MSC INDUSTRIAL DIRECT CO INC annual report, FY2021

Business Context and Reporting Period

MSC Industrial Direct Co., Inc. is a North American distributor of metalworking and maintenance, repair and operations products and services. The company operates one reportable segment and serves customers primarily in the United States, with operations in Canada, Mexico and the United Kingdom. The filing covers the 52-week fiscal year ended August 28, 2021; the filing metadata references 2021 Q4. Fiscal fourth-quarter average daily sales were $13.2 million, up 12.9% from the comparable period.

MSC offered approximately 1.9 million active SKUs through eCommerce, sales, fulfillment centers, inventory centers and customer service channels. Approximately 60.0% of fiscal 2021 sales were transacted through eCommerce platforms. The company employed 6,571 associates at year-end.

Financial Performance and Key Metrics

Metric	Fiscal 2021	Fiscal 2020	Change
Net sales	$3.243 billion	$3.192 billion	1.6% increase
Gross profit	$1.334 billion	$1.343 billion	0.7% decrease
Gross margin	41.1%	42.1%	Down 100 basis points
Income from operations	$301.8 million	$350.7 million	14.0% decrease
Net income attributable to MSC	$216.9 million	$251.1 million	13.6% decrease
Diluted earnings per share	$3.87	$4.51	14.2% decrease
Cash flow from operations	$224.5 million	$396.7 million	Decrease of $172.3 million

Sales growth reflected approximately $42.3 million of pricing and mix benefits, $3.7 million from fiscal 2021 acquisitions and $6.0 million of favorable foreign exchange, partly offset by $1.2 million of lower volume.
Manufacturing customer average daily sales increased 4.5% for the year and 21.8% in the fourth quarter. Manufacturing represented 68% of annual sales and 70% of fourth-quarter sales.
Operating expenses increased 1.9% to $994.5 million, including higher payroll, incentive compensation and freight costs. Freight expense was $133.7 million, compared with $125.9 million.
The effective tax rate declined to 24.4% from 24.7%.
Year-end cash and cash equivalents were $40.5 million, compared with $125.2 million. Working capital was $752.3 million and the current ratio was 2.3, compared with 3.0 in the prior year.
Inventory increased to $624.2 million from $543.1 million, while accounts receivable increased to $560.4 million from $491.7 million. Days sales outstanding rose to 61.1 from 58.2, primarily due to a greater proportion of national-account sales and extended customer terms.

Debt, Liquidity and Capital Allocation

Total debt was $786.0 million at August 28, 2021, compared with $619.3 million, and net debt was $745.5 million, compared with $494.1 million.
The company had $234.0 million outstanding under its $600.0 million amended revolving credit facility and $201.5 million outstanding under uncommitted credit facilities with aggregate maximum availability of $208.0 million.
The company reported $395.8 million of unused revolving credit availability, net of outstanding letters of credit, and stated that it was in compliance with applicable debt covenants.
Net cash used in financing activities was $233.7 million. The company paid $362.7 million of regular and special dividends and repurchased $71.3 million of Class A stock.
Fiscal 2021 dividends totaled $6.50 per share, including a $3.50 special dividend. A quarterly dividend of $0.75 per share was declared in October 2021.
Management stated that existing cash, financing resources and operating cash flow should be sufficient to fund operating requirements and necessary capital expenditures for at least the next 12 months.

Material Changes Versus the Prior Comparable Period

Revenue increased modestly, but profitability declined because of lower gross margins, COVID-19-related PPE inventory write-downs, impairment charges and higher restructuring costs.
The company recorded $30.1 million of PPE-related inventory write-downs and a net $5.9 million impairment loss related primarily to a $26.7 million nitrile-glove prepayment. A $20.8 million legal settlement recovery partially offset that impairment.
Restructuring costs increased to $31.4 million from $17.0 million. Costs included lease-asset impairments, severance, exit costs and consulting expenses.
MSC closed 73 branch offices and transitioned toward virtual customer care hubs, with some locations realigned as regional inventory centers.
The company acquired an 80% interest in Wm. F. Hurst Co., LLC for $15.3 million and acquired additional TAC outsourcing and logistics assets through MSC Mexico for approximately $8.1 million attributable to MSC.
Operating cash flow declined substantially because of increased accounts receivable and inventory investment associated with higher sales and supply-chain challenges.
Net sales remained below fiscal 2019 levels of $3.364 billion, and net income attributable to MSC declined from $288.9 million in fiscal 2019 to $216.9 million in fiscal 2021.

Guidance, Outlook, Commentary and Risks

Management did not provide a specific numerical revenue or earnings forecast in the filing. Its “Mission Critical” program targets market-share gains and improved profitability through fiscal 2023. Planned initiatives include expanding metalworking expertise, sales capacity, vending, vendor-managed inventory and in-plant solutions, while pursuing structural cost reductions in sales, supply chain, general and administrative expenses, distribution centers and real estate.

Management reported improving manufacturing conditions: the fiscal 2021 full-year Metalworking Business Index averaged 57.4 and the Industrial Production index averaged 98.7, compared with a revised 2020 average of 96.6 for the latter.
COVID-19 continued to create risks involving customer demand, supplier availability, freight, labor, inventory levels, collections and operating disruptions. The company noted that shortages of labor, fuel and certain products could affect future results, but could not estimate the impact.
Key risks include cyclical manufacturing demand, intense competition and pricing pressure, gross-margin volatility, supply-chain disruptions, tariffs, labor shortages, inventory obsolescence, customer credit risk and dependence on rapid delivery.
Variable-rate debt exposes the company to interest-rate risk; a 100-basis-point rate change was estimated to affect annual interest costs by approximately $2.8 million. The company also faces uncertainty from the transition away from LIBOR.
Goodwill and indefinite-lived intangible assets totaled $705.5 million and could be impaired if operating performance or market conditions deteriorate.
The company is controlled by principal shareholders holding approximately 65.9% of combined voting power through the dual-class share structure.
The Long Island customer service center was classified as held for sale with a carrying value of approximately $15.3 million; the transaction remained subject to permitting. A new 10-year, approximately 26,000-square-foot lease commenced in September 2021.
Management reported no material adverse effect expected from pending legal proceedings. Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting.

Important Facts for Investors to Verify

Whether the Mission Critical initiatives produce sustainable sales growth, margin recovery and the expected structural cost savings.
Future gross-margin effects from customer mix, large-account pricing, freight inflation, vendor cost increases and PPE inventory normalization.
Inventory aging, demand trends and any additional PPE-related write-downs or recoveries.
Refinancing and rollover risk for the $201.5 million of uncommitted credit facilities and upcoming debt maturities, including $125.0 million due in fiscal 2023 and $334.0 million due in fiscal 2026.
Cash conversion and working-capital requirements, particularly accounts receivable collection periods and elevated inventory levels.
Integration results and contribution from Hurst and the additional TAC assets.
Potential effects of COVID-19, labor shortages, supply-chain constraints, tariffs and the LIBOR transition.
Future dividend and repurchase decisions given increased leverage, lower cash balances and substantial ongoing capital returns.