MSC Industrial Direct Co., Inc. — Fiscal 2014 Form 10-K Summary
Business context and reporting period
MSC is a North American distributor and direct marketer of metalworking and maintenance, repair and operations products. The fiscal year ended August 30, 2014 and comprised 52 weeks; the comparable fiscal 2013 period also comprised 52 weeks, while fiscal 2012 comprised 53 weeks. The company operated 12 customer fulfillment centers and 103 branches, served approximately 364,000 active customers, and offered approximately 850,000 stock-keeping units.
Fiscal 2014 includes a full year of the Class C Solutions Group acquisition, completed April 22, 2013 for approximately $547.3 million. CCSG contributed $292.2 million of fiscal 2014 sales versus $108.4 million in fiscal 2013.
Financial performance and liquidity
| Metric | Fiscal 2014 | Fiscal 2013 | Change |
|---|---|---|---|
| Net sales | $2.787 billion | $2.458 billion | 13.4% |
| Gross profit | $1.286 billion | $1.119 billion | 15.0% |
| Gross margin | 46.1% | 45.5% | Up 60 basis points |
| Operating income | $383.2 million | $385.5 million | Down 0.6% |
| Operating margin | 13.7% | 15.7% | Down 200 basis points |
| Net income | $236.1 million | $238.0 million | Down 0.8% |
| Diluted EPS | $3.76 | $3.75 | Up 0.3% |
| Operating cash flow | $272.4 million | $325.4 million | Down $53.0 million |
Fiscal 2014 sales growth consisted primarily of approximately $183.8 million from the incremental CCSG contribution, $128.7 million from higher sales volume, and $17.0 million from improved pricing, partly offset by customer and product mix, discounting and other items. Average daily sales increased 7.8% in fiscal fourth quarter 2014 versus the comparable quarter. Fiscal fourth-quarter net sales were $726.6 million, gross profit was $331.2 million, operating income was $99.8 million, and net income was $62.8 million.
Cash and cash equivalents were $47.2 million at August 30, 2014. Working capital was $652.3 million, compared with $679.9 million at the prior year-end, and the current ratio declined to 3.1 from 4.2. Net cash used in investing activities was $94.2 million, including $70.6 million of capital expenditures. Net cash used in financing activities was $187.0 million, reflecting $191.4 million of share repurchases, $82.6 million of dividends, debt repayments of $77.5 million, and $135.0 million of new borrowings.
Total borrowings, including capital leases and financing obligations, were approximately $337.1 million at year-end. Credit Facility borrowings were $307.5 million, consisting of $237.5 million under the term loan and $70.0 million under the revolving facility; $95.0 million represented current maturities. The unsecured $650.0 million facility matures April 22, 2018, bears variable interest, and includes maximum leverage and minimum interest coverage covenants of 3.00-to-1.00. The company was in compliance with its covenants at year-end.
Material changes versus the prior comparable period
- Sales growth accelerated, supported by the full-year inclusion of CCSG, higher volume, improved manufacturing demand, and continued growth in large-account programs.
- Gross margin improved because CCSG generated higher margins, although product-cost increases, customer and product mix, and vending-program growth were offsets.
- Operating expenses increased 23.2% to $903.1 million, or 32.4% of sales versus 29.8%. The increase included CCSG expenses, approximately $11.8 million of CCSG integration and restructuring costs, and approximately $3.0 million of executive separation costs.
- Operating income and net income declined despite higher revenue because expense growth exceeded gross-profit growth.
- Field sales representatives increased to 1,923 from 1,790. eCommerce-related sales, excluding CCSG, increased to $1.198 billion, or 48.0% of consolidated sales, from $1.035 billion, or 44.0%.
- The company repurchased approximately 2.4 million Class A shares for $191.4 million, compared with approximately $3.8 million of repurchases in fiscal 2013.
- Construction of the Columbus, Ohio fulfillment center required approximately $49.9 million in fiscal 2014; operations began September 30, 2014.
Outlook, commentary, risks and unusual items
Management stated that manufacturing conditions improved during fiscal 2014 and continued into fiscal 2015. The September 2014 ISM manufacturing index was 56.6%, and management expected continued investment in sales-force expansion, vending, technology, infrastructure and the new Columbus facility.
Management expected fiscal 2015 operating costs to increase because of the Columbus facility, higher compensation and benefits, additional field sales personnel, and vending and other growth initiatives. Management believed cash flow from operations, available cash and revolving-credit availability would fund operations and planned growth for at least the next 12 months. No quantitative revenue or earnings guidance was provided in the filing.
- Key operating risks include cyclical manufacturing demand, customer credit losses, order cancellations, competitive pricing pressure, vendor cost increases, commodity and energy-price volatility, and potential gross-margin pressure from large accounts and vending.
- Execution risks include integrating acquisitions, opening or expanding fulfillment centers, maintaining same-day shipping, supply-chain and transportation disruptions, severe weather, and information-system failures or cyberattacks.
- The company had approximately $644.3 million of goodwill and indefinite-life intangible assets and reported no impairment based on its fiscal 2014 qualitative assessment.
- Various claims and lawsuits were pending, but management did not expect them to materially affect consolidated financial position, results of operations or liquidity.
- The company leases its Atlanta fulfillment center from an entity affiliated with principal shareholders and paid approximately $2.3 million of rent in fiscal 2014.
- On October 27, 2014, after year-end, the board approved a $3.00 special dividend in addition to a $0.40 regular quarterly dividend, totaling $3.40 per share and approximately $209.4 million.
- The company is controlled by holders of Class B shares, who possessed approximately 73.8% of combined voting power as of October 17, 2014.
Most important facts for investors to verify
- Whether revenue growth remains organic after the full-year CCSG comparison and whether manufacturing demand continues to support volume.
- Whether operating-expense growth moderates sufficiently to restore operating margins toward pre-acquisition levels.
- Progress, utilization and incremental costs associated with the Columbus fulfillment center and continued field-sales and vending investments.
- Debt amortization requirements, variable-rate exposure, covenant compliance and availability under the revolving facility.
- Working-capital trends, particularly accounts receivable and inventory growth relative to sales and operating cash flow.
- The cash-flow impact of the $209.4 million special and regular dividend, ongoing share repurchases and future capital expenditures.
- Retention of CCSG customers and employees, realization of integration benefits, and the risk of goodwill or intangible-asset impairment.
- Potential margin effects from large-account pricing, product mix, vendor costs and competitive pressure.