Business Context and Reporting Period
MSC Industrial Direct Co., Inc. is a direct marketer and distributor of metalworking and maintenance, repair and operations products, offering approximately 600,000 SKUs through catalogs, websites, five fulfillment centers and 100 branches. This Form 10-Q covers the thirteen weeks and thirty-nine weeks ended May 28, 2011, compared with the periods ended May 29, 2010.
Financial Performance and Position
| Metric | Q3 FY2011 | Q3 FY2010 | Change |
|---|---|---|---|
| Net sales | $532.4 million | $450.4 million | 18.2% |
| Gross profit | $251.6 million | $204.9 million | 22.8% |
| Gross margin | 47.3% | 45.5% | Up 180 bps |
| Operating income | $98.1 million | $70.4 million | 39.4% |
| Operating margin | 18.4% | 15.6% | Up 280 bps |
| Net income | $62.1 million | $44.2 million | 40.3% |
| Diluted EPS | $0.97 | $0.69 | 40.6% |
For the thirty-nine-week year-to-date period, sales were $1.489 billion, up 21.0%; gross profit was $695.6 million, up 24.3%; operating income was $255.9 million, up 49.4%; and net income was $159.3 million, up 49.9%. Year-to-date diluted EPS was $2.50 versus $1.67.
Year-to-date operating cash flow was $145.3 million, compared with $109.3 million in the prior-year period. Investing cash outflows were $29.6 million, including $19.5 million of capital expenditures and $10.1 million for the Rutland acquisition. Financing cash outflows were $100.2 million, including $105.2 million of dividends and $39.3 million of debt repayments.
Cash and cash equivalents were $136.8 million at May 28, 2011, compared with $121.2 million at August 28, 2010. Working capital was $615.0 million, versus $486.3 million at fiscal year-end. Total borrowings were approximately $42 thousand, compared with $39.4 million at August 28, 2010. The company had no outstanding balance on its revolving credit line or term loan at quarter-end.
Year-to-date dividends totaled $105.2 million, including a special $1.00-per-share dividend and regular quarterly dividends. A further $0.22-per-share dividend was declared on June 28, 2011. The filing reports no material off-balance-sheet arrangements.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected improved economic conditions, market-share gains, higher demand and execution of growth initiatives. Approximately $67 million of the quarterly sales increase was volume- and acquisition-related, while approximately $15 million reflected improved price realization.
- Gross margin benefited from price increases, customer mix and higher vendor rebates. Pricing remained subject to competitive pressure.
- Operating expenses increased 14.1% in the quarter and 13.2% year to date, primarily from payroll, sales-force expansion, fringe benefits, freight and Rutland-related costs. Operating expenses declined as a percentage of sales because of productivity gains and fixed-cost leverage.
- Website sales increased to $170.0 million, or 31.9% of consolidated sales, from $137.1 million, or 30.4%, in the prior-year quarter. Field sales associates increased to 1,015 from 947.
- Interest expense declined substantially because the company repaid its revolving debt and final term-loan installment. The company also completed a $10.1 million business acquisition and repaid approximately $39.3 million of debt during the year-to-date period.
Guidance, Outlook, Risks and Unusual Items
Management expected operating costs to continue increasing through the remainder of fiscal 2011 because of higher sales volumes, compensation, fringe benefits and investment programs. Management also expected fourth-quarter results to face slightly lower supplier rebates and comparison against unusually high government-customer demand in the prior-year fourth quarter.
Management stated that cash, operating cash flow and available credit were expected to fund operations and planned capital expenditures for at least the next twelve months. On June 8, 2011, after the reporting date, MSC entered into a new $200 million unsecured credit facility maturing June 8, 2016, with an option to increase availability by up to $250 million. The prior facility matured and was terminated on the same date.
The May 2011 ISM manufacturing index was 53.5%, indicating expansion but a decline from levels above 60.0%. Management cited uncertainty from events in Japan, Europe and the Middle East, high unemployment and foreclosure rates, government-spending constraints, commodity and energy-price volatility, competition, customer credit risk, order cancellations, supply-chain disruptions, information-system dependence and retention of key personnel.
Legal claims and proceedings were pending in the ordinary course of business, but management did not expect them to materially affect financial position, results or liquidity. Warranty expense was minimal, and the filing reported no material changes in unrecognized tax benefits. Disclosure controls were deemed effective, with no material change in internal control over financial reporting.
Investor Verification Items
- Verify the sustainability of the 47.3% quarterly gross margin, including the contribution from price increases, customer mix and vendor rebates.
- Assess whether sales growth and market-share gains can continue as manufacturing activity moderates and government demand becomes more constrained.
- Review working-capital requirements, particularly the increases in accounts receivable and inventories, as sales expand.
- Confirm the terms, covenant requirements and future borrowing costs of the $200 million credit facility entered into after quarter-end.
- Evaluate the effect of higher payroll, benefits, freight and investment spending on future operating leverage.
- Consider the one-time nature of the $1.00-per-share special dividend and the company’s continuing dividend and repurchase capacity.
- Review the integration and performance of the Rutland acquisition and the related goodwill and intangible-asset balances.