MSM

MSC Industrial Direct Co., Inc. - 10-Q Summary

Business Context and Reporting Period

This Quarterly Report on Form 10-Q covers the thirteen and twenty-six week periods ended February 24, 2007. MSC Industrial Direct Co., Inc. is a leading direct marketer of industrial maintenance, repair, and operations (MRO) supplies. The reporting period includes the full results of the J&L America, Inc. (J&L) acquisition, which closed on June 8, 2006. The Company is currently integrating J&L operations, which is expected to be completed by late spring of fiscal 2007.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 32.3% (13 weeks) and 34.0% (26 weeks) year-over-year. Approximately 70.0% of this growth is attributable to the J&L acquisition. Organic growth was driven by price increases on certain SKUs and expansion in Large Account Customer programs.
• Margin Compression: Gross margins decreased to 46.4% (13 weeks) and 46.3% (26 weeks) from 47.5% and 47.2% in the prior year. This decline is primarily due to J&L's lower gross margins compared to MSC's historical margins, partially offset by purchasing initiatives and price increases.
• Operating Expenses: Operating expenses rose significantly (29.2% and 31.2% increases) due to J&L integration costs, increased headcount (sales force grew to 757 associates), and higher freight costs. However, operating expenses as a percentage of sales decreased slightly due to productivity gains.
• Interest Expense: Interest expense surged from negligible amounts in the prior year to $3.3 million (13 weeks) and $6.5 million (26 weeks) due to term loan borrowings ($200 million) and revolving credit facility usage ($30 million) incurred for the J&L acquisition.
• Share Repurchases: The Company repurchased approximately 1.6 million shares of Class A common stock for $64.0 million during the first 26 weeks of fiscal 2007.

Guidance, Outlook, and Risks

• Acquisition Outlook: The J&L acquisition is expected to be neutral to earnings per share through most of fiscal 2007, becoming accretive towards the end of the year and fully accretive in fiscal 2008 as synergies are realized.
• Economic Indicators: Management notes a downward trend in the Institute for Supply Management (ISM) index (declining from 59.4% to 50.9%), which may moderate revenue growth. The Company is responding by being more selective with growth initiatives and focusing on imported products with higher margins.
• Dividend: On March 29, 2007, the Board declared a quarterly dividend of $0.18 per share, an increase of $0.04 from the previous quarter.
• Liquidity: The Company maintains a $75.0 million revolving credit facility with $30.0 million outstanding. Management anticipates cash flows from operations and available reserves will be adequate for the next twelve months.
• Risks: Key risks include the successful integration of J&L, rising commodity and energy prices, dependence on information systems, and general economic conditions affecting the manufacturing sector.

Investor Verification Checklist

• J&L Integration Progress: Verify the timeline for full integration and the realization of anticipated cost synergies.
• Debt Servicing: Confirm the Company's ability to service the $230.8 million debt load, particularly as principal payments on the term loan begin in June 2007.
• Margin Trends: Monitor whether gross and operating margins stabilize or improve as J&L integration completes and purchasing initiatives take effect.
• ISM Index Impact: Assess the correlation between the declining ISM index and future revenue growth rates.
• Share Count: Track the impact of ongoing share repurchases on future earnings per share calculations.