Q3 2024 MSC Industrial Direct Co Inc Earnings Call

Participants

Ryan Mills; Head of Investor Relations; MSC Industrial Direct Co Inc

Erik Gershwind; President, Chief Executive Officer, Director; MSC Industrial Direct Co Inc

Kristen Actis-grande; Chief Financial Officer, Executive Vice President; MSC Industrial Direct Co Inc

Tommy Moll; Analyst; Stephens Inc.

David Manthey; Analyst; Robert W. Baird & Co.

Kenneth Newman; Analyst; KeyBanc Capital Markets, Inc.

Chris Dankert; Analyst; Loop Capital Markets

Ryan Merkel; Analyst; William Blair

Chirag Patel; Analyst; Jefferies

Patrick Baumann; Analyst; JPMorgan

Presentation

Operator

Good morning, and welcome to the MSC third quarter fiscal 2024 earnings call. (Operator Instructions) Please note this event is being recorded.
I would now like to turn the conference over to Ryan Mills, Head of Investor Relations. Please go ahead.

Ryan Mills

Thank you, and good morning, everyone. Welcome to our third quarter fiscal 2024 earnings call. Erik Gershwind, our Chief Executive Officer; and Kristen Actis-Grande, our Chief Financial Officer, are both on the call with me today.
During today's call, we will refer to various financial data in the earnings presentation and operational statistics document that accompany our comments, both of which can be found on our Investor Relations website.
Let me reference our Safe Harbor statement found on slide two of the earnings presentation. Our comments on this call, as well as the supplemental information we are providing on the website, contain forward-looking statements within the meaning of US security laws. These forward-looking statements involve risks and uncertainties that could cause actual risk, and we would like to refer to those results to differ materially from those anticipated by these statements. Information about these risks is noted in our earnings press release and our other SEC filings.
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 or on our website, which contains the reconciliations of the adjusted financial measures to the most directly comparable GAAP measures.
I'll now turn it over to Erik.

Erik Gershwind

Thank you, Ryan. Good morning, everyone, and thank you for joining us today. During today's call, I'll provide an update on progress of the corrective actions that we outlined on our preliminary third-quarter call. I'll then pivot to current trends in the macro environment, before passing it over to Kristen, who will cover our fiscal third quarter results and our full-year outlook in greater detail.
Over the past couple of weeks, our team has been heads down and focused on getting MSC back to the high standards demanded by our mission statement and regaining the momentum from our first mission critical chapter. Though there is still much work to be done, I am encouraged by how our team is rallying. We remain committed to the strategy that we outlined at the start of the fiscal year, which is our second mission critical chapter.
And as a reminder, this strategy has three components. First, to maintain momentum on our high touch and technical solutions. Second, to re-energize our core customer growth. And third, to drive productivity and reduce costs to serve, enabling expansion to the mid-teens adjusted operating margins over time.
During our preliminary results release, we described that our biggest disappointment impacting this fiscal year's results has been re-energizing our core customer, due in large part to delays in our website improvements. We also experienced some unexpected gross margin pressure in our fiscal third quarter following the full rollout of web price realignment.
Let me jump right into the steps taken and the progress made since our preliminary results call, starting with web price realignment. The corrective actions that we took during May are working. This has resulted in gross margin improvement through the fiscal month of June, compared to the 3Q lows we experienced in April and early May. With these issues resolved, our web price realignment initiative is performing as planned.
However, we remain in a heightened state of awareness and will continue monitoring performance closely. With respect to mscdirect.com, we are also making progress. The recent executive changes have given me a chance to get even closer to our team and to our development efforts. I'm passionate about this part of the business, as building one of the initial iterations of mscdirect.com was one of the more exciting times in my career.
We have a capable, experienced, and tenured team working on this initiative, many of whom I've worked with for well over a decade. I'm confident that we're taking the right steps, and we'll bring MSC's e-commerce efforts to new heights.
We have taken a few recent steps to improve execution under the newly formed team. First, as I mentioned a couple of weeks ago, we've added third-party expertise. This was done to validate our architecture and provide the arms and legs to move production along more swiftly. We've also implemented twice per week executive reviews, and those include me. These reviews are bringing more transparency, collaboration, and energy to the program.
We expect to deliver enhancements to search and product discovery beginning this month. These include improvements to search accuracy and relevance, and the introduction of a new presentation of results, which will begin with a narrow slice of our product offering and roll out on a broader scale in the upcoming quarters.
We are targeting to have the site ready to support the launch of our marketing campaign during the second quarter of fiscal 2025. At that point, we would expect to realize the benefits of the three initiatives aimed at re-energizing our core customer, which works synergistically together, and those are the new web pricing, the new web platform, and our marketing program to attract new customers and achieve higher retention and growth of existing customers.
Given the hiccups we've experienced with the web enhancements and the web price realignment, we're taking a fresh look across our other technology initiatives, including the upgrade and timing of our digital core and back-office value streams. We'll provide an update of our finding next quarter following the completion of this review.
On the operations side, we are on track with our key initiatives, including the timing of our Columbus CFC closure. Additionally, we're pleased with the progress of our network study, and we'll provide more information next quarter.
Turning to slide 6, we had two exciting additions to the portfolio in Premier Tooling and ApTex. Supported by our strong balance sheet, these two acquisitions build upon our history of bolt-on M&A in the metalworking space. Premier Tooling Group designs, manufactures, and reconditions cutting tools through a state-of-the-art facility and a talented team located in Goodyear, Arizona.
This acquisition strengthens our regrind and special tooling service offering that was recently enhanced through the acquisition of Tru-Edge by expanding our reach to western parts of the US.
The second addition is ApTex, a production-oriented industrial distributor with a heavy focus on cutting tools, located in Waukesha, Wisconsin ApTex's strong team of sales engineers, combined with our breadth of products and best-in-class metalworking offering, strengthen our technical expertise and ability to gain market share.
We plan to seamlessly integrate ApTex and further strengthen our regional market position as we did with the fiscal '22 acquisition of Engman-Taylor. The entire MSC team welcomes both Premier Tooling Group and ApTex, and we're looking forward to our future success.
As it relates to Carr Industrial, which we acquired in the fiscal second quarter, I'm pleased to share that integration is going as planned. In fact, we've already begun receiving proposal requests from some of Carr's largest customers to cover the entirety of their MRO and metalworking needs, as Carr now has access to MSC's full breadth of products.
Before I hand it over to Kristen, I'll spend a few moments discussing the current environment. As we mentioned a couple of weeks ago, conditions remain soft, especially in metalworking-related end markets, such as heavy machinery and equipment and fabricated metals. The softness is reflected in recent readings of the IP, sentiment surveys such as the MBI, and in our estimated June growth rate, which is in line with our revised outlook.
Looking at growth by customer types, the softness is most notably felt in our core customer base, many of whom are heavily exposed to metalworking manufacturing. Our national accounts program continues to show resiliency, aided by the success of solutions, including our vending and implant programs.
With that, I'll now turn things over to Kristen.

Kristen Actis-grande

Thank you, Eric, and good morning, everyone. Please turn to slide 7, where you can see key metrics for the fiscal third quarter on both a reported and adjusted basis.
Fiscal third quarter sales of $979 million declined 7.1% year over year on an average daily sales basis and includes an approximately 300-basis point headwind related to non-repeating public sector orders in the prior year. The remaining 400 basis points of the year over year declines was primarily driven by lower volumes which was partially offset by benefits from acquisitions.
Sequentially, we experienced an improvement of approximately 3%, largely driven by higher volumes. However, this performance was below our expectations due to lower pricing benefits related to the issues from our web price realignment, which have been addressed, and a slower ramp in our core customer base.
By customer type, national accounts declined 1% year over year. When considering continued softness in the larger portions of our end market exposure and only 43 of our top 100 accounts showing growth, I'm encouraged by the resiliency displayed here.
Core and other customers declined approximately 7%, driven by macro softness and delays in the rollout of our web enhancement, which are expected to re-energize this customer base in conjunction with our web price realignment actions. The public sector declined approximately 25% due to large, non-repeating orders in the prior year. Excluding this impact, public sector would have shown year-over-year growth in the quarter.
Sequentially, average daily sales improved across all customer types, including public sector in the mid to high teens. From a solution standpoint, we continued momentum in the quarter, despite ongoing manufacturing softness.
In vending, Q3 average daily sales improved 2% year over year and represented 17% of total company net sales. Sales through our in-plant programs grew approximately 4% year over year and represented approximately 16% of total company net sales. This was supported by healthy rates of [signings] across both solutions during the quarter, as seen by the year-over-year growth in our installed base.
Moving to profitability for the quarter, our gross margin of 40.9% improved 20 basis points year over year. Sequentially, however, gross margin declined 60 basis points from 2Q levels and was below our expectations. This was driven by two primary factors that were roughly the same in size. The first being customer mix that was predominantly public sector driven and headwinds stemming from issues related to our web price realignment that we believe have been addressed.
Both reported and adjusted operating expenses for the quarter were approximately $289 million. On an adjusted basis, operating expenses declined by approximately $1 million year over year, primarily driven by productivity and lower variable incentive compensation that more than offset labor inflation and strategic investments.
Reported operating margin for the quarter was 10.9% compared to 12.8% in the prior year. On an adjusted basis, operating margin of 11.4% declined 170 basis points compared to the prior year. GAAP earnings per share was $1.27 compared to $1.69 in the prior year period. On an adjusted basis, EPS was $1.33 versus $1.74 in the prior year.
Turning to slide 8 to review our balance sheet and cash flow performance. We continued to maintain a healthy balance sheet with net debt of approximately $480 million, representing roughly one-time EBITDA. Working capital was a favorable source of cash in the quarter, including a contribution of roughly $20 million from inventory reduction. This resulted in another strong quarter of operating cash flow, with conversion of 201% in 3Q and 160% fiscal year to date, keeping us on track to exceed our full-year target of greater than 125%.
Capital expenditures during the quarter of approximately $30 million increased to $6 million year over year primarily driven by strategic investments and ongoing solutions growth. Together, this drove strong free cash flow generation of approximately $114 million in fiscal 3Q and $230 million fiscal year to date.
Our balance sheet and cash generation remain strong and continues to fuel our capital allocation priorities shown on slide 9. We deployed cash in several of these buckets during the quarter, including the strategic acquisitions of Premier Tooling Group and ApTex that Eric mentioned earlier. We also have approximately 2.1 million shares remaining on our current authorization.
Turning to slide 10, we are maintaining the updated outlook we presented during our preliminary call in June. As a reminder, this revised outlook assumes average daily sales declining 4.7% to 4.3% year over year, adjusted operating margin of 10.5% to 10.7%, and includes impacts from recent acquisitions. Other items embedded in our outlook are included on the slide.
Before I turn the call back over, I will spend a few moments discussing what the midpoint of our annual outlook implies for the fourth quarter. Starting with sales, we have one fewer selling day sequentially in 4Q and expect average daily sales to fall within a range similar to 3Q levels. As we discussed during our June call, we expect 4Q gross margins to perform at or slightly better than the historical 3Q to 4Q sequential decline of approximately 40 to 50 basis points.
As Eric previously mentioned, following our corrective actions, June's gross margin trend is performing in line with this expectation. Adjusted operating expenses are expected to step up $8 million to $10 million from the third quarter. This is driven by an increase in variable compensation expense due to non-repeating benefits that occurred in the third quarter of roughly $4 million. Costs from strategic investments, higher depreciation and amortization, and recent acquisitions represent the remaining [$46 million].
And with that, I will now turn the call back over to Eric.

Erik Gershwind

Thank you, Kristen. This was a challenging quarter in what has been a tough fiscal year for MSC. Since our update call a little over two weeks ago, we've been heads down driving corrective actions to improve performance. And I've been encouraged by how our team is rallying in response.
We believe this progress will begin bearing fruit during fiscal 2025 and strengthen our position to achieve our long-term targets, which include sales growth of at least 400 basis points above IP over the cycle and adjusted operating margins in the mid-teens.
With that, we'll now open up the line for questions.

Question and Answer Session

Operator

(Operator Instructions) Tommy Moll, Stephens Inc.

Tommy Moll

I wanted to follow up on some of the end market commentary, particularly around heavy manufacturing and just see if there's any way to get a sense of when we might bottom here. I think it's fair to say going into 2024 across the market, volumes were set to decline.
But just given some of the high-profile reductions and outlooks from big public bellwethers as recently as May, plus just observing the sales trends that you've seen more recently, it feels like we took another step down this spring. And so I'm just curious for any insight you have from your customers or sales force.

Erik Gershwind

Tommy, look, I think you summed it up well. It does feel like things have softened further and you can look no further than yesterday's MBI reading as another proof point in line with what you're saying. I would say in terms of visibility, Tommy -- and by the way, definitely what we're seeing and experiencing is that the softness is more acute in metalworking-related end markets. So you think machinery, equipment, metal fabrication, kind of like art core, which is part of what's going on with our core customer, the closer you get to the core, the softer things appear.
So I would say, Tommy, visibility is in our business. It's generally pretty limited because we are such a short-cycle business. It's probably more limited than usual. Certainly, gearing up towards an election probably isn't helping things. You've got a lot of people in wait-and-see mode, Tommy, and that combined with interest rates not being reduced, people are cautious.
So not a lot of visibility. Certainly, beyond November, I think that will be the next big milestone coming at -- look, what I will say is, bigger picture, if you zoom out, things are soft right now. We still feel really good about where we're positioned with North American manufacturing. All the things that we talked about coming out of COVID, the reshoring trends, the strengthening North American manufacturing footprint, we still feel very confident in. Near-term, though, for sure, there is more softness and limited visibility.

Tommy Moll

And I suppose a related topic here is on pricing, where after the pre-announce, I think you intended to communicate that some of the hiccups you experienced in the quarter were purely driven by execution factors and not a broader marketplace pressure on pricing. But I did just want to double-click on the latter there and anything you've seen in the market that might suggest something broader than what you just experienced internally. Thank you.

Erik Gershwind

Yeah, sure, Tommy. And yeah, look, you're right. Q3, we had identified of that 60 bps, just as a refresh for you and the rest of the callers. It was about 50-50 between, roughly between a mixed factor and then execution on the list price repositioning. So the work that I've been describing in the company that Kristen talked about we're seeing in June, that's execution and shoring things up, and we feel good about that.
In terms of the pricing environment more generally, it's interesting because you sort of have two competing factors going on, I'd say. On the one hand, no question, inflation has proven to be a bit stickier than expected. So there are some pockets where costs remain elevated. And look, we'll plan to react accordingly where those pockets exist.
At the same time, we're seeing a phenomenon that we've seen -- I've seen pretty much through my career, it happens like clockwork. Every time the demand environment softens, customers have more time to shop. And so there are more scrutinists of everything that goes out the door. There's more reopening of RFPs.
So on the one hand, you have a little bit stickier inflation, which should buoy the pricing environment. On the other hand, the competitive environment is intense when it's soft. I will say in a lot of ways, that plays really well into our value proposition. So all of the high-touch stuff that we talked about that's working, and you could see the proof points there in in-plant and vending, a lot of those wins happen because our customers right now are starved for productivity and tangible cost savings, and that's where we can shine, and we can deliver.
So right now, even our vending and in-plant numbers, those growth numbers are really subdued compared to what we're used to, and I think that's reflective of the environment. When things turn, we should see that lift. But hopefully that gives you a flavor of how we would size up the pricing environment.

Operator

David Manthey, Baird.

David Manthey

Referencing slide number 4, you note that conditions were worse in the metalworking and machinery elements of IP. But looking at the data, it doesn't seem like MSC really outperformed those subcomponents of the index by 400 basis points either, and I understand the web pricing situation and the government year-to-year comp.
But it seems like something changed between the fourth quarter of last year and the first quarter of this fiscal year when the company suddenly stopped outperforming the IP benchmark. Is there anything you can point to that changed in terms of your approach or something at the company that's different relative to that outperformance expectation?

Erik Gershwind

Dave, I would point to two. Look, there's no question you're right, that you look at the past three quarters and growth relative to IP, even relative to the sub-indices, is not what we would expect and not consistent with the performance we had.
I think there's two things going on, and one is macro, and one is micro. The macro factor is the heavier rotation for us into markets that are particularly soft. Like, the recent MBI readings are pretty breathtaking, and I think indicative of softness and customers pulling back on spent. I think that's one.
And then, two, no question that where we're underperforming, Dave, as in the core customer where we look to re-energize. And I would go back to there -- what changed, it would just be the execution on the couple of initiatives we called out during the preliminary release that we were relying on to improve our turbocharged performance that had been delayed.
So from our standpoint, this is a timing issue. I think we've taken some good steps here. But those are the two things. I think one is macro and one is micro.

David Manthey

Okay, thanks for that, Erik. Second, on the acquisitions that you've announced, could you address the multiples you're paying for these? I assume you're paying less than your own EBITDA multiple for these acquisitions.
And just a broader question, why are you making acquisitions while you're in the midst of this sort of mission-critical playbook and having submissions and things? It seemed like it would be a good time to focus internally. Could you just talk about that relative to share repurchase, frankly?

Erik Gershwind

Yeah, sure, Dave. So let me address M&A first, and then I'll address share repurchase, and I think your broader question on capital allocation.
So why M&A now? I think, look, your point is a fair one. And certainly, I think at the moment, given the fixes going on inside of the company, I don't think you should expect to see us do anything that's really big and outside of our core business.
So where you're seeing us acquire is tuck-in businesses that are into our core, where we do feel like we have a good playbook and a good track record that's building, really building over the past several years now with many of the recent, and we mentioned one or two on the call. So these are businesses that we know, spaces that we know.
Regarding multiples, obviously, it's tricky to talk publicly on the multiples. But from a financial standpoint, suffice it to say that when we're doing these deals, we look at a couple of different criteria. One is we would like to see earnings accretion within the first full year. The second is we want to see returns on capital in excess of our weighted average cost of capital in three years or less.
So if we're going to be doing an acquisition, it's going to be meeting those hurdles financially. As I said, operationally, the playbook here is pretty good because these are right into our core. They're giving us market share. They're giving us talent. They're enabling us to leverage current customer relationships. They're enabling us to leverage our product offering. So these are right in our sweet spot.
So I think if this were something that were really bigger and outside what we know how to do, I think I would agree with you. But these are good.
Relative to share repurchase, look, we've articulated the handful of priorities on capital allocation. Kristen mentioned our cash generation has been strong this year. I think that's one area where we have executed well. So I wouldn't be -- given the size of these deals that we're doing that they need to come at the expense of an alternative use of capital.

Operator

Ken Newman, KeyBanc Capital Markets.

Kenneth Newman

I just wanted to circle back to the sequentially stable ADS guide from 3Q to 4Q. Just to clarify, Eric, I mean, you did highlight some of the deterioration that we're seeing in the macro, whether it's ISM or the MBI here earlier this week. What gives you confidence in that guide kind of being stable from 3Q to 4Q, given some of those macro deterioration? Is that primarily just reflecting the web price issues being fixed? Or is there something else there?

Erik Gershwind

I think, Ken, it's really just a function of what we're seeing in the trending of the business, to be honest. So when we're giving a forecast, we're not banking on any massive change. So the web -- the pricing corrective actions, where you're going to see that evidence is in stability and gross margin that Kristen talked about, in terms of having a counting on, if you will, a major inflection in our core customer absent the macro.
In the prepared remarks, I really pointed to Q2, where you'd see a convergence of what we expect to have the website really ready for prime time, combined with a marketing campaign that will then feature the web pricing, and all these things should work synergistically. So we're not counting on anything, any massive change in Q4, but more looking at trending and typical seasonal patterns.

Kenneth Newman

Okay. And then for my follow-up, Kristen, I think in the past, you've talked about this idea that every point of ADS growth is around 20 basis points of EBIT margin. There's obviously some impact on the fourth quarter that makes that math a little fuzzier. But from a higher level, I'm just curious if that framework still holds true as we think about fiscal '25 and whatever that recovery look like?

Kristen Actis-grande

Yeah, Ken, so for the year that is what we had communicated back in the Q2 release, obviously, we're pretty far off of that with the revised guidance, and that, of course, has to do with the web pricing challenges we've had, the timing of the core ramp up.
Beyond '24, it's really too early to say. I know there's going to be a strong demand out there for insight around FY25, especially just given what's happening in the macro environment, what kind of -- what we can see and what we have line of sight to. But generally, it's really still too early for us to say.
On the top line, of course, we are very short cycle, and that's, I'd say, even in a normal demand environment condition, certainly in the situation we're in. Today, with the macro uncertainty that makes it even a little bit harder to predict.
And then on gross margins, like if I just kind of walked down the P&L to try to at least get some color into '25, we are really pleased with the way that gross margins have been trending in 4Q, especially the recovery that we're seeing post-web-price realignment issues. But again, it's a lot of moving pieces. We've got the stabilization of the web price. Timing of core customer recovery is a big piece of that.
And then, of course, what happens with mix with respect to the customer type growth in public sector and national accounts. One thing I can give you is a little bit more direct color on with OpEx, though, specific to '25 in the first quarter. I do think it's important to note that we have line of sight to a sequential step-up in OpEx Q4 to Q1, and that has to do with the resetting of the variable compensation programs to the new fiscal year and a step-up in DNA.
So I know that's a small bit of specific information for '25, but hopefully that leaves us with a finer point on OpEx for the first quarter. And then we will follow up with more insight on the year when we do the Q4 release and try to share as much as we can about guidance for '25 at that time.

Operator

Chris Dankert, Loop Capital.

Chris Dankert

First off, Erik, I know that you had the largest deal in recent memory here, but congrats on adding ApTex and a really solid team there in Waukesha. I guess just first off here, thinking about the big marketing push after we kind of get through the web reset here, is there any historical precedent or any kind of reads from pilot programs in terms of how long it takes to kind of get the juice from that marketing push?

Erik Gershwind

Yeah, Chris, that's a good question. So I can tell you that there is no direct analogy to draw from, and I know what you're getting at, is what can we expect in a lift. What I will tell you is from a marketing standpoint, while the campaign will be new, many of the tactics that we'll use in terms of digital marketing, print marketing, and personal outreach are tried and true. It'll be a new combination and a new message, but the means by which we're getting to customers are means that we are very familiar with and do have a track record with.
If what you're looking for is more kind of a specific quantitative inflection. It's a tough one to give you, and it's tough in particular because who knows what the world's going to look like by the time we get to Q2. And it's sort of tough to predict, but I do think -- I think the other thing I'll say, by the way, Chris, beyond the marketing campaign, is we do expect improvements in the website.
There's some betting on the come with marketing. But improvements in the website should -- there are quantitative measures that we're tracking daily that you could see when we see improvements in site effectiveness that yields a higher conversion rate, meaning for every hundred people coming to the website, how many convert into a sale and how big is the sale.
Those are metrics that we're tracking carefully, and we would fully expect to see read through into revenue improvements on the existing base of business. The marketing campaign reenergizing new customers is a bit trickier to quantify.

Chris Dankert

Got it. Got it. Understood. And then just -- I have to follow up here. I guess moving to in-plant, nice to see, the growth is better than kind of overall. I guess maybe just any comments on what the cost to serve looks like in that business relative to what your expectations were. How's the profitability progressing in that piece of the business perhaps?

Kristen Actis-grande

Yeah, Chris, so broadly, we're seeing stable performance in the profit for the in-plant customers. There's definitely a difference depending on how mature the in-plant customer is. And that's one of the things that we've been kind of dealing with on the P&L in '24 because the growth has been so high. We have to make that upfront investment in the in-plant resource, take time for the account to ramp up.
But generally, we've continued to see performance as we expected on those accounts and then really once you hit like the six to nine-month mark, we see really nice stabilization of profit there. The accounts start to reach maturity. And if you look back like kind of by class at the in-plants, which is just how we look at things internally. Once you hit that point of stability, we see a nice contribution margin from the in-plant customer.

Erik Gershwind

Hey, Chris, one thing I'll add just on -- and I'll add for commentary, I think Kristen nailed it on the profitability front. On the growth side, you mentioned, so while in-plant is outperforming the company nicely, I think we said growth in the in-plant program in the quarter was 4%.
I mean, if you look at the first -- Kristen mentioned that there's a ramp in classes of customers, the first year or two with an in-plant, we see explosive growth. So if you go back to our mature classes of customers, growth is well below that. And these are our best customers. Again, I think indicative of market softness that as we continue signing more in-plants, we're building an embedded base of business that as things turn should give us a nice lift.

Chris Dankert

Got it. Thanks a lot for the call there.

Kristen Actis-grande

Yeah. And Chris, one more thing to clarify. I said a nice contribution margin, but to be clear, it is at or above company operating margin at that point.

Operator

Ryan Merkel, William Blair.

Ryan Merkel

I had a couple questions on the web realignment. I guess first off, Erik, what percent of sales are going to see a lower price, and then can you give us a rough range of how much lower prices are for that group of customers?

Erik Gershwind

So Ryan, in terms of what percentage, if you looked at today's base of business, okay, it would be under half of our business because many of our customers already have negotiated pricing. The opportunity here is both, number one, for that base of existing customers who don't have a negotiated price; and then number two, tapping into a whole new set of business and customers that we don't have. So I think that's point one.
Point two, in terms of what price the customer will see, it's hard to get -- averages are really deceiving. So I could give you an average, but the average would be entirely misleading. Let me explain what I mean by that. Basically, what we've done is on a item-by-item basis, identified what the range of market looks like. And we wanted to make sure that for all of our items were in that range.
And so in some cases, that meant that we had to take pricing down considerably. There were other cases where we actually found we were below the range. Obviously, there were more that we were above the range than below the range. But an average would be tricky.
I think what we do feel good about is that our customers can feel confident that we're going to have a market credible price, if you will, and be within some bands of reason. Again, the strategy here was not to win business on price. It was to take away cases where we were losing business on price.

Ryan Merkel

Okay. No, that makes sense. And really where I'm going with the question is what's the opportunity? What are we going to get? So it sounds like we'll give up a little bit of price vis-a-vis where we were before, but you're -- you think you're going to get the core customers growing high single digits, and then the core customers are also higher gross margin. Just talk about when you get this right, what it means for the P&L.

Erik Gershwind

Yeah. Ryan, and I think you teed it up probably better than we did. I think that's exactly right, and it's why so much of our focus here is on re-energizing the core customer. These customers are certainly higher margin than our average customer, lower cost to serve. And it's not just -- and that was where we wanted to go back to kind of the trifecta of the initiatives of the web pricing, which is really an enabler, if you will, to put us in a, as I said, sort of a reasonable range, and then combine that with a marketing effort and a website.
And it was why on the last, on the pre-release, Ryan, we were really disappointed and sort of pointed to the website, because without the website being really ready for prime time, if you will, it sort of -- it held us back on the other two initiatives.
So we're pointing to Q2. We feel pretty good right now about progress that's going on, on the website. So you combine those three efforts, and all of a sudden, we take a portion of the business, a big portion of the business that has been diluted to growth rate, even bringing it to company average. Number one, massively improves the growth rate; and then number two, to your point, our company, for the last however many years you've been following us, there's been this built-in gross margin, customer mix headwind because the larger accounts that have been growing faster or lower margin.
If that goes away, it opens up a whole new world in terms of incremental margins because all of a sudden there's no longer gross margin dilution, we're leveraging top-line growth, and then layering in some productivity like the supply chain study we mentioned. So thank you for the question.

Operator

Chirag Patel, Jefferies.

Chirag Patel

I just wanted to circle back on the M&A for a quick second here. I wanted to get a sense for how much revenue contribution we can think of on an annual basis for the two businesses that were acquired in June, and then whether or not those businesses also are currently performing at the current MRC margin, and maybe the initiatives that are anticipated to maybe even have an outgrow of the form over time.

Kristen Actis-grande

Yeah, Chirag, I can take that one. So the annualization of the two we just acquired is a little bit over $20 million. And I think the second part of your question was are they at or above the company operating margin. One is currently above, one is below, which is not atypical on the initial acquisition for some of our bolt-ons. But we are able to quickly bring synergies in place, both on the cost side that usually get that up, depending on the degree to which we have to do the work. Some are faster than others.
But the longer-term synergy play, Chirag, on the M&A bolt-ons is on the growth side. And there's typically things that we do kind of on day one to initiate, like cross-sell with the acquired company, for example. That's an area I think we talked about in the prepared remarks that we're having early success with Carr. But then the growth synergy benefit tends to grow incrementally each year the more that we mature where we are post acquisition, like with all of the initiatives that are in place.
So every acquisition we do is a little bit different, even on the bolt-ons. But these two, I'd say, are very much kind of aligned to the playbook that we run and really low risk in terms of our confidence in getting synergies in line.

Chirag Patel

Got you. And actually, on that playbook front, it's a nice slide to have where it kind of shows you what you're kind of hitting on as far as the M&A criteria go. We're kind of missing on the side growth and market piece of the pie. I wanted to touch on that. I'm going to pause on that for a second. One, just the idea of how much of your business currently is kind of -- in what you would qualify as these high-end growth markets, and then maybe even identifying a couple of them would be helpful as you kind of look at the growth going forward, I guess.

Erik Gershwind

Yeah, sure. I'm happy to take that one. So first of all, what I'd say is you see a number of criteria on that slide that we wanted to get across. So the high-growth end markets is one, but there's several others. And the last two and the last several we've done check a number of boxes.
In terms of the high-growth end markets, look, the first thing I'll say is I mentioned a little earlier on, we feel pretty good about being positioned in North American manufacturing. At the moment, it doesn't feel so good when you look at the MBI and we look at maybe the next couple of months here. But if we zoom out and look at the next few years, we do feel like North American manufacturing as a whole is going to be a secular grower, is going to benefit from the post-COVID reshoring trends. So we feel like it's a pretty good place to be.
Within that, there's obviously pockets that are growing faster and are projected to grow faster than others. I mean, one certainly would be aerospace that comes to mind that has been, since COVID, on a good trajectory and is projected to continue on a good trajectory.
In there, an example would be an acquisition that we did a few years ago, Wm Hearst, which is in Wichita, which is heavily aerospace exposed. That would be an example of one in our portfolio that does check the high-growth end market, if you will. So definitely, it's in our mind, it's part of what we look at, but not the only thing we look at.

Chirag Patel

Understood. And then if you were to qualify the idea of high-growth end markets, how much of your portfolio currently addresses that? And how much -- what do you think would be a good mix longer term?

Erik Gershwind

So I would say today, the majority of our -- we talked in the prepared remarks a little bit about the majority. If you look at -- so MSC today is roughly 70% manufacturing. Of that, a good chunk is sitting in end markets that run on high-growth end markets that right now, are weighed down disproportionately, and probably not considered necessarily outgrowing the rest of manufacturing.
So today, the high-growth end markets would be a minority of the 70%, certainly less than half the 70%. Think aerospace, think medical, think -- there's a couple of other ones that -- just sensitivity reasons, we're not going to call out on the call.
What I'd say is over time, given the goals that we have for market share capture for MSC, one would think it would be fair to say that our portfolio of business should be somewhat reflective of what the market looks like.
So today, it's a little bit more heavily weighted towards heavy equipment and machinery, metal fabrication, which would be reflective of our job shop type customer. And that over time, we'd like to see the portfolio mirror what the market looks like.

Operator

Patrick Baumann, J.P. Morgan.

Patrick Baumann

I had a couple here. One for Kristen -- good morning, Kristen. How are you?

Kristen Actis-grande

Good. How are you?

Patrick Baumann

I'm good. Just had the first one for you, maybe, on the OpEx. The $8 million to $10 million sequential increase is a bit more than we would have expected. Can you talk about the drivers again into the fourth quarter? And I thought that the Columbus closure impacts things starting in June, but maybe I'm off on timing.
Then you mentioned OpEx up again in the first quarter because of merit. What type of pay increase are you doing? And I thought maybe you would get some headcount reductions from that CFC closure, which would offset some of that. But maybe just some insight into the moving parts. on third quarter to fourth quarter, fourth quarter to first quarter.
And then the magnitude to think about in terms of step-up marketing costs from first quarter to second quarter, because you said something about second-quarter marketing expenses.

Kristen Actis-grande

Yeah. Yeah. Happy to walk you through that. Let's start with the Q3 to Q4 sequential. The first factor in there is that we had a benefit in the third quarter related to the variable compensation programs. That benefit is not going to repeat in Q4. That's a step-up of $4 million. And then the balance of the expense sequentially stepped up is -- I'm going to break it down in a few buckets. We've got increased DNA. There's incremental strategic investment tied to primarily the solutions programs. So think like the implant headcount, for example.
And then we have a step-up coming in from the acquisitions that were brought online in June. The net of all those is $4 million to $6 million. When we talked in the third quarter, we had not included the acquisition expense in the sequential step-up. So if you're thinking that the Q4 number is a little bit higher, it is a bit higher than what we articulated in Q3 pre-release call.
We did not want to get ahead of ourselves on the acquisition announcement, but that was contemplated in the revised full-year operating margin outlook, just to be totally clear.
Your next question, I think, Pat, was on the Q4 to Q1 change in OpEx. The increase that I mentioned earlier actually does not have to do with typical labor inflation, although that obviously is an element that we'll have to deal with heading into '25. The item I had called out was really specific to the reset of the variable compensation program. Not surprisingly, we're not having a good year.
Most of the variable comp programs are not paying out. They're not paying out really much at all, so think your sales commission's programs, your corporate bonus program. When those things reset in '25, that becomes a sequential step-up for us, Q4 to Q1.
The typical merit increase that we do goes into effect in November, so you don't have as much of an impact in Q1 on that as you do in the later -- the Q1 to Q2 sequential step-up. And I think the last thing you'd asked about in there was some of the productivity initiatives. I think Columbus you called out, and then the voluntary. And you're right, those will benefit '25.
Columbus is shutting down in Q4, so not -- you'll get a little pickup in Q1 tied to Columbus. And as a reminder, that's about $5 million to $7 million on annualized savings. And then the voluntary, we're seeing that savings already in the Q4 number, so not as much of an impact Q4 to Q1 sequentially.
And then kind of beyond that, the real big one on productivity for us is the rest of the work on the network optimization. Initiatives, Columbus comes online first. The other initiatives will start to kick in more throughout the year, and we'll give some added color on how to think about productivity when we do the Q4 release.

Patrick Baumann

Is that impacted by the re-evaluation of the digital initiatives, that last thing, in terms of the network optimization, or is that something different?

Kristen Actis-grande

No, no, no, that's different. So this really has to do, I think, more supply chain and operations focused than network optimization. This is kind of everything from physical footprint, which is where something like Columbus comes in to kind of how we fulfill customer orders.

Patrick Baumann

Okay, and the re-evaluation of the other digital initiatives is related -- like, were there benefits expected from that that are being pushed out, or elaborate on what you said in the preamble on that?

Erik Gershwind

Yeah, on the re-evaluation of the other digital initiatives, no, nothing that would drive benefit in '25. I would say that the big one here is really just around looking at the progress in the digital core program, which is a reminder. That's the expense that you're seeing in -- we kind of call it out in our CapEx guidance, but it's actually in CCA on the balance sheet. So you're going to see -- you're not going to see any impact to the P&L in 25 because of that re-evaluation.
And again, it is just a re-evaluation, so it doesn't necessarily mean we're doing anything differently. But I think what you're getting at is, is there productivity at all tied to that, or even investment specific to '25, and on the P&L, there's really nothing related to digital core contemplated at this point.

Patrick Baumann

Okay, thanks. And then a couple, I guess, post-mortem questions for Erik, maybe, just trying to understand the timing of this stuff. I mean, it seemed from the outside that the core customer has been underperforming for a long time now. So maybe just help us to understand why the website investment has been so stale for such a long period of time when it's -- you've lagged leaders like Granger on this front probably for many years.
And then also, looking back, why you didn't think you needed to address the web price issue when they did it back in 2017, when you clearly had exposure with the non-contract business within the company?

Erik Gershwind

Pat, good questions. I think that -- first of all, what I would say is I think there has been some degree on the web in particular investment all along. I think what we're looking at now is the step function. And I think what you're seeing is a reflection of choices that we made. We proactively and consciously made a pretty hard pivot, if you recall, over the past several years to move the value proposition into a high-touch technical one.
And so like every company, there's choices that we make about where we're going to invest. We're mindful of how much we invest at any one time and the need to produce financial performance. And so a lot of our investments went into the areas that we're now highlighting are actually doing quite well. And we did those by design.
And so I think for us now, we're turning our attention knowing that that portion of the business, the high-touch is working, and it's now the tip of the spear for us. And how we win an account, this is now -- we're now following it up behind it with the core customer.

Patrick Baumann

I mean -- cadence-wise, obviously, the solutions business is performing really well. So totally get that, and those investments are bearing fruit. So this was more of kind of a prioritization of things as opposed to you not recognizing that there were things that needed to be addressed with the core.

Erik Gershwind

No, I think that's right. I think both from a capacity inside the company of how much would we get done at one time and a capacity on the P&L of how much can we absorb in terms of investment, those were choices we made.

Operator

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

Ryan Mills

Thank you for joining today's call, and please reach out with any questions or follow-up requests. Our fiscal fourth-quarter earnings call is scheduled for Thursday, October 24, and we look forward to seeing you on the road and at conferences in the coming months. Goodbye.

Operator

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