Business Context and Reporting Period
MSC Industrial Direct Co., Inc. is a North American direct marketer and distributor of metalworking and maintenance, repair and operations products. This Form 10-Q covers the 13 and 39 weeks ended May 31, 2014, compared with the periods ended June 1, 2013. The fiscal year ends August 30, 2014. Results include the Class C Solutions Group (CCSG), acquired from Barnes Group on April 22, 2013.
MSC offered approximately 795,000 catalog and web SKUs, operated 11 customer fulfillment centers and 103 branches, and had approximately 1,188 field sales associates excluding 708 CCSG sales associates.
Financial Highlights
| Metric | Q3 FY2014 | Q3 FY2013 | 39 Weeks FY2014 | 39 Weeks FY2013 |
|---|---|---|---|---|
| Net sales | $720.5 million | $636.9 million | $2,060.5 million | $1,783.9 million |
| Gross profit | $333.4 million | $289.5 million | $955.1 million | $811.0 million |
| Gross margin | 46.3% | 45.5% | 46.4% | 45.5% |
| Operating income | $104.9 million | $100.2 million | $283.4 million | $293.2 million |
| Operating margin | 14.6% | 15.7% | 13.8% | 16.4% |
| Net income | $64.7 million | $62.4 million | $173.3 million | $181.6 million |
| Diluted EPS | $1.03 | $0.98 | $2.76 | $2.86 |
| Cash dividend per share | $0.33 | $0.30 | $0.99 | $0.90 |
Q3 sales increased 13.1%, gross profit increased 15.2%, operating income increased 4.6%, and net income increased 3.8%. For the first 39 weeks, sales increased 15.5% and gross profit increased 17.8%, but operating income declined 3.3%, net income declined 4.6%, and diluted EPS declined 3.5%.
CCSG contributed $75.4 million of Q3 sales and $217.5 million of 39-week sales. Management attributed the 39-week sales increase primarily to $182.8 million from CCSG, $81.2 million from higher volume, and $12.6 million from pricing, partially offset by customer and product mix, discounting and other factors.
Cash Flow, Balance Sheet, Debt and Liquidity
| Metric | May 31, 2014 | August 31, 2013 |
|---|---|---|
| Cash and cash equivalents | $45.4 million | $55.9 million |
| Accounts receivable | $369.5 million | $345.4 million |
| Inventories | $429.4 million | $419.0 million |
| Total assets | $2,018.4 million | $1,943.0 million |
| Total liabilities | $594.5 million | $552.6 million |
| Shareholders’ equity | $1,423.9 million | $1,390.4 million |
| Total borrowings | Approximately $274.6 million | Approximately $255.8 million |
- Operating cash flow for the first 39 weeks was $226.6 million, compared with $245.4 million in the prior-year period.
- Investing cash outflow was $79.5 million, including $55.9 million of capital expenditures and $25.0 million invested in available-for-sale securities. The prior-year period included approximately $548.8 million of CCSG acquisition spending.
- Financing cash outflow was $157.8 million, driven by $115.6 million of share repurchases, $62.0 million of dividends and $54.4 million of debt repayments, partly offset by $50.0 million of credit-facility borrowings.
- The credit facility had $240.6 million outstanding under the term loan and $5.0 million under the revolving facility at May 31, 2014. The revolving balance was repaid in June 2014, leaving the $400.0 million revolving facility available for working capital purposes.
- The facility matures April 22, 2018 and requires a maximum leverage ratio of 3.00 to 1.00 and minimum interest coverage of 3.00 to 1.00. MSC was in compliance with the covenants at May 31, 2014.
- Working capital was $670.1 million and the current ratio was 3.7 at May 31, 2014, compared with $679.9 million and 4.2 at August 31, 2013.
Material Changes Versus the Prior Comparable Period
- Sales growth was aided materially by the inclusion of a full period of CCSG operations, while core business volume and pricing also increased.
- Gross margin expanded 80 basis points in Q3 and 90 basis points year to date, primarily because CCSG generated higher gross margins. Product costs, customer and product mix, and greater vending sales partially offset the benefit.
- Operating expenses increased 20.7% in Q3 and 29.7% year to date. CCSG accounted for approximately $36.7 million of Q3 and $107.8 million of year-to-date operating expenses.
- Non-recurring CCSG integration and restructuring costs were approximately $2.3 million in Q3 and $10.7 million year to date. Year-to-date operating expenses also included approximately $3.0 million of executive separation costs.
- The effective tax rate increased to 37.89% in Q3 and 38.20% year to date, partly because the prior-year period benefited from a favorable federal tax audit settlement.
- MSC repurchased approximately 1.5 million Class A shares for $115.6 million during the first 39 weeks. Approximately 2.9 million shares remained authorized for repurchase at May 31, 2014.
- eCommerce sales excluding CCSG increased to $875.9 million, or 47.5% of consolidated sales, from $760.5 million, or 43.5%, in the prior-year period.
Guidance, Outlook, Risks and Unusual Items
Management did not provide formal revenue or earnings guidance in the filing. Management expects operating costs to remain higher through the balance of fiscal 2014 because of the full-year inclusion of CCSG, integration and restructuring costs, compensation, vending and other investment programs, the Davidson headquarters, and the Columbus fulfillment center.
Management expects approximately $2.0 million to $3.0 million of additional CCSG integration and restructuring costs during the remainder of fiscal 2014 and additional costs through fiscal 2015. The Columbus, Ohio fulfillment center is expected to begin operations in fall 2014; total planned capital investment is approximately $55.0 million, of which approximately $46.9 million had been spent during the first 39 weeks.
Management stated that the manufacturing environment was expanding, citing a June 2014 ISM index of 55.3%, but noted continued macroeconomic uncertainty and customer purchasing caution. Management believes operating cash flow, existing cash and available revolving credit will fund operations, planned capital expenditures and growth requirements for at least the next 12 months.
- Key risks include CCSG integration and synergy realization, fulfillment-center delays, economic and manufacturing volatility, competition, customer credit risk, order cancellations, supply-chain disruptions, commodity and energy price volatility, information-system dependence, personnel retention, regulatory or litigation outcomes, and potential goodwill or intangible-asset impairment.
- Various legal claims and proceedings are pending, but management does not expect them to materially affect financial position, results of operations or liquidity.
- The Company has an affiliated-party lease for its Atlanta fulfillment center and paid approximately $1.7 million of rent to the affiliate during the first 39 weeks.
- The filing states that there were no material changes in market-risk exposures, no off-balance-sheet arrangements, and no material changes in unrecognized tax benefits.
- New accounting guidance on revenue recognition and discontinued operations had been issued but had not yet been adopted; the Company was evaluating the potential effects.
Important Facts for Investors to Verify
- Determine how much reported growth and margin expansion is sustainable after CCSG acquisition comparisons normalize.
- Track whether CCSG integration costs, restructuring charges and operating-cost growth continue to pressure operating margins.
- Verify execution, timing and final cost of the Columbus fulfillment center and related capital-lease obligations.
- Monitor working-capital investment, inventory and receivables growth, operating cash conversion, and continued share repurchases and dividends.
- Review credit-facility leverage and interest-coverage compliance as debt amortizes and investment spending continues.
- Assess exposure to manufacturing demand, customer and product mix, government accounts, supply-chain disruption and competitive pricing.
- Confirm the effect of the higher effective tax rate and the absence of prior-year tax benefits on future EPS comparisons.