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MSM > SEC Filings for MSM > Form 10-Q on 9-Jan-2014All Recent SEC Filings

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Form 10-Q for MSC INDUSTRIAL DIRECT CO INC


9-Jan-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is intended to update the information contained in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 2013 and presumes that readers have access to, and will have read, "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in such Annual Report on Form 10-K.

Overview

MSC Industrial Direct Co., Inc. (together with its subsidiaries, "MSC," the "Company," "we," "our," or "us") is one of the largest direct marketers and distributors of a broad range of metalworking and maintenance, repair, and operations ("MRO") products to customers throughout North America. Our goal is to become the preferred supplier of MRO supplies for businesses throughout North America. We continue to implement our strategies to gain market share against other suppliers and generate new customers, increase sales to existing customers and diversify our customer base.

We offer approximately 725,000 stock-keeping units ("SKUs"), excluding BDNA, through our master catalogs; weekly, monthly and quarterly specialty and promotional catalogs; newspapers; brochures; and the Internet, including our websites, MSCDirect.com, MSCMetalworking.com and Use-Enco.com (the "MSC Websites"). We service our customers from 14 customer fulfillment centers and 104 branch offices. We employ one of the industry's largest sales forces. Most 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. Excluding BDNA, we offer a nationwide cutoff time of 8:00 PM Eastern Time on qualifying orders for customers in the contiguous United States, which will be delivered to customers the next day at no additional cost over standard MSC ground delivery charges.

Net sales increased 17.5%, or approximately $101.0 million for the thirteen week period ended November 30, 2013 compared to the same period in the prior fiscal year. As discussed below, during the fiscal third quarter of 2013, we acquired substantially all of the assets and assumed certain liabilities of BDNA. BDNA contributed $72.4 million of net sales for the thirteen week period ended November 30, 2013. Our financial results for the thirteen week periods ended November 30, 2013 and December 1, 2012 reflect execution of our growth strategies, including acquisitions, to increase revenues. We have also invested in our business by increasing our sales force, increasing our investment in vending solutions, making technology investments to improve our electronic procurement tools, and making productivity and infrastructure investments. We believe these investments, combined with our strong balance sheet, extensive product assortment, high in-stock levels, same day shipping, and high levels of execution, have increased our competitive advantage over smaller distributors.

Key manufacturing measurements, such as the Institute for Supply Management ("ISM") index, evidenced an expanding manufacturing sector environment throughout most of fiscal year 2013 and the trend has continued through our fiscal first quarter of 2014, with the most recent ISM index in December 2013 of 57.0%. During this time, we experienced a divergence between the ISM index and the core metalworking manufacturing sector that is more reflective of our business environment. In particular, metalworking related indices continued contracting during fiscal year 2013. This rate of contraction slowed during our fourth quarter of fiscal 2013 and this trend has continued through the first quarter of fiscal 2014. We will continue to monitor the current economic conditions for its impact on our customers and markets and continue to assess both risks and opportunities that may affect our business. See the discussion below describing recent fluctuations in economic indicators and the possible impact on our future sales and margins.

Our gross profit margin was 46.4% for the thirteen week period ended November 30, 2013, as compared to 45.9% for the same period in the prior fiscal year. The increase in gross margin was primarily driven by higher gross margins from BDNA, partially offset by increases in product costs, changes in customer and product mix and lower gross margins from our vending programs.

Operating expenses increased 34.0% or $55.4 million for the thirteen week period ended November 30, 2013, as compared to the same period in the prior fiscal year, as a result of the acquired BDNA operations as well as non-recurring integration costs associated with the acquisition. BDNA's operating expenses accounted for approximately $35.7 million of total operating expenses for the thirteen week period ended November 30, 2013. We incurred operating expenses of approximately $3.8 million for the thirteen week period ended


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November 30, 2013 related to non-recurring integration costs. Excluding BDNA, operating expenses increased as a result of increased payroll and payroll related costs, costs associated with our investment programs, and costs related to the establishment of our new co-located headquarters in Davidson, North Carolina. For the thirteen week periods ended November 30, 2013 and December 1, 2012, our operating margins were 14.3% and 17.7%, respectively.

We expect operating costs to continue to increase throughout fiscal year 2014 as compared to fiscal year 2013 due to increased expenses related to inclusion of a full year of BDNA operations, non-recurring integration costs and restructuring charges, increased compensation expenses and fringe benefits costs, and increased costs associated with executing on our vending and other investment programs. In addition, we expect increased costs associated with our co-located headquarters in Davidson, North Carolina and we also expect to incur operating costs associated with the establishment of our new customer fulfillment center in Columbus, Ohio. We will continue to opportunistically seek additional growth opportunities that will help position us for future expansion. We believe that cash flows from operations, available cash and funds available under our revolving credit facility will be adequate to support our operations and growth plans for the next twelve months.

The ISM index, which measures the economic activity of the U.S. manufacturing sector, is important to our planning because it historically has been an indicator of our manufacturing customers' activity. A substantial portion of our revenues came from sales in the manufacturing sector during the first quarter of fiscal 2014, including certain national account customers. An ISM index reading below 50.0% generally indicates that the manufacturing sector is expected to contract. Conversely, an ISM index reading above 50.0% generally indicates that the manufacturing sector is expected to expand. The ISM index was 57.0% for the month of December 2013 and averaged 53.9% for the past twelve months. Details released with the most recent index indicate that economic activity in the manufacturing sector related to new orders, production, and employment are growing, while inventories are contracting from the previous month. Although the most recent measurement trend indicates that the manufacturing sector is expanding, there remains uncertainty relating to the current economic environment. Moreover, as discussed above, we have experienced continued contraction in our core metalworking manufacturing sector. Continued concerns relating to macroeconomic factors may continue to influence our customers to be more cautious in their purchases of MSC's products. In particular, growth in sales to governmental agencies continues to be constrained by the government spending environment. Sales to our government accounts represented approximately 8% of our total sales during the thirteen week period ended November 30, 2013 compared to 9% for the thirteen week period ended December 1, 2012.

We are continuing to take advantage of our strong balance sheet, which enables us to maintain or extend credit to our credit worthy customers and maintain optimal inventory and service levels to meet customer demands during these challenging economic conditions, while many of our smaller competitors in our fragmented industry continue to have difficulties in offering competitive service levels. We also believe that customers will continue to seek cost reductions and shorter cycle times from their suppliers. Our business model focuses on providing overall procurement cost reduction and just-in-time delivery to meet our customers' needs. 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 drive cost reduction throughout our business through cost saving strategies and increased leverage from our existing infrastructure, and continue to provide additional procurement cost savings solutions to our customers through technology such as our CMI, VMI, and vending programs.

On April 22, 2013, we acquired substantially all of the assets and assumed certain liabilities of BDNA, pursuant to the terms of the Asset Purchase Agreement, dated February 22, 2013, between us and Barnes. In connection with the acquisition, the total cash consideration we paid to Barnes was $547.3 million which is net of a post-closing working capital adjustment in the amount of $1.4 million that we received in September 2013. The acquisition was funded in part with borrowings under our new unsecured credit facility, which was closed simultaneously with the acquisition, and the remainder was funded from available cash reserves. BDNA is a leading distributor of fasteners and other high margin, low cost consumables with a broad distribution footprint throughout the U.S. and Canada. BDNA has a strong presence with customers across manufacturing, government, transportation and natural resources end-markets. BDNA specializes in


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lowering the total cost of their customers' inventory management through storeroom organization and vendor managed inventory. With this acquisition, we add a highly complementary provider of fasteners and other high margin consumable products and services (often referred to as "Class C" items) with an experienced field sales force and VMI solution. With the integration of the two businesses, we will have the opportunity to bring our MRO offering to BDNA's customers, and BDNA's Class C offering and VMI system to our customers. As a result of the BDNA acquisition, we incurred non-recurring transaction and integration costs and restructuring charges associated with associate severance costs, stay bonuses and the impairment of long-lived assets due to the closure of facilities. Integration costs and restructuring charges are estimated to be between approximately $10.0 million and $15.0 million throughout the remainder of fiscal year 2014.

Results of Operations

Net Sales

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                              Thirteen Weeks Ended
                     November 30, 2013     December 1, 2012      Percentage Change
                                         (Dollars in thousands)
Net Sales           $         678,510     $         577,491               17.5 %

Net sales increased 17.5%, or approximately $101.0 million, for the thirteen week period ended November 30, 2013, as compared to the same period in the prior fiscal year. We estimate that this $101.0 million increase in net sales is comprised of $72.4 million from the BDNA operations, which we acquired in April 2013, approximately $27.6 million is volume related and approximately $1.0 million is from improved price realization, which includes the effects of price increases, discounting, changes in sales and product mix, and other items. Of the above $101.0 million increase in net sales, our government and national account programs ("Large Account Customer") increased by approximately $11.9 million and there was an increase in our remaining business of approximately $89.1 million.

The table below shows the pattern to the change in our fiscal quarterly average daily sales from the same period in the prior fiscal year:

             Average Daily Sales Percentage Change - Total Company
                                  (unaudited)

[[Image Removed]]   [[Image Removed]]
                          Thirteen
Fiscal Periods       Week Period Ended
                         Fiscal Q1
2014 vs. 2013                 17.5 %
2013 vs. 2012                  5.8 %

Excluding BDNA operations, the trends noted above can be further analyzed by customer type. Approximately 76% of our business is with manufacturing customers and our non-manufacturing customers represent approximately 24% of our business. BDNA operations are excluded from the tables below until we have annual comparative information. The table below shows the pattern to the change in our fiscal quarterly average daily sales by customer type from the same period in the prior fiscal year.

        Average Daily Sales Percentage Change - Manufacturing Customers
                         (unaudited and excluding BDNA)

[[Image Removed]]   [[Image Removed]]
                          Thirteen
Fiscal Periods          Week Period
                           Ended
                         Fiscal Q1
2014 vs. 2013                 5.1 %
2013 vs. 2012                 6.2 %


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      Average Daily Sales Percentage Change - Non-Manufacturing Customers
                         (unaudited and excluding BDNA)

[[Image Removed]]   [[Image Removed]]
                          Thirteen
Fiscal Periods          Week Period
                           Ended
                         Fiscal Q1
2014 vs. 2013                 3.9 %
2013 vs. 2012                 4.9 %

Exclusive of BDNA operations and customers in the U.K, average order size increased to approximately $405 for the first quarter of fiscal 2014 as compared to $402 in the first quarter of fiscal 2013. We believe that our ability to transact business with our customers through various electronic portals and directly through the MSC Websites gives us a competitive advantage over smaller suppliers. Sales made through our eCommerce platforms, includes sales made through Electronic Data Interchange systems, VMI systems, Extensible Markup Language ordering based systems, vending machine systems, hosted systems and other electronic portals, but excluding BDNA, were $279.0 million for the first quarter of fiscal 2014, representing 46.0% of consolidated net sales, compared to $246.9 million for the first quarter of fiscal 2013, representing 42.8% of consolidated net sales.

We grew our field sales associate headcount to 1,818 at November 30, 2013, an increase of approximately 66.3% from field sales associates of 1,093 at December 1, 2012. Included in the sales force numbers at November 30, 2013 are 687 field sales associates related to BDNA sales force. We plan to continue to increase our field sales associate headcount through the end of fiscal 2014. We will continue to manage the timing of our sales force expansion based on economic conditions and our selected mix of growth investments.

In fiscal 2014, in the MSC catalog distributed in September 2013, we added approximately 18,000 new SKUs and removed approximately 12,250 SKUs. Approximately 22% of the new SKUs are MSC private brands. SKUs are primarily removed as they are consolidated to other items providing our customers equal or higher value and are consistent with our margin expansion initiatives. Our objective is to continuously and significantly increase the number of SKUs available to our customers through our eCommerce, telesales and catalog channels. We executed on our SKU expansion plan during the first quarter of fiscal 2014 by introducing approximately 40,000 new SKUs to the market through our eCommerce channels, bringing our total active, saleable SKU count to approximately 1,065,000 and our total SKUs available for order via the web to approximately 725,000, excluding BDNA. We expect this SKU expansion plan through our eCommerce channels to continue throughout fiscal 2014.

Gross Profit

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                                             Thirteen Weeks Ended
                       November 30, 2013       December 1, 2012      Percentage Change
                                            (Dollars in thousands)
Gross Profit          $       314,855        $       265,089                  18.8 %
Gross Profit Margin              46.4 %                 45.9 %

Gross profit margin increased for the thirteen week period ended November 30, 2013 primarily as a result of higher gross margins from BDNA. This was partially offset by increases in product costs, changes in customer and product mix and lower gross margins from our vending programs.

Operating Expenses

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                                                Thirteen Weeks Ended
                          November 30, 2013       December 1, 2012      Percentage Change
                                               (Dollars in thousands)
Operating Expenses       $       218,105        $       162,737                  34.0 %
Percentage of Net                   32.1 %                 28.2 %
Sales


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The increase in operating expenses as a percentage of net sales for the thirteen week period ended November 30, 2013, as compared to the same period in the prior fiscal year, was primarily a result of additional operating expenses incurred as a result of the acquired BDNA operations as well as non-recurring integration costs associated with the acquisition.

The increase in operating expenses in dollars for the thirteen week period ended November 30, 2013, as compared to the same period in the prior fiscal year, was primarily a result of additional operating expenses incurred as a result of the acquired BDNA operations as well as non-recurring integration costs associated with the acquisition. BDNA's operating expenses accounted for approximately $35.7 million of total operating expenses for the thirteen week period ended November 30, 2013. Approximately $3.8 million of expenses related to non-recurring integration costs associated with the BDNA acquisition were also included in operating expenses for the thirteen week period ended November 30, 2013. Excluding BDNA, operating expenses increased primarily due to increased incentive compensation, an increase in payroll and payroll related costs, increased costs associated with our vending program, increased advertising expense and approximately $2.0 million of non-recurring relocation costs associated with the establishment of our new co-located headquarters in Davidson, North Carolina.

Payroll and payroll related costs represented approximately 54.1% of total operating expenses for the thirteen week period ended November 30, 2013, as compared to approximately 54.5% for the same period in the prior fiscal year. Included in these costs are salary, incentive compensation, and sales commission. These costs increased for the thirteen week period ended November 30, 2013, as compared to the same period in the prior fiscal year, primarily due to increased costs associated with the acquired BDNA operations, increased incentive compensation as the fiscal 2014 bonus payout is expected to be at higher levels than fiscal 2013, and an increase in our staffing levels primarily related to sales associates, other program development and volume related positions to support our growth initiatives as well as significant investments in vending programs. Payroll and payroll related costs decreased as a percentage of operating expenses for the thirteen week period ended November 30, 2013 as compared to the same period in the prior fiscal year as a result of increased other operating expenses due to the factors discussed above.

We experienced an increase in the medical costs of our self-insured group health plan for the thirteen week period ended November 30, 2013 compared to the same period in the prior fiscal year. There was an increase in the number of participants in the plan as a result of the BDNA acquisition, which resulted in an increase in the number of medical claims filed. The number of medical claims filed increased 27.9% for the thirteen week period ended November 30, 2013 compared to the same period in the prior fiscal year. Also, the average cost per claim increased by 21.8% for the thirteen week period ended November 30, 2013 as compared to the same period in the prior fiscal year.

Freight expense was approximately $28.5 million and $24.5 million, for the thirteen week periods ended November 30, 2013 and December 1, 2012, respectively. The primary driver of this increase was increased sales.

Income from Operations

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                                               Thirteen Weeks Ended
                         November 30, 2013       December 1, 2012       Percentage Change
                                              (Dollars in thousands)
Income from                      96,750        $       102,352                 (5.5 )%
Operations
Percentage of Net                  14.3 %                 17.7 %
Sales

The decrease in income from operations for the thirteen week period ended November 30, 2013, as compared to the same period in the prior fiscal year, was primarily attributable to the increase in operating expenses, offset in part by increases in in net sales and gross profit described above. Income from operations as a percentage of net sales also decreased for the thirteen week period ended November 30, 2013, as compared to the same period in the prior fiscal year due to those same factors.


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Provision for Income Taxes

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                                               Thirteen Weeks Ended
                         November 30, 2013       December 1, 2012       Percentage Change
                                              (Dollars in thousands)
Provision for Income    $        36,650        $        39,140                 (6.4 )%
Taxes
Effective Tax Rate                38.30 %                38.25 %

The effective tax rate for the thirteen week period ended November 30, 2013 was 38.30% compared to 38.25% for the comparable period in the prior fiscal year.

Net Income

[[Image Removed]]         [[Image Removed]]     [[Image Removed]]     [[Image Removed]]
                                                Thirteen Weeks Ended
                           November 30, 2013     December 1, 2012       Percentage Change
                                               (Dollars in thousands)
Net Income                $          59,046     $          63,187              (6.6 )%
Diluted Earnings Per      $            0.93     $            1.00              (7.0 )%
Share

The factors which affected net income for the thirteen week period ended November 30, 2013, as compared to the same period in the previous fiscal year, have been discussed above.

Liquidity and Capital Resources

As of November 30, 2013, we held $48.4 million in cash and cash equivalent funds. We maintain a substantial portion of our cash, and invest our cash equivalents, with well-known financial institutions. Historically, our primary capital needs have been to fund our working capital requirements necessitated by our sales growth, the costs of acquisitions, adding new products, facilities expansions, investments in vending solutions, technology investments, and productivity investments. Cash generated from operations, together with borrowings under credit facilities, have been used to fund these needs, to repurchase shares of our Class A common stock, and to pay dividends. At November 30, 2013, total borrowings outstanding, representing amounts due under the credit facility (discussed below) and all capital leases and financing arrangements, were approximately $322.0 million. At August 31, 2013, total borrowings outstanding, representing amounts due under all capital leases and financing arrangements, were approximately $255.8 million.

On April 22, 2013, in connection with the acquisition of BDNA, we entered into a new $650.0 million credit facility (the "New Credit Facility"). The New Credit Facility, which matures on April 22, 2018, provides for a five-year unsecured revolving loan facility in the aggregate amount of $400.0 million and a five-year unsecured term loan facility in the aggregate amount of $250.0 million. The New Credit Facility replaced our $200.0 million former credit facility dated June 8, 2011.

The New Credit Facility also permits us, at our request, and upon the satisfaction of certain conditions, to add one or more incremental term loan facilities and/or increase the revolving loan commitments in an aggregate amount not to exceed $200.0 million. Subject to certain limitations, each such incremental term loan facility or revolving commitment increase will be on terms as agreed to by us, the Administrative Agent and the lenders providing such financing.

Borrowings under the New Credit Facility bear interest, at our option, either, at (i) the LIBOR (London Interbank Offered Rate) rate plus the applicable margin for LIBOR loans ranging from 1.00% to 1.375%, based on our consolidated leverage ratio; or (ii) the greatest of (a) the Administrative Agent's prime rate in effect on such day, (b) the federal funds effective rate in effect on such day, plus 0.50% and (c) the LIBOR rate that would be calculated as of such day in respect of a proposed LIBOR loan with a one-month interest period, plus 1.00%, plus, in the case of each of clauses (a) through (c), an applicable margin ranging from 0.00% to 0.375%, based on our consolidated leverage ratio. Based on the interest period we select, interest may be payable every one, two, three or six months. Interest is reset at the end of each interest period. We currently elect to have loans under the New Credit Facility bear interest based on LIBOR with one-month interest periods.


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We are required to pay a quarterly undrawn fee ranging from 0.10% to 0.20% per annum on the unutilized portion of the New Credit Facility based on our consolidated leverage ratio. We are also required to pay quarterly letter of credit usage fees ranging between 1.00% to 1.375% (based on our consolidated leverage ratio) on the amount of the daily average outstanding letters of credit, and a quarterly fronting fee of 0.125% per annum on the undrawn and unexpired amount of each letter of credit.

The New Credit Facility contains several restrictive covenants including the . . .

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