MSC Industrial Direct Co., Inc. — Fiscal 2019 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, offering approximately 1.7 million stock-keeping units through catalogs, eCommerce, inventory-management solutions, call centers and branches. The filing covers the thirteen and thirty-nine weeks ended June 1, 2019, compared with June 2, 2018. The fiscal year ends on the Saturday closest to August 31.
The company operated 12 customer fulfillment centers and 99 branches. Approximately 69% of third-quarter revenue came from manufacturing customers. The United States represented 96% of quarterly sales and 97% of year-to-date sales.
Financial Performance and Key Metrics
| Metric | Q3 FY2019 | Q3 FY2018 | Change |
|---|---|---|---|
| Net sales | $866.5 million | $828.3 million | Up 4.6% |
| Gross profit | $368.7 million | $361.0 million | Up 2.1% |
| Gross margin | 42.5% | 43.6% | Down 110 bps |
| Operating income | $110.5 million | $115.4 million | Down 4.2% |
| Operating margin | 12.8% | 13.9% | Down 110 bps |
| Net income attributable to MSC | $79.6 million | $79.1 million | Up 0.7% |
| Diluted EPS | $1.44 | $1.39 | Up 3.6% |
For the thirty-nine weeks ended June 1, 2019, sales were $2.521 billion, up 6.6%; gross profit was $1.078 billion, up 4.4%; gross margin was 42.8% versus 43.7%; operating income was $309.5 million, down 1.0%; and diluted EPS was $4.00 versus $4.51. Net income attributable to MSC declined 13.3% to $222.3 million, largely reflecting the prior-year tax benefit related to the Tax Cuts and Jobs Act.
The third-quarter effective tax rate was 25.0% versus 29.3% in the prior-year quarter. The year-to-date effective tax rate was 25.1% versus 15.3%, with the prior-year rate benefiting from the revaluation of deferred tax liabilities after enactment of the Tax Cuts and Jobs Act.
Cash Flow, Liquidity, Debt and Capital Allocation
- Year-to-date operating cash flow was $187.2 million, compared with $230.2 million in the prior-year period.
- Capital expenditures were $36.0 million. Investing cash outflow was $20.6 million, helped by $27.0 million of proceeds from redemption of Finance Authority bonds.
- Cash and cash equivalents were $38.8 million at June 1, 2019, versus $46.2 million at September 1, 2018.
- Total debt was $531.0 million, compared with $535.3 million at fiscal year-end; net debt increased to $492.2 million from $489.1 million.
- Short-term debt was $246.3 million and long-term debt was $284.7 million. The short-term balance primarily reflected $246.0 million outstanding under uncommitted bank facilities.
- The company had a $600 million committed revolving credit facility, with reported unused availability of approximately $597 million, reduced by outstanding letters of credit, and six uncommitted facilities with aggregate maximum availability of $440 million.
- The company stated that it was in compliance with applicable debt covenants, including a maximum leverage ratio of 3.00-to-1.00 and minimum interest coverage ratio of 3.00-to-1.00.
- Year-to-date financing cash outflow was $174.0 million, including $84.5 million of share repurchases and $104.3 million of dividends. The company repurchased approximately 1.1 million shares during the period.
- Working capital was $729.7 million and the current ratio was 2.5 at June 1, 2019. Days sales outstanding increased to 59.2 from 55.6 at September 1, 2018, while inventory turnover was 3.5.
Material Changes Versus the Prior Comparable Period
- Quarterly sales growth reflected $13.3 million of higher core volume, $11.6 million from AIS, $9.9 million from MSC Mexico, and $4.9 million from pricing and mix, partly offset by a $1.5 million foreign-exchange impact.
- Year-to-date sales growth reflected $83.1 million of higher core volume, $46.3 million from AIS, $12.8 million from MSC Mexico and $16.7 million from pricing and mix, partly offset by a $3.6 million foreign-exchange impact.
- Gross margin declined primarily because of higher product costs and customer and product mix. MSC Mexico reduced quarterly margin by approximately 30 basis points and AIS by approximately 10 basis points.
- Operating expenses increased 5.1% in the quarter and 6.7% year to date, driven principally by payroll, sales-related costs, freight, AIS and MSC Mexico. Quarterly freight expense increased to $35.1 million from $33.4 million.
- Quarterly operating margin declined to 12.8% from 13.9%, while net income remained broadly stable because of the lower tax rate.
- The company completed the acquisition of certain TAC Insumos Industriales assets in February 2019 for aggregate consideration of $18.5 million; MSC’s 75% portion was $13.9 million, subject to a final working-capital adjustment.
- The Columbus, Ohio capital lease and related Finance Authority bonds were settled on May 29, 2019, reducing capital lease obligations by approximately $27.0 million and generating $27.0 million of bond proceeds.
- eCommerce and electronic-channel sales represented 60.1% of consolidated sales in both the quarter and year-to-date period, broadly consistent with the prior year.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management stated that existing cash, available credit facilities and operating cash flow should be sufficient to fund planned capital expenditures and operating requirements for at least the next twelve months. The filing does not provide specific revenue, earnings or margin guidance.
Management observed continued manufacturing expansion, but noted that the May 2019 Metalworking Business Index reading of 51.6 was the slowest expansion level since 2017. The company intends to continue pursuing profitable sales growth, market-share gains, customer diversification, productivity initiatives, technology-enabled inventory solutions and strategic acquisitions.
Principal risks include economic and manufacturing-cycle weakness, changing customer and product mix, competition and pricing pressure, commodity and energy volatility, tariffs and trade-policy changes, customer credit and order cancellations, supply-chain or key-supplier disruptions, business interruptions, cybersecurity and information-system failures, employee retention, acquisition integration, debt restrictions, litigation, environmental compliance, goodwill impairment and significant shareholder control.
The company adopted the new revenue-recognition standard effective September 2, 2018, with no impact on opening retained earnings. It expected to adopt the new lease standard in the first quarter of fiscal 2020 using an optional transition method; the filing did not quantify the expected balance-sheet impact. Pending legal matters were not expected by management to have a material adverse effect on financial position, results of operations or liquidity. Disclosure controls were deemed effective, and no material changes to internal control over financial reporting were reported.
Important Facts for Investors to Verify
- Whether gross-margin pressure from product costs, pricing, customer mix, AIS and MSC Mexico persists.
- Whether sales growth remains dependent on acquisitions and new operations versus underlying core volume.
- The refinancing and liquidity implications of $246.0 million of short-term uncommitted borrowings and applicable covenant headroom.
- Conversion of earnings to cash, including the year-to-date decline in operating cash flow and increases in receivables and inventories.
- The timing and balance-sheet impact of adopting the lease-accounting standard in fiscal 2020.
- Integration performance and profitability of AIS, TAC and MSC Mexico, including recurring versus non-recurring costs.
- Exposure to manufacturing-cycle deterioration, tariffs, competitive pricing, cyber incidents and supply-chain disruptions.
- The effect of continued dividends and share repurchases on leverage, liquidity and per-share results.