MSC Industrial Direct Co., Inc. — Fiscal 2017 First-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. The filing covers the unaudited thirteen weeks ended December 3, 2016, compared with the thirteen weeks ended November 28, 2015. Fiscal 2017 is a 52-week year ending September 2, 2017. The company offered approximately 1.16 million SKUs through 12 fulfillment centers and 85 branch offices and employed more than 6,000 associates.
Financial performance and key metrics
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $686.3 million | $706.8 million | Down 2.9% |
| Gross profit | $308.7 million | $319.0 million | Down 3.2% |
| Gross margin | 45.0% | 45.1% | Down 0.1 percentage point |
| Operating expenses | $218.1 million | $228.6 million | Down 4.6% |
| Operating income | $90.6 million | $90.4 million | Up 0.2% |
| Operating margin | 13.2% | 12.8% | Up 0.4 percentage point |
| Net income | $54.1 million | $55.0 million | Down 1.7% |
| Diluted EPS | $0.95 | $0.89 | Up $0.06 |
| Operating cash flow | $75.4 million | $122.1 million | Down $46.7 million |
Interest expense increased to $2.9 million from $1.6 million. The effective tax rate was 38.2% in both periods. Average diluted shares declined to 56.6 million from 61.4 million, supporting the increase in diluted EPS despite lower net income. The quarterly dividend increased to $0.45 per share from $0.43.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $32.1 million at December 3, 2016, compared with $52.9 million at September 3, 2016.
- Total debt was $543.8 million, down from $606.8 million; net debt was $511.7 million, down from $553.9 million.
- Debt consisted primarily of $166.0 million drawn on the revolving facility, a $175.0 million term loan, $175.0 million of private-placement senior notes and $28.6 million of capital lease and financing obligations.
- The revolving credit facility had $226.0 million of unused capacity at December 3, 2016. The company reported compliance with its debt covenants, including a maximum leverage ratio of 3.00 to 1.00 and minimum interest coverage of 3.00 to 1.00.
- Working capital was $460.8 million and the current ratio was 2.0. A prospective deferred-tax classification change reduced reported current assets and working capital by approximately $46.6 million.
- Capital expenditures were $12.5 million. The company stated that cash, available revolver capacity and operating cash flow should fund planned capital expenditures and operating requirements for at least the next 12 months.
Material changes versus the prior comparable period
- Sales declined $20.5 million, estimated by management to reflect approximately $9.3 million of lower volume, $2.7 million of foreign-exchange impact and $8.5 million from pricing, customer mix, product mix, discounting and other items.
- Manufacturing-customer sales declined 4.2%, while non-manufacturing-customer sales increased 0.6%. Manufacturing represented approximately 68% of revenue.
- Large Account Customer sales declined approximately $5.7 million; sales to other customers declined approximately $14.8 million.
- eCommerce-platform sales increased to 59.6% of consolidated sales from 57.0%.
- Gross margin narrowed slightly because of pricing and customer mix, but lower operating expenses—particularly payroll-related costs and amortization—more than offset the gross-profit decline at the operating-income level.
- Operating cash flow decreased primarily because of increased inventories and less favorable changes in receivables and working-capital accounts.
- Net debt declined because debt repayments exceeded new borrowings. During the quarter, the company borrowed $15.0 million under the revolver and repaid $66.0 million of revolver borrowings and $12.5 million of term-loan principal.
Outlook, risks, contingencies and unusual items
The Metalworking Business Index averaged 48.8 in the quarter and 46.7 over the preceding 12 months. Although the index was improving, readings below 50 generally indicated contraction in the metalworking manufacturing environment. Management stated that it would continue monitoring economic conditions and pursuing cost reductions, market-share gains, customer diversification and technology-enabled procurement solutions.
- The company expected $8.0 million to $10.0 million of additional capital expenditures for the remainder of fiscal 2017 to complete its core financial-systems upgrade, targeted for spring 2017. Management identified implementation-related risks to internal controls over financial reporting, although disclosure controls were effective at quarter-end.
- Management identified risks including economic conditions, customer and product mix, competition, commodity and energy-price volatility, customer credit, order cancellations, supply-chain disruptions, information-system failures and cyberattacks, key-personnel retention, regulatory matters, goodwill impairment, acquisition integration and debt restrictions.
- Various claims and lawsuits were pending, but management did not expect their ultimate resolution to materially affect financial position, results of operations or liquidity.
- The company adopted the deferred-tax balance-sheet classification standard prospectively, moving $46.6 million from current deferred-tax assets to long-term liabilities. It was evaluating the future effects of standards addressing share-based payments, leases, inventory measurement and revenue recognition.
- The company withheld or repurchased 40,085 Class A shares during the quarter, primarily to satisfy employee tax-withholding obligations. Approximately 1.44 million shares remained authorized for repurchase under the plan.
Important facts for investors to verify
- Whether improving manufacturing indicators translate into sustained sales and volume growth after the reported 2.9% revenue decline.
- Whether pricing and customer-mix pressure continues to affect the 45.0% gross margin.
- Progress, cost and control implications of the core financial-systems upgrade.
- Debt maturities, refinancing plans and covenant headroom as the $650.0 million credit facility approaches its April 2018 maturity.
- Inventory growth and working-capital conversion, given the substantial year-over-year decline in operating cash flow.
- The effect of the deferred-tax reclassification on reported liquidity metrics and comparability.
- Execution of the stated cost-reduction, eCommerce, vending and customer-diversification initiatives.