Msc Industrial Direct Co Inc Q4 FY2020 Earnings Call

Good morning, and welcome to the MSC Industrial Supply 2020 Fourth Quarter and Full Year Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to John Chironna, Vice President of Investor Relations and Treasurer. Please go ahead. Thank you, Constantino, and good morning, everyone. 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. During today's call, we will refer to various financial and management data in the presentation slides that accompany our comments as well as our operational statistics, both of which can be found on the Investor Relations section of our website. Let me reference our safe harbor statement under the Private Securities Litigation Reform Act of 1995, a summary of which is on Slide 2 of the accompanying presentation. Our comments on this call, as well as the supplemental information we are providing on the website, contain forward-looking statements within the meaning of the U.S. securities laws, including statements about the impact of COVID-19 on our business operations, results of operations and financial condition, expected future results, expected benefits from our investment and strategic plans and other initiatives and expected future growth and profitability. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks is noted in our earnings press release and the risk factors and the MD&A sections of our latest annual report on Form 10-K filed with the SEC as well as in other SEC filings. The risk factors include our comments on the potential impact of COVID-19. These forward-looking statements are based on our current expectations, and the company assumes no obligation to update these statements. Investors are cautioned not to place undue reliance on these forward-looking statements. In addition, during this call, we may refer to certain adjusted financial results, which are non-GAAP measures. Please refer to the GAAP versus non-GAAP reconciliations in our presentation, which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures. I'll now turn the call over to Erik.

Thank you, John. Good morning, everybody. And let me start by saying that I hope everyone remains safe and healthy. We have a pretty packed agenda this morning, so we'll get right into it. I'm going to begin with a brief overview of our fiscal fourth quarter, and I'll then turn it over to Kristen so she can review the financials with you. After that, we're going to look forward, and we're going to look forward to the next 3 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 company-wide 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 onetime 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. As you may have seen in our operational statistics released earlier this morning, September average daily sales declined 8.5%, and our October estimated sales declined 4.6% and benefited from some large orders. 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 1 shift as opposed to the 2 or 3 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. Before I turn it over to Kristen, I want to take a moment to thank Greg Clark for his interim leadership of our finance team. 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. And Kristen, welcome aboard. Welcome to your first earnings call, and we're thrilled to have you. So with that, I will turn it over to you.

Thanks, Erik. 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. On Slide 4 of the presentation, you'll find key metrics for the fiscal fourth quarter and full year on a reported basis. Slide 5 reflects adjusted results, and those will be the primary focus of my comments this morning. 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.

Thanks, Kristen. 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 3 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 time frames 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 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 full fiscal '21, taking into account the PPE headwind that we will face primarily in our fiscal third quarter. There are 5 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 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. First is metalworking. 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, which 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 3 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 3 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 3 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 3 separate tracks. 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 3 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 reduce 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 5 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. And then I'll turn it back over to you, Erik.

Thanks again, Kristen. Before we open things up for questions, I'll just close with a brief summary here. Over the next 3 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 5 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. We'll now open up the line for questions.

The first question comes from the line of Kevin Marek with Deutsche Bank.

You noted that a big focus operationally going forward is on share capture. I was wondering if you could talk about some of the customers or end markets beyond government where you feel like you can expand nicely?

Yes. Sure, Kevin. Look, I think the first thing I'll say is the share capture algorithm or formula that we laid out has 5 levers to it. And first and foremost, look, we are reinvesting into our core business: so that's metalworking, that's some of the solutions programs that I talked about; that's the CCSG business; and our key supplier partners who've invested with us. That's all about reinforcing the core. One of the 5 that I mentioned was diversified end markets. And look, we highlighted what today would be the biggest one of those in government. We've talked about putting a full-court press on to it. We've been pleased with the performance to date. And so it's encouraging us to do more. Certainly, outside of government, we have our eye on a couple of others. I would say, for competitive reasons, I'll sort of be opaque about which ones. But the nice thing is the ones that we have our eye on fall within the umbrella of where there is some business today. We do have some scale, and it will be about pressing harder. But it would be areas that fit within our industrial profile, but are outside of our core metalworking markets.

Great. And then just one more before I pass it on. Wondering if you could give us an updated color on kind of customers during the pandemic, kind of government or otherwise, and whether you've seen some of those customers show willingness to reorder with you? Or whether you found, over time, that most of them are really onetime opportunistic buyers?

You mean, so Kevin, are you talking about some of the PPE that we provided to those customers?

Yes. Yes. That or, even outside PPE, if you saw customers kind of come to you because maybe others couldn't service them during the kind of the depths of the pandemic. Just kind of an update on that dynamic.

Yes. Look, Kevin, there’s likely a combination of factors at play. A significant portion of our business comes from our core customers, who have been with us for many years. While we did assist some organizations that typically do not engage with us much, I would say our primary focus has been on supporting our long-term customers, with whom we have established relationships.

The next question is from the line of Hamza Mazari with Jefferies.

This is Mario Cortellacci filling in for Hamza. Just wanted to ask a question on just your sales force productivity. And you talked about, obviously, the measurable actions to reaccelerate your market share capture. But I guess, just could you give us an idea of how you're measuring sales force productivity today? How that has maybe changed? Or how has that tracked relative to history, given where we're in corona and your headcount reductions? And then also, with your optimization, do you expect that those productivity measurements to change going forward and to reach your goals for 2023?

You raised an important question about measuring sales force productivity. We have identified five growth levers, and one area where we are investing is in the sales force, which supports each of these five levers. A straightforward way to assess sales force productivity is by looking at sales per employee, but this metric can be misleading. Our Head of Sales, Eddie, found that we had too many account managers and not enough sales hunters. Prior to COVID, we reduced sales headcount significantly as part of our strategy to build back by increasing our hunter presence, and we are still committed to that plan. After a pause in hiring during the pandemic, we are now resuming recruitment. We are measuring performance in a much more detailed manner than simply sales per employee. Eddie and the sales management team are creating performance tracking and scorecards at the MSA level for each of the five growth levers we identified. Our focus will not just be on achieving a specific sales per employee metric, but on delivering sales in the specific programs we are investing in. This approach will help us optimize performance at a fundamental level. Additionally, we acknowledge that circumstances may change over time, so we will be adjusting our strategies as necessary based on performance data over the next three years and beyond.

Great. I have one more question before I turn it over. Kristen mentioned that you renegotiated your freight contracts. Could you provide more details about that? Are you able to quantify any expected savings over the next few years? Also, what is your outlook for inflation on freight, and how do you think that will impact your gross margin as you work towards your targets?

Yes. So Mario, as you can imagine, given our logistics model, which is centralized, the majority of our freight costs are associated with overnight and next-day shipping with large carriers. Without getting into too much detail, I can say that we've made improvements across all areas of the supply chain, particularly in our programs with carriers where we've established mutually beneficial arrangements. I think that's about as far as I can go on that topic.

Erik, this is John. I would just add to Mario's very last comment. Keep in mind that freight, for us, the bulk of our freight frayed out that you see in the 10-K and in our reporting. That's not in our gross margin. That's part of SG&A. So just to be clear on that.

Got it. That's helpful. I appreciate it.

And Mario, I will mention one other thing on the freight line. And this is part of the work that was done with Mission Critical, where, with kind of a deeper look using kind of sophisticated analytics, a deeper look into the business, one of the things that we did see, in addition to just renegotiations, was an opportunity to optimize our freight and order patterns with customers. So meaning, by aggregating orders as opposed to shipping out onesie-twosies, we could sort of shrink the whole pie for us and the customer and bring freight costs down. So within the footprint of what Kristen was describing, that is another program.

The next question comes from the line of David Manthey with Baird.

Dave, we can't hear you, if you're there. You may be muted.

Mr. Manthey can you hear us? We are experiencing some technical difficulties. Mr. Manthey, we can't hear you. Can you hear us? Moving on to the next question. The next question comes from the line of Michael McGinn with Wells Fargo.

I was wondering if I could switch gears and talk about free cash flow in terms of the investments that you're making. You mentioned vending as one of the drivers for Mission Critical. Also, digital is a big component. Can you talk about what you're expecting CapEx to be or as a percent of sales or maybe dollars over this 3-year horizon?

Yes. Yes, sure. So CapEx for '21 and beyond, we're definitely expecting to see kind of an increase over our historic run rate. I'd say, '21 CapEx dollars, you can expect to be about $70 million to $75 million range. And if you look at kind of what that represents as an increase over our historic patterns, I'd say about half of that is investment into digital related to the growth levers that Erik described. And the other half is kind of split across the other initiatives we discussed, things like solutions, for example. So we will see a higher sustained level of CapEx for a few years that helps bring those growth levers online and enables the programs that Erik talked about.

Great job on the operating margin framework; your quarterly performance was impressive in terms of execution. It appears that the midpoint of your 2021 framework is approximately the same as your year-end 2020 figures, and it looks like growth is improving slightly. I'm interested in the details regarding costs and how they relate to gross margin. Are the on-site vending operations experiencing lower growth but better performance? I'm wondering why this positive SG&A performance wouldn't continue. Could you address that at a high level?

Sure, sure. So maybe let me start with just gross margin. So I think if things play out favorably for us from a mix perspective, we've got line of sight to keeping gross margins flat, 20% to 21%. So I'd say, right now, mix is kind of the biggest lever or driver of gross margin that we're really keeping an eye on. We mentioned some of that PPE-driven. But if we don't see a big mix headwind, I think you can expect to see gross margins stay roughly flat. If we do see a bit more of a mix headwind, we think the max exposure there is probably down 50 basis points. Maybe pivoting to kind of the OpEx side of the equation, to your point, we did have a strong fourth quarter OpEx expenses versus the prior year, we're down about $25 million. So if you kind of like pick apart the pieces of that, about roughly $10 million of it is tied to just variable related costs associated with the revenue decline. About $7 million of that would be some of the upside from the Mission Critical savings in 2020 that we discussed. And then if you break down the remainder, I'd say about half of that is cost reductions related to temporary cost actions we took. And then the other half is what I'll call kind of just generalized spending delays. We slowed a few things down. And then we're picking them back up in 2021. So of the $25 million that we were down in Q4, I'd expect about 8% to 9% of that comes back online in Q1, and it's a little bit more indicative of what a run rated figure could look like for '21.

The next question comes from the line of Ryan Merkel with William Blair.

Everyone, thanks to the great details. So first off, the growth programs you mentioned are not new. I think, Erik, you mentioned that. So my question is, what has changed that you're now in a position to structurally drive share gains? Is it mainly that the heavy lifting on the sales force optimization is done? Or is the investment in digital and on-site solutions equally as important?

Yes, Ryan, I believe there are several factors contributing to our increased confidence. First, we've completed significant work to reposition the sales force, which was initially distracting but is now behind us. Second, we are seeing these programs in action, which helps us understand their impact on both our customers and our growth. Third, we have established a structural cost program that allows us to fund investments in growth without placing the burden solely on our shareholders; we are utilizing productivity gains to support this investment. Consequently, we have greater conviction in these programs and a clear mechanism for funding them. Additionally, Eddie has effectively improved the sales team's rigor, inspection, and execution. Overall, I feel more confident investing in this area because of the strong execution from him and the improvements Kristen is bringing as our CFO in enhancing operational performance.

Yes. Yes, that makes sense, especially funding the new sales hires with cost takeout. So let me ask about that. I think Kristen mentioned $25 million of costs coming out in 2021. So 2 questions. Is that all structural? And then secondly, over the next 3 years, how much costs are you targeting to take out?

Yes. Ryan, so for '21, the $25 million, yes, I would characterize that as structural cost savings. And then over the course of 3 years, we're targeting about $90 million to $100 million of cost takeout related to Mission Critical.

Yes. So Ryan, just on that one. On that point, realize that for us, too, if we're going to see 200 basis points of OpEx improvement, and we're talking about the need to reinvest into growth, then you can imagine, right, the total cost number has to be bigger because of the reinvestment.

Yes, exactly. As Erik mentioned, this is primarily about funding growth and investing in those growth opportunities.

The next question comes from the line of Chris Dankert with Longbow Research.

You guys mentioned that doubling the implant sales over the next 3 years, that's pretty aggressive growth. I guess, can you just kind of size us for today how big that is and where we're starting from?

Yes, of course. Chris, I want to emphasize that this program has been part of the company for several years now. The key reason we are highlighting it is that it's gaining momentum. Initially, it has been conducted reactively or on an individual basis, but it's now reached a point where it accounts for about 5% of company sales. Doubling it over three years would bring that to approximately 10%. The main difference is that we are shifting towards a proactive approach and making it a dedicated area of investment rather than handling it case by case.

Got it. Got it. Super helpful. And then, again, getting back to the high single-digit growth rate target over time here. Again, strong goal. I assume that means you've got a really kind of National Account focus to kind of generate that level of growth. How are we kind of providing some guidelines or benchmarks for the salespeople on the ground to make sure that we're really capturing margin-accretive business and not just kind of bringing in stuff that ends up being difficult to really get the return on?

Yes. Chris, your point has been a significant focus for Eddie and the sales management team. The aim is to avoid bringing in revenues that don't yield profit. We ensure this by aligning compensation, rewards, and incentives not only around revenue growth but also around profitable growth. We have several methods to achieve this, including training and increasing awareness, as well as equipping our sales team with better analytics to make informed pricing decisions using our database. All these aspects are in place to ensure that our growth is indeed profitable.

Got it. Got it. If I could just dig on that just a tiny bit. As far as incentivizing for profitable growth, are we benchmarking to gross margin? Is it op margin? Just any color there for the actual salespeople on the ground would be great.

Yes. What I would say with that, sales comp is sort of a sensitive subject. I won't get too specific other than to say a little bit of both of those things.

The next question comes from the line of John Inch with Gordon Haskett.

This is Karen Lau dialing in for John. Erik, I was curious about your growth pillars for Mission Critical and how pricing factors into that, if at all. This is relevant because your main competitor lowered prices years ago to boost growth. With the initiatives you're discussing, like expanding into a relatively new customer category, I'm wondering how you view pricing moving forward.

Pricing is a crucial initiative for our company that influences everything we do. On one hand, we want to remain competitive in the market. On the other hand, we believe our value proposition is unique and differentiated. For instance, our MSC MillMax is saving customers money and improving productivity, so it's important we are compensated for that. We offer over 1 million SKUs to hundreds of thousands of customers, and it can be challenging for salespeople to always price correctly. That's why we're enhancing our pricing strategies to use more analytical approaches rather than relying solely on intuition. While there are always competitive pressures on pricing, we also see great potential in optimizing our pricing strategies by leveraging data and analytics. We've seen successful results with recent price increases, and past experiences, like the midyear increase in fiscal '20, show strong realization levels. We believe this success is also due to our improved pricing intelligence.

Mr. Inch's line has been dropped. Moving on to the next question. The next question comes from the line of Patrick Baumann with JPMorgan.

Welcome, Kristen. Congratulations on getting this out. I wanted to start with a big picture strategic question. Can you discuss the sales trends for September and October, specifically the differences between safety, jan-san, and the rest of the business? I recall you mentioned something about large orders in October. Will that have any impact on near-term gross margins?

Let me start by providing some insights on the growth trends before moving on to gross margin, Pat. Regarding the growth trend, safety janitorial is still performing well, though not at the same level as during the surge, with an approximate year-on-year growth of around 20%. This has remained consistent for now. For all other categories, excluding safety janitorial, we saw a low point in May where growth was down in the high 20s, but there has been a steady improvement since then. In fact, over the last couple of months, the pace of recovery has picked up. For September and October, we observed declines in the low double digits. As for gross margin, I anticipate it will be similar to what you observed in Q4. Pricing continues to perform well, and costs are trending positively as expected, which is encouraging for gross margin performance. However, we do expect to face some ongoing headwinds from the PPE mix in Q1, with an impact comparable to what you saw in our fiscal fourth quarter.

And you're talking year-over-year, though, right? I mean it should step up sequentially like it normally does.

I would say we were more similar sequentially.

So first quarter similar to just fourth quarter sequentially?

Similar, yes. And again, the big driver there is the PPE. Otherwise, it's the same.

I'm sorry, could you clarify your comment about large orders? You mentioned the rest of the business was down low double digits. Were the large orders related to safety and janitorial supplies, or something else?

Yes. In October, mostly safety, jan-san.

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

Thank you, Constantino. A quick reminder that our fiscal first quarter 2021 earnings date is now set for January 6, 2021. Before we get there, we'll be at several equity conferences over the coming months, so we look forward to seeing you there. I want to thank you all for joining us today, and please continue to stay healthy and safe. Bye for now.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.