Business Context and Reporting Period
MSC Industrial Direct Co., Inc. is a North American distributor of metalworking and maintenance, repair and operations products and services. This unaudited Form 10-Q covers the thirteen and thirty-nine weeks ended June 2, 2018, compared with the corresponding periods ended June 3, 2017. The fiscal year ends September 1, 2018.
During the period, MSC completed the acquisition of All Integrated Solutions (AIS), a distributor of industrial fasteners, components, MRO supplies and assembly tools, for approximately $86.7 million. The company also continued integrating DECO Tool Supply, acquired in July 2017.
Key Financial Metrics
| Metric | Q3 FY2018 | Q3 FY2017 | Change |
|---|---|---|---|
| Net sales | $828.3 million | $743.9 million | Up 11.3% |
| Gross profit | $361.0 million | $329.5 million | Up 9.6% |
| Gross margin | 43.6% | 44.3% | Down 70 bps |
| Operating income | $115.4 million | $101.8 million | Up 13.4% |
| Operating margin | 13.9% | 13.7% | Up 20 bps |
| Net income | $79.1 million | $62.8 million | Up 25.8% |
| Diluted EPS | $1.39 | $1.09 | Up 27.5% |
| Cash dividends per share | $0.58 | $0.45 | Up 28.9% |
| Metric | 39 Weeks FY2018 | 39 Weeks FY2017 | Change |
|---|---|---|---|
| Net sales | $2.366 billion | $2.134 billion | Up 10.9% |
| Gross margin | 43.7% | 44.6% | Down 90 bps |
| Operating income | $312.8 million | $279.0 million | Up 12.1% |
| Operating margin | 13.2% | 13.1% | Up 10 bps |
| Net income | $256.2 million | $170.7 million | Up 50.1% |
| Diluted EPS | $4.51 | $2.98 | Up 51.3% |
Cash Flow, Liquidity and Debt
- Cash provided by operating activities was $230.2 million for the first 39 weeks, compared with $159.1 million in the prior-year period.
- Investing cash outflow was $116.6 million, including $85.8 million for acquisitions and $30.8 million of capital expenditures.
- Financing cash outflow was $89.7 million, including $92.6 million of dividends and $25.4 million of share repurchases, partially offset by $23.1 million from stock option exercises.
- Cash and cash equivalents were $40.0 million at June 2, 2018, up from $16.1 million at September 2, 2017.
- Total debt was $535.5 million, compared with $533.0 million at fiscal year-end. Net debt declined to $495.5 million from $516.9 million.
- The $600 million revolving credit facility had approximately $407.9 million unused through June 20, 2018, after subsequent net repayments and borrowings. The weighted-average borrowing rate at June 2, 2018 was 3.03%.
- Management stated that cash, available financing and operating cash flow should fund planned capital expenditures and operating requirements for at least the next twelve months.
- Working capital was $587.7 million and the current ratio was 2.1 at June 2, 2018. Days sales outstanding, excluding DECO and AIS, increased to 56.0 from 54.4 a year earlier; inventory turnover was 3.5.
Material Changes and Unusual Items
- Q3 sales growth reflected approximately $38.4 million of higher volume in the legacy business, $32.7 million from DECO, $6.7 million from AIS, $1.7 million from foreign exchange and $4.9 million from pricing and mix.
- The gross-margin decline was attributed to the lower-margin DECO business, which reduced Q3 margin by approximately 80 basis points and year-to-date margin by approximately 90 basis points.
- Operating-expense leverage improved margins despite higher payroll, medical, incentive compensation and freight costs. Operating expenses were 29.7% of sales in Q3 versus 30.6% in the prior-year quarter.
- The effective tax rate was 29.3% in Q3 versus 36.3% in the prior-year quarter. For the 39-week period, the effective rate was 15.3% versus 36.8%, primarily due to the Tax Cuts and Jobs Act.
- MSC recorded a provisional net tax benefit of $41.2 million from revaluing deferred tax liabilities, and reported a $58.1 million total tax benefit related primarily to tax reform effects. These amounts remain subject to measurement-period adjustments.
- AIS contributed $6.7 million of revenue and a $1.7 million pretax loss during the 39-week period. Purchase accounting was preliminary and included $39.6 million of goodwill and $23.2 million of identifiable intangible assets.
- On June 11, 2018, after the quarter-end, MSC issued $60 million of senior notes with maturities from 2020 through 2025.
Guidance, Outlook and Risks
The filing does not provide explicit quantitative revenue or earnings guidance. Management cited continued expansion in the manufacturing environment, with a Q3 Metalworking Business Index average of 59.2 and a trailing twelve-month average of 57.5, while noting that the index had moderated from its February high.
Management expects to pursue profitable sales growth, market-share gains, customer diversification, productivity initiatives, technology investments and strategic acquisitions. The filing states that operating results for the interim periods are not necessarily indicative of full-year results.
- Key risks include economic conditions, customer and product mix, aggressive competition and pricing, commodity and energy-price volatility, customer credit risk, order cancellations, supply-chain disruptions and loss of key suppliers or brands.
- Additional risks include cybersecurity and information-system failures, business interruptions, extreme weather, regulatory or litigation outcomes, trade-policy changes, environmental and safety compliance, acquisition integration and potential goodwill or intangible-asset impairment.
- The company was in compliance with its debt covenants at June 2, 2018. Debt agreements generally require a maximum leverage ratio of 3.00 to 1.00, temporarily expandable to 3.50 to 1.00 after a material acquisition, and minimum interest coverage of 3.00 to 1.00.
- Various ordinary-course claims and lawsuits were pending; management did not expect them to have a material adverse effect on financial position, results or liquidity.
- Disclosure controls and procedures were evaluated as effective, and no material change in internal control over financial reporting was reported.
Investor Verification Checklist
- Verify the preliminary AIS purchase-price allocation, working-capital adjustment and the acquired business’s post-acquisition profitability.
- Assess whether DECO and AIS integration, product mix and pricing could sustain or further pressure gross margins.
- Separate recurring operating earnings from the provisional $41.2 million tax revaluation benefit and other tax-reform effects.
- Reconcile total debt, subsequent June note issuances, revolving-credit availability and compliance with leverage and interest-coverage covenants.
- Monitor receivables growth, the increase in days sales outstanding and inventory levels as sales expand.
- Review acquisition-related goodwill and intangible assets for impairment exposure and confirm future amortization obligations.
- Confirm the continuation and funding impact of dividends and the authorized share-repurchase program, which had approximately 2.565 million shares remaining at June 2, 2018.