MSC Industrial Direct Co., Inc. — Fiscal 2019 First-Quarter 10-Q
Business context and reporting period
MSC is a North American distributor of metalworking and maintenance, repair and operations products and services, offering approximately 1.666 million saleable SKUs through eCommerce, catalogs, inventory-management solutions, call centers, branches and 12 customer fulfillment centers. The filing covers the unaudited thirteen weeks ended December 1, 2018, compared with the thirteen weeks ended December 2, 2017. Fiscal 2019 is a 52-week year ending August 31, 2019.
Manufacturing represented approximately 71% of first-quarter revenue. The customer mix was 49% heavy manufacturing, 22% light manufacturing, 8% government, 5% retail/wholesale, 4% commercial services and 12% other. The United States generated 97% of sales.
Financial performance and key metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $831.6 million | $768.6 million | +8.2% |
| Gross profit | $358.0 million | $335.1 million | +6.8% |
| Gross margin | 43.0% | 43.6% | Down 60 bps |
| Operating expenses | $255.0 million | $235.8 million | +8.1% |
| Income from operations | $103.0 million | $99.3 million | +3.7% |
| Operating margin | 12.4% | 12.9% | Down 50 bps |
| Net income | $74.2 million | $59.6 million | +24.6% |
| Net margin | 8.9% | 7.8% | Up 110 bps |
| Diluted EPS | $1.33 | $1.05 | +26.7% |
| Cash dividends per share | $0.63 | $0.48 | +31.3% |
- Revenue growth comprised approximately $40.3 million of higher volume excluding AIS, $17.7 million from the AIS acquisition, $5.8 million from pricing and mix, partially offset by a $0.8 million foreign-exchange impact.
- eCommerce sales represented 60.1% of consolidated sales, compared with 59.8% in the prior-year quarter, excluding eCommerce sales from the DECO and AIS acquisitions.
- The effective tax rate declined to 25.1% from 37.8%, primarily due to the Tax Cuts and Jobs Act. Management reported an approximately $13.0 million tax benefit in the quarter.
- Cash flow from operations was $76.9 million, compared with $82.0 million. Capital expenditures were $10.1 million, and no cash was used for acquisitions during the quarter.
- Cash and cash equivalents were $11.6 million at December 1, 2018, compared with $46.2 million at September 1, 2018. Working capital was $654.8 million and the current ratio was 2.4.
- Total debt was $522.6 million, down from $535.3 million at fiscal year-end, while net debt increased to $511.0 million from $489.1 million because of the decline in cash. The company had approximately $597 million of unused committed credit-facility capacity, reduced by outstanding letters of credit.
- Days sales outstanding increased to 58.4 from 57.3 in the prior comparable period, while inventory turnover remained 3.6 times.
Material changes versus the prior comparable period
- Sales increased 8.2%, with manufacturing customer sales up 8.7% and non-manufacturing customer sales up 6.9% on an average-daily-sales basis.
- Gross margin contracted because of the lower-margin AIS business, higher product costs and changes in customer and product mix.
- Operating expenses increased primarily because of payroll, payroll-related costs, freight and AIS-related expenses. AIS operating expenses, including non-recurring acquisition and integration costs, were approximately $4.9 million.
- Operating income grew more slowly than sales, resulting in a 50-basis-point operating-margin decline.
- Net income and EPS benefited materially from the lower effective tax rate.
- Financing cash use increased to $101.3 million from $68.1 million, primarily because share repurchases rose to $63.5 million from $4.0 million and dividends increased to $34.9 million from $27.1 million.
- The company repurchased approximately 778,000 Class A shares for $63.5 million, including approximately 238,000 shares purchased from certain Class B shareholders. Approximately 1.43 million shares remained authorized for future repurchase at quarter-end.
Guidance, outlook, risks and unusual items
- Management expects the full-year fiscal 2019 effective tax rate to be approximately 25.0% to 25.5%.
- Management stated that existing cash, operating cash flow and available credit facilities should be sufficient to fund planned capital expenditures and operating requirements for at least the next 12 months.
- The Metalworking Business Index remained in expansion territory, but declined from 57.7 in October to 54.7 in November; the December reading was 53.4. Management noted slower growth in new orders and production.
- The company adopted the revenue-recognition standard in the quarter with no impact on opening retained earnings. The lease standard is expected to become effective in fiscal 2020 and is expected to significantly increase recognized assets and liabilities.
- Debt agreements impose, among other restrictions, a maximum total-debt-to-EBITDA ratio of 3.00 to 1.00, with a temporary 3.50 to 1.00 threshold after a material acquisition, and a minimum EBITDA-to-interest ratio of 3.00 to 1.00. The company was in compliance at December 1, 2018.
- Key risks include economic and manufacturing-cycle weakness, competition and pricing pressure, commodity and energy-price volatility, tariffs and trade-policy changes, customer credit and order cancellations, supply-chain disruptions, cyberattacks and information-system failures, personnel retention, acquisition integration, goodwill impairment, litigation, tax-rate volatility and restrictions associated with debt.
- Various claims and lawsuits are pending in the ordinary course of business. Management does not expect their ultimate resolution to materially affect financial position, results of operations or liquidity.
- After quarter-end, the company repurchased approximately 273,000 shares for $20.8 million from December 18, 2018 through January 3, 2019, and declared a $0.63-per-share quarterly dividend payable January 22, 2019.
Most important facts for investors to verify
- Whether sales growth remains healthy after separating organic volume, pricing and mix effects from AIS acquisition contributions.
- Whether gross-margin pressure from AIS, product costs and customer mix persists or reverses.
- Whether the lower tax rate and reported $13.0 million tax benefit are sustainable in subsequent quarters.
- Working-capital trends, particularly the increase in accounts receivable, DSO and inventory investment relative to operating cash flow.
- Share-repurchase and dividend spending relative to cash generation, cash balances and net debt.
- Compliance with debt covenants and the continued availability and cost of committed and uncommitted credit facilities.
- Indicators of manufacturing demand, including the Metalworking Business Index, customer order trends and the effects of tariffs or broader economic slowdown.
- The eventual balance-sheet impact of adopting the lease accounting standard in fiscal 2020.