Welcome everybody to session two for the Jefferies Global Industrials Conference. I am Stephen Volkmann, industrials analyst at Jefferies. We are going to be doing a bit of a fireside chat here today with MSC Industrial, and very pleased to welcome Martina McIsaac, who is the CEO. Ryan Mills, who is SVP of IR, will keep us all in line here. We are going to do sort of a fireside chat format here. If anybody wants to get involved, certainly happy to share the weight. I will come up for air a couple times and queue you guys. But if you do not, I will keep going and we will have an interesting conversation. Martina, welcome. Thank you for coming.
Thank you. Thanks for having us.
Great. You have been at MSC now, I think around four years or coming up on four years. You have been the CEO since-
January
January. Since you took over in January, you have been working on some sales force restructuring, and we have 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 are trying to manage the business, and where you think it can go.
Sure. Thank you. Well, thanks for having us, Steve. I have been at MSC for just about four 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. We were able to lay the groundwork for a turnaround that we are in the middle of executing. We are 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 have made a lot of progress so far. Our sales force restructuring is what we have talked about the most this year.
That is my next question.
Yeah. We have also completely revamped our pricing structure. We have invested a lot in network optimization, so managing the balance of freight versus footprint, optimizing within the four walls of our distribution centers, and there are a lot of early wins to be seen in our numbers already. If you look at what is happening with fuel cost, we have been able to offset most of that because of what we have done already on the network side of things. Whether it is contracts or AI-driven planning and inventory placement, we have built a lot of fundamentals in the first three years that I was at the company, and now we look to accelerate organic growth with the sales restructuring.
Just in case people are not in the weeds here, the goal is mid-teens EBIT margin.
Mid-teens. That is right.
Today, we are around 10%, so that is a pretty good hill to climb still.
Yeah. We ended last year at 8.4, so it is a climb, but we will get there.
What are the tools that get you there?
To get us to the mid-teens?
Yeah.
There's a couple of things. I'll dive right into the guts. The first thing that we did was we aggressively benchmarked our cost structure against our competitors. There's no perfect proxy competitor to MSC in industrial distribution, so we looked across the competitive set to hold ourselves accountable to what we think best in class is. We identified that our cost structure, to give you a representation, at the same sales level, we're about 1,000 heads heavy to deliver the same sales result as our competitors. That gave us the North Star of where we want to go. Certainly tackling that, and we have a roadmap 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 roadmap to do that.
The other side of the equation is, of course, to accelerate organic growth. 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. Now, we look at putting in place the disciplined sales execution to get us there.
The 1,000 heads comes up a lot.
It does, yeah.
I am sure it is a nice round number. What does that remind me, as sort of a percentage of total MSC?
We are about 7,000 today.
Okay.
Yeah.
All right. You are looking at a reasonable chunk of folks.
Yeah.
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 is an excellent question. The metric that we have 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 is not included in the 1,000. This is an additional 1,000 that is primarily in the back office in our warehouses right now. So how do we do without them? We change the way we work. So we are looking at increasing the level of automation in our supply chain and in our back office, and leveraging some AI as well.
Okay. If my math is right, which is always a big question, that probably, if you can do that, gets you 200-250 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.
I'd say directionally that's right, but there's also some fixed cost leverage to be had too on the top line. 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. You don't have to go easy on me here. It's okay. I can take it if I'm wrong. The other half of the gain then is more about what you're talking about, Ryan Mills, 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: incremental should be at or close to 20%. High single, low double-digit: the incremental should look upper 20s or potentially a little bit better than 30%. That's the baseline. As you model out the out years, as we attack our cost structure and take heads out, that'll be additional or incremental to that incremental margin framework, if you will.
Okay, good. For some reason, distribution investors seem to obsess about gross margin. Talk about how gross margin sort of reacts to this whole process.
We have, starting in 2023 and ending in 2024, we revamped our whole pricing structure, and we have now, I believe, put in place a very logical, competitive, and reliable pricing system. We are 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. We are not really looking to expand gross margin anymore. We would like it to be stable in that 40%-41% range. That is what you can count on while you are modeling.
Okay, great. You talked about pricing, so let us dive into that a little bit. Pricing has been pretty good this year. We have had this backdrop of tungsten being sort of crazy.
Yeah.
Just let us lay the groundwork for what you are seeing in terms of pricing and what the outlook is.
Okay. For just a little bit of background, if you don't know our business well. Cutting tools represent about 15% of our total revenue. The tungsten carbide affects cutting tool production, and the inflation there has been extreme, like in the neighborhood of 500%. 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. There has been inflation. Tungsten 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.
We're still hearing from suppliers based on their own control of their own supply chains and their access to. 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.
It's been significant. I think you had 7.5 points of price and
Yes
50 bips of volume, right?
Yes. Yeah.
Was that the second quarter or the first?
Our second quarter. Yeah.
Third quarter.
Third. Yeah, sorry.
Oh, third quarter, yeah. The calendar second quarter.
Exactly. Yes. The fact that we're seeing 50 basis points of volume, do you think there's any demand destruction from all this price that's being pushed through?
No. 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 far, we're still seeing unit growth on the metalworking side. We are uniquely positioned to capture any leakage that would come from a demand shift, because what is a 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 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 think we're the biggest metalworking player, so we've also been able to use our cash to pre-buy some product. We have great cooperation with our suppliers to navigate this.
Okay. 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 are not over yet.
Okay.
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. Every supplier is behaving a little differently. But there is still a wave to come. I think we said in the third quarter, we expected our late fourth quarter, early first quarter, there would be another price increase.
Okay. All right, good. Let us 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.
Yeah. Yeah. 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 are positive. Some barely positive, but after a long trough, we are starting to see indications. We look for things like sales through individual vending machines or sales through In-Plant Solutions. 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. Now we are 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 are 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? No.
No, it just feels like broad-based improvement. That's it.
Okay. Since we are tugging at that thread and we are on a webcast, any update you might want to provide relative to the current quarter?
No.
No? That is good. That is a good answer, too. The last one, it was funny. I do not know if any of you guys were in this, but I did the whole thing, and at the end he says, "Can I just say the third quarter is looking good?" All right. I guess I should have asked.
Well, our fourth quarter is closed at the end of August, so we will report at the end of October.
Perfect. We will be ready. Let us talk about capital allocation and your plans for that going forward.
Can I first tell you how excited I am that we have a new CFO?
Yeah. Let's do that. Let's do-
We announced it yesterday. We have been looking for a new CFO to join our team since last August. We've been extremely picky. We announced yesterday, Rob Kuhns, who was the CFO of TopBuild, will join us next Monday. Very, very excited about that. 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. Obviously, we'll let him take a fresh look at our capital allocation priorities. Right now, what I would say is the best opportunity that we have is still organic reinvestment in the business. Continuing to drive the supply chain improvements, this automation that we're doing, and to go after our turnaround objectives.
Obviously, we support continued growth in the dividend and buyback of share-based comp. Besides that, I'll wait and let Rob tell you once he's on board.
All right. We'll look forward to having him next year, maybe.
Yeah.
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.
Yeah. One of the things during the past year that we've done is we've 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. We are lucky, I think, that we have a lot of legacy technology, so we have a real opportunity to leap ahead there. We gave John Reichelt, our COO, we gave him this time to do an assessment, and we'll be sharing more in the coming months of where we're going with that.
Clearly, AI is an opportunity, and I do think we're one of the fortunate that we don't have a lot of an anchor. We can leap forward into new possibilities. 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 what you think it should be today?
I think we certainly have capacity. We can double our revenue without needing to add any capacity. Another add who has been here about a year and a half 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 will 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. 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. 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. We have metalworking; we have an equal-sized business that is what we call MRO. 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. When we did our sales force redesign, the goal was to say, how do we leverage the whole portfolio across the whole sales force? We're already seeing a lot of fast growth there.
That's where I think our fastest organic growth will come in the coming months. 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 break on throughput through a plant. 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 operation. Do we lead with metalworking? Yes. Do we want to sell the full portfolio? Yes. Now we compensate our sellers on selling that full portfolio. That's new since last December. We've been growing 18%-20% in OEM fasteners as a result. I expect you'll see us talking more about the rest of the business.
Okay. On the metalworking side, what do you think your market share is roughly?
Oh, we still have lots of room to go.
Yeah.
It's highly fragmented. Yeah.
Right. Okay. So why do people pick you instead of somebody else? Because there are some other distributors out there.
Yeah. I'll give you my opinion. We've been doing this for over eight 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 the technical capability to optimize production and to make the right recommendations. So we are not tied to any one brand. So a customer senses 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?
Our reason for being.
Exactly right. How do you strike the balance with that? Is there an opportunity?
There is. I think if you look at the last 18 months, we have 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. We do sell 2.5 million SKUs. It is a complex business to manage, and inventory is our weapon; especially in metalworking, we are very proud of the fact that we have what customers need, and we can get it to them the next day. That does not mean that there cannot be optimization in terms of the way we plan and what we stock. We are continuing to focus on that, and that is a big area where AI is supporting us.
I think there is also obviously, on the DSO side, this is again a complex business, and it is the 20% of our customers' world, so it does not always get their attention. I think that, again, bringing order there to the chaos, we should have an opportunity to improve.
Okay. There's been a lot of discussion around, excuse me, 80/20 optimization in distribution. I do not know if you would characterize yourselves as doing that or not, but would you expect to have more SKUs or fewer SKUs in five years?
What we call weaponizing inventory is about the right assortment. In distribution, you do not 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. We have been working with our supply community for about a year and a half to define what is the strategic assortment. That would actually narrow the SKU count instead of increasing it, inflating it.
Okay, interesting. Maybe a growth question, and then I will see if there's anything here in the audience. But you talked, I think, about a February event where you had 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.
In distribution, you hear a lot of times that we are a short-cycle business, so the word pipeline does not come up very much. If I were making airline turbines, you would have this long backlog, and you would know what your pipeline is. 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 do not know when they are going to need something, but we better know that they are going to come to us when they do need it. White space management becomes critical to our strategy, and that is new for MSC.
What we did in February was we had basically a Supplier Council, not a typical Supplier Council, which is like a trade show where you walk around and pick up swag, but actually more like what you are going to do today. We analyzed together with suppliers, white space. To give you a reference, what is white space? If you are buying metalworking tools from me, but you are not buying PPE, that is white space. You need PPE to run your machines. Why are you not buying it from me? We were able to map that with our core suppliers and link 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 is about $500 million of vetted opportunities that the suppliers signed off that they were going to support us, and our sellers signed off that the opportunity was real, and now we are just working that pipeline. We will give you an update on it in October. But after the first quarter, we had closed about 10% of it. These are new muscles for MSC. But, to me, that is how you. I know I have told you this before, but I have an expression: You either get wet when it rains, or you make it rain. 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.
Martina, I think the Supplier Council is a key enabler for that, so maybe if you wanted to give some color on that.
Yeah. Obviously, suppliers are a critical stakeholder for us, and we have a very active Supplier Council that works with us. Together, what we are talking about is, what does industrial distribution look like in the future? How do we professionalize it together? What processes do we want to bring? It is things like, how do we more effectively commercialize their innovation? Or how do we jointly work together to capture more share? They have 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 that the process- we're going to go back to 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?
Yeah. Let me take a step back and talk about what we were trying to achieve with our salesforce optimization. MSC has a very large 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. 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. Customers that were no longer core to our strategy. Over the course of 2025, we implemented a new territory planning model, very data-driven, again, help of AI, to define for us what the structure should look like.
We did that, and that is not in our thousand heads; that was before that, but in three chunks, we took out about 100 sellers. 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 three or four or five MSC people calling into the same MSC account, which just led to handoffs and a poor customer experience. Now you have one unified compensation plan and this very clear team assignment. 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.
We put telematics on our vehicles. We have a new sales management process. We are asking you to build and manage a pipeline. We are coaching to that. It is a different environment, and we knew that some people would opt out. We did not expect it to be as immediate, and that is what I shared in our Q2 call. We actually had 90 more people than we expected leave the company. The overall attrition is less than our total anticipated attrition, but it happened in a more compressed timeframe. We felt the brunt of that in our second quarter, because if you are not physically there covering customers, then we lose sales. We were able to fill all that vacancy. The team is in place now, and there was some face change that we could not control. We had tried to minimize face change to customers.
That is 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 were not ready for. Now we are building that back up. 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 are very excited. People want to win, so we are there now.
Okay. One last chance. Good. One in the back. There is a mic that I think
Thanks. If we go back, 10 minutes to the tungsten pricing.
Yeah.
Is that pretty quick for you guys to pass through or roll back, and what happens if tungsten rolls over for you guys? Do you hang on to that price for a little bit, or no?
Let me answer that in two 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? If you had asked me about tariffs, I would have given you the same answer. Until they move their list price, we do not typically move, and we would have to see their reaction time. 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 consequently, any change- any lower-cost inventory would take some time to work through the P&L. But primarily, it is the trigger of a supplier signaling to the market.
If it did roll over, you would eventually pass that back again.
Absolutely, yeah.
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 costs?
Yeah, I assume there's inflation that you're seeing there.
Yeah. So right now, we are very happy with our transportation performance because, not that we foresaw this, but like I said, we have made so many changes to our supply chain. Again, whether it is 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 is offsetting for right now. And again, we move with published freight pricing.
All right, good. Well, with that, unless there is any one last question, maybe we will wrap it up. Seems like a good place to stop. Thank you guys so much.
Thank you.
Very interesting.
Thank you.
I think you guys are the first to report.
October 22nd.
Yep.
We'll have that to look forward to.
Yep.
Thank you.
Thank you.
Thanks, Steve.