Kristen. Raw material costs have been going up. Have you seen that reflected in the prices of your purchase products? And how, Erik, are you thinking about the annual price increase? And maybe you could talk about just supplier pricing actions and trends, in general?

John, so you're right. What you're pointing out is something we have -- our sourcing folks have their eyes on closely, particularly as it relates to metals. What I would tell you is, to date, it's been a little early to see it translated. As you know, in following us for a while, one of the real triggers for us is seeing the commodities movements translate into supplier list increases, which have not yet come in earnest. We do expect, though, that, that's going to build, should the inflation sustain.

As of now, our thinking is we would expect to implement a price increase. Timing-wise, it's still a little early, but figure roughly, end of Q2, beginning of Q3 is kind of what we're thinking now.

And John, the only other thing I'll point out is, I think if you look at our growth decomposition, you'll see, we're seeing improved price realization. The most recent increase we took was back over the summer, it was in the 1% range. So it was pretty modest given the low inflation at the time. So we're encouraged. We've invested a lot into price -- sort of price execution, price analytics, and we think we're starting to see that in the form of improved realization.

So just based on your answer, it's too soon to tell if the rising raw material costs are going to translate into higher product costs? Like what's traditionally the lag? And are your competitors raising prices yet? Or are they also kind of waiting and seeing?

So generally, there is a lag, and it will depend on how -- it's usually a several month lag. It depends on exactly when depends on how fast they snap back. And of course, I think it would have to be sustained for a bit of time before our manufacturers pass it along.

We watch pricing carefully. I would say, to date, we've not seen a lot of movement. But history would suggest that if what we're seeing now in inflation does hold, that it would yield increases coming from our suppliers. And it's a matter of time.

No, that makes sense. And then just as a follow-up question, Erik. So the 400 basis points of targeted market outgrowth, does your plan provide for a more granular breakdown, say, by targeted industries? So some aspects, government might be more than 400-some less? And if so, I'm assuming that's the case, could you give us any details to kind of square up the 400 target?

Yes. So look, inside the company, John, we have the 400 broken out a few ways. Certainly, by customer type, we have a look. We also have a look by product and service category. And we have another look that's literally down to the geography, the ZIP codes sort of level by initiative of our 5 big levers. So we have multiple cuts at it.

Certainly, there's going to be industries that grow faster than others. What I would say is a couple of things. One is you're going to see us -- it's -- for us, it's a balance. On the one hand, you're going to see us continue to invest in our core. Our core is metalworking, and metalworking gets sold into those heavy manufacturing sectors that have been hit pretty hard.

So if you look at the IP numbers, they've been lagging -- those heavy metalworking-centric end markets have been lagging. At some point when there's a real recovery, those will snap back. And we think we'll benefit in an outsized way by staying focused on that segment.

The second piece would be the balance is sort of the fifth lever, if you will, is the diversified end markets. And the biggest focus for us right now is the one you touched on, John, government. Certainly, we're encouraged by momentum there. That would be one that we would expect to outpace the 400, for sure, given its relative size in our portfolio, size of market and the level of investment we're putting there.

You mentioned metalworking on the last call, Erik, as a continued focus. So does metalworking grow faster than 400? Or is it kind of around the 400, based on your plan?

Look, I think it will move around, John. And obviously, it'll be a function of how we execute, how much share we capture. I think the way we look at it is given our relative size in metalworking and market share that we have, if we were growing at 400 basis points above IP in metalworking, that would be a pretty good result and would allow us to widen the lead given the size of the base we're starting with.

Our next question comes from Hamzah Mazari from Jefferies.

Happy New Year. So my question is just around the re-acceleration of market share. And you mentioned there's a new energy building inside the company. Maybe you could talk about sort of how is this restructuring different from a cultural buy-in perspective?

And then how conservative are the numbers you've put out there, the 400 basis points, the ROIC, sort of mid-teens? How do we think about those 2 items?

Hamzah, so let me start with the energy, the question around the energy, and there is. I mean, if you're inside the company and right now, by large measure, that's inside it virtually, you would feel a change.

And what I would say is like go back to say, look, if you go back over the life of this company or particularly our life as a public company, we're going on 25 years now. The DNA of this company is a growth company, and one that always stretched and saw itself having goals that were much bigger than where it was at the time.

And look, over the past few years, we've been through a lot of changes. We're coming out the other side of the changes and are reconnecting with that legacy and the idea of thinking big and setting stretched goals. I think that's one of the sort of the biggest things is a reconnection with that idea and a leadership team that's embracing, that's embracing the idea of stretching for (inaudible). And I think that's beginning to trade this way through the organization.

So to your point about how conservative are the goals? Look, as you can imagine, like most things inside the company, we are stretching. And for any goal that we're talking to you about, you could imagine that for the group inside of sales, is there a higher aspiration? Sure. For the group that's focusing on the cost side by area, is there a higher aspiration? Sure. Because we are trying to build the mentality into the company of stretch and think big.

Got it. And then just on the gross cost savings target of $90 million to $100 million, do you have a sense of how big the reinvestment you're thinking into growth will look like and where you're going to reinvest? I know you talked about sort of rebuilding the sales force and hunters, [50], I think you said as a number. But just order of magnitude, how much of those gross savings would be reinvested? And is it going to be all in sales? Or are there other areas?

Yes. So for this year, we're looking at a $15 million reinvestment. That would be for fiscal '21. For '22 and '23, you can definitely look for that annual number to step down. We're going to continue to invest. I don't think we've given a specific range whereby say you could probably look for $7 million to $8 million of reinvestment in '22 and '23. That's always changing, though, as we continue to add more to the pipeline, look at the prioritization of when things come online.

As far as where the investment goes, we're focused on the 3 areas: cost out in G&A, supply chain and sales and service. It is an investment really underpinning all 3. This year is a bit more focused on the sales and service areas, particularly with the digital initiative ramping up very quickly, but you're going to see investment across the board.

As Erik mentioned, a lot of the stuff we're looking at on the cost side is really transformative due and requires investment. So it will be across the board, nearer term, a bit more weighted to sales and service.

The next question is from Kevin Marek from Deutsche Bank.

Can you just update us on what happened in sales in terms of safety versus non-safety performance? Like how are the trends by month through the quarter and then obviously through December?

Yes, sure. And we can get you specific numbers. I mean, what I'll do, Kevin, is just give you sort of the general picture as to what's going on is it's consistent with what we're seeing in the indices. Like I -- we are seeing a sequential build in the performance, particularly of the base business. And by base, I mean non-safety, non-janitorial.

So if you look at safety and janitorial, which is a great proxy for our PPE program, through the first quarter, that was growing in the low-20s. December stepped up to high 20s, close to 30%. But I think the real story is what's been happening in the non-safety/janitorial, the other -- the core of the business, which has been a steady climb up.

So when you go back to the teeth of the pandemic, we were talking down, I believe, it was mid-20s, I mean, in the depths of this thing. And we've been on sort of a gradual climb up. And then, obviously, look, we got a nice pleasant surprise in December, where the all other, the base business was down low single digits.

So 1 month does not a trend make. It was an encouraging sign. We got some benefit of some CARES Act spending as that was expiring. But it's been a steady climb up in the base business.

Got it. And then as a follow-up, is there any gross margin implication that you would call out from the trends you've seen in December as far as 2Q expectations are concerned? I think typical seasonality maybe doesn't call for much of a change Q-over-Q?

Yes. Let me touch on gross margin, and I'll put it back in the context of kind of the guidance we gave last quarter around the operating margin framework.

So what we told you last quarter on gross margin range, thinking about the year, is you can expect this to be flat to maybe down 50 bps. The biggest variable there is really mix driven by the PPE headwinds.

So since then, we've seen a couple of things happen. One, our price and cost execution has been really strong, like we alluded to for December. I'd say it's as good or better than we had envisioned. Two, we see a higher chance of larger PPE headwinds for 1 quarter or 2. And what's behind that is, one, we've got a large inventory position on masks.

The virus is surging, we may end up selling through a lot of those. At the same time, it's no surprise to share that mask pricing has come down over the past couple of quarters. But really, given the strong price cost performance, we'll still likely fall within that flat to down 50 bps range, even with the larger PPE headwind.

I think if the PPE headwind were to become really large, it's possible we could stray outside that down 50 bps range. If that happens, I think what you'd see us do is enact countermeasures, whether it's on the gross margin line or elsewhere on the P&L to mitigate that risk as much as possible, but really trying to still protect that investments that are going to drive the growth, both in '21 and beyond.

Regardless of what happens with PPE, it is a temporary headwind. I think in a couple of quarters, the underlying price cost dynamic, that's what we're most focused on, and we're really pleased with what we see there.

And more broadly, we're still very committed to the 2 overall Mission Critical targets around the market growth capture and ROIC improvement.

The next question is from Michael McGinn from Wells Fargo.

Happy New Year. So I wanted to touch on your annual margin framework. Historically, your financials have seen a slow start given the first half seasonality of the business. But you were able to meet the low end of your full-year framework on a mid-high single-digit revenue decline.

So assuming mix is normalizing and price building momentum to the benefit of your gross margin, I was just curious, what are your embedded assumptions for SG&A in terms of cost-out opportunity? And maybe what would -- what factors would push that to the high end of the annual framework?

Sure. Sure. So drilling in a bit on SG&A in terms of the op margin framework that we laid out last quarter. Our thinking on the operating expenses still holds. Really, if you end up seeing revenue flat to slightly down, you can look for the OpEx expense to be slightly down as well, and we are on target for that still.

If you think about kind of what would drive us to the upper end of the overall op margin framework, I'd say you could have one potential where you're looking at potentially overdriving the productivity programs. We're always looking to be more aggressive on things in that department.

On the gross margin side, again, we are seeing strong underlying price and cost performance. I'm not sure that I would say the mix headwind is behind us yet because we still do have PPE volume moving through. And especially in the next couple of quarters, it's still likely that PPE mix could be a headwind.

But I'd say the operating expenses, largely still in line with the framework. Gross margin, we feel confident we're in that flat to down 50 bps range. So if you saw anything advantageous against either of those, those could tick us up to the upper end of the range.

Okay. I appreciate that. And then you mentioned some nice trends within milling and the MillMax initiative you have. I'm assuming that's catering to your core customer as well as some government. Can you remind us what milling and maybe CCSG combined as a percent of your revenue is?

So let me talk a little bit. And Mike, what I'll do is maybe frame for you MillMax, which is really -- you're right, MillMax is powering the core business.

The interesting dynamic, though, is it's powering it in the metalworking category, but we see an opportunity to power through other ancillary MRO products within the heavy manufacturing sector. So let me explain a little bit.

So metalworking in the U.S., we size at $12 billion to $15 billion, and it fluctuates based upon what's happening in the market. You can imagine right now with spending being down, the economy being soft, it's at the lower end of that.

Cutting tools, as a whole, represents 30% to 40% of metalworking. That's been the company's bread and butter for a long time. Within the cutting tool universe, milling is one of the biggest applications within cutting tool. That's where MSC MillMax is designed to show productivity.

And look, the results, in terms of improving customer throughput, productivity, have been really, really encouraging. So frame there, we believe there's roughly around 45,000 locations -- customer locations in the U.S. that would be candidates for MSC MillMax. And those are -- that's basically the universe of where we see the right fit of heavy manufacturing that's doing milling applications.

The opportunity for us is to go in there, and it's not just -- it's to improve the customers' productivity. And then as we described, we're really providing a service. And then in exchange for the service, we're asking for incremental market share capture.

In many cases so far, and obviously, it's still very early, what we're seeing though is the market share capture may or may not happen in cutting tools. It may happen in the customer's ancillary spend. So if you go into a typical manufacturing operation, generally, for every dollar of cutting tools they're spending, they're going to spend some multiple of that on MRO purchases and sort of that's the bigger opportunity for us. And all of this, obviously, is to power the 400 basis point outperformance that we're gearing ourselves towards.

Okay. And if I could dig into that a little further. Can you maybe touch upon why MillMax is important to have in the hands of a distributor versus maybe an OEM? Because my perception is you're going in, you're providing these services and you're finding the best and right solution.

So how does that work with your maybe supplier relationships? And you're able to provide the best product that you know works versus favoring one or another product where an OEM might?

Yes, Mike. So that's -- it's a great question. And look, I think, I really -- as much as I love the MillMax technology and about what it's doing, I think we are perfectly positioned to be the one to bring this to market, for a couple of reasons.

One is the technology by itself is a piece to the puzzle. The end here is about finding productivity and helping customers improve throughput, reduce wasted materials, et cetera. To do that, you need the -- this technology is unique. But by itself, it's not enough. You actually need a technical person alongside to interpret the data. Somebody who understands machining and metalworking, which, obviously, we've got the largest national footprint of metalworking tech specialists in our field and in our customer care centers.

And then on top of that, Mike, and this gets to your question about the suppliers. Look, suppliers -- our suppliers and the manufacturer could do this. Here's the challenge they face. Ultimately, what this tool does is it brings objectivity. And it removes brand preference, because it's -- it moves it to performance.

And so the benefit that a customer has by doing business with MSC is we're going to give them the right -- We're going to use -- interpret the data, and then we're going to give them the right answer to their problem. And the nice thing there is MSC has the broadest and deepest metalworking portfolio in the industry.

So I think all 3 of those components together are what's needed to really maximize value to this thing. And I think we're in a fortunate position to have all 3.

The next question is from Adam Uhlman from Cleveland Research.

Happy New Year to you, all. I was wondering if we could start with a discussion about your hiring plan for the sales force for the rest of the year.

I'm wondering if you'd be willing to mention just how many folks you are looking to add to the sales force? And then -- or maybe more of this reinvestment, the $15 million for the year is -- should I be thinking of that as going forward as being more digital investments and not headcount-related?

So Adam, I'll start. Look, let me start with the bigger question on investments, growth investments. We are really focused on this 3-year -- if I haven't said it enough, the 400 basis points plus and building momentum along the way. We've got 5 growth levers, and we believe all 5 are critical to hitting the 400 basis points plus. And then underpinning that is the sales force expansion, which I'll get to.

But again, those 5: metalworking; solutions; selling the full portfolio; digital; and diversified segments, which right now is government, you're going to see investment. Where the growth investment is going? It's going directly into those 5, and then into the sales force that's going to power those 5.

In terms of the sales force, particularly, look, we've been -- it's been a few years now since we've expanded the sales force. Adam, you've been following our story for a while. We have been through this whole repositioning of the business. And we needed to reshape the sales force in order to bring this thing to life.

And what that meant was, over the last couple of years, under Eddie's watch, we've taken headcount down, because what we found was that we were over-assorted in certain roles, i.e., in farmers, did not have enough in hunters and some other key roles in metalworking that we're now throttling up. So we're reshaping the sales force.

You saw us add 50 in the first quarter. Look, if we can continue hiring the right people as we're doing, we could see that continue at sort of that rate and pace for the balance of -- plus or minus, for the balance of the fiscal. We'd like to get it where we're back to 2019 levels on what we published in our sales and service stats by the end of the fiscal.

And look, obviously, the idea is we're going to be funding that growth investment. That's a headcount addition in the sales force. We're going to be funding that through the productivity work that Kristen described.

Okay. Great. That's very helpful. And then, secondly, Kristen, could you provide the magnitude of the PPE headwind to gross margin this quarter within that 30 basis point decline? And just given what you're seeing so far here in December with the surge in PPE orders.

Did I hear you correctly say that, that similar headwind in the second quarter, is that still up in the air?

Yes. I'd say second quarter is likely to be higher. We didn't -- we're not seeing it yet in December. But based on what we think is going to happen with the inventory moving out the door, we do see a larger PPE headwind for Q2, probably also for Q3.

And then I think I heard you mention something in there on Q1. We did see some PPE mix headwind in Q1. That was really driven by some large orders that went out the door, which is a similar reason that we would expect to see increased risk in the second and third quarters as well.

So do you think your gross margin was closer to flat with the positive pricing and purchasing that you had, if you were to back that out?

Yes, I'd say we were closer to flat.

Yes. Adam, maybe just to chime in a little bit with a couple -- two cents on gross margin. And look, Kristen hit this, I want to underscore a couple of points. I think what we're seeing, since we basically said, hey, for the year, we see ourselves flat to down 50 basis points. Since last quarter, 2 things, right? So one is we like what we're seeing on price execution, and we like what we're seeing on the purchase cost side and the sourcing side. I think that's a net positive.

I think what we are saying though is we do see the potential in the next quarter or 2 for more pronounced PPE headwinds based on the factors that Kristen described. You got a big mask inventory, virus surging, no secret, prices have come down on masks. So there is the potential for a more pronounced PPE headwind for the next quarter or 2 than we've seen in the last quarter or 2, where there's been some that we've absorbed, but not as much as what we may face in the next quarter or 2.

I think for me, what I want to underscore -- what I'm looking at is, saying, hey, the PPE stuff we're talking about a once-in-a-generation kind of episode here that's really hard to predict. It was really hard to predict months ago, it's really hard to predict now. For me, again, sights set on the 3-year goals, on the ROIC improvements. The real underlying value creation drivers for us are going to be price and cost. That's where we like what we're seeing.

The next question is from Steve Barger from KeyBanc Capital Markets.

Just a couple of follow-ups. Just first, for the impairment, you said the ability to get the gloves is increasingly in question. Is that just based on how long it's been? Or is there something more specific? And really, I'm trying to understand if we should be worried about inventory risk for other pandemic stuff as cases hopefully slow down as '21 progresses?

Yes, Steve. So look, this is a -- this was a really unique situation with nitrile gloves. And we followed -- not only a unique, but a really difficult situation that is isolated to nitrile gloves in terms of a prepayment and an exposure of this size.

The accounting rules are pretty clear, that when you reach a certain point of uncertainty, and without going through all the details, you can imagine, we're pursuing every path possible. But we reached a certain point of uncertainty. It was clear. We impaired the asset, which is a prepayment.

What I'd say is we have used the prepayment tool many times over during this pandemic, and it's been -- it's become a fairly standard industry practice, actually through the pandemic, to secure scarce product. It's worked out most of the times.

This case, to date, it hasn't worked out. What I would say, though, is in terms of prepayment exposure, if that's where you're going, no, we don't see another case like this. This is pretty unique.

So truly a one-off and you don't see inventory risk for other pandemic-related products?

We certainly -- what I would say is we don't see any prepayment risk. I mean, look, obviously, as Kristen described, we're sitting on a lot of mask inventory. That will be a function of how it moves. Is there risk there? Sure, of course, depending upon how the virus moves.

But what we're talking about, the said effects with the nitrile gloves, with the prepayment, isolated to that.

Got it. And of the 50 people added, did you break out how many were metalworking specialists versus the hunters? And how long does it take a new metalworking specialist to reach the level of productivity you want versus that new salesperson?

So we did not -- Steve, just for competitive sensitivity, we don't break out specifically. What I can tell you is we gave you the 3 sort of primary buckets of the 50, which are the BD hunters, metalworking, government, as the 3 big areas of focus.

What I would say with metalworking is we generally find a faster ramp-up because they are coming with industry expertise. The one caveat, in most cases, when we're hiring a metalworking specialist, they don't necessarily have their own book of business. What they're doing is they're supporting.

So the way we see the benefit in a metalworking specialist, number one, we're going to see it certainly in MillMax installations. But we'll then see a lift in their geography for our metalworking salespeople who are out there generating sales because of the technical expertise the individual brings.

And presumably, that's a really fast ramp to get them up to speed on MillMax to get them in the door to hopefully leverage to other MRO products?

There is a ramp on -- there is a ramp on MillMax, and we've been super aggressive about rolling it out. There is a little bit of a ramp on MillMax.

I mean, it's not rocket science. But certainly, it's a new trick. It's a new technology. And that's the case, not just for a new person, but for all of our metalworking experts. So Kristen is mentioning pockets of investment. It's certainly been one area of investment where we've been rolling out sample kits and testing tools and doing training for our metalworking folks at a pretty fast rate, and that's a piece of our investment, and we'll continue that.

And just to be clear, that MillMax program is unique to you?

Yes.

Our last question comes from Patrick Baumann from JPMorgan.

Just quickly, you talked about investments in SG&A of $15 million incrementally this year. And I forgot what you said annually beyond this year. But my question is on CapEx expectations. And if you expect CapEx to go up over time as well as a result of the initiatives? And by how much?

Yes. So for this year, CapEx, we're estimating in the range of $70 million to $80 million, which is a step-up over our historical run rate. And in the future years for the program, in '22 and '23, I'd expect we're seeing more of a sustained level over where we've been historically. Probably not as high as the top end of that range, but you're definitely going to see a sustained increase for the next 3 years.

So that $70 million to $80 million is going to be more of the sustained level then for those years? Is that what you were saying?

I'd say the lower end of the range, maybe think $60 million to $70 million for '22 and '23, but we're still working through a lot of the detailed planning on that. It's going to be dependent on how we prioritize different projects in the pipeline, what the specific investments are that we bring online at what time. But we can give you some clear guidance on that as we get closer to 2020 -- as we get closer to 2022.

Got it. And then on the longer-term kind of ROIC target, can you kind of remind us of the components of that? Like how much of that is sales versus margins? And I guess the invested capital side of the equation, are you assuming like changes in that by that time, whether with working capital investment or I guess maybe you're using debt and equity as the denominator as you made buybacks, I don't know. Just trying to understand the components of that high-teens number.

Yes. So we haven't broken that out specifically yet on what kind of the drivers are, the components of getting to the high-teens ROIC. I would say everything is on the table right now. We've been talking a lot, of course, about the growth and the operating expense side of things, where we see gross margins going. But really, everything is on the table for us as far as opportunities go, and we did touch last call on turning our sights more aggressively to looking at working capital opportunities. And that's something that we'll be getting into throughout '21.

And just last one for me on the -- remind me of the gross margin dynamics annually through that time, what you expect?

Sure. So for the op margin framework for '21, you can think flat to down 50 bps is what -- is the guidance we've been giving. And then for the out-years, we haven't commented specifically on what we expect to have in margin. But we're seeing very strong price costs. We're investing heavily into pricing analytics. Not sure what the inflation dynamics are going to look like that might be driving costs yet in '22 and '23, but we'd be looking to cover that exposure and to continue to deliver strong realization.

Is there still a mix headwind though that you have to deal with over that time? I mean, that's been kind of the story the last few months.

Yes. Yes. So there's always -- it makes it the biggest unknown, right, and where we fall on those kind of ranges on gross margin. Right now, you're hearing us talk a lot about the PPE pressure, which, as Erik mentioned, that's really specific to '21. It's kind of a unique situation given the pandemic dynamic.

But mix could remain a fluctuating factor for where we land in that range in '22 and '23. But I'd say it's more about where those come from in terms of the products, where we're growing, the parts of the business where we're growing and then how fast each of those 5 growth levers comes online. That could definitely influence the margin rates.

Yes. Pat, just to maybe add a little perspective on gross margin. So if you think about our formula over time, what -- sort of what's going on as what we've talked about is, let's put -- this year is a funky year with PPE and wild swings. Ex PPE, just the ordinary course of business, somewhere between 30 and 50 bps has been where we fluctuated in mix headwind.

And so the assumption we've had and what we've seen for a while is if price costs are flat, then you're looking at modest gross margin arose year-on-year. And that's sort of what the thinking has been. What I would tell you is, this year, in particular, what you're hearing from me and Kristen is we may have outsized mix headwinds specifically because of PPE.

But looking beyond that, you're hearing us encouraged by our price realization and our execution there and the work happening on the sourcing side. And if those things continue, and that momentum continues, it could create positive price/cost spread, which could eat into that mix headwind and create a little bit different dynamic for us, a better one.

So obviously, to be determined and we're early, but on the price cost front, we're encouraged by momentum.

This concludes our question-and-answer session. I would like to turn the conference back over to John Chironna for any closing remarks.

Thank you, Jason. Before we end the call today, a quick reminder that our fiscal second quarter 2021 earnings date is now set for April -- sorry, April 7, 2021.

And I'd like to thank you for joining us today, and please stay healthy and safe. Take care, everyone.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.