MSC Industrial Direct Co., Inc. (MSM) Q3 2021 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the MSC Industrial Supply 2021 Third Quarter Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note, today's event is being recorded. At this time, I'd like to turn the conference call over to John Chironna, Vice President of Investor Relations and Treasurer. Sir, please go ahead.

Thank you, Jamie, and good morning to everyone. Erik Gershwind, our Chief Executive Officer; and Kristen Actis-Grande, our Chief Financial Officer, are both on the call with me. As we continue working remotely at MSC, please bear with us if we encounter any technical difficulties. And before I get into our cautionary language, I wanted to highlight that we recently created a micro site dedicated to corporate social responsibility. For many years, the concept of doing the right thing has driven everything we do in all of our stakeholder interactions at MSC. I invite you to learn more about our community relations, diversity and inclusion, corporate governance and environment and sustainability efforts by visiting our website. This is only at the very beginning of our ESG journey, but we are committed to progress and continually striving for excellence. 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 US 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 and 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 our 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, except as required by applicable law. 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 reconciliations of the adjusted financial measures to the most directly comparable GAAP measures.

Thank you, John, and thank you, everyone, for joining us. I hope you enjoyed your holiday weekend. I'm excited to update you today on our progress this quarter. We are seeing the benefits of the strategic pivot that's been made by our company over the past few years. We made significant investments across the organization to transition from a leading spot-buy provider to a mission-critical partner on the plant floor, augmented by our spot-buy capabilities. With the bulk of the less visible changes completed, we outlined our plan to return to historic levels of revenue and earnings growth consistent with the legacy of our company. Mission Critical is our program to translate those investments into superior financial performance. And we shared with you two goals that underpin our efforts. First, to accelerate market share capture with the target growth rate of at least 400 basis points above IP by the end of our fiscal 2023. Second, to return ROIC into the high-teens powered not only by leveraging growth but also by structural cost takeout of $90 million to $100 million, also by the end of fiscal 2023. This year, our fiscal 2021 began our proof of concept with our fiscal third quarter serving as the latest encouraging data point. With respect to revenues, we committed to achieve a minimum of 200 basis points of positive spread versus the IP by our fiscal fourth quarter. Q3 is muted by PPE comps, but the non-safety and non-janitorial business grew about 21% year over year, and we expect our total company growth to meet or exceed our fiscal Q4 commitment. This year, with the help of numerous structural cost reductions, we increased our customer-facing sales headcount and we'll continue doing so into fiscal 2022. We've grown share in metalworking through investment and innovation that improve our customers' businesses. At the tail end of fiscal 2021 and into fiscal '22, we're implementing improvements in e-commerce. We started with the new production information system earlier this year and are now rolling out enhanced search capabilities, new user interfaces for both desktop and mobile, a new transactional engine, and overall improved functionality. We've committed to maintaining our gross margin through a series of initiatives and excluding the writedown for PPE, we have done so. The macro environment is driving price increases; and given our inventory turns and innovative merchandising and pricing programs, we expect strong realization to continue.

Thank you, Erik. I'll begin with a review of our fiscal third quarter and then update you on the progress of our Mission Critical initiatives. On Slide 4 of our presentation, you can see key metrics for the fiscal third quarter on a reported basis. Slide 5 reflects our adjusted results. Our third quarter sales were $866 million, up 3.8% versus the same quarter last year. We had one more selling day this year in our third quarter. So on an average daily sales basis, net sales increased 2.2%. Erik gave some details on our sales growth, but I'll just reiterate that our non-safety and non-janitorial sales grew 21% in the quarter, while our safety and janitorial sales declined 42%. Moving to gross margins; execution and realization on our mid-year price increase was solid. Our gross margin for fiscal Q3 was 42.3%, up 30 basis points sequentially after adjusting out our inventory write-down from last quarter and down just 10 basis points from last year. Looking ahead, we took our summer increase in early June in response to the continuing inflation we are seeing from our suppliers. We expect the recent trending to continue and aim to achieve a gross margin for fiscal 2021 that is flat with fiscal 2020. Operating expenses in the third quarter were $257.3 million, or 29.7% of sales versus $242.8 million, or 29.1% of sales in the prior year. Our third quarter includes just $400,000 of legal costs associated with the loss recovery, which I'll discuss shortly. So OpEx as a percent of sales, excluding those costs, was the same as the GAAP figure or 29.7%. Let me share a few more details on our third quarter OpEx. As I mentioned on our last call, we expected OpEx to increase sequentially from our second quarter, not only by the variable operating expenses associated with higher sales but also due to expected higher incentive compensation as well as growth investments related to Mission Critical. Recall that our adjusted OpEx for Q2 was $244 million. A $90 million increase in sales means roughly $9 million of variable-related OpEx. The remainder of the increase was primarily related to higher incentive compensation. While Mission Critical growth investments did increase sequentially, this was offset by an increase in Mission Critical savings, which I'll speak to in more detail in a few moments. As you may have seen in our earnings release this morning, we had a very positive development regarding the nitrile glove impairment we announced in our fiscal first quarter. We're pleased to report that last month we received a $20.8 million loss recovery of the original $26.7 million impairment loss recorded in Q1. That recovery is below the operating expense line in the P&L, but it does increase our GAAP operating income, such that our GAAP operating margin for the quarter was 14.8%. Excluding the $20.8 million loss recovery and associated legal fees as well as restructuring charges during the quarter of $1.3 million, our adjusted operating margin was 12.6%, down 70 basis points from the prior year. GAAP earnings per share were $1.68. Adjusted for the loss recovery as well as restructuring and other charges, adjusted earnings per share were $1.42.

Thank you, Kristen. Fiscal 2021 is finishing on a high note and we expect that momentum to continue into fiscal '22. We are gaining steam internally and our end markets are strengthening as evidenced by IP readings. The inflationary environment, along with our ongoing price realization should continue to support gross margins. On the structural costs front, we've made strong progress on our Mission Critical program and will deliver further savings over the next two years and beyond. All of that should translate into incremental margins at or above 20% for the next two years. I thank our team for all of their hard work and dedication. And we'll now open up the line for questions.

Ladies and gentlemen, at this time, we'll begin the question-and-answer session. And our first question today comes from Tommy Moll from Stephens. Please go ahead with your question.

Good morning. Thanks for taking my questions.

Hey, Tommy.

Hey, Tommy. How are you?

Doing great. Erik, I wrote down one of your comments and I think I'm getting this about right. You talked about this being one of the most robust pricing environment you've seen in years. So, I wanted to dig in on that. Talked about another increase in June. Possible we'll see another one before the end of your fiscal year. Any way you could frame for us what the June increase looks like quantitatively? And if you play this out longer term beyond the next quarter or two in this kind of inflationary environment, is this a net benefit, net neutral to your platform? How does this play out?

Tommy, so, yes, look, I think -- let me start with the macro and the environment, and you did capture the -- my comments accurately. If you go back and for those who have been studying our space for long periods of time, you go back to different eras that we've experienced for the past 10 years or 15 years and generally, strong robust inflation is a distributors' friend . And so if you looked at MSC's gross margin performance in the 2000s versus what it's been the last several years, you'd see a noticeable difference. And we've talked about our gross margin formula consisting of three things; price, cost and mix. And we've talked about the fact that there is generally a mix headwind in the business of somewhere 30 basis points to 50 basis points. So to the extent pricing costs were awash, we would see erosion of somewhere, 30 basis points to 50 basis points. And not surprisingly over the past few years, that's about what you've seen from us in a very low inflation environment, I think unusually low. 2000s may have been unusually strong. This is unusually low. Certainly, some of the supply chain issues that we discussed in scarcity are leading to more inflation than we've seen -- than I've seen in at least a decade. Price increases coming from suppliers is fast and furious. You're right, for us to take two moves in a matter of a few months, we haven't done that in a while and that's in response to the environment. Net-net, Tommy, we view this as a positive. Typically, what you would see from us is the early stages of an inflation cycle. Price would outpace cost, and we believe that's where we're at right now. Certainly in the later stages, things can flip around, but to the extent that this inflationary cycle has some legs to it, as it appears, we would expect price to outpace cost. So if you look, the proof in the pudding will obviously be in our numbers, but you think about, yes, we're going to begin to start seeing costs in our P&L, yes that will begin to happen as early as this quarter. But you sort of zoom out and say, okay, fiscal 2021 we're calling to be plus or minus flat with prior year. And as best we can tell now and, of course, we will come back next quarter with a framework as we normally do. But as best we can tell now, we're giving you sort of a look ahead to '22 and say, we're seeing a roughly flat picture that would imply positive price cost in each of those years to offset mix. And then you take it a step further, and I'll stop talking, Tommy, but if this business can produce roughly flat gross margins and IP does what it is forecasted to do and we continue to build on our internal momentum and outpace IP, you're looking at strong top line growth, roughly flat gross margins, enhance that with some costs take-out and we think we have a really compelling picture.

Thank you, Erik. That's all very helpful. I wanted to follow up with the question on inventory, which you provided some helpful comments on in the script. What -- has the philosophy changed at all in the appropriate level there? I mean you've got potential supply chain issues that you may want to protect against. I think you referenced in the script the opportunity to deploy or to put your balance sheet to work with some inventory to take market share. Has anything changed in your mind about how to manage that or what do you want us to know about how you're thinking about inventory right now? Thank you.

Tommy, I would say this, no change in philosophy, some change in tools and tactics, and keeping up with the times. But in terms of philosophy, no change. And again, going back, being in this business now over two decades, times of growth and times of product scarcity create really compelling opportunities for distributors like MSC. Bottom line is if you have stuff on the shelf, you're going to capture share. So, I think what you're seeing, the big build in inventory you're seeing over the past quarter, we telegraphed, we expect it to continue. We would have liked it to be even bigger if it weren't for scarcity issues. We're going all in on making sure that we have product on the shelves for our customers at a time when product is scarce. And it's critical as the economy now ramps back up, the industrial economy that our customers keep their lines running. So, we are going all in on inventory and it sort of is a reflection of our view on the outlook of the economy and a view on the importance of having product to capture share.

Thanks, Erik. I'll turn it back.

Our next question comes from Hamzah Mazari from Jefferies. Please go ahead with your question.

This is actually Ryan Gunning on, filling in for Hamzah. Could you just talk about your current vending initiative and how much of your customer base or what percent of revenue is vending and what kind of growth you're seeing there?

Yes, sure. Good morning, Ryan. And what I'll do is just connect back to, if you recall, we are right now laser focused on restoring the kind of market share capture rates that this business had become accustomed to. And so we put our first marker out there, 400 plus basis points by '23. The first sort of goalpost in getting there is going to be our fiscal fourth quarter of at least 200 basis points. And then if you recall, we outlined five growth initiatives that are going to get us there. One of those is what we refer to a solutions. And in solutions, specifically it's three things. It's vending. It's vendor-managed inventory and it's our implant program, all of which were aimed at bringing us closer to the customer and embedding us onto the plant floor. So, what I would say is vending is picking up steam. We definitely saw, not surprisingly, Ryan, we saw a low in our new account signings. The growth rate, of course, the growth rate of the installed base came down with COVID and has bounced back as the business has. The new signings took a low during the pandemic because of the inability to get into plants. We are seeing it come storming back. So, we're measuring size of funnel, dollars in funnel, close rate, all of those are doing what we wanted to see happen. As the years gone on, they've gotten stronger and stronger. So what I would say is it remains an important growth driver, along with VMI implant as part of this solutions initiative.

Got it, that's helpful. Thank you. And then I guess kind of switching gears. Can you talk about what you're seeing in terms of metalworking markets from a growth perspective and just the competitive dynamics there?

Yes. So, I think from a market standpoint, what we're seeing is -- and particularly, Ryan, this quarter, if you think about metalworking and our end-market exposure, they're very tightly coupled. And so not surprisingly, nearly half of our sales are tied into five heavy manufacturing end markets that are the bulk of where the metalworking consumption happens. Those heavy manufacturing end markets went down deeper than most of the economy and quite frankly has been a little slower to recover. We saw that start to flip in the past quarter. And so if you take a look at below the IP reading, you can see some of the sub-indices. We are starting to see the heavy manufacturing markets come back and we think that's a great opportunity for us. In terms of share capture, we're still sitting sole leadership in metalworking, but still sitting in the neighborhood of 10% market share. So, we've got a big runway ahead of us in terms of share capture. And we have end markets that we think have legs to them in terms of this recovery. So, we're excited by our metalworking outlook. And what I would say is to capture that share, there's a few things that are powering it; investment into people. So, you see our headcount ticking up, that's investment into metalworking talent. We did it both organically in the past quarter through acquisition. We're really excited about Hurst joining the family. We're doing it through technology with initiatives like MSC Millmax that are combined with our people are really helping customers take costs out of their operation. And then, I mentioned earlier to Tommy's question, sort of the old fashion way of just having product on the shelf when others don't, we think that really matters as well. So, all of those sort of feed into what we think is an exciting metalworking outlook.

Great, that's all super helpful. Thank you very much.

Our next question comes from Adam Uhlman from Cleveland Research. Please go ahead with your question.

Hi, guys. Good morning.

Hey, Adam.

Hey, Adam.

Good morning, Adam.

Hey, can we go back to the price increase discussion we are having earlier? I guess in the operational stats, it looks like there was $1 million attributed to price, which seems kind of low. And I understand there are some other offsets that you call out and there are like customer mix and product mix and discounting. Can you maybe parse that apart between what were the headwinds that offset the price increase from March? And then as we put this price increase through in June, how should we be tracking that contribution to total sales growth? I guess maybe you could just mention it. It sounds like low single digits, but maybe you could clarify that.

Sure. So going back to first part of your question, the first thing I'd say is price realization, I think, as Erik touched on is solid. We're pleased with what we're seeing around realization. And then the second metric that you mentioned, which is what we see in the growth composition in the op stats, that has about 0.1% of growth assigned to both price and mix. So to your point, it's a combination of things that are in that metric. Normally, that's a pretty good indicator for how you could think about price growth in the business. But what's happening in the second half of this year in Q3 and Q4 is if you look at the large amount of PPE volume that we had in the base, so in second half of '20, it's really making it not a very meaningful metric to think about how price is impacting the business. So, that's kind of what you see near term. I think if you zoom out and you look at what's happening, sequentially, we did grow margins from Q2 to Q3. So, that's an indicator that we're seeing on the price benefits that we had expected to see coming into the numbers. And then beyond that, like Erik touched on, we're seeing about flat margins '20 to '21, which is not something we typically see in the business. I mean, through offsetting, the costs coming down the P&L and that traditional mix headwind that we see in the business and we're expecting to do the same thing again in 2022.

Okay, got you. Thanks, that's helpful. And then for Mission Critical, I guess, so there's $40 million of gross savings remaining over the program for the next couple of years. Could you mention some of the bigger buckets that you expect those savings to come from? And then have you changed your thoughts at all on your reinvestment appetite of those savings?

Yes. So for the few -- for the following two years on the program '22 and '23, we've got program -- we've got programs that are working across all areas of the P&L. I think we're -- if you think about kind of the transformational work that we have ahead of us sort of like the bigger longer-term projects to execute, you'll probably see us pivoting a little bit more to the operation side of the business. We did a lot of work around the sales side of the business that you saw us execute in '21. So, there'll be a bias towards operations on the transformational work. But then the pipeline of projects really touches every part of the P&L. There is a lot of small things that are going to deliver benefits, particularly in kind of '22, second half of '22. Will that carry over in the beginning of '22 from what happened with that? In particular, the sales program or the sales restructuring that you saw us execute in fiscal '21 and then those transformational projects are going to kind of position us on for '23 and beyond. And in terms of the reinvestment, I'll give you guys some firmer guidance on that next quarter when we published the framework. And one of the things that we're looking at right now is kind of which projects we want to bring online and when on the growth side and we're really committed to delivering that incremental margin of greater than 20%. So, we'll probably adjust the investment schedule accordingly based on our other assumptions to make sure we're delivering on that incremental north of 20% that we committed to for fiscal '22 and '23.

Okay, thanks.

Welcome.

Our next question comes from David Manthey from Baird. Please go ahead with your question.

Hi. Good morning, everyone.

Hey, Dave.

First off, Kristen, in your discussion there on price mix, if we set mix aside, it sounds like you had solid price realization on the March increase. And with the glide path from that increase, in addition to the new June increase in light of the current inflationary environment, should we be reading that your expectation for price realization alone might be on the higher end of low single digits or even in the mid-single digits in the coming quarter?

No, I'd say lower single digits is a reasonable expectation, Dave. And I think what's starting to happen too in Q4 is the costs. All the inflation we're seeing passed on to us from suppliers are starting to roll on to the P&L. So it's dampening a little bit of the price cost spread we might have been hoping to see when we look forward last quarter. But generally, still really pleased that we've been able to offset the mix, cover the costs and keep the margins flat for the full year.

Okay. I know you've always been hesitant to talk about price realizations specifically. But if based on your comments, it sounds like from your price realization, forgetting about mix and forgetting about the costs side, it sounds like you're seeing good realization which might imply a little bit higher than low single digits. Is that in the ballpark?

We are seeing our realization come online as expected, yes. Q – David Manthey: Okay, fair enough.

And Dave, just to put color on that, as Kristen mentioned, so the metric, that's the public metric she mentioned. Because of last year, the PPE surge, the mix component of that metric is so distorted compared to what it typically is in normal time. That will correct itself in the quarter or two. As you could imagine, inside the company, our pricing team has 10 ways until Sunday in which they're looking at more micro price realization metrics. And yes, we're seeing, just as Kristen said, just as we would have expected in terms of outcomes.

Okay, sounds good. And second, on the e-commerce front, it seems like that metric lost momentum during the pandemic and has since re-accelerated. I think, trailing 12-months, you are back over 60% e-commerce. What does that tell us about the trends in the business, if anything, as we come out of the downturn here?

Yes, Dave. So, I think important to understand just sort of what makes up sort of the buckets. Under that 60% e-commerce, obviously, there is a big chunk. Over half of that is mscdirect.com. And that's the part right now I mentioned investments into digital. Most of the investments are directed there to take mscdirect.com to another level. And certainly, I would expect over time that portion of the business to grow as a percentage of revenues. The total 60% includes other buckets like vending, things flowing through a vending machine, e-procurement with large accounts, which -- so there was sort of like mixed dynamics going on underneath the covers because as you can imagine, I mentioned earlier, vending dropped considerably during the pandemic and is now climbing back. For us, what I'm going to be looking at is the quality of the experience on mscdirect.com. I'm going to be looking at retention, average order size and some of the sort of micro measures. And then, yes, I think for you, over time seeing at 60% grow will be the way to look at it and evaluate it.

Great. Thanks, Erik.

Our next question comes from Ryan Merkel from William Blair. Please go ahead with your question.

Hey, everyone. Nice job on gross margins this quarter.

Hey, Ryan.

Hey, Ryan. Thank you.

So my first question is on SG&A leverage. I know you expect strong leverage in '22. But should we expect SG&A leverage in the fiscal fourth quarter?

Yes. So fiscal fourth quarter is going to -- we're going to come down sequentially, Ryan, relative to where we were in Q3, a little bit of that come in with the decline in sales. And then we're also going to see a bit of a normalization on the sales -- excuse me, the sales incentive compensation. So, we will see a more favorable OpEx rate coming in Q4, better leverage coming in Q4 and then for the year, feeling confident that will land inside that low single digit framework. I'd say, probably on the lower end of that, given where we think revenues going to land and kind of given what we see happening in the inflationary environment. Really, we've talked a lot about kind of what's happening on the cost of goods sold with inflation, but we're also seeing some costs start to creep into the business on the SG&A side, around things like labor inflation, wage increases, things like that.

All right. So it sounds like SG&A leverage will improve in 4Q and then it will improve more so in 2022, is that right?

Correct.

Okay. And then, my second question. June average daily sales growth, that was a nice number. I know you're not giving guidance, but I'm hopeful to get your view on what inning of the macro recovery we're in and then if sales growth can accelerate from the June level?

So Ryan, look, I think from our perspective, we are encouraged. I think, for me, June is sort of one data point. We're looking sort of at a bigger story here. And I am encouraged by the momentum we're seeing and I think that goes for macro but also sort of for micro, meaning how is the company doing relative to IP? We had a pretty good quarter in Q2. Obviously, PPE noise here, but we are starting to see progress. In terms of the macro recovery, again, Ryan, we're coming from a fairly slanted view where we're heavily exposed to heavy manufacturing, which have been hit hard at a later stage. So, we think there is plenty of room here. We're kind of hitting a speed bump as an economy and industrial economy with the supply chain and labor constraints right now, no question, impacting growth with our customers anyway. But we think there is a nice recovery here, particularly in certain end markets where we think there is ways to go, to answer your question early innings. And then, I feel the same about internally. We still feel like we're in the early innings. We think this year has kind of been a proof point that we're on the right track. But we have sites set high in terms of share capture and spread above IP and still feel like we're early innings there too. Q – Ryan Merkel: Sounds good, Erik. Thanks.

Thanks, Ryan.

Our next question comes from Michael McGinn from Wells Fargo. Please go ahead with your question.

Hey, everyone. Good quarter.

Hey, Mike.

I was hoping to get a little more color -- hi. I was hoping to get a little more color on the recent acquisition. Is there -- can you frame for us what aerospace is like, round about percentage of your business today? Is there an ever a point from a portfolio management standpoint where you think you cap yourself?

Mike, so we're sitting at around -- and I'll touch on what Hurst brings to us. So aerospace, roughly a 10% of MSC's revenues. We think that it is a really good fit in terms of an end market for MSC for a number of reasons. First and foremost of which, we can really move the needle for our customers' productivity using metalworking, our metalworking experts, metalworking technology like MillMax, our product portfolio, etcetera. So, we think it's a good fit. In terms of capping it, at some point, that will be a very high-class problem. We think we have a ways to grow in penetrating that market. We really like the timing of Hurst because aerospace obviously has been on its back and we think has a long way to go in recovery. And what really excites us is the team there is really technical and really focused. So, they're bringing something, in some sense, expanding our metalworking capabilities for sure. But they're really bringing something that we don't have organically in the business, which is a metalworking focus specific to aerospace. And we think that's a capability, not just the build out and cross-sell into their customer base, but for John and his team, we think we can leverage that team across MSC's broader aerospace customers to increase penetration. So, we see -- bottom line is we see a ways to go with aerospace and at some point, we'll be in the high-class position. I have to try to cap it, but we've got a long runway in front of us there.

Got it. And then, going back to the earnings algorithm you outlaid earlier in the call mentioning, if we can get flat gross margins. Just in terms of that, how much runway do we have to get back to normal in terms of gross margin rebates and in terms of the local core customer catching up to that national account?

So here's what I'd say, Mike, so let me break apart gross margin into three buckets: price, cost and mix. What I would say is, we still see over the past few years, price and cost have more or less than a wash. And what you're hearing is that price is now outpacing costs. And we think that as long as the inflation cycle continues and by all measures, given product scarcity labor scarcity, etcetera, etcetera, it does feel like we're in the early stages of an inflation cycle. To the extent that continues, while costs are going to creep into the P&L, we think we can stay ahead with price. That brings us to mix. Mix has a lot of -- you mentioned a couple of moving parts, Mike. There's a lot of moving parts to mix in terms of which product lines are growing faster, which end markets are growing faster, size of customers, you said national accounts, etcetera. Net-net, when you put it in the wash and you put all of the mix components in the wash, we still see a negative sort of a headwind coming from mix. And we do still see it somewhere in the 30 basis points to 50 basis points and it's tough to give you a precise number. It moves around. But somewhere 30 bps to 50 bps per year. So the way we get to sort of -- the way we get to flat and take '21, for instance, is some mix headwind, yes, but price outpacing costs and thus being a wash.

Got it. Appreciate the time. Thank you.

Our next question comes from Kevin Marek from Deutsche Bank. Please go ahead with your question.

Hi, good morning. Thanks for taking my questions.

Good morning.

Good morning.

A lot has been asked, I guess. Maybe wondering if you could give some more color on some of the supply chain constraints. What are you seeing in terms of labor, product availability? And have things gotten better or worse for you and for your customers and kind of how are you managing that? A – Erik Gershwind: Yes, Kevin. So let me talk about -- I'll talk about sort of broad marketplace, which would include customer and supplier. I would say over the past quarter, the supply chain issues have become more acute, not less. And I think that in particular, the one that is just white hot is access to labor. Everybody I'm talking to is feeling the pinch. And what that means is, it's really, at this point, constraining growth. I think the exciting thing is, to the extent this is a speed bump, the long-term prognosis outlook is really good. But what it means for our suppliers an inability to hire people who are needed to produce stuff and shift stuff to distributors like MSC. For our customers, it's much the same. Their order backlogs are massive and they can't keep up and they can't get product out the door. I think from our standpoint, Kevin, we think we're really well positioned to navigate this. First of all, it should be -- it should be temporary. And who knows how long it takes to believe ? But it should be temporary. The second thing is, we think we're well positioned. Number one is that whatever issues we are facing and we are facing them. And we mentioned we would like inventory levels to be even higher than they are. We're facing issues from our suppliers. But whatever we're facing, remember 70% of our market is made up of local distributors who really struggle in gaining access to the product. So, we think there is a tremendous market share capture opportunity. And then the second thing I'd say is that all of these constraints and scarcities are what is fueling the inflation, that is fueling -- is then fueling the ability to take price. So, we think we're well positioned to navigate this. We think the outlook is really good. But to be clear, absolutely, the issues are acute and labor is at the top.

Got it, thank you. That's really helpful. Maybe just one more. Getting back to some of the Mission Critical commentary. Is there scope to, by the time we get through fiscal '23 to be above $90 million to $100 million, given that you are executing on a chunk of it kind of faster than originally anticipated? I'm wondering if there are other things or other initiatives that maybe you didn't make the first round of planning for Mission Critical that you now feel like you may have the ability to pursue?

Yes. I think we're definitely optimistic that that's possible. We're clearly at the higher end of that $90 million to $100 million range right now. And one of the things we talked a lot about internally is that we communicate Mission Critical as kind of time fence between '19 and 2023. But really what we're doing here is changing the culture of the company to make this idea of driving these costs out of the business, an ongoing -- an ongoing part of what MSC does year after year. So, we do have a long pipeline of projects. I think it's always possible, we shuffle timing on some things, pull some things forward that could provide the potential to go above that. But one of the things we are thinking through for '22 is you've got some big projects in '21 that carry over smaller new things. We're going to execute that help us in '22. And then you're going to see us really reload and kind of recharge on the transformational projects that will hit in '23 and beyond. So to the extent that we could bring those big transformational things on faster or maybe to a greater extent than we are originally contemplating, that would be the path to going above that $90 million to $100 million range right now.

Got it, understood. Thanks a lot. I appreciate it.

Welcome.

And our final question today comes from Patrick Baumann from J.P. Morgan. Please go ahead with your question.

Patrick, is it possible your phone is on mute?

Hello. Sorry about that. Can you hear me now?

Patrick, yes.

Hey, Patrick.

It was on mute. Apologize for that. Erik, wondering if you could talk some more about what you're doing to the website and why is this -- is this just basic upgrades or is it something more transformational in the way you interact? And then on this front, like how would you benchmark yourself the website capabilities, I guess, MSC Direct versus kind of leaders in the industry at this point?

So Patrick, what I would say and I'll answer your question on e-commerce. I just want to underscore something Kristen said and it was in relation to Mission Critical. And that was about a cultural change happening inside the company. And I bring this up in the context you asked me about e-commerce because what Kristen described happening in Mission Critical was it becoming a way of life and kind of like constantly raising the bar on ourselves. The same thing is happening everywhere in the company across our commercial organization, across marketing, across structural costs, you name it. So, I think what's happening here and the investments being made is we're raising the bar on ourselves. And certainly, we benchmark peers inside and outside of the industry for capabilities. But I have to tell you the North Star for us that's driving these changes is the customer. How we can make their lives better? How their expectations with a younger millennial influence workforce growing as a percentage of total workforce? Like, we -- this is about raising the bar on ourselves and doing better for customers. So, what we're doing is, and I'd call it somewhere between an upgraded transformation of really changing the technology stack we use. And what that means is moving certainly more cloud-based, where we can capture changes that happen overnight as opposed to needing to do upgrades. We're talking about using capabilities like AI powered intelligence and logic that allows our search engines, our website, our whole digital experience with the customer to constantly improve. So, I think some of this is around technology. And then, some of it is flat out just around customer experience and reducing friction and creating a better experience, a stickier experience for the customer. So, that's really what's going on. It will happen. So, we're beginning to put things into market in this quarter. That will continue. So, we will continue to launch sort of iterations along the way. It won't be big bang into the first couple of quarters of '22 and obviously, we'll be watching carefully for performance. But I think this all goes back to the idea of raising the bar on what we expect out of ourselves and for our customers.

What do you use to track kind of the progress? Is it -- it sounds like some voice of customer maybe? There's got to be some metrics. You mentioned stickiness. Like, is it site visit, is it sales metrics, is it revenue per visit? I don't know. What do you use?

Yes. So one of the things that are new and we've really upgraded our digital team. It's a strong group. And one of the things they've implemented is a weekly business review process, where they're managing through a whole bunch of metrics. A couple of them you've mentioned, whether that's average order value, whether that's number of unique visits, whether that's conversion from the top of the funnel, meaning people coming to the site to the bottom of the funnel ordering and looking at all points along the funnel. So, there is a bunch of metrics. They are meeting weekly. And literally, when they see metrics move one way or another, they're adjusting by weeks. So if it's going to be doubling down on it, if they see sort of a negative rate trend getting to root cause and then making adjustments real-time. So, that's happening on a weekly basis.

Great. Helpful color, Erik. Maybe one for Kristen really quick. A follow-up on OpEx. You mentioned variable comp incentives as positive sequentially in the fourth quarter. Do you also expect any sequential net savings from the various programs that you have in flight? And then also what about freight costs? Any update on what you're seeing in the P&L there going into year end?

Sure. So sequentially, for Mission Critical, no impact from investments and savings on a net basis. It will be flat sequentially. And then on the freight side, sequentially, not really seeing any headwinds. Freight is a bit more of a story for us on a year-over-year basis. And that really has more to do with lower freight rates that we saw in the second half of '20 last year due to how we were shipping the PPE out to our customers where the customers were taking possession of that product. So, we are seeing a bit of freight inflation creep in. Sequentially, it's not an impact. It's maybe $1 million to $2 million on a year-over-year basis in the fourth quarter. But we feel like freight is relatively well controlled given what's happening in the macro environment. We do a lot of small parcel shipment and that is -- so the terms of how we pay for that are pretty well bound by our contracts, expect to see a little bit more pressure coming in from our LTL shipments next year. But I think given what could be happening with freight from what we know of the macro environment, we're in a pretty good position.

Great, helpful color. Thanks. Thanks a lot. Really appreciate the time and best of luck.

Thank you.

Thank you, Patrick.

And ladies and gentlemen, with that, we'll conclude today's question-and-answer session. I'd now like to turn the floor back over to John Chironna for any closing remarks.

Thank you, Jamie. Before we end the call, a quick reminder that our fiscal fourth quarter and full-year 2021 earnings date is now set for October 20, 2021. I'd like to thank, everyone, for joining us today. And we certainly hope you enjoy a fun, healthy and safe summer. Take care, everyone.

And ladies and gentlemen, with that, the conference call has now concluded. We do thank you for attending today's presentation. You may now disconnect your lines.