Prompt:
Human: Those documents can be found on our website at marathonoil.com.
We'll also hear from Dane and Mike today before we go to our question-and-answer session.
Not only have our teams continue to manage through the COVID-19 pandemic as critical essential infrastructure providers, they also successfully overcame the challenges of Winter Storm Uri during first quarter, maintaining their focus on safety while still delivering on all of our core operational and financial objectives.
Though 2020 was a challenging year for our industry, it also brought with it opportunity.
And Marathon Oil chose to leverage the supply demand crisis to further optimize and enhance our business model.
We high-graded and focused our capital program.
We lowered our cost structure, and we further improved our financial strength and flexibility.
As a result, we have dramatically enhanced the resilience of our company, driving our free cash flow breakevens consistently below $35 per barrel WTI and building on a multiyear trend of sustainable free cash flow and getting that cash back in the hands of our investors.
And we have dramatically enhanced our ability to sustainably deliver robust financial outcomes.
Financial outcomes that can compete with any sector in the S&P 500 and do so across a much broader and lower range of commodity prices.
We recognize that given the inherent volatility of our commodity business that we must offer outsized free cash flow generation, coupled with investor-friendly actions to make a compelling investment case.
To that end, first-quarter '21 results are a testament to the strength of our business model and how we have positioned our company for success.
During first quarter, we generated over $440 million of free cash flow.
Despite the challenges associated with Winter Storm Uri, production volumes were in line with the midpoint of our full-year 2021 guidance, and we are fully on track to meet the annual production, capex, and cost guidance we provided at the beginning of the year.
And we are on track to exceed our free cash flow objectives.
For $1 billion of capital spending, we now expect to generate $1.6 billion of free cash flow at $60 per barrel WTI, up from the prior guidance of around $1.5 billion.
This corresponds to a free cash flow yield approaching 20% and a sub 40% reinvestment rate.
All at an assumed oil price that is below the current forward curve.
We remain committed to our $1 billion capital program.
There will be no change to our capital budget even if oil prices continue to strengthen.
We will simply generate more free cash flow and further solidify our standing as an industry leader when it comes to capital discipline, a hard-earned reputation we have established over multiple years.
We have accelerated our balance sheet and return of capital objectives, the specifics of which Dane will cover in just a few minutes.
Importantly, everything that we are doing is sustainable.
Our peer-leading capital efficiency, our outsized free cash flow generation, our competitive cost structure, our investment-grade balance sheet, and our rising return of capital profile.
The proof point for this sustainability is our five-year benchmark maintenance scenario that can deliver around $5 billion of free cash flow from 2021 to 2025 and a flat $50 per barrel WTI price environment or closer to $7 billion of free cash flow at the current forward curve, along with a corporate free cash flow breakeven of less than $35 per barrel throughout the period.
And the foundation for these differentiated financial outcomes is our multi-basin U.S. portfolio with well over a decade of high-return inventory, complemented by our integrated gas position in EG.
Finally, we are leading the way in our approach to ESG excellence and are committed to continually enhancing all elements of our company's ESG performance.
Safety remains our top priority, we are building on the record safety performance we delivered last year with a very strong start to 2021, as measured by total recordable incident rate.
Best-in-class governance remains at the forefront of everything we do.
We have appointed two new directors to the board this year and remain committed to ongoing refreshment, independence, and diversity.
We also reduced and redesigned executive and board compensation for improved alignment with investors, as I highlighted early this year.
And last but not least, we remain committed to reducing our greenhouse gas emissions intensity.
We made tremendous strides during 2020, reducing our overall GHG intensity by approximately 25%.
We are hard at work to achieve our GHG intensity-reduction target of 30% in 2021, a metric hardwired into our compensation scorecard, as well as our goal for a 50% reduction by 2025, both relative to our 2019 baseline.
And we have included $100 million of investment over the five years of the benchmark scenario to support this goal.
At the center of our capital allocation and reinvestment rate framework is our objective to return at least 30% of our cash flow from operations back to our investors.
Our capital return strategy prioritizes balance sheet enhancement through gross debt reduction and direct return of capital to equity holders through our base dividend and over time, likely through other return vehicles as well.
We have a strong track record of generating free cash flow and directing that cash back to our investors, are fully committed to this model, and are well-positioned to meaningfully beat our objectives in 2021.
When considering our updated debt-reduction target on recent base dividend increase, we're actually on track to return well over 40% of our cash flow back to investors this year.
First, we accelerated our 2021 gross debt-reduction objective of $500 million, fully retiring our next significant maturity and we're now targeting at least another $500 million of gross debt reduction, bringing our total 2021 debt-reduction target to $1 billion.
Reducing our gross debt is entirely consistent with our goal to further enhance our balance sheet, our investment-grade credit rating.
More specifically, our goal has been to reduce our net debt-to-EBITDA to below 1.5 times, assuming more of a mid-cycle $45 to $50 per barrel WTI environment.
We're making rapid progress toward achieving this milestone by the end of the year.
And in parallel, our aim is to significantly reduce our gross debt moving toward a $4 billion gross debt level.
Beyond the obvious benefit to our financial flexibility, the interest expense reductions associated with the structural gross debt reduction have the added potential to fund future dividend increases at no incremental cost to the company, thereby preserving our very competitive post-dividend corporate free cash flow breakeven.
Along with reducing our gross debt, we also raised our quarterly base dividend by 33%.
Our objective is to pay a base dividend that is both competitive relative to our peer group in the S&P 500 and sustainable throughout commodity price cycles.
Our decision to raise our dividend is a sign of our confidence in the strength and sustainability of our financial performance, and we see potential for disciplined, sustainable, and competitive base dividend growth over time.
We're targeting up to 10% of our cash flow from operations toward the base dividend, assuming $45 to $50 price environment, and we currently have ample headroom to progress under this framework.
And to ensure sustainability through the price cycle, we're focused on maintaining our post-dividend breakeven well below $40 a barrel WTI.
In fact, even with the recent dividend increase, our post-dividend free cash flow breakeven currently sits around $35 per barrel of WTI.
In summary, we are well-positioned this year to return over 40% of our cash flow to investors through gross debt reduction and our base dividend, our top near-term priorities.
As we make significant progress toward our $4 billion gross debt objective, we will likely take the balance of 2021 to accomplish.
And as we continue to advance further base dividend growth in line with our framework, we'll look to transition toward simply retiring debt as it matures and focusing more on alternative shareholder return mechanisms, including share buybacks or variable dividends, all funded through sustainable free cash flow generation.
We are not a cash taxpayer in the U.S. this year.
cash federal income taxes until the latter part of this decade.
This holds true even if the tax rules for intangible drilling costs or IDCs are changed or if the corporate tax rate has increased.
We have significant tax attributes in the form of net operating losses, approximately $8.4 billion on a gross basis, in addition to foreign tax credits of over $600 million.
These attributes will be used to offset future taxes.
Neither of these items is energy sector-specific, so we don't expect any new tax legislation to threaten them.
The bottom line is we don't expect to be a U.S. cash taxpayer until the latter part of this decade.
My key message today is that we're on track to achieve all of our 2021 operational objectives that we set at the beginning of the year, including our $1 billion capital program, and that we are on track to exceed the free cash flow objectives.
Our strong performance is due to tremendous execution from our asset teams during first quarter, despite the significant challenges associated with Winter Storm Uri.
Flat quarter on quarter, total oil production of 172,000 barrels per day was quite an accomplishment in light of the operational challenges we experienced and the impact to production you've seen reported by peer companies.
Our teams did an exceptional job keeping our volumes online and delivering much-needed production at a time when utilities and households were in critical need.
Our success began with extensive preplanning efforts and continued with a hands-on approach to managing our operations throughout the storm.
We did not proactively shut in our volumes as a preventative measure, rather we fully leveraged our digital infrastructure to prioritize protecting our highest volume, highest rate wells, intelligently routing operators to our highest-priority locations.
All the while, we kept the safety of our people as our top priority.
Our hands-on approach clearly paid off, and our operational and financial results speak for themselves.
Our capital spending during 1Q came in slightly below expectations, reflecting solid well-cost execution but also the shift in timing of some capital from first to second quarter largely due to storm-driven delays.
Looking ahead to 2Q, we expect a slight sequential decline in our oil production, the result of fewer wells to sales in the first quarter, particularly in the Bakken.
This is simply a function of the timing of our wells to sales, reflecting a natural level of quarter-to-quarter variability.
We will continue to prioritize maximizing our capital efficiency and free cash flow generation sustainably over time, not the production output of any individual quarter.
We do expect the significant increase in our second-quarter wells to sales to translate to an improving production trend as we move into third quarter.
With the increase in wells to sales and shifting capital from 1Q to 2Q, we expect 2Q capex to rise to the $300 million range, likely representing the peak capex quarter for the year.
Still, our capital program is fairly well-balanced and ratable, split almost 50-50 between the first half and second half of the year.
More importantly, our full-year capital spending and production guidance remain unchanged.
As the most capital-efficient basins across the Lower 48, the Bakken and Eagle Ford will still receive approximately 90% of our capital this year.
However, both our Oklahoma and Permian assets have high-return opportunities that can effectively compete for capital today.
Both assets provide capital allocation optionality, commodity diversification, and incremental high-quality inventory.
Consistent with what we previously disclosed in our five-year maintenance case and our plan entering the year, our objective is to reintroduce a disciplined level of steady-state activity back into Oklahoma and the Permian by 2022 at 20% to 30% of the total capital budget.
When we do, our expectation is that both assets will support accretive corporate returns and incremental free cash flow to the enterprise.
I will now pass it back to Lee, who will provide a few more comments before we move to Q&A.
I would like to briefly put the 2021 capital program, Mike just discussed, into context by comparing our capital efficiency, our cost structure, and our free cash flow generation to peer disclosures from the fourth-quarter earnings season.
As highlighted by Slide 10 in our earnings deck, our 2021 capital program is among the most capital-efficient and free cash flow generative of any company in our peer space.
The top two graphics summarize peer reinvestment rate normalized to a $50 and $60 WTI price environment.
As you can see, our reinvestment rate, which is a reasonable proxy for both operating and capital efficiency in a maintenance or flat production scenario is among the lowest in our peer group.
For every dollar of capital we are spending, we are delivering more cash flow than virtually any of our peers.
Similarly, our 2021 capex per barrel of production on either an oil or oil equivalent basis is among the lowest in our space.
In the current more disciplined environment, operating and capital efficiency are paramount and, in fact, represent our competitive differentiators.
Most importantly, as shown by the bottom right graphic, our free cash flow generation relative to our current valuation remains compelling and outsized against our peers and the broader market with a free cash flow yield approaching 20%.
We continue to believe that we must deliver outsized free cash flow generation relative to the S&P 500 to effectively compete for investor capital.
This is why we remain so focused on sustainably reducing our corporate free cash flow breakeven, now an integral part of our compensation scorecard, and continuing to optimize our cost structure.
With a free cash flow breakeven comfortably below $35 per barrel, we can generate free cash flow yield competitive with the S&P 500, assuming an annual oil price down to approximately $40 per barrel WTI.
We never rest when it comes to our structure.
In a commodity business, the low-cost producer wins, and Slide 11 provides additional details around our ongoing efforts and reinforces our multiyear track record of cash cost reductions.
We have opted to use an all-in cost basis that normalizes peer-reported data and avoids the challenges of how each operator categorizes their respective cost.
As you can see from the data, our all-in 2020 unit cash costs are well below the peer average.
On a more apples-to-apples comparison basis, our all-in unit cost are top-quartile among our direct multi-basin peers.
Specific cost-reduction actions already taken this year are broad-based, including a 25% reduction to CEO and board compensation, a 10% to 20% reduction to other corporate officer compensation, a workforce reduction to more appropriately align our headcount with a lower level of future activity, a full exit from corporate-owned and leased aircraft, and various other cost-reduction initiatives.
Finally, I would like to again underscore the sustainability of all that we are doing.
The sustainability of our sector-leading capital efficiency and free cash flow generation is underscored by the financial strength of our previously disclosed five-year benchmark maintenance capital scenario.
And our maintenance scenario is underpinned by well over a decade of high-quality inventory that competes very favorably in the peer group as validated by credible third-party independent analysis shown on Slide 13.
The quality and depth of our inventory, in combination with our reinvestment rate capital allocation approach, provides us with visibility to continued strong financial performance.
Further, we have a demonstrated track record of ongoing organic enhancement and inventory replenishment.
Even in our maintenance scenario, we continue to direct capital toward resource play exploration and targeted organic enhancement initiatives, including our redevelopment program in the Eagle Ford.
In conclusion, I truly believe our combined actions have positioned Marathon Oil for success not only relative to our E&P peer group but relative to the broader S&P 500 as well.
And our long-term incentives now reflect that conviction explicitly.
Our company was among the first to recognize the need to move to a business model that prioritizes returns, sustainable free cash flow, balance sheet improvement, and return of capital.
We also led the way in better aligning executive compensation to this new model and with investor expectations.
We are positioned to deliver both financial outcomes and ESG excellence that are competitive, not just with our direct E&P peers but also the broader market.
With that, we can now open up the line for Q&A.
 Assistant:

Chosen response:
q1 oil production of 172,000 net bopd and q1 oil-equivalent production of 345,000 net boed.
no change to 2021 production guidance.
now targeting at least $500 million of additional gross debt reduction, bringing total debt reduction target to at least $1 billion in 2021.
minimal production impact from winter storm uri in q1.


Prompt:
Human: Joining me on the call today are Nish Vartanian, Chairman, President and CEO; and Ken Krause, Senior Vice President, CFO and Treasurer.
These risks, uncertainties and other factors are detailed in our Form 10-K filings with the SEC.
Yesterday, I reviewed our annual employee engagement scores and was really pleased to see the overall scores improved from our high levels a year ago.
The connection our associates have with our mission was a highlight of the survey.
Today, I'll provide a quick overview of the quarter then I'll highlight three areas that give me confidence in our business.
Beginning with the quarter.
It was a challenging start to the year.
Quarterly revenue was down 10% from a year ago.
Keep in mind, Q1 2020 reflects a pre-pandemic environment for MSA.
So it's a challenging comparison.
In addition, our business is seasonally lower in Q1.
Economic conditions and COVID impacts created additional pressure.
We saw that pressure in January and February, followed by a strong recovery in March.
I'm optimistic that recent trends in our order book support a much brighter outlook and also recognize the road to recovery might not be a straight line.
Based on economic stimulus and vaccine deployment, the U.S. is leading the recovery in our business.
At the same time, the situation remains challenging in Europe, Latin America and some other smaller markets with COVID lockdowns.
That said, on the whole, we're optimistic that the worst is behind us from a demand perspective.
We're staying close to the challenges associated with the supply chain.
We expect resin supply to improve in Q3 and anticipate continued challenges with electronic components throughout the year.
We've managed through effectively with limited constraints in production.
We recognize this as an evolving situation, and we've experienced inflation in these areas, and we'll manage that effectively.
As macroeconomic conditions become more favorable, I'm very confident in our position to create value for all of our stakeholders.
As you've heard me say before, there are three key areas that continue to support my confidence in the future of MSA.
We've made progress in each of these areas in the first quarter.
First, MSA's innovation engine is stronger than ever.
In Q1, we continue to launch technologies that solve our customers' toughest safety challenges.
Second, our continuous improvement culture positions us to achieve our long-term margin aspirations as revenue growth returns.
We've made some nice progress with our manufacturing footprint.
Third, we're using our balance sheet to make strategic acquisitions that strengthen our position in key markets.
In Q1, we closed the acquisition of Bristol and the integration work is on track, and our M&A pipeline remains healthy.
Starting with the first area.
MSA's innovation engine and R&D pipeline, which is really the lifeblood of our business.
Our engineering excellence has never been more evident than our breakthrough innovations in connected firefighter technology and connected industrial technology.
I'm pleased to report that our team has celebrated exciting milestones in both of these areas.
On the fire service side, we launched the LUNAR firefighter location system.
It's a big accomplishment for teams of associates across MSA that worked on this system and it's the most technologically advanced product and software system that we've ever unveiled.
LUNAR is a handheld device that uses cloud technology to deliver fire scene management capabilities for incident commanders.
It also helps search and rescue teams locate a separated firefighter, and it's a thermal imaging camera.
I know the fire service is excited about this product.
It will help them tremendously with their work.
Our connected platform also provided competitive advantage in industrial markets.
We recently began delivery to supply one of the largest utilities in the U.S. with connected gas detection, utilizing our cloud-based grid software.
This customer is now able to use databased insights to manage their gas detection program with greater effectiveness.
They ordered thousands of ALTAIR 5 timesR portable gas detectors with safety IO subscriptions.
Over the next few years, this will result in a total order value of over $5 million.
These are just some of the indicators I'm seeing in Q1 that our innovation engine is running strong, achieving the milestones we've expected.
Long-standing investments in connected technology position us to deliver new to world products for our customers.
This is timely as the pandemic has accelerated connected applications that will help workers become safer and more efficient.
Our team is always striving to drive higher levels of productivity and efficiency throughout the organization.
Along those lines, we continue to execute our gas detection manufacturing consolidation project.
As we announced in 2020, we're making capex investments to expand our Cranberry township gas detection center of excellence.
Consolidation -- production -- consolidating production will help with inventory management and having our engineering and operations teams under one roof will certainly drive greater effectiveness and efficiency, which will improve margins.
As part of the program, we remain on track to close a manufacturing operation in California in the third quarter of this year.
As you know, I worked with the team out there when we acquired General Monitors, and I'm very proud how our associates have managed through this process.
The third area I want to discuss today is using our balance sheet to make strategic acquisitions that strengthen our leadership position in key markets.
At the start of the quarter, we closed the acquisition of Bristol Uniforms.
Our integration plans are off to a good start.
We've spoken before about the U.K. fire service market being a potential growth opportunity for MSA.
We're investing organically and inorganically to penetrate this opportunity.
Both the recent launch of the M1 SCBA and now Bristol are great examples of the investments we've made.
And will see benefits across the entire international fire service market by having a greater range of head to toe solutions for our customers.
In addition to having strengthened our balance sheet, we continue to move forward with an M&A pipeline focused on evaluating assets that align with our safety mission.
So to summarize, there are three key areas that give me confidence in MSA's future: First, MSA's innovation engine is stronger than ever; second, our continuous improvement culture is positioning us for long-term success; and third, we're effectively using our balance sheet to grow our business.
I'll start the discussion with financial highlights centered on revenue, profitability and cash flow.
First, looking at revenue.
We expected the first quarter to present challenges versus the record quarter a year ago.
We also talked about COVID lockdowns pressuring demand in Europe and labor constraints in certain factories due to precautionary contact tracing.
With that, I am pleased to say that our order pace strengthened in March and into April.
Fire service order activity is healthy, and the order pace in industrial-related markets started to show year-over-year growth in March.
That strength has continued into April, and that gives us good momentum moving into Q2.
Second, our profitability was pressured based on the lower revenue and trends that unfolded within gross profit, and I'll provide more detail on that shortly.
And third, I continue to be pleased by our cash flow performance.
We generated cash flow conversion in excess of 100% of net income.
The strength of our balance sheet positions us very well to pursue additional growth opportunities across the portfolio.
Now let's take a closer look at the financial results in the first quarter, and let's start with a focus on revenue.
Quarterly revenue of $308 million was down 10% from a year ago or 11% in constant currency.
In constant currency, revenue in the Americas was down about 9%, while international was down 16%.
The more severe international decline partially reflects the impact of COVID lockdowns in key geographies like France and Germany.
Expanding on my earlier comment, we saw challenging comparisons in three key areas: FGFD, industrial PPE products and respiratory protection.
First, our FGFD business declined 16% compared to our very strong Q1 of last year, while much of this business is project-based and will respond slower to economic recovery.
We are seeing good growth opportunities with orders up in April.
The business trends in this area take time to ship and while one month is not indicative of a longer-term trend.
I am encouraged by the uptick in orders in April and pipeline of new opportunities.
Second, we knew industrial PPE revenue in the quarter would provide a challenging comparison.
We did not start to see the impact of the pandemic until April a year ago in the industrial PPE lines.
Turning to page and looking at the first quarter of this year, we had a slow start in January and February but we saw return to growth in March and April.
Orders across these areas were up 9% in March and were up double digits in April versus a year ago.
We know the pace of deliveries and revenue performance could be impacted by the challenges in our supply chain but I am especially encouraged by the improvement in demand levels across our international or -- I'm sorry, our industrial-related products.
And third, our air purifying respirators presented another tough comparison due to the initial pandemic surge last year.
This landscape continues to evolve as stimulus packages are allocated to enhance PPE supplies for workers.
While the pace of incoming business in 2021 has been a bit disappointing thus far, we continue to stay ready to supply these products when called upon, consistent with the MSA mission.
Touching on fire service, backlog remains very healthy in this area.
It was also encouraging to see that funding allocated to our first responders and municipalities was included in the U.S. stimulus packages.
This funding and the mission-critical nature of our products provides a healthy outlook for the fire service business.
Gross profit declined 240 basis points from a year ago.
The decline is related to three primary areas: first, lower demand led to lower throughput in our factories, which drove inefficiencies and inventory charges.
The inventory charges were primarily related to lower demand for respiratory protection.
Second, a less favorable product mix and higher input costs impacted margins.
We've made adjustments to certain pricing actions already, and we will continue to evaluate additional pricing opportunities as we navigate the inflationary pressures.
And last, our Bristol turnout gear business was about 50 basis points dilutive to overall gross profit.
Gross margins for turnout gear are lower than our corporate average.
And that said, we expect to improve Bristol margins as we execute our integration plans.
Now I'll shift to SG&A expense.
Our expense of $75 million was down 6% or about $5 million from a year ago, and this includes $2 million of costs associated with the recent acquisition of Bristol.
We delivered $7 million to $8 million of savings from restructuring programs and discretionary cost savings associated with reduced travel, controlled hiring, professional services and other costs.
About half of these savings are temporary, and I expect these will return to some extent as the business improve and travel opens up.
The other half, however, of the savings are structural in nature.
Overall, I remain confident in our ability to deliver the cost savings we've committed to for 2021 across the income statement.
In the second quarter, we will continue to manage our cost structure very closely.
However, we expect the year-over-year SG&A comp to become more difficult.
I say that because our SG&A in the second quarter of 2020 was $69 million, and that number reflects the initial cost reduction activities that occurred at the onset of the pandemic.
Our quarterly adjusted operating margin was down 330 basis points on the gross profit headwinds and overall lower revenue volume.
Looking at our segment performance, International margins were down 270 basis points to about 8.8% of sales.
What we're seeing here is the impact of the lower revenue.
Our cost reductions and pricing programs remain very much on track.
But it's difficult to get leverage on the double-digit sales decline.
Bristol, which is our operating -- which is in our International reporting segment, was dilutive to the international margins by about 120 basis points.
And looking ahead, I know we remain well positioned in this area.
I say that because I believe we will see continued margin expansion in the international segment as the volume comes back online and COVID lockdowns ease.
Americas margins were down about 420 basis points to 21.7%.
The gross profit challenges that I mentioned previously drove this decline.
We are focused on driving improvements in our Americas segment margin performance, and I am confident in our ability to drive improvements in this area going forward.
From a cash flow and capital allocation perspective, quarterly free cash flow conversion was about 100% of net income.
In fact, operating cash flow was up more than 200% compared to a year ago.
We generated strong cash flow despite the P&L challenges, and I'm encouraged by the strong performance across working capital, which declined about 100 basis points as a percentage of sales from year-end without the impact of Bristol.
As I've noted on many different occasions, growth continues to be a top priority in our capital allocation strategies.
We deployed $63 million for the Bristol acquisition in the first quarter, and leverage remains very healthy at 0.7 times EBITDA on a net basis.
We remain active in pursuing M&A opportunities as well as funding organic projects that drive long-term growth for MSA.
As we look ahead, we're operating in a very dynamic environment.
There are a number of evolving factors that will continue to influence our revenue outlook.
These factors include, among other things, the effectiveness of the vaccine rollout, risk of additional COVID lockdowns, industrial employment rates, the pace of economic recovery and the extent of supply chain challenges as economies open back up.
Collectively, all of these variables make the outcome very hard to predict, but we know our order trends have improved in March and April, and they've improved across a number of key areas in our business.
So today, I do have a greater sense of confidence heading into the second quarter.
To wrap up, my optimism is based upon our March and April order book performance.
While near-term supply chain challenges could impact revenue performance, demand levels are improving.
Our market positions have never been stronger, and we continue to invest in growth and productivity programs across our business.
Further, I remain confident that the steps we're taking to improve our competitive position and our business model will be beneficial for MSA as conditions continue to improve.
While it was a challenging start to the year, the improving order book in March and April provides more optimism for the second quarter and beyond.
I'm very confident that our long-term focus areas will position MSA for success in the years ahead.
At this time, Ken and I will be glad to take any questions you may have.
Please remember that MSA does not give guidance.
 Assistant:

Chosen response: q1 revenue fell 10 percent to $308 million.


Prompt:
Human: Greg and Jason will review our results along with commentary, and Jack and Mahesh will join for Q&A.
These materials include GAAP to non-GAAP reconciliations for your reference.
These statements are based on current expectations and assumptions that are subject to a variety of risks and uncertainties.
Information about factors that could cause such differences can be found in today's earnings news release and the comments made during this conference call, in the Risk Factor section of our 2020 annual report on Form 10-K and in our other reports and filings with the SEC.
I'm going to start off by sharing a few thoughts about the overall business before Jason takes us through our results and our outlook.
First, Q3 results highlight the continued strong demand we're seeing across the business.
We grew revenue 13%, earnings per share 21% and expanded operating margins by 150 basis Additionally, we ended the quarter with a record Q3 backlog of $11.4 billion, up 7% from last year.
Second, we saw strong growth in all three technologies during the quarter.
In LMR, revenue was up 11% while navigating a very challenging supply chain environment and video security and access control revenue was up 26%, driven by strong broad-based demand for both our fixed and mobile video offerings.
And in Command Center Software revenue was up 13% as we continue to expand within our existing installed base and win new customers.
And finally, based on our strong Q3 results and our expectations for the remainder of the year, we're again raising our full year guidance for both sales and EPS.
Our Q3 results included revenue of $2.1 billion, up 13%, including $15 million from acquisitions and $25 million from favorable currency rates.
GAAP operating earnings of $451 million and operating margins of 21.4% compared to 18.9% in the year ago quarter.
Non-GAAP operating earnings of $555 million, up $92 million or 20% from the year ago quarter and non-GAAP operating margins of 26.3% of sales, up from 24.8%, driven by higher sales, higher gross margins and improved operating leverage in both of our segments.
GAAP earnings per share of $1.76 compared to $1.18 in the year ago quarter.
The increase was primarily due to higher sales, higher gross margins and improved operating leverage as well as a loss related to the refinancing of long-term debt that occurred in the third quarter of 2020.
Non-GAAP earnings per share of $2.35 compared to $1.95 last year, primarily due to higher sales, higher gross margin and improved operating leverage again in both segments.
Opex in Q3 was $496 million, up $41 million versus last year, primarily due to higher compensation related to incentives and higher expenses related to acquisitions.
Turning to cash flow.
Q3 operating cash flow was $376 million compared with $392 million in the prior year, while free cash flow was $315 million compared with $343 million in the prior year.
The decrease in cash flow was primarily due to an increase in working capital, inclusive of our higher inventory, partially offset by higher earnings.
Year-to-date operating cash flow was $1.1 billion, up $225 million compared with last year, and free cash flow was $959 million, up $201 million over last year.
The increase in cash flow year-to-date was primarily driven by higher earnings, partially offset by higher cash taxes paid during this year.
Our capital allocation in Q3 included $137 million in share repurchases at an average price of $234.18, $120 million in cash dividends and $61 million of capex.
Additionally, during the quarter, we closed the acquisition of Openpath, a leader in cloud-based access control solutions for $297 million, we invested $50 million in equity securities of Evolv, whose technology powers our concealed weapons detection solution.
And subsequent to quarter end, we acquired Envysion, a leader in enterprise video security and business analytics for $124 million net of cash.
Moving next to our segment results.
Q3 Products and Systems Integration sales were $1.3 billion, up 14%, driven by strong growth in LMR and video security.
Revenue from acquisitions in the quarter was $12 million.
Operating earnings were $273 million or 20.6% of sales, up from 18.9% in the year prior on higher sales, higher gross margins and improved operating leverage.
Some notable Q3 wins and achievements in this segment include $72 million of P25 orders from a large U.S. federal customer, a $70 million TETRA order from the German Navy, a $45 million TETRA upgrade from a large EMEA customer, a $43 million P25 order from a large North America customer, a $22 million P25 upgrade from Metro Sao Paulo in Brazil.
And also during the quarter, we grew our Video Security and Access Control product revenue by 23%.
Moving to the Software and Services segment.
Q3 revenue was $782 million, up 11% from last year, driven by growth in LMR services, video security and command center software.
Revenue from acquisitions in the quarter was $3 million.
Operating earnings were $282 million or 36% of sales, up 140 basis points from last year, driven by higher sales, higher gross margins and improved opex leverage.
Within this segment, some notable Q3 wins included a $41 million command center software contract with a large U.S. state and local customer, $31 million P25 multiyear extension with a customer in North America, a $17 million push-to-talk over broadband multiyear renewal with a large U.S. customer, a $7 million Command Central suite and video security order with the city of Yonkers, New York, which expanded off of a prior body-worn camera win.
During the quarter, we grew our video security and access control software revenue by 32%.
Additionally, we launched the M500, the first in-car video system enabled by artificial intelligence.
Moving next to our regional results.
Q3 North America revenue was $1.4 billion, up 14% and growth in LMR, video security and command center software.
International Q3 revenue was $658 million, up 10%, also driven by LMR, video security and command center software.
We saw strong growth in EMEA and Latin America during the quarter, while in Asia Pac, we continue to experience headwinds related to COVID-19 lockdowns in various countries.
Ending backlog was a Q3 record of $11.4 billion, up $710 million compared to last year, driven primarily by growth in North America.
Sequentially, backlog was up $144 million, also driven primarily by growth in North America.
Software and Services backlog was up $6 million compared to last year, driven by a $479 million increase in multiyear services and software contracts, partially offset by revenue recognition on Airwave and ESN over the last year.
Sequentially, backlog was down $112 million, driven primarily by revenue recognition for Airwave and ESN during the quarter, partially offset by growth in services and software contracts in North America.
Products and SI backlog was up $704 million compared to last year and $256 million sequentially, driven primarily by LMR growth in both regions.
Turning next to our outlook.
We now expect full year sales to be up 10% to 10.25% compared to prior guide of 9.5% to 10%.
And we now expect full year earnings per share between $9 and $9.04 per share, up from our prior guide of $8.88 to $8.98 per share.
This increased outlook includes the video security and access control technology growing greater than 30%.
It also includes our current view of supply chain conditions, FX at current spot rates and an effective tax rate of 21.5%, along with a diluted share count of 174 million shares.
And finally, we now expect full year opex to be $1.95 billion, inclusive of our two latest acquisitions, Openpath, and Envysion, and we expect full year operating cash flow to be approximately $1.825 billion, up $25 million from our prior estimate.
First, our results for the quarter were outstanding, and I'm extremely proud of how the team is executing through a very tough supply chain environment.
We achieved record Q3 sales, operating earnings and earnings per share and expanded operating margins by 150 basis points and finished the quarter with a record Q3 ending backlog.
Second, I want to share some color on what we're actually seeing in the two segments.
In Products and SI, demand for both our LMR and video security remained robust, highlighted by the strong revenue growth in Q3 and record ending backlog.
Supply chain constraints continue to impact our LMR business and in particularly, our PCR business as demand outpaced our ability to obtain supply in Q3, and we expect we'll continue to do so in Q4.
In software and services, we continue to see strong demand, which is driving revenue growth and improved profitability.
In fact, as we finish the year, we now expect operating margin to increase by 200 basis points year-over-year for the segment.
Our customers continue to increase their investment in our value-added services.
And in software, while we now expect Command Center Software revenue growth to be low double digits, our video security and access control software revenue growth will likely be greater than 35% this year and is the fastest growing area within our software portfolio.
Finally, as I look ahead, I'm encouraged by how we're positioned.
Our strong Q3 backlog in both segments provides us with significant demand visibility.
We're expanding our relationships within our existing installed base to provide more software and services.
The customer funding is as good as I've seen it.
And our NDAA compliant manufacturing in North America is providing a key differentiator for our fixed video solutions.
And while we expect the challenging supply chain environment to be with us through at least the first half of next year, we're still planning for another year of strong revenue, earnings and cash flow growth in 2022.
[Operator Instructions] Operator, would you please remind our callers on the line how to ask a question.
 Assistant:

Chosen response:
compname posts q3 sales of $2.1 billion.
sees fy revenue up 10 to 10.2 percent.
q3 sales rose 13 percent to $2.1 billion.
qtrly gaap earnings per share (eps) of $1.76.
qtrly non-gaap eps* of $2.35.
raises full-year revenue and earnings per share guidance again.
sees fy non-gaap earnings per share $9.00 to $9.04.
sees fy revenue growth of 10% to 10.25%.


Prompt:
Human: Erik Gershwind, our chief executive officer; and Kristen Actis-Grande, our chief financial officer, are both on the call with me.
As we continue working remotely at MSC, please bear with us if we encounter any technical difficulties.
For many years, the concept of doing the right thing has driven everything we do in all of our stakeholder interactions at MSC.
I invite you to learn more about our community relations, diversity and inclusion, corporate governance, and environment and sustainability efforts by visiting our website.
This is only the very beginning of our ESG journey, but we are committed to progress and continually striving for excellence.
Let me reference our safe harbor statement under the Private Securities Litigation Reform Act of 1995.
These risk factors include our comments on the potential impact of COVID-19.
I hope you enjoyed your holiday weekend.
I'm excited to update you today on our progress this quarter.
We are seeing the benefits of the strategic pivot that's been made by our company over the past few years.
We made significant investments across the organization to transition from a leading spot-buy provider to a mission-critical partner on the plant floor augmented by our spot-buy capabilities.
With the bulk of the less visible changes completed, we outlined our plan to return to historic levels of revenue and earnings growth, consistent with the legacy of our company.
Mission Critical is our program to translate those investments into superior financial performance.
And we shared with you two goals that underpin our efforts: first, to accelerate market share capture with a target growth rate of at least 400 basis points above IP by the end of our fiscal 2023; second, to return ROIC into the high teens powered not only by leveraging growth, but also by structural cost takeout of 90 to $100 million also by the end of fiscal 2023.
This year, our fiscal 2021 began our proof of concept with our fiscal third quarter serving as the latest encouraging data point.
With respect to revenues, we committed to achieve a minimum of 200 basis points of positive spread versus the IP by our fiscal fourth quarter.
Q3 is muted by PPE comps, but the non-safety and non-janitorial business grew about 21% year over year, and we expect our total company growth to meet or exceed our fiscal Q4 commitment.
This year, with the help of numerous structural cost reductions, we increased our customer-facing sales headcount and will continue doing so into fiscal 2022.
We've grown share in metalworking through investment and innovation that improve our customers' businesses.
At the tail end of fiscal 2021 and into fiscal '22, we're implementing improvements in e-commerce.
We started with a new production information system earlier this year and are now rolling out enhanced search capabilities, new user interfaces for both desktop and mobile, a new transactional engine, and overall improved functionality.
We've committed to maintaining our gross margin through a series of initiatives, and excluding the writedown for PPE, we have done so.
The macro environment is driving price increases.
And given our inventory turns and innovative merchandising and pricing programs, we expect strong realization to continue.
Finally, we've picked up the pace on structural cost takeout.
We've already exceeded our $25 million cost takeout goal for fiscal 2021 for the full year.
Looking ahead, fiscal 2022 is setting up even better than the current year.
We will build on our momentum and continue making progress toward our goal of 400 basis points or more of market outgrowth as measured against the IP index.
On the gross margin line, we expect inflationary pressures to continue.
While purchase cost increases are beginning to make their way into our P&L, they will be offset by ongoing price realization, yielding a stable gross margin outlook year over year.
On the structural cost front, we'll deliver roughly $20 million of incremental savings on top of that, which has been achieved over the past two years.
And that will include benefits from existing initiatives, which will deliver incremental savings during the first half of '22 plus benefits in the second half from new initiatives that we have yet to execute, along with a handful of more transformational projects that will deliver additional savings in '23 and beyond.
We will once again reinvest a portion of these incremental savings into our five growth initiatives to build upon market share capture.
Nonetheless, we expect incremental margins at/or above 20%.
How far north they go will be a function of how high we can get revenue growth and how much price realization we see.
With all of this as the backdrop, I'll now turn to the specifics of the quarter beginning with the external landscape.
The economic environment improved significantly.
Most of our manufacturing end markets turned positive during the quarter, and this evidenced itself in IP readings that turned to double-digit growth in April and May and in sentiment readings, such as the MBI index, which are at very high levels.
All of this is supported by our customers' outlooks, which are robust.
At the same time, the industrial economy is experiencing very real supply chain shortages and disruptions.
These disruptions are evidencing themselves in product scarcity, freight delays, and extreme labor shortages that are resulting in significant availability and inflationary pressures.
And we are certainly not immune to these challenges.
And in fact, we're seeing them play out.
That said, we are very well-positioned to navigate the current environment, particularly when compared to the local and regional distributors who make up 70% of our market.
MSC's broad multi-brand product assortment, our high inventory levels, strong supplier relationships, and next-day delivery capabilities position us well to accelerate market share capture.
Additionally, the supply chain challenges are resulting in significant and growing inflation that is producing the most robust pricing environment we've seen in years.
Turning now to our performance.
You can see our reported numbers on Slide 4 and adjusted numbers on Slide 5.
Revenues were up 2.2% on an average daily sales basis as we're seeing continued sequential improvement in our sales levels.
Most notably, non-safety and non-janitorial product lines improved through the quarter from mid-single-digit declines in our second quarter to 21% growth in our third quarter.
Sales of safety and janitorial products, as expected, given the significant surge during the pandemic last year, declined just over 40% for the quarter.
Looking at our performance by customer type and excluding for a moment, the safety and janitorial product lines, all of our customers, all types, were up strong double digits.
However, including all product lines and given the extremely difficult comparisons, government sales declined nearly 40%.
National accounts returned to growth by posting a low single-digit increase, while our core customers improved and grew in the mid-teens.
CCSG grew mid-single digits.
June showed continued improvement with total company year-over-year growth estimated at 15.4%.
Our non-safety and non-janitorial growth is estimated at roughly 20%, while safety and janitorial are estimated to be down roughly 10% against last year's continued PPE surge.
We expect strong growth rates in non-safety and non-janitorial products for the balance of the fiscal year.
On the pricing front, we've seen solid realization of the March price increase that we mentioned last quarter.
And as a result, we saw a sequential lift in gross margin from our fiscal second quarter's adjusted rate of 42%.
Since that last call, we've seen continued significant pricing activity from our suppliers.
And as a result, we've implemented a June price increase.
This is earlier than normal but certainly warranted given the environment.
We will not hesitate to move again if suppliers continue raising their prices.
Beyond the numbers, we had a couple of positive developments during the quarter.
One was the recovery of the nitrile glove impairment, which Kristen will touch on in just a bit.
The other was the acquisition of a majority stake in the William Hurst Company in June.
Hurst is a metalworking distributor based in Wichita, Kansas with a heavy focus on the aerospace sector, and this deal is meaningful to MSC in several ways.
Hurst goes to market with a highly specialized and highly technical sales force.
It fills out a geography in which MSC was underpenetrated and, more importantly, brings technical capabilities that we can leverage across the entire MSC business.
Aerospace is roughly 10% of total MSC sales today.
It's an industry that is poised for strong growth coming out of the pandemic, and the Hurst platform will considerably enhance our effectiveness in serving and growing that portion of our business.
Hurst has been led by CEO, John Mullen, who remains at the helm and retains a meaningful ownership stake in the business.
I'll now turn things over to Kristen to cover the financials and our mission-critical progress.
I'll begin with a review of our fiscal third quarter and then update you on the progress of our mission-critical initiatives.
Slide 5 reflects our adjusted results.
Our third-quarter sales were 866 million, up 3.8% versus the same quarter last year.
We had one more selling day this year in our third quarter.
So on an average daily sales basis, net sales increased 2.2%.
Erik gave some details on our sales growth, but I'll just reiterate that our non-safety and non-janitorial sales grew 21% in the quarter, while our safety and janitorial sales declined 42%.
Moving to gross margins.
Execution and realization on our midyear price increase was solid.
Our gross margin for fiscal Q3 was 42.3%, up 30 basis points sequentially after adjusting our inventory writedown from last quarter and down just 10 basis points from last year.
Looking ahead, we took our summer increase in early June in response to the continuing inflation we are seeing from our suppliers.
We expect the recent trending to continue and aim to achieve a gross margin for fiscal 2021 that is flat with fiscal 2020.
Operating expenses in the third quarter were 257.3 million or 29.7% of sales versus 242.8 million or 29.1% of sales in the prior year.
Our third quarter includes just 400,000 of legal costs associated with the loss recovery, which I'll discuss shortly.
So OPEX as a percent of sales, excluding those costs, was the same as the GAAP figure or 29.7%.
Let me share a few more details on our third-quarter OPEX.
As I mentioned on our last call, we expected OPEX to increase sequentially from our second quarter, not only by the variable operating expenses associated with higher sales but also due to expected higher incentive compensation, as well as growth investments related to Mission Critical.
Recall that our adjusted OPEX for Q2 was 244 million.
A 90 million increase in sales means roughly 9 million of variable-related OPEX.
The remainder of the increase was primarily related to higher incentive compensation.
While mission-critical growth investments did increase sequentially, this was offset by an increase in mission-critical savings, which I'll speak to in more detail in a few moments.
We're pleased to report that last month, we received a 20.8 million loss recovery of the original 26.7 million impairment loss recorded in Q1.
That recovery is below the operating expense line in the P&L, but it does increase our GAAP operating income such that our GAAP operating margin for the quarter was 14.8%.
Excluding the 20.8 million loss recovery and associated legal fees, as well as restructuring charges during the quarter of 1.3 million, our adjusted operating margin was 12.6%, down 70 basis points from the prior year.
GAAP earnings per share were $1.68.
Adjusted for the loss recovery, as well as restructuring and other charges, adjusted earnings per share were $1.42.
Turning to the balance sheet and moving ahead to Slide 7.
Our free cash flow was 3 million in the third quarter, as compared to 49 million in the prior year.
The largest contributors were our increasing inventory and accounts receivable balance as our sales picked up significantly in the quarter.
I would also note that we repurchased 47 million of stock during the quarter or about 507,000 shares at an average price of 92.92 per share.
This underscores our ongoing commitment to a balanced capital allocation philosophy and our goal to maximize total shareholder returns.
In fact, to date in our fiscal Q4, we repurchased another 229,000 shares at an average price of $89.07.
Lastly, when it comes to cash flows, please note that the 20.8 million loss recovery was received in June and will therefore be reflected in our fiscal fourth-quarter cash flows.
As of the end of fiscal Q3, we were carrying 598 million of inventory, up 66 million from last quarter.
We're actively managing inventory levels to ensure we can support our customers as sales continue accelerating.
Therefore, inventory levels are likely to continue climbing in the fourth quarter.
We still expect capital expenditures for the fiscal year of approximately 55 million, and we still expect our cash flow conversion or operating cash flow divided by net income to be above 100% for fiscal 2021.
Our total debt as of the end of the third quarter was 759 million, reflecting a 75 million increase from our second quarter.
Roughly two-thirds of that increase was used to repurchase shares under our ongoing share repurchase program.
As for the composition of our debt, 187 million was on our revolving credit facility.
About 200 million was under our uncommitted facilities, 20 million was short-term fixed-rate borrowings, and 345 million was long-term fixed-rate borrowings.
Cash and cash equivalents were 27 million, resulting in net debt of 732 million at the end of the quarter.
Let me now provide you with an update on our Mission Critical productivity goals.
On Slide 8, you can see our original program goals of 90 to a hundred million of cost takeout through fiscal 2023, and that is versus fiscal 2019.
Our cumulative savings for the first half of fiscal '21 were 17 million, and we saved another 12 million in our third quarter bringing our year-to-date savings to 29 million against our goal of 25 million by the end of this year.
We also had invested roughly to 7 to 8 million in the first half of fiscal '21, and we invested another $7 million in our third quarter, bringing our total year-to-date investments to 15 million, which compares to our original full-year target of 15 million.
Given the success of the program through the first three quarters, we now expect to achieve savings for fiscal 2021 of roughly 40 million.
Regarding total investments for fiscal '21, we now expect roughly 25 million, which would result in net savings of 15 million for this year.
With respect to sales, the difficult safety and janitorial comparisons will ease in our fiscal fourth quarter and into fiscal '22.
We expect double-digit growth rates for the total business in our fiscal fourth quarter and continued strength into fiscal '22.
For fiscal '21, we expect a low single-digit total company growth, and we aim to achieve gross margins that are flat with fiscal '20.
In terms of adjusted operating expenses, sequentially from our third to fourth quarters, we will see a decline due to volume-based expenses from sequentially lower sales dollars and lower incentive compensation.
With that in mind, we remain on track with our adjusted annual operating framework for fiscal 2021, which you can see on Slide 9.
Furthermore, and as Erik mentioned earlier, we expect to achieve 20% or higher incremental margins in both fiscal '22 and fiscal 2023.
Fiscal 2021 is finishing on a high note, and we expect that momentum to continue into fiscal '22.
We are gaining steam internally, and our end markets are strengthening as evidenced by IP readings.
The inflationary environment, along with our ongoing price realization should continue to support gross margins.
On the structural cost front, we've made strong progress on our Mission Critical program and will deliver further savings over the next two years and beyond.
All of that should translate into incremental margins at/or above 20% for the next two years.
 Assistant:

Chosen response:
q3 earnings per share $1.68.
quarterly adjusted diluted earnings per share $1.42.


Prompt:
Human: Erik Gershwind, our chief executive officer; and Kristen Actis-Grande, our chief financial officer, are both on the call with me.
As on our last call, we are all remote, so bear with us if we encounter any technical difficulties.
The risk factors include our comments on the potential impact of COVID-19.
And let me start by saying that I hope everyone remains safe and healthy.
After that, we're going to look forward and we're going to look forward to the next three years to discuss what is the next stage of our transformation journey.
We've completed the heavy lifting of our sales force transformation and are now focused on accelerating market share capture and improving profitability.
This is a companywide effort that we're calling Mission Critical.
And Mission Critical is more than just a project name, it's reflective of our business strategy of serving as a mission-critical partner to our customers on their plant floors.
And it also reflects the fact that accelerating market share capture and improving profitability and doing so with urgency is mission critical for our organization and our stakeholders.
A lot more is coming on this shortly, but I'll first turn to the quarter, and we've provided some highlights on Slide 3.
Our fiscal fourth-quarter financial results continue to reflect solid execution in a tough environment.
Versus the prior year period, overall sales were down 11.3% or 12.7% on an average daily sales basis.
Gross margin was down 40 basis points and operating margin was 9.8% as compared to 10.7% in the prior year.
Excluding one-time adjustments, our operating margin was 11.2%, down just 30 basis points from 11.5% in the prior year due to implementing effective cost controls.
This all resulted in solid earnings for the quarter.
As we noted in our August sales release, sales of our nonsafety and nonjanitorial product lines have continued to improve sequentially through the quarter.
Sales of safety and janitorial products also continued growing, with year-over-year growth of roughly 20% each month on average and for the quarter.
Looking at our performance by customer type.
National Accounts declined slightly more than 20%, while our core customers declined mid-teens and CCSG was down in the low double-digits.
Government sales and that's both state and federal, were up significantly due to the surge in large safety and janitorial orders, partially offsetting the declines in the other customer types.
All of this shows that sales levels have continued to lift and have seen a slight increase in the rate of improvement over the past couple of months.
Most manufacturing end markets, while showing sequential improvements in the quarter, are still soft.
Many national accounts are running one shift as opposed to the two or three shifts they were running pre-pandemic.
Our job shop and machine shop customers continue carrying smaller-than-normal backlogs.
These customers remain cautious about spending and they're burning off inventory as much as possible, given continued uncertainty.
The persistence of COVID-19 and its potential for future surge is certainly playing a role in all of this.
And this caution is reflected in recent sentiment indices, such as the MBI, which remains negative on a rolling 12-month average.
That said, the readings have improved over the past couple of months and actually reached neutral territory in September.
Should this improvement continue, it would bode well for our business and should translate into continued sequential lift in our revenues.
In terms of end markets, the softness in industrial demand was broad-based, with acute weakness in heavily metalworking-centric end markets such as aerospace and oil and gas.
There are some pockets of strength in certain areas, but not in our core end markets which remain suppressed.
We continue to hear that local distributors are suffering.
And the longer that the weak conditions persist, the more pressure they're coming under.
This continues to create market share capture opportunities and we are focused on capitalizing on them.
Moving now to gross margins.
I remain pleased with our performance.
In particular, we're executing well on both the pricing and the purchase cost fronts.
We're seeing strong realization from our annual price increase and we're continuing to benefit from supplier programs on the purchase cost line.
You'll note that our sequential drop from the third quarter to the fourth quarter in gross margin was on the higher side of the typical seasonal decline.
This was strictly the result of mix and, in particular, the sale of PPE-related SKUs.
Absent this headwind, we maintained underlying gross margin stability.
September and October gross margins continued our recent trending.
Price and costs are performing well, but will likely have continued PPE mix pressure in the first quarter, similar in size to that of our fourth quarter.
Looking beyond the first quarter, as we move past the PPE-related mix noise, we expect gross margins to remain at levels close to or at prior year.
Cash flow in the quarter remained strong and allowed us to repay a significant amount of debt.
He and the team did an exceptional job over the past few months, particularly during the COVID crisis.
We're grateful, Greg, for your hard work.
And of course, you continue to be an integral part of our future efforts.
It's great to be here, and I am looking forward to the work ahead of us.
Over the coming months, hopefully, I'll have an opportunity to meet those of you on the phone who I haven't met already, although that will probably be virtual, of course.
As Erik mentioned, I'm going to run us quickly through the numbers for our fiscal fourth quarter and then, we'll devote time to discussing Mission Critical.
Our fourth-quarter sales were $748 million, a decline of 11.3% versus the same quarter last year.
Our average daily sales in the fiscal fourth quarter were $11.7 million, a decrease of 12.7% on an ADS basis versus the same quarter last year.
Our operating margin was 9.8% compared to 10.7% in the same period last year.
Excluding severance and other costs, our adjusted operating margin was 11.2% versus an adjusted 11.5% in the prior year.
Within our operating profits, Erik touched on the items impacting our gross margin, which was 41.6% or 40 basis points below the prior year.
So I'll go a little deeper now into our operating expenses.
Total operating expenses in the fourth quarter were $238 million or 31.9% of sales versus $263 million or 31.2% of sales in the prior year.
This also includes about $11.2 million of costs related to severance and the review of our operating model mentioned on previous calls.
You'll see a sizable drop in our total company headcount in our operating statistics.
This was the result of actions tied to our structural cost initiative and explains the severance costs in the quarter, which were $8.1 million of the $11.2 million.
Excluding those costs, operating expenses as a percent of sales were 30.4% in the prior year, excluding $6.7 million of costs related to severance, operating expenses were also 30.4% of sales.
Our results for the quarter reflect the swift cost containment measures we implemented due to COVID-19, including temporary reductions in variable hours, in executive and management salaries, temporary suspension of our 401(k) match, a hiring freeze, and virus-related travel restrictions.
We've now reversed some, but not all of these temporary actions.
For example, in our fiscal first quarter, we restored our 401(k) match.
All of this resulted in earnings per share of $0.94.
And adjusted for severance and other costs, earnings per share was $1.09.
Turning to the balance sheet on Slide 7.
We achieved strong free cash flow of $171 million in the fourth quarter.
A key driver was the $32 million decrease in inventory from last quarter to $543 million.
This reflects typical contraction in a soft environment, but also maintains levels that support share capture.
We also benefited from a large reduction in receivables.
We continue to manage our liquidity very closely.
Given the stabilizing environment, we paid down over $300 million of our revolving credit facility in August, as well as, $20 million of maturing private placement debt.
Our total debt as of the end of the fourth quarter was $619 million, comprised primarily of a $250 million balance on our revolving credit facility, $20 million of short-term fixed rate borrowings, and $345 million of long-term, fixed-rate borrowings.
Cash and cash equivalents were $125 million, so our net debt was $494 million.
In September and October, we deployed our strong cash flow by paying down another $120 million of our revolving debt.
Overall, our balance sheet and liquidity remain very healthy.
Turning to Slide 8.
Many of you know that over the past couple of years, we've been working hard to reposition MSC from a spot-buy supplier to a mission-critical partner on the plant floor of our industrial customers.
Our focus now turns to implementing Mission Critical to deliver reaccelerated market share capture and a step change in improving profitability over the next three years.
We plan to do so with the same sense of urgency that we demonstrated during the pandemic.
I'll start with reaccelerating market share capture, which is on Slide 9.
Our target is to outgrow the markets in which we compete by at least 400 basis points over the cycle.
This market share growth capture is indexed against industrial production or the IP Index.
Our analysis shows that IP is highly correlated with our growth rate over a cycle and it's a good proxy for the relative health and performance of the end markets that we serve.
This is shown on Slide 10.
IP is not perfect over shorter timeframes as the aggregate IP Index includes some of our noncore end markets as well.
Nonetheless, we're going to use it going forward as our primary benchmark, as it gives us the opportunity to better measure our performance over time.
This does not mean that sentiment indices, such as the MBI, are no longer important indicators to gauge the state of our markets.
They are, but they're less indicative of outgrowth or share capture since they're purely sentiment service.
Competitor and supplier growth rates also remain relevant, but differences in end market and product line exposure result in different levels of market growth for each of us.
Spread above IP over a cycle is, we believe, the best gauge for outgrowth of our markets.
Looking over extended periods of time, average IP growth is in the 2% to 3% range.
So this implies MSC growth of at least 6% to 7% over a cycle.
We believe that the actions we've taken recently, and those that we're taking now and into the near future, build to this level of outperformance over time.
At the same time, we think that we can outgrow the market over the nearer term as well.
And so our goal is to exit fiscal 2021 at roughly 200 basis points above IP.
Most forecasts indicate a return to low single-digit positive growth for IP and during calendar 2021.
Adjusting for our fiscal calendar, and assuming that these forecasts are accurate, it would mean that we would expect to be growing in the mid single-digits in our fiscal fourth quarter.
But that would still be slightly down for the full fiscal '21, taking into account the PPE headwind that we will face primarily in our fiscal third quarter.
There are five growth priorities that will deliver this above-market growth.
And none of these should surprise you, given that they're aligned with the work that I've spoken about pre -- previously.
What you should take away from this discussion, though, is the details within each and the specific actions and investments that we're making to produce measurable returns.
Let me spend a moment on each one.
This is the core of our business, a position where we have leadership today and where we think we can widen our lead.
We will do this by building on our talented team of metalworking specialists through hiring and training.
We've begun this effort in earnest and plan to add about 25% to our metalworking specialist team over the course of the year.
We'll also continue adding to our industry-leading product and supplier portfolio, and we'll introduce value-added services to our customers such as MSC MillMax, an exclusive technology that we just brought to market.
It's a proprietary product that, with a simple tap on a machine, uses data and analytics to optimize our customers' machining operations.
Early customer response has been very good.
And more importantly, MSC MillMax is delivering improvements to their operations.
We're now making it available to all of our customers.
The second lever, selling the strength of our broad portfolio.
This encompasses investing in our CCSG or Class C consumables business, leveraging the cross-selling that results from it, and leveraging the programs that we've put in place with those supplier partners who have recently invested with MSC and stepped-up programs.
Our joint opportunity funnels are growing nicely along each of these dimensions and we are focused on converting those into new business.
The third lever, expanding our solutions footprint and that includes: vending, VMI, and our growing implant solutions program.
We're finding that bringing these solutions to our customers consistently produces higher growth, better retention rates, and stronger lifetime value.
As a result, we're increasing investments into each of them and we're raising our performance expectations.
Our goal for implant solutions program sales is to double them over the next three years.
Our fourth lever is digital.
E-commerce has long been a strength of ours and represents roughly 60% of our sales today.
However, standing still is not an option and so we're raising the bar on ourselves to produce a better experience for our customers.
We have hired a new leader, who is staffing a new team with deep digital expertise.
Their focus will be on our website and on other digital tools that bring us closer to our customers and build higher levels of loyalty and retention.
This will include a new product information system, a new search engine, a new user experience, and the new front-end transactional engine.
The fifth lever is diversified customer end markets.
While the core of the business is selling into durable metal-cutting manufacturers, we're also focused on building scale in other areas that are countercyclical and that still leverage many of our strengths.
Government is a good example of this.
It's no secret that we had some execution issues there a couple of years back.
We've worked hard to rebuild our team and our business, and we're seeing the payoff in the form of accelerated growth rates, which of course, have been aided by COVID relief.
We plan to continue building on this momentum.
Towards that end, we'll be adding hunter roles that are specific just to government.
I'll now turn to our second goal, as summarized on Slide 11, to deliver ROIC, return on invested capital, in the high teens within the next three years.
This would imply profit growth of at least the high single digits and it would also imply incremental margins in the high teens.
Again, all of this assumes that IP grows in the ranges that I mentioned earlier on.
We launched an operational cost and productivity initiative to deliver on this goal back in fiscal 2020.
As you've heard me mention, we expect this initiative to deliver about 200 basis points in cost down on an operating expense-to-sales ratio basis over the next three years.
I'm going to now turn things over to Kristen, who will give you more details on the actions that will define our productivity runway.
As Erik mentioned, a significant part of the Mission Critical program is to reduce operating expenses as a percent of sales.
The cost takeout is going to come from an assortment of programs aligned to three separate tracks.
So the first is sales and service, the second is supply chain, and the third is general and administrative costs.
Erik covered some of the sales and service initiatives, so I'll elaborate a little bit more on supply chain and the G&A tracks.
Let me first say that the productivity comes from a number of projects and we are tracking each of them closely, with several already announced or even executed.
For example, under supply chain, we recently announced that we will be closing one of our smaller distribution centers located in Dallas and moving the service to the remainder of our distribution network.
We are also stepping up our use of automation and robotics at several of our customer fulfillment centers for packaging.
This was started last year in Harrisburg and is now being expanded to Elkhart.
These moves will improve our productivity and allow associates to perform greater value-added services.
We have also renegotiated our freight contracts and will realize significant savings over the next three years.
When it comes to G&A, in our fiscal fourth quarter, we completed a process redesign of our talent acquisition function, which resulted in outsourcing that function.
This is allowing us to find talent at a faster pace and reduced cost.
Another example is the voluntary retirement program we offered in our fourth quarter.
The take-up on the program was very good, as is evidenced by the significant headcount drop in our fiscal fourth quarter.
While we will likely reinvest some of these cost savings over time into the five growth initiatives that Erik mentioned earlier, the program will still produce meaningful overall cost reduction.
We've also revised our travel policy such that a significant portion of the COVID-related temporary travel cost savings will become permanent.
And finally, we're renegotiating indirect spend contracts, where we'll see an opportunity for further savings.
Stepping back from these examples, just kind of thinking about the overall operating expense dollars.
In fiscal '20, we reported operating expenses of $993 million.
In fiscal '21, the add-back of costs associated with the temporary cost reduction measures roughly offsets the reduction in variable costs from slightly lower sales.
As Erik mentioned, Mission Critical includes growth investment, and that will be in the range of about $15 million in our first year of the growth program which is 2021.
This will be more than offset by total structural Mission Critical savings in 2021 in the range of $25 million.
And by the way, this is in addition to approximately $20 million of savings that we've already achieved in 2020.
Putting all of this together means that we would expect operating expenses to be slightly down if sales are flat to slightly down in fiscal '21.
Now let's dig into 2021 a little bit more to supplement what Erik mentioned earlier on the growth line.
On gross margin, we expect the full year to be flat to down 50 basis points year over year.
An operating margin framework is shown on Slide 13 for GAAP and 14 for adjusted figures.
Operating margins will naturally vary based on the sales level.
If sales are down slightly on an adjusted basis, we would expect operating margin to be in the range of 11.2%, plus or minus 20 basis points.
If sales are flat, we would expect operating margin to be in the range of 11.4%, plus or minus 20 basis points.
And finally, if sales are slightly up, we would expect operating margin to be in the range of 11.7%, plus or minus 20 basis points.
Over the next three years, we are implementing a change equation that we believe will accelerate market share capture and improve profitability.
On the growth side of that equation, we're targeting growth rates of at least 400 basis points above market over the cycle by investing in the five growth levers I described earlier.
Our investments will be funded by costs being taken out of the business and we're looking to grow profits faster than sales.
This will enable us to improve returns on invested capital into the high teens.
All of this is aligned with our ongoing work to reposition MSC from a spot-buy supplier to a mission-critical partner on the plant floor of our industrial customers.
The results will not come overnight, particularly, given that we're still dealing with the uncertainty being driven by COVID-19.
However, you saw some early actions being taken in the fiscal fourth quarter and more is to come.
As we move into fiscal 2021, despite the uncertain environment, we're going to press ahead with urgency.
This is going to be a year of taking measurable action to change the course of this business over the long-term.
It will be a year of investment, investment that will be more than funded through cost savings.
2021 is also going to be a year about recommitting to our values: doing the right thing, being humble, putting our customers first, embracing differences, being transparent, transforming, and most importantly, delivering results.
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Chosen response:
compname reports q4 adjusted earnings per share $1.09.
q4 adjusted earnings per share $1.09.
q4 earnings per share $0.94.
quarterly net sales of $747.7 million, decrease of 11.3% yoy.