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. It serves customers primarily in the United States, with operations in Canada and the United Kingdom, through approximately 1.645 million active SKUs, 12 customer fulfillment centers and 100 branches.
This Form 10-K covers the 52-week fiscal year ended September 1, 2018, compared primarily with the 52-week fiscal year ended September 2, 2017. The filing also provides unaudited fourth-quarter results.
- Fiscal 2018 sales were approximately 68% manufacturing-related, excluding U.K. operations.
- More than 60% of orders were submitted digitally, and eCommerce platforms represented 60.1% of consolidated sales.
- MSC completed the $87.8 million acquisition of All Integrated Solutions (AIS) on April 30, 2018.
Financial Performance and Key Metrics
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Net sales | $3,203.9 million | $2,887.7 million | 10.9% |
| Gross profit | $1,393.0 million | $1,286.2 million | 8.3% |
| Gross margin | 43.5% | 44.5% | Down 100 bps |
| Operating income | $420.6 million | $379.0 million | 11.0% |
| Operating margin | 13.1% | 13.1% | Flat |
| Net income | $329.2 million | $231.4 million | 42.3% |
| Diluted EPS | $5.80 | $4.05 | 43.2% |
| Cash flow from operations | $339.7 million | $246.8 million | 37.6% |
Fiscal 2018 net margin was 10.3%, compared with 8.0% in fiscal 2017. Net income benefited materially from a $40.5 million tax benefit associated primarily with the Tax Cuts and Jobs Act and the revaluation of deferred tax liabilities. The effective tax rate declined to 18.9% from 37.1%.
- Fiscal 2018 sales growth included approximately $151.4 million of higher underlying volume, $113.0 million from DECO, $24.7 million from AIS, $13.1 million from one additional sales day, $9.1 million from pricing and mix, and $4.8 million from foreign exchange.
- Operating expenses increased 7.2% to $972.4 million but declined to 30.4% of sales from 31.4%, reflecting productivity and operating leverage.
- Freight expense increased to approximately $130.3 million from $120.0 million.
- Working capital was $657.0 million, the current ratio was 2.3, days sales outstanding excluding acquisitions was 56.0 days, and inventory turnover excluding acquisitions was 3.5 times.
Fiscal Fourth Quarter
| Metric | Q4 Fiscal 2018 | Q4 Fiscal 2017 | Change |
|---|---|---|---|
| Net sales | $838.0 million | $753.8 million | 11.2% |
| Gross profit | $359.7 million | $333.5 million | 7.9% |
| Operating income | $107.8 million | $100.0 million | 7.8% |
| Net income | $73.0 million | $60.7 million | 20.2% |
Cash Flow, Debt and Liquidity
- Cash flow from operations was $339.7 million. Investing cash outflow was $131.9 million, including $87.0 million for acquisitions and $44.9 million for capital expenditures.
- Financing cash outflow was $177.6 million, including $125.4 million of dividends and $82.4 million of share repurchases, partly offset by $24.2 million from option exercises.
- Cash and cash equivalents were $46.2 million versus $16.1 million at the prior year-end.
- Total debt was $535.3 million, including $224.1 million classified as short-term debt. Net debt was $489.1 million, down from $516.9 million.
- The company had a $600.0 million unsecured revolving credit facility maturing April 14, 2022. Management reported approximately $413.4 million of unused availability after borrowings through October 1, 2018, subject to letters of credit and covenant limitations.
- Senior notes and other debt maturities total $224.0 million in fiscal 2019, $20.0 million in fiscal 2020, $20.0 million in fiscal 2021, $125.0 million in fiscal 2023 and $120.0 million thereafter.
- MSC stated that existing cash, operating cash flow and available credit were sufficient to fund planned capital expenditures and operating requirements for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- Sales growth accelerated substantially, driven by organic volume, the full-period contribution from DECO, the AIS acquisition and favorable pricing and foreign exchange.
- Gross margin declined 100 basis points, which management attributed exclusively to the lower-margin DECO and AIS businesses.
- Operating margin remained stable at 13.1% despite acquisition costs and higher payroll and freight expenses.
- Net income increased much faster than operating income because of the Tax Cuts and Jobs Act benefit and the lower ongoing federal corporate tax rate.
- Operating cash flow increased by $92.8 million, while investing outflows increased primarily because of the AIS acquisition.
- Debt composition shifted toward longer-term fixed-rate debt, reducing short-term debt by approximately $107.9 million while increasing long-term debt by approximately $110.2 million.
- Management was transitioning the sales force from a transaction-oriented model to a higher-touch value-added customer model. The transition temporarily pressured growth because of account and sales-associate changes and declining sales headcount.
Outlook, Commentary, Risks and Unusual Items
- Management expects fiscal 2019’s income tax rate to be approximately 25.0% to 25.5%, assuming no significant excess tax benefits or expenses. The filing does not provide a clear fiscal 2019 revenue or earnings forecast.
- The Metalworking Business Index remained in expansion territory, with a fiscal 2018 fourth-quarter average of 57.1, but declined from its February 2018 peak, indicating slower prospective manufacturing growth.
- Management’s strategy emphasizes market-share gains, technical metalworking expertise, inventory-management solutions, eCommerce, vending, national and government accounts, SKU expansion and selective acquisitions.
- Key risks include cyclical industrial demand, customer and product mix pressure on gross margin, intense online and traditional competition, commodity and freight inflation, supply-chain disruptions, customer credit risk, government-contract compliance, cybersecurity and privacy requirements, acquisition integration, and interest-rate exposure.
- Goodwill and indefinite-lived intangible assets totaled approximately $689.1 million at year-end. The fiscal 2018 qualitative impairment assessment indicated no impairment.
- Legal proceedings were described as incidental to the business, with management not expecting a material adverse effect on financial position, results or liquidity.
- The company was in compliance with its debt covenants at September 1, 2018. A 100-basis-point change in interest rates was estimated to affect annual interest costs by approximately $2.1 million.
- MSC declared a quarterly dividend of $0.63 per share on October 18, 2018. The company paid annual dividends of $2.22 per share in fiscal 2018 and repurchased $82.4 million of Class A common stock.
Important Facts for Investors to Verify
- Separate the $40.5 million tax benefit from recurring earnings and assess the expected fiscal 2019 tax rate.
- Evaluate whether organic sales growth can continue after adjusting for DECO, AIS, the additional sales day, pricing and foreign exchange.
- Monitor whether gross-margin pressure from acquisitions, large accounts, vending and eCommerce persists.
- Review the $224.0 million fiscal 2019 debt maturity and confirm refinancing or repayment plans and revolver availability.
- Assess the execution and financial effects of the sales-force transition and AIS integration.
- Review working-capital trends, particularly the increase in days sales outstanding and inventory balances.
- Consider the effect of concentrated voting control: holders of the Class B shares controlled approximately 70.1% of combined voting power as of October 1, 2018.
- Confirm that the reported unqualified audit opinions and effective internal-control assessments remain applicable to subsequent filings.