Morning, and welcome to the MSC Industrial Supply Fiscal 2026 Fourth Quarter and Full Year Conference Call. At this time, all participants are on a listen-only mode, and a question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note that this event is being recorded. I would now like to turn the conference over to Mr. Ryan Mills, Vice President of Investor Relations and Business Development. Ryan, the floor is yours.
Thank you, and good morning, everyone. Welcome to our Fiscal 2026 fourth quarter earnings call. Martina McIsaac, President and Chief Executive Officer, and Rob Kuhns, 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 two 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 vs 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 Martina.
Thank you, Ryan, and good morning, everyone. We appreciate your interest in MSC and your participation on the call today. We are very happy with the way we finished our fiscal 2026 and continued to strengthen our position in the marketplace. Before we get into those details, I want to turn to slide four to share just how excited I am to have Rob Kuhns, who joined MSC last month as CFO, on the call with me today. For a brief introduction to Rob, he's a seasoned public company CFO with extensive financial and operational experience across both industrial and distribution markets. In his leadership roles, he's demonstrated an ability to deliver high levels of profitable growth, developed a proven track record of successfully executing on M&A, and has a history of strong team building and talent development.
I look forward to increasing the value MSC creates for its stakeholders with Rob's contributions towards the achievement of our long-term financial targets. At this time, I would also like to take a moment to thank Greg Clark for his interim leadership of our finance team over this past year and his ongoing support of the transition with Rob. Now, moving to slide five, I will begin with a high-level overview of our results for the quarter that Rob will cover in more detail. I am really pleased by our strong finish to the fiscal year that resulted in record sales and further margin expansion in the fiscal fourth quarter. Sales of approximately $1.1 billion grew 8.6% on an ADS basis, driven by both price and volume.
The team also did a great job executing on this growth, as seen by the adjusted incremental margin of 27% that resulted in adjusted operating margin expanding 170 basis points to 10.9%. Execution is improving, as seen by these better-than-expected results and everything accomplished by the team this fiscal year. I would like to reflect on a few of the milestones the team achieved this year, shown on the slide. First, we successfully navigated the impact of tungsten and tariff-driven inflation. As you recall, we entered the fiscal year in a tough price-cost position that pressured gross margin in 1Q. However, due to consistent action throughout the year, we were able to manage gross margin to support volumes while navigating price-cost dynamics. This resulted in gross margin expansion year-over-year, beginning in 2Q and throughout the remainder of the fiscal year.
During this challenging period, we nevertheless made significant progress in strengthening our key supplier relationships. We continue to benefit from those partnerships, in particular through the ongoing momentum from our growth forum in February that had over 1,000 associates and 400 suppliers in attendance. This event established a solid pipeline of joint opportunities, which has supported an important change in our sales culture as we continue to track and realize wins from this pipeline, which now exceed $100 million. Fiscal year 2026 also saw us strengthen other strategic relationships. A great example of this would be our relationship with Autodesk. As we announced recently at IMTS, we have deepened our partnership with Autodesk and now leverage Autodesk Fusion's connected supply capabilities and all-in-one cloud platform.
This will further differentiate MSC as a leader in metalworking by allowing our experts to optimize tool paths and validate cutting tool parameters more efficiently through state-of-the-art virtual testing capabilities. Lastly, we have transformed the way we operate in the field. We have an optimized structure that targets potential, maximizes coverage of the right customers, and integrates MSC's full value proposition. We have an effective compensation system that rewards the right behavior. We have new standards within a professional sales management process that has accelerated momentum and supported execution. For example, by the fourth quarter, we have nearly doubled the number of daily in-person customer touches with roughly 170 fewer sellers, and are growing volumes with roughly 250 fewer total heads. We have rebuilt the team after a period of attrition.
We're attracting great talent to MSC and have put a best-in-class onboarding program in place, which is already accelerating time to money for our sellers. Turning to slide six, this improved execution is reflected in the KPIs that matter most to MSC. Starting with the core customer, ADS trends have now outpaced total company growth for five consecutive quarters, achieving double-digit growth in the fourth quarter for the first time in over three years. Sales per rep per day and trailing 12-month sales per total headcount trends also remain favorable and show we continue to do more with less. I take this improved performance during a period of immense organizational change as evidence that our team is with us and our execution and operational rigor is strengthening. This gives us the confidence to continue on our path to transformation across other areas of the business, for example, our technology strategy.
As a reminder, we have defined an aggressive productivity roadmap focused on customer experience, associate productivity, and the headcount opportunities that come with automation of manual work. To ensure our path to mid-teens operating margins, it was necessary to align our technology investments to this strategy. As I have shared on previous calls, our CIO, John Reichelt, has spent the last few quarters performing a detailed assessment of our technology infrastructure against the needs of the business. To this point, MSC had been pursuing a program we have referred to as Digital Core, which was an end-to-end modernization of our procure to pay and order to cash processes. Following the completion of John's review this quarter, we concluded that a greater degree of speed and flexibility is required to achieve our goals.
As a result, we have reshaped our tech strategy, moving towards an AI-first modular approach to systems enhancements and have decided to discontinue the previous Digital Core program, resulting in an asset impairment charge of approximately $42 million. This shift allows us to take a faster, more flexible pay-as-you-go approach to our productivity roadmap. We see lower risk due to smaller and narrower implementations, reduced fixed costs, and faster time to money in achieving ROI. We are already seeing benefits from our early implementation of AI solutions in the areas of cross-sell, up-sell and inventory management. We will now accelerate this focus to other areas of the business. To support the speed and agility we seek in this transformation, I'm pleased to announce that we've added Andrei Dumitriu to my team in the newly created role of VP, Business Systems and AI Strategy.
Andrei comes to us from Shopify, where he most recently served as Head of Revenue Technology and AI. We will keep you posted as we progress and expect these investments to fit within the envelope of our profitability targets. Switching gears to the macro environment, we continue to see increasing evidence of an industrial recovery taking hold with positive IP readings across all of our top manufacturing end markets. Further evidence can be seen in recent MBI readings that remain above 50 and in the ADS trends of our solutions that continue to show volume improvement on a per unit basis. As you can see on slide seven, average daily sales outpaced the IP index for the fifth consecutive quarter and was above our target of 400 basis points again this quarter.
While this continues to be largely price driven, our improving volume trend signals that our initiatives are taking hold and we are headed in the right direction. Before I turn it over to Rob, I would like to acknowledge the efforts of the entire MSC team. We implemented a lot of changes during my first year as CEO. A year ago on this call, I said that we would succeed if we raised our own expectations, inspired curiosity and a spirit of continuous improvement in our team, and drove speed and accountability as we deliver on commitments. We are building a performance culture, and I could not be more proud of our MSC associates for the way they have responded. With that, I will now turn the call over to Rob to introduce himself as our new CFO and cover our financial results in more detail.
Thank you, Martina, and good morning, everyone. I am very excited to be here and to work with Martina and the entire MSC team as we make progress on the unique opportunity that MSC has for improved financial performance and shareholder value creation. My focus will be on the key drivers of that value creation, profitable organic growth, sustainable margins, strong cash flow generation, and disciplined capital allocation. To further support the performance culture Martina mentioned, I will ensure we take a rigorous, fact-based approach, establish clear accountability, and translate our priorities into measurable results. I commit to maintaining clear and consistent communication with all of our stakeholders as we move forward. Moving to our fiscal 4Q performance on slide eight, I am encouraged by the continued momentum that led to these better-than-expected results. Sales of approximately $1.1 billion grew 8.6% year-over-year on an average daily basis.
This performance was better than expected and primarily driven by price of 6.9%, as well as improving volumes that contributed another 1.6%. Sequentially, average daily sales improved approximately 3% and outperformed historical 3Q to 4Q averages. By customer type, we were pleased to see core and other customer daily sales growth above 10% and continue the trend of outperforming total company. We also saw continued improvement in national accounts with growth of approximately 9% in the quarter. In the public sector, daily sales declined approximately 1% due to a tougher comparison in the prior year. In solutions, we are seeing a compelling growth setup with sales trends suggesting further macro improvement as our installed base continues to expand. In vending, 4Q average daily sales were up approximately 20%, while sales to customers with an In-Plant Program were up 19%. Moving to profitability for the quarter.
Gross margin of 40.6% improved by 20 basis points year-over-year despite slightly negative transactional price cost. Our price cost headwinds are being driven by targeted strategic volume decisions and timing differences between material inflation and changes to contract prices. However, it is important to note that while transactional price cost is having a decremental impact on our gross margins, it is still incremental at the operating margin level as we leverage our fixed operating costs on higher sales. Operating expenses in Q4 were approximately $323 million and $321 million on a reported and adjusted basis, respectfully. On an adjusted basis, operating expenses were up $16 million year-over-year and performed slightly better than expected. As a percentage of sales, adjusted operating expenses declined 140 basis points compared to the prior year due to the lift in sales and savings from our cost optimization efforts, partially offset by inflation and freight.
In addition to the reported operating expenses, we incurred a $42 million non-cash impairment charge related to our Digital Core project, as Martina mentioned. Reported operating margin for the quarter was 6.7%, compared to 8.6% in the prior year. On an adjusted basis, operating margin of 10.9% exceeded the high end of our guided range for the quarter and improved 170 basis points compared to the prior year. This resulted in an adjusted incremental operating margin of 27%, coming in slightly better than we expected for the quarter. Lastly, on the income statement, we reported GAAP earnings per share of $0.85 compared to $1.01 in the prior year. On an adjusted basis, EPS of $1.45 improved 33% from $1.09 in the prior year. The asset impairment in Q4 negatively impacted operating margin by 390 basis points and $0.56 to GAAP earnings per share.
Now let's turn to slide nine to review our balance sheet and cash flow performance. We continue to maintain a healthy balance sheet with net debt of approximately $412 million or roughly one times EBITDA. During the quarter, we continued to generate strong cash flow despite the increase in inventories and receivables associated with the lift in sales. We delivered free cash flow of approximately $64 million or 133% of net income in the quarter. This resulted in free cash flow conversion of 102% for the fiscal year. However, it is worth noting that the asset impairment during the quarter was a non-cash item that positively impacted our free cash flow conversion. Turning to capital allocation 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.
We repurchased approximately 160,000 shares throughout the year. Combined with our quarterly dividend, we returned approximately $208 million to shareholders in the fiscal year. Moving to our expectations for fiscal 2027, let's look at our first quarter outlook on slide 11. Starting with the top line, we expect first quarter average daily sales to grow 9.5% to 10.5% compared to last year. Sales were up 9.5% in September, and we expect growth of approximately 11.5% in October and 9% in November. At these growth levels, we expect our adjusted operating margin for the quarter to land between 9.5% and 10.1%. Breaking that down further, we expect gross margins to slightly underperform our typical fourth to first quarter sequential decline of about 10 basis points due to ongoing material inflation and the timing of our pricing actions.
In addition, we expect a slight sequential increase in adjusted OpEx due to higher employee-related costs and freight, partially offset by productivity gains and lower variable expenses. I will now turn to slide 12 to review our expectations of certain line items for the full fiscal year. We expect depreciation and amortization expense to be $100 million- $105 million. Interest and other expense will be $40 million- $45 million. Capital expenditures will total $90 million- $100 million. Our effective tax rate will be in the range of 24.5%- 25.5%. Lastly, despite working capital needs to support growth, we see another solid year of cash generation and expect free cash flow to be 80%- 90% of net income. With that, we will open the line for Q&A.
Thank you. At this time, we will be conducting our question and answer session. If you would like to ask a question, please press star one on your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star two if you wish to remove your line from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question is coming from Ken Newman with KeyBanc. Your line is live.
Hey, good morning, guys. Rob, congrats on the new home at MSC, and I look forward to working with you.
Thank you. Looking forward to it as well.
Yep. For my first question, it is on the ADS growth guide for the fiscal first quarter. Rob, I think you just touched on it in your prepared remarks, but it does look like the midpoint of the range implies a modest step down in November vs both where you saw preliminary September and October numbers. Just to clarify, is that primarily just reflecting conservatism, or is there something structural that we should kind of be aware of in that estimate?
Yeah, the sequential is really driven by the comparisons to last year, Ken. When you look at it, in prior year, we had the government shutdown that really impacted the month of October and then got better in the month of November. That is why you see a bit of a stronger month of October and a little bit weaker month of November. The ADS across the three months is similar to kind of our historical ADS across those three months.
Understood. Okay. For my follow-up here, it looks like the implied incremental for this first quarter guide is in the mid-20s. Just given all the work that you have been doing on cost out and volume improvement, I know you do not want to guide to the full year, but is there a way to help us think about base case operating leverage as we move through the year and help us understand the cadence of some of these benefits from productivity initiatives as the volume continues to improve?
Sure. I will start. I am sure Ryan or Martina may want to jump in here with a few more details, but as you said, we do not give full year guidance. Obviously, one of the things I have been digging into a lot is that flow through methodology we look at and how we talk about that and what we are looking at for the full year. The reality is right now, there is a lot of variables at play, right? I think the framework we have out there of 20%-30% makes a lot of sense. I think coming in at mid-20s is not something we feel like we need to apologize for. We feel like that is a really good performance for the company and certainly is accretive to the overall company.
As you think about the year, we have a number of things going on in the business that we are dealing with right now as well that are going to have some impacts on that, right? From a price cost perspective, right, we are in a highly inflationary time. We are working through putting through that price with our contract customers, and that takes time and negotiation. So there is sometimes a bit of a timing difference there. Overall, it is still incremental to the bottom line like we talked about, but it can have a little bit of impact on gross margin there, and it may not be coming forward at the full 30% initially. As well as we are out there going after incremental volume, right? National accounts, areas like that.
The reality is, hey, if you get new business at a 35% gross margin, 10% variable cost coming off of that, at 25%, while that is below maybe the 30% you are looking for, it is still going to be incremental to the overall business. Those are some of the things going on. Martina or Ryan may want to add on to that.
Yeah. Let us talk about the first quarter first, Ken. I think what is happening is you got two intersecting factors. We have said we are going to start using price as an offensive weapon. We see the volume coming, national accounts and core. We want to continue to fuel that. So that is putting some pressure on gross margin at the same time as we are taking just continued absolutely unprecedented inflation. We had signaled to you that the tungsten inflation and metalworking inflation was not behind us, and we were going to take price in the first quarter, which we have. Now we have got another wave which has to be worked out of the business. If you think about it, the same thing happened at this time last year, right?
We entered Q1 kind of upside down on price cost and then worked it out of the business. There is a little additional pressure right now, which is, I think, driving that 24%. But the algorithm, we still expect to be able to deliver.
Yep. Ken, the other factors I wanted to talk about also was on freight, we are seeing inflation there and then on employee-related expenses as well, and the biggest one being medical expense. So that is also something that we are navigating as well.
Understood. Very helpful. Thanks.
Thank you. Our next question is coming from Chris Dankert with D.A. Davidson. Your line is live.
Hey, morning, everyone. Thanks for taking the questions here. I wanted to start off on just the pace of headcount reduction. Obviously, we've seen some really nice sales growth here. Are we kind of moving a little bit more slowly on the headcount reduction, just given, hey, we want to support that growth? Maybe just kind of talk us through some of the puts and takes around optimizing our labor here.
Yeah. Thanks for the question, Chris. No, we're still full speed ahead with our plans. I think what we've tried to say in the past is, I wish it were going to be linear. It's not going to be linear. It's going to be chunky and based on initiatives. We did have, I think, a net 40 heads in the fourth quarter. That was related to work that we had signaled a couple of quarters ago, which was related to our sub-scale businesses. So that's one of the initiatives on the roadmap. We're looking for synergies there. But honestly, the biggest step forward on this whole headcount productivity initiative was the decision to stop the work on the Digital Core project and take that impairment this quarter.
That was truly the rock in the river, because a lot of these initiatives have to do with process change, but a lot of them have to do with automation, and we were constrained with what we could do following that path. Now that that decision is behind us, and Andrei's on board, and Rob's on board, what it gives us the chance to do now is rephase some things, because we want speed as well, right? I'm going to repeat what I've said before. We're not going to signal ahead of time. It will come on in chunks, but we'll be able to do smaller chunks sooner with benefit sooner. Everything is on track, and that really sort of supercharges what we're doing.
Got it. Thank you so much for the color. Definitely helpful. Just to follow up, I guess, and forgive me if I missed it, but on first quarter, the kind of sales expectation, can you just level set us on what you expect price to contribute in the quarter?
Yeah, this is Rob. I'd say it's going to be pretty similar to Q4, which means volumes we continue to see slightly improving quarter-over-quarter.
Yeah. Thanks so much, guys.
Thank you. Our next question is coming from Guy Hardwick with Barclays. Your line is live.
Hi, good morning, Martina and Rob. I was just wondering, with volumes now picking up, including the benefit of the extra day, volumes are up like 3% year-on-year. At what point do you start benefiting from supplier rebates? I think, Martina, you said your strategy was to reinvest some of those in wallet share and growth. Maybe if you can potentially talk about dynamics for FY 2027 in terms of volume rebates and if they occur, to what extent will you reinvest those?
Yeah, this is Rob. I'll start off. Supplier rebates, we're starting to see some of those benefits this year as well. That was a benefit we saw in the fourth quarter, year-over-year. Call it 20, 30 basis points in that ballpark, and then some of the headwinds we mentioned are what offset that. The biggest driver of the quarter-over-quarter change there was really just normal seasonality that we typically see in the fourth quarter. As we move into next year, yeah, with volumes starting to increase and continuing to accelerate, we would expect to continue to get rebates and, yes, use those to help drive some of the things we're doing to capture additional volume.
Thank you.
Thank you. Our next question is coming from William Blunt with Rothschild & Co. Your line is live.
Thank you. Good morning, everyone. Just firstly, could I ask a question for a bit of an update on the sales force disruption we saw earlier in the year? Could you quantify maybe the current growth gap between those core customers that were affected by those changes earlier in the year and those that weren't? Then maybe sort of what are your expectations for that gap to close? Thanks.
Yes, absolutely. Just to recap, we had shared that we're tracking customers in a couple of buckets. So customers that we would describe as not having had significant change during the restructuring and customers that did have either an uncovered period or a significant amount of phase change in the process. The first group is performing in sort of the mid-teens range for growth. Remember, I think I've said this is a game of averages. The second group was in the second quarter negative, went positive in the third quarter. By this past fourth quarter, they are in the mid-single digit range. What's important to remember with that group is we've now even started to tease that apart a little bit more in the sense that in that group are also customers who will be permanently uncovered going forward.
I want you to think about a two-person auto body shop that MSC used to be calling on, we're not calling on in person anymore. That volume loss will, of course, drop off as soon as we cross over into December. So I would say it's 1/3, 1/3, 1/3 . So we've come up to positive, now we're mid-single digits, and we're closing that gap every quarter.
That's useful. Thanks. Could I just ask a follow-up maybe actually on the vending sales, which accelerated again to, I think you said 20% on the call this quarter. Is that seeing an artificial boost from the conversion of some of your less profitable In-Plant Program back to vending only revenues? Or is this pointing to a stronger take-up more generally? Thanks.
Yeah, William, this is Ryan. I wouldn't say we're really seeing that. The growth in vending, the install base in vending year-over-year was similar to what we've been seeing all quarter. I think what it is more of a reflection of an improving macro conditions. If you look at average daily sales per vending machine, they were up low teens year-over-year in Q4. To us, that's a real good gauge on production activity and increased demand. We're starting to see the volume benefits of that. So that's how I would look at that improvement there.
The rationalization you see in the net number of new In-Plant Program, it's mainly on the In-Plant side that we're assessing that profitability. If you look in the op stats, you see maybe an increase of five, a net five. But the new signings are four times that. If you think about my analogy of get wet when it rains, that's volume through existing installed base of vending, and making it rain, we're seeing an acceleration in new signings and you see the strong growth in national accounts.
That's very useful. Thank you.
Thank you. Our next question is coming from Tommy Moll with Stephens. Your line is live.
Good morning, and thank you for taking my questions.
Hi, Tommy.
Martina, I wanted to circle back to some comments you made regarding personnel. If we just look at the quarter-over-quarter trends here, overall associate headcount was down. Field sales associate headcount was up for the second consecutive quarter. We have some crosscurrents here. Could you unpack both sides of that? I think you already commented on some of the reductions, but anything more you could offer would be appreciated. Thank you.
Yes, absolutely. On the sales side, you're seeing two things happen. The first is we're filling. We had that attrition, and so we're catching up, and I would say we're caught up. We're pretty full in terms of the sales force. But in the sales onboarding program, and I've talked about it before, what we really want is time to money, right? As soon as we can give Rob the algorithm that says a new seller is going to be productive at this date, then that's going to really allow us, within the context of our turnaround, to start adding sales heads back in where we see potential. Historically, a territory doesn't even start paying back after a new add at MSC for more than 12 months, and we're already seeing payback within three months.
What you're starting to see are some very surgical insertions of new sellers, and we intend to drive growth. We are going after coverage and growth. So where we see potential, we'll continue to do that. Cautiously, right? We want the payback, but that's that plan. So the net number, as I said, in this quarter in particular, the largest moves were in finding some synergies in some of our subscale businesses. So you're looking at it exactly the right way. To consider our headcount productivity initiatives, it's the net number. Sales heads may continue to increase as we grow volume.
Yep, and that net number, as a reminder, is total headcount less our sales headcount, and that was down about 43 heads quarter-over-quarter.
Yeah. And so that's why we gave you that target of trailing 12-month revenue divided by total headcount, which continued to improve for another quarter, because that sort of combines all of these moving parts together.
Yep. Appreciated. Let me also ask about price cost. There are a lot of inflationary headwinds that you flagged this morning. If I am hearing you correctly, I think what you are saying is to start the year, we should think about price cost once again in a negative position. I am putting words in your mouth here, but I am just going to guess full year aspiration for 2027 would be neutral. I think so. That would imply that as you go through the year, things should improve, and probably a lot of that is tied to the timing of these contracts that you can renegotiate. If that framing is not accurate, please correct me? Thank you.
Yeah, this is Rob. I will add a little bit of color there. Overall price cost from a dollar perspective is certainly positive, right? At the gross margin and operating profit level. Because of some of that timing that we are talking about on contracts, we do have some things that take a little bit longer. At the gross margin line, we may not fully be recovering from a margin perspective, so there is a little bit of a decrement there. But we are talking 10, 20 basis points at this point in the quarter. Nothing too significant. But we are managing through that, working through that, and we have some higher costs that are going to be rolling through, so we have more work to do to get through the year.
Like I said in the prepared remarks, it is important to remember that is still incremental at the op income level where we are at today, and we are working through what we are going to do the rest of the year. To your point, the goal is always to remain neutral on that, right? We are always looking to, from a margin perspective, fully recover and maintain our margins. That is the goal. But we are working through those negotiations, and we will have to ultimately see where we land there. But the overall goal on the gross margin, and Martina said it before, is to stay in that 40%- 41%. Percent range, and we've got a lot of stuff going on with price cost in there, and we've also got new customers and incremental volume coming into it as well.
Thank you. I'll turn it back.
Thank you. Our next question is coming from Ryan Merkel with William Blair. Your line is live.
Hey, everyone. Thanks for the question. I wanted to start with first quarter, the volume's up 3%, I think is what you're implying. I was thinking it would be more like mid-single digits or better. I guess my question is why isn't the volume better at this point, given improving markets? It sounds like some of the growth initiatives are really kicking in.
Yeah. This is Rob. When we look at it from a sequential standpoint, right, and from where we are today, typically Q4 to Q1, I believe the sequential step up is around 1%. We're going to be a little bit better than that at 2%. We do see us growing faster than what we anticipated. We think there's more opportunity out there for sure. We went through a major sales reorganization last year, and honestly, I'm impressed with where the company is today from that in terms of how quickly they've recovered when you go through something like that. We're now driving sales to the bottom line, actually with better margins than we had before. We're very happy with that change, and we just see momentum building. But it's going to take time. We've hired new salespeople.
We've got a new Time to Win project that gets them on board quicker that I'm sure Martina's detailed in the past. If not, she can give more details. We're excited about where volumes are going from here.
Ryan, this is Ryan. I just want to add another data point, too. If you look at the volumes on a two-year stack base from 4Q to 1Q, we're still showing further improvement at the midpoint of our outlook.
Okay. Appreciate that color. Thank you. I had a question on incremental margins. I appreciate some of the pressures that you're talking about here in 1Q, but my question is, can we still do high 20s incremental margins in FY 2027 if the top line is near 10%? Or are we saying that might be a little difficult just given some of the cost pressures that you're seeing?
I didn't hear. Did you just say 20% in there?
High 20s.
Oh, high 20s.
High 20s. Yeah.
We're shooting to do better than that, right? We're always working to do better than that. We're looking to drive more productivity. With some of the big decisions we've made now, we think we can move faster with some of those things. We're looking to do better, but we have headwinds, and we just want to be upfront with that, right? In terms of inflationary pressures, both on materials, freight, labor as well. We're working through those, but we're confident we're going to be in that 20%- 30% range. Like we've said in the past, when we do these waves of headcount adjustments, and they will come in waves, we can certainly do better than that.
Okay. Got it. Thanks. Pass it on.
Thank you. Our next question is coming from Robert Davies with Wolfe Research. Your line is live.
Hello. Thanks for taking my question. I had two. First one was just around, I guess, evolution of pricing and the ability to hold onto price in the face of deflating tungsten prices. I guess if tungsten prices were to go down over 2027, are you comfortable in being able to hold on the price you've already got and potentially benefit from a margin perspective? That was the first question. The other one was just if we could get an update in terms of some of your key AI initiatives and the rollout of that across the business, where you think that's going to move the needle first? Thank you.
Yeah. Let's talk about tungsten first. We certainly don't see any deflation in the price of carbide cutting tools. I think the indexes have started to stabilize. But at best, what our suppliers had been signaling coming into the fourth quarter was stability, and now we're starting to take on new increases. What we've tried to do is protect our customers to the extent that we can in this uncertainty, which is the timing lag of pricing that we're all talking about now for the first quarter. We're going to have to move, and we will move. And we will not have to reduce any prices until our suppliers reduce their manufacturer's list price, and none of that is coming in the near future. I think we can hold on to the price level where we are.
And then your second question was around the AI initiatives. We've deployed AI successfully in a number of areas. If you heard us talk last year, we had both in terms of guided selling and some of our network optimization initiatives around placement of inventory, which has let us stay in front of the largest piece of this freight inflation, right? We have had productivity offsetting the freight inflation. This extreme inflation now that we're experiencing, we've got to work out of the business, but we've been using a lot of different productivity steps in supply chain to offset. And we're also now using AI in a number of other areas. We're using it in sales assist, particularly in the safety area to do assessments. We're using it in what we would call product cross-reference, so managing product data. We're automating orders.
And so the biggest opportunity that we feel that we have is really in the customer experience. So how can we drive speed and efficiency in our interactions with customers, whether that's on inbound orders, that's on product recommendations, et c. And so that's all part of our plan to get back to the mid-teens operating margin. And so we haven't shared more detail of what the implications of each of those changes will be, but those are the kinds of things that we're looking at.
Very helpful. Thank you.
Thank you. Our next question is coming from David Manthey with Baird. Your line is live.
Yeah, thank you. Good morning, everyone, and congratulations, Rob.
Thank you, Dave.
So back on the cadence for price increases here, was it September that you raised price? And, Rob, with your answer to a prior question, you sort of implied that the first quarter would see price close to 700 basis points against what looks like a 200 basis point harder comp. I just want to confirm that up front. And assuming that is the case, even as comps get tougher through the year, it seems like maybe you can sustain a mid-single-digit pricing for fiscal 2027. Is any of that outside the bounds of how you're thinking about things?
Yeah. You are definitely right that we took a price increase in September. Q1, we do expect to be in that 7% range, so some of that is carryover. A big chunk of that is carryover, but we do have the new price increase that went in as well that is going to offset some of the fall-off from price increases last year. Obviously, how the rest of the year plays out is to be determined from here. But mid-single digits, it seems very. We are looking at probably 3%-4% carryover impact for the full year. And we are still seeing inflation, so mid-single digits does not seem too crazy to me from here.
Okay. Thank you for that. And then on your commentary around the normal fourth quarter to first quarter gross margin progression, my model only goes back to 1995 and I cannot figure out a pattern here. Could you tell me what you see as normal?
Yeah, Dave. This is Ryan. What we look at is typically the five-year average, but there is a big outlier in that one. If you remember, in 2023, we had some outsized public sector orders in the back half of the fiscal year. So that to us was an outlier because it pressured gross margin quite a bit and really helped out that sequential. But if you look at past five years and then pre-COVID, I think that is a good way to look at it. Directionally, it is about 10 basis point decline from 4Q to 1Q.
Okay. It looks like it ranges between down, I do not know, 30 or 40 and up 30. But you are saying down 10? Is that what you said, Ryan?
Yeah, down 10, if you look at the five-year average and exclude the 2023 outlier from 4Q 2023 to 1Q 2024. Then if you look past the COVID average, it is around down 10.
Yep, I see that. Okay. Thank you very much.
Thank you.
Thank you. Ladies and gentlemen, we have reached the end of our question and answer session, so I would like to turn the call back over to Mr. Ryan Mills for any closing remarks.
Thank you for your interest in MSC today. Our next earnings call will be on January 6, 2027.
Thank you. Ladies and gentlemen, this does conclude today's call. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation.