MSC Industrial Direct Co., Inc. Class A Stock

All right. It looks like we're going here. Welcome, everybody, to session 2 for the Jefferies Industrials Conference. I'm Steve Volkmann, industrial analyst at Jefferies. We're going to be doing a bit of a fireside chat here today with MSC Industrial and very pleased to welcome Martina McIsaac, who's the COO; Ryan Mills, who is VP of IR, will keep us all in line here. We're going to do sort of a fireside chat format here. If anybody wants to get involved, certainly happy to share the weight. I'll come up for air a couple of times and cue you guys. But if you don't, I'll keep going, and we'll have an interesting conversation. So Martina, welcome. Thanks for coming.

Thank you. Thanks for having us.

Great. So you've been at MSC now, I think, around 4 years or coming up on 4 years. You've been the COO since January. And since you took over in January, you've been working on some sales force restructuring, and we've seen margins expand so far, so good, it seems. Maybe you can talk about sort of your big picture, sort of what your goals are, how you're trying to manage the business and where you think it can go?

Sure. Thank you. Well, thanks for having us, Steve. So yes, I've been at MSC for just about 4 years. I was able to start as the COO and really get under the covers of the company and then did a year as President. And we were able to lay the groundwork for a turnaround that we're really -- we're in the middle of executing. We're very happy with our progress. We intend to return the company to a mid-teens operating margin framework. We are in the early innings of the game. But we've made a lot of progress so far. I mean our sales force restructuring is what we've talked about the most this year.

My next question.

Yes. But we've also completely revamped our pricing structure. We have invested a lot in network optimization, so managing our -- the balance of freight versus footprint, optimizing within the 4 walls of our distribution centers. And there's a lot of early wins to be seen in our numbers already. If you look at what's happening with fuel cost, we've been able to offset most of that because of what we've done already on our network -- on the network side of things. So whether it's contracts or AI-driven planning and inventory placement, we have built a lot of fundamentals in the first 3 years that I was at the company, and now we look to accelerate organic growth with the sales restructuring.

So just in case people aren't in the weeds here, the goal is mid-teens EBIT margin. Today, we're around 10%. So that's a pretty good hill to climb.

Yes. We ended last year at 8.4%. So it's a climb.

So what's the -- what are the tools that get you there?

To get us to the mid-teens? I mean there's a couple of things. I'll dive kind of right into the gut. So the first thing that we did was we aggressively benchmarked our cost structure against our competitors. Now there's no perfect proxy competitor to MSC and industrial distribution. So we looked across the competitive set to kind of hold ourselves accountable to what we think best-in-class is and we identified that our cost structure to give you kind of a representation, at the same sales level, we're about 1,000 heads heavy to deliver the same sales result as our competitors. So that gave us sort of the North Star of where we want to go.

So certainly tackling that, and we have a road map to do that to basically look at ways to take out manual work, to change work, to automate processes, to introduce AI, and we're on the road map to do that. And then the other side of the equation is, of course, to accelerate organic growth. So we have looked hard at our sales structure, which customers we cover, how we cover them with what resources. And we feel we've now designed a structure that covers the right potential. And now we look at kind of putting in place the sales -- disciplined sales execution to get us there.

So the 1,000 heads comes up a lot. It's a nice round number. What is that? Remind me, sort of the percentage of total MSC.

So we're about 7,000 today.

Right. So you're looking at a reasonable chunk of folks. And is it a situation where you think you can operate without these folks? Or is it more you want to grow into that type of cost structure?

It's an excellent question. So the metric that we've given you to watch is the trailing 12-month revenue divided by total headcount because obviously, there is a numerator and a denominator in this game and growth will help us but we actually intend to attack the cost structure and take those heads out. Now just for clarity, over the last year, we took about 400 people out of our field-facing team. So we eliminated some redundancies, some overlapping teams, some duplication. That's not included in the 1,000. This is an additional 1,000 that is primarily in the back office and our warehouses right now. So how do we do without them? We change the way we work. So we're looking at increasing the level of automation in our supply chain and in our back office and leveraging some AI as well.

Okay. So if my math is right, which is always a big question, that probably, if you can do that, gets you 200 to 250 basis points, so maybe halfway to your 15% goal. Do you want to correct me before I go to the next part of the question?

That's probably fair. Yes, you want to...

Directionally, that's right, but there's also some fixed cost leverage to be had, too, on the top line. So you also have the margin benefit from us attacking our cost structure and reducing heads, but also as we grow too, because there's a lot of fixed cost in the business to leverage.

Okay. Yes, you don't have to go easy on me. It's okay. I can take it if I'm wrong. But -- so the other half of the gain then is more about what you're talking about, Ryan, the sort of fixed cost leverage. Is there anything else that we should focus on in terms of opportunities there?

I think one of the best ways to look at it is we gave the incremental margin framework, mid-single-digit growth, incrementals should be at or close to 20%, high-single, low-double-digit, the incrementals should look upper 20s or potentially a little bit better than 30%. That's the baseline. So as you model out the out years, as we attack our cost structure and take heads out, that will be additional or incremental to that incremental margin framework, if you will.

Okay. Good. And for some reason, distribution investors seem to obsess about gross margin. So talk about how gross margin sort of reacts to this whole process.

So we have -- starting in '23 and ending in '24, we revamped our whole pricing structure. And we have now, I believe, put in place a very logical, competitive and reliable pricing system. So we're producing pretty stable and predictable gross margins right now. We have not yet started to use gross margin as an offensive weapon to grow volume, which is the next step for us. So we are not really looking to expand gross margin anymore. We'd like it to be stable in that 40% to 41% range. So that's what you can count on when you're modeling.

Okay. Great. So you talked about pricing. So let's dive into that a little bit. I mean pricing has been pretty good this year. We've had this backdrop of tungsten being sort of crazy. Just lay the groundwork for what you're seeing in terms of pricing and what the outlook is.

Okay. So for -- just a little bit of background if you don't know our business well. So cutting tools represent about 15% of our total revenue. And so the tungsten carbide affects cutting tool production and the inflation there has been extreme like in the neighborhood of 500%. So there's been a lot of price activity on the metalworking side of our business. And then, of course, the rest of our business impacted by geopolitical events. So there has been inflation. But tungsten is -- has been the biggest driver. And it's not our whole business, but it's a chunk of business, and it's not behind us. So we're still hearing from suppliers based on their own control of their own supply chains and their access. So tungsten is an input to carbide, which is an input to cutting tools. And based on their own supply chains, they're still taking and seeing inflation that they'll pass through.

And it's been significant. I think you had 7.5 points of price and 50 bps of volume, right? And was that the second quarter or...

Our second quarter...

Third quarter.

Sorry.

Third quarter, yes. Calendar second quarter.

Exactly, yes. So the fact that we're seeing sort of 50 basis points of volume, do you think there's any demand destruction from all this price that's being pushed through?

No, there's -- if you think about the metalworking business, it is complicated to change the way you make a part, to change the way that part is designed to change the inputs to it. So it's relatively inelastic, the demand there. It's also a relatively small part of a customer's inputs, right? So even though the cost is going up in an extreme way, it's not a big piece of their cost structure. So, so far, we haven't seen -- we're still seeing units growth on the metalworking side.

We are uniquely positioned to capture any leakage that would come from a demand shift because what is the customer going to look at doing now? They're going to look at reusing their tools, regrinding their tools. They're going to look at redesigning their applications, and MSC has all of the resources to support that. So, so far, not a big issue from customers. It's hard for them to switch. When they do switch, they stay within the MSC house.

Do you get a gross margin tailwind, albeit perhaps temporary with these sort of inflationary conditions?

We have been price/cost positive on metalworking for the year. We try to maintain rate when we pass through inflation. We've been successful doing that. We also have tremendous scale in the market. I mean I think we're the biggest metalworking player. So we've also been able to use our cash to prebuy some product via great cooperation with our suppliers to navigate this.

Okay. And you said that it wasn't over yet, but I believe tungsten prices have kind of flattened out a bit.

They have stabilized, but the ripples through the supply chain aren't over yet. So some suppliers, for example, depending on where they source their tungsten powder and how much they had on hand, the cadence of their increases is all different. So every supplier is behaving a little differently, but there's still a ways to come. I think we said in the third quarter, we expected late -- our late fourth quarter, early first quarter, there would be another price increase.

Okay. All right. Good. So let's talk about the other 85% or so of customers. Just give us sort of the lay of the land. What are you seeing in terms of demand? You guys have a lot of various verticals that you serve.

Yes. I mean we have been positively encouraged by the way the landscape looks right now. If you look at the sub-IP indexes of most of our end-use markets, they're positive. Some barely positive, but after a long sort of trough, we're starting to see indications. We look for things like sales through individual vending machines or sales through in-plant programs. Why we were so confident that we were not losing share in the downturn that our business has gone through is that our people are on site in our customers every day.

And so the drop in demand was more a drop in their production. And now we're starting to see the throughput increase on those machines and in those programs, which means that our customers' actual demand is picking up. So we're most excited. Aerospace has been strong for this whole period, but we're most excited. We're starting to see machinery and equipment get turned positive. Automotive, we had some early signals, heavy truck. So we're optimistic.

Anything lagging that we should know about?

Anything lagging that?

No, it just feels like broad-based improvement. That's it.

Okay. And since we're tugging at that thread and we're on a webcast, any update you might want to provide relative to the current quarter?

No.

No. That's good. That's a good answer, too. The last one, it was funny. I was -- I don't know if any of you guys were in this, but I did the whole thing. And at the end, he said, can I just say the third quarter is looking good. I guess I should have asked.

Well, our third quarter is closed at the end of August, so we'll report at the end of October.

Perfect. We'll be ready. Let's talk about capital allocation and sort of your plans for that going forward.

Can I first tell you how excited I am that we have a new CFO?

Yes. Yes. Let's do...

We announced it yesterday. So we have been looking for a new CFO to join our team since last August. We've been extremely picky. And so we announced yesterday, Rob Kuhns, who was the CFO of TopBuild, will join us next Monday. So very, very excited about that. And if you look into Rob's history at TopBuild, really, really excellent and strategic management of his balance sheet and the way he supported aggressive growth, both organic and inorganic during that time, I think a 16% CAGR while he was with TopBuild.

So obviously, we'll let him take a fresh look at our capital allocation priorities. But right now, what I would say is the best opportunity that we have is still organic reinvestment in the business. So continuing to drive the supply chain improvements, this automation that we're doing and -- to go after our turnaround objectives. And then obviously, we support continued growth in the dividend and buyback of share-based comp. But besides that, I'll wait and let Rob tell you once he's on board.

We look forward to having him next year maybe. So fine, we can leave that. Let's talk a little bit then about some of the technology stuff that you guys are working on because it feels like technology and perhaps AI, maybe there's an overlap there in terms of your path to getting your cost structure where you want it to be. Talk about some of what's happening there.

Yes. One of the things during the past year that we've done is we completely revamped our leadership team. So in the past 12 months, we have a new SVP of Sales. We have a new SVP of Customer Experience. We've built a whole customer experience ecosystem. We have a new General Counsel. Now we have a new CFO. We also have a new CIO who's been assessing over the past quarters what the strategy is around our tech stack. So we are lucky, I think, that we have a lot of legacy technology. So we have a real opportunity to leap ahead there. And so we gave John Reichelt is his name, our CIO. We gave him this time to kind of do an assessment, and we'll be sharing more in the coming months of where we're going with that. But clearly, AI is an opportunity.

And I do think we're one of the fortunate that can -- we don't have a lot of an anchor, we can leap forward into new possibilities. So automation in our warehouses is ongoing. We have fully automated our picking operations in half of our network. We still have more to do there. So all across the business, there's opportunity for that.

Is your fulfillment footprint sort of what you think it should be today?

I think we certainly have capacity. We can double our revenue without needing to add any capacity. And we -- another add who's been here about 1.5 years on my team, we have an outstanding SVP of Operations, who comes to us from Amazon and Walmart, and he continues to build internal capacity, bring new processes. The where of our network, I think, will be something that we'll look at as we go forward, and it will certainly be something that we take into consideration before we invest, but capacity is not driving a change in network.

Okay. Interesting. Are there -- is it your dream to expand more in other geographies?

Yes. I have a lot of dreams, though.

Are all those geographies in North America?

Right now, our focus is North America. We have a highly fragmented environment in North America. We have a unique role to play in the distribution market because of the strength that we have in metalworking. And right now, that's our focus.

Okay. Do you think it makes more sense to focus more on metalworking and sort of do what you do best and be the player there? Or do you want to be more diversified overall?

It's an interesting question. So one of the reasons that we looked hard at our sales structure is the fact that we actually have businesses that touch almost every part of a customer's operation. So we have metalworking. We -- we have an equal sized business is what we call MRO. So obviously, MRO is our whole category, but then you're thinking about things like safety and janitorial and power tools and that kind of thing. We have a C-parts business. So think fuses, fittings, fasteners, hydraulics. And then we have an OEM production fastener business. These have been run relatively separately up until now. So when we did our sales force redesign, the goal was to say, how do we leverage the whole portfolio across the whole sales force. And we're already seeing a lot of fast growth there. That's where I think our fastest organic growth will come in the next -- in the coming months.

So the benefit to that is -- it lets us play everywhere in the plant. And when you are trusted to be a metalworking partner, metalworking is usually the brake on throughput through a plant. So when you're trusted to be the metalworking partner, it doesn't take too much to be the paper towel partner, right, or the maintenance crib partner because we are trusted at the heart of a customer's technical operations. So do we lead with metalworking? Yes. Do we want to sell the full portfolio? Yes. And so now we compensate our sellers on selling that full portfolio. That's new since last December, but we've been growing 18%, 20% in OEM fasteners as a result. So I expect you'll see us talking more about the rest of the business.

Okay. And on the metalworking side, what do you think your market share is roughly?

We still have lots of room to go. It's highly fragmented, yes.

Okay. So why do people pick you instead of somebody else because there are some other distributors out there.

Yes. I mean I'll give you my opinion. We've been doing this for over 8 decades. And we have a reputation for not only technical competence, but what I call technical integrity. So we respect very much the choices that customers have to make in their metalworking production. We are brand agnostic. We have a technical capability to optimize production and to make the right recommendations. So we are not tied to any one brand. And so a customer sense that, and they understand that we're really there to be a productivity partner. We returned $500 million of documented productivity to our metalworking customers last year. So our sellers and our technical team have the goal to optimize applications for customers, and we actually track that. So it's part of their performance metrics and customers have to sign off on the recognized profit that we drive. So I think that's unique.

Interesting. Okay. Let's see, working capital. It's interesting. I get questions from investors about how distributors can manage that more tightly. But at the same time, your whole kind of goal in life is fulfillment, right? And so...

Reason for being...

Exactly, right? So how do you strike the balance with that? Is there an opportunity?

There is. I mean I think if you look at the last 18 months, we've made a significant reduction in our inventory. One of the first changes that we made in our supply chain optimization was to bring AI into our planning process. So we do sell 2.5 million SKUs. It's a complex business to manage. And inventory is our weapon. And especially in metalworking, we are very proud of the fact that we have what customers need, and we can get it to them next day. But that doesn't mean that there can't be optimization in terms of the way we plan and what we stock. And so we're going to -- we're continuing to focus on that, and that's a big area where AI is supporting us.

I think there's also, obviously, on the DSO side, this is, again, a complex business, and it's the 20% of our customers' world, so it doesn't always get their attention. So I think that, again, bringing order there to the chaos, we should have an opportunity to improve.

Okay. There's been a lot of sort of discussion around 80/20 optimization in distribution. I don't know if you would characterize yourselves as doing that or not, but would you expect to have more SKUs or fewer SKUs in 5 years?

What we call weaponizing inventory is about the right assortment. So in distribution, you don't necessarily grow because you add SKUs. You grow because you add categories. But within a category, you need to have the right assortment and not too big an assortment. And so we've been working with our supply community for about 1.5 years to kind of define what is the strategic assortment. And so that would actually narrow the SKU count instead of increasing it, inflating it.

Okay. Interesting. So maybe a growth question, and then I'll see if there's anything here in the audience. But you talked, I think, about a February event where you had like a $500 million sort of funnel of opportunity, and I think you converted maybe 10% of that as of the last quarter. Talk about that process and how that drives some growth.

So in distribution, you hear a lot of times that we're a short-cycle business. So the word pipeline doesn't come up very much. Like if I were making airline turbines, you would have this long backlog and you would know what your pipeline is. And historically, I think people shy away from that in something like distribution. I completely disagree with that. I think if you think about one of our customers, yes, we don't know when they're going to need something, but we better know that they're going to come to us when they do need it. And so white space management becomes critical to our strategy, and that's new for MSC.

So what we did in February was we had basically a supplier conference, not a typical supplier conference, which is like a trade show where you walk around and pick up swag, but actually more like what you're going to do today, we analyzed together with suppliers white space. So to give you a reference, what's white space? If you're buying metalworking tools from me, but you're not buying PPE, there's -- that's white space, right? You need PPE to run your machines, why aren't you buying it from me? So we were able to map that with our core suppliers and linked to individual customers. And then every seller got a list of opportunities that they had to work with the suppliers.

Then we rolled that up to a pipeline. Like you said, it's about $500 million of vetted opportunities that the supplier signed off that they were going to support us and our sellers signed off that the opportunity was real. And now we're just working that in the pipeline. So we'll give you an update on it in October. But after the first quarter, we had closed about 10% of it. This is -- these are new muscles for MSC. But to me, that's how you -- I know I've told you this before, but I have an expression, you either get wet when it rains or you make it rain, right? So we want to get wet when it rains. We want to cover the right customers and be there. But the real growth will come from bringing some of these techniques into our business so that we can actually drive the result.

And Martina, I think the supplier council is a key enabler for that. So maybe if you wanted to give some color on that.

Yes. So obviously, suppliers are a critical stakeholder for us, and we have a very active supplier council that works with us. And together, what we're talking about is what does industrial distribution look like in the future, right? How do we professionalize it together? What processes do we want to bring? It's things like how do we more effectively commercialize their innovation or how do we jointly work together to capture more share. And so they've been really, really instrumental, and they helped us plan that event.

Great. Let's take a second. Anybody in the audience would like to ask a question? All right. Maybe not.

It's too early for industrial distribution.

I think the process -- we're going to go back to kind of the headcount reductions and the cost reductions. And I think the process has changed out some sellers, and I think you've noticed a little bit of friction in some of your past couple of quarter calls around people seeing new faces and things like that. Are we done with that process yet? Is that going to continue? How would you characterize that?

Yes. So let me take a step back and kind of talk about what we were trying to achieve with our sales force optimization. So MSC has a very large presence in the feet in the street presence, and we intend to keep that. We are committed to a human direct sales force. You need to be standing beside a machine to help an operator optimize it. So we want to do that. But we had legacy structures, overlapping structures, overlapping compensation systems, redundancy. And in some cases, we were straight up covering the wrong customers. So customers that were no longer sort of core to our strategy.

So over the course of 2025, we implemented a new territory planning model, very data-driven, again, help of AI to kind of define for us what the structure should look like. And so we did that in -- we -- that's not in our 1,000 heads. That was before that. But we -- in 3 chunks, we took out about 100 sellers. And what we basically landed on is a model where we have a geographically designed organization where you have a seller and a service person covering a customer. Prior to that, it was possible that you could have 3 or 4 or 5 MSC people calling into the same MSC account, which just led to handoffs and a poor customer experience. And so now you have one unified compensation plan and this very clear team assignment.

So when we made the final set of changes, we did expect to have attrition in our sales force. It feels very different to sell for MSC now than it did a year ago, and it will feel different a year from now. So we have -- we put telematics on our vehicles. We have a new sales management process. We're asking you to build and manage a pipeline. We're coaching to that. So it's a different environment. And we knew that some people would opt out. We didn't know -- we didn't expect it to be as immediate. And that's what I shared in our Q2 call. We actually had 90 more people than we expected to leave the company.

The overall attrition is less than our total anticipated attrition, but it happened in a more compressed time frame. So we felt the brunt of that in our second quarter because if you're not physically there covering customers, then we lose sales. And so we were able to fill all that vacancy. The team is in place now. And so there was some face change that then we couldn't control. We had tried to minimize face change to customers. That's always important in a change like this. But having the 90 people leave kind of on an unplanned basis imposed some face change on us that we weren't ready for. So now we're building that back up. And I think the culture, we have a fantastic sales leader. Her name is Jahida Nadi. The culture is positive. People are back to growth. They're very excited. People want to win. So we're there now.

Okay. One last chance. Okay, one in the back. There's a mic that I think.

If we go back, sorry, like 10 minutes to the tungsten pricing, is that pretty quick for you guys to pass through or roll back? And like what happens if tungsten rolls over for you guys? Like do you hang on to that price for a little bit or no?

So let me answer that in 2 ways. The suppliers obviously will have to work through their own supply chain, and we try to anchor our pricing to movements that tie to their published list prices, right? I would give -- if you'd ask me about tariffs, I would have given you the same answer. Until they move their list price, we don't typically move. And so we would have to see their reaction time. And like I said, I think that is still in an inflationary mode. On our side, we run an average costing system. So it takes time for higher cost inventories to work through the P&L. And then consequently, any change in any lower cost inventory would take some time to work through the P&L. But primarily, it's the trigger of a supplier signaling to the market.

But if it did roll over, you would eventually pass that back...

Absolutely.

What about the only cost you didn't mention in that short statement was transportation and freight. How are you handling that?

In terms of the current fuel cost?

Yes, I assume there's inflation that you're seeing...

Yes. So right now, we're very happy with our transportation performance because not that we foresaw this. But like I said, we've made so many changes to our supply chain, again, whether it's better contracts better placement, understanding where customers are getting product closer to them, reducing air freight. There were a whole bunch of initiatives in our network optimization, and that's offsetting for right now. And again, we move with published freight pricing.

All right. Good. Well, with that, unless there's any one last question, maybe we'll wrap it up. It seems like a good place to stop. Thank you guys so much. Very interesting. And this is what I think you guys are the first to report.

October 22.

So we'll have that to look forward to.

Thank you.

Thank you.

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

Thank you, and good morning, everyone. Welcome to our fiscal 2026 3rd quarter earnings call. Martina McIsaac, President and Chief Executive Officer; and Greg Clark, Interim Chief Financial Officer, are on the call with me today. During today's call, we will refer to various financial data in the earnings presentation and operational statistics document, both of which can be found on our Investor Relations website.

Let me reference our safe harbor statement found on Slide 2 of the earnings presentation. Our comments on this call as well as the supplemental information we are providing on the website contain forward-looking statements within the meaning of the U.S. securities laws. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks are noted in our earnings press release and our other SEC filings.

Lastly, during this call, we may refer to certain adjusted financial results, which are non-GAAP measures. Please refer to the GAAP versus non-GAAP reconciliations in our presentation or on our website, which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures.

I will now turn the call over to Martina.

Thank you, Ryan, and good morning, everyone. On today's call, I will briefly cover our fiscal third quarter results, and we'll provide an update on the progress of our initiatives and the current demand environment. I will then turn the call over to Greg to provide greater detail on our fiscal 3Q performance and our outlook for the fiscal fourth quarter.

Starting with our results on Slide 4. Average daily sales exceeded expectations with year-over-year growth of 7.8%, underpinned by continued strength in the daily sales of our core customer and noticeable improvement in national accounts. Adjusted operating margin of 10.6% also performed better than expected, resulting in an incremental operating margin of 32% in the quarter.

Since becoming CEO earlier this year, I have spent a portion of my time getting to know our external stakeholders at conferences and roadshows. This time has been well spent as it allowed me to ensure that the high-level KPIs we're using to drive urgency and performance in the business are aligned with the way our shareholders will evaluate our results and hold us accountable to progress.

To summarize here, we are focused on sales per rep per day and sales per total headcount, year-over-year volume improvement, adjusted operating margin expansion and adjusted incremental margin. And lastly, ROIC, which will improve naturally when the KPIs I just mentioned are firing on all cylinders. We are fully committed to restoring MSC to a mid-teens operating margin, a goal which is understood and driving action across the enterprise. While we aren't hitting any home runs yet with these KPIs as of the third quarter, I am encouraged by the singles and doubles we are producing, which I will now discuss in greater detail.

Starting with sales per rep per day. we are making progress on our goals. As you recall, our sales force optimization initiative was completed in December with actions taken to streamline and professionalize our service organization which in turn resulted in some noise in our 2Q. This headwind is largely behind us, as evidenced by the improving ADS of impacted customers and the inflection seen in national accounts during the quarter. sales per rep per day has improved high teens year-over-year, suggesting that at this point in time, we are fundamentally doing more with less with 225 fewer heads in the fields, we're targeting the right customers and meaningfully increasing customer touches through disciplined sales execution.

As you can see on Slide 4, average daily sales to our core customer once again outperformed total company with volumes beginning to improve. A portion of this improvement is being driven by daily sales growth in the double-digit range on mscdirect.com. As we look at the business today, in process for new sellers. We expect this will accelerate growth, reduce attrition and strengthen our ability to quickly add new sales head count where we see potential in the market. We've also instituted new sales management processes throughout the selling organization, guided by our sales leadership, sellers now operate to new standards with new tools and a supportive pipeline review process.

Early benefits of this work and our initiatives over the last year resulted in improved cross-selling that helped contribute to OEM fastener growth of more than 15% in the quarter, as sellers are guided to sell MSC's full value proposition. Added to this work, we continue expanding our vending and implant footprint. The growth of our installed base is showing the benefits of an improving macro environment that should result in higher sales across existing locations, an effect which we commonly refer to as the coiled spring.

We started to see early signs of this in the third quarter with daily sales trends on a per unit basis showing volume improvement. I'm also pleased that the company continues making strides to improve its cost structure as demonstrated by the 150 basis point reduction in adjusted operating expenses as a percent of sales in the quarter. This is being driven by several factors, including our recent head count actions, our new sales structure, which eliminated duplicative commissions being paid on the same dollar lowering our selling costs by reducing commission expense in the quarter and lower freight expense compared to the prior year despite elevated fuel costs as a result of benefits from our various optimization initiatives.

Acting on our productivity pipeline and optimizing our cost structure will be at the forefront of our strategic focus as we progress towards our long-term targets. As we have said, we intend to challenge MSC's cost structure to restore the company's operating margins to the mid-teens. Our own competitive benchmarking on sales per total head count suggests that at today's revenues, we are relatively heavy by 1,000 heads.

To close the gap to that benchmark, we will have to grow and aggressively target changes in the way we work with a focus on AI and automation. That focus is already being recognized. Just this month, MSC was awarded Verint's Global Customer award and accelerated insights with AI that recognizes efforts in pushing AI beyond pilots and into real-time use.

Switching to the macro environment, we are seeing further signs of an industrial recovery taking shape with positive IP readings across most of our top manufacturing end markets and 5 consecutive months of MBI readings above 50. Turning to Slide 5. Average daily sales outpaced the IP Index for the fourth consecutive quarter and was above our target of 400 basis points in the fiscal third quarter. though still primarily price-driven, I'm encouraged, however, by the trend of volume improvement in April that has continued through June and suggest that our initiatives are beginning to take hold. While there is plenty of room to further improve, when I consider our financial results, the improvements made to strengthen our performance-based culture, increasing engagement scores from our associates, and the tangible evidence of progress achieved in the quarter across our focused areas of improvement, I'm confident that MSC is headed in the right direction to enhance our long-term profitable growth algorithm and create meaningful value for shareholders.

And with that, I will now turn the call over to Greg to cover our financial results in greater detail and expectations for the fiscal fourth quarter.

Thank you, Martina, and good morning, everyone. Please turn to Slide 6, where you will find key metrics for the fiscal third quarter on both a reported and adjusted basis. Fiscal third quarter sales of $1.047 billion came in above our expectations for the quarter and improved 7.8% year-over-year. Price was the primary driver of the improvement and contributed 720 basis points to growth followed by volumes that contributed another 50 basis points. Sequentially, average daily sales outperformed historical averages and improved 12.3% compared to the fiscal second quarter. Looking at our sales performance by customer type, we see some signs of encouragement. Core customer daily sales continued the trend of outperforming total company with year-over-year improvement of approximately 8% in the quarter.

National accounts, we were pleased by the improving trend and compared to the first half of the year with the growth in the third quarter of approximately 7% -- and lastly, in the public sector, daily sales improved roughly 8% and primarily driven by increased defense activity in the quarter and a lower comparison in the prior year. In solutions, we remain pleased by the continued expansion of our footprint in 3Q. In vending, the number of machines installed at quarter end increased 7% year-over-year to approximately 30,800 machines. The number of customers with an implant program improved 7% year-over-year to a total of 426 programs.

As you recall, at the start of the fiscal year, our implant program count growth began to moderate as we strengthened financial discipline in the field and sharpen the quality of our decision-making. This is prompting us to transition certain existing implant programs with suboptimal returns to more cost-effective service options that are better scaled to customer needs. As was the case in the first half of the fiscal year, signings in the third quarter were higher than the sequential increase in total program count. Looking at the sales through these solutions, -- average daily sales through ending were up 15% year-over-year and represented approximately 20% of total company net sales. Sales to customers with an implant program were up 16% year-over-year and represented approximately 21% of total company net sales. Moving to profitability for the quarter.

Gross margin of 41.1% came in slightly ahead of our expectations and improved 10 basis points year-over-year. Operating expenses in fiscal third quarter were approximately $324 million on a reported basis. On an adjusted basis, operating expenses of $319 million increased approximately $9 million year-over-year or $11 million quarter-over-quarter. However, we saw a sizable improvement in adjusted operating expenses as a percentage of sales with declines of 150 basis points year-over-year and 310 basis points quarter-over-quarter. This performance was better than expected as sales growth meaningfully outpaced expense growth driven by our productivity and headcount actions taken over the year.

Reported operating margin for the quarter was 10.2% compared to 8.5% in the prior year. On an adjusted basis, operating margin of 10.6% exceeded the high end of our outlook for the quarter and compared favorably to 9% in the prior year. We delivered GAAP EPS of $1.44 compared to $1.02 in the prior year. On an adjusted basis, we delivered EPS of $1.43 compared to $1.08 in the prior year, an improvement of 32%. Turning to Slide 7 to review our balance sheet and free cash flow performance. We continue to maintain a healthy balance sheet with net debt of approximately $433 million, representing roughly 1x EBITDA.

Capital expenditures of $21 million were down slightly year-over-year, and we achieved free cash flow conversion above 100% despite the step-up in AR related to the increase in sales. This is resulting in free cash flow conversion of 94% fiscal year-to-date, keeping us on track to achieve our updated target of 95% for the fiscal year.

Looking at our capital allocation strategy on Slide 8. Our highest priorities remain organic investment to fuel growth and advance operational efficiencies across the business. Returning capital to shareholders also remains a priority with approximately $49 million returned to shareholders in fiscal 3Q and $160 million fiscal year-to-date in the form of dividends and share repurchases.

Moving to our expectations for the fourth quarter on Slide 9. To reflect quarter-to-date trends, including daily sales in fiscal June that are expected to grow approximately 7% and more difficult comparisons with prior year this quarter, we are anticipating average daily sales improvement of 6.5% to 8.5% compared to the prior year, gross margins to follow the historical 3Q to 4Q sequential decline of 40 to 50 basis points and the continuation of profitable growth demonstrated by the midpoint of our adjusted operating margin range of 10% to 10.8%, implying adjusted incremental operating margins in the mid-20s. As we approach the end of the fiscal year, we have updated our expectations for some line items that can be found at the bottom of the slide. We now expect depreciation and amortization expense to be approximately $100 million for the fiscal year versus our prior expectation of $90 million to $100 million. We're also reducing our CapEx assumption from $100 million to $110 million to approximately $100 million.

This is resulting in our expectations for free cash flow conversion to increase from 90% to approximately 95% for the fiscal year. Our expectations on the other line items for the fiscal year remain unchanged and include interest and other expenses of approximately $30 million, including the $5 million employee retention credit benefit we recognized in Q3, which is excluded for adjusted EPS and a tax rate between 24.5% to 25.5%. And with that, we will open the line for Q&A.

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

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

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

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

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

Maybe any kind of additional commentary there to make that would be very helpful.

Absolutely. We're exactly where we thought we would be. So you want to think about this in 2 phases. So first, thinking about the structure and the analogy that I use with the team is you want to get wet if it rains. So you want to be in the right place at the right time with the right opportunities, with the right programs and put it into our context, able to take advantage of the tailwind that we're seeing in some of the industrial trends, and that's happening.

So proof points, you look at the volume through our vending units, we've got vending and implant up mid-teens ADS in the quarter. We've got vending per unit up high single digits, which is clearly a volume driver. That's that coiled spring we've been waiting for. So the structure piece is behind us, and we're happy with our segmentation and our coverage. Now the next piece, which is really more exciting is you want to make it rain as well. And that's what we're talking about around the sales excellence side of things.

So we've compressed our time to hire. We have filled the vacancy. We're onboarding and training people differently. We've got new sales management processes. So now you start to drive growth and volume through your day-to-day activity and your day-to-day sales management. So we're exactly where we thought we'd be. This is a long game that we're playing, and you'll start to see it as the volume improves in the next quarter and beyond.

To this point.

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

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

Yes. Ken, thank you for the question because that -- I think it is important that we're all on the same page. So let's take one step back and say, where did this benchmark come from? We committed -- we're committed to that mid-teens operating margin or beyond in terms of a turnaround for the company. And we needed an internal benchmark. We needed something to anchor ourselves against and to shoot for. And so we did all of this benchmarking to say, today, to deliver $4 billion in sales, it takes us 1,000 more people than it would take one of our public peers. And that's the measure of efficiency then that we're looking at internally.

So if you quickly do the math, you're talking about 570,000 ish per head, that's what we generate today. We want that number to be $100,000 more, right? That's what the 1,000 heads turns into. So then the team takes that target and says either, a, I need to be able to grow without adding heads or I need to take heads out to make my process more efficient. And it's a combination of both because we want to improve associate experience and take manual work out and build up the foundation that can absorb growth without needing new headcount. And in doing so, we want to improve customer experience.

So there's a whole set of interconnected factors that we're looking at. So we have a road map today. I mean, if you think about it, we're almost at the end of our fiscal year. So we've already mapped out the target for 27 that gets us closer to that benchmark, but that's the number that we want you to be tracking. So you can look at absolute headcount progress if you look at total head less the sales headcount, but it's really that ratio, I think that's the more important measure of progress. And the other thing I'll say is based on the road map, we're not going to share a lot of details upfront for competitive reasons and honestly, to support the strong momentum and morale that is within the company around this benchmark. But as we log the wins, we will share them. But you'll see them in those 2 numbers. And it's not going to be linear.

This quarter, for example, we didn't see a lot of movement. Some projects are small, some are much bigger, some are short term, some take a little longer, but those are the 2 places you should look.

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

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

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

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

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

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

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

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

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

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

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

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

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

Okay. So I'll try to unpack that. There's a couple of pieces in there. I'll let Greg give you the breakdown on the SG&A. The one thing I'm most happy about is that what we try to achieve with our variable compensation redesign is being felt. One of the issues that MSC struggled with in the past is that we didn't have a responsive commission program. So our sales might be down, but we wouldn't see them the benefit in our SG&A. So the new comp design, this is the first quarter that we see it fully working the way it should. Very happy about that. Maybe I'll first pass it to Greg. Do you want to break down the rest of SG&A?

Yes. So I'll give you a little bit of color on the OpEx we saw in 3Q. And I just want to first say, I'm encouraged to see the evidence that we're making progress on our cost structure as seen by the 150 basis point decline in our operating expenses as a percentage of sales. And really that's helped to contribute to or significantly contributed to the improvement of 160 basis points in the adjusted operating margin year-over-year and 32% incremental margin that we're seeing. I can talk a little bit about some of the expenses year-over-year here. I see a little more color. We saw a step-up of $9 million year-over-year in our operating expenses, and it was driven primarily by increases related to personnel-related expenses. We continue to see investments in implants and advertising to both support and drive volume growth. We saw a little incremental D&A pickup.

And then lastly, there was an unexpected during the quarter, we saw a year-over-year step-up of a few million dollars in bad debt expense that was driven by a couple of customers that were isolated and not reflective of the current environment. And then from a standpoint, it partially offset by our productivity from our headcount. We did see some lower freight driven by the combination of our network initiatives during the quarter as well as we did see last year, we had some higher outbound freight that was related to some public sector work that didn't repeat in the period. And we are also seeing some early benefits from our sales force optimization work that eliminated the duplicative commissions being paid on the same revenues and resulted in lower commissions expense year-over-year despite higher sales volumes. And since you asked a little bit about SG&A, I can tell you that from a payroll and payroll-related costs as a percentage of sales, it's an improvement year-over-year for the quarter, about 250 basis points. They went to 53.7% versus 56.1% in the prior year.

I'd like to turn it back to you.

Yes. So maybe I'll take it back just since volume is on everybody's mind, ours included, right? That's one of our major metrics that we're measuring inside the business. So Ryan said it earlier, but just to recap. So volumes returned to growth across all customer types in April and May, and now we see it again in June.

Just backing us up, we were flat on volumes in the first quarter. We dug ourselves a hole to about negative 4% in the second quarter. We know what happened there with the sales redesign. We're back to just above flat. So we're positive in all customer types now for the third quarter, and we expect that to continue to grow. We have very weak volume comps coming up. So you will start -- as we start lapping price, we're very confident that we'll start to see that impact in volume. And then initiatives are starting to take hold.

So one thing we didn't talk about today in the prepared remarks was the Growth Form pipeline. We have a pipeline of $500 million in opportunities. We converted about 10% of that on an annualized basis. The type of pipeline management that we're doing, the very consequent sales coaching and sales management will continue to drive volumes. So we're optimistic. You were asking me into '27. I think we've got a good solutions footprint across the industry. And now we're starting to see that ADS was up mid-teens for vending and implant this quarter and high single digits through machines. We have to optimize the volume through machines. And I think the industrial recovery is the wind in those sales. Then like I said, sales excellence continues to develop.

So I think a combination of those things, you'll see our volumes now start to accelerate.

We're out of the hole that we dug.

.

Your next question is coming from Tommy Moll with Stephens Inc.

Martina, all the commentary around demand and volumes returning to growth sounds pretty positive. But I do want to perhaps put a finer point on the guide for fourth quarter, where I believe your midpoint implies again in July and/or August, another trend above your typical month-over-month progression. June is a pretty high bar. You outperformed significantly there. So I'm just curious what gives you the confidence to make that assumption.

Yes. Thanks for the question, Tommy. We just feel confident in what we're seeing. Yes, whether it's in the macro or pipeline, we're continuing to see benefits from our sales force work grow. As Martina mentioned, our sales excellence program is starting to take hold in early innings there. But I just feel like we're on good footing and feel confident that, that trend will continue. There might be a little bit more price in the quarter, depending on what we see from our suppliers. But as we sit here today, don't feel like we really got ahead of our teas here.

Yes. I think, It's hard to describe. I think you've heard me say sales as a science. It's hard to describe the difference that selling for MSC today represents compared to selling for MSC a year ago, we're still a short-cycle business. we will still have limited insight into what's coming. But the pipeline management the white space steering, things like conversion on the Growth Forum pipeline, those are becoming very real and starting to have teeth in our planning. And I think also the change in the onboarding, we put about 120 sellers through a new program to get them to money faster. We're measuring that time. we're intervening when that time is stretching out. So it's -- these are just muscles that we're building and I don't have the proof points for you that will have 6 months from now, but I'm very, very confident in the infrastructure and the ecosystem.

And Tommy, just to dive a little deeper in your July, August comment. If you look at July and August ADS combined versus June, Historically, we're up around 50 basis points. The midpoint of our outlook implies a little more than 1%. So we're not applying a lot of more volume improvement. So just to help level set you there.

Yes. As a follow-up, I wanted to circle back to the discussion on incremental margins. Martina, you've addressed multiple times today, the benefits in terms of incrementals from the prior restructuring actions. You've talked about the internal benchmark to continue to improve employee productivity. So there's a lot of tailwinds here as we think about incrementals looking ahead. If you roll it all together, is mid-20s a fair base case for fiscal 2027?

For fiscal '27. I think we want to -- we have not updated the algorithm that Ryan mentioned. So mid-single, 20% higher than that, that we do the math. There probably will be a moment that we could sharpen that algorithm and give you maybe a more aggressive direction. I think we have a plan, but -- for now, this is where we are, if that makes sense. I think in terms of the 4Q outlook, where gross margin is entirely based on our historical performance.

Our mix typically changes. We're starting to lap some price actions. There could be some upside there. And as Ryan said, we've got some onetime things we're comping in the fourth quarter in terms of some personnel actions and that kind of thing. Otherwise, I think that incremental would be stronger for the fourth quarter.

And Tommy, I just want to say one more thing. I think it's clear that we're fundamentally doing more with less. We're beginning to grow volumes. And if you look at our headcount, full-time head count is down 360 year-over-year and billed sales is down 225. So I think that's the one thing we're most encouraged about.

Your next question is coming from Steve Volkmann with Jefferies.

Most of mine have been answered, but maybe a couple of longer-term ones. Martina, I wanted to just kind of come back to the sort of 1,000 heads relative to volume. Is that still the right number? Because I know you also said you were down to '25 on sales heads in the field. Is -- are we starting now from 1,000 or are we already below that?

No, the clock resets. So take the starting point at the beginning of the -- let's say, the beginning of the third quarter even. But those had the sales actions and the previous actions that we've taken that's not in the benchmark.

So the benchmark that I gave you that about that 40% to 41% range kind of as a steady level and anything that we achieve because of our own efficiencies or because of our pricing as we professionalize our pricing process, we'd like to take those proceeds and actually turn them into price for our customers so that we can continue to grow volume. So there's a competitiveness opportunity that we see there as we continue to improve our gross margin.

Your next question is coming from David Manthey with Baird.

I'd like to discuss the 6.8% growth in manufacturing specifically. So, I assume that pricing in manufacturing because of the impact of tungsten is greater than the company average, 7.2%. So Martina, I'm wondering, as you look at -- you mentioned MDI and of course, ISM has been above 50 for 5 months now. I know there's a lot of change happening in MSC, but are you disappointed you haven't seen a resurgence in manufacturing volume growth at this point in the cycle? Or is it just your expectation we'll see that next quarter and beyond?

Dave, thanks for the question. I'll give a little color on there and pass it over to Martina One of the things that's driving that is -- if you think about our smallest a small core customers or uncovered core customers that transact on the web. Web average daily sales were up double digits. Those are characterized in the other bucket and that falls into nonmanufacturing. So on a mix basis, it's showing 6.8%, but in all other purposes. I would say that, that number is a little depressed just because of the way we characterize the smallest and small core customers. And then Martina, I don't know if there's anything you want to add.

Yes. I think -- I mean, are we blowing it out of the water on volume yet, Dave, we're not, right? We're -- we -- like I said, we've completed our Phase 1 of our restructuring. And now what we expect to see is the volume growth. I think there's volume kind of underlying everything that we're doing is because we're covering new customers now with the new segmentation and obviously, everything that they're -- that's implying volume, even though we don't reflect it that way yet.

So I think, yes, we -- there is a tailwind. We will benefit from it. And as Ryan said, it's not so clear cut, how the different industry markers spread across our different customer types. But -- what I see when I see vending up high teens, that's coming from manufacturing growth. And so we see it across different customer segments.

Okay. And given the price read-through we had this quarter, if you strip that out, by my math, it seemed like contribution margin ex price would have been negative. And I understand you're looking at flattish volumes here, but guiding fourth quarter lower, are there other lingering cost factors that we should consider fourth quarter and beyond before we get to sort of operational contribution margins that are in that 20% range? Because clearly, you're sort of implying there's a handoff and I think the math would imply that, that there's sort of a price to volume handoff that's upcoming. And I just wonder what your confidence level is there.

Yes, Dave, I'll chime in and then pass it over to Martina. What I would say is Yes, everybody has our own assumptions on how we would lever on volumes. But if you look at 2Q, we had a 25% incremental margin, low 30s here in 3Q and then 4Q implying 23%-ish at the midpoint. As we mentioned earlier, a portion of that is driven due to just the timing of some of our head count actions in the prior year and some moving pieces on a year-over-year basis, for instance freight was a good guy in 3Q. It will be a bad guy in 2Q. The other things to consider is D&A will step up a little bit year-over-year. So there's just a couple of moving pieces. But as Martina mentioned our long-term growth algorithm, mid-single digits, at least 20% incremental margins remain intact, and then Martin, I don't know if there's anything else.

Yes. I mean we've been here before, Dave, let me get a little candid for a second, right? So when we were in the post-COVID period and there was a lot of price inflation, -- we had really attractive and interesting numbers that weren't sustained by let's say, operational change. That's not where we are right now. So that -- those freight savings are absolutely real. We're taking the same fuel increases as everyone else, but we've optimized the network and we're paying less. We're down 360 head count and still absorbing the volume that we need. We are finding productivity in a lot of small process. It's going to drive the ability to head towards that 1,000 heads benchmark. So we're let's say that all cylinders are not firing yet, but there's progress everywhere, and I think that momentum is real.

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

Thank you, everyone, for joining today's call. Our fiscal fourth quarter earnings call will be on October 22.

Thank you, everyone. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.

Greetings. Welcome to the MSC Reports Fiscal 2026 Second Quarter Results. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Ryan Mills, VP of Investor Relations and Business Development.

Thank you, and good morning, everyone. Welcome to our fiscal 2026 second quarter earnings call. Martina McIsaac, President and Chief Executive Officer; and Greg Clark, Interim Chief Financial Officer, are on the call with me today. During today's call, we will refer to various financial data in the earnings presentation and operational statistics document both of which can be found on our Investor Relations website.

Let me reference our safe harbor statement found on Slide 2 of the earnings presentation. Our comments on this call as well as the supplemental information we are providing on the website contain forward-looking statements within the meaning of the U.S. securities laws. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks are noted in our earnings press release and our other SEC filings. Lastly, during this call, we may refer to certain adjusted financial results, which are non-GAAP measures. Please refer to the GAAP versus non-GAAP reconciliations on our presentation or on our website, which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures.

I'll now turn the call over to Martina.

Thank you, Ryan, and good morning, everyone. On today's call, I will briefly cover our performance in the fiscal second quarter, then share my thoughts on the progress of our initiatives and the current state of underlying industrial demand. I will then turn the call over to Greg to provide greater detail on our quarterly performance and outlook for the fiscal third quarter.

Starting with our performance in fiscal 2Q. ADS growth of 2.9% fell short of 4.5% growth at the midpoint of our outlook. While we did experience modest headwinds from weather and the partial government shutdown, the change in our service organization, which represents the last structural phase of our sales optimization work, created some noise in the quarter that's worth digging into. As we previously shared, at the end of 1Q and early 2Q, we completed the last round of structural changes and accompanying head count reductions related to our sales optimization work.

To recap, in fiscal year '25, we took actions designed to bring head count levels more in line with an efficient territory design. Those actions primarily impacted our core sellers. Then in December, as we shared, we had a final round of changes, which involve all of our remaining customer-facing roles. Prior to this change, for legacy reasons, it was possible that an MSC customer was serviced by 2, 3, 4 or even 5 MSC representatives. Creating overlap of multiple sales and service activities and resulting in multiple MSC reps supporting the same revenues. These inefficiencies caused our cost to serve to become inflated over time, particularly within national account customers where customer needs are the greatest.

In the action taken at the beginning of our fiscal 2Q this resource model was greatly simplified to create a geographically aligned service organization that matches our sales structure and is appropriately sized to customer potential. Total impacted customer-facing head count was approximately 130 associates. This consolidation was complex and could not be achieved without some level of relationship change in the field. We anticipated this and intentionally calendarized this change in fiscal 2Q when demand is seasonally low. Impact varied by customer but was most felt in our national accounts and larger core customers who have the largest service teams. Those customers saw some level of face change as the responsibilities were handed off through the consolidation of the team that supports them.

The new structure now clarifies responsibilities and will result in greater ownership and accountability in our teams, driving focus across all of MSC's product offerings. It's important to note that these changes did not impact the momentum of our vending and implant programs as reflected in our offset for the quarter. Now under [indiscernible] leadership, we are accompanying these organizational enhancements with its strong sales management process and improved pipeline management. While these actions weighed on our results in the quarter, this change was necessary. We are enhancing MSC's ability to produce sustained levels of profitable growth for the future by taking measured steps to optimize our cost structure and improve our effectiveness in the field.

We have greatly simplified and aligned our sales and service organizations. And though it takes time for a change like this to take hold, month to date in March, we are seeing the year-over-year trend in the sales to impacted customers continued to improve compared to levels in January and February as new relationships are developed. Following these changes, growth acceleration is our primary objective. Supporting my confidence is the momentum I see building across the organization from our supplier growth forum. By intentionally bringing more than 1,000 MSC associates and 400 suppliers together, we strengthened relationships, aligned priorities, set the foundation for meaningful long-term growth and created a defining moment for our company.

We facilitated over 3,000 prescheduled meetings to discuss white space overlap and joint growth opportunities that we identified using AI, and I couldn't be more pleased with the outcome. In just 3 days, these strategic conversations translated into nearly 10,000 opportunities totaling close to $500 million in combined near-term and long-term potential, creating tremendous energy, both internally and externally, as shown in the quote from a supplier on Slide 4. Strong execution, like that's seen in the growth forum can be seen across MSC. A good example is the year-over-year margin expansion that our team achieved in the quarter.

Gross margin of 41.1% performed better than expected and improved 10 basis points year-over-year. This improvement is the result of price actions taken in fiscal 1Q and 2Q in response to inflation as well as the continued professionalization of our pricing processes and margin management. The combined impact of these activities resulted in price contributing approximately 6.5% to our daily sales performance in the quarter. In addition to gross margin, I'm encouraged by how the team managed operating expenses more closely to sales during the quarter.

Adjusted operating expenses improved 20 basis points compared to the prior year as a percentage of sales. This was primarily driven by the combined benefits of our head count reductions and the productivity actions associated with our network optimization strategy, which is beginning to show through in our financial performance, as you can see on Slide 5. Our planning and procurement team, led by [ Kathy Mack ] has been focused on improving our planning processes, embracing AI and embedding it into our daily work to produce the improved inventory metrics shown on this slide.

Our operations teams led by [ Derek Collier ] continue to optimize within the 4 walls of our distribution centers as seen by the favorable trends in their head count and compensation expenses. Both cases are perfect examples of the results, a data-driven focus on continuous improvement could have, and I'm looking forward to the greater impact it will have on MSC as this mentality takes shape across the company. Progress made in both these areas of the P&L resulted in adjusted operating margin of 7.5%, a 40 basis point year-over-year improvement and within the range of our outlook. Together, this allowed us to achieve 2Q adjusted incremental margins of 21% towards the upper end of our expectations.

Switching to the macro environment, I would describe the current state as a tale of 2 realities. On one hand, signs of a potential industrial recovery are encouraging. As you can see on Slide 6, the IP readings across most of our top manufacturing end markets are beginning to form more favorable trends. Customer sentiment has been improving also as seen by recent MBI readings, which have produced consecutive monthly readings above 50 for the first time in a multiyear period. However, on the other hand, geopolitical tensions, the war with Iran and rising fuel costs present heightened uncertainty. While we haven't seen any meaningful disruption yet, we are in constant communication with customers and are taking proactive steps to secure supply.

Looking at our performance against the IP index, our average daily sales has outperformed for the third consecutive quarter. That said, outgrowth remains below our stated goal of 400 basis points and has been primarily supported by price. I am encouraged, however, by our volume performance in February that began showing modest year-over-year improvement in core customer daily sales. The changes to our sales structure were the right ones and were necessary to set MSC up to achieve higher levels of growth. We see encouraging signs of improvement and this momentum is captured in our outlook for the fiscal third quarter as seen by the accelerated growth that is implied in April and May. We are making progress on our strategic initiatives. We are operating with greater focus and discipline, and we have a leadership team committed to building a stronger business.

Looking ahead, this gives me confidence in MSC's ability to execute and create long-term value for shareholders. And with that, I will now turn the call over to Greg to cover our financial results in greater detail and expectations for the fiscal third quarter.

Thank you, Martina, and good morning, everyone. Please turn to Slide 7, where you'll find key metrics for the fiscal second quarter on both a reported and adjusted basis. Fiscal second quarter sales of $918 million improved 2.9% year-over-year, primarily driven by benefits from price of 6.6%. Volumes in the quarter declined 4% year-over-year and included a combined headwind of approximately 100 basis points related to the weather and the partial government shutdown. Sequentially, average daily sales declined 6.5%. By customer type, we remain encouraged by core customer daily sales that continue to grow above total company and improved approximately 6% this quarter compared to the prior year. National account daily sales were essentially flat compared to the prior year. In the public sector, daily sales declined roughly 1% due to tougher comps and impacts felt later in the quarter from the partial federal government shutdown.

In solutions, we were pleased by the continued expansion of our footprint in 2Q. In vending the number of machines installed at quarter end increased 8% year-over-year to approximately 30,400 machines. The number of customers with an implant program improved 9% year-over-year to a total of 423 programs. As you recall, last quarter, our implant program count growth moderated as we strengthened financial discipline in the field and sharpen the quality of our decision-making. This is prompting us to transition certain existing implant programs with suboptimal returns to more cost-effective service options that are better scaled to customer needs. As a result, signings in the second quarter were higher than the sequential increase in total program count. Looking at the sales through these solutions, average daily sales through vending were up 8% year-over-year and represented 20% of total company net sales. Sales to customers with an implant program were also up 8% year-over-year and represented approximately 20% of total company net sales.

Moving to profitability for the quarter. We were pleased with gross margins of 41.1% that improved 10 basis points year-over-year or roughly 40 basis points sequentially. This gross margin performance was better than expected and primarily driven by favorable price cost as a result of our pricing actions and the continued professionalization of our pricing processes. Operating expenses in the fiscal second quarter were approximately $310 million on a reported basis.

On an adjusted basis, operating expenses were $308.5 million down approximately $3 million versus the prior quarter but up approximately $7 million year-over-year as ongoing productivity improvements and head count actions were more than offset by the combination of personnel-related cost increases, investments and higher depreciation. When combined with higher sales year-over-year, this resulted in year-over-year improvement of 20 basis points in adjusted operating expenses as a percentage of sales for the quarter. Reported operating margin for the quarter was 7.1% and compared to 7% in the prior year. On an adjusted basis, operating margin of 7.5% was within our outlook range of 7.3% to 7.9%. and compared favorably to 7.1% in the prior year. We delivered GAAP EPS of $0.76 compared to $0.70 in the prior year. On an adjusted basis, we delivered EPS of $0.82 compared to $0.72 in the prior year, an improvement of 14%.

Turning to Slide 8 to review our balance sheet and free cash flow performance. We continue to maintain a healthy balance sheet with net debt of approximately $466 million, representing roughly 1.2x EBITDA. As a reminder, during the quarter, we amended our AR securitization facility and increased its capacity by $50 million. Excluding this $50 million reduction in AR, working capital was a use of cash in the quarter with the proactive build of inventory being the primary driver. Together, this resulted in operating cash flow conversion of 224% for the quarter. Capital expenditures of roughly $21 million were down approximately $9 million year-over-year and similar to levels last quarter as expected. This resulted in free cash flow conversion of approximately 173% in the fiscal second quarter and 86% fiscal year-to-date, keeping us on track to achieve our target of approximately 90% for the full year.

Looking at our capital allocation strategy on Slide 9. Our highest priorities remain organic investment to fuel growth and advancing operational efficiencies across the business. Returning capital to shareholders also remains a priority with approximately $49 million returned to shareholders in fiscal 2Q and $110 million fiscal year-to-date in the form of dividends and share repurchases.

Moving to our expectations for the third quarter on Slide 10. We expect average daily sales to grow 5% to 7% compared to the prior year. The range of our outlook takes into consideration our daily sales estimate for fiscal March of approximately 4% when including the anticipated headwind of 100 basis points from the timing of Good Friday. Under this revenue assumption, we expect our adjusted operating margin for the fiscal third quarter to be between 9.7% and 10.3%. Driving this expected range are the following assumptions for the quarter. Gross margin of approximately 41% and the sequential step-up in the adjusted operating expenses primarily driven by higher variable expense associated with the expected increases in sales. Together, these assumptions resulted in an implied adjusted incremental margin of approximately 25% at the midpoint of our outlook. Keeping us on track to achieve our expectation of roughly 20% adjusted incremental margins for the full year and a mid-single-digit growth outcome.

Turning to Slide 11. Our expectations on certain line items for the full year remain unchanged. As a reminder, this includes depreciation and amortization expense of $95 million to $100 million, interest and other expense of roughly $35 million; capital expenditures, including cloud computing arrangements of $100 million to $110 million; a tax rate between 24.5% and 25.5%; and lastly, free cash flow generation of approximately 90% 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 key considerations.

And with that, we will open the line for Q&A.

[Operator Instructions] Your first question for today is from Ryan Merkel with William Blair.

I wanted to start with the sales trends. Can you just talk about why you're confident that average daily sales is going to accelerate to 7% plus in April and May? And in your answer, can you talk about is price going to build more? And then what are you assuming for the national account recovery because I think it was sort of flat in the quarter.

Ryan, yes, let me start by digging in a little bit to the second quarter impact, which is then driving our confidence in the third quarter. So in the second quarter, as we tried to explain on the call, we made changes across our indirect -- basically our indirect sales force. And many of our customers had safe changes, which led to some volume contraction. So let me explain what was happening in that time. You're talking about the people that have to be on the plant floor every day, understanding the customers' business, capturing all of the unplanned demand of the account, managing our BMI programs. So it takes a little while for somebody new to come up to speed to understand those responsibilities to rebuild their network. So we had guided softer in the second quarter because we knew there would be a disruption in volume.

And as we started to make the change, we saw 2 effects. We planned a very detailed warm handoff and transition of our -- from one team member to another. So if you can imagine what was happening, you might have been taking on more responsibilities in your current customers or you might have been moving to take on responsibilities in a new portfolio of customers or you might have been moving to an uncovered customer. So there's a lot to learn in that process and we had planned an overlap of resources so that the incumbent associates could work with the new associate over a period of time.

And what happened to us in the second quarter, which caused us to have a softer result than we had anticipated, is that the weather shut a lot of our customers down in that overlap period. So if your role is to get into a new facility, learn it, understand it, make new contacts take over that business, and you can't get there because the facility is buried in snow or you can't get out of your driveway, then essentially what happened is it pushed the, let's call it, recovery for lack of a better word, it pushed it out in the calendar farther than we anticipated. So we're seeing in March, what we had hoped to see in February and so on. So we lost some time -- we had an impact to volumes due to timing.

The other thing that happened in the quarter is, as we made these changes, hunting and complacency is no longer part of our compensation plan. We changed -- we're raising the bar on expectations. We changed compensation. We changed responsibilities. We're raising standards. And we had a higher percentage of attrition than we expected to have. So a lot of you have asked me about, do I expect attrition as we sort of drive a performance culture in MSC. And we do and we did expect to see attrition as a result of this change. But again, we had calendarized it a little more gently. Like we expected that it would happen later in the cycle, and we have quite a lot of attrition immediately. So then we had customers that were uncovered for a period of time, and so we were missing some of that unplanned demand.

So if you look at our offsets, you'll see that despite the fact that this plan intended a reduction in sales head count of 130. I think we're down 158 heads quarter-over-quarter. You see the residual impact as we've been filling those roles. So all that to say, we're starting now to see the volume recovery that we expected, and that's what's giving us confidence in April and May were just pushed out from where we had intended to be because of those 2 impacts. So as you look at March, I can use March as an example, we were looking for 2 volume effects as we went through this change.

The first one was we wanted to see a greater integration of all the parts of our business. So for example, we are -- we consolidated legacy sales forces from 10 year-old acquisitions, we brought our OEM fastener business now into the main responsibility of our core field sales and field service teams, and we wanted to see acceleration in those businesses, and we are seeing it. So for example, OEM, our OEM business is growing mid-teens in February, even higher in March. So we're having the behavior change that we wanted to see, which makes us confident in volume. And then we just -- we wanted to see that hunting mentality start to show up, which we are also seeing across the board. So we're seeing month-over-month improvement, as I said in the prepared remarks, on customers that were impacted. Our core customer exited 2Q with positive volume, national accounts was up low single digits in February and now mid-single digits month-to-date in March.

So the biggest -- if you wanted to size the impact of volume or this change on volume in the second quarter, I'll walk you from our outlook. At the midpoint of our outlook was 4.5%, we had anticipated a bigger negative impact for our growth form, which we really didn't see and we got a little more price than we thought. So add 100 basis points to that, that puts us at 5. 5 then take another 100 basis points off for the impact of weather in the public sector and you're looking at a gap of about 150 basis points. So we saw -- we had what we believe was an outsized impact on volume, which is transitional, which is behind us, about 2/3 of that impacted national accounts. So that gives you kind of a feeling of why we feel national accounts will recover and the value we can count on the outlook for March and April.

Got it. All right. That's actually very helpful. And good to hear the national accounts is recovering. Just a follow-up on price then. Are you expecting more price increases from your suppliers? And maybe talk about tungsten because it sounds like there might be another price increase there.

Yes. So when we talked -- since we talked to you in January about tungsten, we've taken about -- we've seen price increase notices that range from between 7% to 15%, so the prices continue to climb. Even the market for scrap carbide has gone up 500% since we talked to you last. So there's -- we're definitely seeing pressure. Those price increases probably will become effective sort of May, June. So we will likely have another pricing action around that time. We're -- we don't know where this will end. I still would say what I said in January. I don't think the suppliers have captured all of it. We're starting to see a little bit of supply constraint now.

And Ryan, this is Ryan. Just come over the top. We took a little surgical price increase in March, less than 1% but as you think about 3Q year-over-year, the price benefit should be pretty similar to what we saw in 2Q, just to give you a little color on that.

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

So maybe to follow up on the pricing question. It sounds like you feel pretty confident in improving volume trends here in March to date. But just given all the uncertainty in the macro, I'm curious if there's a way for you to decipher if the customer conversations have suggested that there's been a negative impact on the uncertainty? And is there a risk that starts to get pushed out to the right?

We are, as I said, in deep conversations with customers. So we're at the phase where they're starting to assess potential risks and they want to understand supply, security of supply, but we haven't seen any change that would suggest that the demand is slowing down. It's the opposite. They see demand picking up and they want to make sure that their supply is secure. That's what we've seen so far.

Understood. And then maybe for the follow-up. I understand that the tungsten oriented inventory is only about 15% of the portfolio. But maybe could you just give us a little bit of color on, one, how much of that is going through the core customer versus national accounts as we think about that price mix dynamic? And then secondly, what is -- can you remind us just how do you source that tungsten? Is there -- I'm guessing it's index based, but is there an inherent lag relative to how that price is versus the spot?

So we don't source tungsten, right? We resource carbide cutting tools. So what you're seeing -- I mean, some of our suppliers do have some level of backward integration to tungsten. But what we're tracking, obviously, is we're tracking the price of tungsten as an input to carbide cutting tools, but we're monitoring the supply for that. I'm not sure if I understood the question, Ken.

Yes. I guess the ultimate question I'm trying to get a sense of is what is -- maybe deciphering how much of the pricing is coming from tungsten-oriented inventory versus the broader portfolio?

Yes, Ken, I'll give you a little color on that. The price increase we took in mid-January, we said low single-digit range. A good portion of that was on the cutting tool side. And as you heard Martina in the last question from Ryan, we anticipate some further pricing moves in the May to June time frame. I would say it would be a similar -- it'd be a good portion on the cutting tool side.

We have started to get notices from other suppliers as the conflict continues, so anything that has -- I mean you can imagine the portfolio that might be impacted, there's fuel surcharges and discussions. So it's not only going to be carbide, I think, that we'll see going forward. But that -- up until this point, that's been the big mover.

Your next question for today is from Tommy Moll with Stephens.

Martina, I want to make sure I heard you correctly, December was the last planned round of significant head count actions. And assuming the answer there is yes, that I heard you correctly, what's your confidence level in the disruption from all the sales organization changes fading as quickly as it sounds like you're assuming. I mean, noted that the most recent quarter, perhaps the headwinds were a little bit worse than expected, but that you've seen some more recent signs that are really encouraging. These progressions tend to not be linear. And so I'm just curious what your conviction level is that it's all clear from here or all better from here.

I appreciate the question, and I appreciate the comment that this is disruptive. We believe that it was 100% necessary. So we have to bring it to balance indirect resources versus direct resources. We had to change the sales culture back to a hunting culture and enable people to do that. So there are a lot of positives going on right now in our sales force. New tools, new support like the growth forum, new compensation plan, which is very lucrative to the hunting behavior that we want.

And it's -- I'm not going to share too many details for competitive reasons. But when you look inside the portfolio, and you take out maybe the customers who had a later introduction to the changes because of the attrition that we mentioned. We're seeing growth rates that are very exciting. And so I do believe we'll still have attrition. Selling right now in MSC doesn't feel like it did 6 months ago, and it doesn't feel like it's going to 6 months from now. But we're building an engine that will deliver sustainable organic growth for the long term, and I feel very confident that we're on the right track.

And Tom, maybe I'll give a little bit more detail on February and March. February, that growth rate is a little masked by public sector was down mid- to high teens. Reason being is the partial government shutdown delayed funding, and we had a tough comp there. As you heard Martina say, in February, core was up mid- to high single digits. National Accounts was up low single digits. And then as we look at March month-to-date before we go against that Good Friday headwind. The core is growing at a similar rate and national accounts is up a little bit more than low single digits. So we're starting to see that improvement now that Martina is alluding to.

So pivoting to a broader demand discussion. To the extent you can exclude all the factors the MSC specific factors that you've already identified that impacted recent results. Is it possible to just benchmark the tone of some of the end market dynamics or customer conversations? I don't know, year-to-date, quarter-over-quarter, however you want to slice it feel like things have gotten a little better or stay the same?

Yes. Thanks for the question. I mean we do. That's why we said it's a little bit of a mixed picture right now. But we're looking for improvement and recovery in fabricated metals and primary metals, and we are seeing it. And we are outgrowing IP in both of those end markets. That gives us confidence for the continued core customer recovery. And then even some of the other segments, I mean, let's leave aerospace to the site, but even some of the other segments where we're heavily indexed in national accounts, like ag and automotive. They're definitely not getting worse. We're seeing some beginning signs of life. Some of it may not impact us in our fiscal year because it will be -- they're sort of projecting changes and investments that will impact the back half of the calendar year, but we're definitely -- things are waking up and shaking up with some of our biggest national accounts.

Your next question is from Patrick Baumann with JPMorgan.

Just wanted to follow up on a couple of things. Just on the pricing comment. So I think I heard you say that there was a surgical increase in March in addition to what you did in January, and then there's more to come in May. But then I thought you said that the year-over-year price in the back half would be like similar to what it is in the second quarter which I guess makes some sense because of the year-over-year comps maybe. But maybe just clarify, I just want to make sure I heard that right. So maybe like 6.5% to 7% price in the back half is kind of what you're thinking at this stage? Or is that off?

Yes. I think, yes, we're going to start to comp some of the actions that we took last year when the tariffs first started to roll out and maybe for modeling purposes, Ryan, you can...

Yes, Patrick. Yes. So we start comping again some of our pricing actions here at 3Q depending on the timing of the late May or May, June price increase the comps get tougher in 4Q. So as you model the back half, I would -- you're exactly right. I just taking that 6.5% to 7% range on the pricing front.

And is there any impact from like the evolving tariff situation on that in terms of the changes that have been -- you have talked about with [ APA ] versus Section 122 or what have you?

No. That -- the math on that work out to be fairly stable for us right now. And remember, we're not the importer of record for 3/4 plus of what we bring in. So we haven't seen any meaningful movement on -- from our suppliers right now. So right now, sort of modeling stability.

Understood. And then a follow-up on the headcount. So like I know we talked about, I think, the field associates side, but if you look at total heads, they were down about 240 in the quarter sequentially which is more than -- I think we were expecting like 100 people, and you talked about some attrition in field associates as well. Just curious, as you look forward, like in the near to medium term, like do you see potential for cost cuts from like redundancies similar to what you found in the second quarter? Do you think that this will be an ongoing lever in terms of OpEx opportunity? Or are we kind of like -- I'm asking a context, you had a slide there for supply chain heads. I don't know what's in the other head count. So just trying to understand a little bit better, like how you think the total head count will evolve over the next, I don't know, 6 to 12 months or 24 months or however long you're willing to talk about it?

Yes. Thank you. So our ambition, Patrick, which we've stated publicly, we want to restore MSC to the mid-teens level of operating margin. And in order to do that, we have to accelerate organic sales growth, which is behind this first range of initiatives, and we've got to challenge all of our cost structures. And that includes some legacy structures like we collapsed in this last change of the sales force. And there are other places in the business where we will look to change the way that we perform work, and we'll look at automation and AI in the facilities and in the office.

And I do think you'll see us continue to try to challenge that cost structure for greater leverage as we continue to grow with mid-teens being kind of the target. So if you look, we brought the head count down by more than 400 heads in the last 12 months. The sales changes are done now, but we are making improvements in productivity within the CFCs, which is allowing us to bring head count down. We're deploying AI across the business, which is letting us not replace a treated head count for the moment. But yes, we're absolutely committed to challenging our cost structure.

Your next question for today is from Stephen Volkmann with Jefferies.

Just a couple of quick follow-ups for me. One, I'm trying to think about since this whole tungsten explosion has happened in terms of pricing, how much do you think pricing is up since, I don't know, 2 years ago or something? I'm trying to think about whether there is going to be some demand destruction because the stuff is getting really expensive or maybe some sort of different product, maybe substitution or something? Just anything in those lines we should be thinking about?

I mean, as the leading metalworking distributor, we are always working with customers to look at substitutions, to take cost out of their business. We took $500 million out of customers' operations last year. And if it were to become an extreme situation, we could always support. But it's not easy to change a cutting tool once a customer is working with certain technology and it depends on what you're doing and what you're cutting. So I think, obviously, there is a limit where anything would create demand destruction. But I think right now, we're supporting customers where they're asking for help, and we'll continue to do that.

On the 2-year stack, maybe Ryan, I don't know if I can throw that one over to you, do you have any additional comments?

No, I would just say for the cutting tool side, there might be an opportunity to switch to a high-speed steel cutting tool. I mean it varies by customer, whether it's a custom tool. That being said, I think it provides a good opportunity for us to leverage our technical expertise, an ability to drive savings in customers' facilities to offset that inflation. So we look at it as more as an opportunity and also Martina talked about us building our inventory, availability is #1 priority of our customers. So we're also taking advantage of that as well.

Okay. Great. And then I think last year, we were sort of comping against some destock, if I remember correctly. I assume that's kind of ended, but is there any sign of like a restock? Or is anybody trying to get ahead of some of these price increases with some inventory build? Just any commentary there, and I'll pass it on.

So it's interesting when you think about our business and you have 60% or say, the majority of our business is planned demand there's really no restocking happening there. That's more of a negotiation where we're taking the responsibility to keep the customers' stock. So they're not acting there. And the triggers we look for in terms of prebuy, exceptionally large orders, anything that would signal a change. We're really not seeing a lot of that. There's been some increased pull for certain products. Now that as the conflict is escalating. Obviously, you can imagine the end markets that might have a bit more demand right now. But in general, we haven't seen the big -- if we were expecting a big restock and return to inventories anticipating that -- customers were anticipating an increase in demand. We haven't seen that yet. So neither prebuy for price or restock.

Your next question is from Nigel Coe with Wolfe Research.

Obviously, we covered a lot of the topics here. On the field office headcount, so just to be clear, are we assuming that the head count from here is fairly stable in the back half of the year? Maybe could you just maybe quantify kind of the cost reduction and what that does SG&A in the back half of the year?

Yes. I'll throw the SG&A question to Greg. But the sales head count is not stable in the sense that we are going to fill those traded positions and then we expect to be adding direct sellers, Nigel. Like our goal was to bring into balance direct and indirect. When you have too many indirect sellers, you have too many people being paid on the same sales dollar. But as we see sales acceleration, we hope to be able to be adding sellers and covering more customers, which is something MSC has not done for a very long time. But in general, we're not projecting massive changes to the size of what we just cut.

But Greg, you want to share any additional color there?

Yes. I think what I can do is I can give you some color on just what happened in Q2 on the OpEx and then if there's anything more I want to talk Q3, Ryan can jump in. But just to give you some color on the OpEx on a year-over-year basis, we did see the OpEx stuff up about $7 million. This was driven by -- primarily by an increase in personnel-related costs of about $9 million. And of that merit and the fringe benefit inflation are the big drivers there, followed by stock compensation -- stock-based compensation, about $1 million. We had increase in depreciation and amortization as well of about $2 million related to our digital e-com spend, which is what we use for enhancements to the web. We also saw $2 million of additional outbound freight due to rate increases. And also just spend on the investments, which are geared towards solutions growth and other items such as the growth forum for about $1 million. And this is partially offset by the productivity that we've talked about, including the network optimization, benefits as well as some of the head count actions that we're taking.

Okay. That's great color. Maybe we'll dive into that as even deeper and off-line. I just want to another crack at the pricing question. First of all, the March price increase that you referred to, did that hit in March? Or was that effective in April? I know it's a small point, but fairly important. Because when we think about the sequentials, if we take March as a good run rate account for the good fit of timing. I think we're using -- if we use normal seasonality month-over-month, we're kind of getting to the high end of your range. So I'm just wondering the 5% to 7%, obviously, a lot better than what we saw in 2Q but does that assume that some of this volume attrition continues into the third quarter?

Yes. Nigel, this is Ryan. The March price increase, that was mid-March and keep in mind that we have to get a notice period to our contract customers. So I'd say it really didn't provide that much of a benefit in March as we look into April and May, the midpoint of our guidance assumes growth of about 7%. So that would imply a little bit of volume growth year-over-year and then low single digits, call it, 2%, 3% on the top end of the range. Feel good about where we're at right now, still had a little bit of some of this sales force optimization noise in March, but it's easing. That's giving us confidence. We talked about the growth rates we saw in March in core national accounts, that's improving. As Martina mentioned, the impact of customers we're improving both month-over-month and year-over-year modestly in March. This is all month-to-date, but feel good where we're at right now.

Your final question for today is from David Manthey with Baird.

First off, Martina, you mentioned that you expect volumes to improve through the year. As we look at the year-over-year trends, the comps are pretty easy. I think they're low single-digit negative in April and May. So effectively, this statement on the fiscal year is a bet on June, July and August. And I know we've asked you much a conviction in the outlook a number of times here. But given the fact that your customer event was in February, which is sort of ahead of the conflict, I think there was some optimism growing then. Have you gotten early reads from customer attitudes since the conflict began like in the last month, for example, that still gives you confidence in that growth through the end of the fiscal year?

Yes. I mean I think as I shared before, customers are mostly asking us right now to secure supply against an increasing demand that they feel they're going to see. So they want to make sure that we are planning volumes, that they're imagining an understanding. So we haven't seen a dampening of sentiment. And of course, the indexes wouldn't show it yet.

Yes. Dave, the thing I'd add to is encouraging to see the MBI be above 50 for 2 consecutive months. That's the first time over a multi-period not seeing anything too concerning from a demand destruction standpoint as of today due to conversations we're having in the field and with customers I'd say we're probably cautiously optimistic on the end market fundamentals for the remainder of the fiscal year.

That's good to hear. And then finally, I too, I'm trying to dimensionalize the impact of these head count changes. So could you tell us when in the quarter the risk happened? I mean I guess you're down 158 field sales heads sequentially and if I heard you correctly, you said you're going to refill those positions. I'm just thinking about how we thread the needle between 9% less year-over-year and adding those people back and then what's the cost impact and you're assuming no sales impact. So I'm sorry to ask it again. I'm just trying to dimentionalize the changes.

No, no. Thank you, Dave, for the question. And we -- like I said, we didn't give you a lot of details in our January call for competitive reasons, I'm happy to share a little bit more now. So the action was -- the sellers -- impacted service people were notified right before Thanksgiving and the action took place throughout the month of December and into January because we did plan that overlap period.

And when I say we're going to backfill those roles, I mean some of the attritted roles. We permanently contracted the sales force by 130 people. So you're talking about a couple of tens of roles that are vacant that we intend to fill so that we can have the complete complement of sellers that we planned for in this change. So depending on the role, the handoff happened quickly and sellers left the company in the month of December. Some of them had not a little bit longer. We had planned a longer transition period but I would say that by mid-January, all of those heads were out, and those were only a very few exceptions that we had to make just because of the longer handover period. It mostly happened in sort of early December.

We have reached the end of the question-and-answer session, and I will now turn the call over to Ryan Mills for closing remarks.

Thank you for joining us on today's call. We look forward to seeing you under the road at NDRs and upcoming conferences. Our next earnings call for the fiscal third quarter will be on July 1. Have a good day.

This concludes today's conference, and you may disconnect your phone lines at this time. Thank you for your participation.

Greetings. Welcome to the MSC Reports Fiscal 2026 First Quarter Results. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Ryan Mills, Vice President, Investor Relations and Business Development. You may begin.

Thank you, and good morning, everyone. Welcome to our fiscal 2026 First Quarter earnings call. Martina McIsaac, President and Chief Executive Officer; and Greg Clark, Interim Chief Financial Officer, are on the call with me today.

During today's call, we will refer to various financial data in the earnings presentation and operational statistics 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 U.S. securities laws. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks are noted in our earnings press release and other SEC filings. During this call, we may refer to certain adjusted financial results, which are non-GAAP measures. Please refer to the GAAP versus non-GAAP reconciliations in our presentation or on our website, which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures. I will now turn the call over to Martina.

Thank you, Ryan, and good morning, everyone. As many of you know, this marks my first week as CEO of MSC. Before we dive into our fiscal first quarter performance, I would like to share some thoughts since we last spoke.

First and foremost, it's an honor and privilege to serve as the fifth CEO in MSC's 80-plus year history. As part of the transition over the last couple of months, I've spent time engaging with our people, our suppliers and our customers. This time has reaffirmed our direction, and I would like to share more about those near-term priorities on our path to creating incremental value.

First, we are reconnecting and growing with our core customer, and we must remain steadfast in our focus to execute on the initiatives that have restored this growth. Most of these initiatives have been in flight for less than a year and tremendous opportunity remains ahead.

In addition to our work on pricing, website and marketing, our highest priority over the last year has been to optimize the design of our sales organization to better match resource to potential and put us closer to the core customer.

At the end of the first quarter, we turned our attention to our service model now, applying the same principles and aligning those teams to our more efficient geographic territory design. This will lead to an improved customer experience and enabled us to further optimize our cost structure in early 2Q.

We now look forward to driving sales excellence as we leverage our recent organizational changes and our new leadership structure that balances long-term MSC tenure with new thinking from the outside.

I am particularly excited now that [ Jai Donati ] is onboarded in her role as SVP of Sales. She will continue to strengthen our sales execution in the field as [ Kim Shaklee ] moves fully into her new role as SVP customer experience.

By decentralizing and streamlining decision-making in this new structure, we will amplify the impact of these changes and strengthen our position to achieve our long-term vision, to enhance customer experience and accelerate our ability to capture greater share of wallet.

To truly outperform, we must leverage our supplier community as a strong partner in these efforts as well. Over a year ago, we created a supplier council that we meet with regularly to share ideas and opportunities. These discussions are now evolving to the development of joint strategies to accelerate MSC's growth.

For example, turning to Slide 4. I'm pleased to announce that in late February, we will be hosting an inaugural growth forum where approximately 1,400 MSC associates in customer-facing roles will come together with our supplier community. The event was designed in collaboration with our supplier council for maximum effectiveness and impact.

Using data to pair sellers and suppliers in pursuit of a pipeline of customer opportunities this highly curated 3-day industry-leading event will be unlike our previous or other supplier conferences in its level of focus and partnership with our suppliers. We expect this event to be a key growth accelerator for MSC, demonstrating MSC's clear commitment to take sales execution to the next level.

To enable our vision, it's clear that we must drive speed and consistency in our daily decision-making through our technology platform. Our CIO, [ John Reichelt ] and his organization have continued making progress on the evaluation of our systems road map and will provide recommendations upon completion. We must also strengthen and improve financial visibility through our operating system to enhance our daily decision-making. Having the right leader will be critical in achieving this, which is why we are taking a selective approach to our search for a permanent CFO that remains a top priority.

And finally, we're committed to elevating our strong differentiated culture. Our culture is a competitive advantage rooted in a highly talented and technical team that consistently puts the customer first. Building on the proud family legacy that is shaped who we are, we are raising expectations, driving more rigorous performance management and embedding a mindset of continuous improvement to deliver even stronger results.

By remaining steadfast in these key areas of focus, we will capture the tremendous potential I see ahead and position MSC to achieve higher levels of profitable growth.

In short, I am more energized than ever, and I want to thank our entire team of associates for their support and endless dedication to providing the best service to our customers.

Before we move to the quarter's results, I want to highlight one further element of our strong culture and our commitment to improving each and every day and share with you some highlights from our most recent ESG report released last month.

First, we've reaffirmed our commitment to the planet and established a new long-term goal of reducing our Scope 1 and 2 greenhouse gas emissions by 15% by 2030. We supported the recycling of over 8,000 pounds of carbide. We were recognized as being the best company to work for by several organizations across several dimensions. And lastly, we continue our strong partnership with nonprofit organizations, including American Corporate, with whom we work to provide mentorship to military members as they transition into a civilian workforce.

Now digging deeper into our 1Q results on Slide 6, I am pleased with our performance in the fiscal first quarter.

Average daily sales came in at the midpoint of our outlook and increased 4% year-over-year. This was primarily driven by benefits from price of approximately 4.2% that was partially offset by volumes that contracted by 30 basis points. The decline in volumes was largely driven by the federal government shutdown, which negatively impacted sales by approximately 100 basis points in the quarter. This headwind was felt most in the public sector as seen by a year-over-year decline of 5% in the quarter.

Following the resolution of the shutdown, however, we have seen public sector sales resume growth in December. We were pleased to see National Accounts return to growth in the quarter, but once again underpinning our sales performance were daily sales trends in core and other customers that have now outperformed total company sales for two consecutive quarters.

Core customers grew approximately 6% in Q1 and buoyed by our initiatives around e-commerce, marketing and seller optimization.

Looking at the details, we experienced another quarter of year-over-year improvement in the number of customer location touches logged by field sales in fiscal 1Q. This is having a direct impact on our sales per rep per day trend as seen by the high single-digit improvement in this quarter. The positive trend in these two metrics as well as in total company sales was achieved with fewer sellers, reflecting the efficiency of our new territory design. We will now take these learnings and apply them to geographies outside the U.S.

Second, benefits from our web upgrades and enhanced marketing efforts continue to be realized in the quarter. Average daily sales on the web increased mid-single digits year-over-year. This was supported by several KPIs that continued improving year-over-year during the quarter, including the conversion rates of our top channels and direct traffic to the website.

With respect to marketing, our efforts continued producing benefits in the quarter, including high single-digit improvement in the daily sales of our uncovered core customers. Given this building momentum, accelerated investment in marketing will likely continue.

And third, we continue expanding our solutions footprint with our installed vending base, which was up roughly 9% year-over-year, and our implant programs, which were up 13% at quarter end. While implant signings remain strong, our year-over-year growth in the net number of programs at quarter end moderated in comparison to recent trending. This is not due to a slowing in the opportunity funnel but rather an increased emphasis on sharpening financial acumen in the field.

As a result, we saw a number of existing implant programs convert back to more cost-effective service options, better scale to customer needs, such as traditional MI. By working together with those customers, we were able to retain revenues at a lower cost to serve.

Moving to profitability for the quarter. Gross margin of 40.7% came in at the midpoint of our outlook, as a reminder, in fiscal 4Q, gross margin was pressured by negative price cost due to greater-than-anticipated levels of inflation during the last 2 months of that quarter. This was addressed in fiscal 1Q by taking action on price in late September and early October.

Given the timing of these actions, price cost and gross margin performed similar to 4Q for the month of September, that said, I'm pleased with our performance with price cost and gross margin, both returning to expected levels as we exited the first quarter.

Reported operating margin came in at 7.9% and adjusted operating margin of 8.4% came in at the upper range of our outlook, resulting in an incremental operating margin of 18% on an adjusted basis.

Looking ahead, under a mid-single-digit growth scenario, we continue to expect adjusted incremental operating margins to be approximately 20% for the full fiscal year.

Underpinning this confidence are several factors. First, we expect continued traction on our growth initiatives and hence growth above the IP index. Second, we anticipate ongoing benefits from price, which should yield gross margin stability. And third, our productivity initiatives, including our ongoing network optimization should continue yielding benefits, allowing us to support higher levels of revenues in the back half of the year with moderating operating expense growth.

Turning to the environment. I would describe demand across the majority of our primary markets as stable. Aerospace remained strong, while some areas of softness remain in automotive and heavy truck. These mixed levels of demand are reflected in the MBI as seen by the recent readings, which remain in contractionary territory.

Looking at Slide 7, however, I am encouraged to see how MSC is performing in this environment. Average daily sales outpaced the Industrial Production Index for the second consecutive quarter as a result of our improved core customer performance.

Thus far in the fiscal second quarter, average daily sales for fiscal December, which ended for MSC on January 3, improved approximately 2.5% year-over-year.

On a sequential basis, however, the month-over-month decline of roughly 20% was worse than what we typically experience in the month. Feedback we were receiving from customers around their planned shutdown activity suggested the month would be challenging. However, in addition, Christmas and New Year's occurred on a Thursday this year, which historically is typically the most challenging day for the holidays to fall on. To put some color on this, our sales from Christmas through the end of the fiscal month were down approximately 20% year-over-year and weighed heavily on the overall growth rate in fiscal December.

Having said that, we were pleased to see the core customer maintained its trend of outperforming total company sales during the month.

Looking ahead with only 3 days into fiscal January, visibility into demand levels entering the new calendar year and the remainder of the quarter is limited. Greg will provide more detail on what this implies for our 2Q outlook.

But despite this uncertainty, under a mid-single-digit growth scenario, we continue to expect adjusted incremental operating margins to be approximately 20% for the full fiscal year, supported by the momentum from the execution of our initiatives that continues to build.

And with that, I will now turn the call over to Greg to cover our financial results in greater detail and expectations for the fiscal second quarter.

Thank you, Martina, and good morning, everyone. Please turn to Slide 8, where you'll find key metrics for the fiscal first quarter on both a reported and adjusted basis. Fiscal first quarter sales were approximately $966 million came in at the midpoint of our daily sales outlook and improved 4% year-over-year. Price contributed 420 basis points to growth and was partially offset by a 30 basis point decline in volumes that can be attributed to the 100 basis point headwind related to the federal government shutdown.

Sequentially, I am pleased by our modest improvement in daily sales despite the headwind during the quarter that I just mentioned. This was largely driven by benefits from price and strength in both core and national account customers.

By customer type, we were pleased by the continued strength in core customer daily sales with a year-over-year improvement of 6% in the quarter. National Accounts improved 3% and while Public Sector daily sales declined 5% as a result of the federal government shutdown.

On a sequential basis, average daily sales improved approximately 2% for both National Accounts and core customers, while Public Sector daily sales declined by approximately 14%.

In solutions, as Martina mentioned, we are encouraged by the continued expansion of our footprint. From a sales perspective, Daily sales in vending for the first quarter were up 9% year-over-year and represented 19% of total company sales. Daily sales to customers with an implant program grew by 13% and represented approximately 20% of total company net sales.

Moving to profitability for the quarter. gross margins of 40.7% performed as expected and was flat compared to the prior year period. This was primarily driven by benefits from mix due to lower public sector sales of 10 basis points that were offset by a price cost headwind. As a reminder, we took actions on the price after the first month in 1Q and exited the quarter in a better price/cost position.

Operating expenses in the first quarter were approximately $312 million on both a reported and adjusted basis and slightly favorable compared to the midpoint of our expectations. On an adjusted basis, operating expenses were up approximately $8 million year-over-year, primarily driven by the combination of higher personnel-related costs and depreciation and amortization being partially offset by productivity.

Adjusted operating expenses as a percentage of sales improved 40 basis points compared to the prior year to the increase in sales.

Sequentially, adjusted operating expenses increased approximately $7 million and was primarily due to the same drivers of the year-over-year increase.

Reported operating margin for the quarter was 7.9% compared to 7.8% in the prior year. On an adjusted basis, operating margin of 8.4% and was slightly above the midpoint of our outlook and compared favorably to 8% in the prior year.

We delivered GAAP EPS of $0.93 compared to $0.83 in the prior year. On an adjusted basis, we delivered EPS of $0.99 compared to $0.86 in the prior year, an improvement of 15%.

Turning to Slide 9 to review our balance sheet and free cash flow performance. We continue to maintain a healthy balance sheet with net debt of approximately $491 million, representing roughly 1.2x EBITDA. Capital expenditures are roughly $22 million or up approximately $2 million year-over-year as expected.

We generated approximately $7.4 million of free cash flow in the quarter, representing approximately 14% of net income. It's worth noting that inventory investment, combined with a step up in receivables and prepaid expenses were the primary factors of the free cash flow decline year-over-year. Despite the slow start, we remain on track to achieve our expectation of 90% free cash flow conversion for the fiscal year.

Lastly, in 2Q, we proactively amended our AR securitization facility and increased its capacity by $50 million to $350 million. Compared to the use of alternative sources, such as our revolver, this approach is expected to lower our cost of funds by over $1 million annually.

Looking at our capital allocation strategy on Slide 10. Our highest priorities remain organic investment to fuel growth and advancing operational efficiencies across the business. Returning capital to shareholders also remains a priority. And in fiscal 1Q, we returned approximately $62 million to shareholders in the form of dividends and share repurchases.

Moving to our expectations for the fiscal quarter on Slide 11. We anticipate average daily sales growth of 3.5% to 5.5% compared to the prior year. Sequentially, we expect daily sales to decline approximately 4% to 6% compared to the fiscal first quarter. While the midpoint of our outlet compares favorably to our sequential performance moving from 1Q to 2Q last year, it is below our historical performance in 2Q and driven by the following factors that I will now highlight.

First, through the timing of our supplier conference that takes place during the last week of the fiscal quarter, we anticipate some revenues to shift from 2Q to 3Q and create a headwind of approximately 50 basis points.

Second, and as seen in the operating stats, December sales this fiscal year were weaker than normal. This was anticipated due to the holidays, which fell on a Thursday this year, combined with feedback from customers on their planned shutdown activity for the month.

That said, there are some sequential factors that we expect to work in our favor in 2Q and partially offset these headwinds.

Starting with public sector, assuming headwinds related to the government shutdown in 1Q did not occur in 2Q, it will benefit daily sales by approximately 50 basis points sequentially.

As a reminder, is typically the seasonal low for public sector sales, which was considered in the amount of the expected benefit. And second, we expect sequential benefits from price and momentum from our growth initiatives to continue in 2Q.

Lastly, on sales. The midpoint of our range implies a year-over-year growth a little more than 5% in January and February. Under this revenue range, we expect adjusted operating margin for the quarter to be 7.3% to 7.9% or up approximately 50 basis points at the midpoint compared to the prior year driven by the following assumptions.

Gross margins of 40.8%, plus or minus 20 basis points, that includes negative mix from the public sector sequentially of approximately 10 basis points.

In operating expenses, the head count actions in early 2Q that were enabled by our sales optimization work to offset the sequential headwind to the two extra months of the annual increase in 2Q versus 1Q.

Lastly, included in the operating expenses are costs related to our supplier conference that won't be self-funded through supplier registration fees such as travel, which will negatively impact adjusted operating margin by approximately 10 basis points.

It is worth noting that this includes incremental margins in January and February that are higher than the average implied for the quarter following a seasonally soft December, we expect the January and February strength to sustain for the balance of the fiscal year as the benefits from productivity and pricing is expected to support higher levels of revenues with moderating operating expense growth.

All of this underpins our confidence that under a mid-single-digit growth scenario, we expect adjusted incremental operating margins to be approximately 20% for the full fiscal year.

Turning to the next slide for an updated view of our expectations on certain line items for the full year. Depreciation and amortization expense of $95 million to $100 million or an increase of $5 million to $10 million year-over-year. Interest and other expense of roughly $35 million, capital expenditures of $100 million to $110 million a tax rate between 24.5% and 25.5% and free cash flow conversion of approximately 90%.

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 in key considerations for the second quarter and the back half of the fiscal year.

And lastly, we have one extra selling day year-over-year in the fourth quarter as shown at the bottom of the chart.

And with that, we will open the line for Q&A.

[Operator Instructions] Your first question for today is from Ryan Merkel with William Blair.

My first question is just on price. And I guess it's a 2-parter. So the 4% price, I think that was a little bit more than you expected. Could you just unpack what drove that? And then how should we think about price in fiscal 2Q? Do you think you'll see more price?

Ryan, this is Ryan. I'll talk about the 1Q price, and then I'll pass it over to Martina to talk about our expectations for 2Q.

Now, price came in kind of how we're expecting it. If you recall, we took a price action in June -- late June, and we had some carryover from that. And then we took another price action in late September, early October, to address the price cost issues towards the end of fiscal 4Q. So you net it all together, price came in as expected. And then Martina, if you want to give some color on...

Ryan, thank you. So we're still seeing inflation, not the intense pace that we saw in July and August, but we're still taking pockets of inflation across the business. is seen on the metalworking side, and I think that's not a surprise for anybody who's kept track of what's happening with tungsten.

So just to ground everybody, tungsten is the major input into carbide cutting tools. And we have supply controlled by China, and we've seen price increases now that exceed 100% on tungsten. So we are taking mid- to high single-digit price increases from our metalworking suppliers, and we will pass that on starting in mid-January.

To give you a little bit of a flavor on our exposure with tungsten, it impacts about 15% of our sales. So I'll walk you through that. Metalworking is about 50% of our total sales within metalworking, cutting tools is a big category, not the only category, right? We have abrasives and machinery and accessories and fluids. There are other large categories as well, but cutting tools is a major category within metalworking. And then carbide cutting tools is a major -- it's not an overwhelming majority, but it's about half of our cutting tool business. We also have high-speed steel and cobalt and other things in there, too.

So our exposure is about 15%. We'll take the first price increase in January. I don't think we're done. So I think there will be more inflation path to us on that, and we're in conversations with our suppliers. So we may see another action needed later on in '26.

And then, Ryan, if you take the carryover from the late September, early October pricing actions and then what Martina alluded to in the mid-January, late January price increases, it wouldn't be a surprise if price was a little north of 5% year-over-year and around 1.4% quarter-over-quarter, just to give you a little bit of an idea.

Got it. Okay. Super helpful. And then my second question is on the topic of [ EPA ] and we're going to get a ruling Friday it seems. This may be hard to answer. But can you share any thoughts on the impact if [ EPA ] tariffs are ruled invalid.

Yes. So we'll get the benefit from lower inventories working through the P&L. And then, of course, if the market adjusts price, we would too. So it kind of be opposite of how price cost falls through our average inventory accounting method. So I'd say we'd probably take a hit initially, and then we get a benefit as we work through the inventory and start to receive that lower cost inventory. So that's the way I think about it ran.

Your next question is from Ken Newman with KeyBanc.

So maybe for my first question here, Martina, I just wanted to run through that comment around -- I mean you guys have certainly kind of hammered this idea of, call it, 20% incremental margins in a mid-single-digit environment, when I run through the historical seasonality against the midpoint of the 2Q guide, it does imply the back half is growing something a little closer to low to mid-single digits.

I just want to give you the chance to maybe clarify the intent behind that mid-single-digit comment and the opportunity to help us understand maybe the pockets of opportunity for better operating leverage in the back half versus typical seasonality?

Yes. Ken, this is Ryan. I'll give you a little bit of color and then pass it over to Martina.

You're right. If you run that seasonality, it would imply low to mid-single digits. But if you look at the annual outlook side, in the commentary due to price and continued momentum in our initiatives. We wouldn't be surprised if we outperformed historical seasonal trends quarter-over-quarter in the back half.

And then when we think about the productivity front, that will continue to grow. And we expect incrementals to be a little bit stronger in the back half.

And just to give you a little bit of color on the confidence there. If you look at the midpoint of our outlook for 2Q, incremental margin around 18%. We talked about some increase in costs related to the supplier conference around travel and other costs. We view that as an opportunity to partner with our suppliers. We didn't feel it was the right thing to do to make them pay for that. If you back that out, it's about $1 billion. Incrementals look closer to 20% on what was a challenging December in the quarter. So that gives us confidence in incrementals as we move through the rest of the fiscal year. And then Martina, I didn't know if there's anything you want to add.

Yes. I mean I think we're confident in our -- in the momentum in our growth initiatives. So we expect to be decoupling from our trend. Everything that we're doing is around sales execution and share I think we have the right structure in place now. And now we turn to accelerated execution in the field. And what we're seeing is encouraging. So we're not declaring victory, but we do expect that higher pace of of growth, particularly in our core customer.

And then as I said, we're on track with a productivity program that we started a couple of years ago in terms of our network optimization and optimizing the way we spend -- all of our big drivers of costs, right, where we spend freight dollars, how we optimize within our four walls. And so we're seeing the trajectory there, and it makes us pretty confident.

And then Ken, other thing I'd add too is the core customer has been growing for 2-plus quarters. The MBI still signals contraction. And then if you look in the offset, this is the second quarter that manufacturing daily sales outpaced price, so that's giving us encouragement too, that the initiatives in place are working.

Got it. That's really helpful color. Maybe just for my follow-up here. I'm curious if there's a way to quantify how you think about the net margin impact from the public sector sales implied in the second quarter.

I know that's -- I think you mentioned it's resuming back to growth after the shutdown headwinds last quarter, but it's still against a pretty tough comp. I think that's a lower mix portion of the business. And -- just how do you think about that maybe normalizing out mix-wise in the back half of this year?

Yes. So in the public sector, what we said is due to the headwinds in the first quarter from the shutdown quarter-over-quarter mix headwind will be about roughly 50 basis points. We don't expect to see a strong ramp in the public sector. We expect it to go back more to business as usual. And I would assume that to be the case in the back half of the fiscal year. That's how I would think about it, Ken. And then keep in mind that our outlook assumes for 2Q assumes that there is not another federal government shutdown. I just wanted to throw that out there as well.

Your next question is from Tommy Moll with Stephens Inc.

Martina, in your prepared comments, you talked about some cost measures taken in early 2Q, and it was in the same breath, as I mentioned, on turning your attention to the service model.

So I guess it's a 2-part question here on the cost measures. What can you share there in terms of details, perhaps sizing or context? And was that meant to be linked to your comments around service? Or were they more aimed at the selling organization.

Yes. Thanks for the question. Yes. So our whole sales optimization program has sort of been pointed at our strategic goals of accelerating organic growth and optimizing our cost to serve. And that's what I've been talking about for the past year, and we focused primarily through those efforts on our core selling rule. So we optimize geographies, we balance portfolios. And like I said, we believe that we're starting to see the impact of that, right? Growth comes from more coverage and a better customer experience. and cost to serve comes from an efficient resource deployment. So that work we had completed.

But as you can imagine, there's a lot of other customer-facing roles in the business. So if you think about our core customer, you're talking about anyone from a small metalworking shop with 20 people up to a complex multisite business. And we have a lot of teams that support that business. Both in business acquisition and then in terms of service, once we have customers enrolled in different programs. And so we had not touched that side of the business. And so what we have done over the past quarter and a half is apply those principles to our service or to basically marry it up with what we've done in sales.

And again, the goal is to match the right amount of resource to the right potential. So we completed that work right at the end of the first quarter. And then at the beginning of we did have a head count benefit as a result of that optimization. So I don't -- I won't to share a lot more detail for competitive reasons, but we think we have the right structure in place now.

And then, Tommy, just to size it, the way I would think about it is the head count actions Martina alluded to early on in fiscal 2Q, in further productivity, eating away a large chunk of that $4 million quarter-over-quarter headwind from 2x for months of [ Merit ].

Okay. That's helpful. And then just sticking on the theme of profitability here. You gave helpful guidance on fiscal second quarter in terms of gross margin and OpEx, any comments you want to offer now on seasonality for either gross margin percentage or OpEx, I mean, I guess the starting assumption might be gross margin percentage flat, maybe even a little bit improved as price/cost improves post Q2 and on OpEx I mean, unless you would point anything out. I think the starting assumption there would just be model normal variable expense associated with the sales commission and volumes fluctuate, but any additional context would be helpful.

Yes, Tom, good question. The way I think about it, starting with 2Q. We have -- I'll start with gross margin. Starting with 2Q. I think the outlook, 4.8%-plus or minus 20 basis points, with 1 month under our belt and in what we see looking forward in the next 2 months, it doesn't feel like a tough hurdle to be at the upper end of that range as you go through the remainder of the year, that's going to be dependent on core customer acceleration and further inflation working through the P&L if we see more supplier price increases.

So as a ballpark, I'd probably stay at that 40.8% plus or minus 20 basis points with some potential upside in the back half. As we think about OpEx, to your point, I think it's a good idea to take the variable OpEx associated with the sales growth. But then the other thing to keep in mind, too, is we expect productivity to improve throughout the year. So what I'm alluding at is we have a 20% incremental margin target for the year. 18% in 1Q at the midpoint of 2Q, we're at 18%. So that implies some stronger incremental margins in the back half. And what we have line of sight to, we feel pretty comfortable on that.

Your next question for today is from Nigel Coe with Wolfe Research.

Martina, congratulations on the new role. Just want to go back to December. Just I understand the holy timing and the impact on the customer shutdowns. But any more color on why it's so extreme, just given -- was a 1-day shift from last year from Wednesday to Thursday. So just wondering if there's any more kind of color in terms of why customers decided to shut down over that period? And then have you seen sort of noble operations resuming in January so far?

Yes. Nigel, good question. The dynamics was December. First off, it wasn't a surprise with the holidays falling on a Thursday. And keep in mind, our fiscal December runs through January 3, so we also had the impact from New Year's. The reason Thursday being the worst is customers take off Friday to for a long weekend. Just to give you an idea, the last time if the holidays fell on a Thursday, it was back in 2014, December was down 16% month-over-month. We're down 20% roughly month-over-month. And then going back to the prepared remarks, December on through the rest of the fiscal month, we were down 20%. So we really got hit hard in the back half of the month.

Looking out to January, visibility is still limited. I mean we have 2 days under our belt. But going back to what Martina said on our growth initiatives, the fact that core continued to grow in that challenging December and was our top grower, we expect that trend to continue. So regardless of macro conditions, we feel like there's opportunity to take share, particularly within that core customer. Martina, I don't know if there's anything?

Yes. I think, Nigel, the important thing that we always call out is that January second day or the last Friday actually falls into our quarter. It will fall into everyone else's January because of our fiscal calendar, and that represented a headwind alone of about 100 basis points on growth. .

And coming into Christmas, we were actually seeing trends that made us encouraged and positive. So core is still outperforming. We believe we're still taking share. So I -- it was a disappointing number, obviously, for December, but as Ryan said, expected because of where the holidays fell.

No, that's great color and Jeremy I definitely hurts you a bit more. The -- just a quick follow-on gross margins. You provided some really good color there. Obviously, you've got some pretty aggressive price increases coming through in January. I'm just wondering, have you included the benefit from those price increases in your 2Q guidance? I know it's in your sub portion of that price increase, but would that be in your 2Q guide? And do you anticipate maintaining gross margins on both the price and cost inflation?

Yes. Yes. So I'll give a little color on 2Q and then maybe I'll pass it on over to Greg to talk about price cost and gross margin in 1Q.

Contemplated in our outlook is the price increase that we have for mid-January, we're not going to speculate on future pricing from our suppliers for the remainder of the quarter of the year. but our goal is to maintain price/cost neutrality. And like I said earlier, see some upside to the range for 2Q, about for half of the range and 40.8% plus or minus 20 basis points for the back half of the year. sounds like a good ballpark with some potential upside.

And then, Greg, I don't know if you wanted to touch on how gross margin trended through 1Q.

Yes. Thanks, Ryan. Taking a look at -- just looking at gross margin, I talk quarter-over-quarter, sequentially, with positive price costs and public sector driven mix were the biggest drivers of the 30 basis point improvement that we saw during the quarter. .

These benefits were slightly offset by some adjustments that didn't go our way during the quarter. Just taking our price cost in general.

At the beginning of the quarter, we saw price cost was negative and similar to 4Q levels. However, following our price actions in late September, early October, we had started to see price cost improve and exited the quarter in a much better position, which led to the 40.8% plus or minus 20 bps guide for Q2.

Your next question for today is from Patrick Baumann with JPMorgan.

Sorry, I was muted. Thank you for letting me know. I just want to dive back into Nigel's question on December cadence. So you said that, I think from Christmas through the end of your fiscal month, it was down 20%. I'm guessing like sales trends at that time of the year are the greatest anyway on a daily basis. So curious, up until Christmas, what was the ADS growth versus that 2.5% you did for the month?

Yes. Just if you do the math, Pat, it's about 4% to 5%-ish roughly.

Okay. And then when you're thinking about the first quarter and the January, February number being 3% above that at the midpoint of the second quarter number. Can you talk about the thinking behind that, I guess, you mentioned price, but just curious how compares to history? And then with limited visibility that you have, why you think that's kind of a reasonable place to be?

Yes. Good question, Pat. To your point, January and February at the midpoint, up roughly 3%. That's combined January, February ADS up 3% versus 1Q. Historically, that's roughly 2% digging a little bit deeper, for the quarter, we talked about a 50 basis point benefit to ADS from the federal government shutdown headwinds of 1Q. We already picked up a little bit of that in December. Public Sector was up mid- to high single digits sequentially December versus November. So what I'm getting at there is maybe for January, February, that looks more like 35, 40 basis points.

And then we talked about a 50 basis point headwind from the timing of our supplier conference. That's in the last week of February. We said 50 basis points, but if you isolate it for that 2 months, it looks more like 75 basis points. So we're in the whole 30 basis points roughly on -- when you add those two together, what's given us confidence is the price action in mid-January, that will go into effect and also the continued acceleration we see in core customers. and national accounts as well. As we mentioned, December, despite a challenging December quarter was still up mid-single digits. We feel confident that, that could continue.

Got it. And then maybe one for Martina. I guess, the supplier event that you're hosting this year, what are you hoping to accomplish from it. You're bringing 1,400 associates to it and a bunch of suppliers the volume growth that the company is delivering is still versus industrial production, not exciting. Can you talk about how you get that to improve? And maybe if this event is meant to help start to drive that?

Yes. Thanks for the question. So since I've been at MSC, one of the things that I really focused on is rebuilding trust with our suppliers and strengthening those relationships. And we've done a lot of things in the background that we haven't talked about with you around making ourselves easier to do business with and increasing our supplier transparency.

But one of the things that did that was really important was to put the supplier council together because we talk straight about how to improve MSC's growth and how supplier collaboration with MSC can help us continue to outperform.

So they actually designed what an ideal session would look like. And this is not a trade show. This is a working session, very detailed joint business planning that was designed by suppliers to be different from what they do in the industry today. And we do exactly, as you say, expect to come out of that with an engagement plan in the field that will be followed up and executed on and will be a growth accelerator.

So it's a huge undertaking. It's a lot of upfront data-driven prep. It is a lot of people, as you said, but I think it's one way to make a big bang post all of these structural changes to aggressively go after growth in partnership with suppliers. We're really excited about it, and we think it's worth the effort of taking all those folks out of the field for a few days. But as Brian said, it will shift some revenue then into the third quarter.

Your next question is from Chris Dankert with Loop Capital.

I guess just to poke at the 2Q guide a little bit more here. So if we're expecting price to be up 5% or a little bit north of that in the second quarter, obviously, there's moving parts with supplier conference and whatnot. But volumes here are implied to still be flat to down a bit.

Can you kind of put that in context? Is that just being cautious given the macro backdrop or we expect to get positive in the back half of the year? Maybe like how do we get that core volume back up? And how does that compare with what is the demand on the ground here? .

Yes. Chris, so if you look at a year-over-year basis, keep in mind, a challenging December, January and February applies roughly up 5.5% year-over-year. We said, I wouldn't be surprised if price was a little north of 50 basis points. I mean a little north of 5% year-over-year. So maybe a little bit of volume improvement.

Going to the supplier conference, I would say we were probably a little conservative on the potential impact. That's 3 days in the last week, 14,000 customer-facing individuals at MSC being out, it could be less, it could be more. And given the fact that we don't have a lot of visibility here into the new calendar year, I'd say we're a little bit cautious with our outlook and what we're implying with January and February.

That's helpful context. And then maybe just as we think about growth drivers, you have noticed the implant sales growth is great, but the signings have tapered a little bit here. Are we more focused on the core and kind of letting the implant kind of bubble up more organically? Has that been deemphasized? Is it just timing? And I'm overlooking into this? Just any context on implant growth there?

Yes, I'm so glad you asked because no, we still have on our largest customers. We have an incredible team engagement -- team customer engagement concept that we call MRO Go that build programs for customers, and that includes placing implants if that's the appropriate part of the solution, and that's aimed at the top end of our customer segment, so our largest, most complex customers, national accounts, and that is still ongoing.

I think what you saw in the conversion in the first quarter, you saw the net number sort of continue to grow but grow a little bit more slowly. And that's because at the same time that we are fully engaged in opening new programs for suppliers, we're also very engaged on challenging our own cost structure, looking at the drivers of profitability and building that financial acumen in the field.

So not every customer needs an implant, we can provide outstanding service through a number of our service teams in a number of different models. And if a customer's needs are simpler, then the better thing to do is to allow that service to be provided in a simpler way. So we actually stepped down off a couple of existing programs in cooperation with the customer as part of our cost savings program that we put in place for them and offer a different solution.

So we'll continue to examine those going forward, but absolutely no slowdown in the pipeline. Absolutely, no shift in emphasis, the teams that are working with those largest customers are still intact and in place.

So Chris, I would also add that the sequential growth you saw in the number of implant programs what Martin is getting at is the signings are greater than that increase.

Your final question for today is from David Manthey with Baird.

Yes. Thank you. Good morning, everyone. My question too is on the first quarter to second quarter sequentials. If I'm calculating this right, if you go to say, a 6% ADS in the second quarter, theoretically, that would still be sequential of like minus 4%, and you're saying the minus 2% is the historical average, and if you go to that 5.5% or 6%, I guess you'd be sort of factoring out the holidays and the sales meeting and all that stuff.

So -- and then on top of that, you get better government sales, you get this pricing acceleration. I'm just -- what I'm getting at is, unless market demand is deteriorating why wouldn't you be seeing more normal sequential trends in the second quarter versus what was already a seemingly weak first quarter? And then why wouldn't those be more normal or even higher as we move through the year if the economy gets better?

Yes. Dave, we tried messaging this at the fireside chats at recent conferences and following up with investors in the sell side. Look, December wasn't a surprise. Thursday is the worst day for the holidays to fall on. And if you look at the -- if you go back to the slides last quarter, in the annual slide when we talk about assumptions for the quarters and the back half, what we said is the past 2 years, the average is down 4.5%. And we're at 5% at the midpoint. Like we said, visibility is a little bit limited. Going to your point about the public sector, yes, we'll get a little bit of a pickup there. But keep in mind that 2Q is a seasonal low for the public sector. And we -- the expectation is that it's going to go back to business as normal. So you're not going to recoup that 100 basis points in 2Q.

So as we stand here today, you saw in the macro indicators, the PMI contracted new orders in the MBI contracted in December as well. Visibility is limited. We feel good about what we're doing from a growth initiative standpoint, but not going to get ahead of our skis and feel like that we're doing a good job on just giving what we currently view the market to be in our expectations. And then also keep in mind that the supplier conference, too, that's something that we alluded to as well with sales potentially getting pushed back up from 2Q to 3Q.

Okay. Yes, I know there's a lot of moving parts. We'll have to work through that. But additionally, if you're looking at incrementals sort of near term and even through the remainder of the year, Here, too, if essentially, you're talking about mid-single-digit price increases being essentially all of the growth in the near term and maybe a little bit less than that going forward. But a big chunk of the growth with price predominantly driving your revenue growth with super high read-through on that, in addition to some of these cost reduction efforts.

Again, I'm not trying to push you on these numbers and get you outside your comfort zone. But why wouldn't contribution margins be higher than 20% in if it's price plus cost reduction efforts, it would seem like you'd see abnormally high incrementals in that type of environment. What's the offset there that I'm missing?

So if you look at what we're applying for the quarter, 18% at the midpoint, given the soft December, there's a 5-week month, there's a lot of fixed costs associated with that. you could imagine operating leverage was pretty challenged in December. That would imply January and February look a lot better from an incremental margin standpoint than what's representative of the average for the quarter. And keep in mind, we have about $1 million in incremental expense related to travel for the supplier conference. .

And then you heard us say in the back half, we expect incremental margins to be better than the first half. And if we were to be in a high -- mid- to high single-digit growth environment, to your point, Dave, we'd expect those incremental margins to be a lot stronger.

We have reached the end of the question-and-answer session, and I will now turn the call over to Ryan Mills for closing remarks.

Thank you, everybody, for attending today's call. Our next earnings call for fiscal 2Q will be on April 1. Have a good day. Bye.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.

Well, good morning, everyone. Thanks for joining us here in Nashville for the Stephens Conference. I'm Tommy Moll, analyst here at Stephens. One of the companies I cover is MSC Industrial Direct. We're delighted to host them today, specifically 2 members of the management team. To my immediate left is CEO, Erik Gershwind. To his left is Ryan Mills, Head of Investor Relations. Erik and Ryan, good to see you both, and thanks for coming.

Thanks for having us, Tommy. Great to be here.

So we've got about 45 minutes together. I have Q&A prepared for roughly half of that time. If you have a time-sensitive question during the first half, by all means shoot up a hand. Once we get to the back half of our time together, though, please, anyone and everyone, feel free to ask any question you have directly will foster a good back-and-forth dialogue today. But I want to start with some very high-level questions for those of you who may be new to the story, that's kind of how we design this conference. Sometimes you can pop in and get up the curve quickly with these fireside.

So let's just start very high level, Erik with the spot buy to mission-critical evolution. These are terms that probably don't mean much to those who aren't in the weeds on distribution but give us a sense of what that initiative looks like at the company years ago.

Sure. And good morning, everybody. Can you hear me okay? Good. Yes, I'm getting on. So yes, maybe what I'll do is just start at the beginning. So the company MSC grew up as what Tommy referred to as a spot buy or long tail supplier in the industry, we were known as a catalog house. Of course, catalogs are not all that present anymore, but the spirit behind it was that for industrial customers, MSC would play the role of keeping their plant running.

The industrial suppliers or MRO marketplace is very large and very fragmented. So you're talking about literally millions of SKUs that key plants running dispersed among thousands of suppliers. And oftentimes, these are low dollar value parts. So the customer who are mostly in our case, manufacturers are -- have not historically spent a lot of time worried about them. And yet if one of these parts is not in stock, it can shut down a line.

So the role for really -- the better part of 2 decades that MSC played was to be their backstop. We carried well in excess at the time of 1 million SKUs. Today, that number is up to 2.5 million SKUs. Most of them were stocked in 1 of 4 large centralized warehouses or DCs that range in size between 700,000 and 1 million square feet, all located near UPS hubs. And basically, the gist of it was get product to customers next day with a seamless wonderful customer service experience. And that was the crux of the business for a long time. Tommy referenced this pivot that we made, if you will, a transformation from being a catalog house to being something more. And that was coincident with my tenure as CEO. I grew up in this business, I'm 54. I've been in the business for basically 53 years. It was started by my grandfather, but I took over as President and 2011 CEO in 2013. And bit by bit, we started to see changes happening in the industry.

Certainly, one was the advent of the Internet or Google Search, which made shopping for customers much easier, much more transparent. We saw the entry of single channel online players like Amazon with declaring their intent to get into B2B. And that caused us to take a step back. And the other thing, Tommy, I would say we saw was our customer base. So 70% of our revenues are tied into manufacturing end markets in North America. And it began, I would say, after the global financial crisis of '08, '09, where bit by bit, there's been a drumbeat that persists to this day about the need for help in U.S. manufacturing, help in running their businesses better. That could mean help in finding productivity because most of our customers are under margin pressure. It could mean help in freeing up capital because they have limited working capital and want to grow. It could be helping getting products into their customers' hands faster.

And so we saw this interesting opportunity to pivot what MSC did that for 2 decades, basically our role ended when we would drop stuff off at our customers loading dock. And we decided that we were going to play a bigger role and reach inside of our customers and actually help them on the plant floor to achieve all of those objectives I described. And so during my tenure, there was a really aggressive build-out of our product offering. So it was moving it from just carrying everything to we continue to carry everything, but to focus and specialize on product categories that are either technical or high touch in nature that would be needle moving for the customer's manufacturing process. It led to a build-out of inventory management services.

So beyond just shipping into products, if you go to an MSC customer today, you'll find vending machines, you'll fund vendor-managed inventory programs that are outsourced to us, so we help our customers manage their inventory better. You'll find technical experts. So we had an aggressive build out a network of well in excess of 150 technical experts. So these are people with deep roots in manufacturing and machining who have done the job that the customer is doing and can help them find productivity opportunities.

The last one I'll call out and then I'll stop talking is our In-Plant program. So we reached the point where we're actually placing MSC associates, as we call them, our employees, full time inside of our larger customers' operations. These folks are playing a role anywhere from sourcing, procurement, put away, kidding, they'll do lean walks, They'll bring in technical experts. And this one has been of particular note because we feel like we're tapping into something nearly every one of our customers that we speak to, if you ask them, namely your 2 biggest challenges or obstacles, access to qualified labor is always 1 of the 2. And this program seems to be tapping into that.

So as for instance, our In-Plant program went from more or less 1% of sales pre-COVID. We decided to hit the foot on the accelerator. It's now at 20% as of our most recent quarter, and that's growing quarter-over-quarter. So in essence, I would say, Tommy, that's a summary of the pivot that we made.

Yes. And one of the product categories that's consistent through the whole history there, Erik is metalworking, which is the largest for you, not always the largest for your peers, so it's not as well understood, I think, by investors. So can you frame for us what kind of contribution it delivers to your overall revenue pie? And then just give us a sense of some of the value add and the compare and contrast in metalworking specifically versus other product categories that folks may be more familiar with?

Yes, Tommy, it's actually a good call out that I should have mentioned as part of the pivot. When we were listening to our customers, we looked inside of MSC and said, beyond logistics capability and a broad product offering, what else do we have to bring to the table? And so just by virtue of my grandfather growing up selling cutting tools, roughly 45% of our business today is what we call metalworking. So if you take the total North American market for the products we sell, MRO industrial supplies, you're looking somewhere depending upon the estimates, [ $220 billion to $250 billion ]. Of that, metalworking represents approaching north of [ $15 billion and approaching $20 billion ] of it.

So metalworking think primarily cutting tools, abrasive supplies that would finish anything that would help form, cut, shape metal, machine tool accessories and such. And what's really interesting about that product category for us, Tommy, and that's really where our expertise comes in is unlike some of the products we sell that are kind of in and around the plant floor, janitorial products or a power tool that's repairing something, cutting tools, you're actually influencing the final output. So they're really important to the customer. And we found that as our pivot. So we do think it's a big part of the mode. It's not the only mode, but it's a big part of what we lean into. It's interesting. So we're sitting today, we're still at just touching 10% both the metalworking market. So it's still a very fragmented market. We still see plenty of room for growth here. And it's -- so it's a big part of our advantage that we want to keep pressing on.

Erik, you mentioned the company was started by your grandfather. So I want to give a quick sketch of the family history here and then give us the latest on the transition. So founded by your grandfather, you've been CEO, I think you said since 2013 officially. Recently was announced that you'll transition to an Executive Chairman role, and you've named your successor CEO, who is not a family member. So I've kind of hit on the themes there but give us what additional context do you think is important for folks who want to underwrite a potential investment idea here?

Yes, I think so. So a couple of things I'll say. The family ownership. So it's been -- it's 1941, the company was founded and is -- through me, we've only had 4 CEOs in company history. So Martina McIsaac who I've been grooming for the better part of 3 years now will be the fifth. We've had 1 other nonfamily member in between me and my uncle, [ Mitch, David Sandler ], who groomed me as I've done with Martina.

So I mean, it's a pretty unique culture. If you think about over 80 years, only 4 CEOs and 3 of the 4 of us are from the same family. You can imagine a couple of things. One is, I think the values and the culture inside the company, it's a very value-driven company as a result. And we've been an interesting blend because we certainly have all of the governance of your typical public company. If you look at our Board of Directors, we always say we fight above our weight. We've got Board members that I feel fortunate to be surrounded by but there is something different. Like when you walk the halls, it does feel a little bit different.

I will say, speaking of governance, we -- a couple of years ago now, we made the decision to collapse. So we had a dual share structure in which a 10:1 voting right for B shares that were held by the family. We made the decision to collapse that. And it was really about looking at sort of reading the tea leaves, looking at where the world was going, looking at good governance. And so we collapsed the family today has a little over 20% of the economics of the company. Although as part of the agreement, we did cap our voting rights at 15%. So whatever difference there is, we vote pro rata.

I think even with Martina coming on, I think if you went inside the company, most would tell you and dealt with customer supplier, it's a net competitive advantage for us. Just in terms of number one, a very long institutional memory, a strong sense of culture and values and the ability to think long term, which I think is paying off for us in some of the pivots that we made, I think it would have been tough for me to do without the benefit of that the family influence.

Yes. One more personnel-related topic, and then we'll dig into the operating environment. But in terms of the CFO, where are you in the process, the search process for a new CFO?

So we're right in the midst of it. So Martina, over the past 3 years, Martina joined us as Chief Operating Officer. We had not had 1 in the company since me actually before [indiscernible] CEO and felt it was the right time Martina got promoted over a year ago to President. And over the course of the 3 years, she's really put together a strong management team. And I would say that's a balance of some fresh thinking that she brought in from the outside, a couple of people recently in sales, in supply chain, along with giving opportunity to long-standing MSC people who understand the culture and the heritage. So it's been a nice blend.

This, Tommy, is the last piece of the puzzle is the CFO search. So we are -- our former CFO, Kristen Actis-Grande, left beginning of August. We are in the midst of a search. We do expect to go outside. So interest seems really good. I think about prior searches. It generally takes a couple of quarters to find Mr., Miss Right. I will say we have a lot of confidence in the meantime and the team here. Greg Clark, our Interim CFO, has been Controller for a long time. Man to my left here, Ryan Mills does a terrific job with the investment community. So we feel like it's solid, and we're right in the midst of the search. And that should really be the last piece of the puzzle to the team.

So let's dive in on the operating environment here. Erik, on your recent earnings call, you used terms like stable to describe demand. You talked about some pockets of improvement, but really still highlighting an overhang from some of the uncertainty. Reflecting on a lot of the conversations I've had with investors, particularly before last earnings season, there was a lot of hope about short cycle recovery. Basic elements of the thesis, including a rate cut, 1 big beautiful bill, this idea that we're kind of due for it, just given how long PMI has been sub-50. Are there any signs of life that you can point to about a recovery? Or does it feel like we may be sliding into a pretty slow end of calendar '25 here?

I would say we feel, Tommy, for the most part, that there's been some notable improvement. But I would call the improvement more stabilization than inflection upwards. So I realize we're coming off of 70% of our business into manufacturing, 50% into heavy manufacturing. So think heavy machinery and equipment, ag type equipment, think metal fabrication, auto, aero and other than aero for the last 2 years, it's been brutal. I mean, really brutal.

To your point, we look not only at PMI, there's another index that if you want to track us, that's highly correlated, it's called MBI, the metalworking business index, it's run by the Gartner Group, very similar to a PMI sentiment survey. That index, I think, Ryan, it's like 26, 27 months now and going of being negative. And I ask the team to say, can you go back and show me what happens with this kind of projected negative reading and they said, we can't because it's never happened before. So this is unchartered water, and it's been a rough couple of years.

I would say all of us had hopes. I think the way the tariffs played out, there's just an overhang of uncertainty. The rate cut is not that significant. But we have seen some stabilization. So I would describe it that for those who are on webcast, they won't be able to see this, but instead of just going like this down, it's been level. And when you've been down so long, it feels like up. It's -- we felt like in our business, with our goals at a flat industrial production index, we ought to be able to grow mid-single digits. And that's starting to come to fruition. Of course, we are getting the benefit of some price.

I would say we still feel, Tommy, like -- it's been one thing after another. Obviously, the tariff situation, the government shutdown, the prolonged government shutdown for us, public sector is around 10% of company's revenues. And of course, there's a little bit of a ripple effect you get with those selling into the government take a defense contractor. But so it's kind of been one thing after another.

I think as we look out, we're cautious, I would say, cautiously optimistic that the worst is behind us and perhaps there's more upside than there is downside. I think for us, we're particularly encouraged because we actually have started to see which I'm sure we'll touch on important parts of our business inflect positively due to some of the work that we've done. So I think our feeling is even if it's just a leveling and a stabilization that we ought to be able to grow and are starting to do so.

We will certainly address some of those trends you referenced. But first, just to stick on some of the high-level themes here. You mentioned pricing, Erik, what details can you share about the increases that you pushed through in June and September? What are you seeing in terms of supplier price notifications? And if you run all this together, would you characterize what you have seen lately as the kind of inflation that should all things equal, be a tailwind to margins? Or is there some reason that, that might not be the case this time around?

So it's a 2-part answer. I think to date, what we've seen to date has actually surprised us to the negative and not been a margin tailwind. I think as we look forward, it's beginning to feel more like the kind of inflation cycle that would be a tailwind.

Let me put more color on that. So when the tariff noise began after election early in the calendar year, we were really surprised at how slow the industry and by industry, as a distributor, price movement is typically triggered by what the manufacturers who are suppliers what they do, and no one was moving. And it really -- it took us by surprise because we were expecting a wave of inflation that didn't come. And what we were hearing was no one had enough conviction confidence that the tariff environment would remain stable, and we're afraid about having to move and pull back.

So what happened was there came a period and it was right around our last earnings call, we -- I thought we had a good fiscal fourth quarter, but gross margin was a disappointment to the tune of 50 bps. And there was 10 or 20 basis points that were kind of noise and onetime items, but 30 basis points was price/cost performing worse than we expected. And for us, we're on an average costing system. So usually, early in an inflation cycle, we'll take price right away, the cost bleeds in and we see a benefit. So we got caught by surprise and a couple of things happened.

One, it was like an avalanche. So for all of this time of not moving, suppliers move in a hurry. And just to put some data to that, we went back and looked, we got in supplier cost increases in a 2-month period and it was right around our earnings call. The equivalent of nearly a year's worth of inflation post COVID, which was a robust time. It was crazy. The other thing that happened was it became like a mad scramble. We typically have the ability to work and partner with our suppliers to say, hey, give us 30 days notice, give us 60 days notice so we can buy ahead of it and plan. We were getting like 3 days notice, 4 days notice, like, hey, starting on Monday. So it was a bit of like a 100-year flood. And so what ended up happening was price/cost flip negative and really because we took more cost than we expected.

I think if there's a good news story there, what I was most pleased about, I was concerned about when margins turned negative, but pleased to see the outcome, we got price. So we got exactly what we felt we got for price. The lesson learned was we didn't take it off. And so what we did, we kind of -- we didn't knee-jerk. We took it on the chin a little bit in August and September. And the reason we did that is we've developed a pretty good cadence with our customers about giving them time and felt like that's more important than a month's worth of margin drag is the integrity, the transparency and consistency.

So what we mentioned on our October call is end of September, early October, we took pricing moves. And those were intended really to catch up for what's happened. So what we expect, we gave a gross margin guide for fiscal Q1 in September to November that was up 30 bps from Q4. But it was kind of like a tale of 2 quarters in that our month of September look pretty lousy. It would look more like Q4, and we were expecting better performance after pricing in October, November.

I will say one other point on pricing, Tommy, is we're beginning -- I mentioned it's a 2-part answer. We're beginning to see the signs that would make this cycle look more like a typical inflation cycle. And what I mean by that? The tariff driven increases have been really, really wonky. There's kind of been a knock-on effect here, which is the tariffs had led to commodities inflation in certain instances. So the one it's funny, we've been study following tungsten forever in our business, but it's starting to get mainstream headlines. But tungsten is the single biggest ingredient into carbide and carbide is the biggest material for cutting tools, our cutting tool assortment. And so that tungsten prices and we've been talking to our suppliers about this something like 90% year-on-year.

So to the extent that sustains, what we would expect to happen is our suppliers raise their list prices. And that would look more like a normal cycle to us where we can get ahead of it, plan for it, buy into it and be able to see the kind of price cost dynamic we expect.

Yes. So let's tick through some of the different types of customers and the initiatives you have to attack each type. So I've got core, national and public sector, we'll take them in that order. So on the core customer side, first of all, just a level set on the language when you guys talk about core customer, what does that mean? And in terms of the substance here, why did the trends there diverge for a while from IP and what were some of the corrective actions that you took?

So these are pretty broad categories. And what we try to do for the public is make it specific enough to be able to explain differences but simple enough to keep it simple stupid. So core national accounts government.

Let me start with the other 2, public sector. Public sector is pretty straightforward. I mentioned it's 10% of our revenues, but those would be sales to any federal or state agency or organization. There, the 10% is broken up roughly 2/3 federal. So I think military basis, for instance and 1/3 state government. The second bucket National Accounts would be where we have a larger organization typically has a centralized purchasing function and disparate kind of dispersed plants that would have large amounts of spend that function more like a corporate relationship where we're putting a contract in place as opposed to a one-off. That is about [indiscernible] [ 55-ish ] of revenues.

So the balance, which is around 55%, is what we call core. Core is a big bucket, but it's made up primarily of manufacturing businesses and small and medium-sized operations. So I'm overly simplifying here. But for the most part, our core customers will behave less like a large corporate that has a large purchasing team and contracts and more on a one-off basis.

So the really important thing about core to note is that, number one, because as you can imagine, smaller customers, not as [ strong an ] ability to plan, these tend to be our highest margin customers. And number two, we have underperformed tier. I'm going to say for the better part of the decade. And I think the reason for that, there's probably one sort of structural industry issue, which is just smaller businesses have not fared as well as larger. But some of it is our own doing, which is that a lot of our resources and effort went into that mission-critical pivot I described. Those value-added services play really well for larger organizations who are thinking about total cost of ownership, who are willing to sit down and negotiate for a smaller shop.

First of all, they don't play as well. And second of all, they're not always as cost-effective to introduce into the customer. And so there, what we were left with was a back to our catalog house value proposition that I would say was still fine. But at one point, it was industry leading. And if you don't move forward, others do, and we needed to play some catch up. And so this was actually -- I've been really encouraged to see, but Martina came in. And this is probably the biggest -- she's had a few big imprints on the company, but her diagnosis was, this is the economic engine of the business. We got to get the core customer back and came up with basically a 4-part plan to do so.

Number 1 was to realign our public-facing web pricing. So if you're a customer that logs on to our website and you don't have a negotiated discount, our pricing had drifted up, which was kind of similar with how the industry pricing structure worked. Add in, I mentioned earlier on in Amazon or some other single channel models and we looked out of [ WACC ]. That was one.

Two, we needed to upgrade our e-commerce experience, which was really good for the sophisticated large buyers not as good and at one point was industry leading, we needed to play catch up for the smaller customer.

Three was marketing. And really, once our feeling was once our pricing was realigned and the web experience was back to industry leading, we wanted to hit the foot on the accelerator with respect to marketing, but in a different way from our legacy, which was mostly print which, in some there's some great things about print, but it tends to be costly, it's slow and it's not personalized. And so we built out a much more aggressive digital tech stack that allowed us to get more timely and more personalized and targeted in our marketing.

And then the fourth leg of the stool around sort of reinvigorating the core customer was optimizing our seller coverage. So what Martina came in and diagnosed was we had a large concentration of our sales force focused on these big relationships where we're doing great, not enough coverage in the smaller guys. And so she took a look and brought in -- I know you referenced this on the -- on your note, but sales is a science. I mean, Martina comes from an organization called [ HILTI ] that was really a selling machine and she actually brought somebody in from HILTI recently. It seems terrific. And they're bringing a science-based approach to how you, number one, expand reach. Number two, construct the portfolio of customers the right way. Number three, look at compensation. And number four, look at the tools that are surrounding the salesperson.

So all of these 4 bodies of work, long-winded way of saying, have come to fruition between basically -- we're early in our fiscal '26, the end of fiscal '24, with the big pieces in the middle of fiscal '25. So I think early this calendar year, February and March. And sure enough, we launched the website, we launched -- upgraded the website, the marketing. And bit by bit, we have begun to see the core customer improve. So that core customer was in decline in the first part of our fiscal '25 or about a year ago, hefty numbers, high single digits, low double digits. We saw a continued steady climb to the point where so Q4, again, is June through August, the company grew [ 2.7 ]. The core customer grew [ 4. ] And we mentioned that we actually saw it continue to improve in September and October. So we think we're on the right track there, which opens up a lot of market share capture, but also margin expansion for us.

And Erik, if you could compare and contrast the core value prop that you bring to the national account versus the core, I use core twice there, to the core customer. But with national account, as you've referenced, it's more of a total cost of ownership type pitch, and they are all different ways, largely service-based that you can deliver of lower cost of ownership to the customer.

In the core category, what would be the equivalent there? I mean, buying experience has to be part of it, and you talked about some of the web experience there. But do a better job than I am right now of summarizing, what is it you're attempting to construct to capture the core?

Yes. So it's a great question, Tommy, because some of the things I described like getting your pricing right and a web experience [indiscernible]. So what's been interesting is what we found along this journey is that even the small and medium-sized customers, they care about the same things. They're not as sophisticated in how they go about it, but they care about making their business better, which means how do I take cost out, how do I increase throughput.

And so what we've done is looked at how we deliver a similar kind of value that we do at the high end to a medium and even a smaller customer. And so I'll give you an example. We have a technical team that is an inbound technical team. So these are people who spent years or decades working in a machine shop and no longer wanted the grind of that and are now sitting in one of our call centers. we're opening up access to small shops to this group. And that changes the value proposition from just, hey, it's price and transact to these people. With Facetime, I mean, they're actually able to help the customer save money and find productivity. So there's other examples like that, Tommy, that are kind of like the difference maker in the small and medium.

So national accounts, we've hit on several times, but maybe give us the latest and greatest on how you're bringing that total cost of ownership solution. The on-site location is part of it. But you've had some of these initiatives in place for some time. So where are you spending most of your time today on the national account side?

So for the national accounts, what I would say is the whole model is anchored in how do we improve customers' output cost down or revenue up. So for our national accounts program, there's a regular cadence where we will sit, we'll go in early on, diagnose what we see happening and come back with a recommendation to the customer, that will identify a total size of prize of what we think we could help them achieve in either revenue up or cost down. And it has to be in the customer's math.

We will use that as our anchor. We call that a business needs analysis. That turns into a plan. And that's kind of our north star with the customer. We will have a regular cadence, depending upon the size of customer, monthly, quarterly of kind of rinse and repeat of looking at how we're doing against it. And then we deploy a whole number of tools on how we actually bring the savings to light. So obviously, we talked about In-Plant. We talked about our vending initiative, which is bringing shrinkage down and improving tool usage. Our technical team, so we also have people that will go in and walk plant floors and help customers identify opportunities to use a different tool to use technology that we have that helps them run machines faster so they can save time and not have to invest in more capital. So it's a very rigorous process. And yes, that's been fueling our national account success.

Along those lines, could you just give us a little context of [indiscernible] gone from the catalog company to providing obvious additional value-added services? Structurally, how much higher -- margins given the value you're bringing to customers? [indiscernible]

So I would say, right now, we're sitting at high single digits EBIT or operating margin and we see -- that has been a combination of some heavy investments in fixed costs that we've made, whether it's digital, our e-commerce upgrade and such along with 2 years of contraction. We feel like there's a path back -- I mean, what our stated goal is at least mid-teens on the operating margin front. We haven't time bound that. A lot of that will be a function of the pace of revenue recovery. So for instance, our fiscal '26 as a kind of rule of thumb, we had shared that we expect a mid-single-digit revenue growth to produce around 20% incremental margins.

We would expect, if I look out over the next 3 years, that would be in a flat environment if either the environment in flex or our share capture picks up pace or we get more price than we're getting now, that revenue number should improve. The revenue number improves, the incremental margin number should lift. And the incremental margins, so the mid-teens operating margin target is really going to be fueled by a couple of things. Number 1 is revenue growth and leverage. Number 2 is going to be -- for the -- if I look back over the last 10, 15 years for us and most of our peers, there's been a gross margin headwind in the business of call it, 30 to 50 basis points because the big customers grow faster than the small ones. We're kind of encouraged here that this could eat into that gap and stabilize gross margins if the core continues to outperform.

The third lever is productivity. And Martina's really brought a, I would say, a sharper edge to productivity inside the company that would overlay on top of just leveraging a fixed cost base but actually eat into the cost base. So she's looking at -- there's a couple of big areas. Supply chain is one. And we've highlighted some numbers that we're expecting to achieve in a run rate basis right now. Seller optimization, I mentioned is another. And then she's got some things cooking on just general SG&A as well. So that would be our outlook.

Can you talk to these value-added services? Is there a way to look at just what it's done for customer satisfaction scores or churn or however [indiscernible] best way to measure what these initiatives about?

That's -- those are exactly the metrics. So if you're sitting in our boardroom, you'd hear a push, and I'll be transitioning to being -- management, maybe I'll start giving this push. But hey, why aren't we charging for these services, if they're so valuable. And there's elements where we can, the biggest levers we see to value creation are not a service fee. It's share capture and revenue growth, particularly for an existing account if we get share of wallet. That's a very strong incremental margin and retention.

So as a case in point, when we put in a vending machine, there's an expectation we have, the customer will sign a letter of understanding. I mean, it's not a legally binding document but saying, hey, in exchange for this, I will divert x amount of spend to you, MSC from one of your competitors. And depending upon how big the machine is and how many machines, that number will vary. With In-Plant or retention is another thing we look at. And if you looked at our retention rates for our core customer that doesn't have any sales relationship, they're going to be rather low and getting better but still low. If I go to the other end of the spectrum, an In-Plant. So we have 411-ish In-Plant locations that I could probably count on 1 hand the number that we've lost. They're extremely, extremely sticky.

Any other questions from the audience?

Well, let me take that 411. Where were you a year or 2 years ago? Can that number be 1,000? [indiscernible]

Yes, north of that.

Yes. We were at 287 beginning the last fiscal year. Our 411 -- In-Plant program count has been growing at a 20%, 25% year-over-year clip for quite some time. [ Pending ] has been growing at high single digit clip for quite some time as well.

[indiscernible] every national account of potential [indiscernible]

I would say not every, but a lot. So with the In-Plant program, different from a national account, the agreement is generally signed at the corporate level. The In-Plant decision is made at a site level because you're bringing the resources into the site. So we could have a national account that has 20 sites that could have 2 or 3 In-Plant. There's typically a breakeven number of revenue that we need to justify putting somebody in their [ full ]. Usually, it's a person, and we're bringing vending machines in. So the cost becomes the cost of a person or people and then the depreciation on the vending machines that are in the plan. So it's a side by side. But let's put it this -- I mean, if we look out over time and the runway is in the thousands.

Do national accounts [indiscernible] and then you've seen them roll with [indiscernible]

Yes.

Thanks for the questions and anyone else that wants to shoot up a hand, please do. I've got more topics, but certainly welcome anything from the audience, yes.

A couple of questions. One is, it looks like about 60%, 70% is [ business related matter manufacturing ] [indiscernible] There's an downturn [indiscernible]

Okay. So to that one, I would say, yes, look, we made a choice that we're going to lever into manufacturing and heavy manufacturing because we think our competitive advantage is strong, and we think the long-term end markets, for the most part, are sound, that the growth outlook is good. I think if you want to understand what would happen in a heavy downturn the last 2 years are evidence of that. So it does make us a bit more cyclical.

The last 2 years, heavy manufacturing has been really soft. We saw negative revenues. Our thesis is that if we look over long periods of time, we are in, number one, manufacturing for the most part. As I said, we feel good about the long-term outlook. Number two, the distribution market is so fragmented. So the top of [indiscernible] what are some of the fastest-growing end markets. So I mean, aerospace is an obvious one where it's been strong and the backlog is a decade plus, and that's an area where we actually have increased our concentration. There's a couple of others we have our eye on.

And I also add that we're probably better position for a downturn than we were in this past [ 1 ] due to the seller effectiveness and optimization work we've done last quarter. [ Selling heads ] were down about [ 100 year-over-year ] quarter-over-quarter and about [ 60 ] year-over-year. Customer [indiscernible] were up low double digits year-over-year. So we're being more effective and efficient with our sellers, too. And then if you think about the enhancements to the website as well, there is a mix benefit there from [indiscernible] website. So I'd say we're better positioned to attack a downturn if it does occur.

And then 1 more question on -- it looks like you have, correct me if I'm wrong, [indiscernible] In-Plant [ not that ] if you look ahead like, let's say 3 years, 5 years, where do you see that, that's sort of increased?

Yes. We think it increases. It's -- the rate limiter on implant as a percentage of total will be how our core customer fares because if we're able to grow the -- the In-Plant ant will not make sense for most of our core customers because they're simply not big enough, and there's not enough spend. I am hopeful that we can keep that rate down not because In-Plant doesn't grow, but because the core customer grows faster. I would say if you looked at our count. So we're at [ 411, ] as I said. I mean, that number in a few years should be well into the thousands, like we don't see a runway there.

The interesting thing about In-Plant, so that it's 20% today. If you look at the economics on an In-Plant, the gross margin on an In-Plant will be several hundred basis points lower than our core customer. And that's because bigger customer, better ability to negotiate, one. And two, we're penetrating deeper and deeper into the customer, which tends to mean lower margins. But what we do see on an operating margin basis, particularly by the time you get to year 3, and I can describe why at or above company average and certainly at or above our target. So if we want to get to mid-teens operating margins over time, In-Plant is not a barrier to that when you get to year 3 because what happens is we put the person, we put the vending machines, all the cost goes in upfront, the revenue, it generally takes a good 2 years before you hit kind of like a steady state.

So you trade-off between your gross margins and maybe long-term [indiscernible]

Yes, because it's a higher degree of fixed costs than the rest of our business. And we actually experienced that in the last 2 years with the softness Ryan refers to as a coiled spring effect that our In-Plant program. So if you look this last quarter, count was up -- In-Plant count was up 20-something percent. Revenues were up 10%. So on a per In-Plant basis, revenues were actually down. Now part of that is because we're signing newer accounts that have a lower average spend with us, but also part of it is you take -- we have some really good In-Plant accounts in the heavy truck sector, which is just getting...

How much is [indiscernible]

So depending upon the size of the site, it could be between 1 and 3 people. .

One in three people CapEx associated?

And then depending upon vending machines, 10, 20 vending machines and then our average...

But what I'd say is when an In-Plant gets to about $2.5 million in sales, it's closer to company average of margin to give you a little bit of perspective there. And the revenue through that In-Plant program at Erik's point, we have the pretty much the maximum share of wallet we could have. The revenues from the In-Plant program match whatever the production rates are. So if we see a customer go from 2 shifts to 1, that In-Plant program is really going to fuel that because consumption rates are lower.

So it's the same machine going in different places? I'm just looking at scalability. I mean, do you have to custom get out of this?

Our customs would be more on the vending machines because they're more catered towards metal working. And you can have like a pop vending machine because if you drop that cutting tool, you're going to chip it. So I'd say we're differentiated on the vending side because it's located towards metalworking.

Okay. One last 1 question. Talk about customer experience and how the larger customers, they know how to go through your system, but then you revamp [indiscernible] What kinds of general things did you [indiscernible] Did you have to go change the back end, invest in the back end? I mean, talk about the...

Most of the customer experience improvements have been what I'll call either front end or a technology foundation. If you're thinking back end, like our service level, our fill rates to customer, our product offering, our delivery model is good. And we track Net Promoter Scores every week. So we see -- we're really good at getting product to customers.

The biggest thing was the experience -- and if a customer -- if you're a customer and you call one of our -- what we call our customer care associates you're going to get -- it goes back to the culture and the family feel pretty great experience, and you get people who will jump over backwards to delight a customer and do whatever it takes. There's that kind of mentality. Our e-commerce experience, it wasn't good enough. It didn't match what we did off-line. So I would say the easiest -- what we did first is we upgraded the tech platform, and we modernize the stack just to make it much simpler, cleaner, and that work is done.

So what's in [indiscernible] other than [indiscernible]

We had -- so it's -- I mean, it's number one, it's actually reevaluating the technology platform rather than looking at 1 monolithic platform. We broke it into pieces, which is a more modern, modular way to go. Two, is search. That's really the holy grail, if you will, when there's this many SKUs, the ability to find stuff fast. And so that actually leads me. So we upgraded our search model and the way we present products.

The other thing we're doing now that is still got a way to go, I would say, is content, the build-out of data and content. And I think what's exciting is that this is an area where technology -- I mean, in particular, AI, opens up so many avenues to build content faster because you could have the greater search engine in the world, but if the data behind the search engine is not robust enough organized properly, it will be tough to find. I think there's still an unlock for us there. So I would say our e-commerce experience is the biggest thing about the customer experience upgrade. I would call us good now. I would say we were mediocre. I think we're good but we need to be great, and we're not great yet.

And this last fiscal quarter, web average daily sales turned positive for the first time in quite a while. We're seeing improvement in the conversion rates, average order size and the direct traffic. And then we also streamlined our checkout experience too. And what we saw is within the first 0 to 5 minutes, somebody adding an item to their cart improved year-over-year for the first time in a while, so [ that's telling us this one ]. It's -- our search is working and to the checkout experiences working as well.

Erik, you mentioned AI, and that's the theme I want to end on today. Where are you in that journey? What are -- any examples you can share where you've deployed the technology internally?

We're very early stage. Let me start by saying, Tommy, I don't know that there's a better industry that's ripe for AI than distribution because we just -- we talked about millions of SKUs, thousands of suppliers, hundreds of thousands of customers, so all these permutations. So we think it's going to change the company and the industry in very fundamental ways. So I mean, we're in the very beginning stages, but we've taken a few steps and we've got a pretty robust road map right now.

So the first thing we did is we brought somebody -- and this was during COVID. So this was before generative AI actually, but we brought somebody to our Board of Directors who had lived in the AI early-stage venture space for 15 years. So she was in it well before generative AI because we wanted to have somebody with a network and a knowledge of working base on our Board. So the second thing we've done is we plug somebody out of our company who she's really strong engineering and data science background. She's in [ Melville ], where I'm located. She's really smart and eager and she's getting a lot of support from our Board, and she's got a team. And basically, that team is chartered to build a road map along 3 vectors, if you will, but look at every possible use case and catalog and prioritize for customer experience, revenue generation and productivity. And then we have like a game board, if you will, on what we've prioritized.

In most cases, I mean, there are some obvious things that we're doing with whether it's Copilot or the real basics stuff. But in most cases, we're trying to be humble enough to say we don't need to go build this stuff. There's people way smarter than us that are building new things every day. And so we're trying to partner with companies outside of us who are in that ecosystem. So I mean, I'll give you a couple of examples. One is cross-selling and upselling. We've been partnering with somebody for a few years. But when a customer calls into us or visits our website, we are serving up highly relevant recommendations or -- and the numbers, we had tried this on our own before using AI and the numbers are just leaps and bounds ahead. We're marketing. So we've been talking about some of the success in our core customer was driven by -- and I'll just be careful for competitive reasons, the marketing efforts. We mentioned we're stepping up investment where it's working AI-driven marketing, which is getting more personalized and more targeted and more real time is a big one.

And then on the productivity front, you can imagine it's probably not that dissimilar to many of our peers looking at [indiscernible] repetitive function's where there's cost down opportunity. [indiscernible]

I want to thank everyone for your attention and interest in MSC. And again, I want to thank Erik and Ryan for their time and insight. We appreciate it. .

Thank you. Thanks, everybody.

Thank you, everyone, for joining us for the 55th Annual Baird Industrial Conference. And great to have MSC Industrial here this year again. Erik, probably your swan song here as CEO for sure. But to speak with us today about the company, we have Erik Gershwind, CEO; and Ryan Mills, who's the Head of IR.

Erik is going to go through a few overview slides, and then we'll go to Q&A, small room, so we can clearly take questions from all of you. [Operator Instructions] So with that, Erik, take it away.

Great. Thank you, Dave. Good morning, everybody. Dave, I think you're right. It will be my swan song at Baird. It's been a great conference. So thank you. It's nice to see everyone here despite the weather. I've seen standing room only before. I've not seen sitting room only. So Kevin, at least you're here. Dave, thank you. So I -- we're going to be brief in terms of the prepared remarks, and this is really intended for those who aren't familiar with the story.

MSC is a leading industrial distributor of over 2.5 million SKUs across a wide range of industrial product categories with revenues approaching $4 billion in revenues. We have a long history that goes back to 1941 and over the years, have obtained a leading position in the metalworking supplies, which represents one of the categories we sell. Metalworking is roughly 45% of MSC's revenues and that business is supported by a large network of technical expertise that's located throughout North America and the U.K.

We compete in a market that is very large and highly fragmented. So the North American MRO market is in excess of $200 billion. And interestingly, the top 50 distributors still after all these years and all this time I've been doing it, Dave, the numbers, the ratio has changed slightly, but not all that much. So the top 50 have a little in excess of 1/3 of the market. So that has inched up over time, my time doing this, but not nearly as fast as one would think which is pretty compelling.

Lastly, roughly 95% of MSC's revenues occur in North America. And most of those revenues are levered into the manufacturing sector, which we think is also offers a compelling long-term outlook.

I'll move to our financials and highlight some of the key characteristics that I think make us compelling aside from the growth prospects, which I think are probably the first and foremost headline Beyond that, though, we do have a healthy balance sheet with a net debt-to-EBITDA ratio of just around 1x. We have a strong cash generation profile. We've generated free cash flow in excess of 120% over the past 2 fiscal years. And this has allowed us to return cash to shareholders in a couple of forms, most notably in an ordinary dividend which has a yield around 4% right now, which is certainly relatively high.

We've also made some enhancements to our corporate governance that I'll touch on and our leadership that I think are pretty exciting. One is, it's roughly 2 years now we collapsed. The company was a dual-class share structure company. We collapsed that -- the A and B shares together and did repurchase any dilution within the first year.

And then, Dave, we mentioned last month as part of what's been a planned transition Martina McIsaac is going to be assuming, is only the fifth CEO to the company has been around since 1941 and only the fifth CEO in company history as I transition to the role of Vice Chair of the Board. I'll talk a little bit about if Ryan, are you moving us along here.

Yes.

Thank you. Perfectly. A little bit about our strategic direction. And what I'll do is highlight what we refer to as our mission-critical program. We had a Chapter 1, which concluded at the end of our fiscal '23. We are currently in our second Chapter of it. And there's really 3 priorities. The first is maintaining momentum on what we refer to as our high-touch solutions, most notably our inventory management programs, our implant programs that are bringing us closer to the customer. And if seen strong momentum, which I'm sure we'll touch on.

The second is investing in a couple of new areas for growth and probably the most notable there is what we refer to as our core customer base which is slightly in excess of half of the company's revenues and is made up of small- and medium-sized customers. And this is a customer base that has underperformed the company's average for the last decade. There's been an intent focus on reenergizing that customer base. through several initiatives that I'm sure we'll also get into, and we're pretty encouraged by progress.

And then the third priority is reducing our cost to serve. And in this area, there's -- Martina, in particular, has been leading the way here. And there's two, I think, two exciting areas where we've been making progress for now with more to follow. The first one being supply chain and optimizing our network. So we've been quoting a number of $10 million to $15 million in run rate savings to be achieved essentially. Now we're on track with that.

And the other is optimizing our sales model, seller coverage and effectiveness. This has been one of Martina's primary areas of focus and also an area that I'm sure we'll touch on that we're seeing, part of what's fueling the reenergizing of the core customer.

So a lot of heavy lifting has been done. We're encouraged by -- in spite of what's a bit of an uncertain environment right now, an unstable environment, some improving performance that, so all the hard work is starting to translate. So just a couple of data points from our most recent fiscal quarter.

And as a reminder, for those who aren't familiar, we run a fiscal year, September through August. So our fiscal fourth quarter was June, July and August and that's what we reported on just a couple of weeks back. So 10% growth in our installed base of inventory management or vending systems, a 20% growth in our installed base of implant initiatives, and both of those are driving market share capture and penetration.

And I think most notably, a return to growth for the company overall and in particular, the core customer base that I mentioned, which is driven by really several factors that Dave will talk about, I'm sure. So we did see momentum as we reported on Q4, we shared progress for September, October, at least on the top line. We did see momentum continue into the first months, the first 2 months of our fiscal 2026 despite some uncertainty and, of course, choppiness with the government shutdown. But really excited about the future -- the future of the company. I think we're on a great path. I'm excited for Martina. I'm excited to be part of it in a Board capacity. And I think, Dave, with that, maybe we'll -- I'll turn it back to you.

Okay. Let's launch into some questions. They want us to ask all companies. So I'll start off with this 2 quick things. One is on the impact of changing government -- government policies. And that could be -- it could be anything really. I think people are wondering about the old BBVA and regulation, immigration, M&A. Any other factors related to government and how you see that impacting the business today?

So Dave, what I would say -- and maybe what I'll do is break the answer apart into two what we see over time. I could give you kind of a long-term answer and a right now answer. And I think the long-term answer would be I think most of the regulation, most of what you're describing or deregulation would be favorable to business. And for us, MSC where we're coming from is primarily, as I mentioned, levered into manufacturing and heavy industry. We think most of it is very constructive. I think in the near term, certainly, there's been, I would say, 2 headlines just in terms of the way things have played out with tariffs, in particular, has been uncertainty and inflation.

So I guess, certainly, the tariffs for sure, but even immigration policy, there are inflationary factors here that we reported on our last quarter, and anybody who's in the industrial space right now is talking about inflation being very real. So over time, we think that the prognosis for North American heavy industry and manufacturing between the tax stimulus and the intent of the tariffs is quite good.

Near term, customers don't like uncertainty. They certainly don't like inflation. So there's been some choppiness, I would say. I think the other thing is -- it actually the push to inflation, it's generally been, over time, fairly good for distributors. And I think it's particularly good for MSC because one of the tenets of our value proposition and what we do in the metalworking environment, is bring cost savings to our customers. And in times of inflation, most of our customers will understand, they all read the headlines, prices are going up. The discussion quickly turns to what can you do to help me offset this pressure? And I think that plays well into our value proposition.

All right. Sounds great. Second, there's this thing AI. It stands for artificial intelligence. If you haven't heard that acronym. But -- so they want us to ask what are some specific examples of implementation that you've done with AI? How it's impacting the business and some specific outcomes if you've done anything that have resulted from that?

Yes. we have -- I don't know that there's a better industry. I mean, AI is changing the world for all of us, but I don't know that there's a better application for an industry that's more ripe for AI than distribution and industrial distribution, in particular, because for many companies like MSC, we're dealing with, as we mentioned, millions of SKUs, hundreds of thousands of customers. And so you think about all the permutations, it sets up beautifully for AI to help the business. So we've been taking it very seriously from a Board standpoint of bringing some expertise on to the Board.

And then inside the company, we do have a full court press. We have a high potential person with an engineering and data science background, who has a team that's living and breathing, working this through the company. And basically, David, it's along 3 dimensions. Number one is revenue growth. Number two is customer experience and number three is productivity.

And we see applications across all. We're doing it in partly inside the company and part through partnerships with some folks outside of the company who do this for a living. But whether it's on the revenue growth front, AI has been a big part of some of the marketing success that we've had that we've talked about fueling the core customer, some cross-sell and upsell activity, customer experience, whether it's looking at our inventory management systems and how we help that our customers better manage their inventory, looking at product content build-out, what our customers would experience from us digitally. And so that would be in the customer service area. And then on the productivity front, I mean, there are so many applications, whether it's receivables and payables, applications, but a lot of the road functions are AI is being applied there.

That's great. Okay. Well, maybe we could talk about the 4 key initiatives at the company, web pricing realignment, e-commerce enhancements, accelerated marketing efforts and sales force optimization and some of the early benefits you're seeing there?

Yes. And they kind of fit together, Dave. So I mentioned in the prepared remarks that a little over half of our business is what we call our core customers, small- and medium-sized shops. And what we found over the years is the first pillar that I mentioned of the high-touch solutions, which tend to fit well with larger organizations had really gained traction. And in some cases, those same solutions aren't cost effective to bring to a small and medium-sized shop. And so we had to take a hard look at our value proposition, and we did and identified kind of 4 areas of focus for the small- and medium-sized shops, and you mentioned them, Dave. So one was our public-facing web pricing with which all of the changes in the industry had moved out of line. And so we've been pretty public about that. And during our fiscal '24 made adjustments there. So that certainly is behind us.

The second was continually upgrading the quality of our e-commerce experience. And this was an area that was a -- one of my first jobs at MSC actually was to build out our early e-commerce presence. And it's one of those areas where if you're not moving forward, you're moving backwards because everyone is making progress at warp speed. And our experience went from being what we felt was industry leading to somewhere in the middle of the pack, and that's with all the alternatives, that's just not good enough. So we did put a heavy focus on upgrading our e-commerce experience, which, in some ways, is -- it's painting a bridge you're never done. But I would say the heavy lifting for us was completed with a platform upgrade during -- in the middle of our fiscal '25. So February, March time frame.

With those 2 things done, there were 2 other important drivers. The third was marketing. The company, in many ways, the roots of MSC had been what was known in the industry as a catalog house or a direct marketer but really embracing the move towards a more aggressive digital marketing build-out, which does a few things. It allows you to get more personal, more personalized, they should say, and more real time and agile. And so we launched once the pricing and the web experience were where we wanted them, we've been pretty aggressive about our marketing acceleration, which happen in the back half of our fiscal year.

And then the fourth along the way was I mentioned, Martina, what she brought with her is kind of a really strong expertise with sales force optimization, which I would say is not something we were great at until she came along. And those 4 together have really started to gain traction. So our core customer, which had underperformed the company moved to -- it was encouraging sort of bit by bit during the fiscal year, we saw improvement. But in our fiscal fourth quarter returned to growth and actually outgrew company average. So we still -- we think we've got a long way to go here. And especially as the environment stabilizes we've got high expectations for that part of the business.

Am I wrong to think that sales force optimization is the biggest opportunity at MSC?

There's so many good ones. I don't think you're wrong. I think there are several, but that is -- I mean, it's one of the biggest cost basis, certainly. It's where a lot of our investment and people have gone. And certainly, it's the biggest driver of revenue. So it's a big area of focus. You may have seen among we've had a few organizational updates and changes in addition to me, one being the split a part of our traditionally, our sales organization into two parts and one focused on proactive selling and share capture in Martina's words, and you've heard on the earnings call, but firm belief that sales is a science. And she brought somebody in that she had worked with for many years at Hilti, who's been obviously early days, but terrific in bringing that sort of mindset.

And then Kim Shacklett, who is a long-time MSC leader and industry leader and she's terrific, has taken customer experience, which is really about wrapping our arms around every customer, every transaction from a service standpoint. So I think you're not wrong to think that it's the biggest opportunity.

Okay. We look forward to seeing that play out. Maybe we could talk about the solutions offering and do you expect growth to continue there? And how will that benefit the business longer term?

I do, Dave. I mean it's -- the solutions part of the business has been growing, and it's interesting because it's what Ryan has been referring to as a coiled spring effect because if you followed us for any period of time during this last couple of years where manufacturing has been soft, our footprint has been growing aggressively, much faster than the revenue growth that these customers has been growing. And these are some of our best customers where we have a very good handle on market share in a lot of cases, they're just not spending. But we do see -- and it's primarily inventory management systems, whether that's a vending or a vendor-managed inventory program and our implant program, where we're placing MSC associates full-time inside of our customers.

I think part of the confidence that I have and the growth is our execution of the programs. But part of it is also, Dave, it does seem like we're tapping into something our customers -- you go and visit customers right now, anybody doing manufacturing and 9 out of 10 times when you ask a general manager and owner of a shop, what's your single biggest issue, what's keeping you up at night? One of the top two things you're going to hear is access to talent and labor. It's reached a fever pitch. And so the idea of assisting with that, whether it's do it in an outsourced inventory management program or people inside of our customers' operations that are taking over lower value-add functions for them, be it sourcing, put away, kitting and then bringing in some of our technical experts and our lean experts who are walking plants and finding opportunities for productivity, I think we're tapping into what's most critical to a manufacturer right now.

Does that center on metalworking? Do you lead with metalworking as a key offering for you?

We do -- I mean, metalworking is critical to what we do, Dave. But I would say if you asked what we lead with, it's around improving our customers' output and it's really centered in how do we find productivity for the customer. And productivity for the customer could come in the form of cost down, meaning material, helping them cut material at a faster rate and less machine downtime. It also could come in the form of helping them grow their revenues faster. So if we can help them run their machines faster and speed up throughput and we have a whole number of people who are capable of it, armed with technology that helps them do it, we can actually speed up production which will allow them to take on more business and not have to add machine capacity. So I would say that's the anchor for us is how do we improve our customers' output. And then metalworking is a big piece of the story.

Got it. Small room. I'd give you the iPad information. But if anybody has any questions, you just want to raise your hand, we can go to the audience here. Okay, we'll keep going. And could you talk about -- we already discussed the government more as a regulatory body, but could you talk about end market segments and then government as a customer and what you're seeing currently with the shutdown and how you see that playing out?

Yes, sure. So I'll start overall. And I think on the last call, we described it as stabilizing end market. So we been in a period of 2 years. So again, you're getting a vantage point of MSC whose 70% of our revenues are manufacturing and the vast majority of that 70% would be heavy manufacturing industries. And with a couple of exceptions like Aerospace, most of those industries for the last couple of years have been particularly soft. What we've seen over the past several months is what I would call stabilization for the most part. So you have some pockets like aerospace that are still doing really well. You have pockets like heavy truck that are still really struggling. But I would say the overwhelming kind of headline would be stabilizing in an uncertain environment, which we felt like we don't need -- we shouldn't need strong end markets to be able to outgrow IP and produce positive growth, just stabilization.

As it relates to the government, Dave, so public sector is around 10% of our revenues. It's been a good story over the past several years. Of that, we've shared about 2/3 of that is federal, 1/3 state. So call it, I'm rounding here, but around 7% of our business is acutely affected by the shutdown activity. We did call it out on the earnings call that we saw a pretty sharp and immediate impact being felt. So to put color on that public sector had been growing and it's kind of lumpy, but it had been growing nicely, call it, high single digits during the last fiscal year 2025 September public sector was, Ryan, I believe, double digits.

Low double digits.

Low double digits, and then we called out. We were only about -- when we did the earnings call, I think we were halfway through our fiscal month, but it had already gone negative. So we did see the effects of it. Hopefully, things will be coming to a wrap. At some point, they will, hopefully, sooner than later.

Yes. For you and for all of us that need to travel back after the conference.

The turnout is remarkably good considering it has been.

It has been. It's resilience. So maybe you could talk about I know you don't provide quarterly guidance, but any color you could provide on expectations for sales and profitability in the remainder of the fiscal year?

Yes. So I think on the revenue side, and we -- there was a period of time where we give an annual guidance, and we are such a short-cycle business that most of what we're selling, we're shipping next day. So our view into long term to try to go out a quarter, let alone a year is really difficult. So we went back to giving guidance 1 quarter at a time where at least we have a better line of sight. And usually, when we give the guidance, we have a month to 1.5 months under our belts in fairness. It's just hard to look out.

I think on the revenue line, Dave, what I would say is, in general, we feel encouraged, absent some change in the environment that who knows that between the stabilization in the environment, the momentum and the growth initiatives and then, of course, pricing and what's seeming more inflation, that the revenue growth, we feel pretty good about for the back half of the year.

I will say our fiscal second quarter includes December. It wouldn't surprise -- the last couple of years, the holiday time is like post-COVID, it seems like the holidays have had a more pronounced effect than I remember before COVID and usually when they're in the middle of the week, it's even more pronounced up.

Thursday this year, I think .

Right. Right. Maybe not as bad as ones, last year was Wednesday, but it wouldn't surprise me if Q2 had more of a seasonal dip to normal with the holiday time. But putting that aside, like looking out, we feel pretty encouraged by the rest of the year and building momentum. And then on the profitability side, Dave, what we've talked about publicly is targeting an incremental margin on our growth of around 20% at mid-single-digit revenues. Certainly, to the extent we do better than that. And to the extent there's more price in that number, then we would expect to do better than 20%.

Yes, I'm a big fan of contribution margins for distributors. It just seems like a very logical metric to track and to project using -- so beyond this year, when we think about into the -- well into the future, if you're able to achieve a mid-teens kind of operating margin, could you talk about the contribution margins as we sit here today between here and there, what should that sort of look like on a normalized basis, assuming it's not overweight price or some other factor?

Look, I think the idea of 20% at mid-single digits for this year would seem to be a reasonable proxy, Dave. I would say, over the next few years, given the softness we've had and given some of the -- our own self-help here that we should have a couple of years here that are considerably better than mid-single-digit growth. So if I think about that and then I think about the work that Martina has been driving on the productivity front, that's kind of a new tool in the tool belt for us, I would expect some years where we could do considerably better than 20%.

Okay. Sounds good. One of the -- another sort of soft side key initiative is to strengthen the culture. And I'm just wondering your impressions on that. What does that mean to you? And how important is that?

Yes, it's been -- it's -- I mean the culture has been -- you could imagine, with 4 CEOs over 80 years, 80 plus years and 3 of the 4 being from the same family, there's a very strong culture inside of MSC. And I think what's exciting to me is Martina has been with us 3 years now and has gotten to understand I think like anything in life, they say your greatest strength is also your greatest weakness. There's this incredible commitment to the customer inside of MSC, and we will jump through hoops to take care of a customer. And that's ingrained in us, and it's wonderful, and it's something I never want to lose.

I think the opportunity that we have, number one, is to scale it and make it more repeatable and number 2 is to introduce the word Martina used was more -- a little more curiosity to say, all right, if we're jumping through hoops to solve the same issue 3 times, how do we do a better job more quickly getting to root cause and solving it the first time? And I think that's probably the enhancement where she's focused, I would say, most notably.

Okay. We've got a couple of minutes left here. Again, any questions from the audience at all? All right. Then I definitely want to touch on capital allocation priorities and noting that your net debt to capital is currently 1. And you mentioned the roughly 4% dividend yield. I mean, M&A, of course, but put capital allocation into context, but with a heavy emphasis for me on share repurchase, given that situation, you're throwing off a lot of cash and you've got the situation where it seems like there's an opportunity that's greater than usual. Can you just talk about your thoughts there?

Absolutely, Dave. And I would say, despite leadership transition, that's one thing that you could expect not to change a whole lot. It's been from the start, a Board-level top Board, CEO, CFO level topic, that will continue. I think in terms of the pecking order, and I'll talk repurchase for sure. But priority one for us is organic reinvestment. We see right now a great path to value creation, just executing basically the road map that we've talked about this morning. And to the extent we continue to see high return projects, that's going to get top priority.

I think number two, continued steady growth of the ordinary dividend. Given the last couple of years, the payout ratio is higher than we'd want it to be over time in the '90s, but we expect with performance between this year and next year or 2, that will come back and we can continue ordinary dividend growth.

As for share repurchase, M&A, I would say, right now, less of a priority given the organic opportunities that we have. In terms of share repurchase, it certainly is a good opportunity. I think I'm mindful of a couple of things. One is interest rates while coming down are still high, and that does impact the return profile of a share repurchase.

The second thing is, and this is not to say we're not going to do them because we will. We agree with you that it's an encouraging outlook is I do think there's probably more upside than downside in terms of economic recovery in the next 6 to 12 months in manufacturing. And if there were to be any sort of snapback in the environment, combined with initiative traction, we could start eating up working capital fairly quickly on a rebound which would mean inventory and receivables. And I just want to make sure we're a long way from being hamstring at one time, to your point. So share repurchases in the mix. But I would want to make sure that we keep plenty of dry powder to take advantage of a snapback because what we found over time, interestingly, the best opportunity to capture share from the vast majority of the distributors that aren't as well capitalized, it's even more so on a snapback than on a downturn because everybody is struggling for cash. So we want to make sure we have the inventory on the shelves, the -- so I would say we'll do it, but we're going to be moderated with that in mind.

We are good. Erik and Ryan thank you for the presentation.

Thank you, and good morning, everyone. Welcome to our fourth quarter and fiscal year 2025 earnings call. Erik Gershwind, Chief Executive Officer; Martina McIsaac, President and Chief Operating Officer; and Greg Clark, Interim Chief Financial Officer, are on the call with me today. During today's call, we will refer to various financial data in the earnings presentation and operational statistics 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 U.S. securities laws. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks are noted in our earnings press release and 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 today. I'll begin the call with some perspective on our recent performance and a view into our mission-critical path forward. I'll then offer some commentary on our end markets and overall economic conditions. Greg will cover our results for the fiscal year before passing it over to Martina to provide her perspective on our recent performance and our expectations for fiscal year 2026. I'll then wrap things up by providing some additional color on today's announcement regarding our upcoming leadership transition. As we turn the page on fiscal 2025, I'm encouraged by the progress that's happening inside of our company.

We entered the year with 3 top priorities, and those were to maintain momentum in our high-touch solutions, to reenergize our core customer and to optimize our cost to serve. We're making strides on all 3 fronts and are doing so in the face of an uncertain environment. While there is still plenty of work to be done, our recent progress is beginning to evidence itself in our financial performance as we return to daily sales growth, and we're poised for operating margin expansion once again. First, our high-touch solutions, including vending and implant, continue the strong track record that we've seen all year long.

Martina will provide more details shortly. Second, and most notably, we've begun to see our core customer average daily sales growth rate inflect and turn positive. As you recall, we launched 4 initiatives aimed at reenergizing our core customer base. And those were realigning our public-facing web pricing, which was completed during our fiscal 2024, upgrading our e-commerce experience, accelerating our marketing efforts and optimizing seller coverage.

The largest milestones occurred at the end of our fiscal second quarter as we launched our upgraded website and our enhanced marketing efforts. Since that time, we've seen a steady improvement in core customer performance. Third, we've made progress in optimizing our cost to serve. We're on track with the supply chain productivity improvements that are yielding between $10 million to $15 million in annualized savings. We improved seller coverage and effectiveness by leveraging an enhanced data-driven territory model and tools that help reps more easily identify white space opportunity. And we have a growing pipeline of additional productivity programs that we expect to fuel more gains in fiscal 2026.

I'll now turn to the specifics of our fiscal fourth quarter on Slide 4, where you can see average daily sales performed better than expected and improved 2.7% year-over-year. The return to growth in our core customer base, along with continued strength in the public sector, resulted in better-than-expected volumes and was the primary driver of the beat. Benefits from price came in as expected during the quarter, contributing 170 basis points to growth year-over-year and 90 basis points sequentially. As a reminder, we took a broad-based low single-digit pricing action towards the end of our fiscal June.

That said, gross margin came in below our expectations at 40.4%, declining 60 basis points both year-over-year and sequentially. The primary driver here was tariff-driven purchase cost escalation, which came in faster and hotter than we expected during July and August. We also saw some other headwinds such as public sector-related customer mix. We have since taken action with pricing moves in the fiscal first quarter and have begun to see gross margins improve.

Operating expenses in the quarter were approximately $306 million on a reported basis. And on an adjusted basis, operating expenses stepped up approximately $8 million year-over-year to $305 million for the quarter, but remained flat on a percentage of sales basis. The primary drivers of the year-over-year increase were driven by higher personnel-related costs and depreciation expense.

Sequentially, adjusted operating expenses performed slightly ahead of expectations and declined approximately $6 million compared to the fiscal third quarter. Reported operating margin for the quarter was 8.6% compared to 9.5% in the prior year. An adjusted operating margin of 9.2% declined 70 basis points compared to the prior year.

This did, however, exceed the high end of our outlook by 20 basis points. We delivered GAAP EPS or earnings per share of $1.01 compared to $0.99 in the prior year's quarter. And we also saw year-over-year improvement on an adjusted basis. With EPS growing nearly 6%, coming in at $1.09 compared to $1.03 in the prior year.

The positive trend we saw in the fiscal fourth quarter has continued into the first couple of months of fiscal 2026 as our daily sales growth rate ticked up further to 5% in September, and it's we're expecting to grow between 4% and 5% in October despite impacts from the government shutdown. As we look ahead, we expect the step up in operating expense to moderate and productivity to build.

All of this positions us well in our efforts to restore profitable growth and operating margin expansion in fiscal 2026 and beyond. Turning to the environment. We characterize conditions as stable with some pockets of improvement, while the ongoing overhang of uncertainty remains. Tariffs have moved from a possibility to a reality as we're now experiencing meaningful price inflation across many areas of the business. Customers are generally understanding of price increases, as long as we provide sufficient transparency into tariff-related impacts. That said, the need to provide customers with offsetting cost savings measures is very real. And this plays well into our high-touch and technical value proposition.

Our suppliers are describing continued cost pressures on certain raw materials that are heavily China-based or influenced. And if this sustains, it could lead to further price inflation in the coming months. From an end market perspective, we've seen stabilization and even firming up in some of our larger verticals. Aerospace remains strong, while end markets such as heavy equipment and agriculture, which have been particularly weak over the past 2 years, or at least stabilizing. Some areas of acute softness do remain such as heavy truck.

Looking at Slide 5, I I'm encouraged to see how MSC is faring in this environment. Average daily sales in the quarter began to outpace the Industrial Production Index once again, supported by our improved customer performance and continued strength in the public sector.

With that, I'll now pass things over to Greg for an overview of our financial results for the fiscal year.

Thank you, Eric. Good morning, everyone. Please turn to Slide 6, where you can see key metrics for the fiscal year on both a reported and adjusted basis. Average daily sales declined 1.3% year-over-year primarily due to softer volumes in the first half of the fiscal year and the slight FX headwind. These headwinds were partially offset by positive price that contributed 60 basis points to growth and some carryover benefits from acquisitions in the prior year.

Moving to profitability for the year. Gross margin of 40.8% contracted 40 basis points compared to the prior year due to negative price cost and customer mix. Operating expenses stepped up approximately $56 million and $55 million on an adjusted basis as expected. Combined with slightly lower sales, this resulted in a 190 basis point increase in adjusted operating expense as a percentage of sales. However, we exited the fiscal year with adjusted operating expenses as a percentage of sales performing in line with the prior year. Reported operating margin for the fiscal year was 8% compared to 10.2% in the prior year.

On an adjusted basis, operating margin declined 230 basis points compared to the prior year. Together, this resulted in GAAP EPS of $3.57 or $3.76 on an adjusted basis, compared to $4.58 and $4.81 in the prior year, respectively. Now let's turn to Slide 7 to review our balance sheet and cash flow performance. We continue to maintain a healthy balance sheet with net debt of approximately $430 million, representing roughly 1.1x EBITDA, continue generating healthy cash flow in the quarter despite the increase in receivables through lifts and sales, we delivered free cash flow of $58 million during the fourth quarter, representing 104% of net income. This resulted in free cash flow conversion of 122% for the fiscal year ahead of our annual target.

Turning to capital allocation on Slide 8. Our highest priorities remain organic investment to fuel growth and advancing operational efficiencies across the business. Returning capital to shareholders also remains a priority. We purchased approximately 496,000 shares throughout the year. Combined with our quarterly dividend, which we increased by approximately 2% this month, we returned $229 million to shareholders in the fiscal year.

I will now turn the call over to Martina for a deeper dive into our quarterly performance and expectations for the new fiscal year.

Thank you, Greg, and good morning, everyone. Turning to Slide 9. We're encouraged by our daily sales trend that continues to improve across all customer types. During the fiscal fourth quarter, we were most pleased by the return to growth of the core customer with daily sales improving 4.1% year-over-year, driven by both price and volume. National Accounts declined 0.7% year-over-year.

This customer base continues to see a greater impact from the macro environment as only 44 of our top 100 customers showed growth in the quarter. However, on a sequential basis, national accounts performed in line with core customers and improved a little more than 1%. And Public sector continued its strong trend in the quarter with daily sales growth of 8.5% year-over-year and 10% sequentially. While this business has been impacted by the government shutdown, with sales growth turning negative in October compared to up low double digits in September, we view this as temporary.

Let's now dig a little deeper by looking at some of the key initiatives and KPIs supporting the daily sales improvement in the quarter on Slide 10. First, I continue to be pleased by the ongoing expansion of our solutions footprint. Our installed vending count grew 10% year-over-year or 3% sequentially to more than 29,600 machines. Average daily sales in the quarter for vending were also up 10% year-over-year and represented approximately 19% of total company sales. With respect to implants, our program counts at 411 expanded 20% year-over-year and grew 3% sequentially. Daily sales from customers with an implant program grew 11% year-over-year and represented approximately 20% of total company sales.

Improvements to our core customer growth rate have been driven by several programs, which Erik mentioned earlier. The first is sales territory optimization. Moving to the middle of the slide, you can see the increase in coverage effectiveness, which enables us to be more present at customer sites. The number of customer location touches locked by field sales were up double digits year-over-year and mid-single digits sequentially.

This increase was achieved with fewer sellers illustrating the potential that still lies in our sales effectiveness efforts. As we have shared, we've also invested in website upgrades and enhanced marketing efforts to restore core customer growth. In the fourth quarter, average daily sales on the web turned positive year-over-year with growth in the low single-digit range. We experienced similar improvements in the trend of certain KPIs such as direct traffic to the web and conversion rates of our top channels.

Our streamlined checkout experience drove declining abandonment rates in the quarter and enhancement to the search function of our site also started showing early positive signs. The percentage of users adding to cart within the first 0 to 5 minutes, improved in the low single-digit range, giving us confidence that users are finding what they're looking for more efficiently. Before I move past our quarterly results, I would like to spend a few moments on gross margin. Q4 gross margins came in about 50 basis points lower than our expectations.

20 basis points of the miss can be attributed to mix and other factors. 30 basis points of the miss was due to price cost. While our price realization performed as planned, cost realization did not. A combination of a rapid surge in the number of supplier increases, compressed supplier notification period, higher sales volume and a greater mix of direct ship orders all led to higher cost realization than planned during the quarter.

In response, we've made further pricing moves during the fiscal first quarter and are seeing gross margins improve off of 4Q levels. Before we get into our outlook, I want to highlight some exciting changes made to the leadership team that will strengthen our commitment to growth and the customer experience. You turn to Slide 11. We First, we welcome [indiscernible] to MSC as our new SVP of Sales. [indiscernible] brings 2 decades of engineering and field sales management experience from her time at Hilti with a proven track record of consistently delivering above market growth.

In this role, she will build on the progress made by MSC towards sales excellence. With Gida's arrival, Kim [indiscernible] will be taking on the newly created role of SVP customer experience. Leveraging Kim's 30 years in the industry, this new team will be dedicated to ensuring that every interaction a customer has with a is seamless and memorable, driving customer retention and share of wallet growth. I would like to congratulate both [indiscernible] and Kim on their new roles and look forward to sharing their future success.

As for the rest of the management team, John Reichelt is settling in his role as Chief Information Officer. He and the team continue making progress on the evaluation of our systems design. And lastly, our search for a permanent CFO is underway, and we have begun discussions with both internal and external candidates and hope to fill the role in the next quarter or 2. Let's now move on to our expectations for fiscal '26 by starting with our outlook for the fiscal first quarter on Slide 12.

We expect average daily sales to grow 3.5% to 4.5% year-over-year. The lower end of the range assumes the government shut down less through the remainder of the quarter, whereas the higher end of the range assumes that the shutdown ends before the end of our fiscal quarter. Our expected range also takes into consideration quarter-to-date sales with September up 5.1% and October trending towards 4% to 5% growth. As a reminder, we returned to growth last fiscal November, making it our toughest comparison to the prior year for the fiscal first quarter.

We expect adjusted operating margin to fall within the range of 8.0% to 8.6%, which takes into consideration the following: gross margin to improve from 4Q levels, and to be 40.7%, plus or minus 20 basis points and an increase in adjusted operating expenses compared to the fiscal fourth quarter of approximately $7 million to $10 million primarily driven by an annual step-up in depreciation and amortization from fiscal year '25 to fiscal year '26, a step-up in incentive compensation expense, 1 month of the merit increase and an increase in marketing investment, partially mitigated by continued productivity.

The increased marketing investments are the result of the progress we're seeing in our core customer and are all directed towards high-return areas of our accelerated marketing program. Turning to Slide 13 for our expectations of certain line items for the full year. We expect depreciation and amortization costs to be roughly $95 million to $100 million, representing a year-over-year increase of approximately $5 million to $10 million.

This largely reflects carryover from the investments made in technological and digital capabilities as well as continued growth in vending. Other underlying assumptions include interest and other expense of roughly $35 million, capital expenditures of $100 million to $110 million and a tax rate between 24.5% and 25.5%. Free cash flow is expected to be approximately 90% of net income. And lower than the previous year, driven by working capital needs to support top line growth.

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 key considerations for the second quarter and the back half of the fiscal year. And lastly, we have 1 extra business day year-over-year in the fiscal fourth quarter, as shown at the bottom of the chart. Looking beyond the fiscal first quarter, we expect incremental margins of approximately 20% at mid-single-digit revenue growth as gross margin restores to expected levels as we exit the fiscal first quarter and the benefits of our productivity initiatives build through the fiscal year.

And with that, I will now turn the call back over to Erik for closing remarks before we get into Q&A.

Thank you, Martina. I'd like to close out the call on a more personal note. It has been an honor and a privilege to serve as MSC's leader for the last 1.5 decades. And while I'm stepping away from day-to-day leadership, I will continue to serve MSC as Non-Executive Vice Chair of the Board. As I prepare to transition I've taken some time to reflect on my 30-year history at MSC.

Working alongside such an exceptional team has been 1 of the greatest privileges of my career. We have, together, grown and transformed this company from a traditional spot by distributor into the trusted mission-critical adviser and industry leader that you see today. Most importantly, we achieved this while living up to the values set forth by my grandfather, when he began selling cutting tools from the trunk of his car all the way back in 1941.

Succession planning and leadership development have been pillars of MSC's values since its inception over 8 decades ago. Leaders are chosen carefully, and they're thoughtfully developed over time. Like my grandfather, like Mitchell and David before me, 1 of my most important responsibilities is developing our next leader and then stepping aside when that person is ready. And so it is with great pleasure that I hand the baton to Martina who will succeed me as MSC's fifth CEO.

As you all know, Martina has been with MSC for over 3 years, and she knows every operational corner of the company. We've worked hand-in-hand during a critical phase at MSC, and she's been instrumental in shaping our operational improvements and our strategic growth initiatives. The board and I have the utmost confidence in her and we look forward to seeing her build on the momentum that's seen in our recent results and to provide a very bright future for MSC. I'd like to thank everyone on the call for your friendship and your support over the years. It's been a pleasure working with each and every 1 of you.

Martina, I'm going to turn it back over to you to close the call.

Thanks, Erik. First and foremost, on behalf of all of us at MSC, I would like to take a moment to acknowledge your extraordinary leadership and the lasting impact you've had on the company. Over our nearly 30 years here, you've guided us through remarkable growth in transformation. And Erik, your leadership means a great deal to all of us. It has shaped the company we are today. Personally, I would also like to thank you and our Board of Directors for your confidence in me and for this opportunity to continue driving MSC's growth and operational performance.

During my time leading our day-to-day operations for the past 3 years, I've been deeply engaged listening to our associates, our customers, our suppliers and our shareholders and this has helped shape the strategic initiatives, which are starting to be reflected in our results today.

With these building blocks and a strong leadership team now largely in place MSC is set to achieve new levels of growth and further strengthen its leadership position. I could not have asked for a better opportunity. As I look ahead and prepared to step into the CEO role on January 1, our focus will be on value creation, maintaining our recent growth momentum and delivering a balanced capital allocation strategy. all while living up to our core values.

I believe this is possible by turning our attention to 3 key areas. First, we must harness the incredible commitment of MSC's talented associates to strengthen our culture. We want to raise our own expectations and inspire curiosity, self-responsibility and a spirit of continuous improvement. Second, we must build on the momentum from the initiatives that have resulted in a return to growth you see today. We do this by executing on our recent organizational changes to drive disciplined sales excellence and a relentless commitment to customer experience.

And third, MSC needs to deliver on its commitment. We must bring productivity and consistency to our everyday work and use data to drive speed and accountability through our operating system. I could not be more excited to step into this role, and I look forward to building stronger relationships with everyone on today's call.

And with that, please open the line for questions.

[Operator Instructions] Your first question for today is from Ryan Merkel with William Blair.

And great to see the inflection in the business and, of course, to Erik and Martina congrats on the new roles. My first question is just on gross margin, the 30 basis points of the negative price cost. I don't recall ever hearing Erik, a surge in supplier price increases and costs working through the P&L sort of faster.

Can you talk about what sort of happened there? And then how you addressed it. It sounds like you raised prices a bit more.

Yes, Ryan, so I'll start, and then I'll turn it over to Martina just to provide some historic context. You are correct that this is unusual. And obviously, you and I together have seen in this industry a lot of inflation cycles. This 1 was has been a fairly unique we look back, the concentration of increases that we saw really in a very short window of time was unusual, even unusual relative to a post-covid inflation period, which had also been historic.

So I do think it's played out a little differently from prior cycles. I'm going to turn it over to Martina to talk about how we're handling that, and we're encouraged about what we're seeing in a bounce back in Q1.

But I'll let Martina talk in a little more detail.

Yes. So Ryan, the 30 basis points, I was price behaved exactly as we expected. We were very pleased with the work that our team did. Price contributed 170 basis points right on our forecast, and we were able to work with customers. I think you heard in Erik's prepared remarks, customers are understanding of what we're doing and why we're doing and we're helping them navigate a very uncertain time. Cost, to give you a little bit of context of what Erik just said, we took a price increase at the end of June.

So sort of between mid-June when we lock that increase in the end of August, in those weeks, we took more inflation than we took in 9 months post COVID in 2022. So that kind of gives you a feeling for scale. And it was both the number of increases, the changes in these increases, the changes in supplier behavior compressed lead times. So we amassed this amount of inflation in the business, and we had committed to pricing stability, so we did not plan to take another increase until Q1.

So we didn't react and we have now since taken, I think, the right actions in Q1 gross margin is restoring. We headed into the quarter with a headwind on price cost. We will exit the quarter in a much better position. And I think we have taking a hard look at our processes. When you think about where we want to take the company, I think good, we're happy with the accountability and the way our team reacted in September. But this is a great example of where our operating system where we could have where we need increased visibility because we would have taken more price in the quarter.

Got it. Okay. Very helpful. And then for my follow-up, I heard you say mid-single-digit revenue growth was achievable this year if you just use the sequential and then 20% incremental margins. So that's great to hear. On the 20% incremental margins, I know you're not giving specific guidance, but are you expecting to have gross margins sort of up year-over-year given initiatives and then SG&A as a percent of sales, do you think that you can work that down year-over-year because you talked about some productivity and then maybe leveling off of the cost increases. So a little more color there on what your expectations would be helpful.

Yes. So let's start with gross margin. I think we've taken the price increase actions now in the first quarter. We expect to be price cost stable over the cycle and stable through the rest of the year. I think, obviously, our best opportunity is to accelerate growth and leverage our cost structure, but we do have a very healthy pipeline of productivity projects that will continue to build through the year. And so we're looking we're expecting incremental margins in the teens in the first quarter, and we expect that to build through the year.

And Ryan, just to give a little bit more perspective on that incremental margin commentary, if you look at where we ended up at the fiscal year and at a mid-single-digit growth assume gross margins stay stable. It implies roughly a $30 million to $40 million step up in OpEx. We feel pretty comfortable achieving that where the business currently sits today.

Your next question is from Tommy Moll with Stephens.

I wanted to ask about some of the seller effectiveness KPIs that you updated us on today. customer touches sales per rep per day both moved up significantly this quarter. What's behind those inflections? And what inning are we in, in terms of some of the operational changes that you've made and the improvement that they can drive going forward? .

Yes, absolutely. So we're in the I'd say we were in about the third inning. So we've got taken the first steps, and I'm really excited about [indiscernible] join the team to take the next steps we have a sales management process in place now that looks at a whole range of leading and lagging indicators, and that is different by role and by level.

If you boil it up, the 2 things that we look at are how often are we in front of the customer as a leading indicator, we need to be on the plant floor in order to drive growth. And then we're measuring sales per rep per day. So we'll continue. I I believe sales is a science. There are fundamentals that need to be in place. We've taken the first step, which is really around good territory design. We have to make sure our sellers are pointed at the right potential, and we'll continue to optimize as we move forward.

I wanted to follow up with a question on macro. Erik, I'm looking back at some of your comments. I think you talked about some of your verticals you're seeing some firming up, maybe even some pockets of improvement. It's hard to parse though because clearly, you have some internal initiatives that are helping on the core customer side that may not apply ex MSC.

And if we look at the national account data, down again quarter-over-quarter. And I think the comment there was that's primarily a macro phenomenon. So there's a lot of speculation in the market about where we have potential for some kind of short-cycle recovery. I'm just curious on your thoughts about how we can parse the results today and better understand the macro environment. Basically, the question is, how much of this is self-help where you're clearly benefiting versus a broader macro, where there's still some acute challenges.

Yes, Tommy, it's a really good question in a very murky environment. I think the headlines that we were trying to get across this morning are a couple. One is, I would say, I wouldn't necessarily call things firming up, but we have pockets and end markets that are meaningful to us that we would refer to as stabilizing. So take heavy machinery and equipment, ag-related end markets where things have been really soft for the last couple of years. And it's not like things have inflected that much positively, but they're at least stable.

So that, in a sense, is up from where we've been. What I would say is you then have pockets, Tommy, of, look, there continue to be pockets of strong growth, i.e., aerospace but also there remains some pockets of acute softness. So a great example of that. I actually think you called this out in your note, is heavy truck. That would be an example of an end market that when we talk about the influence on our national accounts program would be weighing us down. So as it relates to national accounts.

I would say we're seeing some encouraging signs here in September and October. We definitely so the numbers we shared slightly down year-on-year for have turned positive in September and October thus far. You can imagine October, especially with public sector moving from healthy positive to negative with the shutdown, core and national accounts actually are doing better and better.

So I think that's turning. But overall, stable look, an overhang of uncertainty that's there. If you're trying to parse out how much of this is macro versus micro, there's probably some of both going on, Tommy. I would say, hopefully, you could hear in our prepared remarks, we're encouraged by what's happening in the core customer and particularly is probably more self-help and micro than it is macro.

Obviously, there's a little bit of price benefit, too. But clearly, when we track back the inflection in the improvements, they do go right back to the initiatives that we've been talking about now and what got put in place sort of midway through our fiscal year with the website upgrades and marketing. So I think that part of it is a good deal of self-help. And then I described the rest as stabilizing with still an overhang of uncertainty.

And Tommy, maybe where you can see a little bit of that self-help if you think about the core customer consecutive months of year-over-year growth. And then you look at the MBI, it still remains below 50. So that's starting to break that trend a little bit might show some of that self-help and that shining through.

Your next question for today is from Chris Dankert with Loop Capital Markets.

I guess I just have the congratulations to both Erik and Martina here. I guess, Martina, on your comments around the level of price increases we've taken here being on par with 2022, I guess, does that imply that we're talking about 5 points or more of pricing in 2026. Can you kind of give us some context for how we think about pricing into the new year?

Yes, I think it's so uncertain. I don't know that I can give you a good answer on that. I think we our intention is obviously to meet the inflation as it comes. I think we've done that now with our actions in Q1 but it's so uncertain, I really I don't know what to tell you.

And Chris, what I would say is if you think about where we the price increase we put at the end of June, low single-digit range, we talked about another low single-digit increase in in 1Q. So if you assume 1.5%, 2%, you're in that 4% range. And as we said, we'll make additional pricing moves as warranted. .

Got it. That color that's really helpful. And then I guess just on the kind of $30 million to $40-ish million of SG&A growth in the new year, and again, obviously, that's something to change, but does that assume digital investment and marketing investment are kind of leveling off here? Maybe kind of walk through some of the components of what you're thinking about for SG&A growth?

Yes, Chris, so when Ryan referenced that, that sort of ties back to the idea of how we get to a roughly 20% incremental margin and mid-single-digit growth. And really, what that's reflective of is the variable expense to service the growth, the normal inflation we experienced in the business, the investment spending that we do and then offset by the productivity that Martina is driving through the business. It does.

So there are certain pockets of investments that we'll be leveling. So e-commerce is a good example of that, although we are we talked about a DNA step-up, that's part of it is our digital investments that are now value and improving core customer growth. I will call out, Martina mentioned in Q1, part of the OpEx build is a step-up in marketing expense so that would be an area where we're actually increasing investment, and we're doing it because we like the returns that we're seeing, quite frankly, it's part of the driver behind core customers. So as Martina mentioned, we're channeling those investments where we're seeing the highest return.

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

This is Katie on for Ken. I wanted to dig in a little bit more on the supplier price notifications. What's the risk that it's more difficult to pass these on to customers as we go through the year, especially if they accelerate, like I know tungsten prices are up a lot year-to-date. Just curious how you're thinking about that in the context of further increases from your suppliers?

Yes. Thanks, Katie. So far, we have been really pleased with the price realization. So I'm not I'm not worried that we're going to be able to pass it on in a constructive way with our customers. We're obviously working with them always to optimize their costs as part of our technical value proposition, and I think we're in a great place right now. So we were happy with price realization, and we continue to be we do see more inflation coming, obviously, and it is it will put pressure on us. But that part of the equation, I'm not worried about.

And maybe I'll just chime in Katie, funny, you mentioned 1 of the raw materials that obviously, we're keeping our eye on and we're hearing about from suppliers in tungsten. So's it's almost like there's a knock-on effect here from the tariffs which is out of the gate, what we've been experiencing from our suppliers is direct tariff-related inflation, and we do see bubbling, the knock-on effect being impacts on certain raw materials that are drivers of the products that we sell.

So tungsten is a great example for cutting tools. As Martina said, our experience with price realization has actually been quite good. Should there be further inflation? If tungsten pricing sustains, I think you're right, we would expect more pricing from suppliers, it's an unknown. But if it does, we would and we'd expect to pass it along. One of the things we tried to highlight in the prepared remarks, customers are understanding right now because the headline everything is going up.

The key is, number one, we have to be transparent about it, which is why Martina and team made the choice to stick with our pricing cadence and not react in Q4, being clear and transparent. And the other is the other side of the conversation is how are we as a distributor, bringing productivity to our customers. And that's something that's right in our sweet spot.

So for all those reasons, if the inflation does sustain in this uncertain world, we do feel confident in the ability to pass it along.

Great. That's really helpful color. My follow-up is regarding the government shutdown. How do we think about any impact year-to-date from this? I know the lower end of your guide implies that it should last through the remainder of 1Q. But any way to think about what you've seen year-to-date within the business?

Yes. I'm sorry, you broke up in the middle, Katie, but I think you're asking how do we see the government shutdown impacting the business? What are we forecasting? So we had as you heard in the prepared remarks, we had a very strong fourth quarter in the public sector, and that growth continued into September. We've seen some softening now with the shutdown. That will have a positive a small positive mix effect. We don't expect that to be more than about 10 basis on our margin.

And the outlook that we gave really is predicated on both ends of the scenario. So the high end of our growth range if the shutdown ends and the low end of our growth rate if the shutdown continues to the end of the quarter.

And then, Katie, the additional color I'll add there is just who knows when the shutdown is. But 1 thing we can be pretty sure at some point, it will end. And as I look back on my career in some of my recent years here, 1 of the things really proud of is the performance of the public sector team. I mean, they continue to deliver and to outgrow markets and to take market share. And we don't see any of that changing. Obviously, Martina mentioned, we went from double-digit growth in September to negative in October.

That's just a reduction in spend. So the exciting thing for us is, at some point, that restores. We expect our share capture to continue. And then if our momentum in core and national accounts continue and public sector goes back to doing what they've been doing for a while, it creates a potentially encouraging picture.

Your next question is from Patrick Baumann with JPMorgan.

I'll echo comments from others, congrats Martina on the new role. And good luck, Erik, it's been great working with you over the years. I appreciate all the help. So on the OpEx side, maybe I missed this, but it looks like the head count that you report in the earnings deck came down a bit at year-end. Just wondering what drove that?

And then what's the outlook for head count in, I guess, fiscal '26. And then on the marketing side, wondering if you could give some perspective on where your spend levels are today and where you think you might need to take that to sustain better results that you're seeing currently in the core?

Okay. Thanks, Patrick. I'll take the head count piece. So our cost structure is too high right now for the size of our business. So obviously, the best and the highest way to remedy that is for us to accelerate growth, and we're at full speed ahead on those initiatives. But in the meantime, we're taking a look at how we perform work, and we're taking a look at performance.

And so what you see in those head count numbers are 2 sets of actions. One of them was a reduction force in our sales force. I believe strongly that we owe our sellers good territory design. So we point them at the right potential we owe them a strong sales management process with clear expectations and good coaching and when you put those 2 in place, you can fairly and quickly assess performance.

So we took out our underperformers and our sales territory optimization, just moved right in. And that's why in the prepared remarks, we told you we're actually covering more customers more effectively with fewer people. I'm very happy about that. And then on the other side of the business, which is the rest of the head count change, we have an operating system, same thing. We're setting clear expectations. We know how to measure performance, and we action. Asking me about head count for the rest of the year. I mean, we will continue to self-help, and we'll continue to look at our processes as we go forward.

And then maybe Yes, I'll take the marketing, Pat. So what I'd say there is we're at our Q1 levels, obviously, we're going to be at a level that's up from where we were running in fiscal '25. And Hard to say, to give you a clear outlook. And the reason it's hard to say is our investment in marketing, the beauty about the way we're investing, number one, it's been a driver of the core customer we see the return profile on our investments relatively quickly.

And so that number will be fluid based upon the returns that we see. So put another way, if we continue to see the returns in the form of improving growth rates with core customers, will continue to ratchet up marketing. And if for some reason, those returns subside, you'd see us tone it down. But either way, it would be captured in our outlook on incremental margins.

Got it. And then a couple of cleanups. Just a follow-up on the government shutdown impact. Can you remind me like your federal exposure? I didn't think you had like a big exposure to federal government. So I'm just wondering why you saw the slowdown in sales in public sector from, I think you said double digit to negative in the October period.

Yes, Pat, our government exposure is about 2/3 of federal and more weighted towards military and defense, just to give you some color around that.

So are you seeing pullback in military like where in federal are you seeing pullback.

We're seeing so the pullback from September to October was pretty much all in federal, Pat. And what I would say, it was not I mean I won't get too specific here. It was not across the board. But there were pockets the negative in October is an average across our roughly if we're a 10% public sector, I'm rounding here, but around 7% being federal. It wasn't down consistently across the board, but we saw pockets of federal that are off like 50%, 60%, where there's clearly no sign of market share loss. So yes, we did see a pretty quick drop. And look, again, at some point, that's going to reverse end and reverse.

Yes. That makes sense. And then last cleanup, just on price. Can you give any color on any particular product categories that stand out in terms of the increases you're taking, whether it's are you seeing more inflation in metal working in certain MRO products and exclusive brands? Any color on the pace of price inflation among those different categories.

Yes, Pat, I would say it wouldn't be shocking to you as to where basically the more you get to things that come out of China and the more you get to things that are made of steel the more inflation we're seeing. So for instance, fasteners and our OEM business are seeing really high levels of inflation. Some categories like safety, if we've done a lot of sourcing Asian sourcing, China sourcing, we'd be seeing it.

So it wouldn't surprise you. Interestingly, some, of course, in our private brands. But remember, 1 of the things that we've been talking about, a good percentage of our private brands particularly in cutting tools are made in U.S.A. So those have been shielded and that's been another kind of quiver in our marketing arsenal, if you will, is focused on our maiden USA offering. But it wouldn't be shocking where we're seeing the increases.

Your final question for today is from David Manthey with Baird.

Congratulations to Martina. Erik I'll for my fair well I see you in Chicago in a few weeks here. Yes. So my first question is, you mentioned direct ship orders. And I guess, I'm just trying to get a read on what percentage of your sales does that represent today? And maybe if you could outline the types of products that are primarily affected by direct ship.

Yes, Dave, I'll take it. So we don't really break out specifically direct ship orders as a percentage of sales. I'll tell you it is the minority but particularly, it's grown in recent years as we've penetrated customers more and more. whether it's our implant program, whether it's some of our public sector relationships where we're doing more and more sourcing and value add for a customer. So typically, as those programs ebb and flow, so goes our direct ship volume.

So I don't think there's anything sort of structural systemic that I call out, like if you're looking forward, is something to note as a major headwind or tailwind, but we did see and look, the team mentioned that sequentially from Q3 to Q4, our public sector business was up considerably. There's a correlation there.

So when it comes in the form of public sector, you can imagine it's a lot of MRO product. more so than metalworking. And so that's a little color. But I wouldn't make that much of it for the future, but it did we brought it up because it was a piece of the 50 basis point gap versus where we thought it was a piece of the story.

Okay. But it sounds like it's measurable. And if you're saying it's driven by government and implant or things like that, it does sound like we should see that continue to at least gradually move up over time, right? .

Yes, I guess, I mean, it has been certainly. But the 1 thing I would say to counter it is, remember, this is really if I look back over the past few years, you've had areas like implant and public sector growing and core or at least core growing at less than the company average. So counterbalancing would be if the traction we're seeing on the core customer continues, that would be somewhat of an offset.

And Dave, if you're getting if I think what you're getting at, I don't think you would hear us call out the rec ship going forward when it comes to our gross margin performance.

Okay. Fair enough. And then second, reshoring, are you seeing any benefits for reshoring at this point? And when you talk to your core metalworking job shops, are they relaying any optimism on that front? Or it's still vaporware at this point? .

So I would say if Dave, if the definition of reshoring is new plant build out, we're not seeing it. If the definition of reassuring is an existing global manufacturer that has capacity in multiple locations inclusive of the U.S. shifting manufacturing to the U.S. that we are there's tangible data points there, some of which were releases, I think, this week and last week. So that we're seeing, we're not seeing new greenfield build out.

Right. Yes, I was thinking that if not necessarily that you're selling directly to that factory that's reshoring or expanding in the U.S., but your machine shops and the metalworking job shops might be seeing an increase in business as they're selling more product to domestic manufacturers. But yes, I don't know, I was just seeing if you're hearing anything along those lines.

I don't think we're seeing it like we're not seeing it in the numbers yet. I would say that there is there does remain some optimism about more production coming to the U.S. though. That headline is still there, right.

Dave, I think about areas about auto. You heard some from some releases this week shifting more capacity manufacturing capacity into the U.S. I think as that comes to fruition, you'll start to hear some of that optimism trickle through into the job machine shops.

We have reached the end of the question-and-answer session, and I will now turn the call over to Ryan Mills for closing remarks.

Thank you, everyone, for joining us on today's call. Our next earnings call will be on January 7. In the meantime, we look forward to seeing you all at upcoming investor conferences. Have a good day. Bye.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.

Session here with MSC Industrial. I'm Chirag Patel, I cover the machinery, multis and distribution space here at Jefferies, along with Steve Volkmann. It's our pleasure to have Erik Gershwind, the CEO of MSC Industrial and then Ryan Mills, Head of Investor Relations.

I was going to actually start out with a quick little overview of the company and the business. And then let's jump right into the meat of it.

That sounds great. Thank you for having us, Chirag.

So just a brief overview of the business trends that you're seeing currently, the dynamics that you've kind of laid out in your latest earnings call that are kind of important to be mindful of at this point.

Yes, sure. And so thank you again for hosting us. Chirag, as a reminder, we reported -- so we have maybe a clarification. If anybody is new to the story. We're on a fiscal calendar that runs September to August. So we are in day 2 of our fiscal '26 off to a rocking start here. We gave -- so we gave an update on our third quarter results on July 1. So our third quarter would have been, I got to get myself here oriented March, April, May. And I would describe it as -- so we sell in a little backdrop on the company, industrial distributor selling over 2 million SKUs, primarily into heavy industry and manufacturing end markets in particular. So about 70%. Virtually all of the company sales are North American, 70% of our sales, plus or minus, are into the manufacturing sector, which has been soft and our end markets, in particular soft for the last 18 to 24 months. We did highlight that in our fiscal third quarter, we started to see some sequential improvement.

So we were a little under flat, which by no means there's anything to write home about, but I think we're starting to see a little bit of sequential improvement and I think, which I'm sure we'll get into. But most notably, the most encouraging part was we -- there's three customer types that we talk about publicly, our core customer, which is around mostly made up of small and medium-sized businesses, which is around half of the company's sales. The second customer type is our national accounts customer base; and third, being public sector, which is around 10% of company sales. So I think most notable about our third quarter was seeing the most sequential improvement in our core customer base, which is heavily levered to manufacturing, even more heavily levered to metal cutting manufacturing, which is kind of the roots and the bread and butter of MSC. It's been a customer base where we've underperformed for a number of years and have put a full court press on revitalizing or as we call the reenergizing that base started to see some sequential improvement.

Since that point, and then I'll stop, Chirag, but we did share -- you mentioned July so June, July, we did share -- so our fiscal -- because we're on a fiscal calendar, our June is a 5-week month and runs through -- actually ran through the July 4 week. So when we had reported our third quarter results, we gave an estimate for June. We were still in the midst of that last week that had June at about flat which was continuing this slight progression. We ended up, we shared -- we actually came in considerably stronger that final week than we were expecting. So June ended up coming in at positive 2.5% growth. And the color we added was that July, which at the time when we haven't shared anything since was the July wasn't finished that we were remaining in positive growth territory with how we put it. So I would see environment is certainly not exactly booming. Customers are cautious. It's a little bit uncertain still, but we are starting to see a little bit of positive trending there.

That positive trend that you saw through the June, July time period, is that still primarily based on the core customers -- that dynamic? Or are we seeing a little bit more on the national account side?

So we didn't put color on the breakout, and we will come October. But I think the core customer I mentioned, we've got our eyes on that because it is 50% of the company's revenues. It is the highest margin part of the business where we have underperformed. We've had several programs that have been in flight for a while now aimed at reenergizing it. So it's definitely where we have our eyes on, and we'll give more color. But between tariffs, which I'm sure we'll get to and pricing along with core customer, I brought it up. we feel like both of those are encouraging signs as we now look into 2026 prospects.

And I guess the other thing I was looking at was the idea of the pricing dynamic. In distribution, there's definitely a nice little favorable pricing trend historically. What are you kind of seeing right now in just underlying pricing? And then what are you taking as far as actions on the tariff side of the equation? And remind me, I don't think you quantified the number or maybe you did and I missed it already.

So part yes, part no. What we did, so our fiscal second quarter, so third quarter was July 1, our fiscal second quarter, we reported the morning pre-market after Liberation Day was post market. And I think if I track back to that moment in time, which was just impeccable timing. Out of the gate, I would say pricing had been slower to come by meaning price increases slower to come by than we were expecting. And just to be clear, out of our revenue base, roughly 3/4 of our business is we are not the importer of record where we're selling an industry brand for resale as a distributor. And then there's a quarter where we're direct sourcing. And some of that quarter we're direct sourcing domestically here in the United States. And then somewhere we would be an importer of record.

When I say pricing was slower going out of the gates, we saw -- in a normal inflation cycle, when there's an impetus like this, we would see our branded manufacturers move pretty quickly and pretty aggressively on price increases. And because of the way things have played out with all the toing and froing, most of the manufacturing base was reluctant to move out of the gate. So this is going back to the April time frame. So what we had done at the time was we did move in a targeted way on products where we were the direct importer of record and seeing a tariff increase. We reported on July 1 that we, for the first time, moved in a broader way outside of that, where we did start to see manufacturers move on their list price increases, we described it as a low single digit was the color that we put on the increase. I would say since that time, there certainly has been probably more of a firming up and a building momentum around our supply base, putting pricing through. So as we look ahead, we normally try to be very selective in how often we go to market with price increases, just we have a cadence with our customers. I would say this is not normal times, though. So certainly, if conditions warrant and continue, we would consider moving again during the calendar year and early in our fiscal '26, if warranted.

Pricing is one aspect of it. There's always a fear on the opposite side of demand destruction kind of associated with that. Are you seeing anything on that front at this point?

You know, so far, I would describe, and I'll go back to the comments we shared in July, which is the environment cautious, but stable. So it's not like things have dropped off a cliff. It's not like things have really inflected in terms of the environment, cautious but stable is what I would describe. I would say most of our customers are understanding everyone sees the headlines and read the news. They understand that where tariffs are in play, prices will go up.

I think the trick for us and it's been received say, favorably because no one likes pricing, but empathetically is that number one is we're trying to be transparent and to focused pricing on where there's tariffs and not make it broad-based, which keeps our credibility high with our customers. The second thing is the conversation with the customer immediately turns to, what are you as a distributor going to do to help me offset the inflation, where are you going to help me find productivity. And that actually plays into MSC's strengths pretty well because our -- one of the things we anchor ourselves in is being able to go and work with our customers on their plant floor to help them find productivity improvement. So that's been part of the discussion every time. And I think that's why it's been reasonably well received. So to get back to your question about demand destruction, I would say we would characterize the environment as stable. So no major demand destruction to do, no.

Very good. And I guess I wanted to kind of touch into the market environment and the end market dynamics that you're seeing, specifically starting with the heavy manufacturing side of the equation. What's kind of the expectation? What are you seeing currently play out in that where we're at the bottom of the ag cycle seems to be a little improvement in the construction side of the equation. What are you guys seeing?

So yes, and I'll preface it by giving you the porch we sit on, which is I mentioned 70% manufacturing. As you said, Chirag, most of that is heavy manufacturing, and there's five top end markets that are the bulk of the manufacturing for us, which is machinery and equipment, which would capture ag as part of that primary metals, fabricated metals, which would be where machine shops and job shops would play, automotive and aerospace. And if I look at the last 18, nearly, 24 months. It's been a slog in heavy manufacturing with the notable exception of aerospace.

I would say of late -- just a proof point. One of the indicators that we track that's been remarkably correlated to MSC performance over time has been something called the MBI or the Metalworking Business Index. So for those familiar with the PMI survey that's administered by ISM. It's a sentiment survey, 50 being neutral, greater than 50, growth and less contraction. It's very much fashioned along those lines, but geared towards metalworking end markets. That reading had been negative for, I want to say, 24, Ryan? 24, 25 straight months.

Yes. With the exception of March.

One month. And we looked back over the course of as long as that survey has been administered decades, we've never seen that before. I would say -- I mentioned cautious but stable right now. It's probably from our view, more upside than there is downside from where we sit right now. It's just been most of the end markets depressed for a while. We certainly think that once we do get through tariff noise that a lot of the administration's push to bring manufacturing back to the United States will be good for the economy, good for us. Some of the tax work that could stimulate reinvestment and interest rates, the outlook is probably, as I said, more upside than downside in the next 12 to 18 months.

So we are kind of waiting on the uncertain macro for customers to kind of unlock a little bit of the opportunity as we go forward then?

I think so. I think -- and we'll get to it, Chirag. From our standpoint, so I think that's right in the macro. We do feel like there's a real self-help story at MSC, both on the revenue and the operating margin line, whereby we don't feel like we should need to see a really robust macro in order to drive growth that if we get just some stability based on some of the things we have going on, we would expect to grow.

And we're talking about a stable kind of quarter-over-quarter kind of client base -- customer base currently. Is there any sort of inventory issues that you're worried about from the customer standpoint at this point or?

We think that we gauge this all the time with our customers that for the most part, inventory levels are appropriately sized from what we can tell and that customers are ordering as they need it. So I would say it doesn't feel like, again, there's not a lot of downside in terms of destocking. If there were to be an inflection, usually there'd be a build in inventory that we could benefit from if that were to happen. So I would say, again, probably sized right with more upside than downside if there's improvement.

Very good. And then we touched a little bit on the end markets, but one of the big things is the strategic efforts that you guys are making internally on the digital side of the transformation. I kind of want to touch on that first and then talk through some of the other changes that are happening at the business Level.

Yes, sure. So I think probably the biggest headline here, I mentioned the core customer and reenergizing growth in the core customer, which not only hits the revenue line but would generate leverage and improve the margin profile for sure. We've had -- there's four initiatives that we've had in flight for the past two fiscal years that are pretty much behind us now, which means that we're at the point where we would expect to be able to begin to harvest benefits. So the first was realigning our public-facing web pricing. That was completed last fiscal year, and there's still fine-tuning being done, but for the most part, that would be behind us. The second being upgrading our e-commerce experience and web platform, which was a while in the making. The new platform is pretty much live as of the end of our fiscal second quarter. The third initiative being accelerating and enhancing our marketing program, using some technology, which that is now in flight and the fourth being optimizing seller coverage, which also has been done over the past year or so.

So we feel like most of the ingredients are there. It's always difficult to time out. Some of these things, like when we install some of our high-touch programs, we install a vending machine, we put an implant program in place. We can predict pretty much by month how that ramps. These programs, there's a little bit of betting on the come in terms of seeing the improvement. But I would say we began last fiscal quarter, seeing some early signs of progress that have us encouraged and I'm happy to touch on any of those four.

Yes. And actually, I do want to kind of delve in a little bit deeper into those. But one of the things I want to look on the overarching side is those actions that you've taken, what's kind of the expectation for how that should translate to market share gain as you look through that.

So the biggest proof point, I think, for the public world is going to be there's going to be our overall growth. So our -- we expect to grow and historically have at 400 basis points above the industrial production index. So that's inclusive of volume and price, but that would be overall. More specifically, I mentioned the core customer, restoring that segment to growth in a stable environment, so call it a flat IP environment, I think will be a good marker as to progress. And then obviously, we're measuring carefully, particularly our e-commerce upgrade and our marketing efforts. We have several KPIs for each of those two programs that we're tracking carefully to say, are they doing what they're supposed to be doing. Are we seeing traction that should lead to improvement in the core customer?

Got you. What's a good way to kind of track and get a sense for the impact that your enhanced web on kind of website and e-commerce platform is getting us?

So there'll be a couple of ways that you'll be able to easily see. One is going to be the core customer growth, which we report on quarterly. So we gave the color in our fiscal third quarter that, again, I mean, getting close to flat is nothing to write home about. But we did see from Q2 to Q3, the core customer sequentially and average daily sales grew. It was the fastest grower in our business. And that was when -- that was the first quarter in which the new web platform was in market. So that was encouraging. We also publicly -- we produce -- we publish our digital rep, our e-commerce revenues. So you could see our total revenues and revenues as a percentage of sales. That's going to be another metric we track. And then we'll share on an ongoing basis, some of the KPIs we look at on both initiatives. We gave a few proof points on our last earnings call. So for instance, with respect to the website, we're looking at what percentage of the traffic that comes to the website is converting to find what they're looking for and ultimately place a purchase. And are we seeing those conversion rates go up? We saw some early indicators, Yes. On our marketing programs, we're looking under the covers at return on ad spend, at conversion rates and effectiveness and again, we saw some early proof points. But I think ultimately, what you'll be able to see publicly is core customer growth rate and digital growth.

Okay. And are you seeing an increase in the wallet share that you're gaining through the e-commerce platform from a customer? Is the enhanced website finding you the extra dollar as well?

So there's -- the formula on the web and what I would say is we only have, publicly, one quarter under our belt. So it was early, but there's basically three metrics in its most simplest form, three things we're tracking. Number one is how much volume are we getting to the site, which is really a marketing effectiveness question. How much volume is coming at what cost? Two is, how is that volume translating into orders, which is conversion rate; and the third is our average order size. Are we seeing an increase in the average order size. And what we noted was that we saw some early signs in terms of improvements on conversion rate and average order size. So again, early indicators, one quarter, but some encouraging signs, yes.

And moving from that, I wanted to talk a little bit about the vending and plant opportunities, roughly about 18%, a little under 20% of the total sales at this point. One, how large can that business be for you as you go through it? What's the advantage of having that kind of part of the platform?

Yes. Okay. So this is actually the flip side of the core customer story where the company over the last really decade has put a heavy focus on becoming what we refer to as mission-critical to our customers, which means going beyond just selling product, shipping it to our customers loading dock and stopping. But we've put a heavy emphasis on expanding the role that MSC plays inside of our customers and particularly our larger customers that value total cost of ownership that want a more integrated relationship where MSC is actually reaching inside of the customer's plant floor. So if you go to MSC customers today, you'll find an MSC VMI, or vendor-managed inventory program, managing inventory, you'll see MSC industrial-grade vending machines. And in some cases, as you mentioned, you'll see MSC people full time in our customers playing a role, anything from procurement, to put away, to kitting, to really being an extra set of eyes and ears for the customers.

The implant one in particular, has been fascinating. So the program -- if I go back to pre-COVID, we did a handful of implants. So it would have been low single digits at best as a percentage of revenues, and we did it reactively. Along the way, a combination of customer receptivity, COVID kind of put on steroids this idea of a skills gap and a labor shortage for our customers. We found that we were really tapping into something, and we kind of hit the throttle. So implant is now 18% of sales in just a few years. And I think the benefit for the customer is they're getting arms and legs, they're getting somebody to give them fresh eyes, bring in new ideas and we're closing. I mean when I visit customers, the single biggest issue continues to be access to qualified skilled labor. We're helping solve the biggest challenge that they have. For MSC, there is an added cost for sure. We're adding to our fixed cost base because what we've seen is when the economy goes down, our implant associate, our vending machines, the cost is still there, the revenue base drops. But what we are getting is share of wallet, and retention rates are really strong.

So the flip side of that, as manufacturing restores, we should have what we refer to as kind of like a coiled spring effect where the fixed cost is already in place and we get the revenue back. So we think it's pretty good. The signings rate continues to grow on implants over 20%, for vending, Ryan, close to 10% on a high base.

Yes. High single digits, low double basis. Yes.

So if I think about runway, there's plenty of it. To try to put some color on that, our national accounts program as a percentage of revenues is let's call it, mid-30s. And I think many of our national accounts if the economics can work and be a win-win would be potential candidates for an implant program, not to mention companies we don't do business with. So I think there's a lot of runway still.

Got you. Is there -- we talked about the fixed cost structure to that. Is there a potential for when volumes are good, how does the margin work on that versus for the total company?

It will be the reverse effect, which means that -- so Ryan has been sharing the data that our implant program count is north of 20% growth year-on-year and yet our implant revenue base -- was it 10% last quarter?

Yes. It was down single digits. Yes.

So on a per site basis, down high single digits. Now part of that is because we're bringing on all these new accounts and the new accounts are smaller in absolute dollars and they're averaging down. But part of it is also that you got a lot of accounts that large accounts that are just soft that have been implants for a couple of years, we kind of ride the tide with them. But as they restore their -- the volume per store, we get very strong incrementals because the costs are all fixed, and it's just pick-pack ship costs on the way back up.

Increasing the signings currently, what's the ramp-up time in a normal condition?

Yes. So for the timing, we signed an implant for revenue generation beginning to occur typically takes three months. And then from there, we experienced a strong ramp in revenue for about six months until we get closer to that contracted spend. So I'd say, on average, about nine months that implant program is fully ramped. Now to Erik's point, that implant program is heavily tied to that customer's production rates. So if they're going at one shift, that ramp is going to take higher -- that ramp is going to take longer. And then going back to your original question on the op margin for the implants, when an implant gets to about $2.5 million in sales annually, you get to a point where you're flexing your fixed costs at a point where that implants operating margin is at or slightly above company average. So that's what has excited as we think about a potential recovery because we should benefit from that from both the top line and margin perspective.

Have you given a number on the number of implants that are currently out there, just a total?

Yes. 399 last quarter.

All right. And so I guess the next piece of this is having done the strategy part, having kind of implemented these actions at this point. What should we be thinking about from the financials part of -- as we get volumes back, what are the incrementals that we should be thinking about? What should we think about will drop to the bottom out here in [ MS ]?

Yes. So I think the punchline is, as we're now in fiscal '26, what we've been trying to position the business for is who knows what happens with the macro. But if environment stays stable, and let's defined stable as a roughly flat IP. We would expect to restore top line growth at a flat IP, and that would be a combination of continuing the momentum in the high-touch stuff that has already been working plus some price from tariffs, plus some improvement in the core customer. And we feel like our aspiration has been 400 basis points or more above IP. We feel like we should be positioned to do that. So if we can grow mid-single digits in our fiscal year, we feel like the business is positioned to drive 20% incremental margins or better, possibly.

And the story there beyond the revenues would be a roughly stable gross margin picture, which we think would be a good outcome. And most notably, on the operating expense line, the last couple of years, we've had some big step-ups in OpEx as revenues are dropping. Those moderate. And on top of that, we've done a lot of work in the last two years on rebuilding a productivity pipeline that's -- we've talked a little about it during fiscal '25 on the supply chain front, but there's a bunch of stuff behind it. that has been building and will build in the numbers. So we feel like we're positioned to do at least 20% at mid-single digit, which on a relative basis compared to prior points in history, I think would be a pretty good outcome. And then, of course, if we get any improvement from the macro, we would expect the incremental margin outlook to get better.

Very good. Can we talk a little bit about the competitive landscape out there in the world? You're playing against some other large industrial distributors that are out there. Talk about where MSC sits in this, talk about a little bit about the opportunity that you see?

So yes, it's a fascinating market. So the first thing I'd say is just it's an amazingly fragmented market, given its size. So the industrial distribution market is around $250 billion and in North America. And the top 50 distributors have only 35% of the market. So that means 65% of the market, we're competing against local regional distributors, kind of [ MSA by MSA ]. So there's a pretty massive runway for share capture. And that can be organic. That doesn't mean a roll up through acquisition necessarily, but organic market share capture from companies that don't have the scale, the technology the capitalization that an MSC or some of our peers would have. So I think there's a massive opportunity there.

Within that, the niche we've attempted to carve out for ourselves, we are really focused on -- certainly, we're oftentimes known for metalworking, which is about 40%, 45% of our revenues, metalworking-related products. So cutting tools, abrasives, machine tool accessories. The reason -- but from our standpoint, we think that the competitive positioning kind of goes beyond metalworking. And it really goes to focus on improving customer -- a manufacturing customer's operations. And that means helping them get more products out faster and doing it at a lower cost. So the reason metalworking is important in that is because compared to other industrial supplies, safety to a degree or janitorial or power tools, we're -- the cutting tools, the metalworking supplies actually influence the output of the customer. So they're really important. So we're really focused on helping customers improve operations. So we're doing that with our product offering. We're doing that with technical experts. So relative to peers, we've got a large percentage of our sales force, which is in the thousands, with deep machining and manufacturing background, so they can be on the plan for making recommendations.

We supplement them with technology. So we're using technology, we're using AI to make them smarter and to bring savings opportunities to our customers. So an example, we have something that we've referred to publicly MSC MillMax, which is using data, basically data science to help customers optimize how they machine things. So I would say we feel pretty good about our footprint and our competitive advantage. I think beyond that, I mentioned some of the value-added services where we're reaching inside of our customers' operations with vending and implant.

Got you. Is there -- given the expertise of those local salespeople on the metal side of the equation, does it behoove you guys to also introduce additional products as well to kind of make it a more full kind of experience or?

Yes. I mean we do regularly. So our product portfolio is sitting at 2-plus million SKUs. So the offering's robust, it's constantly getting replenished. I think on the metalworking side, it's kind of like a 3-part formula that allows us to uniquely bring value to the customer. Number one is we bring in somebody who's an expert. Number two is they have a portfolio of products, they're carrying all the brands. So there's a degree of objectivity that as a distributor, we can bring that others can't bring. And then the third thing, we're taking these people with a lot of experience, and we're using data and technology to inform them. So we're mining decades worth of testing data that we have from all of our other customers, and we're putting those at our rep's fingertip. So they can go and not just go on gut feel, which does matter, but also use science.

And then the other thing I'd add, Chirag, is if you think about the local and regional in today's environment, as Erik mentioned, the end market has been soft for about 2-plus years right now, you grow in tariff-related inflation, these locals and regionals are struggling and probably bleeding off some working capital. And product availability is the #1 thing our customers care about, given our working capital investment, our breadth of inventory, we're using that as a lever to gain shares to as well.

Given that market dynamic, are you seeing those local and regional competitors try to exit? Or what's kind of the dynamic of that right now?

So I would say what's fairly they usually don't exit. They will usually -- at times, there's an opportunity for acquisitions. I would say that market right now, given interest rates is fairly subdued. It's more an opportunity to take market share. So the strong local distributor will typically have a handful of really good customer relationships that under normal times are difficult to penetrate. But when there's times of disruption, it's tougher to get product. They're under financial strain, they're not carrying as much inventory, maybe they can't carry receivables as long. It creates a wedge where it's an opportunity for us to take market share organically.

And that market share gain from that kind of an action, how sticky is that at the end of the day?

If it's -- if we're using some of the things I described, the kind of arrows in the quiver of the technical expertise, the inventory management solutions like vending and an implant, it becomes very sticky. The retention rate really shoots up.

Got you. And one of the other things I wanted to kind of cover here while we have a couple minutes left is just the idea of what's driving the core customer to kind of utilize some of the tools that you're providing to them right now? What's the impetus for them to make that investment in that digital aspect of things or?

I think if we do it right, we actually don't need the customer to do much of anything differently. A lot of the actions for the core customer are around meeting the customer where they're at with an effective offer, a fair price and an effective marketing engine that's compelling them to buy. And -- so that's a lot of the work that's gone on, Chirag. So I mean we're using a lot of data science and AI to help us do that, both to improve the web experience to make our marketing offer sharper and more relevant. So just to give you an example of what we're talking about, that if a customer is on our website as opposed to just following them up with a generic offer, like we're able to get very specific to see what they're looking at and follow up with them with offers that we know or what they've already looked at? Or if there's an item that's backordered and we know that we have -- our engine can bring back a recommended alternative that's an equivalent to follow up with them, those sorts of things that are really timely. So we want to make it such that the customer doesn't have to work very hard. That to us is success.

One of the things is just our enhanced search and product navigation on the website, making it easier for the customer to find what they're looking for is something that they value pretty immensely. For instance, a cutting tool could be attributed 200-plus ways. So we've built that search engine in-house by people who know the native language and speak the industry and then also streamlining our checkout experience. We reduced the amount of time or number of clicks by 50%. So just making it more smoother and seamless to transact on MSCdirect.com, is another one.

And if I'm on the website trying to buy a couple of products, how is my pricing different from Ryan, who buys thousands of products from you. Is there a difference in the pricing?

Yes. If the customer -- if a customer just comes as a guest, they will not see their -- but most of our customers are logging in or the sites remembering them, they will see their pricing.

But what we did last fiscal year as we went on a SKU-by-SKU basis and developed a market competitive range for each SKU to make sure that, that web price was competitively priced regardless if you're Ryan at Ryan's job shop who has 10 employees or you're a large manufacturer with 1,000 employees where you're spending a lot.

And I think one last thing I wanted to touch on is just talked about the stabilization of the core customer. Talk a little bit about what you're seeing on the national account side of the equation and the penetration that you've had, the growth that you see is and opportunity.

Yes, I think that's probably -- if I look back over the past couple of years, one of the areas that's actually worked quite well. Most of our national accounts, they're sophisticated. They've got multiple sites and they're looking for productivity, whether that's cost down or improved throughput and all the stuff that we talked about with MSC is resonating there well. So I mean, we continue to feel really good about the prospects for the national accounts business.

Excellent. Thank you guys so much for the time. Appreciate you coming through.

Thank you for hosting, Chirag.

Thank you.