MSC Industrial Direct Co., Inc. — Fiscal 2019 Second-Quarter Form 10-Q
Reporting period: Thirteen and twenty-six weeks ended March 2, 2019, compared with the corresponding periods ended March 3, 2018. The company is a North American distributor of metalworking and maintenance, repair and operations products and services, operating in one reportable segment.
Financial results and key metrics
| Metric | 13 weeks ended Mar. 2, 2019 | 13 weeks ended Mar. 3, 2018 | 26 weeks ended Mar. 2, 2019 | 26 weeks ended Mar. 3, 2018 |
|---|---|---|---|---|
| Net sales | $823.0 million | $769.0 million | $1,654.6 million | $1,537.5 million |
| Gross profit | $351.8 million | $337.2 million | $709.8 million | $672.3 million |
| Gross margin | 42.7% | 43.9% | 42.9% | 43.7% |
| Income from operations | $96.0 million | $98.1 million | $199.0 million | $197.4 million |
| Operating margin | 11.7% | 12.8% | 12.0% | 12.8% |
| Net income attributable to MSC Industrial | $68.4 million | $117.6 million | $142.7 million | $177.1 million |
| Diluted EPS | $1.24 | $2.06 | $2.56 | $3.12 |
Cash flow and liquidity: Year-to-date operating cash flow was $98.6 million, down from $118.2 million. Capital expenditures were $23.2 million and cash used for the TAC acquisition was $11.6 million. Cash dividends paid were $69.6 million and share repurchases were $84.4 million. Cash ended at $31.2 million, compared with $46.2 million at fiscal year-end.
Debt and working capital: Total debt was $593.2 million, up $57.9 million from September 1, 2018; net debt was $562.1 million. Short-term debt was $308.6 million and long-term debt was $284.7 million. Working capital was $676.0 million, the current ratio was 2.2, days sales outstanding were 54.5, and inventory turnover was 3.6. Management stated that existing cash, available credit and operating cash flow should fund planned needs for at least the next 12 months.
Material changes versus the prior comparable periods
- Second-quarter sales increased 7.0%; year-to-date sales increased 7.6%. Management attributed the year-to-date increase to higher base-company volume of approximately $69.8 million, AIS sales of $34.7 million, MSC Mexico sales of $2.9 million, improved pricing and mix of $11.8 million, partially offset by $2.1 million of foreign exchange impact.
- Gross margin declined 120 basis points in the quarter and 80 basis points year to date, primarily due to higher product costs and customer and product mix. AIS reduced second-quarter and year-to-date margin by approximately 30 basis points; MSC Mexico reduced second-quarter margin by approximately 10 basis points.
- Operating expenses increased 7.0% in the quarter and 7.6% year to date, driven primarily by payroll-related costs, higher freight expense and acquired operations. Operating expenses remained 31.1% of sales in the quarter and 30.9% year to date.
- Operating income declined 2.2% in the quarter and increased only 0.8% year to date, reflecting gross-margin pressure. Interest expense increased to $4.5 million in the quarter and $8.6 million year to date.
- Net income declined substantially because the prior-year periods included a favorable tax adjustment related to the Tax Cuts and Jobs Act. The current-year effective tax rate was 25.1%, compared with a tax benefit rate of 23.9% in the quarter and a 7.1% rate year to date in the prior year.
- On February 1, 2019, MSC Mexico acquired certain TAC assets. MSC owns 75% of the entities. Total acquired assets were valued at $18.5 million, including $6.2 million of customer-related intangibles and $2.9 million of goodwill; MSC’s purchase consideration was approximately $13.9 million. Acquisition accounting remains preliminary.
Guidance, outlook, risks and unusual items
- Management expects a fiscal 2019 effective tax rate of approximately 25.0% to 25.5%.
- The manufacturing environment remained expansionary: the February 2019 Metalworking Business Index was 53.6, with a 12-month average of 56.7. Management plans to monitor economic conditions and customer demand.
- Management identified risks from economic conditions, customer and product mix, competition and pricing, commodity and energy-price volatility, tariffs and trade policy, customer credit and cancellations, supply-chain interruptions, business disruptions, cybersecurity and information systems, employee retention, acquisitions, litigation, environmental compliance, goodwill impairment, borrowing restrictions and shareholder control.
- The company was in compliance with its debt covenants at March 2, 2019. The committed credit facility had approximately $597 million of unused availability, reduced by outstanding letters of credit. Variable-rate borrowings expose the company to interest-rate risk.
- Legal claims and proceedings are ongoing, but management does not expect them to have a material adverse effect on financial position, results of operations or liquidity.
- The company adopted the new revenue-recognition standard effective September 2, 2018 with no impact on opening retained earnings. Lease accounting under ASC 842 is expected to significantly increase reported assets and liabilities upon adoption in fiscal 2020.
- The board declared a quarterly dividend of $0.63 per share payable April 23, 2019. Approximately 1.157 million shares remained authorized for repurchase at March 2, 2019.
Investor verification priorities
- Verify whether gross-margin compression from product costs, mix and AIS persists and affects operating leverage.
- Assess the sustainability and profitability of growth from AIS, MSC Mexico, pricing and higher base-company volume.
- Reconcile increased debt and reduced cash with share repurchases, dividends, acquisitions and working-capital investment.
- Monitor compliance with leverage and interest-coverage covenants, particularly as uncommitted borrowings are short term and interest rates are variable.
- Evaluate the preliminary purchase-price allocation for TAC, including the working-capital adjustment, goodwill and customer-related intangible valuation.
- Confirm the fiscal 2019 tax-rate outlook and distinguish recurring tax expense from the prior-year TCJA-related benefit.
- Assess the balance-sheet effect of adopting lease accounting in fiscal 2020 and the eventual impact of expected-credit-loss and goodwill-impairment standards.