MSC Industrial Direct Co., Inc. — Fiscal 2016 Third-Quarter Form 10-Q
Business context and reporting period
MSC is a North American distributor of metalworking and maintenance, repair and operations products and services, serving manufacturing and non-manufacturing customers through approximately 1.14 million SKUs, 12 customer fulfillment centers, 94 branches and electronic ordering platforms. The filing covers the 13 weeks and 39 weeks ended May 28, 2016. Fiscal 2016 is a 53-week year ending September 3, 2016; prior-year comparisons are for the periods ended May 30, 2015.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 39 weeks 2016 | 39 weeks 2015 |
|---|---|---|---|---|
| Net sales | $727.5 million | $745.5 million | $2.118 billion | $2.183 billion |
| Gross profit | $327.0 million | $338.4 million | $954.8 million | $989.4 million |
| Gross margin | 45.0% | 45.4% | 45.1% | 45.3% |
| Operating income | $105.8 million | $104.2 million | $276.7 million | $284.1 million |
| Operating margin | 14.5% | 14.0% | 13.1% | 13.0% |
| Net income | $64.8 million | $63.3 million | $169.4 million | $172.3 million |
| Diluted EPS | $1.05 | $1.03 | $2.75 | $2.78 |
| Effective tax rate | 38.2% | 38.3% | 38.2% | 38.4% |
Q3 operating expenses were $221.2 million, or 30.4% of sales, versus $234.2 million, or 31.4%, in the prior-year quarter. Year-to-date operating expenses were $678.1 million, or 32.0% of sales. The filing does not present a separate EBITDA figure.
Cash flow, balance sheet and liquidity
- Year-to-date operating cash flow was $285.8 million, compared with $163.0 million in the prior-year period, driven principally by reductions in inventory and accounts receivable.
- Capital expenditures were $34.7 million, compared with $38.2 million. Financing cash outflow was $257.0 million, including $254.8 million of Credit Facility repayments, $79.4 million of regular dividends and $19.4 million of treasury-stock purchases.
- Cash and cash equivalents were $32.3 million at May 28, 2016, versus $38.3 million at August 29, 2015.
- Working capital was $680.4 million and the current ratio was 3.3, compared with $609.7 million and 2.4, respectively, at August 29, 2015.
- Total debt, including capital leases and financing obligations, was $262.5 million, down from $428.3 million at August 29, 2015. This included $193.8 million of term debt, $40.0 million drawn on the revolving facility and $28.8 million of capital lease and financing obligations.
- The unsecured Credit Facility matures in April 2018 and has $400.0 million of revolving capacity. Management stated that the currently unused revolving capacity was available for working capital. The company was in compliance with its debt covenants at May 28, 2016.
- Management believes cash, operating cash flow and available revolver capacity will fund planned capital expenditures and operating requirements for at least the next 12 months.
Material changes versus the prior comparable period
- Q3 sales declined 2.4%, while 39-week sales declined 3.0%. Management attributed the 39-week decline to approximately $54.3 million of lower volume, $5.2 million of foreign-exchange impact and $5.0 million of pricing and mix effects.
- Manufacturing customer average daily sales declined 6.8% in Q3 and 5.7% year to date; non-manufacturing customer sales increased 2.6% and 1.4%, respectively. Large Account Customer sales increased approximately $1.9 million in Q3 and $11.8 million year to date.
- Gross margin narrowed 40 basis points in Q3 and 20 basis points year to date, primarily from pricing and customer and product mix.
- Cost controls, including lower payroll-related costs, freight expense and discretionary spending, reduced operating expenses and increased Q3 operating margin by 50 basis points. Year-to-date operating margin increased 10 basis points despite lower operating income.
- eCommerce platforms increased to 58.6% of Q3 sales from 56.0% and to 57.8% year to date from 55.3%.
- The company repaid substantially more debt in fiscal 2016, while the prior-year period included a $185.4 million special dividend. Fiscal 2016 regular dividends totaled $79.4 million through May 28, 2016, versus $74.1 million of regular dividends plus the prior-year special dividend.
Outlook, commentary, risks and unusual items
- Management reported a weak manufacturing environment: the Metalworking Business Index averaged 47.0 in Q3 and 45.1 year to date, with contraction reported for 14 consecutive months. Management plans to continue cost reduction and investments in customer inventory, vending and technology solutions.
- On June 23, 2016, the board declared a $0.43 quarterly dividend payable July 26, 2016, estimated at approximately $26.4 million.
- On July 6, 2016, the company announced a proposed modified Dutch-auction tender offer of up to $300.0 million at $66.00 to $72.50 per share. It also agreed to purchase a pro rata number of Class B shares to preserve the Class B holders’ ownership and voting power. The proposed purchases were expected to be financed with $175.0 million of unsecured senior notes and Credit Facility borrowings, subject to successful note issuance and other conditions.
- The proposed transaction could increase leverage and interest expense, reduce liquidity and borrowing flexibility, limit future acquisitions or repurchases, and reduce public float and trading liquidity.
- On July 1, 2016, a subsidiary agreed to purchase the Atlanta fulfillment center and related real property from an entity owned by company directors and family-related parties for $33.65 million. Closing was expected in August 2016; the price was based on an independent appraisal and the transaction was approved by a special committee of independent directors. The company expected accelerated depreciation, partly offset by release of deferred rent, during the remainder of fiscal 2016.
- Risks include economic and manufacturing contraction, competition, customer credit and order cancellation, supplier and supply-chain disruption, information-system failures and cyberattacks, key-person dependence, litigation and regulatory matters, environmental compliance, goodwill impairment and acquisition integration. Management did not expect existing legal proceedings to have a material adverse effect.
- Management stated that disclosure controls were effective and that no material change occurred in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether manufacturing demand and the Metalworking Business Index improve or continue to pressure volume and mix.
- The completion, financing, final terms and leverage impact of the proposed $300.0 million tender offer and related Class B share purchase.
- Actual debt balances, covenant compliance and available revolver capacity after the proposed share repurchases and senior-note issuance.
- Closing and accounting consequences of the $33.65 million related-party Atlanta fulfillment-center purchase.
- Whether cost reductions and eCommerce growth can offset sales volume declines and gross-margin pressure.
- The sustainability of operating cash flow, particularly as inventory and receivables normalize and capital expenditures continue.