MSC Industrial Direct Co., Inc. — Fiscal 2020 Third-Quarter Form 10-Q
Business Context and Reporting Period
MSC is a North American distributor of metalworking and maintenance, repair and operations products and services, serving manufacturing, government, retail, commercial and other customers. The filing covers the unaudited thirteen and thirty-nine weeks ended May 30, 2020, compared with June 1, 2019. Results were significantly affected by the COVID-19 pandemic and related economic disruption.
Key Financial Metrics
| Metric | Q3 FY2020 | Q3 FY2019 | Change |
|---|---|---|---|
| Net sales | $835.0 million | $866.5 million | Down 3.6% |
| Gross profit | $354.0 million | $368.7 million | Down 4.0% |
| Gross margin | 42.4% | 42.5% | Down 10 basis points |
| Income from operations | $109.9 million | $110.5 million | Down 0.6% |
| Operating margin | 13.2% | 12.8% | Up 40 basis points |
| Net income attributable to MSC | $77.7 million | $79.6 million | Down 2.4% |
| Diluted EPS | $1.40 | $1.44 | Down 2.8% |
For the thirty-nine weeks, net sales were $2.445 billion, down 3.0%; gross margin was 42.2% versus 42.8%; operating income was $277.8 million, down 10.2%; operating margin was 11.4% versus 12.3%; and diluted EPS was $3.57 versus $4.00.
Net cash provided by operating activities was $214.9 million for the thirty-nine weeks, compared with $187.2 million in the prior-year period. Capital expenditures were $35.9 million, and cash used in investing activities was $38.2 million. Cash and cash equivalents increased to $353.4 million from $32.3 million at August 31, 2019.
Total debt, including finance lease obligations, was $977.7 million at May 30, 2020, compared with $441.9 million at August 31, 2019. Net debt was $624.3 million. The increase primarily reflected a precautionary $300.0 million draw under the committed revolving credit facility and other debt activity during the pandemic. The company reported $7.8 million of unused committed-facility capacity, net of outstanding letters of credit, and was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Q3 sales declined $31.6 million, attributed by management to approximately $38.7 million of lower volume and $1.0 million of unfavorable foreign exchange, partly offset by $8.1 million from pricing and customer or product mix.
- Manufacturing average daily sales declined 17.0% in Q3, while non-manufacturing average daily sales increased 26.2%. Government sales increased to 15% of Q3 revenue from 7%, driven by demand for safety and janitorial products.
- Gross margin declined modestly in Q3 due primarily to increased product costs. For the year-to-date period, the larger margin decline also reflected MSC Mexico operations and customer and product mix.
- Q3 operating expenses fell 5.4% to $244.1 million, reflecting lower payroll, freight, travel and entertainment costs. This more than offset the gross-profit decline and supported the higher Q3 operating margin.
- Year-to-date operating expenses included $3.5 million of consulting costs related to operational optimization and $2.4 million of severance and separation costs. The optimization plan was largely placed on hold during Q3 because of COVID-19 uncertainty.
- The company paid $402.5 million of cash dividends during the thirty-nine weeks, including a $277.6 million special dividend, versus $104.3 million of regular dividends in the prior-year period. It repurchased no shares under the public repurchase plan; share repurchases were primarily employee tax-withholding transactions.
- The company adopted lease accounting standard ASC 842 on September 1, 2019, recording operating lease assets of $61.2 million and operating lease liabilities of $60.7 million at adoption. The adoption had an immaterial income-statement and cash-flow effect.
Guidance, Outlook, Risks and Unusual Items
- Management expected the fiscal 2020 full-year effective tax rate to be approximately 24.5% to 25.0%.
- Management stated that existing cash and operating cash flow were expected to fund necessary operating requirements and capital expenditures for at least the next twelve months, while acknowledging that future sales and net income would be reduced by COVID-19 effects.
- The company ceased hiring, reduced discretionary spending, limited operating and capital spending to critical items, and developed additional cost-reduction contingency plans if conditions deteriorated.
- COVID-19 risks include reduced customer demand, manufacturing and supplier disruptions, transportation constraints, workforce limitations, customer payment delays and potential facility closures. Management stated that the duration and ultimate financial impact could not reasonably be estimated.
- The Metalworking Business Index averaged 38.7 in fiscal Q3, below the 50.0 level generally indicating expansion; the June reading of 42.9 also indicated contraction.
- In June 2020, the company paid $20.0 million to satisfy the Series 2018A notes. On June 30, 2020, the board declared a $0.75 per-share quarterly dividend payable July 28, 2020.
- Other risks include customer and product mix, competition and pricing, supply-chain concentration, credit risk, litigation, information-system disruptions, tariffs, goodwill impairment, interest-rate and LIBOR transition risk, and the effects of economic recession.
Important Facts for Investors to Verify
- Whether manufacturing demand and the Metalworking Business Index recover, and whether COVID-19 disruptions produce further volume declines.
- The sustainability of gross margins after pandemic-related product, customer and channel-mix changes.
- Debt repayment capacity, available revolving-credit capacity, covenant compliance and exposure to variable interest rates.
- The sustainability of the unusually high fiscal 2020 dividend payout, including the special dividend, relative to future free cash flow.
- Accounts receivable aging and collections, given days sales outstanding of 60.7 days and heightened customer-credit risk.
- The timing and expected benefits of the paused operational-optimization program and the effect of restructuring costs.
- Potential effects of COVID-19, the economic recession, supply-chain disruptions and LIBOR replacement on future results.