MSC Industrial Direct Co., Inc. — Fiscal 2015 Third-Quarter Form 10-Q
Reporting period: Thirteen and thirty-nine weeks ended May 30, 2015, compared with the corresponding periods ended May 31, 2014. The filing was dated July 9, 2015. MSC is a North American distributor of metalworking and MRO products, serving customers through approximately 970,000 searchable SKUs, 12 fulfillment centers, 100 branches, eCommerce channels, and more than 6,500 associates.
Key Financial Metrics
| Metric | Q3 FY2015 | Q3 FY2014 | YTD FY2015 | YTD FY2014 |
|---|---|---|---|---|
| Net sales | $745.5 million | $720.5 million | $2,183.0 million | $2,060.5 million |
| Gross profit | $338.4 million | $333.4 million | $989.4 million | $955.1 million |
| Gross margin | 45.4% | 46.3% | 45.3% | 46.4% |
| Operating income | $104.2 million | $104.9 million | $284.1 million | $283.4 million |
| Operating margin | 14.0% | 14.6% | 13.0% | 13.8% |
| Net income | $63.3 million | $64.7 million | $172.3 million | $173.3 million |
| Diluted EPS | $1.03 | $1.03 | $2.78 | $2.76 |
Q3 sales increased 3.5%, while year-to-date sales increased 5.9%. Q3 net income decreased 2.1%; year-to-date net income decreased 0.6%. The effective tax rate was 38.27% in Q3 and 38.37% year to date, versus 37.89% and 38.20%, respectively, in the comparable periods.
Cash Flow, Balance Sheet, and Liquidity
- Year-to-date operating cash flow was $163.0 million, down from $226.6 million, primarily because inventory increased $62.8 million to support sales growth.
- Year-to-date capital expenditures were $38.2 million, compared with $55.9 million in the prior-year period.
- Cash and cash equivalents were $24.9 million at May 30, 2015, compared with $47.2 million at August 30, 2014.
- Working capital was $565.6 million and the current ratio was 2.2 at May 30, 2015, versus $652.3 million and 3.1 at fiscal year-end.
- Total debt, including capital leases and financing obligations, was $460.3 million, compared with $337.1 million at August 30, 2014. Debt consisted principally of a $218.8 million term loan and a $213.0 million revolving balance.
- The unsecured credit facility matures in April 2018 and provides a $400.0 million revolving facility and a $250.0 million term loan. The applicable borrowing rate at May 30, 2015 was 1.32%.
- The company stated that it was in compliance with all credit facility covenants. The facility requires a maximum leverage ratio of 3.00 to 1.00 and minimum interest coverage of 3.00 to 1.00.
- After quarter-end, MSC repaid $15.0 million under the revolving facility. Management reported approximately $202.0 million of unused revolving capacity.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven by higher volume, particularly from Large Account Customers. Q3 volume contributed approximately $26.8 million of the $25.0 million sales increase, with foreign exchange reducing sales by approximately $2.7 million. Year-to-date volume increased approximately $133.6 million, partly offset by pricing and mix effects and $5.4 million of foreign exchange pressure.
- Non-manufacturing customer average daily sales increased 10.1% in Q3 and 13.1% year to date, while manufacturing customer average daily sales increased 1.2% and 3.3%, respectively.
- Gross margin declined 90 basis points in Q3 and 110 basis points year to date, primarily because of higher product costs, customer and product mix, and growth in vending-program sales. Low commodity inflation constrained price increases.
- Operating expenses increased 2.5% in Q3 and 5.0% year to date. Higher payroll, staffing, freight, advertising, medical, and growth-program costs were partly offset by lower CCSG integration and restructuring costs and lower incentive compensation accruals.
- Q3 operating income declined slightly despite higher gross profit; year-to-date operating income increased only 0.3% because expense growth largely absorbed the gross-profit increase.
- Year-to-date cash dividends were $259.5 million, including a $185.4 million special dividend and $74.1 million of regular dividends. The prior-year period included $62.0 million of dividends and no special dividend.
- MSC repurchased $26.4 million of Class A stock year to date, compared with $115.6 million in the prior-year period.
- eCommerce and other electronic channels represented 55.3% of year-to-date consolidated sales, compared with 52.1% in the prior-year period. The searchable product database expanded to approximately 970,000 SKUs.
Outlook, Commentary, Risks, and Unusual Items
Management expects operating costs to continue increasing through the remainder of fiscal 2015 because of the Columbus, Ohio fulfillment center, higher compensation and benefits, additional staffing, vending and other growth programs, and related infrastructure investments. Management believes cash from operations, existing cash, and available revolving capacity will fund operations and planned growth for at least the next 12 months.
The Columbus fulfillment center began operations on September 30, 2014. MSC spent approximately $3.6 million on the facility during the first three quarters of fiscal 2015, following approximately $49.9 million spent in fiscal 2014.
Management described the manufacturing environment as expanding but at a declining pace. The filing identifies risks from economic and political conditions, competition, customer and product mix, commodity and energy-price volatility, customer credit, order cancellations, supply-chain disruptions, information-system failures and cyberattacks, key-personnel retention, regulatory or litigation outcomes, environmental compliance, and potential impairment of acquisition-related goodwill and intangible assets.
Various ordinary-course legal claims and proceedings remain pending, but management does not expect them to have a material adverse effect on financial position, results of operations, or liquidity. The filing reports no material changes in market-risk exposure, no off-balance-sheet arrangements, and no material changes in unrecognized tax benefits.
The company is evaluating the future revenue-recognition standard, ASU 2014-09, and had not selected a transition method or determined its impact. Management did not expect the other recently issued accounting standards discussed in the filing to have a material effect.
Investor Verification Items
- Verify whether sales growth can continue while gross margin remains pressured by product costs, mix, vending expansion, and limited pricing power.
- Monitor inventory growth and operating cash conversion, particularly after the year-to-date decline in operating cash flow.
- Review leverage, covenant headroom, interest costs, and the company’s dependence on revolving borrowings after the special dividend and share repurchases.
- Assess the earnings contribution and cost burden of the Columbus fulfillment center, expanded sales force, eCommerce investments, and vending programs.
- Evaluate exposure to manufacturing-sector trends, oil-price effects, foreign exchange, customer concentration, and Large Account Customer growth.
- Confirm the sustainability of the regular $0.40-per-share quarterly dividend and the absence of additional special dividends in future periods.
- Review pending litigation, acquisition-related goodwill and intangible assets, cybersecurity and information-system risks, and the eventual impact of ASU 2014-09.