MSC Industrial Direct Co., Inc. — Fiscal 2012 Second-Quarter 10-Q
Reporting period: Thirteen and twenty-six weeks ended February 25, 2012, compared with February 26, 2011. Fiscal 2012 is a 53-week year ending September 1, 2012. MSC distributes approximately 600,000 metalworking and MRO products through five fulfillment centers, 108 branches, sales representatives, catalogs, and e-commerce channels.
Key Financial Metrics
| Metric | Q2 FY2012 | Q2 FY2011 | Change |
|---|
| Net sales | $563.0 million | $483.4 million | 16.5% |
| Gross profit | $259.5 million | $226.3 million | 14.7% |
| Gross margin | 46.1% | 46.8% | Down 70 bps |
| Operating income | $96.5 million | $80.6 million | 19.8% |
| Operating margin | 17.1% | 16.7% | Up 40 bps |
| Net income | $60.1 million | $49.7 million | 20.9% |
| Diluted EPS | $0.95 | $0.78 | 21.8% |
| Metric | 26 Weeks FY2012 | 26 Weeks FY2011 | Change |
|---|
| Net sales | $1.109 billion | $956.2 million | 15.9% |
| Operating income | $193.4 million | $157.7 million | 22.6% |
| Operating margin | 17.4% | 16.5% | Up 90 bps |
| Net income | $119.9 million | $97.2 million | 23.3% |
| Diluted EPS | $1.89 | $1.53 | 23.5% |
| Operating cash flow | $74.1 million | $80.3 million | Down $6.2 million |
Balance Sheet, Cash Flow, Debt, and Liquidity
- Cash and cash equivalents were $108.9 million at February 25, 2012, compared with $96.0 million at August 27, 2011.
- Working capital was $676.6 million, versus $586.2 million at the prior fiscal year-end. The current ratio increased to 5.2 from 4.4.
- Accounts receivable increased to $292.0 million and inventories increased to $377.9 million, reflecting higher sales and inventory investment to support service levels, supplier rebates, and anticipated cost increases.
- Operating cash flow was $74.1 million. Investing cash outflows were $49.7 million, including $32.4 million for acquisitions and $17.3 million for capital expenditures. Financing cash outflows were $11.4 million, including $31.5 million of dividends.
- Total borrowings were approximately $4.2 million, consisting of capital lease and financing obligations. No borrowings were outstanding under the $200 million unsecured revolving credit facility, which matures in 2016. MSC was in compliance with its covenants.
- Management stated that cash, operating cash flow, and available revolving credit capacity should be adequate to fund operations and planned capital expenditures for at least the next twelve months.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected improved economic and manufacturing conditions, market-share gains, acquisitions, higher demand, and price realization. Management estimated that the Q2 sales increase included approximately $64 million from volume, $2 million from the ATS acquisition, and $14 million from price realization and mix.
- Manufacturing customers, approximately 75% of the business, experienced 19.4% average daily sales growth in Q2; non-manufacturing customers grew 9.2%.
- Sales through MSC websites rose to $189.5 million, or 33.7% of consolidated sales, from $150.8 million, or 31.2%, in the prior-year quarter.
- Gross margin declined because of higher product costs, customer and product mix, and lower margins at acquired businesses. Operating expense leverage more than offset the gross-margin pressure, increasing operating margin.
- Operating expenses increased 11.8% in Q2 and 11.2% year to date, driven by sales-force expansion, volume-related payroll and freight, investment programs, medical costs, and acquisition expenses.
- On January 31, 2012, MSC acquired certain assets and assumed certain liabilities of ATS Industrial Supply for a cash purchase price of approximately $31.2 million. The acquisition contributed $2.4 million of Q2 revenue and $0.3 million of pretax income and generated $10.6 million of goodwill.
- MSC paid regular quarterly dividends totaling $31.5 million year to date, compared with $91.2 million in the prior-year period, which included a $1.00-per-share special dividend. The Board subsequently declared another $0.25-per-share dividend payable April 24, 2012.
Outlook, Commentary, Risks, and Unusual Items
- Management expected operating costs to continue rising through fiscal 2012 because of sales growth, compensation and benefits, vending and metalworking capability programs, and other investments.
- Management cited an ISM manufacturing index of 53.4% for March 2012 and noted that the index had remained above 50% for 32 consecutive months, while cautioning that economic uncertainty remained.
- Government-account sales, approximately 9% of year-to-date net sales, remained constrained by government spending conditions.
- Management planned to increase field sales associates to approximately 1,090 by the end of fiscal Q3, compared with 1,081 at quarter-end, and intended to add approximately 20,000 SKUs through e-commerce channels during fiscal 2012.
- Key risks include economic and political conditions, manufacturing demand, customer and product mix, competition, acquisitions and integration, commodity and energy-price volatility, customer credit risk, order cancellations, supply-chain or supplier disruptions, extreme weather and transportation interruptions, information-system dependence, litigation, regulatory proceedings, and retention of key personnel.
- Various legal claims and proceedings were pending, but management did not expect them to have a material adverse effect on financial position, results, or liquidity. The company was also under federal income-tax examination for fiscal years 2009 and 2010.
- The filing reported no off-balance-sheet arrangements and no material changes in market-risk exposures. Disclosure controls and procedures were deemed effective.
Important Facts for Investors to Verify
- Whether sales growth and manufacturing demand remain strong as economic conditions and the ISM index change.
- Whether gross-margin pressure from product costs, mix, and acquired businesses persists or reverses.
- The integration, profitability, and potential synergies of ATS and other recent acquisitions.
- Inventory and receivables growth relative to sales, and the resulting effect on operating cash conversion.
- The pace and returns of investments in sales personnel, vending, e-commerce, technology, and fulfillment infrastructure.
- Future dividend and share-repurchase activity, including the remaining 5 million-share repurchase authorization.
- Results of the pending federal tax examination and the development of legal contingencies.
