0001003078-19-000035.txt : 20190109 0001003078-19-000035.hdr.sgml : 20190109 20190109151341 ACCESSION NUMBER: 0001003078-19-000035 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 57 CONFORMED PERIOD OF REPORT: 20181201 FILED AS OF DATE: 20190109 DATE AS OF CHANGE: 20190109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MSC INDUSTRIAL DIRECT CO INC CENTRAL INDEX KEY: 0001003078 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-INDUSTRIAL MACHINERY & EQUIPMENT [5084] IRS NUMBER: 113289165 STATE OF INCORPORATION: NY FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-14130 FILM NUMBER: 19518112 BUSINESS ADDRESS: STREET 1: 75 MAXESS RD CITY: MELVILLE STATE: NY ZIP: 11747 BUSINESS PHONE: 516-812-2000 MAIL ADDRESS: STREET 1: 75 MAXESS ROAD CITY: MELVILLE STATE: NY ZIP: 11747 10-Q 1 msm-20181201x10q.htm 10-Q 20181201 10Q Q1





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

__________________________________________

FORM 10-Q

__________________________________________



 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended December 1, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For transition period from           to



Commission File No.: 1-14130

__________________________________________

MSC INDUSTRIAL DIRECT CO., INC.

(Exact name of registrant as specified in its charter)

__________________________________________

 

 

New York
(State or Other Jurisdiction of
Incorporation or Organization)

11-3289165
(I.R.S. Employer Identification No.)

 

 

75 Maxess Road, Melville, New York
(Address of principal executive offices)

11747
(Zip Code)



(516) 812-2000

(Registrant’s telephone number, including area code)

__________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a  smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



 

Large accelerated

filer 

Accelerated

filer 

Non‑accelerated filer 

Smaller reporting

company 

Emerging growth

company 



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   No 

As of December 18, 2018, 45,146,984 shares of Class A common stock and 10,193,348 shares of Class B common stock of the registrant were outstanding.

 

 


 

SAFE HARBOR STATEMENT

This Quarterly Report on Form 10-Q (the “Report”) contains forward‑looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Discussions containing such forward‑looking statements may be found in Items 2 and 3 of Part I and Item 1 of Part II of this Report, as well as within this Report generally. The words “believes,” “anticipates,” “thinks,” “expects,” “estimates,” “plans,” “intends,” and similar expressions are intended to identify forward‑looking statements. In addition, any statements which refer to expectations, projections or other characterizations of future events or circumstances are forward‑looking statements. We undertake no obligation to publicly disclose any revisions to these forward‑looking statements to reflect events or circumstances occurring subsequent to filing this Report with the Securities and Exchange Commission (the “SEC”). These forward‑looking statements are subject to risks and uncertainties, including, without limitation, those discussed in this section and Items 2 and 3 of Part I, as well as in Part II, Item 1A, “Risk Factors” of this Report, and in Part I, Item 1A, “Risk Factors” and in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended September 1, 2018. In addition, new risks emerge from time to time and it is not possible for management to predict all such risk factors or to assess the impact of such risk factors on our business. Accordingly, future results may differ materially from historical results or from those discussed or implied by these forward‑looking statements. Given these risks and uncertainties, the reader should not place undue reliance on these forward‑looking statements. These risks and uncertainties include, but are not limited to:

·

general economic conditions in the markets in which the Company operates;

·

changing customer and product mixes;

·

competition, including the adoption by competitors of aggressive pricing strategies and sales methods;

·

industry consolidation and other changes in the industrial distribution sector;

·

volatility in commodity and energy prices;

·

the outcome of government or regulatory proceedings or future litigation;

·

credit risk of our customers;

·

risk of customer cancellation or rescheduling of orders;

·

work stoppages or other business interruptions (including those due to extreme weather conditions) at transportation centers, shipping ports, our headquarters or our customer fulfillment centers;

·

dependence on our information systems and the risks of business disruptions arising from changes to our information systems and disruptions due to catastrophic events, power outages, natural disasters, computer system or network failures, computer viruses, physical or electronic break-ins and cyberattacks;  

·

recent U.S. tax legislation and increased volatility in the effective tax rate;

·

retention of key personnel;

·

retention of qualified sales and customer service personnel and metalworking specialists;

·

risk of loss of key suppliers, key brands or supply chain disruptions;

·

changes to trade policies, including the impact from significant restrictions or tariffs;

·

opening or expanding our customer fulfillment centers;

·

litigation risk due to nature of our business;

·

risks associated with the integration of acquired businesses or other strategic transactions;

·

financial restrictions on outstanding borrowings;

·

failure to comply with applicable environmental, health and safety laws and regulations;

·

goodwill and intangible assets recorded resulting from our acquisitions could be impaired;

·

common stock price may be volatile; and

·

our principal shareholders exercise significant control over us.

 

2


 

MSC INDUSTRIAL DIRECT CO., INC.

INDEX



 

 



 

Page

PART I.  FINANCIAL INFORMATION

 

Item 1.

Condensed Consolidated Financial Statements (Unaudited)

 



Condensed Consolidated Balance Sheets as of December 1, 2018 and September 1, 2018

4



Condensed Consolidated Statements of Income for the Thirteen Weeks Ended December 1,  2018 and December 2, 2017

5



Condensed Consolidated Statements of Comprehensive Income for the Thirteen Weeks Ended December 1, 2018 and December 2, 2017

6



Condensed Consolidated Statement of Shareholders’ Equity for the Thirteen Weeks Ended December 1, 2018

7



Condensed Consolidated Statements of Cash Flows for the Thirteen Weeks Ended December 1, 2018 and December 2, 2017

8



Notes to Condensed Consolidated Financial Statements

9

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

24

Item 4.

Controls and Procedures

24

PART II.  OTHER INFORMATION

 

Item 1.

Legal Proceedings

25

Item 1A.

Risk Factors

25 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

25

Item 3.

Defaults Upon Senior Securities

26

Item 4.

Mine Safety Disclosures

26

Item 5.

Other Information

26 

Item 6.

Exhibits

27 

SIGNATURES

28 





 

3


 

PART I. FINANCIAL INFORMATION

Item 1.  Condensed Consolidated Financial Statements

MSC INDUSTRIAL DIRECT CO., INC.

Condensed Consolidated Balance Sheets

(In thousands, except share data)







 

 

 

 

 



 

 

 

 

 



December 1,

 

September 1,



2018

 

2018



(Unaudited)

 

 

ASSETS

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

$

11,615 

 

$

46,217 

Accounts receivable, net of allowance for doubtful accounts of $14,964 and $12,992, respectively

 

531,406 

 

 

523,892 

Inventories

 

527,984 

 

 

518,496 

Prepaid expenses and other current assets

 

60,928 

 

 

58,902 

Total current assets

 

1,131,933 

 

 

1,147,507 

Property, plant and equipment, net

 

307,586 

 

 

311,685 

Goodwill

 

674,464 

 

 

674,998 

Identifiable intangibles, net

 

119,762 

 

 

122,724 

Other assets

 

31,053 

 

 

31,813 

Total assets

$

2,264,798 

 

$

2,288,727 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Short-term debt

$

210,979 

 

$

224,097 

Accounts payable

 

154,896 

 

 

145,133 

Accrued liabilities

 

111,241 

 

 

121,293 

Total current liabilities

 

477,116 

 

 

490,523 

Long-term debt

 

311,656 

 

 

311,236 

Deferred income taxes and tax uncertainties

 

99,714 

 

 

99,714 

Total liabilities

 

888,486 

 

 

901,473 

Commitments and Contingencies

 

 

 

 

 

Shareholders’ Equity:

 

 

 

 

 

Preferred stock; $0.001 par value; 5,000,000 shares authorized; none issued and outstanding 

 

 —

 

 

 —

Class A common stock (one vote per share); $0.001 par value; 100,000,000 shares authorized; 54,381,687 and 54,649,158 shares issued, respectively

 

54 

 

 

55 

Class B common stock (ten votes per share); $0.001 par value; 50,000,000 shares authorized; 10,193,348 and 10,454,765 shares issued and outstanding, respectively

 

10 

 

 

10 

Additional paid-in capital

 

660,185 

 

 

657,749 

Retained earnings

 

1,316,489 

 

 

1,325,822 

Accumulated other comprehensive loss 

 

(20,975)

 

 

(19,634)

Class A treasury stock, at cost, 9,234,703 and 9,207,635 shares, respectively

 

(579,451)

 

 

(576,748)

Total shareholders’ equity

 

1,376,312 

 

 

1,387,254 

Total liabilities and shareholders’ equity

$

2,264,798 

 

$

2,288,727 



 

 

 

 

 

See accompanying notes to condensed consolidated financial statements.



 

 

 

 

 

 

4


 

MSC INDUSTRIAL DIRECT CO., INC.

Condensed Consolidated Statements of Income

(In thousands, except per share data)

(Unaudited)







 

 

 

 

 



Thirteen Weeks Ended



December 1,

 

December 2,



2018

 

2017

Net sales

$

831,597 

 

$

768,561 

Cost of goods sold

 

473,612 

 

 

433,492 

Gross profit

 

357,985 

 

 

335,069 

Operating expenses

 

254,985 

 

 

235,791 

Income from operations

 

103,000 

 

 

99,278 

Other (expense) income:

 

 

 

 

 

Interest expense

 

(4,056)

 

 

(3,237)

Interest income

 

162 

 

 

163 

Other (expense) income, net

 

 

 

(408)

Total other expense

 

(3,892)

 

 

(3,482)

Income before provision for income taxes

 

99,108 

 

 

95,796 

Provision for income taxes

 

24,876 

 

 

36,211 

Net income

$

74,232 

 

$

59,585 

Per share information:

 

 

 

 

 

Net income per common share:

 

 

 

 

 

Basic

$

1.34 

 

$

1.06 

Diluted

$

1.33 

 

$

1.05 

Weighted average shares used in computing net income per common share:

 

 

 

 

 

Basic

 

55,502 

 

 

56,287 

Diluted

 

55,831 

 

 

56,504 

Cash dividends declared per common share

$

0.63 

 

$

0.48 



 

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

 



5


 

MSC INDUSTRIAL DIRECT CO., INC.

Condensed Consolidated Statements of Comprehensive Income

 (In thousands)

(Unaudited)







 

 

 

 

 

 



 

Thirteen Weeks Ended



 

December 1,

 

December 2,



 

2018

 

2017

Net income, as reported

 

$

74,232 

 

$

59,585 

Other comprehensive income, net of tax:

 

 

 

 

 

 

  Foreign currency translation adjustments

 

 

(1,341)

 

 

(843)

Comprehensive income (1)

 

$

72,891 

 

$

58,742 

__________________________

 

 

 

 

 

 

(1) There were no material taxes associated with other comprehensive income during the thirteen-week periods ending December 1, 2018 and December 2, 2017, respectively.



 

 

 

 

 

 



 

 

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

 



 

6


 

MSC INDUSTRIAL DIRECT CO., INC.

Condensed Consolidated Statement of Shareholders’ Equity

Thirteen Weeks Ended December 1, 2018

(In thousands)

(Unaudited)







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Class A
Common Stock

 

Class B
Common Stock

 

Additional

 

 

 

 

Accumulated
Other

 

Class A
Treasury Stock

 

 

 



 

Shares

 

Amount

 

Shares

 

Amount

 

Paid-In Capital

 

Retained
Earnings

 

Comprehensive
Loss

 

Shares

 

Amount
at Cost

 

Total

Balance at September 1, 2018

 

54,649 

 

$

55 

 

10,455 

 

$

10 

 

$

657,749 

 

$

1,325,822 

 

$

(19,634)

 

9,208 

 

$

(576,748)

 

$

1,387,254 

Exchange of Class B common stock for Class A common stock

 

262 

 

 

 —

 

(262)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

Exercise of common stock options

 

118 

 

 

 —

 

 —

 

 

 —

 

 

9,329 

 

 

 —

 

 

 —

 

 —

 

 

 —

 

 

9,329 

Common stock issued under associate stock purchase plan

 

 —

 

 

 —

 

 —

 

 

 —

 

 

457 

 

 

 —

 

 

 —

 

(13)

 

 

497 

 

 

954 

Shares issued upon vesting of restricted stock units, including dividend equivalent units

 

91 

 

 

 —

 

 —

 

 

 —

 

 

363 

 

 

 —

 

 

 —

 

 —

 

 

 —

 

 

363 

Stock-based compensation

 

 —

 

 

 —

 

 —

 

 

 —

 

 

4,174 

 

 

 —

 

 

 —

 

 —

 

 

 —

 

 

4,174 

Repurchases of common stock

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

40 

 

 

(3,200)

 

 

(3,200)

Repurchase and retirement of common stock

 

(738)

 

 

(1)

 

 

 

 

 

 

 

(11,887)

 

 

(48,439)

 

 

 —

 

 —

 

 

 —

 

 

(60,327)

Cash dividends paid on Class A common stock

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(28,436)

 

 

 —

 

 —

 

 

 —

 

 

(28,436)

Cash dividends paid on Class B common stock

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(6,422)

 

 

 —

 

 —

 

 

 —

 

 

(6,422)

Dividend equivalent units declared, net of cancellations

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(268)

 

 

 —

 

 —

 

 

 —

 

 

(268)

Foreign currency translation adjustment

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(1,341)

 

 —

 

 

 —

 

 

(1,341)

Net income

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

74,232 

 

 

 —

 

 —

 

 

 —

 

 

74,232 

Balance at December 1, 2018

 

54,382 

 

$

54 

 

10,193 

 

$

10 

 

$

660,185 

 

$

1,316,489 

 

$

(20,975)

 

9,235 

 

$

(579,451)

 

$

1,376,312 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to condensed consolidated financial statements.



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

7


 

 

MSC INDUSTRIAL DIRECT CO., INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)













 

 

 

 

 

 



 

 

 

 

 

 



 

Thirteen Weeks Ended



 

December 1,

 

December 2,



 

2018

 

2017

Cash Flows from Operating Activities:

 

 

 

 

 

 

Net income

 

$

74,232 

 

$

59,585 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

 

15,846 

 

 

15,749 

Stock-based compensation

 

 

4,174 

 

 

3,894 

Loss on disposal of property, plant, and equipment

 

 

141 

 

 

126 

Provision for doubtful accounts

 

 

2,814 

 

 

1,698 

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable

 

 

(10,630)

 

 

(9,291)

Inventories

 

 

(9,803)

 

 

(4,259)

Prepaid expenses and other current assets

 

 

(2,044)

 

 

(1,663)

Other assets

 

 

753 

 

 

1,252 

Accounts payable and accrued liabilities

 

 

1,383 

 

 

14,888 

Total adjustments

 

 

2,634 

 

 

22,394 

Net cash provided by operating activities

 

 

76,866 

 

 

81,979 

Cash Flows from Investing Activities:

 

 

 

 

 

 

Expenditures for property, plant and equipment

 

 

(10,053)

 

 

(9,028)

Cash used in business acquisitions, net of cash received

 

 

 —

 

 

(738)

Net cash used in investing activities

 

 

(10,053)

 

 

(9,766)

Cash Flows from Financing Activities:

 

 

 

 

 

 

Repurchases of common stock

 

 

(63,527)

 

 

(4,018)

Payments of cash dividends

 

 

(34,858)

 

 

(27,087)

Proceeds from sale of Class A common stock in connection with associate stock purchase plan

 

 

954 

 

 

959 

Proceeds from exercise of Class A common stock options

 

 

9,329 

 

 

2,405 

Borrowings under the revolving credit facilities

 

 

245,000 

 

 

24,000 

Payments under the revolving credit facilities

 

 

(259,000)

 

 

(65,000)

Other, net

 

 

753 

 

 

606 

Net cash used in financing activities

 

 

(101,349)

 

 

(68,135)

Effect of foreign exchange rate changes on cash and cash equivalents

 

 

(66)

 

 

91 

Net increase (decrease) in cash and cash equivalents

 

 

(34,602)

 

 

4,169 

Cash and cash equivalents—beginning of period

 

 

46,217 

 

 

16,083 

Cash and cash equivalents—end of period

 

$

11,615 

 

$

20,252 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

 

Cash paid for income taxes

 

$

1,761 

 

$

1,757 

Cash paid for interest

 

$

1,685 

 

$

2,068 



 

 

 

 

 

 

See accompanying notes to condensed consolidated financial statements.



 

 

 

 

 

 

 



 

8


 

 MSC INDUSTRIAL DIRECT CO., INC.

Notes to Condensed Consolidated Financial Statements

(Dollar amounts and shares in thousands, except per share data)

(Unaudited)

 

Note 1. Basis of Presentation



The accompanying condensed consolidated financial statements include MSC Industrial Direct Co., Inc. (“MSC”) and all its subsidiaries (hereinafter referred to collectively as the “Company”). All intercompany balances and transactions have been eliminated in consolidation.



The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation (including normal recurring adjustments) have been included. Operating results for the thirteen-week period ended December 1, 2018 are not necessarily indicative of the results that may be expected for the fiscal year ending August 31, 2019. For further information, refer to the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 1, 2018.





The Company’s fiscal year ends on the Saturday closest to August 31 of each year. Unless the context requires otherwise, references to years contained herein pertain to the Company’s fiscal year. The Company’s 2019 fiscal year will be a 52-week accounting period that will end on August 31, 2019 and its 2018 fiscal year was a 52-week accounting period that ended on September 1, 2018.



Recently Adopted Accounting Pronouncements



Effective September 2, 2018, the Company adopted the Financial Accounting Standards Board (“FASB”)  Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606) as modified by subsequently issued ASUs 2015-14, 2016-08, 2016-10, 2016-12, 2016-20 and 2017-05. These ASUs outline a single comprehensive model for entities to use in the accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. Revenue continues to be recognized when products are shipped to the customer and the adoption of these ASUs, using the modified retrospective approach, had no impact to the Company’s opening retained earnings. The Company reports its sales net of estimated sales returns and sales incentives. Sales tax collected from customers is excluded from net sales. Additional information and disclosures required by this new standard are contained in Note 2,  Revenue.



Effective September 2, 2018, the Company adopted ASU 2017-01, which clarifies the definition of a business to assist entities with evaluating when a set of transferred assets and activities is considered a business. This standard will be applied to appropriate business combinations that occur beginning September 2, 2018.



Accounting Pronouncements Not Yet Adopted



In February 2016, the FASB issued its final standard on accounting for leases,  ASU 2016-02, Leases (Topic 842). This standard requires that an entity that is a lessee recognize lease assets and lease liabilities on the balance sheet for all leases and disclose key information about leasing arrangements. This update is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with earlier application permitted. The new standard is effective for the Company for its fiscal year 2020.  While we are still in the process of evaluating the effect of adoption on our consolidated financial statements and are currently assessing our leases, we expect the adoption will lead to a significant increase in the assets and liabilities recorded on our Condensed Consolidated Balance Sheets.



In June 2016, the FASB issued its final standard on measurement of credit losses on financial instruments. This standard, issued as ASU 2016-13, requires that an entity measure impairment of certain financial instruments, including trade receivables, based on expected losses rather than incurred losses. This update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted for financial statement periods beginning after December 15, 2018. The new standard is effective for the Company for its fiscal year 2021.  The Company is currently evaluating this standard to determine the impact of adoption on its consolidated financial statements.



In January 2017, the FASB issued its final standard on simplifying the test for goodwill impairment, ASU 2017-04, Intangibles – Goodwill and Other (Topic 350). This standard will require an entity to perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the

9


 

 MSC INDUSTRIAL DIRECT CO., INC.

Notes to Condensed Consolidated Financial Statements

(Dollar amounts and shares in thousands, except per share data)

(Unaudited)

 

total amount of goodwill allocated to that reporting unit. This update is effective for annual and interim goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted. The new standard is effective for the Company for its fiscal year 2021.  Upon adoption, the Company will apply this guidance prospectively to its annual and interim goodwill impairment tests and disclose the change in accounting principle.



In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders’ equity for interim financial statements. Under the amendments, an analysis of change in each caption of stockholders’ equity presented in the consolidated balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. The final rules are effective for all filings made on or after November 5, 2018, with the option for the filer’s first presentation of the changes in shareholders’ equity to be included in its Form 10-Q for the quarter that begins after the effective date of the amendments. The Company anticipates its first presentation of the expanded disclosure requirements of the changes in stockholders’ equity to be in its Form 10-Q for the second quarter of fiscal year 2019.



Other pronouncements issued by the FASB or other authoritative accounting standards groups with future effective dates are either not applicable or are not expected to be significant to the Company’s financial position, results of operations or cash flows.



Reclassification



Certain of the prior period Cash Flows from Financing Activities line items were reclassified into “Other, Net” within our condensed consolidated statements of cash flows to conform to our current period presentation. These reclassifications did not affect the total amount of Cash Flows from Financing Activities.



Note 2. Revenue



Revenue Recognition



Net sales include product revenue and shipping and handling charges, net of estimated sales returns and any related sales incentives. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products. All revenue is recognized when the Company satisfies its performance obligations under the contract, and invoicing occurs at approximately the same point in time. The Company recognizes revenue once the customer obtains control of the products. The Company’s product sales have standard payment terms that do not exceed one year. The Company considers shipping and handling as activities to fulfill its performance obligation. The Company’s contracts have a single performance obligation, to deliver products, and are short-term in nature. The Company estimates product returns based on historical return rates. Total accrued sales returns were approximately $4,838 and $4,832 as of December 1, 2018 and September 1, 2018, respectively, and are reported as Accrued liabilities in the Consolidated Balance Sheets. Sales taxes and value added taxes in foreign jurisdictions that are collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from net sales.



Consideration Payable to a Customer



The Company offers customers sales incentives, which primarily consist of volume rebates, and upfront sign-on payments. These volume rebates and payments are not in exchange for a distinct good or service and result in a reduction of net sales from the goods transferred to the customer at the later of when the related revenue is recognized or when the Company promises to pay the consideration. The Company estimates its volume rebate accruals and records its sign-on payments based on various factors, including contract terms, historical experience, and performance levels. Total accrued sales incentives, primarily related to volume rebates, were approximately $15,166 and $14,000 as of December 1, 2018 and September 1, 2018, respectively, and are included in Accrued liabilities in the Consolidated Balance Sheets. Sign-on payments, not yet recognized as a reduction of revenue, are recorded in Prepaid expenses and other current assets in the Consolidated Balance Sheets, and were approximately $2,899 and $2,457 as of December 1, 2018 and September 1, 2018, respectively.







10


 

 MSC INDUSTRIAL DIRECT CO., INC.

Notes to Condensed Consolidated Financial Statements

(Dollar amounts and shares in thousands, except per share data)

(Unaudited)

 

Contract Assets and Liabilities



The Company records a contract asset when it has a right to payment from a customer that is conditioned on events other than the passage of time. The Company records a contract liability when customers prepay but the Company has not yet satisfied its performance obligation. The Company did not have material unsatisfied performance obligations, contract assets or liabilities as of December 1, 2018 and September 1, 2018.  



Disaggregation of Revenue



The Company operates in one operating and reportable segment as a distributor of metalworking and maintenance, repair, and operations (“MRO”) products and services. The Company serves a large number of customers in diverse industries, which are subject to different economic and industry factors. The Company's presentation of net sales by customer end-market most reasonably depicts how the nature, amount, timing, and uncertainty of Company revenue and cash flows are affected by economic and industry factors. The Company does not disclose net sales information by product category as it is impracticable to do so as a result of its numerous product offerings and the way its business is managed. The following table presents the Company's percentage of net sales by customer end-market for the thirteen-week period ended December 1, 2018:





 

 

 



 

 

 



 

Thirteen Weeks Ended



 

December 1, 2018

Manufacturing Heavy

 

49 

%

Manufacturing Light

 

22 

%

Government

 

%

Retail/Wholesale

 

%

Commercial Services

 

%

Other (1)

 

12 

%

Total net sales

 

100 

%

__________________________

(1)

The other category primarily includes individual customer and small business net sales not assigned to a specific industry classification.



The Company’s net sales originating from the following geographic areas were as follows for the thirteen-week period ended December 1, 2018:





 

 

 

 

 

 



 

 

 

 

 

 



 

Thirteen Weeks Ended



 

December 1, 2018

United States

 

$

806,075 

 

97 

%

UK

 

 

15,205 

 

%

Canada

 

 

10,317 

 

%

Total net sales

 

$

831,597 

 

100 

%





Note 3. Net Income per Share



The Company’s non-vested restricted stock awards contain non-forfeitable rights to dividends and meet the criteria of a participating security as defined by Accounting Standards Codification (“ASC”) Topic 260, “Earnings Per Share”. Under the two-class method, net income per share is computed by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, net income is allocated to both common shares and participating securities based on their respective weighted average shares outstanding for the period. The following table sets forth the computation of basic and diluted net income per common share under the two-class method for the thirteen weeks ended December 1, 2018 and December 2, 2017, respectively:













11


 

 MSC INDUSTRIAL DIRECT CO., INC.

Notes to Condensed Consolidated Financial Statements

(Dollar amounts and shares in thousands, except per share data)

(Unaudited)

 









 

 

 

 

 

 

 



 

Thirteen Weeks Ended

 



 

December 1,

 

December 2,

 



 

2018

 

2017

 

Net income as reported

 

$

74,232 

 

$

59,585 

 

Less: Distributed net income available to participating securities

 

 

(20)

 

 

(34)

 

Less: Undistributed net income available to participating securities

 

 

(33)

 

 

(69)

 

Numerator for basic net income per share:

 

 

 

 

 

 

 

Undistributed and distributed net income available to common shareholders         

 

$

74,179 

 

$

59,482 

 

  Add: Undistributed net income allocated to participating securities

 

 

33 

 

 

69 

 

Less: Undistributed net income reallocated to participating securities

 

 

(33)

 

 

(69)

 



 

 

 

 

 

 

 

Numerator for diluted net income per share:

 

 

 

 

 

 

 

Undistributed and distributed net income available to common shareholders

 

$

74,179 

 

$

59,482 

 

Denominator:

 

 

 

 

 

 

 

Weighted average shares outstanding for basic net income per share

 

 

55,502 

 

 

56,287 

 

Effect of dilutive securities

 

 

329 

 

 

217 

 

Weighted average shares outstanding for diluted net income per share

 

 

55,831 

 

 

56,504 

 

Net income per share two-class method:

 

 

 

 

 

 

 

Basic

 

$

1.34 

 

$

1.06 

 

Diluted

 

$

1.33 

 

$

1.05 

 



 

 

 

 

 

 

 

Potentially dilutive securities

 

 

408 

 

 

957 

 



Potentially dilutive securities attributable to outstanding stock options and restricted stock units are excluded from the calculation of diluted earnings per share where the combined exercise price and average unamortized fair value are greater than the average market price of MSC common stock, and therefore their inclusion would be anti-dilutive.

 

Note 4. Stock-Based Compensation



The Company accounts for all share-based payments in accordance with ASC Topic 718, “Compensation—Stock Compensation”. Stock‑based compensation expense included in operating expenses for the thirteen-week periods ended December 1, 2018 and December 2, 2017 was as follows:





 

 

 

 

 

 

 



 

Thirteen Weeks Ended

 



 

December 1,

 

December 2,

 



 

2018

 

2017

 

Stock options

 

$

1,205 

 

$

1,194 

 

Restricted share awards

 

 

532 

 

 

902 

 

Restricted stock units

 

 

2,365 

 

 

1,754 

 

Associate Stock Purchase Plan

 

 

72 

 

 

44 

 

Total 

 

 

4,174 

 

 

3,894 

 

Deferred income tax benefit

 

 

(1,048)

 

 

(1,480)

 

Stock-based compensation expense, net

 

$

3,126 

 

$

2,414 

 



12


 

 MSC INDUSTRIAL DIRECT CO., INC.

Notes to Condensed Consolidated Financial Statements

(Dollar amounts and shares in thousands, except per share data)

(Unaudited)

 

Stock options



The fair value of each option grant is estimated on the date of grant using the Black‑Scholes option pricing model with the following assumptions:





 

 

 

 

 

 



 

Thirteen Weeks Ended



 

December 1,

 

December 2,



 

2018

 

2017

Expected life (in years)

 

4.0 

 

 

4.0 

 

Risk-free interest rate

 

2.98 

%

 

1.87 

%

Expected volatility

 

23.13 

%

 

22.13 

%

Expected dividend yield

 

2.70 

%

 

2.30 

%

Weighted-average grant-date fair value

 

$14.05 

 

 

$12.25 

 



A summary of the Company’s stock option activity for the thirteen-week period ended December 1, 2018 is as follows:





 

 

 

 

 

 

 

 

 



Options

 

Weighted-Average Exercise Price per Share

 

Weighted-Average Remaining Contractual Term (in years)

 

Aggregate Intrinsic Value

Outstanding on September 1, 2018

1,760 

 

$

72.96 

 

 

 

 

 

Granted

398 

 

 

83.21 

 

 

 

 

 

Exercised

(118)

 

 

79.27 

 

 

 

 

 

Canceled/Forfeited

(2)

 

 

79.35 

 

 

 

 

 

Outstanding on December 1, 2018

2,038 

 

$

74.59 

 

4.8 

 

$

28,534 

Exercisable on December 1, 2018

973 

 

$

72.33 

 

3.7 

 

$

15,819 



The unrecognized share‑based compensation cost related to stock option expense at December 1, 2018 was $11,887 and will be recognized over a weighted average period of 2.8 years. The total intrinsic value of options exercised, which represents the difference between the exercise price and market value of common stock measured at each individual exercise date, during the thirteen-week periods ended December 1, 2018 and December 2, 2017 was $618 and $577, respectively.



Restricted share awards



A summary of the non‑vested restricted share award (“RSA”) activity under the Company’s 2005 Omnibus Incentive Plan and 2015 Omnibus Incentive Plan for the thirteen-week period ended December 1, 2018 is as follows:



 

 

 

 



Shares

 

Weighted-Average  Grant-Date Fair Value

Non-vested restricted share awards at September 1, 2018

63 

 

$

81.98 

Granted

 —

 

 

 —

Vested

(38)

 

 

82.44 

Canceled/Forfeited

 —

 

 

 —

Non-vested restricted share awards at December 1, 2018

25 

 

$

81.27 



The fair value of each RSA is the closing stock price on the NYSE of the Company’s Class A common stock on the date of grant. Upon vesting, a portion of the RSA award may be withheld to satisfy the statutory income tax withholding obligation. The remaining RSAs will be settled in shares of the Company’s Class A common stock when vested. The unrecognized share-based compensation cost related to RSAs at December 1, 2018 was $1,364 and will be recognized over a weighted average period of 1.0 years. 



13


 

 MSC INDUSTRIAL DIRECT CO., INC.

Notes to Condensed Consolidated Financial Statements

(Dollar amounts and shares in thousands, except per share data)

(Unaudited)

 

Restricted stock units



A summary of the Company’s non-vested Restricted Stock Unit (“RSU”) award activity for the thirteen-week period ended December 1, 2018 is as follows:





 

 

 

 



Shares

 

Weighted-Average  Grant-Date Fair Value

Non-vested restricted stock unit awards at September 1, 2018

377 

 

$

73.18 

Granted

151 

 

 

83.21 

Vested

(87)

 

 

69.66 

Canceled/Forfeited

(5)

 

 

76.40 

Non-vested restricted stock unit awards at December 1, 2018

436 

 

$

77.31 



The fair value of each RSU is the closing stock price on the NYSE of the Company’s Class A common stock on the date of grant. Upon vesting, a portion of the RSU award may be withheld to satisfy the statutory income tax withholding obligation. The remaining RSUs will be settled in shares of the Company’s Class A common stock when vested. These awards accrue dividend equivalents on outstanding units (in the form of additional stock units) based on dividends declared on the Company’s Class A common stock and these dividend equivalents convert to unrestricted common stock on the vesting dates of the underlying RSUs. The dividend equivalents are not included in the RSU table above. The unrecognized share-based compensation cost related to the RSUs at December 1, 2018 was $30,924 and is expected to be recognized over a weighted average period of 3.6 years.

 

Note 5. Fair Value



Fair value accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following fair value hierarchy prioritizes the inputs used to measure fair value into three levels, with Level 1 being of the highest priority. The three levels of inputs used to measure fair value are as follows:





 

 



Level 1

Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active  markets.



Level 2

Include other inputs that are directly or indirectly observable in the marketplace.



Level 3

Unobservable inputs which are supported by little or no market activity.



In connection with the construction of the Company’s customer fulfillment center (“CFC”) in Columbus, Ohio, the Company entered into an arrangement during fiscal 2013 with the Columbus-Franklin County Finance Authority (“Finance Authority”) which provides savings on state and local sales taxes imposed on construction materials purchased by entities that finance the transactions through them. Under this arrangement, the Finance Authority issued taxable bonds to finance the structure and site improvements of the Company’s CFC. The bonds ($27,025 outstanding at both December 1, 2018 and September 1, 2018)  are classified as available for sale securities in accordance with ASC Topic 320. The securities are recorded at fair value in Other assets in the Condensed Consolidated Balance Sheet. The fair values of these securities are based on observable inputs in non-active markets, which are therefore classified as Level 2 in the hierarchy. The Company did not record any gains or losses on these securities during the thirteen-week period ended December 1, 2018. The outstanding principal amount of each bond bears interest at the rate of 2.4% per year. Interest is payable on a semiannual basis in arrears on each interest payment date.



In addition, based on borrowing rates currently available to the Company for borrowings with similar terms, the carrying values of the Company’s capital lease obligations also approximate fair value. The fair value of the Company’s short-term and long-term debt is estimated based on quoted market prices for the same or similar issues or on current rates offered to the Company for debt of the same remaining maturities. The carrying amount of the Company’s debt as of December 1, 2018 approximates its fair value.



The Company’s financial instruments, other than those presented in the disclosure above, include cash, receivables, accounts payable, and accrued liabilities. Management believes the carrying amount of the aforementioned financial instruments is a reasonable estimate of fair value as of December 1, 2018 and September 1, 2018 due to the short-term maturity of these items.

14


 

 MSC INDUSTRIAL DIRECT CO., INC.

Notes to Condensed Consolidated Financial Statements

(Dollar amounts and shares in thousands, except per share data)

(Unaudited)

 



During the thirteen weeks ended December 1, 2018 and December 2, 2017, the Company had no remeasurements of non-financial assets or liabilities at fair value on a non-recurring basis subsequent to their initial recognition. 





Note 6. Debt and Capital Lease Obligations



Debt at December 1, 2018 and September 1, 2018 consisted of the following:





 

 

 

 

 

 



 

December 1,

 

September 1,



 

2018

 

2018



 

(Dollars in thousands)

Revolving Credit Facilities

 

 

 

 

 

 

   Committed bank facility

 

$

 -

 

$

224,000 

   Uncommitted bank facilities

 

 

210,000 

 

 

 -

Private Placement Debt:

 

 

 

 

 

 

   Senior notes, series A

 

 

75,000 

 

 

75,000 

   Senior notes, series B

 

 

100,000 

 

 

100,000 

   Senior Notes

 

 

20,000 

 

 

20,000 

Shelf Facility Agreements:

 

 

90,000 

 

 

90,000 

Capital lease and financing obligations

 

 

29,122 

 

 

27,926 

   Less: unamortized debt issuance costs

 

 

(1,487)

 

 

(1,593)

Total debt

 

$

522,635 

 

$

535,333 

   Less: short-term debt(1)

 

 

(210,979)

 

 

(224,097)

Long-term debt

 

$

311,656 

 

$

311,236 

__________________________

(1)

Net of unamortized debt issuance costs expected to be amortized in the next twelve months.



Revolving Credit Facilities



In April 2017, the Company entered into a $600,000 committed credit facility (the “Committed Facility”). The Committed Facility, which matures on April 14, 2022, provides for a five-year unsecured revolving loan facility.



The Committed Facility permits up to $50,000 to be used to fund letters of credit.  The Committed Facility also permits the Company to request one or more incremental term loan facilities and/or increase the revolving loan commitments in an aggregate amount not to exceed $300,000.  Subject to certain limitations, each such incremental term loan facility or revolving commitment increase will be on terms as agreed to by the Company, the Administrative Agent and the lenders providing such financing.



The interest rate is based on either LIBOR or a base rate, plus in either case a spread based on our leverage ratio at the end of each fiscal reporting quarter.  Based on the interest period the Company selects, interest may be payable every one, two, or three months. Interest is reset at the end of each interest period. The Company currently elects to have loans under the Committed Facility bear interest based on LIBOR with one-month interest periods.



During the thirteen-week period ended December 1, 2018, the Company entered into six unsecured credit facilities that are uncommitted (the “Uncommitted Facilities”), totaling $440,000 of maximum uncommitted availability. Borrowings under the Uncommitted Facilities are generally due at the end of the applicable agreed interest period, but, in any event, no later than the one-year anniversary of the entrance into the applicable Uncommitted Facility.  The Uncommitted Facilities contain limited covenants.  An event of default under the Company’s Committed Facility is an event of default under the Uncommitted Facilities. The interest rate on the Uncommitted Facilities is based on LIBOR or the bank’s cost of funds or as otherwise agreed upon by the applicable bank and the Company.  The $210,000 outstanding at the end of our fiscal first quarter of 2019 under the Uncommitted Facilities are classified as short-term in our Condensed Consolidated Balance Sheets.



During the thirteen-week period ended December 1, 2018, the Company borrowed $245,000 and repaid $259,000 under its revolving credit facilities.  As of December 1, 2018 and September 1, 2018, the weighted average interest rates on borrowings under all its revolving credit facilities were 3.16% and 3.20%, respectively.



15


 

 MSC INDUSTRIAL DIRECT CO., INC.

Notes to Condensed Consolidated Financial Statements

(Dollar amounts and shares in thousands, except per share data)

(Unaudited)

 

Private Placement Debt



In July 2016, the Company completed the issuance and sale of $75,000 aggregate principal amount of 2.65% Senior Notes, Series A, due July 28, 2023 and $100,000 aggregate principal amount of 2.90% Senior Notes, Series B, due July 28, 2026; and in June 2018, the Company completed the issuance and sale of $20,000 aggregate principal amount of 3.79% Senior Notes, due June 11, 2025 (collectively “Private Placement Debt”).  Interest is payable semiannually at the fixed stated interest rates.



Shelf Facility Agreements



In January 2018, the Company entered into Note Purchase and Private Shelf Agreements with Metropolitan Life Insurance Company (“Met Life Note Purchase Agreement”) and PGIM, Inc. (“Prudential Note Purchase Agreement” and together with the Met Life Note Purchase Agreement, the “Shelf Facility Agreements”).



The Met Life Note Purchase Agreement provides for an uncommitted facility for the issuance and sale of up to an aggregate total of $250,000 of senior notes, at either fixed or floating rates. In June 2018, the Company completed the issuance and sale of $20,000 aggregate principal amount of 3.22% Series 2018A Notes, due June 11, 2020 and $20,000 aggregate principal amount of 3.42% Series 2018B Notes, due June 11, 2021. Interest is payable semiannually at the fixed stated interest rates. As of December 1, 2018, the uncommitted availability under the Met Life Note Purchase Agreement is $210,000.



The Prudential Note Purchase Agreement provides for an uncommitted facility for the issuance and sale of up to an aggregate total of $250,000 of senior notes, at a fixed rate. In January 2018, the Company completed the issuance and sale of $50,000 aggregate principal amount of 3.04% Senior Notes due January 12, 2023. Interest is payable semiannually. As of December 1, 2018, the uncommitted availability under the Prudential Note Purchase Agreement is $200,000.



Each of the credit facilities, Private Placement Debt, and Shelf Facility Agreements impose several restrictive covenants including the requirement that the Company maintain a maximum consolidated leverage ratio of total indebtedness to EBITDA (earnings before interest expense, taxes, depreciation, amortization and stock-based compensation) of no more than 3.00 to 1.00 (or, at the election of the Company after it consummates a material acquisition, a four-quarter temporary increase to 3.50 to 1.00), and a minimum consolidated interest coverage ratio of EBITDA to total interest expense of at least 3.00 to 1.00, during the terms of the credit facilities, Private Placement Debt and Shelf Facility Agreements. At December 1, 2018, the Company was in compliance with the operating and financial covenants of the credit facilities, Private Placement Debt, and Shelf Facility Agreements.



Capital Lease and Financing Obligations



In connection with the construction of the Company’s CFC in Columbus, Ohio in fiscal 2013, the Finance Authority holds the title to the building and entered into a long-term lease with the Company. The lease has a 20-year term with a prepayment option without penalty between 7 and 20 years. At the end of the lease term, the building’s title is transferred to the Company for a nominal amount when the principal of and interest on the bonds have been fully paid. The lease has been classified as a capital lease in accordance with ASC Topic 840. At December 1, 2018 and September 1, 2018, the capital lease obligation was approximately $27,025.  



From time to time, the Company enters into capital leases and financing arrangements with vendors to purchase certain information technology equipment or software. The equipment or software acquired from these vendors is paid for over a specified period of time based on the terms agreed upon. During the thirteen-week period ended December 1, 2018, the Company entered into capital lease and financing obligations related to certain IT equipment and software totaling $1,345.  The gross amount of property and equipment acquired under the capital lease obligation at December 1, 2018 was approximately $442. There is no related accumulated amortization for this capital lease as of December 1, 2018.

 

Note 7. Shareholders’ Equity



The Company paid cash dividends of $0.63 per common share totaling $34,858 for the thirteen weeks ended December 1, 2018.  For the thirteen weeks ended December 2, 2017, the Company paid cash dividends of $0.48 per common share totaling $27,087. On December 18, 2018, the Board of Directors declared a quarterly cash dividend of $0.63 per share

16


 

 MSC INDUSTRIAL DIRECT CO., INC.

Notes to Condensed Consolidated Financial Statements

(Dollar amounts and shares in thousands, except per share data)

(Unaudited)

 

payable on January 22, 2019 to shareholders of record at the close of business on January 8, 2019. The dividend will result in a payout of approximately $34,849, based on the number of shares outstanding at December 18, 2018.

 

During the thirteen-week period ended December 1, 2018, the Company repurchased 778 shares of its Class A common stock for $63,527, which is reflected at cost as treasury stock in the accompanying condensed consolidated financial statements. Of these shares, 40 shares were repurchased by the Company to satisfy the Company’s associates’ tax withholding liability associated with its share-based compensation program.  



In July 2018, the Company announced that in connection with its existing share repurchase authorization (the “Repurchase Plan”), the Company had entered into a stock purchase agreement with the holders of the Company’s Class B common stock to purchase a pro rata number of shares, such that their aggregate percentage ownership in the Company would remain substantially the same. For the thirteen weeks ended December 1, 2018, the Company purchased 238 shares of its Class A common stock from certain of its Class B shareholders at a weighted average purchase price of $82.71 per share. This figure is included in the totals provided in the previous paragraph. All of these shares were immediately retired.



Shares of the Company’s common stock purchased pursuant to the stock purchase agreement, as well as shares purchased to satisfy the Company’s associates’ tax withholding liability associated with its share-based compensation program, did not reduce the number of shares that may be repurchased under the Repurchase Plan. The total number of shares of Class A common stock authorized for future repurchase was approximately 1,430 shares at December 1, 2018.  The Company reissued 13 shares of treasury stock during the thirteen-week period ended December 1, 2018 to fund the Associate Stock Purchase Plan. 



Note 8. Product Warranties



The Company generally offers a maximum one-year warranty, including parts and labor, for some of its machinery products. The specific terms and conditions of those warranties vary depending upon the product sold. The Company may be able to recoup some of these costs through product warranties it holds with its original equipment manufacturers, which typically range from thirty to ninety days. In general, many of the Company’s general merchandise products are covered by third-party original equipment manufacturers’ warranties. The Company’s warranty expense for the thirteen-week periods ended December 1, 2018 and December 2, 2017 was minimal.

 

Note 9. Income Taxes



On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted. The TCJA made significant changes to U.S. federal income tax laws including permanently lowering the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. As the Company has a fiscal August year-end, the lower corporate income tax rate was phased in, resulting in a U.S. statutory rate of 25.6% for the fiscal year ending September 1, 2018. The Company’s statutory federal tax rate will be 21.0% for fiscal years 2019 and beyond. U.S. GAAP requires that the impact of tax legislation be recognized in the period in which the law was enacted.



In December 2017, the SEC issued Staff Accounting Bulletin No. 118, which allows a company to report provisional numbers related to the TCJA and adjust those amounts during a measurement period not to extend beyond one year. The Company recorded a net tax benefit of $40,464 due to the revaluation of its net deferred tax liabilities primarily related to the lower federal corporate tax rate, partially offset by the lower federal benefit for state taxes and the change from a worldwide tax system to a territorial tax system in fiscal 2018. The amounts recorded were provisional and are subject to change due to further interpretations of the TCJA, legislative action to address questions that arise because of the TCJA, and/or any updates or changes to estimates the Company has utilized to calculate the impacts, such as return to accrual adjustments and/or changes to current year earnings estimates and the Company’s ongoing analysis of the TCJA.  The Company does not anticipate a significant impact to the provisional amounts recorded.



During the thirteen-week period ended December 1, 2018, there were no material changes in unrecognized tax benefits. 

 

17


 

 MSC INDUSTRIAL DIRECT CO., INC.

Notes to Condensed Consolidated Financial Statements

(Dollar amounts and shares in thousands, except per share data)

(Unaudited)

 

Note 10. Legal Proceedings



There are various claims, lawsuits, and pending actions against the Company incidental to the operation of its business. Although the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.



Note 11.  Subsequent Event



The Company repurchased approximately 273 shares of its common stock for a total cost of approximately $20,773 during the period December 18, 2018 through January 3, 2019.













 

18


 

 

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 September 1, 2018 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 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 more than 1.6 million products, inventory management and other supply chain solutions, and deep expertise from more than 75 years of working with customers across industries. We continue to implement our strategies to gain market share, generate new customers, increase sales to existing customers, and diversify our customer base.



We offer approximately 1,666,000 active, saleable stock-keeping units (“SKUs”) through our catalogs; brochures; eCommerce channels, including our website, mscdirect.com (“MSC website”); our inventory management solutions; and call-centers and branches. We service our customers from 12 customer fulfillment centers (eight are located within the United States which includes five primary customer fulfillment centers, one is located in the United Kingdom (the “U.K.”), and three are in Canada) and 100 branch offices. 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.



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 achieve 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 Customer Managed Inventory (“CMI”), Vendor Managed Inventory (“VMI”), and vending programs.



Our field sales and service associate headcount was 2,417 at December 1, 2018, compared to 2,384 at December 2, 2017.  Beginning in our fiscal fourth quarter of 2018, field sales and service personnel includes all customer-facing associates in an external sales or service role. Prior period headcount numbers have been adjusted to reflect this new definition. 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 for our customers, to enable our customers to achieve higher levels of growth, profitability, and productivity. As we implemented these changes in fiscal 2018, our growth underperformed due to account transitions, sales associate transitions into new roles, and declining sales headcount as we made the migration.



Recent Developments and Highlights



Highlights during the first fiscal quarter ended December 1, 2018 include the following:



·

We generated $76.9 million of cash from operations.

·

We repurchased 778,000 shares for $63.5 million.

·

We paid out $34.9 million in cash dividends, compared to $27.1 million for the same period in the prior fiscal year.



Our Strategy



Our objective is to continue to grow sales profitably while helping our customers become more productive and profitable by reducing their total cost for purchasing, using and maintaining MRO supplies. We continue to pursue strategic acquisitions that expand or complement our business in new and existing markets or further enhance the value and offerings we provide.



19


 

 

Business Environment



We utilize various indices when evaluating the level of our business activity.  Approximately 71% of our revenues came from sales in the manufacturing sector during the first quarter of our fiscal year 2019. Through statistical analysis, we have found that trends in our customers’ activity have correlated to changes in the Metalworking Business Index (“MBI”). The MBI is a sentiment index developed from a monthly survey of the U.S. metalworking industry, focusing on durable goods manufacturing. We have experienced the highest correlation between our sales trends and the MBI by using the rolling 12-month MBI average on a four-month lag. For the MBI, a value below 50.0 generally indicates contraction and a value above 50.0 generally indicates expansion. The MBI index over the last three months and for the past 12-month period was as follows:







 

 

Period

 

MBI

September

 

57.1

October

 

57.7

November

 

54.7



 

 

Fiscal 2019 Q1 average

 

56.5

12-month average

 

57.9



Although the MBI has trended slightly downward, the November reading of 54.7 represents the 23rd consecutive month of expansion. Details released with the November MBI indicate continued expansion in supplier deliveries, while new orders and production recorded slower growth. The most recent December MBI reading of 53.4 is indicative of continued expansion; however, it continues the downward trend resulting in a 130-basis-point reduction from November. We will continue to monitor economic conditions for their impact on our customers and markets, and continue to assess business risks and opportunities.

 

Thirteen-Week Period Ended December 1, 2018 Compared to the Thirteen-Week Period Ended December 2, 2017



The table below summarizes the Company’s results of operations both in dollars (in thousands) and as a percentage of net sales for the periods indicated:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Thirteen Weeks Ended

 

 

 

 

 



 

December 1, 2018

 

December 2, 2017

 

Change



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

$

 

 

%

 

 

$

 

 

%

 

 

$

 

 

%

Net sales

 

$

831,597 

 

 

100.0% 

 

$

768,561 

 

 

100.0% 

 

$

63,036 

 

 

8.2% 

Cost of goods sold

 

 

473,612 

 

 

57.0% 

 

 

433,492 

 

 

56.4% 

 

 

40,120 

 

 

9.3% 

Gross profit

 

 

357,985 

 

 

43.0% 

 

 

335,069 

 

 

43.6% 

 

 

22,916 

 

 

6.8% 

Operating expenses

 

 

254,985 

 

 

30.7% 

 

 

235,791 

 

 

30.7% 

 

 

19,194 

 

 

8.1% 

Income from operations

 

 

103,000 

 

 

12.4% 

 

 

99,278 

 

 

12.9% 

 

 

3,722 

 

 

3.7% 

Total other expense

 

 

(3,892)

 

 

(0.5)%

 

 

(3,482)

 

 

(0.5)%

 

 

(410)

 

 

11.8% 

Income before provision for income taxes

 

 

99,108 

 

 

11.9% 

 

 

95,796 

 

 

12.5% 

 

 

3,312 

 

 

3.5% 

Provision for income taxes

 

 

24,876 

 

 

3.0% 

 

 

36,211 

 

 

4.7% 

 

 

(11,335)

 

 

(31.3%)

Net income

 

$

74,232 

 

 

8.9% 

 

$

59,585 

 

 

7.8% 

 

$

14,647 

 

 

24.6% 



Net Sales



Net sales increased 8.2% or approximately $63.0 million for the thirteen-week period ended December 1, 2018, as compared to the thirteen-week period ended December 2, 2017.  We estimate that this $63.0 million increase in net sales is comprised of (i) approximately $40.3 million of higher sales volume, excluding AIS operations; (ii) approximately $17.7 million from AIS, which we acquired in April 2018; and (iii) approximately $5.8 million from improved pricing, inclusive of changes in customer and product mix, discounting and other items; partially offset by (iv) approximately $0.8 million from foreign exchange impact. Of the above $63.0 million increase in net sales, sales to our government and national account programs (“Large Account Customers”) increased by approximately $15.8 million and sales other than to our Large Account Customers increased by approximately $47.2 million, which includes the $17.7 million of net sales from AIS.

20


 

 



The table below shows the change in our average daily sales by total company and by customer type for the thirteen- week period ended December 1, 2018 compared to the same period in the prior fiscal year:









 

 

 

 

 

 

Average Daily Sales Percentage Change

(unaudited)



 

 

 

 

 

 

2019 vs. 2018 Fiscal Period

 

Thirteen Week Period Ended Fiscal Q1

 

% of Total Business



 

 

 

 

 

 

Total Company

 

8.2 

%

 

 

 

Manufacturing Customers

 

8.7 

%

 

71 

%

Non-Manufacturing Customers

 

6.9 

%

 

29 

%



We believe that our ability to transact business with our customers through various electronic portals and directly through the MSC website gives us a competitive advantage over smaller suppliers. Sales made through our eCommerce platforms, including sales made through Electronic Data Interchange (“EDI”) systems, VMI systems, Extensible Markup Language ordering-based systems, vending, hosted systems and other electronic portals, represented 60.1% of consolidated net sales for the thirteen-week period ended December 1, 2018, compared to 59.8% of consolidated net sales for the same period in the prior fiscal year. This increase was primarily associated with the MSC website and vending. These percentages of consolidated net sales do not include eCommerce sales from the recent acquisitions of DECO and AIS. 



Gross Profit



Gross profit margin was 43.0% for the thirteen-week period ended December 1, 2018 as compared to 43.6% for the same period in the prior fiscal year.  Approximately one-half of the decline came from the AIS business we acquired in the fiscal third quarter of 2018.  The other half of the decline was the result of increased product costs and changes in our customer and product mix.



Operating Expenses



Operating expenses increased 8.1% to $255.0 million for the thirteen-week period ended December 1, 2018, as compared to $235.8 million for the same period in the prior fiscal year. Operating expenses were 30.7% of net sales for both the thirteen-week periods ended December 1, 2018 and December 2, 2017. The increase in operating expenses was primarily attributable to an increase in payroll and payroll-related costs and freight costs, associated with higher sales volumes.  Operating expenses also increased due to the acquisition of AIS in our third quarter of fiscal 2018.  AIS operating expenses, including non-recurring acquisition and integration costs, accounted for approximately $4.9 million of total operating expenses for the thirteen-week period ended December 1, 2018. 

 

Payroll and payroll-related costs were approximately 56.1% of total operating expenses for the thirteen-week period ended December 1, 2018, as compared to approximately 56.8% for the thirteen-week period ended December 2, 2017.  Included in payroll and payroll-related costs are salary, incentive compensation, sales commission, and fringe benefit costs. All of these costs increased for the thirteen-week period ended December 1, 2018, as compared to the same period in the prior fiscal year, with much of the increase attributable to an increase in salary expenses, primarily related to annual merit increases and an increase in our field sales and service associate headcount. Also contributing to the increase in payroll and payroll-related costs were increased costs associated with the acquired AIS operations, increased fringe costs associated with higher medical costs, and an increase in incentive compensation.



Freight expense was approximately $34.2 million for the thirteen-week period ended December 1, 2018, as compared to $31.5 million for the same period in the prior fiscal year. The primary driver of this was increased sales.

21


 

 

Income from Operations



Income from operations increased 3.7% to $103.0 million for the thirteen-week period ended December 1, 2018, as compared to $99.3 million for the same period in the prior fiscal year.  This was primarily attributable to the increase in net sales and gross profit, offset in part by the increases in operating expenses as described above.  Income from operations as a percentage of net sales decreased to 12.4% for the thirteen-week period ended December 1, 2018,  from 12.9% for the same period in the prior fiscal year, primarily the result of the decrease in the gross profit margin mentioned above.



Provision for Income Taxes



The effective tax rate for the thirteen-week period ended December 1, 2018 was 25.1% as compared to 37.8% for the same period in the prior fiscal year. The decrease in the effective tax rate is primarily due to the enactment of the TCJA in December 2017, which reduced the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018. Overall, the TCJA resulted in a net tax benefit of $13.0 million for the thirteen weeks ended December 1, 2018. We expect our full-year tax rate for fiscal 2019 to be in the 25.0% to 25.5% range. See Note 9 “Income Taxes” in the Notes to the unaudited Condensed Consolidated Financial Statements for further discussion.



Net Income



The factors which affected net income for the thirteen-week period ended December 1, 2018, as compared to the same period in the previous fiscal year, have been discussed above.



Liquidity and Capital Resources







 

 

 

 

 

 

 

 

 



 

 

  

 

December 1,

 

September 1,

 

 



 

2018

 

2018

 

$ Change



 

(Dollars in thousands)

Total debt

 

$

522,635 

 

$

535,333 

 

$

(12,698)

Less: Cash and cash equivalents

 

 

(11,615)

 

 

(46,217)

 

 

34,602 

   Net debt

 

$

511,020 

 

$

489,116 

 

$

21,904 

Equity

 

$

1,376,312 

 

$

1,387,254 

 

$

(10,942)



As of December 1, 2018, we held $11.6 million in 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, Private Placement Debt,  and Shelf Facilities, have been used to fund these needs, to repurchase shares of our Class A common stock, and to pay dividends.  As of December 1, 2018, total borrowings outstanding, representing amounts due under our credit facilities, Private Placement Debt and Shelf Facilities, as well as all capital leases and financing arrangements, were approximately $522.6 million, net of unamortized debt issuance costs of $1.5 million. As of September 1, 2018, total borrowings outstanding, representing amounts due under our credit facilities, Private Placement Debt, and Shelf Facilities, as well as all capital leases and financing arrangements, were approximately $535.3 million, net of unamortized debt issuance costs of $1.6 million. We believe, based on our current business plan, that our existing cash, funds available under our credit facilities, and cash flow from operations will be sufficient to fund our planned capital expenditures and operating cash requirements for at least the next 12 months.



The table below summarizes information regarding the Company’s liquidity and capital resources: