MSC Industrial Direct Co., Inc. — Fiscal 2016 Second-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. The filing covers the 13 and 26 weeks ended February 27, 2016, compared with the corresponding periods ended February 28, 2015. Fiscal 2016 is a 53-week year ending September 3, 2016.
The company offered approximately 1.075 million SKUs through 12 fulfillment centers and 95 branches and employed more than 6,500 associates. Approximately 69% of year-to-date revenue came from manufacturing customers. Management characterized the manufacturing environment as contracting, although March indicators showed improving conditions.
Financial Performance and Liquidity
| Metric | Q2 FY2016 | Q2 FY2015 | Change |
|---|---|---|---|
| Net sales | $684.1 million | $706.4 million | Down 3.2% |
| Gross profit | $308.8 million | $320.9 million | Down 3.8% |
| Gross margin | 45.1% | 45.4% | Down 30 bps |
| Operating income | $80.5 million | $85.9 million | Down 6.2% |
| Operating margin | 11.8% | 12.2% | Down 40 bps |
| Net income | $49.5 million | $51.5 million | Down 3.9% |
| Diluted EPS | $0.80 | $0.83 | Down $0.03 |
For the first 26 weeks, sales were $1.391 billion, down 3.2%; gross margin was 45.1% versus 45.3%; operating income was $170.9 million, down 5.0%; and net income was $104.6 million, down 4.0%. Diluted EPS was $1.70 versus $1.75.
- Year-to-date operating cash flow was $183.0 million versus $47.6 million, primarily reflecting lower accounts receivable and inventory associated with lower sales volume.
- Capital expenditures were $26.8 million versus $25.1 million.
- Cash declined to $24.0 million from $38.3 million at August 29, 2015, after $170.4 million of financing cash outflows, including debt repayments, dividends and share repurchases.
- Total debt was $328.0 million versus $428.3 million at fiscal year-end. The company had $99.0 million outstanding on its revolving facility and $200.0 million outstanding under the term loan.
- The $650.0 million credit facility matures in April 2018. The applicable borrowing rate was 1.43%, and the company remained in compliance with its covenants. The unused revolving capacity was $346.0 million at February 27, 2016.
- Working capital was $639.0 million and the current ratio was 2.9, compared with $609.7 million and 2.4 at August 29, 2015.
- Regular dividends paid year to date totaled $52.9 million, or $0.86 per share. A quarterly dividend of $0.43 per share was declared on March 31, 2016. The company repurchased $19.2 million of Class A stock year to date.
Material Changes Versus the Prior Comparable Period
- Q2 revenue declined $22.3 million, attributed by management to approximately $18.5 million of lower volume, $1.9 million of foreign-exchange impact and $1.9 million of pricing and mix effects.
- For the first 26 weeks, revenue declined $46.6 million, consisting of approximately $43.0 million of lower volume and $4.1 million of foreign-exchange impact, partially offset by $0.5 million of pricing.
- Manufacturing average daily sales declined 5.6% in Q2 and 5.2% year to date, while non-manufacturing sales increased 2.6% and 1.9%, respectively.
- Large Account Customer sales increased approximately $3.4 million in Q2 and $9.4 million year to date, while the remaining business declined.
- Cost-saving initiatives reduced operating expenses, including freight, but higher medical costs and incentive compensation partially offset those savings.
- eCommerce-platform sales increased to 57.8% of Q2 revenue from 55.4%, and to 57.4% year to date from 54.9%.
- The prior-year first-half dividend included a $185.4 million special dividend; no special dividend was paid in fiscal 2016.
Outlook, Risks, Contingencies and Unusual Items
Management stated that existing cash, cash flow from operations and available revolving capacity should fund planned capital expenditures and operating requirements for at least the next 12 months. The filing does not provide formal earnings or revenue guidance.
Management expects to continue cost reductions and invest in customer inventory-management, vending, technology and productivity solutions. March 2016 manufacturing indicators improved, but the company continued to monitor economic conditions and their effect on customers and markets.
- Principal risks include economic weakness, manufacturing contraction, competition, customer and product mix, commodity and energy-price volatility, customer credit risk, order cancellations, supplier or supply-chain disruptions, information-system failures and cyberattacks.
- Additional risks include employee retention, regulatory and environmental compliance, litigation, goodwill or intangible-asset impairment, integration of acquired businesses and reputational risks related to conflict-minerals disclosures.
- Various legal claims and proceedings are pending; management does not expect them to have a material adverse effect, although outcomes are not currently determinable.
- The company had no off-balance-sheet arrangements and reported no material changes in market-risk exposures.
- Recently issued accounting standards relating to leases, revenue recognition, share-based payments, inventory, deferred taxes and debt issuance costs were under evaluation; management did not expect the identified standards to have a material impact where stated.
Investor Verification Points
- Verify whether manufacturing demand and PMI/MBI trends improved sustainably after the quarter.
- Track revenue volume, pricing and mix, particularly the divergence between manufacturing and non-manufacturing customers.
- Assess whether gross-margin pressure and higher medical and incentive costs persist.
- Monitor debt repayments, the April 2018 credit-facility maturity and compliance with leverage and interest-coverage covenants.
- Reconcile strong operating cash flow with lower cash balances after dividends, repurchases and debt reduction.
- Review the sustainability of dividends and share repurchases relative to cash generation and capital needs.
- Confirm the effect and timing of new accounting standards, especially lease and revenue-recognition requirements.