Management Analysis and Analysis of the Financial Position and Results of Operations of MSC INDUSTRIAL DIRECT CO INC (Form 10-Q)
The following is intended to update the information contained in
MSC Industrial Direct Co., Inc.'s(together with its wholly owned subsidiaries and entities in which it maintains a controlling financial interest, "MSC," " MSC Industrial," the "Company," "we," "us" or "our") Annual Report on Form 10-K for the fiscal year ended August 28, 2021and presumes that readers have access to, and will have read, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of Part II of such Annual Report on Form 10-K.
MSC is a leading North American distributor of a broad range of metalworking and maintenance, repair and operations ("MRO") products and services. We help our customers drive greater productivity, profitability and growth with inventory management and other supply chain solutions and deep expertise from more than 80 years of working with customers across industries. We offer approximately 2.0 million active, saleable SKUs through our catalogs; our brochures; our eCommerce channels, including our website, mscdirect.com (the "MSC website"); our inventory management solutions; and our call centers, branch offices, customer fulfillment centers and regional inventory centers. We service our customers from 11 customer fulfillment centers (seven customer fulfillment centers located in
the United States, including five primary customer fulfillment centers, one located in the United Kingdomand three located in Canada), seven regional inventory centers, and 26 branch offices. We continue to implement our strategies to gain market share, generate new customers, increase sales to existing customers, and diversify our customer base. Our business model focuses on providing overall procurement cost reduction and just-in-time delivery to meet our customers' needs. Many of our products are carried in stock, and orders for these in-stock products are typically fulfilled the day on which the order is received. We focus on offering inventory, process and procurement solutions that reduce MRO supply chain costs and improve plant floor productivity for our customers. We will seek to continue to achieve cost reductions throughout our business through cost-saving strategies and increased leverage from our existing infrastructure. Furthermore, we provide additional procurement cost-saving solutions to our customers through technology such as our Electronic Data Interchange ("EDI") systems, vendor-managed inventory ("VMI") systems and vending programs. Our field sales and service associate headcount was 2,445 at November 27, 2021, compared to 2,313 at November 28, 2020. We have migrated our sales force from one designed to sell a spot-buy value proposition to one prepared to deliver upon the new, more complex and high-touch role that we play, driving value for our customers by enabling them to achieve higher levels of productivity, profitability and growth.
Highlights during the thirteen week period ended
? We have generated
for the same period of the previous fiscal year.
? We had net refunds of
October 14, 2021, the Company's Board of Directors declared a quarterly cash dividend which resulted in aggregate payments of $41.7 millionon November 30, 2021, after the end of the first quarter of fiscal year 2022. This compares to $41.8 millionin cash dividends paid during the first quarter of fiscal year 2021. ?We incurred $5.3 millionin restructuring costs, compared to $4.0 millionfor the same period in the prior fiscal year. Restructuring costs primarily consisted of severance and separation costs and equity award acceleration costs. The prior year period also includes consulting costs related to the optimization of the Company's operations. Recent Developments Progress on Mission Critical
As previously reported, we have launched a company-wide project, which we call “Mission Critical”, to accelerate market share capture and improve profitability over the period up to the fiscal year. 2023. Among Mission Critical initiatives to achieve growth, we have started and plan to continue investing in our market-leading metallurgy company in
19 -------------------------------------------------------------------------------- adding to our metalworking specialist team, introducing value-added services to our customers, expanding our vending, VMI and in-plant solutions programs, building out our sales force, and diversifying our customers and end-markets. We also are focused on critical structural cost reductions in order to improve return on invested capital. We anticipate that these cost reductions will be comprised of savings in the areas of sales and service, supply chain and general and administrative expenses, and include initiatives to optimize our distribution center network and real estate footprint, renegotiate supplier contracts, and redesign our talent acquisition and retention approach.
Moving and sale pending
December 2020, we announced plans to relocate our Long Island Customer Service Center("CSC") to a smaller facility in Melville, New York. In connection with the announcement, we signed a 10-year lease to occupy approximately 26,000 square feet in an office building in Melville, New York, which commenced in September 2021. In furtherance of these plans, we entered into a Purchase and Sale Agreement to sell our Long Island CSC. This transaction is currently within a permitting period as outlined within the Purchase and Sale Agreement.
Impact of COVID-19 on our business
The COVID-19 pandemic has impacted and may further impact the Company's operations and the operations of the Company's suppliers, vendors and freight carriers, as a result of quarantines, travel restrictions, facility closures and safety directives. Although certain restrictions implemented earlier in the pandemic have been lifted and economic and operating conditions have improved since the early months of the pandemic, the pandemic continues to impact the Company's operations and supply chain. Concurrently with the partial lifting of pandemic-related restrictions,
the United Stateshas experienced disruptions in the supply of certain products and services. These disruptions have affected the price and, at times, the availability of certain products and services necessary for the Company's operations, including fuel, labor and certain products the Company sells or the inputs for such products. These disruptions are also impacting our customers and their ability to conduct their business or purchase our products and services. Such disruptions have impacted, and may continue to impact in the future, the Company's business, financial condition and results of operations. As a result of the COVID-19 pandemic, we have implemented modifications to associate travel and associate work locations and in-person events, among other modifications. We have taken many actions to reduce spending more broadly across the Company, including limiting our operating and capital spending on critical items and reducing hiring and discretionary expenses. We have developed contingency plans that we anticipate would reduce costs further if business and financial conditions deteriorate. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state and local, and foreign authorities. In September 2021, the Federal government issued an executive order requiring federal contractors to require their employees be vaccinated against COVID-19 (the "Contractor Mandate"). In November 2021, the U.S. Department of Labor's Occupational Safety and Health Administrationpromulgated a rule requiring employers with at least 100 employees to require that their employees be vaccinated against COVID-19 or be tested weekly (the "Large Employer Mandate"). The legality and enforceability of both the Contractor Mandate and the Large Employer Mandate have been challenged in federal court and are subject to ongoing litigation. At various times, both the Contractor Mandate and the Large Employer Mandate have been subject to injunctions preventing their implementation and enforceability. At this time, it is not possible to predict with certainty whether the Contractor Mandate and Large Employer Mandate will be implemented at all or, if implemented, how they would affect us or our workforce. Both the Contractor Mandate and the Large Employer Mandate, if implemented and applied to the Company, may result in employee attrition, which could materially adversely affect future revenues and costs, and have a material adverse effect on our business and results of operations. Our number one priority is the health and safety of our associates and their families, our customers, and our other partners. We have taken and will continue to take measures to reduce the risk of infection and to protect our associates and our business, in line with guidelines issued by the authorities in the jurisdictions in which we operate, including federal, state and local governments and the Centers for Disease Control and Prevention. We have instituted enhanced safety procedures to safeguard the health and safety of our associates, including the use of additional protective equipment and the frequent cleaning of our facilities. We have restricted non-associate access to our sites, reorganized our workflows where permitted to maximize social distancing, implemented extensive restrictions on associate travel, and utilized remote working strategies where possible. The extent to which the COVID-19 pandemic, including new variants of COVID-19, will continue to impact the Company's business, financial condition and results of operations will depend on future developments, which are highly 20 -------------------------------------------------------------------------------- uncertain and depend on, among other things, the duration, spread, severity and impact of the COVID-19 pandemic, including emerging virus variants, the success and speed of ongoing vaccination efforts and efficacy of vaccines over time, the effects of the COVID-19 pandemic on the Company's customers, suppliers and vendors and the remedial actions and stimulus measures adopted by local and federal governments. Therefore, the Company cannot reasonably estimate future impacts of the COVID-19 pandemic at this time.
Our primary objective is to grow sales profitably while offering our customers highly technical and high-touch solutions to solve their most complex challenges on the plant floor. Our strategy is to complete the transition from being a spot-buy supplier to a mission-critical partner to our customers. We will selectively pursue strategic acquisitions that expand or complement our business in new and existing markets or further enhance the value and offerings we provide.
We utilize various indices when evaluating the level of our business activity, including the Metalworking Business Index (the "MBI") and the Industrial Production ("IP") index. Approximately 68% of our revenues came from sales in the manufacturing sector during the first quarter of fiscal year 2022. Through statistical analysis, we have found that trends in our customers' activity have correlated to changes in the MBI and the IP index. The MBI is a sentiment index developed from a monthly survey of the
U.S.metalworking industry, focusing on durable goods manufacturing. For the MBI, a value below 50.0 generally indicates contraction and a value above 50.0 generally indicates expansion. The IP index measures short-term changes in industrial production. Growth in the IP index from month to month indicates growth in the manufacturing, mining and utilities industries. Note that the composition of the IP index was revised by the Federal Reservein May 2021which adjusted, among other factors, the base year with which the IP index is calculated. This resulted in a lower level for the historical index in recent years, however the trend in the index continues to show growth as noted above. The MBI and the IP index over the three months ended November 2021and the average for the three- and 12-month periods ended November 2021were as follows: Period MBI IP Index September 57.6 100.1 October 61.8 101.8 November 59.9 102.3 Fiscal Year 2022 Q1 average 59.8 101.4 12-month average 59.6 99.9 During the three-month period ended November 27, 2021, the MBI average remained above 50.0, which indicated growth in manufacturing during the period. Similarly, the average IP index for the three months ended November 27, 2021increased to 101.4. The recent trending in these indices remains in line with the second half of fiscal year 2021, primarily due to the recovery in economic conditions related to the gradual lifting of government-imposed restrictions on economic activity and the abatement of the COVID-19 pandemic. See "Impact of COVID-19 on our Business" above. In calendar year 2021, including the three month period ended November 27, 2021, the United Stateshas seen significant levels of inflation, which has included higher prices for both labor and the products that the Company sells. The Company has sought, where possible, to implement price realization strategies that match or exceed the level of increased costs the Company faces. We will continue to monitor the current economic conditions for the impact on our customers and markets and assess both risks and opportunities that may affect our business and operations. 21
Thirteen week period ended
The table below summarizes the Company’s operating results both in dollars (in thousands) and as a percentage of net sales for the periods indicated:
Thirteen Weeks Ended November 27, 2021 November 28, 2020 Change $ % $ % $ % Net sales
$ 848,547100.0% $ 771,904100.0% $ 76,6439.9% Cost of goods sold 495,951 58.4% 448,586 58.1% 47,365 10.6% Gross profit 352,596 41.6% 323,318 41.9% 29,278 9.1% Operating expenses 256,581 30.2% 238,705 30.9% 17,876 7.5% Impairment loss, net - 0.0% 26,726 3.5% (26,726) (100.0)% Restructuring costs 5,283 0.6% 3,979 0.5% 1,304 32.8% Income from operations 90,732 10.7% 53,908 7.0% 36,824 68.3% Total other expense (4,122) (0.5)% (2,684) (0.3)% (1,438) 53.6% Income before provision for income taxes 86,610 10.2% 51,224 6.6% 35,386 69.1% Provision for income taxes 20,353 2.4% 12,447 1.6% 7,906 63.5% Net income 66,257 7.8% 38,777 5.0% 27,480 70.9% Less: Net income attributable to noncontrolling interest 190 0.0% 323 0.0% (133) (41.2)% Net income attributable to $ MSC Industrial 66,067 7.8% $ 38,4545.0% $ 27,61371.8% Net Sales Net sales increased 9.9%, or $76.6 million, to $848.5 millionfor the thirteen-week period ended November 27, 2021, as compared to $771.9 millionfor the same period in the prior fiscal year. The $76.6 millionincrease in net sales was comprised of approximately $53.7 millionof higher sales volume, $17.8 millionfrom improved pricing, inclusive of changes in customer and product mix, discounting and other items, $4.0 millionof net sales from fiscal year 2021 acquisitions, and $1.1 millionof favorable foreign exchange impact. Of the $76.6 millionincrease in net sales during the thirteen-week period ended November 27, 2021, national account customer sales increased by approximately $39.1 million, sales to our core and other customers increased by approximately $57.7 millionand sales from fiscal year 2021 acquisitions were $4.0 million, partially offset by a decrease in our government customer sales by approximately $24.2 million. The table below shows, among other things, the change in our average daily sales ("ADS") by total Company and by customer type for the thirteen-week period ended November 27, 2021, as compared to the same period in the prior fiscal year: ADS Percentage Change (Unaudited) Thirteen Weeks Ended November 27, 2021 November 28, 2020 Net Sales (in thousands) $ 848,547 $ 771,904 Sales Days 62 62 ADS(1) (in millions) $ 13.7 $ 12.5 Total Company ADS Percent Change 9.9% -6.3% Manufacturing Customers ADS Percent Change 15.7% -13.5% Manufacturing Customers Percent of Total Net Sales 68% 65% Non-Manufacturing Customers ADS Percent Change -0.6% 10.8% Non-Manufacturing Customers Percent of Total Net Sales 32% 35%
(1) ADS is calculated using the number of working days in
22 -------------------------------------------------------------------------------- We believe that our ability to transact business with our customers directly through the MSC website as well as through various other electronic portals gives us a competitive advantage over smaller suppliers. Sales made through our eCommerce platforms, including sales made through EDI systems, VMI systems, Extensible Markup Language ordering-based systems, vending, hosted systems and other electronic portals, represented 60.4% of consolidated net sales for the thirteen-week period ended
November 27, 2021, as compared to 60.7% of consolidated net sales for the same period in the prior fiscal year. These percentages of consolidated net sales do not include eCommerce sales from our recent acquisitions. Gross Profit Gross profit of $352.6 millionfor the thirteen-week-period ended November 27, 2021increased $29.3 million, or 9.1%, compared to the same period in the prior fiscal year. The gross profit margin of 41.6% decreased 0.3 percentage points when compared to the same period in the prior fiscal year. The positive spread between price and cost was more than offset by the negative impact of customer and product mix for the quarter.
Operating expenses increased 7.5%, or
$17.9 million, to $256.6 millionfor the thirteen-week period ended November 27, 2021, as compared to $238.7 millionfor the same period in the prior fiscal year. Operating expenses were 30.2% of net sales for the thirteen-week period ended November 27, 2021, as compared to 30.9% for the same period in the prior fiscal year. The increase in Operating expenses was primarily due to higher payroll and payroll-related costs as well as higher freight costs. Payroll and payroll-related costs for the thirteen-week period ended November 27, 2021were 57.0% of total Operating expenses, as compared to 56.4% for the same period in the prior fiscal year. Payroll and payroll-related costs, which include salary, incentive compensation, sales commission, and fringe benefit costs, increased by $11.7 millionfor the thirteen-week period ended November 27, 2021, as compared to the same period in the prior fiscal year. All of these costs, with the exception of sales commissions, increased for the thirteen-week period ended November 27, 2021, as compared to the same period in the prior fiscal year.
The transport costs were
Loss of value, net
September 2020, the Company prepaid approximately $26.7 millionfor the purchase of nitrile gloves to be sourced from manufacturers in Asiaand experienced significant delays in obtaining possession of this personal protective equipment ("PPE"). The Company evaluated the potential recoverability of these assets and, as a result, recorded an impairment charge of $26.7 millionin the first quarter of fiscal year 2021 to reflect the fact that the Company would not ultimately obtain this PPE or recover its related prepayment. This impairment charge was reflected in the unaudited Condensed Consolidated Statement of Income during the first quarter of fiscal year 2021. In the second half of fiscal year 2021, the Company entered into a legal settlement agreement with a vendor and, as a result, received $20.8 millionof loss recovery related to this prepayment, which was reflected in the unaudited Condensed Consolidated Statements of Income. The Company continues to pursue its legal avenues for recovery of the remaining loss.
$5.3 millionin restructuring costs for the thirteen-week period ended November 27, 2021, as compared to $4.0 millionfor the same period in the prior fiscal year. These charges include associate severance and separation costs, equity award acceleration costs and other exit-related costs. Restructuring costs for the same period in the prior fiscal year also include consulting costs related to the optimization of the Company's operations. See Note 9, "Restructuring Costs" in the Notes to Condensed Consolidated Financial Statements for additional information. 23
Income from operations
Income from operations increased 68.3%, or
$36.8 million, to $90.7 millionfor the thirteen-week period ended November 27, 2021, as compared to $53.9 millionfor the same period in the prior fiscal year. Income from operations as a percentage of net sales increased to 10.7% for the thirteen-week period ended November 27, 2021, as compared to 7.0% for the same period in the prior fiscal year. This increase was primarily attributable to the prior year impairment loss discussed above. Provision for Income Taxes The Company's effective tax rate for the thirteen-week period ended November 27, 2021was 23.5%, as compared to 24.3% for the same period in the prior fiscal year. The decrease in the effective tax rate was primarily due to a higher tax benefit from stock-based compensation.
Factors that affected the net income for the thirteen-week period ended
Liquidity and capital resources
November 27, August 28, 2021 2021 $ Change (Dollars in thousands) Total debt
$ 762,802 $ 786,049 $ (23,247)
Less: Cash and cash equivalents 62,875 40,536 22,339 Net debt
$ 699,927 $ 745,513 $ (45,586)Equity $ 1,193,034 $ 1,161,872 $ 31,162As of November 27, 2021, we had $62.9 millionin cash and cash equivalents, substantially all with well-known financial institutions. Historically, our primary financing needs have been to fund our working capital requirements necessitated by our sales growth and the costs of acquisitions, new products, new facilities, facility expansions, investments in vending solutions, technology investments, and productivity investments. Cash generated from operations, together with borrowings under our credit facilities and net proceeds from the private placement notes, have been used to fund these needs, to repurchase shares of the Company's Class A Common Stock, par value $0.001per share ("Class A Common Stock") from time to time, and to pay dividends to our shareholders. More recently, we have taken the actions discussed above under "Impact of COVID-19 on our Business" to improve our business operations, lower costs and preserve financial flexibility through the COVID-19 pandemic. As of November 27, 2021, total borrowings outstanding, representing amounts due under our credit facilities and notes, as well as all finance leases and financing arrangements, were $762.8 million, net of unamortized debt issuance costs of $1.7 million, as compared to total borrowings of $786.0 million, net of unamortized debt issuance costs of $1.9 million, as of the end of fiscal year 2021. The decrease was driven by repayments on our committed credit facility. See Note 6, "Debt" in the Notes to Condensed Consolidated Financial Statements for more information about these balances. We believe, based on our current business plan, that our existing cash, financial resources and cash flow from operations will be sufficient to fund necessary capital expenditures and operating cash requirements for at least the next 12 months. The Company further believes that its financial resources, along with managing discretionary expenses, will allow us to manage the anticipated further impact of the COVID-19 pandemic on our business operations for the foreseeable future, which will include reduced sales and net income levels for the Company. We will continue to evaluate our financial position in light of future developments, particularly those relating to the COVID-19 pandemic, and to take appropriate action as it is warranted. ? 24
The table below summarizes certain information concerning the Company’s cash flows for the periods indicated:
Thirteen Weeks Ended November 27, November 28, 2021 2020 (Dollars in thousands) Net cash provided by operating activities
Net cash used in investing activities (15,262)
Net cash used in financing activities (19,794)
Effect of foreign exchange rate changes on cash (409)
and cash equivalents Net increase (decrease) in cash and cash
Cash flow from operating activities
Net cash provided by operating activities was
$57.8 millionfor the thirteen weeks ended November 27, 2021compared to $103.2 millionfor the thirteen weeks ended November 28, 2020. The decrease was primarily due to the following: ?an increase in the change in accounts receivable and inventories primarily attributable to higher sales volume, and a decrease in the change in accounts payable and accrued expenses primarily due to prior year increases in income taxes payable and payroll taxes payable related to the CARES Act deferral that did not recur in the current year;
partially offset by an increase in net income as described above.
The table below summarizes certain information concerning the Company’s operations during the periods indicated:
November 27, August 28, November 28, 2021 2021 2020 (Dollars in thousands) Working Capital (1)
$ 762,133 $ 752,317 $ 634,329Current Ratio (2) 2.3 2.3 2.2 Days' Sales Outstanding (3) 61.8 61.1 57.7 Inventory Turnover (4) 3.3 3.4 3.3
(1) Working capital is calculated as current assets less current liabilities.
(2) The current ratio is calculated by dividing the total current assets by the total current liabilities.
(3) The number of days of outstanding sales corresponds to accounts receivable divided by net sales.
(4) Inventory turnover is calculated as the total cost of goods sold divided by inventory using a 13 month average of inventory.
Working capital and the current ratio remained substantially consistent with
August 28, 2021. The increases compared to November 28, 2020were primarily due to increases in accounts receivable and inventories and a decrease in dividends payable, partially offset by an increase in the current portion of debt. The increase in Accrued expenses and other current liabilities from August 28, 2021to November 27, 2021was due to the $41.7 millionin dividends payable. See Note 8, "Shareholders' Equity" in the Notes to Condensed Consolidated Financial Statements for more information about our dividends. The increase in days' sales outstanding as of November 27, 2021as compared to August 28, 2021and November 28, 2020was primarily due to the receivables portfolio consisting of a greater percentage of our national account program sales, which typically have longer payment terms.
Stock rotation at
Cash flow from investing activities
Net cash used in investing activities for the thirteen-week periods ended
Cash flow from financing activities
Net cash used in financing activities was
$19.8 millionfor the thirteen-weeks ended November 27, 2021compared to $167.7 millionfor the thirteen weeks ended November 28, 2020, primarily due to the following: ?net repayments on credit facilities of $24.0 millionduring the thirteen weeks ended November 27, 2021compared to net repayments of $130.0 millionduring the thirteen weeks ended November 28, 2020; ?no dividends paid during the thirteen weeks ended November 27, 2021(dividend declared on October 14, 2021was paid on November 30, 2021) compared to $41.8 millionof dividends paid during the thirteen weeks ended November 28, 2020;
? repurchases of Class A ordinary shares of
?proceeds from the exercise of stock options of
$7.1 millionduring the thirteen weeks ended November 27, 2021compared to $5.6 millionduring the thirteen weeks ended November 28, 2020. Capital Expenditures
We continue to invest in sales productivity initiatives, e-commerce and sales platforms, customer fulfillment centers and distribution networks, as well as other infrastructure and technologies.
April 2017, the Company entered into a $600.0 millionrevolving credit facility which was subsequently amended and extended in August 2021. As of November 27, 2021, the Company also had three uncommitted credit facilities, totaling $208.0 millionof aggregate maximum uncommitted availability. See Note 6, "Debt" in the Notes to Condensed Consolidated Financial Statements for more information about our credit facilities. As of November 27, 2021, we were in compliance with the operating and financial covenants of our credit facilities. The current unused balance of $341.8 millionfrom the revolving credit facility, which is reduced by outstanding letters of credit, is available for working capital purposes if necessary. See Note 6, "Debt" in the Notes to Condensed Consolidated Financial Statements for more information about these balances.
Private placement debt and pre-sale facility agreements
July 2016, we completed the issuance and sale of unsecured senior notes. In January 2018, we entered into two note purchase and private shelf agreements (together, the "Shelf Agreements"). In June 2018and March 2020, we entered into additional note purchase agreements. Pursuant to the terms of the Shelf Agreements, no new unsecured senior notes may be issued and sold after January 12, 2021. See Note 6, "Debt" in the Notes to Condensed Consolidated Financial Statements for more information about these transactions.
From time to time, we enter into financing arrangements with vendors to purchase certain information technology equipment or software. See Note 6, "Debt" in the Notes to Condensed Consolidated Financial Statements for more information about our financing arrangements. Leases As of
November 27, 2021, certain of our operations were conducted on leased premises. These leases are for varying periods, the longest extending to fiscal year 2031. In addition, we are obligated under certain equipment and automobile operating and finance leases, which expire on varying dates through fiscal year 2026. See Note 7, "Leases" in the Notes to Condensed Consolidated Financial Statements for more information about our finance and operating leases.
Critical accounting estimates
On an ongoing basis, we evaluate our critical accounting policies and estimates, including those related to revenue recognition, inventory valuation, allowance for credit losses, warranty reserves, contingencies and litigation, income taxes, accounting for goodwill and long-lived assets, stock-based compensation, and business combinations. We make estimates, judgments and assumptions in determining the amounts reported in the unaudited Condensed Consolidated Financial Statements and accompanying Notes. Estimates are based on historical experience and on various other assumptions that are 26
considered reasonable in the circumstances. The estimates are used to form the basis for making judgments about the book values of assets and liabilities and the amount of reported income and expenditure that is not readily apparent from other sources. Actual results may differ from these estimates.
There have been no material changes outside the ordinary course of business in the Company's critical accounting policies, as disclosed in its Annual Report on Form 10-K for the fiscal year ended
August 28, 2021.
Recently published accounting standards
See note 1, “Basis of presentation” in the notes to the condensed consolidated financial statements.
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