MSC Industrial Direct (MSM) Q4 2024 Earnings Call Transcript

MSC Industrial Direct (MSM -3.77%)
Q4 2024 Earnings Call
Oct 24, 2024, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the MSC Industrial Supply fiscal 2024 fourth quarter and full year conference 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 — Head of Investor Relations

Thank you, and good morning, everyone. Welcome to our fourth quarter fiscal 2024 earnings call. Erik Gershwind, chief executive officer; Martina McIsaac, president and chief operating officer; and Kristen Actis-Grande, chief financial officer, are on the call with me today. During today’s call, we will refer to various financial data in the earnings presentation and operational statistics documents, both of which can be found on our investor relations website.

Let me reference our safe harbor statement found on Slide 2 of the earnings presentation. Our comments on this call, as well as the supplemental information we are providing on the website contain forward-looking statements within the meaning of the U.S. securities laws. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements.

Information about these risks is noted in our earnings press release and 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 the non-GAAP reconciliations in our presentation or on our website 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.

Erik Gershwind — Chief Executive Officer

Thank you, Ryan. Good morning, everyone, and thank you for joining us today. Before I start, I’d like to share a couple of thoughts on recent current events. Our hearts go out to all of those affected by the major hurricanes that hit the Southeast in recent weeks.

I’m relieved to report that our associates in the impacted areas are safe. And MSC remains committed to support the disaster relief and recovery efforts through both monetary donations and by providing products on the Red Cross request list. On today’s call, I’ll reflect on the progress of our mission-critical program and our fiscal 2024 performance. I’ll also cover the current environment.

Before passing it over to Martina who begins joining us on these calls to discuss our fiscal 2025 key initiative pipeline. Kristen will then provide more specifics on our fourth quarter financial performance and our initial expectations for fiscal 2025, and we’ll then open up the line for questions. Before getting into any details, let me offer some broader perspective on our mission-critical journey. Fiscal 2024 was a challenging year.

We have been coming off of a strong three-year run during our first mission-critical chapter, in which we met or exceeded all of our stated goals. During fiscal ’24, we faced the deteriorating environment in particularly our metalworking and heavy manufacturing end markets and compounded that softness with execution challenges in the technology area. Since our last call, I’ve been encouraged to see how our team has rallied despite further softening in the macro. I’m seeing evidence that we are restoring the execution that had been built over the prior three years.

First, we’re maintaining momentum in our high-touch solutions, which is our first mission-critical pillar. During fiscal ’24, we improved our implant program count by 29% to 342 and total installed vending machines by 9% to more than 27,000 at fiscal year-end. This growth helped our national accounts’ average daily sales outperform the IP index by roughly 150 basis points for the full year. Large account wins continue to be powered by our ability to improve our customers’ operations.

In fiscal ’24, we presented roughly $500 million in documented savings to our customers. These savings come from tooling recommendations, manufacturing process improvements, inventory management solutions, and more. Second, progress continues on our next mission-critical pillar, reenergizing the core customer. While core customer growth rates remain suppressed, progress is being made on the critical initiatives that are needed to turn the tide.

Mscdirect.com enhancements are advancing as expected. During the last three months, we improved the overall site experience including upgrades to our search algorithm. Shown in the op stats posted on our investor relations website, e-commerce represents a little more than 60% of total company revenues, roughly half of which is from sales on mscdirect.com. As communicated on the last call, we expect the site to be ready to support an enhanced marketing effort with the launch of these enhancements in our fiscal second quarter of 2025.

Further, we completed our web pricing realignment during fiscal ’24. We see opportunities to continue fine-tuning and we’ll capitalize on those over time. As it relates to gross margins, you’ll recall that our expectation was to complete the project with a roughly neutral gross margin outcome. During our fiscal third quarter, we saw an unexpected dip due to the complexity of our pricing system and discounting algorithms.

We took immediate countermeasures and have restored gross margins to expected levels of performance. In fact, our fiscal fourth quarter gross margin outperformed historical sequential averages, thanks to solid execution by our team. Third, we’ve built a strong pipeline of productivity initiatives that will fuel our last mission-critical pillar, optimizing our cost to serve. These programs begin yielding payback this quarter and are expected to build through the year and into fiscal 2026.

The first of these initiatives was completed during fiscal 2024, which entailed the difficult decision to close our Columbus CFC. This project will yield savings of $5 million to $7 million annually, beginning in the fiscal first quarter. Martina will provide more color shortly on our broader productivity opportunity. Fourth, we made meaningful progress on working capital resulting in $410 million of operating cash flow or 160% of net income.

And lastly, during our previous call, we mentioned that other technology initiatives including the upgrade of our back-office value streams were under review. While the work completed to date is sound, we’ve decided to temporarily pause this project and we’ll resume in a phased approach while we reallocate our focus toward growth and the execution of the initiatives that I just outlined. I’ll now move to a quick review of our results for the fiscal year on Slide 6. Average daily sales declined 4.7%, which includes a headwind of approximately 160 basis points from non-repeating Public Sector orders in fiscal 2023 and a roughly 70 basis point tailwind from acquisitions.

Fiscal full-year gross margins of 41.2% improved 20 basis points year over year. This performance was mainly driven by benefits from non-repeating Public Sector orders in the prior year and our gross margin countermeasures, which were partially offset by negative price cost and lower-margin acquisitions. As a result of lower sales and higher operating expenses driven by our strategic investments, both reported and adjusted operating margins declined 190 basis points year over year to 10.2% and 10.7%, respectively, which is at the high end of our most recent guidance range. Together, this resulted in reported earnings per share of $4.58 and adjusted earnings per share of $4.81.

Approximately $0.17 of the $1.48 year over year adjusted EPS decline was due to headwinds from higher interest and other expenses. Looking ahead to fiscal 2025, the year begins with a continuation of the challenging outlook we faced in fiscal 2024. Conditions remain soft as evidenced by IP readings, particularly for our top manufacturing end markets, the majority of which are contracting. Automotive and heavy trucks, primary metals, fabricated metals, and machinery and equipment are all weak.

Aerospace remained positive in the quarter, but forward-looking expectations have been tempered due in part to the recent strikes in the sector. The manufacturing and metalworking-related softness in particular are also evidenced through MBI readings which have now been negative for 19 straight months, including the last three consecutive readings of 44, 44, and 43 respectively. This is reflected in our Q1 growth rate as September came out of the gates down 4%, and October is trending down between 5% and 6%. The primary drivers remain the same and include the effects of sustained high interest rates, leading to reduced spending levels, along with caution from an upcoming presidential election, which is fairly typical.

On top of these, we’ve seen more recent temporary business disruptions stemming from hurricanes. We estimate the impact from hurricanes resulted in a year over year ADS headwind of 20 to 30 basis points in September and 40 to 50 basis points in October. In addition to starting fiscal 2025 with soft conditions, we’re also as previously communicated, anticipating a step-up in operating expenses, primarily attributed to an expected normalization of incentive-related compensation, along with higher depreciation and amortization expense, due largely to our digital investments. These factors will suppress operating margins in the near term.

While the start of fiscal 2025 is tempered, our outlook for fiscal 2026 is more encouraging. We are well positioned as the majority of our sales are mixed into manufacturing end markets, whose long-term outlook remains strong. In addition, we expect continued market share capture through implant, vending, and other large account wins that are today subdued due to lower spending levels by our customers. We also expect to see improved performance from our core customer group as benefits from pricing, e-commerce, marketing, and enhancements in sales coverage filled over the balance of the fiscal year into 2026.

We anticipate operating expenses to level out exiting fiscal 2025, through a combination of moderating depreciation and incentive compensation trends, along with increasing benefits from the current productivity pipeline. And with that, I’ll now pass the call over to Martina.

Martina McIsaac — Executive Vice President, Chief Operating Officer

Thank you, Erik, and good morning, everyone. I’m excited to start joining our quarterly earnings call. Turning to Slide 7. Let’s dig into some of the focus areas of productivity we have in the pipeline.

Starting with Network Optimization. Through our recent study, we identified a portfolio of opportunities to unlock productivity. In fiscal year ’25, we’ll begin to execute on a portion of these with a focus on core process upgrades in three critical areas. First, we have an opportunity to streamline the supply chain for our OEM fastener and C-part categories.

We intend to consolidate our demand planning and procurement and simplify the flow of materials to leverage our purchasing power and take costs out of our network. Second, we’re upgrading our use of technology and our systemwide inventory planning and allocation. We want to ensure that we have the right inventory as close to our customers as possible to reduce both cost and carbon. By upgrading our planning algorithms, we intend to improve service levels to the customer and work more collaboratively with our suppliers, while we continue to realize working capital benefits through more efficient inventory management.

And third, we see the opportunity to optimize our management of inbound and outbound freight. The shift in our business to planned demand coupled with the more sophisticated demand forecasting and allocation of inventory will lead to a reduction in split shipments and a lower reliance on air freight. The combined benefit to both the cost of goods sold and operating expenses of these three actions are expected to be $10 million to $15 million in combined annualized savings. These benefits will begin building this fiscal year and represent a small subset of the total funnel of identified opportunities.

We’ll keep you updated on our progress as we move through the year. Now, moving to the right of the slide. We’re also taking action to unlock productivity in sales and customer-facing roles. To serve our core customers better, we see opportunity to maximize seller potential through an enhanced and data-driven territory model.

This will result in optimized field seller portfolios in terms of size and reach. We’re encouraged by the results from the pilot of this model and believe this will substantially expand the sales rep’s access to addressable spend. These changes are expected to be completed over the next two to three quarters. In addition to the changes we’re making with core customers, we’re making similar adjustments in national accounts.

This will allow our team to expand coverage into more underpenetrated locations and will be completed in the first quarter. We also see an opportunity to improve time to money on larger wins. We’ve launched a program targeting this opportunity, and during the pilot phase, we reduced solution implementation time on our largest wins with the most complex needs by more than 50%. And lastly, we’re making changes to bolster performance in the field.

We recently enhanced our onboarding process of new hires with customized training road maps for every unique selling role to accelerate the time to perform. For our mature reps, we implemented a new sales tool that drives enhanced analytics to our sellers to enable more cross-selling opportunities in support of our customers’ needs and growth. These actions allow us to target more than $300 million in growth with minimal incremental investment. And with that, I’ll turn it over to Kristen to cover our fourth quarter results and outlook.

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Thank you, Martina, and good morning, everyone. Please turn to Slide 8, where you can see key metrics for the fiscal fourth quarter on both the reported and adjusted basis. Fiscal fourth-quarter sales of $952 million declined 8% year over year on an average daily sales basis, which includes a headwind related to nonrepeating public sector orders in the prior year of approximately 300 basis points. The remaining 500 basis points year-over-year decline was primarily driven by lower volumes, which were partially offset by benefits from acquisitions.

Sequentially, our average daily sales declined by approximately 1%. It’s worth noting that the adverse impact of FX contributed 20 basis points of the sequential decline. By customer type, national accounts declined 2% year over year. During the quarter, only 34 of our top 100 accounts showed growth, which is a reflection of the softness being seen in our top-end markets.

Core and other customers declined approximately 7%, while the public sector declined approximately 28% due to large nonrepeating orders in the prior year. Excluding this impact, public sector sales would have shown a year-over-year decline in the mid-single-digit range. Sequentially, average daily sales improved approximately 3% in the public sector. National accounts performed roughly flat and core customers declined approximately 2%.

From a solutions standpoint, we continue growing the number of implant programs and installed vending machines. However, the average daily sales performance of these solutions reflects the current demand environment as the continued growth of our installed base was largely offset by lower levels of activity. In vending, Q4 average daily sales were flat year over year and represented 17% of total company net sales. Sales through our implant programs grew 5% year over year and represented approximately 16% of total company net sales.

Moving to profitability for the quarter. Gross margin of 41%, improved 50 basis points year over year and 10 basis points quarter over quarter sequentially, outperforming historic seasonal patterns. Our team’s ability to quickly rectify the issues that hampered gross margin during the rollout of our enhanced pricing structure in Q3 was the primary driver of sequential improvement in the fourth quarter. Operating expenses in the fourth quarter were approximately $297 million and $296 million on a reported and adjusted basis respectively.

On an adjusted basis, operating expenses were up $7 million compared to 4Q of last year. Combined with lower sales year over year, this resulted in a 320 basis point increase in adjusted operating expense as a percentage of sales. Sequentially, adjusted operating expenses were up $7 million and performed as expected. The primary drivers of the step-up were a nonrepeating benefit in variable compensation expense in 3Q, as well as higher D&A and acquisition-related costs.

Reported operating margin for the quarter was 9.5% compared to 11.4% in the prior year. On an adjusted basis, operating margin of 9.9% declined 270 basis points year over year. GAAP earnings per share of $0.99 declined $0.57 compared to the prior year period. On an adjusted basis, EPS was $1.03 compared to $1.64 in the prior year.

Approximately $0.05 of the year-over-year decline was related to currency impacts in Mexico. Additionally, our higher tax rate in the quarter represented a headwind of another $0.07, which is primarily driven by the derecognition of certain tax assets. Now, let’s turn to Slide 9 to review our balance sheet and cash flow performance. We continue to maintain a healthy balance sheet with net debt of approximately $479 million, representing roughly one times EBITDA.

Working capital was a favorable source of cash in the quarter, including a contribution of roughly $27 million from reductions in inventories and receivables. This resulted in another strong quarter of operating cash flow with a conversion rate of 199% in 4Q and 160% for the fiscal year, well above our stated target of greater than 125%. Capital expenditures decreased $2 million year over year to approximately $26 million. Together, this drove strong free cash flow generation of approximately $81 million in fiscal 4Q and $311 million for the full year, both of which were well above net income.

Our balance sheet and cash generation remain strong and continue to fuel our capital allocation priorities shown on Slide 10. We deployed cash in several of these buckets during the year, including four strategic acquisitions and $1.9 million in share repurchases with $250,000 repurchased in 4Q. We also continued to maintain a healthy dividend yield through modest increases to the ordinary dividend as seen by the announced increase of $0.02 earlier this month. Moving on to our expectations for fiscal ’25.

Given uncertainty in the current environment, we will start the year by providing a quarterly outlook and return with a longer-range perspective as the environment stabilizes. However, we will provide longer-term insight on certain line items to help you with the expected cadence for the fiscal year. Starting with our outlook for the fiscal first quarter on Slide 11. We expect average daily sales to decline 4.5% to 5.5% year over year.

Our expected range takes into consideration quarter-to-date sales which are down 4.2% in September and an estimated decline of approximately 5% to 6% for the month of October. This implies little to no improvement in November due to uncertainty stemming from the upcoming election, the continuation of end market softness and potential shutdown activities by customers around the Thanksgiving holiday. Under this revenue assumption, we expect adjusted operating margin to fall in the range of 7% to 7.5% which takes into consideration the following: gross margins of 40.8%, plus or minus 20 basis points and a step-up in adjusted operating expenses compared to the fiscal fourth quarter of approximately $8 million. This step-up is being driven by the resetting of the variable compensation programs to the new fiscal year and higher D&A.

Turning to Slide 12. We’ve outlined our expectations on certain line items for the full year. We expect depreciation and amortization costs to be roughly $90 million to $95 million, representing a year-over-year increase of approximately $10 million to $15 million. This largely reflects the investments made in technological and digital capabilities, as well as continued growth in vending.

Other underlying assumptions include interest and other expenses of roughly $45 million. Capital expenditures, including cloud computing arrangements of $100 million to $110 million and a tax rate between 24.5% and 25%. Strong free cash flow generation is expected to continue in this fiscal year and to be approximately 100% of net income. To assist in modeling the cadence of sales for the remainder of the fiscal year, the bottom of the slide provides historical quarter over quarter averages and key considerations.

Lastly, we have the same number of business days year over year throughout each quarter in fiscal ’25, as shown at the bottom of the chart. And with that, we will open the line for Q&A.

Questions & Answers:

Operator

[Operator instructions] First question comes from Tommy Moll with Stephens. Please go ahead.

Tommy Moll — Analyst

Good morning and thank you for taking my questions. So you called out on Slide 4, the top five industry groups, which is helpful, particularly given some of the divergence there. And so, I’ll ask a question that we may not get the exact answer to, but if you can just point us directionally, I think it would be helpful to the investor community. Do you have any rough rules of thumb on how much of your business, each of those five industries drives? Or do you think of them collectively as a rough fraction of your overall revenue? I’m just trying to get a sense of how we can think about those five and the magnitude they may have the call outs useful and just trying to go the next step here.

Erik Gershwind — Chief Executive Officer

Yes, Tommy. So the first thing I’d say is to take a look at what we do break out, so we don’t give specific end market detail, but what you can see is our heavy manufacturing breakout. So that’s the first place to start, which, as you know, is the majority of a big chunk of our manufacturing exposure is heavy manufacturing, which is levered toward metalworking. Of the heavy manufacturing, while we don’t break it out specifically, what I can tell you is that the enumerated end markets are the bulk of that heavy manufacturing number.

So what you’re seeing there is our heavy manufacturing portfolio right now is particularly soft. With the exception of one that we called out being aerospace, which remains positive, a little tempered but positive. The others have been quite negative. And I think one of the best proof points for that we shared in the prepared remarks, I mean, if you look at our largest 100 accounts, so these are accounts where we have a very good relationship and a good share position and it was 34 out of 100 are growing.

That would be illustrative of what we’re seeing here. So the punch line is what we laid out and what we enumerated would make up the bulk of heavy manufacturing.

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Tommy, I can put a little bit of a finer point on that. It’s roughly about half the business of those top five end markets. Machinery and equipment directionally is the largest. Aero and auto are about 10%, and that’s what we can sort of attribute directly into those end markets.

We have some additional end market indirect exposure, but that’s what we have a kind of clean line of sight to.

Tommy Moll — Analyst

Yes. And then, as a follow-up, I wanted to touch on the framework you provided for the first fiscal quarter and for the year. And given the uncertainty, we certainly understand the lighter-than-typical metrics that you’ve provided. But I just want to do my best to get us all on the same page here on some of the margin points, Kristen, you’ve given us helpful jumping-off points for the first fiscal quarter, both for gross margin and operating expense.

What do you want us to know that you can share today on either of those points? And so, what I have in mind here is whatever you view your typical sequential progression to be on a gross margin standpoint, any big deviations from that we should bear in mind? And then, also just maybe even philosophically how you’re thinking about managing the operating expense, the fixed and variable pieces of that as we go through this year. Anything you could share just to get us on the same page would help.

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Yes. So maybe let me start, Tom, just reiterating what we had communicated in Q1 in the prepared remarks. So we’re thinking the midpoint based on what we can see right now on ADS is about down 5% and then 40.8% gross margin, plus or minus 20 basis points. I think you’ve got the opex noted, we had indicated about an $8 million step-up.

So the midpoint of the range, we have an op margin is about $7.25 million. Within that, we’ve kind of communicated before, maybe let me touch on the opex side first, we do have kind of a onetime step-up that’s coming from D&A from the resetting of the compensation programs. On the gross margin side, we’re really pleased with how Q4 ended within fiscal ’24. Good execution by the team on recovering the list price repositioning instability that happened in Q4 and then as we think about Q4 moving into Q1, just directionally, we’re thinking flattish price/cost Q4 to Q1.

And maybe beyond that, I know we’re not giving an annual outlook. It is really uncertain now as you’ve commented, and we do have very limited visibility, but perhaps a little bit more color on sequencing that maybe will at least help with the first half directionally. We talked about revenue in 1Q being down $5 million. So if you think about kind of how we’re expecting Q1 to Q2 sequential to play out, I would note the historic side year average that we had put on the slides in the presentation.

And right now, we don’t anticipate any notable change in that macro environment through calendar year ’24. So — and that’s all the reasons we hit in the prepared remarks. Specific to December, I think it’s important to note that we are expecting to see a larger amount of holiday shutdowns in the month, which is very similar to what we had seen in ’23 — calendar ’23 and calendar ’24. So really, with respect to the rest of the first half, what remains to be seen is the snapback that happens in January and February.

That’s a little bit more color on first half. And then, obviously, what we’re really looking toward is the second half, we noted some of the initiatives on this slide in the investor presentation that we’re really hoping would change the course of the second-half sequential averages that we’ve seen. And that’s, of course, the web enhancements, the marketing initiatives. And then, Martina highlighted some new things around selling effectiveness.

So hopefully, that helps cover this a little bit. I guess maybe the last thing, let me hit on opex, Q1 into Q2, just to give you one more point on first half, I’d expect there’s another small step up Q1 to Q2 on the opex, and that’s because of the timing of the annual salary inflation increases.

Tommy Moll — Analyst

So the D&A will be fully at the run rate for Q1 — but what you just described —

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

It’s a small step up still, Tommy, but it gets washed out by other things, like the tall candlestick, Q1 to Q2 is really around personnel-related costs.

Tommy Moll — Analyst

OK. Noted. Thank you. I’ll turn it back.

Erik Gershwind — Chief Executive Officer

Thanks, Tommy.

Operator

The next question comes from Ryan Merkel with William Blair. Please go ahead.

Ryan Merkel — Analyst

Hey, everyone. Thanks for taking the questions. I wanted to follow up on a couple of the prior questions. So the Slide 12, should we be viewing that as guidance? Or are you sort of communicating that you think you’ll do better than these average sequentials given some of the initiatives that you have?

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Yes, I can take that one, Ryan. So that is really a reference point for — we recognize we’re not giving annual guidance or an outlook. So we would expect that when all of you were starting your modeling, you are looking at how historic sequencing would play out. So that’s really more of a reference point as to what our past five years have been.

We don’t know if it’s going to look like that or not. If we did, we’d be giving you more specificity on an annual range, and we really don’t know at this point. We would expect the initiatives to kick in, in the second half, which are some of the considerations that we’ve noted on the slide. But beyond that, I don’t have any more to share as to what we have visibility into at this point.

Erik Gershwind — Chief Executive Officer

Yes, Ryan. Just add a little color. There’s two variables. One is, as Kristen said, how quickly the initiatives come online.

And look, as I said in the prepared remarks, we’re encouraged by the execution that we’re seeing here coming off of ’24, where we had hiccups in one area of the company. But variable No. 2 is also the macro. And part of the reason we didn’t give our normal annual framework here is because visibility is fairly limited.

And we just don’t know postelection, you have interest rates coming down. We don’t know how quickly do things ramp. We do know that we pin a long time with very low levels of MBI readings and at some point, history says, at some point in the not-too-distant future, things are going to turn, but we just can’t call it.

Ryan Merkel — Analyst

Yes. No, I appreciate that. It’s very murky to put it lately. OK.

And then, SG&A, so it sounds like you have a step-up 1Q, a little higher 2Q, I guess a two-part question. Does it stay stable from there in the second half off the 2Q levels? Or you talked about some opex cost-cutting that you may be doing. So can you quantify that? I’m just curious how much of that will help in ’25 or if there’s a lot of that in ’26?

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Yes, I can add a little more detail on that, Ryan. So for the second half, the way that I would think about that relative to the information I just provided on first half is really volume becomes the big driver. So, however, you’re layering in your volume assumptions in the second half, that’s the big mover on opex on a dollar basis. There is a lot of movement within that specific to investments in productivity.

As you noted, so we are expecting a decent amount of productivity generation in fiscal ’25. You heard Martina mentioned a few of the projects that we’re working on and the network optimization study. We’ve got the benefits from Columbus. That will be building in the second half.

We’re also dealing with some increased G&A throughout the year and we’ve got some investment that will still remain throughout fiscal ’25. So all of those moving pieces kind of taken together from a modeling perspective, I would really just encourage you to look at how the volume is coming in. And I would directionally use like 8% to 10% of volume on that — 8% to 10% of revenue through volume-based expenses.

Ryan Merkel — Analyst

OK. Very helpful. Thank you.

Operator

The next question comes from David Manthey with Baird. Please go ahead.

David Manthey — Analyst

Hi. Good morning, everyone. It seems like we’re all circling around the same thoughts here. But when I look at the quarter-to-quarter progression from third quarter to the fourth quarter actual, it looks pretty normal based on what you laid out in Slide 12, that five-year average.

If we were looking at your guidance, though, I think the quarter-to-quarter progression is minus 3.4 from this fourth quarter to what you’re guiding for the first quarter. If you were to extend that chart on Slide 12 and talk about what the five-year average is quarter-to-quarter from fourth to first, do you know what that is? We can calculate it, but I just — it would be easy if we just hear it from you.

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Dave, you’re asking if you calculate out — just to be clear on your question, if you were to play out the five-year historic sequential through the year based off the 1Q jump-off point, where would you get for the year?

David Manthey — Analyst

No. I’m just looking at — in each of those boxes, you say, here’s what the normal progression is from the quarter to the next quarter. And I’m asking you, what is that normal progression from fourth quarter to first quarter?

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Fourth quarter —

Erik Gershwind — Chief Executive Officer

It’s typically up 1%.

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Yes, up one typically, Dave, on the five-year.

David Manthey — Analyst

OK. So that just gives us an idea of what this — what the guidance is. I mean, again, the calculation looks like it’s down about three — a little more than 3%. So if it’s normally up 1%, that just gives us an idea of the magnitude that we’re looking at there.

Erik Gershwind — Chief Executive Officer

Dave, just to underscore, you’re exactly right, and it really chalks back to what we’re talking about with the end market weakness right now. So clearly, what you’re hitting on is right that the Q1 performance is well below what would be a typical seasonal average. And again, as we drill in there, it’s been a change, a softening, particularly in these end markets. You go back to the 34 out of the top 100 growing.

I think another thing to look at what we’re seeing right now is that the vending stat that Kristen highlighted earlier, where vending signings, if you look at our vending count, it’s plus 9%, and yet vending revenue growth is flat. So on a per machine basis obviously, things are down, things are soft. So what you’re seeing is different from a typical year for sure right now. The question is, obviously, what we just don’t know is what happens from here.

David Manthey — Analyst

Got it. And then, on the SG&A, based on triangulating the data that you gave us, it looks like operating expenses will be up at least low single digits year over year in the first quarter, and I’m just comparing that to the top-line trends. And I’m wondering — I know you’re making a lot of strategic investments, but I’m just wondering, why doesn’t operating expense flex down more with the weak sales trends you’ve seen and then kind of related to that, as we — Kristen, you kind of gave us the details on the year. So as these web enhancements and marketing programs are rolled out in the second quarter, you’re not seeing any incremental cost elements that will come in as a result of that.

You mentioned some of the compensation resets and things. But is there anything related to the web enhancements and marketing programs in the second quarter as well?

Erik Gershwind — Chief Executive Officer

Dave, I’ll let Kristen take the last part of your question first, maybe, and then I want to answer the first part around just why aren’t we seeing cost flex down more, which is a fair question. Kristen, I just want to hit how to think about the web and marketing first.

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Yes. So we really simplified the opex answer before, Dave, but there is incremental investment throughout the year. So in Q2, for example, we have the marketing program coming online. That will create a sequential increase in investments.

We have other productivity initiatives that are covering that. which is I kind of alluded to the one tall candlestick really being around personnel-related expenses. And it’s a similar story through the second half. We have productivity ramping up.

There is some incremental investments throughout the year. Holistically, we are expecting productivity to outweigh the amount we’re investing this year. But as we’ve talked about before, on a full-year basis, there are still some big step-ups that we’re dealing with. And I think we’ve talked about those on a previous call, but that really has to do with the compensation programs resetting and a DNA step-up that we’re dealing with.

So I can size those, if it’s helpful. And I believe we had shared before. We’re expecting — so the compensation step up, just to be clear, that has to do with the incentive compensation programs we’re setting for the fiscal year, that’s probably a $30 million to $35 million headwind on the year. Personnel-related costs, which is sort of the typical amount of inflation that we would see year over year tied to things like merit and benefits inflation.

We would expect that to be around $20 to $25 million and then a D&A increase year over year, which we had indicated in the prepared remarks, was going to be about $10 million to $15 million, and we have a little bit of acquisition carryover from the companies that were acquired inside of fiscal ’24, which is about five. And then, I think one thing that Erik will touch on around tighter cost control is absolutely the focus on productivity which is one of the things that we’ve done a much better job in this down cycle compared to previous. But maybe let me pause and let Erik weigh on the question around cost controls and then we can move back on anything.

Erik Gershwind — Chief Executive Officer

Yes, Dave, so just sort of zooming out for a second, and you’re asking a very fair question around — you look at Q1 and the cost step up relative to revenues. I think — look, the answer here is if our focus were solely on Q1 and Q2 of fiscal ’25. There are other cost actions that we would be taking if the goal was to optimize margins in those two quarters. However, our goal is looking beyond that to restore growth to the company and restore margin expansion.

Growth becomes critical in that. I will tell you, in the meantime, we’re managing discretionary — we are managing discretionary spend. So for instance, if you look across fiscal ’24 at total company headcount, it’s plus or minus flat and that’s with absorbing growth in the sales function due to acquisitions and sellers coming online and the implant program, which means support function headcount is down. So we are managing expenses, but to be clear, if the goal were to optimize margins in Q1, Q2, you’d see us taking other cost levers.

We look out and say, “Hey, our ambitions for this company are to return it to being a growth company, huge fragmented market, strong value proposition.” We still feel very good about the end markets that we’re levered into here. Despite near-term softness, the outlook on most of these end markets is actually quite good. So we feel what’s critical to getting back to outgrowth above market and margin expansion is we have to get the growth engine going and the productivity pipeline going. So what you’re seeing is us being cautious about not pulling levers on the cost side that would impede momentum on the bigger picture.

I would tell you that if we reached a different conclusion and felt this business was not — were not poised for growth, you’d see us taking a different playbook on the cost side.

David Manthey — Analyst

I appreciate the commentary. Thank you.

Operator

The next question comes from Chris Dankert with Loop Capital Markets. Please go ahead.

Chris Dankert — Analyst

Hey, good morning. Thanks for taking the questions. I guess, first off, Kristen, thanks so much for kind of running through all those components on SG&A. The one piece that I think we were kind of hoping for an update on that wasn’t included there was just the digital investment, any quantification on kind of the incremental spending in fiscal ’25 versus ’24 on the digital and the marketing aspect.

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Yes, Chris, so there is additional incremental investment. And then, I would add to that on the sequential G&A increase we mentioned, a good chunk of that is from the investments we’ve been making into digital and technology in previous years. I’m not going to size it specifically. We gave a lot of components on opex.

If I give you the whole range on investment and productivity, I might give — might as well given full-year opex annual guidance, but I hope that the color we’ve provided in the first half is at least helpful to get you through the first and second quarter.

Chris Dankert — Analyst

Yes. No, I fully appreciate that. And again the detail is extremely helpful. I guess, just secondly, on the website rollout search functionality, can you kind of give us an update on is that progressing still to the most recent plan? And then, any kind of update in terms of a soft or hard launch on the kind of enhanced marketing investment when that kind of goes live here?

Erik Gershwind — Chief Executive Officer

Yes, Chris, what I tell you, let me start. On the web, what I would say is, I’d be pleased with how the team has rallied in the past few months. And the punchline is we’re on plan. And I talked in the prepared remarks about upgrades in terms of site navigation, in terms of our search algorithm.

I think the way to think about that is they’re going to continue to roll out. This is not going to be a one-and-done, a big bank. They’re going to continue to make progress. And what we talked about our commitment on the last call was, hey, that by our fiscal — in our fiscal second quarter that the website would be ready to support our marketing efforts.

And we absolutely believe that’s the case. So we’re on a plan with the upgrades. With respect to marketing, I’m not going to give too many details, just it’s competitively sensitive, but what I’d also say there, yes, we would be — we are on track there with marketing in Q2. What I — maybe a little color just in terms of timing, what I’d say on the expense side, I think Kristen covered it and roped it in with our investment spending.

From a timing standpoint, our fiscal two runs December through February. You could have in December, we’re anticipating being a little bit — likely a little bit of a choppy month. We’ll have to see how things play out post-election, but you have holidays and such. So certainly after that would seem to be a logical time when we would ramp up the activities on the marketing front.

And it will be a pretty broad-based marketing campaign, but I’m not going to go into too many details.

Chris Dankert — Analyst

Makes sense. Thanks so much for the color there, guys.

Operator

The next question comes from Katie Fleischer with KeyBanc. Please go ahead.

Katie Fleischer — KeyBanc Capital Markets — Analyst

Hey, good morning, guys. I wanted to go back to Tommy’s question a little bit, just on operating leverage. Can you give any detail about how you’re thinking about that outside of 1Q ’25? And I appreciate that visibility is really limited. But if we — if the macro does improve through the year, any sense of how incremental should react to that?

Erik Gershwind — Chief Executive Officer

Sure. So maybe, Katie, I’ll talk longer term, and then Kristen feel free to add any color you want. But Katie, look, big picture, obviously, ’24 was a challenge. And what we’re describing here is ’25, the year is coming out of the gates as a challenge, and it’s really a combination of a soft macro combined with fixed cost step-ups that we had anticipated.

I did mention that our outlook longer term is more encouraging. And look, we’ve talked about expanding, getting back to expanding operating margins. We still believe that the business has the capability here of strong incremental margins. So if you look at the setup and what we can’t give you right now is timing because we can’t predict the environment, but improving execution, certainly on the high touch side of our business, there’s embedded market share through implant and vending that’s happened that subdued spending levels.

So when the economy returns in these sectors, we know it will, but we don’t know when. We would expect an outsized rebound on the top line for sure. And then, from there, what we also described as we look beyond ’25, fiscal ’24 and ’25, we’ve had unusual step-ups in opex as we were talking about earlier. That normalizes as we get beyond fiscal ’25.

So from there, we would expect this business to get back to the historic kind of incremental margins that the business is capable of producing. And if you wonder what does that mean? Certainly, 20% or north of 20% is where we expect to be.

Katie Fleischer — KeyBanc Capital Markets — Analyst

OK. That’s really helpful. My last question is on the hurricane and aero strike. So Erik, I know you quantified the impacts of those in the quarter.

But any detail on how much of an impact aero has been? Or is that still yet to be seen? And then, given some of the incremental weakness in ADS from September to October, was that mainly driven by hurricanes? Or is there any other color there that you could provide?

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Yes. Katie, I can start, and maybe I’ll hit the question on aero first. Aero throughout FY ’24 was really a strong point for us in terms of growth. We still saw growth through September, but sequentially, we did see negative growth in the aero end markets.

So we’re really watching that situation closely. And one of the key things we’ll be looking for, of course, is when does everything resolve, but then what are the expected production rates beyond that? And what is the ramp-up of that look like? So definitely something we’re watching carefully. And then, I believe your second question was on the hurricane impact, which Erik had touched on. So we are — if you think about what we said for September and October and then what we get for the midpoint, it would imply that ADS in November is down a little bit more than 5%.

And there is an improvement, though, within that because of hurricane headwinds easing coming out of October.

Erik Gershwind — Chief Executive Officer

And Katie, maybe just a little more color would be. What we’ve seen over the past month and a half here as we move from fiscal ’24 to fiscal ’25. Obviously, David Manthey has noted that sequentially things are softer than they’ve been historically. Where we’ve seen this, interestingly, we break out our business into public sector, core customers and then the national accounts.

The core customer has sort of been relatively stable. And the performance, if you look at the growth rates has been pretty consistent now for a few quarters. We expect that to inflect. And that’s our goal is to get that to inflect.

But the change recently has actually been in the large accounts arena, and that’s an area where we have the tightest handle on our market share position, and we feel really good about execution. And yet things have softened there further, and we can directly tie that back to some of these end markets and the softening that we’ve seen there over the past even eight weeks beyond the hurricane noise.

Katie Fleischer — KeyBanc Capital Markets — Analyst

Got it. OK. That’s very helpful. Thanks for taking the questions.

Operator

The last question comes from Patrick Baumann with J.P. Morgan. Please go ahead.

Patrick Baumann — JPMorgan Chase and Company — Analyst

Good morning. Thanks a lot for letting me hop on here. Just maybe, I don’t know if it’s — who wants to take the question. But on gross margin, first of all, like very nice recovery in the quarter.

So good to see execution there. Can you talk about the expectations for gross margin like the cadence through the year? Like in the sense that would there be reasons for it to do anything other than normal seasonality from the first quarter guide that you provided? For example, with the core customers, I think you still make a higher gross margin there than the rest of the company. And so, I would assume if it starts to outgrow the rest of the company, that would help you outperform normal seasonality. Or maybe there’s something you can offer on the pricing environment for the year in terms of price cost, how you’re thinking about developing that would make seasonality different for gross margin? Any color around gross in cadence and things that would make it different than normal seasonality would be helpful.

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Yes. Happy to provide a little color on that path. And you’re absolutely right, the core customer is definitely higher gross margin. So as we think about potential outcomes through the year and where gross margin might trend.

That’s one thing that we are looking closely at is what the pace and degree of recovery is there and how much that may help us in the second half. But based on what we have in line of sight to right now, we’ve indicated Q1, we expect it to be 40.8%. What we’re seeing for the sequencing in the year is probably a similar level, plus or minus 20 basis points throughout the year. Price cost, I think we touched on this earlier, we’re expecting to be flat-ish from Q4 and then improving throughout the rest of the year.

So that’s a little bit of color I would add. We’ve got some productivity coming online within the gross margin space in the second half. So I would say if you’re sequencing, I’d probably look at that 40.8% plus or minus 20 bps as opposed to sort of the historic sequential movement in gross margin.

Patrick Baumann — JPMorgan Chase and Company — Analyst

OK. So that’s a little bit better than historical then because usually fourth quarter — usually fourth quarter comes down a bit. So that’s good.

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

It’s still early days, Pat. So we are going to give more specifics on that as we progress through the year. But based on what we have insights to now, that’s how I’d give you some added color.

Patrick Baumann — JPMorgan Chase and Company — Analyst

No, helpful. I appreciate that, Kristen. And then, maybe one for Martina. First of all, nice to hear you on the call, I look forward to meeting you at some point.

On the customer coverage enhancements you talked about, can you talk a little bit more about the complexity of this? I’m asking because the last time I remember the company tried to work on its sales force effectiveness, there was like a change in roles and responsibilities among sellers and it caused like a lot of disruption despite pilots that were encouraging initially. So maybe if you can talk about exactly what’s changing here for the sellers in the territory coverage and the service optimization plans that you highlighted in your prepared remarks.

Erik Gershwind — Chief Executive Officer

Pat, so maybe what I’ll do is — we’re also happy to have Martina to join these calls. I’m going to just — let me — because of the historic perspective, I’ll start and then I’ll turn it over to Martina, but one thing — a couple of points to make clear because obviously, it is a sensitive one given our history. I think No. 1 is there’s no strategy change here in terms of seller deployment and how we go to market.

This is about tightening up the execution of the current plan and strategy as opposed to a new strategy. And I think the other thing, and then I’ll turn it over to Martina that gives me confidence beyond, obviously, a lot of pressure testing and piloting and learning in the company is Martina brings with her a wealth of experience in a lot of areas, this being one of them with a really good track record of doing this before, which certainly helps. So with that, I just wanted to make clear, not a student body left here at all in terms of strategy. So sorry, Martina.

Martina McIsaac — Executive Vice President, Chief Operating Officer

Yes. No, that’s fine. Yes. Thanks for the question.

So it is not a change in strategy. I think that any large organization that runs a large direct sales force needs as a matter of hygiene to constantly review resource deployment and make sure that we have trained people on the best potential. So we’re using this moment to look at territory design we do respect customer relationships and the sensitivity of them, which is why, as we said, we’re going to make these changes over the next couple of quarters. But this is about covering more and the best potential.

And I think this should be an ongoing good practice, not an event. So we start this year and then that’s part of our hygiene going forward.

Patrick Baumann — JPMorgan Chase and Company — Analyst

OK. So I think I heard you say that you’re not moving — you’re not planning to move sellers with strong relationships with customers off of those customer accounts just because of a change in the territory.

Martina McIsaac — Executive Vice President, Chief Operating Officer

Absolutely. What we’ve tried to target are areas where we have undercapacity or excess capacity and make sure that we can deploy the resources that we have in the most effective way. So a solid relationship would not be interrupted.

Operator

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

Ryan Mills — Head of Investor Relations

Thank you for joining us on today’s call, and we’re looking forward to seeing you at upcoming investor conferences and talking to you on our next earnings call on January 8. Goodbye.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Ryan Mills — Head of Investor Relations

Erik Gershwind — Chief Executive Officer

Martina McIsaac — Executive Vice President, Chief Operating Officer

Kristen Actis-Grande — Executive Vice President, Chief Financial Officer

Tommy Moll — Analyst

Ryan Merkel — Analyst

David Manthey — Analyst

Chris Dankert — Analyst

Katie Fleischer — KeyBanc Capital Markets — Analyst

Patrick Baumann — JPMorgan Chase and Company — Analyst

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