MSC Industrial Direct Co., Inc. — Fiscal 2023 Third-Quarter Form 10-Q
Reporting period: Thirteen and thirty-nine weeks ended June 3, 2023, compared with the respective periods ended May 28, 2022. MSC is a North American distributor of metalworking and maintenance, repair and operations products and services, operating in one reportable segment.
Financial Performance and Position
| Metric | Q3 FY2023 | Q3 FY2022 | Change |
|---|
| Net sales | $1,054.5 million | $958.6 million | 10.0% increase |
| Gross profit | $428.9 million | $411.1 million | 4.3% increase |
| Gross margin | 40.7% | 42.9% | 220 basis-point decrease |
| Income from operations | $135.4 million | $136.8 million | 1.1% decrease |
| Operating margin | 12.8% | 14.3% | 150 basis-point decrease |
| Net income attributable to MSC | $95.2 million | $99.7 million | 4.5% decrease |
| Diluted EPS | $1.69 | $1.78 | 5.1% decrease |
| Metric | 39 Weeks FY2023 | 39 Weeks FY2022 | Change |
|---|
| Net sales | $2,973.8 million | $2,669.6 million | 11.4% increase |
| Gross profit | $1,223.4 million | $1,130.0 million | 8.3% increase |
| Gross margin | 41.1% | 42.3% | 120 basis-point decrease |
| Income from operations | $365.7 million | $324.7 million | 12.6% increase |
| Operating margin | 12.3% | 12.2% | 10 basis-point increase |
| Net income attributable to MSC | $255.6 million | $235.7 million | 8.5% increase |
| Diluted EPS | $4.56 | $4.21 | 8.3% increase |
- Cash flow: Operating cash flow was $567.1 million for the first 39 weeks, versus $135.3 million in the prior-year period. The improvement was substantially driven by the $300.0 million receivables purchase agreement and associated reduction in accounts receivable.
- Investing: Cash used in investing was $84.3 million, including $64.1 million of capital expenditures and $20.2 million for acquisitions.
- Financing: Cash used in financing was $468.1 million, including $330.0 million of net debt payments, $132.5 million of dividends, and $31.1 million of Class A share repurchases.
- Liquidity: Cash and equivalents were $58.4 million at June 3, 2023. Working capital was $632.7 million and the current ratio was 1.9. Management stated that existing cash, financial resources and operating cash flow should fund operating and capital requirements for at least the next 12 months.
- Debt: Total debt, including finance leases and financing arrangements, was $464.3 million, down from $794.6 million at September 3, 2022. Net debt was $405.9 million. The Company had no borrowings under its $600.0 million revolving credit facility, subject to outstanding letters of credit, and reported $594.7 million of unused balance. It was in compliance with applicable covenants.
- Dividends: The Company paid $2.37 per share, or $132.5 million, during the first 39 weeks. A $0.79-per-share dividend was declared on June 21, 2023, with expected aggregate payments of approximately $44.3 million.
Material Changes Versus Prior Comparable Period
- Q3 sales growth reflected $36.8 million from acquisitions, $33.6 million from pricing and mix, $25.0 million from volume, and $0.5 million from foreign exchange. Average daily sales increased 11.7%.
- For the first 39 weeks, sales growth reflected $131.6 million from pricing and mix, $98.7 million from acquisitions, and $77.0 million from volume, partially offset by $3.1 million of unfavorable foreign exchange.
- Q3 gross margin contracted because of large public-sector sales at below-typical margins and a less favorable mix toward national-account and public-sector customers. Acquisitions also pressured margin.
- Operating expenses increased in dollars but declined as a percentage of sales to 27.7% from 28.3% in Q3 and to 28.7% from 29.7% year to date, reflecting Mission Critical cost savings and productivity improvements.
- Interest expense and other expense increased due to higher interest rates and fees under the receivables purchase agreement.
- Restructuring and other costs declined to $1.8 million in Q3 and $5.7 million year to date, compared with $3.3 million and $11.7 million, respectively, in the prior-year periods.
- MSC acquired Buckeye Industrial Supply Co. and Tru-Edge Grinding, Inc. in January 2023 for aggregate consideration of approximately $22.4 million.
- Accounts receivable declined to $438.6 million from $687.6 million at fiscal year-end, primarily because $300.0 million of receivables were sold under the new receivables purchase agreement. The arrangement generated $7.6 million of fees during the first 39 weeks.
Outlook, Commentary, Risks and Unusual Items
- Management continues its Mission Critical strategy, including pricing initiatives, warehouse automation, supply-chain efficiency, expansion of vending, vendor-managed inventory and in-plant programs, sales-force investment, and structural cost reductions.
- The category line review initiated in the second quarter showed early improvements in supply-chain efficiency, customer experience and supplier engagement. MSC is maintaining higher purchasing levels to protect product availability amid uncertain shipping times and supply disruptions.
- Management cited stable volume and favorable conditions in certain end markets, but noted economic uncertainty from elevated inflation, higher interest rates and fluctuating industrial production.
- The Company agreed to a proposed reclassification eliminating the dual-class share structure. Each outstanding Class B share would be exchanged for 1.225 Class A shares, subject to shareholder, regulatory, NYSE listing and other closing conditions. The Class B holders granted an irrevocable proxy supporting the transaction.
- Risks include weaker economic and manufacturing activity, customer and product-mix changes, pricing pressure, commodity and energy volatility, labor shortages, supply-chain disruption, inventory imbalances, information-technology or cybersecurity incidents, customer credit risk, higher interest rates, covenant and refinancing risk, acquisition integration, goodwill impairment, litigation, and failure to complete or realize benefits from the reclassification.
- The Company received $12.7 million related to Employee Retention Credit claims; $11.7 million was recorded as a liability because management determined the probability threshold for recognition had not been met. The IRS is reviewing employment tax matters, including the periods associated with the claims.
- Ordinary-course litigation remains pending, but management does not expect the ultimate resolution to materially affect financial position, results of operations or liquidity.
Important Facts for Investors to Verify
- Whether lower gross margins, particularly from public-sector and national-account sales, persist and affect future earnings.
- The sustainability of operating cash flow after normalizing for the $300.0 million receivables sale and the ongoing fees associated with the arrangement.
- Refinancing requirements and rollover risk for $165.0 million outstanding under uncommitted credit facilities and debt maturities, including $75.0 million of senior notes due July 28, 2023 and $50.0 million due March 5, 2024.
- Progress, costs, shareholder approvals and completion of the proposed reclassification.
- The outcome of the IRS review of Employee Retention Credit claims and the potential recognition of the $11.7 million currently recorded as a liability.
- Execution of the Mission Critical initiatives, acquisition integration, inventory levels, customer demand and the effect of inflation and interest rates on margins and financing costs.
