MSC Industrial Direct Co., Inc. — Fiscal 2020 Second-Quarter Form 10-Q
Reporting period: Thirteen and twenty-six weeks ended February 29, 2020, compared with the periods ended March 2, 2019. The company is a North American distributor of metalworking and maintenance, repair and operations products and services, operating in one reportable segment.
Financial Results and Key Metrics
| Metric | Q2 FY2020 | Q2 FY2019 | Change |
|---|---|---|---|
| Net sales | $786.1 million | $823.0 million | Down 4.5% |
| Gross profit | $331.1 million | $351.8 million | Down 5.9% |
| Gross margin | 42.1% | 42.7% | Down 60 basis points |
| Operating expenses | $253.4 million | $255.8 million | Down 1.0% |
| Operating income | $77.7 million | $96.0 million | Down 19.1% |
| Operating margin | 9.9% | 11.7% | Down 180 basis points |
| Net income attributable to MSC | $55.5 million | $68.4 million | Down 18.9% |
| Diluted EPS | $1.00 | $1.24 | Down 19.4% |
First six months: Net sales were $1.610 billion, down 2.7%; gross profit was $678.2 million, down 4.4%; operating income was $168.0 million, down 15.6%; net income attributable to MSC was $120.9 million, down 15.2%; and diluted EPS was $2.18 versus $2.56. Gross margin declined to 42.1% from 42.9%, while operating margin declined to 10.4% from 12.0%.
Sales drivers: Q2 average daily sales declined 2.9% overall, including a 3.7% decline in manufacturing customers and a 1.0% decline in non-manufacturing customers. Management attributed the quarterly sales decline primarily to $48.5 million of lower volume, partly offset by $7.5 million from MSC Mexico, $3.8 million of improved pricing and mix, and $0.3 million of favorable foreign exchange. Electronic sales represented 60.9% of Q2 sales, compared with 60.0% in the prior-year quarter.
Cash flow and liquidity: First-half cash flow from operations was $155.8 million versus $98.6 million. Investing cash outflow was $28.0 million, including $25.7 million of capital expenditures and $2.3 million for a TAC acquisition-related working-capital adjustment. Financing cash outflow was $115.4 million. Cash increased to $44.9 million from $32.3 million at August 31, 2019.
Debt: Total borrowings, including finance leases, were $677.9 million at February 29, 2020, versus $441.9 million at fiscal year-end; net debt was $633.0 million. The increase primarily supported the $277.6 million special dividend and other financing needs. The company had $100.0 million outstanding on its $600.0 million committed facility and $288.6 million outstanding under uncommitted facilities at quarter-end. The company was in compliance with debt covenants, including a maximum leverage ratio of 3.00-to-1.00 and minimum interest coverage of 3.00-to-1.00.
Material Changes and Unusual Items
- Gross-margin pressure reflected higher product costs and customer and product mix changes; MSC Mexico reduced Q2 margin by approximately 30 basis points.
- Q2 operating expenses included $2.1 million of consulting costs for operational optimization. First-half restructuring and related costs totaled approximately $4.5 million, including $2.4 million of severance and related charges.
- The company paid $360.8 million of dividends in the first six months, including a $277.6 million special dividend, versus $69.6 million of regular dividends in the comparable period.
- Working capital declined to $518.0 million from $752.7 million at March 2, 2019, and the current ratio declined to 1.7 from 2.2, primarily because of higher current debt associated with the special dividend.
- Effective September 1, 2019, the company adopted ASC 842 lease accounting, recording approximately $61.2 million of operating lease assets and $60.7 million of operating lease liabilities. The adoption had an immaterial income-statement and cash-flow impact.
Outlook, Risks and Subsequent Events
Management did not provide formal revenue or earnings guidance. It expected a fiscal 2020 full-year effective tax rate of approximately 25.0% to 25.5% and stated that existing cash, committed credit availability and operating cash flow were expected to fund operating and capital requirements for at least the next twelve months.
The COVID-19 pandemic emerged after the quarter-end and was identified as a significant risk to customer demand, supplier availability, manufacturing, transportation, fulfillment operations, employee availability and customer collections. The company had ceased hiring, reduced discretionary spending, limited operating and capital spending to critical items, and developed additional cost-reduction contingency plans. Management stated that the overall impact could not be reasonably estimated.
After quarter-end, the company issued $100.0 million of senior notes, repaid $100.0 million on its committed facility, and borrowed an additional $300.0 million as a precautionary measure. In April 2020, it repaid $134.0 million of non-renewed uncommitted borrowings, borrowed $34.0 million under other facilities, and had $188.6 million outstanding under uncommitted facilities. Such borrowings could be repayable at the end of the applicable interest period, currently 30 days, if lenders do not renew them. The company reported $295.9 million of unused committed-facility capacity after the March transactions, subject to letters of credit.
Other risks include economic contraction, customer credit and order cancellations, supply-chain disruption, competition and pricing pressure, information-system breaches, interest-rate and LIBOR-transition exposure, covenant restrictions, litigation, acquisition integration, and potential impairment of goodwill and intangible assets.
Investor Verification Priorities
- Verify the pace and duration of COVID-19-related sales, margin and supply-chain effects after February 29, 2020.
- Reconcile subsequent debt issuances, committed-facility borrowings and repayments, and the renewal risk associated with uncommitted facilities.
- Assess leverage and covenant headroom after the special dividend and COVID-19 liquidity actions.
- Evaluate whether lower manufacturing demand, product costs and mix continue to pressure gross and operating margins.
- Review the sustainability of cash generation and dividends given increased debt and reduced expected sales and net income.
- Monitor restructuring and consulting costs, workforce changes, and the effectiveness of the operational optimization program.