MSC Industrial Direct Co., Inc. — Fiscal 2015 First-Quarter 10-Q Summary
Business context and reporting period
MSC Industrial Direct is a North American direct marketer and distributor of metalworking and maintenance, repair and operations products. The filing covers the 13 weeks ended November 29, 2014, compared with the 13 weeks ended November 30, 2013. The company offered approximately 880,000 searchable SKUs, operated 12 customer fulfillment centers and 102 branches, and employed 1,951 field sales associates at quarter-end.
Key financial metrics
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Net sales | $731.1 million | $678.5 million | +7.7% |
| Gross profit | $330.1 million | $314.9 million | +4.9% |
| Gross margin | 45.2% | 46.4% | Down 120 bps |
| Operating expenses | $236.2 million | $218.1 million | +8.3% |
| Operating income | $94.0 million | $96.8 million | Down 2.9% |
| Operating margin | 12.9% | 14.3% | Down 140 bps |
| Net income | $57.4 million | $59.0 million | Down 2.8% |
| Diluted EPS | $0.91 | $0.93 | Down $0.02 |
| Net cash from operations | $57.8 million | $104.4 million | Down $46.6 million |
| Capital expenditures | $13.4 million | $12.5 million | Up $0.9 million |
Sales growth reflected approximately $58.7 million of higher volume, partly offset by approximately $6.1 million from lower pricing, customer mix, product mix and related items. Large Account Customers contributed approximately $37.2 million of the sales increase. Electronic-channel sales were $398.7 million, or 54.5% of consolidated sales, compared with $345.4 million, or 50.9%, in the prior-year quarter.
The effective tax rate was 38.4%, compared with 38.3%. Comprehensive income was $53.5 million, including a $3.9 million unfavorable foreign-currency translation adjustment.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $46.7 million at November 29, 2014, compared with $47.2 million at August 30, 2014.
- Total borrowings, including the Credit Facility and capital leases or financing obligations, were approximately $495.6 million, compared with $337.1 million at the prior fiscal year-end.
- Credit Facility borrowings included $235.0 million outstanding under the revolving facility and approximately $231.3 million under the term loan. The company reported $165.0 million of available revolving capacity.
- The unsecured $650.0 million Credit Facility matures April 22, 2018. The company was in compliance with its financial covenants, including maximum leverage and minimum interest-coverage requirements.
- Working capital was $508.9 million and the current ratio was 2.0 at quarter-end, compared with $652.3 million and 3.1 at August 30, 2014.
- The company paid $208.8 million of dividends, consisting of a $184.2 million special dividend and $24.6 million of regular dividends. The special dividend was $3.00 per share, in addition to the regular $0.40 per-share dividend.
- The Board subsequently declared another regular quarterly dividend of $0.40 per share, expected to total approximately $24.7 million.
Material changes versus the prior comparable period
- Revenue increased 7.7%, but gross margin declined from 46.4% to 45.2% because of higher product costs, customer and product mix changes, and lower vending-program margins.
- Operating expenses increased faster than sales, driven primarily by payroll, freight and advertising costs. Approximately $2.7 million of executive separation costs was recorded in operating expenses.
- Operating income and net income declined despite revenue growth.
- Operating cash flow fell substantially, primarily because inventory increased by $44.8 million, compared with a small inventory-related source of cash in the prior-year quarter.
- Debt increased materially to fund working capital and shareholder distributions. The company borrowed $235.0 million under its revolving facility and repaid $76.3 million of Credit Facility borrowings during the quarter.
- Cash used in investing activities decreased to $13.4 million from $31.4 million because the prior-year period included a $20.4 million investment in available-for-sale securities.
- The new Columbus, Ohio customer fulfillment center began operations on September 30, 2014. Approximately $1.5 million was spent on the facility in fiscal 2015, following approximately $49.9 million in fiscal 2014.
Guidance, outlook, risks and unusual items
Management expects operating costs to remain higher throughout fiscal 2015 because of the Columbus facility, increased compensation and benefits, and continued investments in vending and other growth programs. Management believes cash from operations, existing cash and available revolving credit capacity will fund operations, planned capital expenditures and growth requirements for at least the next 12 months.
Management cited an expanding manufacturing environment, with the ISM index at 55.5% in December 2014 and averaging 55.8% over the preceding 12 months. It also plans to continue expanding the sales force, electronic product offerings and customer procurement solutions, while adjusting investment timing to economic conditions.
- Principal risks include economic and manufacturing-sector weakness, competition, changing customer and product mix, commodity and energy-price volatility, customer credit risk, order cancellations, supplier or supply-chain disruptions, extreme weather and other business interruptions.
- Additional risks include information-system failures, cyber-attacks, retention of key personnel, regulatory or litigation outcomes, environmental and safety compliance, and potential impairment of goodwill and acquired intangible assets.
- Various legal claims and proceedings are outstanding, but management does not expect them to have a material adverse effect on financial position, results of operations or liquidity.
- The company recorded approximately $2.7 million of executive separation costs and paid a substantial special dividend. These items materially affected period-over-period comparability and liquidity.
- The company had no off-balance-sheet arrangements and reported no material changes in market-risk exposures or internal controls over financial reporting.
Important facts for investors to verify
- Whether the lower gross margin persists, particularly in vending programs and during periods of limited commodity inflation.
- Whether sales growth and electronic-channel expansion generate sufficient operating leverage to offset higher payroll, freight, advertising and fulfillment-center costs.
- Inventory growth, working-capital requirements and the resulting dependence on revolving debt.
- Credit Facility utilization, covenant headroom, refinancing requirements and the scheduled current maturities of approximately $260.0 million.
- The sustainability of regular dividends after the $184.2 million special dividend and the impact of shareholder distributions on leverage and liquidity.
- Execution and productivity benefits from the Columbus fulfillment center, vending investments, sales-force expansion and SKU expansion.
- Potential effects of foreign-currency movements, manufacturing-sector conditions, customer concentration and government-account sales, which represented approximately 9% of sales.