MSC Industrial Direct Co., Inc. — Fiscal 2020 First-Quarter Form 10-Q
Business Context and Reporting Period
MSC Industrial is a North American distributor of metalworking and maintenance, repair and operations products and services, serving customers through approximately 1.7 million products, 12 customer fulfillment centers and 99 branches. The filing covers the 13 weeks ended November 30, 2019, compared with the 13 weeks ended December 1, 2018. Fiscal 2020 is a 52-week year ending August 29, 2020.
Financial Performance and Key Metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $823.6 million | $831.6 million | Down 1.0% |
| Gross profit | $347.2 million | $358.0 million | Down 3.0% |
| Gross margin | 42.2% | 43.0% | Down 80 basis points |
| Operating income | $90.3 million | $103.0 million | Down 12.3% |
| Operating margin | 11.0% | 12.4% | Down 140 basis points |
| Net income attributable to MSC | $65.4 million | $74.2 million | Down 11.9% |
| Diluted EPS | $1.18 | $1.33 | Down $0.15 |
| Cash flow from operations | $85.1 million | $76.9 million | Up $8.2 million |
| Capital expenditures | $12.7 million | $10.1 million | Up $2.6 million |
Operating expenses increased 0.8% to $256.9 million, or 31.2% of sales versus 30.7% in the prior-year quarter. The effective tax rate was 25.0%, compared with 25.1%. Electronic and other eCommerce channels represented 60.7% of consolidated sales, compared with 60.1%.
At November 30, 2019, cash and cash equivalents were $27.8 million, working capital was $767.0 million, and the current ratio was 2.9. Total debt, including finance lease obligations, was $406.5 million and net debt was $378.7 million. The company had no borrowings under its $600 million committed revolving facility and reported $595.9 million of available capacity, net of outstanding letters of credit. It was in compliance with debt covenants.
Material Changes Versus the Prior Comparable Period
- Sales declined $8.0 million, reflecting $24.8 million of lower volume excluding MSC Mexico and a $0.5 million unfavorable foreign-exchange impact, partly offset by $10.0 million of MSC Mexico sales and $7.3 million of improved pricing and mix.
- Manufacturing customer sales declined 1.3%, while non-manufacturing customer sales declined 0.3%. Manufacturing represented approximately 70% of sales.
- Gross margin contracted primarily because of increased product costs and changes in customer and product mix; MSC Mexico reduced margin by approximately 20 basis points.
- Operating income declined $12.7 million due to lower sales and gross profit, higher operating expenses, increased depreciation and amortization, and approximately $2.6 million of severance and separation costs.
- Cash flow from operations improved despite lower earnings, primarily due to working-capital movements, including a $20.6 million inventory-related cash benefit.
- Net financing cash outflows decreased to $77.2 million from $101.3 million, primarily because share repurchases fell to $3.0 million from $63.5 million. Dividends paid increased to $41.5 million from $34.9 million.
- Effective September 1, 2019, the company adopted ASC 842 lease accounting, recording operating lease assets of $61.2 million and operating lease liabilities of $60.7 million. The income statement and cash-flow impact was immaterial.
Guidance, Outlook, Risks, Contingencies and Unusual Items
Management stated that existing cash, available credit facilities and operating cash flow are expected to fund planned capital expenditures and operating requirements for at least the next 12 months. The filing does not provide specific revenue or earnings guidance.
The Metalworking Business Index averaged 48.0 in fiscal first quarter 2020 and remained below 50.0 in September, October and November, indicating contraction in the metalworking manufacturing environment. Management reported a December reading of 48.2 and expects to continue monitoring customer activity and economic conditions.
In December 2019, the board declared a regular dividend of $0.75 per share and a special dividend of $5.00 per share, payable February 5, 2020. Expected payouts were approximately $41.5 million and $277.0 million, respectively, initially funded with cash and revolver borrowings. The company also paid a $2.3 million post-closing working-capital adjustment related to the February 2019 TAC acquisition, increasing goodwill.
Approximately 125 associates were affected by fiscal first-quarter severance and separation actions. The company accrued $2.6 million of related costs and had a remaining liability of $2.1 million at November 30, 2019.
Key risks include economic contraction, customer and product mix, competition and pricing, commodity and energy-price volatility, customer credit and order cancellations, supply-chain and information-system disruptions, tariffs and trade policies, acquisition integration, debt restrictions, LIBOR transition, litigation, regulatory compliance, goodwill impairment and shareholder control. The company stated that pending legal matters are not expected to materially affect financial position, results or liquidity.
Important Facts for Investors to Verify
- Assess whether manufacturing-market contraction and lower sales volume persist and whether MSC Mexico contributes profitable growth.
- Monitor gross-margin recovery, product costs, pricing, customer mix and the effect of Mexico operations.
- Evaluate operating-expense discipline, including severance, payroll, depreciation and technology-investment costs.
- Verify funding and leverage effects from the approximately $318.5 million of regular and special dividends declared after quarter-end.
- Review short-term debt of approximately $138.9 million, interest-rate exposure and compliance with the 3.00-to-1.00 leverage and 3.00-to-1.00 interest-coverage covenants.
- Track working-capital trends, particularly days sales outstanding of 59.6 and inventory turnover of 3.5.
- Consider the impact of ASC 842 lease liabilities and the pending adoption of expected-credit-loss accounting in fiscal 2021.