MSC Industrial Direct Co., Inc. — Fiscal 2013 Third-Quarter Form 10-Q
Reporting period: Thirteen and thirty-nine weeks ended June 1, 2013, compared with May 26, 2012. Fiscal 2013 is a 52-week year ending August 31, 2013. The filing is unaudited.
Business context
MSC distributes metalworking and maintenance, repair and operations products in the United States and Canada. Excluding the recently acquired Barnes Distribution North America business (BDNA), MSC offered approximately 600,000 catalog SKUs through five fulfillment centers and 105 branches. The company reported approximately 935,000 active saleable SKUs through e-commerce channels, excluding BDNA.
On April 22, 2013, MSC acquired substantially all assets and assumed certain liabilities of BDNA for $548.8 million. BDNA contributed $34.7 million of sales and $1.3 million of earnings during the thirteen and thirty-nine weeks ended June 1, 2013.
Financial performance
| Metric | Q3 FY2013 | Q3 FY2012 | 39 Weeks FY2013 | 39 Weeks FY2012 |
|---|---|---|---|---|
| Net sales | $636.9 million | $612.0 million | $1,783.9 million | $1,720.6 million |
| Gross profit | $289.5 million | $279.6 million | $811.0 million | $791.2 million |
| Gross margin | 45.5% | 45.7% | 45.5% | 46.0% |
| Operating income | $100.2 million | $110.9 million | $293.2 million | $304.2 million |
| Operating margin | 15.7% | 18.1% | 16.4% | 17.7% |
| Net income | $62.4 million | $70.2 million | $181.6 million | $190.1 million |
| Diluted EPS | $0.98 | $1.10 | $2.86 | $3.00 |
Q3 sales increased 4.1%, or 5.7% on an average daily sales basis. Year-to-date sales increased 3.7%, or 4.2% on an average daily sales basis. Net income declined 11.2% in Q3 and 4.5% year to date, while diluted EPS declined 10.9% and 4.7%, respectively.
The effective tax rate was 37.1% in Q3 and 37.8% year to date, compared with 36.7% and 37.5% in the prior-year periods. Cash dividends declared were $0.30 per share in Q3 and $0.90 per share year to date.
Cash flow, liquidity and debt
- Operating cash flow was $245.4 million for the first 39 weeks, compared with $145.2 million in the prior-year period.
- Capital expenditures were $62.3 million, compared with $28.8 million in the prior-year period.
- Cash used for the BDNA acquisition was $548.8 million; total investing cash outflow was $611.1 million.
- Cash and cash equivalents were $58.0 million at June 1, 2013, down from $168.5 million at September 1, 2012.
- Total borrowings, including capital leases and financing obligations, were approximately $292.9 million at June 1, 2013, compared with $3.2 million at September 1, 2012.
- The new unsecured credit facility totals $650.0 million and matures April 22, 2018, consisting of a $400.0 million revolving facility and a $250.0 million term loan facility. Borrowings outstanding under the facility were $290.0 million at June 1, 2013, including $49.4 million classified as current maturities.
- The applicable borrowing rate at June 1, 2013 was 1.19%. The facility requires a maximum total-debt-to-EBITDA ratio of 3.00 to 1.00 and a minimum EBITDA-to-interest ratio of 3.00 to 1.00. MSC was in compliance with its covenants.
- MSC repaid the remaining $40.0 million revolver balance on June 28, 2013, after the balance-sheet date.
- Working capital was $640.5 million at June 1, 2013, compared with $749.6 million at September 1, 2012. Management stated that operating cash flow, cash and available revolving capacity should fund operations and planned growth for at least the next twelve months.
Material changes versus the prior comparable period
- BDNA added sales and broadened MSC’s fastener, vendor-managed inventory and customer base, including exposure to Canada, transportation, mining, oil and gas and other end markets.
- Gross margin declined because of higher product costs, customer and product mix changes and temporarily lower vending-program margins, partly offset by higher BDNA margins.
- Operating expenses increased 12.2% in Q3 and 6.3% year to date, driven by BDNA costs, acquisition integration and transaction expenses, compensation, investment programs and the new Davidson, North Carolina headquarters.
- Operating income and margins declined despite higher sales. Q3 included approximately $5.5 million of BDNA integration and transaction costs; year-to-date costs were approximately $7.7 million.
- Manufacturing demand remained weak. Excluding BDNA, average daily sales for manufacturing customers declined 0.3% in Q3 and increased 2.3% year to date.
- Sales through e-commerce platforms, excluding BDNA, represented 43.5% of consolidated sales year to date, compared with 40.5% in the prior-year period.
Guidance, outlook, risks and unusual items
- Management expects operating costs to remain elevated through the remainder of fiscal 2013 due to BDNA operations and integration, compensation, headquarters costs and vending and other investment programs.
- BDNA-related transaction, integration and restructuring costs are estimated at $25.0 million to $30.0 million, with most expected in fiscal 2013 and 2014.
- Estimated associate relocation costs related to the Davidson headquarters are $7.0 million to $10.0 million, primarily in fiscal 2013 and 2014.
- MSC expects approximately $37.5 million of total investment in the Davidson facility and approximately $55.0 million for the Columbus, Ohio fulfillment center. Columbus operations are expected to begin in late 2014.
- The manufacturing-sector ISM index had recently stabilized near 50%; the filing cites a June 2013 reading of 50.9%. Government spending constraints also affected demand, with government accounts representing approximately 8.4% of year-to-date sales.
- Key risks include BDNA integration and synergy realization, economic weakness, customer and product mix, competition, commodity and energy-price volatility, customer credit risk, supplier and supply-chain disruptions, information-system dependence, key-person retention and facility delays.
- Goodwill increased to $632.8 million, including $343.9 million from BDNA. The purchase-price allocation remained preliminary, particularly for intangible assets, inventory and post-closing working-capital adjustments.
- Various legal claims and proceedings were pending, but management did not expect them to materially affect financial position, results of operations or liquidity. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether BDNA integration delivers expected revenue synergies, cost savings and margin benefits.
- The final BDNA purchase-price allocation and any resulting changes to goodwill, intangible assets, amortization or tax balances.
- Progress toward reducing acquisition-related leverage while funding planned headquarters, fulfillment-center and technology investments.
- Whether weak manufacturing demand and government spending constraints continue to suppress organic sales growth.
- The magnitude and timing of remaining BDNA integration, restructuring and employee-relocation costs.
- Compliance with the credit facility’s leverage and interest-coverage covenants after the June 28, 2013 revolver repayment.
- Future gross-margin performance, particularly the effects of product mix, pricing, vending programs and BDNA margins.