MSM - NYSE

Good morning, and welcome to the MSC Industrial Supply Fiscal 2025 Second Quarter Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. For webcast listeners, we have become aware of an issue accessing the three supporting files, including the earnings presentation and the operating statistics. We are currently working on resolving the issue. Please email Ryan Mills at [email protected] to request materials. I would now like to turn the conference over to Ryan Mills, Head of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Welcome to our second quarter fiscal 2025 earnings call. Erik Gershwind, Chief Executive Officer; Martina McIsaac, President and Chief Operating Officer; and Kristen Actis-Grande, Chief Financial Officer, are on the call with me today. During today's call, we will refer to various financial data in the earnings presentation and operational statistics documents, both of which can be found on our Investor Relations website. Let me reference our safe harbor statement found on Slide 2 of the earnings presentation. Our comments on this call as well as the supplemental information we are providing on the website contain forward-looking statements within the meaning of the US securities laws. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks are noted in our earnings press release and our other SEC filings. Lastly, during this call, we may refer to certain adjusted financial results, which are non-GAAP measures. Please refer to the GAAP versus non-GAAP reconciliations in our presentation or on our website, which contain the reconciliations of the adjusted financial measures to the most directly comparable GAAP measures. I'll now turn the call over to Erik.

Thank you, Ryan. Good morning, everyone, and thank you for joining us. On today's call, I'll briefly cover our fiscal second quarter performance, then offer my perspective on the state of the company and the current macro environment, before turning things over to Martina and Kristen. Our fiscal second quarter results highlight that while the demand environment remains soft, we are taking measured steps towards improving execution, and returning the company to growth. Average daily sales declined 4.7% year-over-year although we were encouraged to see trends improve through the quarter, with January and February, outperforming historical sequential averages. Gross and adjusted operating margins both came in towards the high end of our expectations, driven by solid execution and some favorability in supplier rebates during the quarter, that Kristen will speak to in more detail. I'll begin by focusing on what is most in our control, execution. There is certainly more wood to chop or in our case, more metal to grind, but we are making progress in improving execution along several dimensions which I'll describe in more detail. We set out to complete a handful of important initiatives in the second quarter, and I'm pleased with how our team rose to the occasion and delivered. First, we continue to maintain momentum in our high-touch solutions. On a year-over-year basis, we improved our in-plant program count by 24% to 387 programs, and total installed vending machines by 9% to over 28,000 machines. While growth rates in many of these customers are suppressed due to soft demand conditions, we believe that the ongoing expansion of our solutions footprint positions us to benefit with a strong volume rebound when the demand environment improves. Second, we took important steps to reenergize our core customer growth. I'll begin with the website upgrades that were completed during the latter half of our fiscal second quarter. As a reminder, these enhancements were focused on making it faster and easier for customers to do business with us, improving our product discovery platform, streamlining our customers' buying journey, and increasing personalization. The recent upgrades serve as a strong foundation that we'll build upon. We've included several slides in the presentation to highlight these changes. Starting with Slide 4, one of our biggest priorities was improving search or product discovery. We want the site experience to reflect the technical expertise that MSC delivers to our customers every day. Achieving this requires a search platform that is built by technical experts who understand the product, the customers' buying journey, and their native language and industry terms. And that is our objective with the new search function. Based on customer sentiment and early indicators, we're off to a good start. We're also aiming to make the search experience more visual, as we did with MSC's print catalog, the Big Book. What you see here is our newly created table view that we began rolling out across our good, better, best offerings, to make it easier for customers to compare products when making a purchasing decision. Customers also want the experience to be fast and simple. We made significant improvements towards that end to our checkout experience. As you can see on Slide 5, our new single-page checkout has reduced the average number of clicks to complete a purchase by about 50%. In conjunction with the completion of our web upgrades, we also launched our enhanced marketing efforts during the quarter, which Martina will cover in more detail. And while it's still early days, we're encouraged by initial progress on several leading indicators. We're seeing increases in new customer acquisition, in mscdirect.com traffic, average daily website revenues, and improvements in several website KPIs. We also continued momentum in one of our other growth priorities, expanding the OEM product line. Average daily sales grew 4% in our fiscal second quarter, aided by a growing cross-sell pipeline. Switching to the macro environment, as you can see on Slide 6, the IP readings across most of our top manufacturing end markets continue to contract and weigh on our performance against the overall index. Customer sentiment and future outlook have been improving as is evidenced by recent MBI readings, which have hovered around 50 for the past couple of months. For now though, there remains hesitancy and caution among our customer base around future production levels due to tariff uncertainty, potentially looming inflation, and sustained high interest rates. We feel well positioned, however, to navigate this uncertain environment for a number of reasons that Martina will explain in just a second. In summary, while the near-term remains choppy, the combination of a solid long-term manufacturing outlook, improving execution, and a robust portfolio of tools to help our customers during these uncertain times leaves us feeling encouraged about our future prospects. And with that, I'll turn the call over to Martina.

Thank you, Erik, and good morning, everyone. I'll begin by describing how we're navigating the tariff landscape. As a reminder, our direct COGS exposure to China is approximately 10% and we have low single-digit exposure in Mexico and Canada. While the tariff situation remains fluid, we are confident that we have a playbook in place, which covers all aspects, including purchasing, pricing, assortment management and productivity tools for customers. We continue to execute on all areas of that playbook. First, in purchasing, we took advantage of our strong balance sheet and accelerated purchases ahead of tariffs on our higher turn products during the quarter. Second, in pricing, we've taken select tariff-related price increases in late March and will continually evaluate additional moves as warranted. In assortment, our intentional sourcing efforts over the years have resulted in a diverse product offering that we will lean on now as we assist customers in working through impacts from tariffs. As shown on Slide 7, we offer over 200,000 Made in USA products that are in stock and ready to ship. Of those, 40,000 are our own exclusive branded products, including well-known brands such as Accupro and Hertel. Not only are these products at lower price points than most industry brands, they're also gross margin accretive. We believe that our Made in USA product offerings, combined with our technical expertise and proven track record of delivering productivity to our customers will further differentiate MSC in the marketplace as our customers seek to navigate this changing landscape. As Erik previously mentioned, we also kicked off our enhanced marketing efforts this quarter, and our Made in USA portfolio is featured as a component of that messaging. We are expanding our reach through several high-return marketing outlets resulting in increased traffic to our website. As it pertains to our productivity support to customers, the traffic has exceeded our expectations. For example, views in the first three months of our new cost savings case studies page on mscdirect.com increased around 60 times compared to the prior three months before launch. Now, let me turn to an update on our productivity initiatives. First, progress on the initiatives designed to maximize coverage and seller effectiveness remains on track. In the public sector, we completed this work prior to the start of the fiscal year, and we're pleased with the double-digit growth we achieved in the second quarter. This work was completed for national accounts just prior to the quarter's start. Implementation in field sales targeting the core customer was completed last month and is ahead of schedule. However, given the unusually soft December and our typical 2Q sequential decline, benefits from the completion of these actions are difficult to see in our quarterly results. However, I have confidence when looking at our national account and core customer performance during the last two months of the quarter and into March. In addition to structural change as we focus on core growth, we're increasing our use of marketing automation and AI to support our sellers. Our customer care center, for example, is harnessing advanced technology to better execute on opportunities to both upsell and cross-sell. And lastly, we're pleased with the progress of our network optimization initiatives and remain on track to deliver $10 million to $15 million in annualized savings by fiscal year '26. As a reminder, this will be achieved through three critical actions. Consolidating demand planning and procurement functions to streamline the supply chain of our OEM and C part categories, upgrading our use of technology and our system-wide inventory planning and allocation to ensure that we have the right inventory close to the customer, reducing working capital cost in carbon. And third, acting on opportunities to optimize our management of inbound and outbound freight by reducing split shipments and reliance on air freight through more sophisticated demand planning. And with that, I'll turn the call over to Kristen.

Thank you, Martina, and good morning, everyone. Please turn to Slide 8, where you can see key metrics for the fiscal second quarter on both a reported and adjusted basis. Fiscal second quarter sales of $892 million declined 4.7% year-over-year. Sequentially, average daily sales declined 5.5% despite January and February exceeding historical month-over-month trends. By customer type, we were pleased with another quarter of strong growth in the public sector with 13.2% improvement year-over-year. National accounts declined 5.4% year-over-year, while core and other customers declined 6.8%. However, as Martina mentioned, both customer types improved as the quarter progressed. We continued to expand our solutions footprint in the second quarter. Despite soft industrial demand and a particularly weak December from a shift in holiday timing, we are encouraged by the continued growth in our installed base. In vending, second quarter average daily sales were up 1% year-over-year and represented 18% of total company net sales. Sales through our in-plant programs also grew 1% year-over-year and represented approximately 18% of total company net sales. Moving to profitability for the quarter. Gross margin of 41% declined 50 basis points year-over-year, driven by higher priced inventories working through the P&L, customer mix, and a slight headwind from acquisition. The 30 basis points of sequential improvement in our gross margin was driven by a greater than expected benefit from supplier rebates due to accelerated purchases at calendar year-end. Operating expenses in the fiscal second quarter were approximately $302 million on both reported and adjusted basis. On an adjusted basis, operating expenses were up approximately $11 million year-over-year as productivity improvements were more than offset by the combination of personnel-related costs, investments, and higher depreciation. Combined with lower sales year-over-year, this resulted in a 270 basis point step-up in adjusted operating expense as a percentage of sales for the quarter. Sequentially, adjusted operating expenses were down $2 million and performed better than expected. This decline was primarily driven by lower variable expenses associated with the decline in sales, and benefits from productivity that were partially offset by an increase in personnel-related expenses. Reported operating margin for the quarter was 7% compared to 9.7% in the prior year. On an adjusted basis, operating margin of 7.1% declined 340 basis points year-over-year. We delivered GAAP earnings per share of $0.70 compared to $1.10 in the prior year quarter. On an adjusted basis, earnings per share was $0.72 compared to $1.18 in the prior year. Now, let's turn to Slide 9 to review our balance sheet and cash flow performance. We continue to maintain a healthy balance sheet with net debt of approximately $498 million, representing roughly 1.2 times EBITDA. Working capital was a use of cash in the quarter with the step-up in inventories being one of the primary drivers. However, operating cash flow conversion remained strong in the quarter coming in at 139%. Capital expenditures increased approximately $4 million year-over-year to $30 million. This resulted in free cash flow conversion of approximately 63% in the fiscal second quarter, and 125% fiscal year-to-date, keeping us on track to achieve our 100% target for the full year. Turning to capital allocation on Slide 10. Our priorities remain the same, with organic investment to fuel growth and operational efficiencies being first in the pecking order. Additionally, we will continue to pursue our strategic bolt-on M&A strategy and return capital to our shareholders. We repurchased approximately 158,000 shares during the quarter, following the 219,000 of shares repurchased last quarter. Combined with the dividend, we returned approximately $60 million to shareholders in fiscal 2Q and $125 million year-to-date. Moving to our expectations for the fiscal third quarter on Slide 11, we expect average daily sales to be down 2% to flat compared to the prior year. Our expected range takes into consideration sales in March that improved approximately 1.3% year-over-year, inclusive of an estimated benefit of 200 basis points from the timing of Easter that will become a headwind in April. Under this revenue assumption, we expect our adjusted operating margin in the fiscal third quarter to be between 8.7% and 9.3%, and reflects the following quarter-over-quarter or sequential assumptions. Fiscal Q3 gross margin of 40.9%, plus or minus 20 basis points as second quarter benefits from supplier rebates won't likely repeat in the third quarter, and largely offset any benefits from price sequentially and a sequential step-up in adjusted operating expenses, primarily driven by higher variable expense associated with the expected sequential lift in sales in our 3Q outlook. Turning to Slide 12, our expectations on certain line items for the full year remain unchanged. As a reminder, this includes depreciation and amortization expense of $90 million to $95 million for an increase of $10 million to $15 million year-over-year, interest and other expense of roughly $45 million, capital expenditures including cloud computing arrangements of $100 million to $110 million, a tax rate between 24.5% and 25% and lastly, free cash flow generation of approximately 100% of net income. To assist in modeling the cadence of sales for the remainder of the fiscal year, the bottom of the slide provides historical quarter-over-quarter averages and other key considerations. And with that, we will open the line for Q&A.

[Operator Instructions] The first question today comes from Ryan Cooke with Wolfe Research. Please go ahead.

Good morning, and thank you for taking my questions.

Good morning, Ryan.

Maybe we can start on the top-line guide -- good morning. Maybe we could start on the top-line guide and just how you're thinking about the back-half. So we have March down about 70 basis points adjusting for Easter, which I think implies kind of flattish ADS in 3Q based on normal April-May seasonality. So, does the kind of down 0% to 2% guidance assume some softening in the end markets at the low end? And is it reasonable for us to be thinking of 4Q is getting back to positive year-over-year growth based on normal seasonality?

Yeah, I can start with that, and Erik, feel free to jump in with any color more broadly that you want to add. So, I agree with your comment, Ryan, on how to think about March and your comment about the implication on the midpoint guide for April and May. We're not necessarily assuming significant further erosion anywhere at this time. I think we're very cautious about the end markets. If you look at how the sequencing in the quarter would play out relative to Q1, it basically assumes that we're fairly flat with Q2 into Q3. Obviously, some things that we would expect to come online that are going our way with the share gain initiatives, we're not contemplating much improvement in the top line from pricing-related to tariffs at this point. So I think we are leaving some room for some potential softening in the macro, but we're very focused on delivering on the share gain initiatives right now, which we're feeling confident about coming out of the second quarter.

Okay. That all makes sense and it's very clear. And maybe we could just touch on the moving pieces for margins in the back-half next. I know you called out the 20 basis point sequential headwind for supplier rebates that won't be repeating, but I guess anything else you'd note in the bridge? I think you had previously mentioned a framework for kind of 8% to 10% incremental OpEx on the first half or second half sales. So, would that still be the case? And I think that pencils out to about 8% operating margin this year.

Yeah, that's -- so roughly I would think about the big moving driver in OpEx as you sequence it through 3Q and 4Q to be the variable expense. I'll put maybe a little bit more color on this. There are some other things moving up and down to be clear. But if you're trying to net out a simple way to model OpEx, that would be it. One thing I'll clarify, Ryan, on how you cast out 4Q is that, that 8% to 10% variable expense associated with your top-line change would be excluding anything that you add on for tariffs at this point. That's how we're still thinking about the guide on OpEx, although we're not giving a specific number out into Q4, if that provides some helpful coloring on sequencing.

Yes, that does. Thank you. I'll turn it over.

The next question comes from Tommy Moll with Stephens. Please go ahead.

Good morning, and thank you for taking my questions.

Good morning, Tom.

Good morning, Tommy.

You mentioned some price increases announced in late March. And I was hoping to just get more detail there. Magnitude, scope, likelihood after yesterday's announcement that you'll need to circle back for more? Anything you can give there would be helpful. Thank you.

Yes. So maybe, Erik, do you want to start broadly, and I can talk about some sizing on March or Martina, who -- anyone want to jump in? Let me start by answering your question, Tommy, first. And then, Martina, I'll turn it over to you a little bit on what we're doing. Your direct question, Tommy, I think was about the March increase first. So, obviously, this entire thing is very fluid, and we got a lot of new information yesterday. The increase that we took in late March was small, and it was mainly covering items where we are the importer of record, and that's primarily in this case on products that's coming in from China. And if you're trying to size that, I'd say it's about 0.5 point of price benefit on the top line. And we don't expect to see much of that in the third quarter. But again, all of this is evolving. The modeling is challenging right now. I think fluid is probably the best word to describe the situation. And I'll let Martina share some color on this, but we don't have a lot of firm information from our suppliers yet on cost or timing, which is obviously a key variable in our modeling. We've been running a pretty robust process on scenario planning, monitoring what's happening and then decisioning, of course, in response to what increases become clear. We'll keep providing color. We're out on the road in May, so we can add more detail as it becomes available. But that's really color-specific to how to think about cost and price related to tariffs. What makes this even more challenging is you have a lot of second-order derivatives here that are harder to predict and that's I think pretty obvious things, but like is there a mix-shift that results from this across products? Is there any change in underlying demand levels? Those are some things that we really need to continue working through on scenario planning. And Martina, I think you're running a pretty tight playbook on how we're managing this. Maybe you can jump in and add some color.

So, maybe just in light of the news from yesterday, let me recap our mix. So, I think we've said some of this before, but just to review, more than half of our product is sourced in the US. We have roughly 10% coming from China. We have another about the same amount coming from Europe, low single-digits from Canada and Mexico. And then beyond that, it's low single-digits from a number of countries. What's important though to understand is we're not the importer of record on all of that. So, about 75% of our sales are industry brands that are coming from other suppliers. And right now, the way suppliers are handling this, it sort of falls into a few buckets. So, as Kristen said, we're really the importer of record, that's very clear. We know what the tariff is, that's the price increase that we pushed through at the end of March. Then we have a group of suppliers who are importing finished goods. They, up until now, had a relatively clear line of sight and are communicating to us kind of in more of a surcharge format. So, it's a little clearer for us to model. But the bulk of our suppliers are looking at multiple overlapping tariffs that are impacting them. And so, to simplify it, they're still doing the math. And of course, now, they have -- we have new information as of yesterday. So, while we're in negotiations with them, they haven't given us size or timing yet. So, what they're implying is it will come in the form of a general price increase across their whole product line, not in a visible surcharge. So, in the meantime, we're working the playbook, as Kristen said, and we're working with customers on how to understand their mix and how their mix could possibly be shifted to a Made in America framework and how we can help them with productivity to offset any tariffs.

Thank you both. As a follow-up, I wanted to touch on the web enhancements and recent marketing initiatives. Correct me if I'm wrong, but it seems like the takeaway there for this quarter is on track. But I wanted to go a little bit deeper if there are specific areas of the programs that you could highlight as progressing ahead of plan and then the flip side, are there any areas that are proving a little more difficult than anticipated, maybe behind plan? And if you just think ahead, what would you frame for us as to what's to come here? Thank you.

Tommy, good morning. It's Erik. I'll take this one. So, I think you're right. I would say -- I would characterize progress is on track. And you heard in the prepared remarks that we were pleased -- we had a bunch of things that we wanted to get over the finish line in Q2. We did. So across the board, the overwhelming headline is on track. I would not call out anything where we're behind. Look, last year, we had areas to call out behind. I think we're doing what we said we were going to do as of now, Tommy. Progress has generally been encouraging. And obviously, this is going to -- we're going to be -- our performance is going to be influenced by the macro. We've talked about a lot of uncertainty now, but what we're focused on is what can we control. And that's do we deliver what we say we're going to deliver and then how do the leading indicators look. And that's in terms of the web marketing, we gave you a sense of some of the KPIs we're tracking internally. They're on track. So, as far as we're concerned, it was a solid quarter. Each one of those tracks, it's not like it's one and done. There's continue -- what we talked about with the web upgrades, we got a good foundation in place that we're going to build upon with a product roadmap now. On the marketing front, we got started. We're seeing some nice traction and momentum. I mentioned in the prepared remarks, seeing new customer acquisition tick up, which was encouraging. There's a lot more to come there. And then, of course, Martina hit sales optimization, which is running ahead of plan in terms of executing on the actions. Now, it's about translating those into results. So, I think in general, what I would say is we're on track. We expect core customer growth to improve. Of course, obviously, we'll be influenced by stuff that's outside of our control here, but in terms of how we execute and perform, we expect to see some improvement.

Thanks, Erik. I'll turn it back.

The next question comes from Ken Newman with KeyBanc Capital Markets. Please go ahead.

Hey, good morning, guys.

Good morning, Ken.

Good morning.

Good morning. So, for my first question, Erik, it doesn't seem like you guys are seeing any pre-buy activity at least through the quarter, but I'm curious if you're getting a sense that some of these customers, they've been trying to get ahead of yesterday's announcement, and if that's being reflected in the preliminary March numbers?

Ken, we have not -- and our stuff, it's tricky because our spend -- our customer spend with us is fragmented across so many SKUs. But we've seen to date, and I would include March in that no evidence of outsized pre-buying to speak of.

Okay. And then maybe quickly for my follow-up here. Totally get that the visibility in the cycle is limited just given all the moving pieces. But maybe if we could just dig a little deeper into the individual end markets from a manufacturing perspective, I know automotive and aero are two of your larger ones. I think they're both 10% each direct. Obviously, we've got some news on the tariff side from automotive, some incremental stuff there yesterday as well. Any high-level thoughts on how you're thinking about those end markets in particular and how you're looking to navigate some of these moving pieces?

Yeah, sure, Ken. I'll take that one as well. So, look, I'll give you -- look, the headline was Q2 remains soft for heavy manufacturing. And you could see that in the IP metrics that we referenced. I think another headline though is we saw continued improvement through the quarter, and that improvement continued into March for the most part across our heavy manufacturing end markets. So, while soft, progressive improvement with pretty much all of them with the exception of automotive and heavy truck which still remain really soft. Now, obviously, trying to predict what's to come is nearly impossible right now. One would think that automotive has been really soft. One would think that yesterday's news and the recent events could weigh on that segment further. The flip side is aerospace, the outlook continues to be robust. But I would say the general tone would be soft, but improving over the past few months, and just a lot of uncertainty around how recent events are going to shake out.

Very helpful. Thanks.

The next question comes from Stephen Volkmann with Jefferies. Please go ahead.

Hi, good morning, guys. Thanks for taking the question. I’m just, I was curious…

Hey, Steve.

A little surprised to see that your pricing was down slightly in the quarter. Can you just talk about sort of what's happening there and what you expect maybe for the third quarter?

Yeah. In the second quarter, Steve, we saw a pretty healthy amount of mix within that price number. And some of that has to do with how customer sector mix, for example, comes into the calculation. There's a few different ways that we look at the price measurement. If we look at it on sort of a lower level of detail, same customer, same item, we had a more favorable price number. It was washed out in the way we reported overall because of mix within customer types. That was 2Q. And then, I think you asked about 3Q on price/cost. So, I'll remind everyone 3Q last year, we were -- this is when we'll comp on the issues we had with the web price realignment in the third quarter of last year. So, that creates a tailwind for us on a year-over-year basis of about 30 basis points. So, if you think about the midpoint guide of 40.9% on gross margin, that would imply flat to prior year. And to break that down, you've got 30 basis points of tailwind on the price/cost lapping from web price realignment. We're expecting some additional improvement from productivity and very slight benefit on the tariffs. That's probably worth about 10 to 20 basis points, but we're also expecting continued mix headwinds. And then, we have some headwind from acquisitions completed since the prior year that largely offset that to get you to about flat at the midpoint gross margin number for 3Q.

Great. Okay. That's super helpful. Thank you. And I apologize, this question might be a little bit too theoretical, but I've been trying to think about price/cost from a bigger perspective. And obviously, you and lots of distributors benefited in terms of gross margin from our last bout of inflation. However, that was also against the backdrop of very strong demand. So, I'm trying to figure out sort of how you look at price/cost assuming that we're headed into an inflationary period. Are you going to be able to sort of get ahead of that and get a little bit of gross margin benefit from this as it happens or is that going to be tougher this time because we're not in quite as big a demand environment?

Yeah, Steve, I'll take that one. And look, you and everybody else are trying to figure it out, right? It's fluid, as Kristen said. But in all seriousness, here's what I'd say. We have always said and continue to believe that in general, inflation and particularly the early stages of an inflation cycle is constructive and positive for a distributor and for us. And that -- we continue to believe that. So, particularly, as I said, early stages of an inflation cycle, we do expect to be able to pass pricing along as we did in the past. Martina referenced, we're going to lean hard on two things this go around in particular that our tools at our disposal even more so than they were kind of in tariffs 1.0, if you will. One is our product offering, which is we have made some moves, certainly reducing China exposure, and we've got a really strong Made in USA offering. And then two is our playbook in terms of productivity to deliver for customers. So, we think all of those things, even notwithstanding what happens in the demand environment, support our ability to get pricing through. We're going to have to. And those are supportive of it and will help with customers. That said, Steve, it's really difficult to go back to prior cycles here because this is a little bit of unchartered water in terms of, number one, the fluidity and just how fast things are moving and changing. Number two, the scope. Obviously, we're looking at, at least as of yesterday's announcement, far-reaching beyond China. So, there's a lot of unchartered water here. But if I pull it back to the headline, we would expect to get price through. We're going to lean on our playbook, our inflationary and tariff playbook here and particularly early stages of an inflation cycle, we would expect to be price cost positive as we have been in other cycles.

Much appreciated. Thanks.

The next question comes from Chris Dankert with Loop Capital Markets. Please go ahead.

Hey, good morning. Thanks for taking the questions.

Good morning, Chris.

I guess, Erik, maybe just to dig in a little bit more on the digital KPIs, any update on the conversion ratio order size, something that can kind of put a little more meat on the bone for what we can expect sales in the future maybe here?

Yeah, Chris, so, good question. You heard us reference some of the indicators that we're looking at and then we kind of said some website KPIs, which obviously were sensitive to how much we share on a call like this for competitive reasons. But you could imagine -- you hit on two of them that we're looking at very carefully, conversion rate and average order value. Conversion rate in particular, out of average order value has some other moving parts. But conversion rate does give us a good indication of how the site is doing, and we are seeing -- we referenced some improvements. And obviously, it's still early days here because the most of the meaningful upgrades, the ones that you saw on the slides happened fairly late in Q2, but we are starting to see positive momentum in those indicators, which would bode well. We are seeing sequential increases in website revenues as well. But I would call the revenue one a trailing indicator, whereas the conversion rate, the average order value is one or two other things that we look at our leading indicators, we are starting to see some movement there.

Got it. Got it. Good news there, I guess. And then I'm going to ask an unfair question, I guess, just conceptually, is there any way to size what percent of your sales are tied to customers who are exporting product here? I mean, it's been a bit, but it seems like trade wars are just going to accelerate. What's the risk of those customers having to pull-back? Just any way to size the export exposure here?

That would be -- so, a tough one to size. Chris, I see where you're going if things were to escalate. Look, I think that's one of the unknowns. So, the short answer is, it's tough to size. We do know that I'm thinking back to prior cycles. If there were a trade war, would there be impact on demand, would there be impact on production in the US? Yeah, there would. We've seen it in other cycles where there's been massive, I mean, I'm thinking of past cycles where it's less about tariffs, more about currency, does that impact production? It does. So, there would be an impact. I sort of directionally, and this is qualitative, not quantitative, but since prior cycles, there has been a shift back to Made in USA, meaning putting production closer to end markets to shrink lead times, which might buffer some of the impact because there'd be more stuff here that's going for this -- going to this market as opposed to being exported. But in general, if export demand softens, we would feel it here.

Understood. Really appreciate your thoughts there.

I'm sorry. I couldn't give -- I realize that's qualitative, not quantitative.

No, I knew it was an unfair question at the beginning. So, thanks for your thoughts.

Chris, going back to your previous question on the web enhancements, just to give you a size. If you look in the e-com [the op] (ph) stats, we have the e-com sales. About half of that is website sales, just to give you an idea on the size of our website.

Thanks, Ryan.

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

Thanks. May you live in interesting times, right?

You ain't kidding, Dave, especially with the timing of this call.

Well, good morning. My question is on performance versus IP. It looks like it took another step back this quarter. And even relative to your -- the five heavy industries of IP, it seems like you're losing share measurably currently. And, Kristen, in your comments, you said you're confident in your share gain efforts. I'm wondering, if you can outline sort of from a timeline perspective, which of the initiatives are going to start to chip away at that gap the soonest, maybe in the next quarter or two?

Yeah, Dave, maybe I'll take it. So -- and let me parse out sort of two things, which is confidence in executing on what we said we were going to do, and beginning to see early leading indicators that those initiatives are going to make a difference. Dave, you're absolutely right. The one thing I would call out is, and Martina mentioned this in her prepared remarks, looking at the quarter on an average, what -- part of what we are encouraged about is seeing sequential improvement through the quarter and into March. So, for instance, if you look at performance, the last two months, let's say, February or March, you're going to get a much different story. It was sort of a tale of two quarters. December was heavily weighed down by holiday timing. The first part of January was really lousy and we think some of that may have been weather or whatever. But the second -- the back half of January into February, now into March, a bit of a different story. Look, I would say from the start here, we have underperformed in part portfolio mix and in part our own doing, and where it's our own doing, it was around the core customer predominantly. And we've outlined four things, Dave, to get done. Web pricing, e-commerce, marketing, and sales optimization. And if I think about those four, web pricing pretty much behind us and complete. E-commerce, the heavy-lifting portion of it now complete -- just complete, but now complete. Marketing, now in market and in flight will build sales optimization winding down. So we feel like we are just at the beginning stages of seeing the fruits from the labor. So, what we're encouraged by is from an execution standpoint, we're on track with what we said we're going to do, and the leading indicators seem encouraging. We now need to see that. And again, February and March may have been early signs, we got to see more of that.

That's great, Erik. Thank you. Yeah.

One point of clarification from what Erik said too, like if you go and you look at that year-over-year performance that Erik referenced like in January, February and into March, that's a true statement for core and national accounts like within that, which obviously are two areas that we're really focused on right now.

Yeah. Thanks, Kristen. That leads me to my next question. I know it's hard to think about anything in a vacuum right now, but could you talk about the effect on gross and operating margin as the shift towards vending and in-plant happen? And then you also have this effect of core customer reacceleration you just mentioned. Where should we think these things net out over the next, say, two to three years, not just near-term?

Yeah. So, just to make sure I understand your question, Dave, you're saying long-term impact from growth of in-plant and you said something else after, was it in-plant vending?

Yeah, in-plant vending and then there's the impact also of the core customer reacceleration, I would imagine.

Yeah, got you. Yes, so, in-plant and vending, when we -- I'll start with gross margin and then go to operating margin. We tend to see on the gross margin line that on the large -- you see more national accounts participating in those programs. National accounts, as we've talked about tend to have a lower gross margin than the average of the company. So, from a gross margin perspective, there's some pressure there. And then the profile of those accounts, though, the longer that they're in place and the more they mature, we see that impact start to neutralize, and eventually will benefit operating margin, especially relative to where we are today. But core customer is the one that we're really the most focused on, that you have the opposite effect on core customer gross margin and that it's higher than the company average, typically has a lower cost of support in a lot of cases, so very accretive on the operating margin side. And that's really one of the areas that have been challenging our operating profit levels today, also the area where we've chronically kind of undergrown the most in the last 18 months to 24 months. So, as we think about how those two elements move together, we haven't necessarily guided like a desired mix of revenue across the two, but we would expect core as these initiatives come online to start growing at a faster rate than some of the underlying in-plant vending businesses where we've continued to do fairly well despite the overall growth declines in the company.

And Dave, I'm just going to chime in with one more point on in-plant and vending. And particularly, this impacts like our outlook, hopefully what you're hearing from us is obviously some near-term caution in terms of the environment, but encouraged by improving execution. And if we get past '25 and the end-market outlook is sound, the picture for '26 and '27, why we're encouraged. So, in-plant and vending, Kristen mentioned the gross margin percentage headwind. When these programs are fully in place, the op margins are strong. They are though subject to when you put an in-plant program in or a vending program into a customer, and the economy softens and their spend reduces, there's an element of fixed cost there, because you have a person, you have depreciation on a machine. These are very sticky relationships. And so, what we're living with now is the fixed cost for those programs and you could hear like the program counts are way up and yet the program revenues are up 1%. Obviously, on a per machine, on a per site basis, they're down because things are soft right now. It is part of the bullishness, if you will, for us looking out because beyond core customer reacceleration, we should get a strong rebound here and the cost structure on those accounts is pretty fixed. Other than a little bit of variable cost, we get the benefit of existing accounts coming back online with the same costs in place, and we get the benefit of an expanded footprint. So, all of that is what has us sort of encouraged and excited about the outlook when we get beyond '25.

Thank you, and good luck.

Thanks, Dave.

The last question today comes from Patrick Baumann with JPMorgan. Please go ahead.

Hi, good morning.

Good morning, Pat.

Good morning, Pat.

I just had a couple, I guess, cleanups here. First on the price that you put through in March. I just wanted to get a sense of what tariff rates you were pricing to offset. And I'm asking because you said it was China-related. But before yesterday, I think there's been 20% tariffs on China and also like the Section 232 tariffs, which were 25%. So, I guess, I'm wondering why it only provides a 0.5% impact if China is 10% of COGS. I'm sure it's like simple math and I'm missing something, but just wanted to clarify that. And then also kind of relatedly, what -- and then also kind of relatedly, like, what's the type of products you're importing from China? Is it like a certain type of MRO? Is it metalworking skewed? Any color on that?

Yeah. So, on the first part of your question, Pat, you're right, that's the -- that was sort of like the known tariffs at the time. But just to clarify, the 10% of COGS in China is looking at total COGS with the country of origin from China, not necessarily where we are the importer of record. So, there are more things that we will likely be responding to as our suppliers provide information for us. As we just get our arms around the whole picture, there will likely be more to come and that kind of leads you into that bucket of what is yet to be quantified that I alluded to earlier in response to one of the first questions. And then your -- can you clarify the second part of your question again? What products did you import from China?

Sure. I can clarify. But, so basically, you're saying that you're less than 5% of your COGS is where you're an importer of record from China is basically what you're saying?

That would be the way to interpret that.

Okay. And then the types of products you're bringing in from there.

Yeah, the types of products, yeah, it's a broad spectrum, Pat, which is probably not a surprise just considering how much is coming out of China. Martina or Erik, do you want to jump in on anything we're more overweighted to, but it really is about every product line or some portion of that coming out of China.

Yeah. And I would say more towards MRO than metalworking. You heard Martina reference our private brands in metalworking, which are pretty robust, a good portion of which are sourced domestically. So, it would be more MRO, Pat.

Okay. That's helpful. And then my second question is on the e-com sales down 4% in the quarter. I think you said in response to a question that website is half of that category, I don't know if you provided color on how website sales are tracking year-over-year within that or if you could, that would be useful. And then maybe also in the operating stat stack, there's like an other category and it was 10% of sales in the quarter. Was 13% last year, 14% in the fourth quarter -- in the first quarter, I think. So, that implies like it was down 25% year-over-year, 30% sequentially. What is happening in that other category in the op stat stack?

Yeah. So, let me take the -- I can take the first part of your question on e-commerce, and I'll answer the op stats question. Pat, so on the e-commerce number, a couple of things I would reference in there. I won't go specifically into like mscdirect.com performance through the quarter necessarily. But particularly in the end of December, beginning of January, we saw some movement in e-com that was pretty depressed that would have impacted that number. And then because there is quite a lot of things that actually are considered in e-commerce, one thing to keep in mind is that when we see really strong growth in public sector, for example, or in businesses that are not as weighted to an e-commerce transaction, that creates a movement in the numbers since we're reporting it as a percentage of total revenue. The public sector probably being the most notable one, there is not as much electronic ordering that happens in that or not as much e-com exposure within public sector. And then on your question on other in the operating statistics, so, two things. There's a lot of industries that map in there where we're like have very low weighted exposure. I believe we say under 2% -- under 3% in the operating statistics. But the other thing that can happen in there is, as we clarify certain end markets that customers belong to, they may move -- they may move out of other. We can more clearly assign them somewhere. So there's a lot of pass-through in and out of that bucket. So, I would not -- I would encourage you not to draw any strong conclusions from the other being down that much.

Okay. Okay. So, don't look like that -- got it. Understood. Okay. Thanks a lot. Best of luck. Appreciate the time.

Thanks, Pat.

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

Thank you for joining us today. As Kristen mentioned earlier, we'll be at -- we'll be on the road in May at the Wolfe Research Conference and the KeyBanc Capital Markets Conference, and we'll host our fiscal third quarter 2025 earnings call on Tuesday, July 1st. Thank you.