MSC Industrial Direct Co., Inc. — Fiscal 2014 Second-Quarter Form 10-Q
Reporting period: Thirteen and twenty-six weeks ended March 1, 2014, compared with the periods ended March 2, 2013. Fiscal 2014 is a 52-week year ending August 30, 2014. The results include BDNA, acquired on April 22, 2013, from the acquisition date.
Business Context
MSC is a North American direct marketer and distributor of metalworking and maintenance, repair and operations products. It reported approximately 760,000 web-available SKUs, 11 customer fulfillment centers, 103 branch offices and approximately 1,163 non-BDNA field sales associates at quarter-end. BDNA contributed $69.8 million of second-quarter sales and $142.1 million of year-to-date sales.
Key Financial Metrics
| Metric | 13 weeks ended March 1, 2014 | 13 weeks ended March 2, 2013 | 26 weeks ended March 1, 2014 | 26 weeks ended March 2, 2013 |
|---|---|---|---|---|
| Net sales | $661.5 million | $569.5 million | $1,340.0 million | $1,147.0 million |
| Gross profit | $306.8 million | $256.4 million | $621.7 million | $521.5 million |
| Gross margin | 46.4% | 45.0% | 46.4% | 45.5% |
| Operating income | $81.7 million | $90.6 million | $178.5 million | $192.9 million |
| Operating margin | 12.4% | 15.9% | 13.3% | 16.8% |
| Net income | $49.5 million | $56.1 million | $108.6 million | $119.3 million |
| Diluted EPS | $0.79 | $0.88 | $1.72 | $1.88 |
For the 26-week period, the effective tax rate was 38.4% versus 38.2% in the prior-year period. Cash dividends declared were $0.33 per share in the second quarter and $0.66 per share year to date.
Cash Flow, Balance Sheet and Liquidity
- Operating cash flow was $151.5 million year to date, compared with $135.0 million in the prior-year period.
- Investing cash flow used $56.5 million, including $33.9 million of capital expenditures and $24.0 million invested in available-for-sale securities related to the Columbus, Ohio, fulfillment center financing arrangement.
- Financing cash flow used $105.6 million, including $115.4 million of share repurchases and $41.4 million of dividends, partly offset by $50.0 million of revolving-credit borrowings.
- Cash and cash equivalents were $45.3 million at March 1, 2014, down from $55.9 million at August 31, 2013.
- Total borrowings, including credit-facility debt and capital leases, were approximately $312.0 million, compared with $255.8 million at August 31, 2013.
- Credit-facility debt consisted of approximately $243.8 million of term debt and $40.0 million of revolving borrowings. The facility matures April 22, 2018 and had $395.0 million of revolving capacity available after a $35.0 million repayment in March 2014.
- The company was in compliance with its maximum 3.00-to-1.00 leverage covenant and minimum 3.00-to-1.00 interest-coverage covenant at March 1, 2014.
- Working capital was $627.4 million and the current ratio was 3.5 at March 1, 2014, versus $679.9 million and 4.2, respectively, at August 31, 2013.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 16.2%; year-to-date sales increased 16.8%. BDNA accounted for most of the reported increase, with management attributing the remaining growth to volume and pricing, partially offset by mix, discounting and other items.
- Gross margin expanded 140 basis points in the quarter and 90 basis points year to date, primarily because BDNA generated higher gross margins. Product-cost increases, customer and product mix and lower vending margins were offsets.
- Operating expenses increased 35.8% in the quarter and 34.9% year to date. The increase reflected BDNA operations, integration and restructuring charges, increased compensation and investment-program costs, headquarters relocation costs and approximately $3.0 million of executive separation costs.
- Operating income declined 9.8% in the quarter and 7.5% year to date, while net income declined 11.7% and 9.0%, respectively.
- Repurchases were approximately 1.5 million Class A shares for $115.4 million year to date, versus $3.6 million in the prior-year period. Approximately 2.9 million shares remained authorized for repurchase at March 1, 2014.
- Electronic-platform sales, excluding BDNA, represented 46.8% of consolidated year-to-date sales, compared with 43.1% in the prior-year period.
Guidance, Outlook, Risks and Unusual Items
- Management expects operating costs to remain elevated through fiscal 2014 because of a full year of BDNA operations, integration and restructuring, compensation, vending and other investments, headquarters costs and the Columbus fulfillment center.
- Remaining fiscal 2014 BDNA integration and restructuring costs were estimated at approximately $5 million to $7 million. The company had incurred $8.4 million in such costs during the first 26 weeks of fiscal 2014.
- The company expects to invest approximately $55 million in the Columbus fulfillment center and expected construction completion and operational commencement in late 2014.
- Management stated that cash from operations, existing cash and available revolving-credit capacity should fund planned capital expenditures and operating requirements for at least the next 12 months.
- Management cited a March 2014 ISM manufacturing index of 53.7%, indicating expansion, but noted continued macroeconomic uncertainty and customer purchasing caution. Government accounts represented approximately 7% of year-to-date sales, down from 9% in the prior-year period.
- Principal risks include BDNA integration and synergy realization, economic and manufacturing conditions, competition, customer and product mix, commodity and energy costs, customer credit risk, order cancellations, supply-chain or transportation disruptions, information-system dependence, key-personnel retention, regulatory or litigation outcomes, and possible impairment of acquisition-related goodwill and intangibles.
- Various ordinary-course legal claims and proceedings were disclosed; management did not expect them to have a material adverse effect on financial position, results of operations or liquidity.
- Disclosure controls and procedures were assessed as effective, and no material change in internal control over financial reporting was reported.
Investor Verification Items
- Separate the underlying organic performance from BDNA-related revenue and expense contributions, including the timing and amount of expected synergies.
- Monitor whether operating-expense growth, integration charges and investment spending normalize sufficiently to restore operating margins.
- Verify leverage, debt maturities, interest expense and covenant headroom after the additional revolving borrowings and share repurchases.
- Assess cash requirements and execution risk for the approximately $55 million Columbus fulfillment-center project and other planned investments.
- Evaluate the sustainability of gross-margin improvement given product costs, customer and product mix, and vending-program margins.
- Review the impact of continued share repurchases and dividends on liquidity and capital allocation.
- Consider macroeconomic exposure, particularly manufacturing demand, government-account sales and potential supply-chain disruptions.