MSC Industrial Direct Co., Inc. — Fiscal 2018 Second-Quarter Form 10-Q
Reporting period: Thirteen and twenty-six weeks ended March 3, 2018, compared with the corresponding periods ended March 4, 2017. Fiscal 2018 ends September 1, 2018. The filing was signed April 10, 2018.
Business Context and Reporting Period
MSC is a North American distributor of metalworking and maintenance, repair and operations products, offering approximately 1.6 million SKUs through e-commerce, catalogs, inventory-management solutions, call centers and branches. The company operated 12 customer fulfillment centers and 93 branches at quarter-end. Approximately 68% of fiscal second-quarter revenue came from manufacturing customers.
The July 2017 acquisition of DECO contributed materially to reported growth but reduced consolidated gross margin. The company continued investing in e-commerce, vending and supply-chain solutions; e-commerce platforms represented 60.3% of second-quarter sales, compared with 59.8% in the prior-year quarter.
Financial Highlights
| Metric | 13 Weeks Ended March 3, 2018 | 13 Weeks Ended March 4, 2017 | Change |
|---|---|---|---|
| Net sales | $769.0 million | $703.8 million | Up 9.3% |
| Gross profit | $337.2 million | $314.6 million | Up 7.2% |
| Gross margin | 43.9% | 44.7% | Down 80 bps |
| Operating expenses | $239.1 million | $227.9 million | Up 4.9% |
| Operating margin | 12.8% | 12.3% | Up 50 bps |
| Net income | $117.6 million | $53.6 million | Up 119.5% |
| Diluted EPS | $2.06 | $0.93 | Up $1.13 |
| Metric | 26 Weeks Ended March 3, 2018 | 26 Weeks Ended March 4, 2017 | Change |
|---|---|---|---|
| Net sales | $1.538 billion | $1.390 billion | Up 10.6% |
| Gross profit | $672.3 million | $623.3 million | Up 7.9% |
| Gross margin | 43.7% | 44.8% | Down 110 bps |
| Operating expenses | $474.9 million | $446.1 million | Up 6.5% |
| Operating margin | 12.8% | 12.8% | Flat |
| Net income | $177.1 million | $107.8 million | Up 64.2% |
| Diluted EPS | $3.12 | $1.89 | Up $1.23 |
Cash flow and balance sheet: Operating cash flow for the first 26 weeks was $118.2 million, compared with $96.7 million in the prior-year period. Capital expenditures and acquisition spending totaled $18.0 million, while financing activities used $84.8 million. Cash increased to $31.6 million from $16.1 million at September 2, 2017.
At March 3, 2018, total debt was $511.2 million, net debt was $479.6 million, and shareholders’ equity was $1.346 billion. Working capital was $593.5 million and the current ratio was 2.2. The company reported $260.0 million outstanding under its revolving credit facility and $50.0 million of newly issued 3.04% senior notes.
Cash dividends were $0.58 per share in the second quarter and $1.06 per share for the first 26 weeks, compared with $0.45 and $0.90, respectively, in the prior-year periods. The company repurchased $21.7 million of stock during the first 26 weeks and had authorization remaining for approximately 2.6 million shares at quarter-end.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected higher underlying volume, the DECO acquisition, foreign exchange and modest pricing. For the quarter, management estimated contributions of $30.9 million from higher volume excluding DECO, $29.9 million from DECO, $1.8 million from foreign exchange and $2.6 million from pricing and mix.
- For the first 26 weeks, management estimated sales contributions of $84.6 million from higher volume excluding DECO, $59.6 million from DECO, $3.0 million from foreign exchange and $0.3 million from pricing and mix.
- DECO reduced gross margin by approximately 80 basis points in the quarter and 90 basis points year to date. DECO operating expenses, including non-recurring integration costs, were approximately $6.3 million in the quarter and $12.2 million year to date.
- Operating expense leverage improved the quarterly operating margin despite lower gross margin. Operating expenses declined to 31.1% of sales from 32.4%; year-to-date operating expenses declined to 30.9% of sales from 32.1%.
- Net income benefited substantially from the Tax Cuts and Jobs Act. The company recorded a provisional $41.2 million net tax benefit from revaluing deferred tax liabilities and a $16.9 million reduction in tax expense from applying the lower blended tax rate.
- Total debt declined $21.7 million from September 2, 2017, while the debt mix shifted toward long-term debt following the January 2018 issuance of $50.0 million of senior notes.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management stated that existing cash, operating cash flow and available credit were expected to fund planned capital expenditures and operating requirements for at least the next 12 months. Through March 26, 2018, the company had made an additional $20.0 million of net debt payments, leaving approximately $356.9 million available under the $600.0 million revolving credit facility, subject to outstanding letters of credit.
Management described the manufacturing environment as expanding: the Metalworking Business Index averaged 58.9 in fiscal second quarter, reached 61.3 in February and had a trailing 12-month average of 56.7. The March reading was 59.5. Management expected days sales outstanding to improve slightly through the remainder of fiscal 2018.
The company was in compliance with its debt covenants, including a maximum consolidated leverage ratio of 3.00 to 1.00 and minimum interest coverage ratio of 3.00 to 1.00. Long-term debt maturities, net of interest, totaled $485.0 million, including $260.0 million due in less than one year.
The principal unusual item was the provisional tax benefit associated with the Tax Cuts and Jobs Act; the amount remained subject to further interpretation, legislative action and updates to estimates. The filing also identifies acquisition integration costs, lower DECO margins and stock repurchases as notable items.
Key risks include economic conditions, customer and product mix, competitive pricing, commodity and energy price volatility, customer credit risk, order cancellations, supply-chain disruption, extreme weather and other business interruptions, information-system failures and cyberattacks, key-personnel retention, trade-policy changes, regulatory compliance, goodwill or intangible-asset impairment, acquisition integration and restrictions under debt agreements. Various legal proceedings were pending, but management did not expect a material adverse effect on financial position, results or liquidity.
Important Facts for Investors to Verify
- Determine the normalized effective tax rate and earnings excluding the $41.2 million provisional deferred-tax benefit and the $16.9 million tax-rate benefit.
- Assess whether DECO can improve toward MSC’s historical gross-margin profile and whether integration costs have ended.
- Review sales growth excluding DECO, foreign exchange and pricing to evaluate underlying demand.
- Monitor gross-margin trends, customer and product mix, freight and payroll costs, and the sustainability of operating expense leverage.
- Verify debt maturities, interest-rate exposure, covenant headroom and the availability of the revolving credit facility.
- Track working-capital needs, particularly accounts receivable, inventory, days sales outstanding and inventory turnover.
- Evaluate capital allocation among dividends, share repurchases, acquisitions and capital expenditures.
- Review subsequent filings for changes to provisional Tax Reform Act accounting, legal contingencies and acquisition-related commitments.