Business Context and Reporting Period
MSC Industrial Direct Co., Inc. is a North American direct marketer and distributor of metalworking and maintenance, repair and operations products. This Form 10-Q covers the thirteen weeks ended November 30, 2013, compared with the thirteen weeks ended December 1, 2012. Results include the acquired Barnes Distribution North America (BDNA) business from April 22, 2013.
MSC offered approximately 725,000 web-orderable SKUs excluding BDNA and operated 14 customer fulfillment centers and 104 branch offices. BDNA contributed $72.4 million of first-quarter net sales.
Key Financial Metrics
| Metric | Q1 Fiscal 2014 | Comparable Period | Change |
|---|---|---|---|
| Net sales | $678.5 million | $577.5 million | 17.5% increase |
| Gross profit | $314.9 million | $265.1 million | 18.8% increase |
| Gross margin | 46.4% | 45.9% | 50 basis-point increase |
| Operating expenses | $218.1 million | $162.7 million | 34.0% increase |
| Operating income | $96.8 million | $102.4 million | 5.5% decrease |
| Operating margin | 14.3% | 17.7% | 340 basis-point decrease |
| Net income | $59.0 million | $63.2 million | 6.6% decrease |
| Diluted EPS | $0.93 | $1.00 | 7.0% decrease |
| Cash flow from operations | $104.4 million | $89.4 million | Increase |
The effective tax rate was 38.30%, compared with 38.25%. The quarterly cash dividend was $0.33 per share, compared with $0.30 in the prior-year period.
Balance Sheet, Debt and Liquidity
- Cash and cash equivalents were $48.4 million at November 30, 2013, compared with $55.9 million at August 31, 2013.
- Total borrowings, including credit-facility debt and capital leases, were approximately $322.0 million, compared with approximately $255.8 million at August 31, 2013.
- Debt included $246.9 million outstanding under the term loan and $50.0 million under the revolving facility. The revolving facility had $350.0 million available.
- The unsecured $650.0 million credit facility matures April 22, 2018 and requires a maximum consolidated leverage ratio of 3.00 to 1.00 and minimum interest coverage of 3.00 to 1.00. The company was in compliance with its covenants.
- Working capital was $591.7 million, and the current ratio was 3.0 at November 30, 2013. Management stated that cash, operating cash flow and available revolver capacity should fund operations and planned growth for at least the next twelve months.
Cash Uses and Capital Allocation
- Cash used in investing activities was $31.4 million, including $12.5 million of capital expenditures and $20.4 million invested in available-for-sale securities related to the Columbus, Ohio fulfillment center.
- Cash used in financing activities was $80.5 million, including $115.0 million for repurchases of approximately 1.5 million Class A shares, $20.9 million of dividends and $50.0 million of revolver borrowings.
- Approximately 2.9 million shares remained available for repurchase under the company’s authorization at November 30, 2013.
- The company expected to invest approximately $55.0 million in the Columbus fulfillment center and expected construction to be completed and operations to begin in late 2014.
Material Changes Versus the Prior Comparable Period
- Sales growth was primarily acquisition-driven: BDNA contributed $72.4 million of the $101.0 million increase. The remaining increase reflected approximately $27.6 million of volume growth and $1.0 million of improved price realization.
- Gross margin improved because of BDNA’s higher margins, partly offset by higher product costs, customer and product mix changes, and lower vending-program margins.
- Operating expenses increased substantially because of BDNA, integration costs, expanded staffing and investment programs. BDNA operating expenses were approximately $35.7 million, and integration costs were approximately $3.8 million.
- Operating income and net income declined despite higher sales and gross profit because expense growth exceeded gross-profit growth.
- Operating cash flow increased by $15.0 million, primarily due to increased accounts payable and accrued liabilities, lower inventories and lower prepaid expenses, partly offset by higher accounts receivable.
- Debt increased following the BDNA acquisition and the addition of revolver borrowings, while cash declined by $7.4 million during the quarter.
- Electronic-channel sales excluding BDNA increased to $279.0 million, or 46.0% of consolidated sales, from $246.9 million, or 42.8%.
Guidance, Outlook, Risks and Unusual Items
- Management expected operating costs to remain elevated during fiscal 2014 because of a full year of BDNA operations, integration and restructuring charges, higher compensation, vending and other investment programs, the Davidson headquarters and the Columbus fulfillment center.
- Additional BDNA-related integration costs and restructuring charges were estimated at approximately $10.0 million to $15.0 million for the remainder of fiscal 2014. The quarter included approximately $3.8 million of such costs, and the accrued restructuring balance was $4.3 million at November 30, 2013.
- Management cited an expanding overall U.S. manufacturing environment, with a December 2013 ISM index reading of 57.0%, but noted continued contraction in the core metalworking sector and uncertainty regarding customer spending. Government-account sales were approximately 8% of sales, down from 9%.
- Principal risks include integration of BDNA and realization of expected synergies, economic and manufacturing conditions, customer and product mix, competition, commodity and energy prices, customer credit, order cancellations, supply-chain and business interruptions, borrowing restrictions, information-system dependence, regulatory or litigation outcomes, and potential impairment of goodwill and intangible assets.
- Legal claims and proceedings were described as incidental to operations; management did not expect them to have a material adverse effect on financial position, results of operations or liquidity.
- The company disclosed a related-party lease with an entity owned by principal shareholders and their related trusts. First-quarter rent was approximately $0.6 million, and management stated that the terms approximated fair market value.
- The company had no off-balance-sheet arrangements and reported effective disclosure controls with no material change in internal control over financial reporting.
Investor Verification Checklist
- Verify the sustainability of sales growth after separating BDNA’s acquisition contribution from organic volume and pricing growth.
- Track whether BDNA integration, restructuring and investment costs moderate as planned and whether expected synergies are realized.
- Monitor operating margin recovery, particularly against continued growth in payroll, vending, technology, headquarters and fulfillment-center costs.
- Review leverage, covenant compliance, revolver usage and the effect of share repurchases and dividends on liquidity.
- Assess progress, timing and total cost of the Columbus fulfillment center and related capital-lease obligations.
- Evaluate exposure to manufacturing and government spending trends, customer credit risk, supply-chain disruptions and potential goodwill or intangible-asset impairment.