Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended August 29,1998
---------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------- -----------
Commission file number 1-14130
--------
MSC INDUSTRIAL DIRECT CO., INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
New York 11-3289165
------------------------------- ------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
151 Sunnyside Boulevard, Plainview, New York 11803-1592
-------------------------------------------------------
(Address of Principal Executive Offices)
(516) 349-7100
-------------------------------
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Exchange on Which Registered
- ------------------- ------------------------------------
Class A Common Stock, par value $.001 The New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
------
As of November 12, 1998, 33,691,315 shares of Class A Common Stock and
34,138,778 shares of Class B Common Stock of the registrant were outstanding
and the aggregate market value of Class A Common Stock held by non-affiliates
was approximately $682,249,000.
The registrant's Proxy Statement for its 1999 annual meeting of
stockholders is hereby incorporated by reference into Part III of this Form
10-K.
MSC INDUSTRIAL DIRECT CO., INC.
INDEX TO ANNUAL REPORT ON FORM 10-K FILED WITH
THE SECURITIES AND EXCHANGE COMMISSION
YEAR ENDED AUGUST 29, 1998
ITEMS IN FORM 10-K
Page
----
PART I
Item 1. BUSINESS.........................................................................................3
Item 2. PROPERTIES......................................................................................13
Item 3. LEGAL PROCEEDINGS...............................................................................13
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............................................13
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...........................14
Item 6. SELECTED FINANCIAL DATA.........................................................................15
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.....................................................................................17
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.....................................................23
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.....................................................................................43
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.............................................44
Item 11. EXECUTIVE COMPENSATION.........................................................................44
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................44
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................................44
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K................................45
Signatures.......................................................................................................46
PART I.
Item 1. BUSINESS.
Some of the statements contained in this report discuss future
expectations, contain projections of results of operations or financial
condition or state other "forward-looking" information. Those statements are
subject to known and unknown risks, uncertainties and other factors that could
cause the actual results to differ materially from those contemplated by the
statements. In light of the significant risks and uncertainties inherent in the
forward-looking statements included in this report, the inclusion of such
statements should not be regarded as a representation by us or any other person
that our objectives and plans will be achieved.
General
MSC Industrial Direct Co., Inc. ("MSC" or the "Company") is one of the
largest direct marketers of a broad range of industrial products to small and
mid-sized industrial customers throughout the United States. The Company
distributes a full line of industrial products, such as cutting tools,
abrasives, measuring instruments, machine tool accessories, safety equipment,
fasteners, welding supplies and electrical supplies, intended to satisfy its
customers' maintenance, repair and operations ("MRO") supplies requirements.
The Company offers over 370,000 stock-keeping units ("SKUs") through its 4,459
page master catalog and weekly, monthly and quarterly specialty and promotional
catalogs, newspapers and brochures and services its customers from
approximately 100 branch offices. Most of the Company's products are carried in
stock, and orders for these products are typically fulfilled the day on which
the order is received.
MSC has grown rapidly due to expanded product offerings, increased
catalog distribution and supplemental mailings and geographic expansion. The
Company's net sales have increased at a compound annual rate of 35.2% from
$174.7 million in fiscal 1994 to $583.0 million in fiscal 1998. During this
same period, income from operations increased at a compound annual rate of
33.4% from $24.0 million to $76.2 million.
MSC's business strategy is to provide an integrated, low cost solution
to the purchasing, management and administration of its customers' MRO needs.
MSC has positioned itself to add value to its customers' purchases by reducing
their total MRO supplies costs, taking into account both the direct cost of
products and the administrative, personnel and financial cost of obtaining and
maintaining MRO supplies. MSC's extensive product offerings allow customers to
reduce the administrative burden of dealing with many suppliers for their MRO
needs. The Company guarantees same-day shipping of products, approximately 99%
of which are generally kept in stock, thereby enabling customers to reduce
their inventory investment and carrying costs. The Company reduces its
customers' administrative paperwork, costs of shipping and personnel costs
related to internal distribution and purchase order management by consolidating
multiple purchases into a single shipment, providing a single invoice relating
to multiple purchases over varying periods of time and offering direct shipments
to specific departments and personnel within a single facility or multiple
facilities.
The Company's customers include a wide range of purchasers of
industrial supply products, from one-man machine shops to Fortune 500
companies. The Company's core business focuses on selling relatively higher
margin, lower volume products and has an average order size of approximately
$185. MSC has in excess of 178,000 active customers (companies that have
purchased at least one item during the past 12 months), which are typically
small and mid-sized companies. MSC's customers select desired products from the
Company's various publications and place their orders by telephone, facsimile
or direct computer link.
The Company operates primarily in the United States, with customers in
all 50 states, through a network of three regional distribution centers and
approximately 100 branch offices. The Company's distribution centers are
located in Harrisburg, Pennsylvania, Atlanta, Georgia and Elkhart, Indiana. The
strategic locations of the Company's distribution centers allow for next day
delivery via low cost ground carriers in 30 states located primarily in the
eastern United States. The Company's experience has been that areas accessible
by next day delivery generate significantly greater sales than areas where next
day delivery is not available. Accordingly, the Company's long-term strategy is
to establish additional distribution centers, supported by local branch
offices, to expand the Company's
3
geographic coverage of next day delivery throughout the continental United
States. A new distribution facility is presently under construction near Reno,
Nevada and is expected to be operational by the first quarter of fiscal 2000.
MSC was formed in October 1995 as a holding company to hold all of the
outstanding capital stock of Sid Tool Co., Inc., MSC's principal operating
subsidiary (the "Operating Subsidiary"), which has been in business since 1941.
The Company's business is principally conducted through the Operating
Subsidiary and the Operating Subsidiary's subsidiaries and, to a lesser extent,
through other wholly owned subsidiaries of MSC. The Company's principal
executive offices are located at 151 Sunnyside Boulevard, Plainview, New York
11803-1592. In November 1997, the Company purchased a building located at 75
Maxess Road, Melville, New York 11747, which will serve as the Company's
principal executive office upon relocation there that is expected to occur by
December 1998.
Industry Overview
The Company operates in a large, fragmented industry characterized by
multiple channels of distribution. The Company estimates the total United
States market for MRO supplies of the categories of industrial products sold by
MSC to be in excess of $140 billion annually, with the top 50 industrial
distributors accounting for approximately 16% of the market. The Company
believes that approximately 130,000 small retailers, dealerships and
distributors, substantially all of which have annual sales of less than $10
million, supply over 65% of the market. The distribution channels in the
industrial products market include retail outlets, small distributorships,
national, regional and local distributors, direct mail suppliers, large
warehouse stores and manufacturers' own sales forces.
Almost every industrial, manufacturing and service business has an
ongoing need for MRO supplies. The Company believes that because most
businesses focus primarily on their manufacturing processes or services
provided, relatively little attention is given to MRO purchasing. Except in the
largest industrial plants, the Company believes that MRO supplies inventories
generally are not effectively managed or monitored, resulting in higher
purchasing costs and increased administrative burdens. MRO items are generally
purchased by personnel whose primary functions involve areas other than the
acquisition of MRO supplies. In addition, within larger facilities, such items
are frequently stored in multiple locations, resulting in excess inventories
and duplicate purchase orders. MRO items are also frequently purchased by
multiple personnel in uneconomic quantities and a substantial portion of most
facilities' MRO supplies are "one-time purchases," resulting in higher
purchasing costs and time-consuming administrative efforts by multiple plant
personnel.
The Company believes that the administrative costs associated with
placing a MRO purchase order can be in excess of $100. Awareness of these high
costs and the purchasing inefficiencies discussed above has been driving large
companies to streamline the purchasing process by utilizing a limited number of
suppliers which can provide adequate selection, prompt delivery and superior
customer service. Customized billing practices and report generation
capabilities tailored to customer objectives are also becoming increasingly
important to customers seeking to reduce costs, allowing such customers to
significantly reduce the need for purchasing agents and administrative
personnel. The Company believes that the mid-size customer has begun to respond
to industry and economic pressures and is moving more rapidly toward the more
efficient, cost saving, single supply source offered by the Company. The
Company also believes that the small shop customer is just beginning to realize
the value of suppliers such as MSC in reducing overall costs through reductions
in paperwork, multiple sources of supply, inventory stocks and delivery times.
Despite the inefficiencies of the traditional MRO purchasing process,
long-standing relationships with local retailers and distributors have
generally perpetuated the status quo. Due to limited capital availability, high
operating cost structures and relatively small sales volumes, suppliers to the
industrial market are experiencing increasing pressure to consolidate and
curtail services and certain product lines in order to remain competitive. Even
large suppliers with extensive field sales forces are finding it increasingly
difficult to visit all buyers cost-effectively and provide the support
necessary to satisfy customer demands for control of costs and improved
efficiency. The Company believes that the relative inability of traditional
distribution channels to respond to these changing industry dynamics has
created a continuing opportunity for the growth of direct marketing
organizations such as MSC. As a
4
result of these dynamics, large warehouse stores and direct mail marketers
have captured an increasing share of sales by providing lower total purchasing
costs, broader product selection and a higher level of service.
MSC believes it provides a low cost solution to the purchasing
inefficiencies and high costs described above. Customers that purchase products
from MSC will generally find that their total purchasing costs are reduced
through consolidation of multiple sources of supply into a single supplier,
consolidation of multiple purchase orders into a single purchase order,
consolidation of multiple invoices into a single invoice, significant reduction
in tracking of invoices, significant reduction in stocking decisions and
elimination or reduction of purchases for inventory and, through the Company's
electronic ordering system, the elimination of paper orders and invoices. The
Company's customers generally will notice a reduction in purchasing costs,
inventory carrying costs and administrative inefficiency.
Business Strategy
The Company's business strategy is to provide its customers with a low
cost means for obtaining and maintaining MRO supplies. The strategy includes
the following key elements: (i) a broad selection of in-stock products; (ii)
prompt response and same-day shipping; (iii) superior, value-added customer
services; (iv) targeted direct mail marketing; and (v) a commitment to
technological innovation. As a result of this strategy, the Company believes it
is able to lower its customers' overall MRO supplies costs by reducing
administrative paperwork, shipping costs, internal distribution costs and
inventory investment and carrying costs.
o Breadth of Products. The Company believes that its ability to
offer customers a broad spectrum of brand name and generic MRO
products and a "good-better-best" product selection alternative
(similar product offerings with varying degrees of name recognition,
quality and price, thus permitting the customer to choose the
appropriate product for its purposes based on cost, quality and the
customer's specific needs) has been critical to its success. The
Company's customers are increasingly consolidating their purchasing
into fewer suppliers to reduce the administrative burden of ordering
from multiple suppliers. By offering for sale over 370,000 products,
approximately 99% of which are in stock and available for immediate
shipment, the Company aims to provide a broad range of merchandise in
order to become its customers' preferred supplier of MRO products.
o Same-Day Shipping. The Company's guaranteed same-day shipping
of products results in delivery the next day or second day for
customers in most of the continental United States. This prompt
delivery allows customers to reduce the administrative burden of
dealing with many suppliers and reduces their inventory investment and
carrying costs. The Company fulfills its same-day shipment of orders
guarantee more than 99.9% of the time. The Company's experience has
been that areas accessible by next day delivery will generate
significantly greater sales than areas where next day delivery is not
available. The strategic locations of the Company's distribution
centers allow next day delivery via low cost ground carriers in 30
states located primarily in the eastern United States.
o Superior Customer Service. Customer service is a key element
in becoming a customer's preferred provider of MRO supplies. The
Company emphasizes customer service and supports this service with
sophisticated information systems and extensive training. Utilizing
its proprietary customer support software, the Company's in-bound
telemarketing representatives implement the Company's "one call does
it all" philosophy. Telemarketing representatives are able to inform
customers on a real time basis of the Company's in-stock inventory
availability, recommend substitute products, verify credit
information, receive special, custom or manufacturer direct orders,
cross-check inventory items using customer product codes previously
entered into the Company's information systems and provide technical
product information. The Company believes that its simple, one-call
method of fulfilling all purchasing needs of a customer through
highly-trained telemarketing representatives, supported by the
Company's proprietary information systems, results in greater
efficiency for customers and increased customer satisfaction. To
5
complement its customer service, the Company seeks to ease the
administrative burdens on its customers by offering customized billing
services, customer savings reports and other customized report
features, electronic data interchange ("EDI") ordering, bulk discounts
and stocking of specialty items specifically requested by customers.
o Targeted Direct Mail Marketing Strategy. MSC's primary tool
for marketing and product reference is its annual master catalog
containing 4,459 pages and over 370,000 items. The Company's master
catalog was supplemented by approximately 80 specialty and promotional
catalog, brochure and newspaper titles in fiscal 1998, covering such
specialty areas as welding, cutting tools, measuring instruments,
abrasives, industrial supply, and hose and tubing. The Company uses
its database of approximately 600,000 companies and 1,500,000
individuals, and also purchases mailing lists of prospective
customers, to target the distribution of these various publications to
specific individuals within an organization whose purchasing history
or other criteria suggest receptiveness to mailings of specific
publication titles. The use of specialty and promotional publications,
which are produced in-house, increases productivity through lower
costs, increased response rates and more efficient use of advertising
space. MSC's publications mailings increased from 4.8 million in
fiscal 1994 to approximately 15.9 million in fiscal 1998. In fiscal
1999, the Company intends to continue to increase direct marketing
efforts to take advantage of the additional products offered and of
its expanded distribution capabilities. The Company's expenditures on
direct mail increased from approximately $6.0 million in fiscal 1994
to approximately $15.6 million in fiscal 1998, and are budgeted to
grow to $20 million in fiscal 1999.
o Commitment to Technological Innovation. The Company utilizes
technological innovation to improve customer service and to reduce its
operating costs through more effective buying practices, automated
inventory replenishment and efficient order fulfillment operations.
MSC's proprietary software tracks all of the approximately 370,000 SKUs
and enables the customer and the telemarketing representatives to
determine the availability of products in stock on a real-time basis
and to evaluate alternative products and pricing. The Company's EDI
system allows a customer to order products directly, set purchase
limits for particular buyers, run customized reports of purchasing
history and select from a variety of billing options. The information
systems developed by the Company have been designed to enhance
inventory management and turnover, customer service and cost reduction
for both MSC and its customers. In addition to internal and customer
information systems, the Company continually upgrades its distribution
methods and systems to improve productivity and efficiency. The Company
has also developed a World Wide Web information site in anticipation of
increased commerce on the Internet.
The Company believes that direct mail is one of the most effective and
low cost methods of reaching customers. The Company continually seeks to reduce
its own costs in order to continue to be the low cost solution for its
customers. For example, MSC's call centers are a lower-cost and more effective
alternative to maintaining a large direct sales force. In addition, the Company
produces its various product and promotional publications in-house, thereby
significantly reducing marketing costs. MSC's increasing volume purchasing
power has also resulted in lower prices from vendors on many of the products it
sells and dispersion of central costs over a wider revenue base.
Growth Strategy
The Company's objective is to become the preferred supplier of
industrial products for small and mid-sized companies throughout the United
States. The Company intends to increase sales to existing and new customers in
existing geographic markets served by next day delivery by (i) increasing the
number of product lines and SKUs offered; (ii) increasing the circulation of
the master catalog and expanding its targeted direct mail campaign; and (iii)
acquiring smaller local distributors to gain access to customers while
consolidating the acquired operations into existing Company distribution
facilities. The Company also intends to increase sales to customers in regions
not currently served by next day delivery by increasing the geographic
availability of next day delivery.
6
o Increased Penetration of Existing Markets. The Company
believes that a significant opportunity to increase profits lies in
the incremental revenue which can be realized from its current
customers and new customers in geographic areas where the Company
currently operates. MSC believes that continuing to increase the
breadth of its product line and providing high levels of customer
service are effective methods of increasing sales to current customers
and attracting new customers. Accordingly, MSC has added in excess of
200,000 SKUs over the past four years while simultaneously increasing
the Company's inventory turns. By expanding the product lines and SKUs
offered, the Company seeks to satisfy an increasing percentage of the
MRO supplies purchases of its customers and to attract new customers.
Additionally, the Company's ability to deliver such expanding product
lines on a next day basis is an important service advantage that
results in lower costs to customers. The Company's commitment to
superior customer service and a broad product base adds to the
convenience and effectiveness of doing business with MSC.
Since fiscal 1997, the Company has shifted its principal growth
emphasis from increasing its offering of SKUs to increasing the size
and diversity of its customer base. This strategy took advantage of
the Company's ability to service the industrial Midwestern United
States through its Elkhart, Indiana facility. In addition, the Company
has accumulated a buyer database of approximately 1,500,000
individuals and utilizes empirical information from this database to
prospect for new customers and to supplement its master catalog with
directed mailings of specialty and promotional publications intended
to increase customer response and product purchases.
o Expansion of Same-Day Shipping into New Markets. The Company
operates primarily in the continental United States through a network
of three regional distribution centers and approximately 100 branch
offices. The strategic locations of the Company's distribution centers
allow next day delivery via low cost ground carriers in 30 states
located primarily in the eastern United States and second day delivery
throughout the rest of the continental United States. The Company's
experience has been that sales in areas accessible by next day delivery
are significantly greater than in areas with second day delivery. The
Company's goal is to open additional distribution centers, supported
locally by branch offices, which will expand the Company's geographic
coverage of next day delivery throughout the United States.
o Selected Acquisitions. The Company seeks to grow through
acquisitions in both current and new markets. In pursuing
acquisitions, the Company seeks to gain immediate access to the
acquired company's customer base while consolidating the acquired
company's operations into MSC's existing distribution system, thus
achieving increased revenue while incurring limited incremental
operating costs. The Company believes that local market acquisitions
of small and medium-sized suppliers of industrial products provide an
attractive opportunity for expanding its customer base in existing
markets. All three acquisitions completed by the Company during fiscal
1998 operate in markets where the Company already was present. Thus,
corporate and administrative infrastructures necessary to support such
acquisitions were already in place.
Products
The Company currently offers in excess of 370,000 SKUs, which number
represents a greater than 247% increase since 1993. The Company attributes a
portion of its sales growth to the total number of SKUs offered. In this
regard, the Company intends to continue to add new product categories and
increase the number of products offered in existing product categories in its
efforts to gain new customers and increase sales from existing customers. The
Company's core products include cutting tools, abrasives, measuring
instruments, machine tool accessories, machinery and safety products. As part
of its strategy of supplying an increasing portion of its customers' MRO needs,
the Company has expanded its product mix to include plumbing supplies, process
instrumentation, hardware, marking products, pumps and pneumatics and has
significantly increased its offering of flat stock raw materials and cutting
tools. MSC seeks to distinguish itself from its competition through offering
both name brand and generic products and significant depth in its core product
lines while maintaining competitive pricing.
7
The Company's offering of specific products from multiple
manufacturers at different prices and quality levels permits MSC to offer a
"good-better-best" product selection alternative. This alternative provides the
customer a choice among similar product offerings with varying degrees of name
recognition, quality and price, thus permitting the customer to choose the
appropriate product for a specific task on the most cost-effective basis. For
example, if a customer requires a drill bit to drill 100 holes, it would not be
cost-effective to purchase the top-of-the-line name brand, which is capable of
drilling 10,000 holes. MSC's telemarketing representatives and technical
support personnel are trained specifically to assist customers in making
intelligent cost-saving purchases. The Company believes that its offering of
multiple product alternatives and the services provided by its knowledgeable
customer service and technical support personnel result in significant amounts
of repeat business and are an integral part of MSC's overall customer cost
reduction strategy.
The following table itemizes the product categories currently offered
by MSC and the number of SKUs available in each product category:
Category Number of SKUs
-------- -------------
Cutting Tools 117,694
Tooling Components 29,584
Fasteners 28,848
Measuring Instruments 20,323
Machinery 20,311
Flat Stock & Raw Materials 17,387
Abrasives 15,639
Hand and Power Tools 15,233
Electrical Supplies 13,683
Power Transmission 13,092
Material Handling 13,049
Plumbing Supplies 8,549
Hose Tube and Fittings 8,474
Safety Products 8,018
Process Instrumentation 6,036
Welding 4,708
Marking & Labeling 4,672
Hardware 3,753
Pneumatics & Hydraulics 3,596
Lubricants 2,762
Janitorial/Maintenance 2,636
HVAC 1,214
Packing & Shipping 787
Pumps 736
Office Equipment 537
Miscellaneous 10,881
----------
Total 372,202
==========
The Company purchases substantially all of its products directly from
approximately 1,600 manufacturers located in the United States. The Company is
not materially dependent on any one supplier or small group of suppliers. No
single supplier accounted for more than 5% of the Company's total purchases in
fiscal 1998. Generic products, primarily machine tools, are manufactured by
third parties to the Company's specifications.
Distribution Centers
A significant number of the Company's products are carried in stock,
and approximately 95% of orders are fulfilled from the distribution centers or
branch offices. Certain products, such as specialty or custom items and
8
some very large orders, are shipped directly from the manufacturer. The
operations of the Company's distribution centers are managed via computer-based
SKU tracking systems and radio frequency devices that facilitate the location
of specific stock items to make the picking process more efficient. The Company
has invested significant resources in technology and automation to increase
efficiency and reduce costs, and continuously monitors its order fulfillment
process and endeavors to maintain its commitment to technological efficiencies
and cost reduction. The Company currently utilizes three distribution centers
for product shipment located in Harrisburg, Pennsylvania, Atlanta, Georgia and
Elkhart, Indiana. In fiscal 1998, the Company began construction of a new
distribution center located near Reno, Nevada, which will move the Company
toward its goal of next day delivery throughout the continental United States.
Sales and Marketing
The Company's customers include a broad range of purchasers of
industrial supply products, from one-man machine shops to Fortune 500
companies. The Company's core business focuses on selling relatively higher
margin, lower volume products and has an average order size of approximately
$185. The Company focuses its marketing efforts on the small shop segment,
consisting of job shops and other small industrial entities with fewer than 100
employees and usually less than $500,000 of annual industrial supplies
purchases, and the mid-size corporate segment, consisting of industrial
entities with 100-999 employees and annual MRO purchases of between $500,000
and $1,000,000. The Company's strategy with respect to the large corporate
segment is to develop relationships with, and supply MRO products directly to,
the integrated supply providers that are hired by large corporations to manage
their MRO purchasing and administrative operations.
The Company also offers wholesalers and other distributors the ability
to create their own customized mail order catalog by offering to these MSC
customers turn-key marketing programs, including promotional mailers. Any
resulting orders are serviced directly by MSC, which stocks and ships the
products under the customer's program. Another division of MSC offers a line of
lower priced products for the budget-oriented customer.
MSC has in excess of 178,000 active customers (companies which have
purchased at least one item during the past 12 months). Typically, a customer's
MRO purchases are managed by several buyers responsible for different
categories of products. The Company targets these individual buyers within an
organization and distributes publication titles corresponding to the product
categories for which such buyers are responsible. The Company is able to
accomplish this directed marketing strategy as a consequence of the depth of
customer information contained in its information systems databases. The
Company's customers select desired products from the Company's various
publications and place their orders by telephone, facsimile or direct computer
link.
The Company has invested significant resources in developing an
extensive customer and prospect database. This database is a key component of
the Company's growth strategy. The customer and prospect database includes
detailed information, including company size, number of employees, industry of
operation, various demographic and geographic characteristics and personal
purchase histories (catalog preference, product preference, order value). The
Company believes that this variety and depth of information on its customers
and prospects offers the Company a significant competitive advantage in
increasing sales to existing customers and attracting new customers.
The Company relies on its approximately 350 in-bound telemarketing
representatives, who are responsible for a majority of customer contacts and
order entries. These telemarketing representatives are highly trained
individuals who build relationships with customers, assist customers in
reducing costs, provide technical support, coordinate special orders and
shipments with vendors and update customer account profiles in the Company's
information systems databases. The Company's "one call does it all" philosophy
is predicated on the ability of the telemarketing representative, utilizing the
Company's information systems' comprehensive databases as a resource, to
respond effectively to the customer's needs. When a customer places a call to
the Company, the telemarketing representative taking the call has immediate
access to that customer's company and specific buyer profile, as well as
inventory levels by distribution center on all of the over 370,000 SKUs offered
by MSC. The customer's profile includes historical and current billing
information, historical purchasing information and plant and industry
9
information. The Company believes that its information systems databases are an
important factor in achieving customer satisfaction and the success of the
Company's business strategy.
MSC's telemarketing representatives undergo an intensive two week
training course, are required to attend regular on-site training seminars and
workshops, and are monitored and evaluated at regular intervals. Additionally,
the telemarketing representatives are divided into teams that are evaluated
monthly and monitored on a daily basis by team supervisors. Telemarketing
representatives receive technical training regarding various products from
vendors and in-house training specialists. The Company also maintains a
separate technical support group dedicated to answering specific customer
inquiries and assisting customers with the operation of products and finding
low cost solutions to manufacturing problems.
Additionally, the Company employs a direct sales force of
approximately 220 sales representatives. These commission-based sales
representatives are responsible for increasing sales per customer and servicing
existing customers.
Branch Offices
The Company currently operates approximately 100 branch offices
located in 34 states. These branch offices receive approximately 54% of all
orders and are staffed with highly trained telemarketing representatives that
receive the same training, are monitored in the same fashion and have access to
the same information systems as the telemarketing representatives mentioned
above. The Company has experienced higher sales growth and market penetration
in areas where it has established a branch office and believes its branch
offices are critical to the success of the Company's business strategy. In
addition to opening new branch offices in support of its distribution centers,
the Company has acquired local distributors and converted them to branch
offices in new geographic locations to obtain an immediate established local
market presence through use of the acquired customer base and integration of
their operations. The Company believes that branch office acquisitions will
result in more rapid growth at a lower cost.
Publications
The Company's primary reference tool is its annual 4,459 page master
catalog, which is supported by specialty and promotional catalogs, brochures
and newspapers. The Company uses specialty and promotional publications to
target customers in specific areas, such as welding, electrical supply and hose
and tubing. The Company distributes specialty and promotional catalogs,
brochures and newspapers based on information in the Company's databases and
purchased mailing lists to customers whose purchasing history or profile
suggests that they are most likely to purchase according to specific product
categories or product promotions. Consequently, specialty catalogs offer a more
focused selection of products at a lower catalog production cost due to
increased response rates and more efficient use of advertising space.
MSC's in-house marketing staff designs and produces all of MSC's
catalogs, brochures and newspapers. Each publication is printed with
photographs, contains detailed product descriptions and includes a toll-free
telephone number to be used by customers to place a product order. In-house
production helps reduce overall expense and shortens production time, allowing
the Company the flexibility to alter its product offerings and pricing and
refine its catalog, brochure and newspaper formats more quickly.
The success of the Company's targeted marketing program in enhancing
revenue has justified an increase in the Company's direct mail budget from
approximately $6.0 million in fiscal 1994 to approximately $15.6 million in
fiscal 1998. The budget for fiscal 1999 is approximately $20 million. As
reflected in the following table, the number of publication titles has
increased from 20 in fiscal 1994 to approximately 80 in fiscal 1998. The number
of pieces mailed has increased from approximately 4.8 million in fiscal 1994 to
approximately 15.9 million in fiscal 1998 and is expected to reach
approximately 21.6 million in fiscal 1999.
10
Fiscal Year Ended
-------------------------------------------------------------------------------
August 27, September 2, August 31, August 30, August 29,
1994 1995 1996 1997 1998
(52 weeks) (53 weeks) (52 weeks) (52 weeks) (52 weeks)
---------- ------------ ---------- ---------- ----------
Number of publication titles 20 38 70 80 80
Number of publications mailed 4,794,000 6,604,000 6,300,000 11,318,000 15,900,000
Customer Service
One of the Company's goals is to make purchasing its products as
convenient as possible. Since a majority of customer orders are placed by
telephone, the efficient handling of calls is an extremely important aspect of
the Company's business. Order entry and fulfillment occurs at each of the
Company's branches and main call centers located at the Company's three
operating distribution centers. Calls are received by highly trained in-bound
telemarketing representatives who utilize on-line terminals to enter customer
orders into computerized order processing systems. The Company's branch offices
field approximately 54% of all telephone orders. The Company's telephone
ordering system is flexible and, in the event of local or regional breakdown,
can be re-routed to alternative locations. When an order is entered into the
system, a credit check is performed, and, if the credit is approved, the order
is electronically transmitted to the distribution center closest to the
customer and a packing slip is printed for order fulfillment. Most of the
orders placed with the Company are shipped by United Parcel Service ("UPS"),
and, to a limited extent, by various other freight lines and local carriers.
Air freight is also used when appropriate. The Company has no written agreement
with UPS but has been able to negotiate favorable shipping rates due to the
volume of shipments from the Company. The Company is not dependent on any one
carrier and believes that alternative shipping arrangements can be made with
minimal disruption to operations in the event of the loss of UPS as the
Company's primary carrier. The Company believes that its relationships with all
its carriers are satisfactory. The Company guarantees same-day shipping if the
order is received prior to 4:30 p.m. eastern time and most customers receive
their orders (other than custom items and large industrial items shipped
directly by the manufacturer) within one or two business days of the order
date. Customers are invoiced for merchandise, shipping and handling promptly
after shipment. Back order levels are, and historically have been, immaterial.
Information Systems
The Company's proprietary information systems allow centralized
management of key functions, including communication links between distribution
centers, inventory and accounts receivable management, purchasing, pricing,
sales and distribution, and the preparation of daily operating control reports
that provide concise and timely information regarding key aspects of its
business. These proprietary information systems enable the Company to ship to
customers on a same-day basis, respond quickly to order changes and provide a
high level of customer service. The proprietary information systems enable the
Company to achieve cost savings, deliver superior customer service and manage
its operations centrally. Certain of the Company's information systems operate
over a wide area network and are real-time information systems that allow each
distribution center and branch office to share information and monitor daily
progress relating to sales activity, credit approval, inventory levels, stock
balancing, vendor returns, order fulfillment and other measures of performance.
The Company also maintains a sophisticated buying and inventory management
system that monitors substantially all of its SKUs and automatically purchases
inventory from vendors for replenishment based on projected customer ordering
models. In fiscal 1998, the Company developed an EDI purchasing program with
its customers with the objective of allowing them to place orders more
efficiently, reduce order cycle processing time, and increase the accuracy of
orders placed.
In addition to developing the proprietary computer software programs
for use in the telemarketing and distribution operations, the Company has also
developed a proprietary MRO management system, the Customer Direct Access Plus
System ("CDA"). CDA is designed to automate, simplify and control the
administration and management of MRO purchasing by giving the customer direct
access to the Company's computers for automatic product selection,
customization of purchasing parameters, a variety of report generation and
product tracking capabilities, and cross-referencing capability to a customer's
own product stock numbers. In addition, the Company
11
has developed a Windows(Registered)-based CD-ROM electronic catalog package and
has commenced providing product information and ordering capabilities on the
Internet.
The Company runs its systems on an AS400 platform and utilizes
disaster recovery techniques and procedures which the Company believes are
adequate to fulfill its needs and are consistent with this type of equipment.
The Company believes that planned enhancements and upgrades to the next
generation of its existing operating platforms will be sufficient to sustain
its present operations and its anticipated growth for the foreseeable future.
Acquisitions
The Company has completed several acquisitions and considers
acquisitions as part of its growth strategy. The Company believes that the
ongoing consolidation within the industrial supply industry is spurring smaller
competitors to seek partners to increase their productivity and reduce costs.
The Company believes that it is well positioned to play a significant role in
this industry consolidation.
The Company believes that the most beneficial acquisitions are those
which can be integrated into its existing operations. Accordingly, the Company
expects to focus on branch office acquisition prospects that can be integrated
into its distribution facilities. The Company will also consider new market
acquisitions if they are of sufficient size that the Company can establish a
meaningful presence in such markets in accordance with its geographic growth
plans.
Upon completing an acquisition within an existing market, the Company
strives to move rapidly to integrate the acquired entity into its existing
operations. The Company believes that such integration offers a number of
opportunities to improve productivity and customer service. These benefits
include: (i) elimination of redundant facilities and services, (ii) reduction
of administrative overhead, (iii) consolidation of purchasing power, (iv)
expanded customer services, and (v) increased merchandise selection. From time
to time, the Company has engaged in, and continues to engage in, preliminary
discussions with respect to potential acquisitions. The Company is not
currently a party to any oral or written acquisition agreement or engaged in
any negotiations with respect to any material acquisition candidate. No
assurance can be given that any acquisitions, when and if made, will be
successfully integrated into the Company's existing operations, nor can there
be any assurance that the Company will be able to implement this phase of its
growth strategy.
Competition
The MRO supply industry is a large, fragmented industry that is highly
competitive. The Company faces competition from (i) traditional channels of
distribution such as retail outlets, small dealerships, regional or national
distributors utilizing direct sales forces, and manufacturers of MRO supplies
and (ii) large warehouse stores and larger direct mail distributors. The
Company believes that sales of MRO supplies will become more concentrated over
the next few years, which may make the industry more competitive. Certain of
the Company's competitors offer a greater variety of products and have
substantially greater financial and other resources than the Company. In the
industrial products market, customer purchasing decisions are primarily based
on one or more of the following criteria: price, product selection, product
availability, level of service and convenience. The Company believes it
competes effectively on all such criteria.
Employees
As of November 12, 1998, the Company employed approximately 2,250
employees, including approximately 2,200 full-time and approximately 50
part-time employees. None of the Company's employees is represented by a labor
union. The Company considers its relationships with employees to be good and
has experienced no work stoppages.
12
Item 2. PROPERTIES.
The Company's distribution centers are as follows:
Approx.
Location Sq. Ft. Operational
-------- ------- -----------
Atlanta, Georgia (1) 340,000 October 1990
Elkhart, Indiana (2) 270,000 March 1996
Harrisburg, Pennsylvania (2) 270,000 January 1997
- ---------------
(1) The related party lease for this facility expires on July 31, 2010.
(2) This facility is owned by the Company.
The Company maintains its headquarters at an 83,000 square foot
facility in Plainview, New York, and sublets to a third party approximately
60,000 square feet of another facility located in Plainview, New York.
In November 1997, the Company purchased a building in Melville, New
York which will serve as the Company's principal executive office upon
relocation there, which is expected to occur by December 1998.
The Company maintains approximately 100 branch offices located in 34
states, ranging in size from 670 to 16,000 square feet. The leases for these
branch offices will expire at various periods between October 1998 and July
2010. The aggregate annual lease payments on these properties in fiscal 1998
was approximately $4,795,000.
The Company believes that, after relocating its headquarters
operations, its facilities will be adequate for its current needs and that for
the foreseeable future, suitable additional space will be available as needed.
Item 3. LEGAL PROCEEDINGS.
There are no material legal proceedings pending against the Company.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
13
PART II.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Class A Common Stock is traded on the New York Stock
Exchange (the "NYSE") under the symbol "MSM." The Company's Class B Common
Stock is not traded over any public market.
The following table sets forth the range of the high and low closing
sales prices as reported by the NYSE for the period from September 1, 1996 to
August 29, 1998:
Price of Class A
Fiscal Year Ended August 30, 1997 Common Stock *
- --------------------------------- ----------------------
High Low
----------------------
First Quarter................................................................... $19-9/16 $15-1/16
Second Quarter.................................................................. 19-9/16 16-1/2
Third Quarter................................................................... 17-15/16 14
Fourth Quarter.................................................................. 21-5/8 17-5/8
Fiscal Year Ended August 29, 1998
- ---------------------------------
First Quarter................................................................... $23 $18-1/2
Second Quarter.................................................................. 24-3/4 19-1/2
Third Quarter................................................................... 27-7/8 23-3/8
Fourth Quarter.................................................................. 33-1/8 27-7/8
On November 12, 1998, the last reported sales price for the Class A
Common Stock on the NYSE was $20-1/4 per share.
The approximate number of holders of record of the Class A Common
Stock as of November 12, 1998 was 489. The number of holders of record of the
Company's Class B Common Stock as of November 12, 1998 was 10.
The Company has not declared cash dividends on the Class A Common
Stock or the Class B Common Stock and does not have any plans to pay any cash
dividends on either such class of stock in the foreseeable future. The Board of
Directors of the Company anticipates that any earnings that might be available
to pay dividends on the Class A Common Stock and the Class B Common Stock will
be retained to finance the business of MSC and its subsidiaries.
* On April 6, 1998, the Company declared a two-for-one stock split in
the form of a stock dividend, distributed May 22, 1998 to shareholders of record
as of April 24, 1998. The Class A Common Stock price per share information
included above has been restated to reflect this stock split.
14
Item 6. SELECTED FINANCIAL DATA.
The following selected financial information is qualified by reference
to, and should be read in conjunction with, the Company's financial statements
and the notes thereto, and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contained elsewhere herein. The selected
income statement data for the fiscal years ended August 31, 1996, August 30,
1997 and August 29, 1998 and the selected balance sheet data as of August 30,
1997 and August 29, 1998 are derived from the Company's audited financial
statements which are included elsewhere herein. The selected income statement
data for the fiscal years ended August 27, 1994 and September 2, 1995 and the
selected balance sheet data as of August 27, 1994, September 2, 1995 and August
31, 1996 are derived from audited financial statements of the Company not
included herein.
Fiscal Year Ended
-------------------------------------------------------------------------
August 27, September 2, August 31, August 30, August 29,
1994 1995 1996 1997 1998
(52 weeks) (53 weeks) (52 weeks) (52 weeks) (52 weeks)
------------ --------------- --------------- -------------- -------------
(in thousands, except per share data)
Income Statement Data:
Net sales $ 174,682 $ 248,483 $ 305,294 $ 438,003 $ 583,043
Gross profit 74,852 103,288 126,775 179,255 238,074
Operating expenses 50,811 69,532 83,666 120,498 161,899
Restructuring charge -- -- 8,600 -- --
Income from operations 24,041 33,756 34,509 58,757 76,175
Income taxes 813 765 5,531 23,518 30,904
Net income 22,573 31,698 28,503 36,017 47,335
Net income per share:
Basic -- -- -- .53 .70
Diluted -- -- -- .53 .69
Weighted number of shares outstanding:
Basic -- -- -- 67,381 67,756
Diluted -- -- -- 68,218 68,964
Pro forma net income(1) 14,149 19,640 20,591 -- --
Pro forma net income per share: (2)
Basic .29 .41 .35 -- --
Diluted .29 .41 .35 -- --
Pro forma weighted number of shares
outstanding: (2)
Basic 48,000 48,000 58,910 -- --
Diluted 48,000 48,000 59,246 -- --
Selected Operating Data(3):
Active customers 98 120 127 146 178
Number of SKUs 170 231 302 332 372
Orders entered 1,348 1,833 2,155 2,425 3,222
Number of publication titles (not in 20 38 70 80 80
thousands)
Number of publications mailed 4,794 6,604 6,300 11,318 15,900
Revenue per employee $ 214 $ 249 $ 266 $ 280 $ 282
15
August 27, September 2, August 31, August 30, August 29,
1994 1995 1996 1997 1998
------------ --------------- --------------- -------------- -------------
Balance Sheet Data (at period end):
Working capital $48,726 $ 81,228 $ 163,785 $ 190,344 $ 183,750
Total assets 91,307 139,032 265,484 334,834 401,702
Short-term debt 12,728 9,208 2,486 213 800
Long-term debt, net of current portion 3,220 30,969 42,191 2,744 2,430
Shareholders' equity $55,750 $ 72,088 $ 172,571 $ 274,995 $ 321,779
(1) Gives pro forma effect to "C" corporation taxation at an assumed annual
rate of 39.5%.
(2) Pro forma net income per common share for the year ended August 31, 1996
includes the pro forma effect of a "C" corporation income tax provision for the
entire year. Pro forma weighted average common shares outstanding include the
weighted average shares of Class A and Class B Common Stock and common stock
equivalents outstanding during the year, after giving pro forma effect to the
recapitalization in the initial public offering.
(3) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- General."
16
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
General
In recent years, the Company made the strategic decision to leverage
its strength as a low-cost, value-added MRO provider by adding new categories
of MRO supplies, such as welding and electrical supplies, which has increased
sales to existing customers and allowed the Company access to new customers.
The Company believes that revenue has increased, in part, as a result of the
increase in the number of SKUs; however, the Company is unable to quantify
precisely the impact of such increase. The Company intends to continue to add
new product categories and increase the number of products offered in existing
product categories in its efforts to gain new customers and increase sales from
existing customers. During fiscal 1998, the Company added approximately 40,000
SKUs and expects to add approximately 40,000 SKUs during each of the next two
fiscal years. The Company generally adds SKUs in response to the feedback it
receives from its existing customers. In this way, the Company seeks to
increase purchases from existing customers through increased product offerings
that it knows are desired by its customers. The Company also seeks to expand
its customer base by offering its increased product lines and product offerings
to customers who have not previously purchased merchandise from the Company.
There can be no assurance that the Company will be able to increase the number
of SKUs offered or that the correlation between the number of SKUs offered and
revenue will continue.
The Company significantly expanded its direct mail marketing program
from approximately 4.8 million pieces in fiscal 1994 to 11.3 million pieces in
fiscal 1997. In fiscal 1998, the Company targeted its marketing program to
enhance its investments in acquired entities and new distribution centers.
Accordingly, in fiscal 1998, mailings increased to 15.9 million pieces.
Targeted mailings to customers or potential customers are designed to maximize
the Company's return in relation to its marketing expenditures. The Company
utilizes its customer databases to match specific customer profiles with an
expanding selection of catalog titles which emphasize specific product
categories. The Company believes that increasing mailings to more targeted
customer segments has resulted in increased marketing productivity.
In fiscal 1999, the Company intends to take advantage of the
additional products offered and its expanded distribution capabilities by
further increasing its direct marketing efforts. These direct marketing
expenditures are expected to enhance the expanded product offerings and
improved distribution capabilities; however, the costs associated with this
program will be incurred substantially in advance of increased sales and may
negatively impact operating margins in the short term. Such costs are expected
to be offset, in part, by increases in vendor funded co-op payments which will
offset a portion of the catalog and mailing expenses. There can be no assurance
that continued expansion of the Company's direct mail marketing program will
result in new customers or an increase in sales from existing customers.
Revenue per employee increased from approximately $214,000 in fiscal
1994 to approximately $282,000 during fiscal 1998. The Company believes that
this increase in revenue per employee is indicative of its efforts to achieve
higher levels of efficiency and cost savings at the employee level.
The number of annual orders entered and processed has increased from
approximately 1.3 million in fiscal 1994 to approximately 3.2 million during
fiscal 1998. The average order size of the Company's core business has increased
from approximately $130 in fiscal 1994 to approximately $185 during fiscal
1998. The Company believes that its targeted marketing campaign strategy, its
strategy of continuing to add new product categories and new products within
existing categories, and increased efficiencies in order processing have been
significant contributing factors to the Company's increase in orders and,
accordingly, sales, both from existing customers and from new customers. There
can be no assurance, however, that the Company will be able to continue to grow
at rates recently experienced or at all.
MSC commenced shipping operations at its distribution center in
Harrisburg, Pennsylvania during fiscal 1997 in order to improve the Company's
efficiency, geographic distribution and market penetration. The opening of
17
this distribution center required a substantial capital investment, including
expenditures for real estate and construction, and a substantial investment for
inventory. The opening adversely impacted distribution expenses as a percentage
of sales, inventory turnover and return on investment. During fiscal 1996, the
Company commenced shipping operations at a new distribution center in Elkhart,
Indiana. The opening also initially had adverse effects similar to those
arising from the opening of the Harrisburg, Pennsylvania distribution center on
distribution expenses as a percentage of sales, inventory turnover and return
on investment.
Results Of Operations
The following table summarizes the Company's historical results of
operations as a percentage of sales for fiscal 1996, 1997 and 1998:
August 31, 1996 August 30, 1997 August 29, 1998
--------------- --------------- ---------------
Net sales (dollars in thousands).......... $305,294 $438,003 $583,043
======== ======== ========
Net sales................................. 100.0% 100.0% 100.0%
Gross profit.............................. 41.5 40.9 40.8
Operating expenses........................ 27.4 27.5 27.8
Restructuring charge...................... 2.8 -- --
Income from operations.................... 11.3 13.4 13.1
Net Income................................ 9.3 8.2 8.1
Pro forma net income...................... 6.7 N/A N/A
Fiscal Year Ended August 29, 1998 Compared to Fiscal Year Ended August 30, 1997
Net sales increased by $145.0 million, or 33.1%, to $583.0 million in
fiscal 1998 from $438.0 million in fiscal 1997. This increase was primarily
attributable to an increase in sales to the Company's existing customers, an
increase in the number of active customers and the effect of acquisitions made
in fiscal 1997 and fiscal 1998. The increase in sales to existing customers was
derived primarily from an increase of 11.4% in the number of SKUs offered, as
well as from more focused marketing efforts. Average annual sales per customer
increased 9.3%, and the number of active customers increased 21.9% in fiscal
1998, as compared to fiscal 1997. Sales from the companies acquired in 1998
accounted for approximately 3.0% of consolidated net sales.
Gross profit increased by $58.8 million, or 32.8%, to $238.1 million
in fiscal 1998 from $179.3 million in fiscal 1997. The increase in gross profit
was attributable to increased sales. As a percentage of sales, gross profit
decreased slightly from 40.9% in fiscal 1997 to 40.8% in fiscal 1998. The
Company's gross profit as a percentage of sales from its core business remained
constant.
Operating expenses increased by $41.4 million, or 34.4%, to $161.9
million in fiscal 1998 from $120.5 million in fiscal 1997. The increase was
primarily attributable to increased sales volume, which required additional
staffing and support. As a percentage of sales, operating expenses increased
from 27.5% to 27.8%. The increase was primarily the result of continuous
investment in new branches and other growth programs, offset in part by
operating efficiencies and the distribution of fixed expenses over a larger
revenue base.
Income from operations increased by $17.4 million, or 29.6%, to $76.2
million in fiscal 1998 from $58.8 million in fiscal 1997. This increase was
primarily attributable to increased sales and gross profit offset in part by an
increase in operating expenses.
18
Net income increased by $11.3 million, or 31.4% to $47.3 million in
fiscal 1998, from $36.0 million in fiscal 1997. The increase in net income is
primarily attributable to increased sales and gross profit, offset by higher
operating expenses.
Fiscal Year Ended August 30, 1997 Compared to Fiscal Year Ended August 31, 1996
Net sales increased by $132.7 million, or 43.5%, to $438.0 million in
fiscal 1997 from $305.3 million in fiscal 1996. This increase was primarily
attributable to an increase in sales to the Company's existing customers, an
increase in the number of active customers and the effect of acquisitions
completed during fiscal 1996 and 1997. The increase in sales to existing
customers was derived primarily from an increase of 9.9% in the number of SKUs
offered as well as from more focused marketing efforts. Average annual sales
per customer increased 8.4%, and the number of active customers increased 15.0%
in fiscal 1997, as compared to fiscal 1996. Sales from the companies acquired
in 1997 accounted for approximately 9% of consolidated net sales.
Gross profit increased by $52.5 million, or 41.4%, to $179.3 million
in fiscal 1997 from $126.8 million in fiscal 1996. The increase in gross profit
was attributable to increased sales. As a percentage of sales, gross profit
decreased from 41.5% to 40.9%, resulting primarily from slightly lower margins
realized from customers and product lines gained through the Company's
acquisitions. The Company's gross profit as a percentage of sales from its core
business remained constant.
Operating expenses, exclusive of the restructuring charge in fiscal
1996, increased by $36.8 million, or 44.0%, to $120.5 million in fiscal 1997
from $83.7 million in fiscal 1996. This increase was primarily attributable to
increased sales volume, which required additional staffing and support. As a
percentage of sales, operating expenses slightly increased from 27.4% to 27.5%.
Restructuring charge of $8.6 million, recorded during the third
quarter of fiscal 1996, is the estimated cost of the relocation of the
Company's Long Island distribution center and warehouses. The Harrisburg,
Pennsylvania distribution center commenced shipping in September 1996, and
became fully operational during the first half of fiscal 1997.
Income from operations, exclusive of the restructuring charge,
increased by $15.7 million, or 36.4%, to $58.8 million in fiscal 1997 from
$43.1 million in fiscal 1996. This increase was primarily attributable to
increased sales and gross profit offset in part by an increase in operating
expenses.
Net income increased by $7.5 million, or 26.3% to $36.0 million in
fiscal 1997, from $28.5 million in fiscal 1996, but increased by $15.4 million,
or 74.8% as compared with pro forma 1996 net income of $20.6 million, which
gives effect to "C" corporation taxation for the entire period. The increase in
net income is attributable to the restructuring charge taken in fiscal 1996,
and increased sales and gross profit offset by the increase in operating
expenses necessary in order to service increased volume and invest in future
growth.
19
Quarterly Results and Seasonality
The following table sets forth unaudited financial data for each of
the Company's last eight fiscal quarters.
Year Ended August 30, 1997 Year Ended August 29, 1998
---------------------------------------- ---------------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
(dollars in thousands)
Income Statement Data:
Net Sales.............. $ 92,214 $ 104,685 $ 123,895 $ 117,209 $ 135,609 $ 142,520 $ 155,098 $ 149,816
Gross Profit........... 38,267 42,710 50,443 47,835 55,339 58,185 63,590 60,960
Income from operations. 11,364 14,675 17,755 14,963 15,256 18,843 22,913 19,163
Net income............. 6,950 8,831 10,921 9,315 9,500 11,662 14,237 11,936
Net income per share:
Basic............... .10 .13 .16 .14 .14 .17 .21 .18
Diluted............. .10 .13 .16 .14 .14 .17 .21 .17
The Company has generally experienced slightly lower sales volumes
during the summer months and the Company expects this trend to continue in the
foreseeable future. As a result, net income in the fourth fiscal quarter is
historically somewhat lower than in the third fiscal quarter, due largely to
the continuation of the Company's fixed costs during slower sales periods. The
Company's quarterly results of operations may also fluctuate as a result of a
variety of other factors, including the timing of commencement of operations at
new distribution centers.
Liquidity and Capital Resources
The Company's primary capital needs have been to fund the working
capital requirements necessitated by its sales growth, acquisitions and
facilities expansions. The Company's primary sources of financing have been
cash from operations, supplemented by bank borrowings under the Company's
revolving credit facility (the "Credit Facility"), and a portion of the
proceeds from the Company's public offering completed at the end of fiscal
1997 (the "Second Offering"). The Company anticipates that the proceeds from
these offerings, its cash flows from operations and available lines of credit
will be adequate to support its operations for the immediate future and for at
least the next 24 months.
Under the terms of the Credit Facility, the Company has available
unsecured borrowings of up to $80 million. Interest on amounts borrowed may be
paid at the option of the Company at a rate per annum equal to the bank's base
rate (8.5% at August 29, 1998) or, alternatively, at the bankers' acceptance
rate or LIBOR rate plus margins, which vary from 0.45% to 0.75% per annum. The
Credit Facility contains certain covenants limiting mergers, use of proceeds,
indebtedness, liens, investments, sale of assets and acquisitions. The Credit
Facility also contains certain financial covenants which require the Company to
maintain a minimum net worth, ratio of current assets to current liabilities,
ratio of liabilities to effective net worth, minimum interest coverage ratio
and positive net income, to refrain from capital expenditures in excess of
certain amounts and to limit the issuance of dividends. As of August 29, 1998,
the Company was in compliance with all bank covenants and had no outstanding
borrowings under the Credit Facility.
Net cash provided by operating activities for the fiscal years ended
August 29, 1998 and August 30, 1997 was $46.8 million and $45.8 million,
respectively. The increase in cash from operations resulted from higher net
income, offset in part by higher net working capital requirements.
Additionally, in fiscal 1998, inventory (excluding inventory of acquired
companies) declined, reflecting improved inventory control policies and
procedures.
Net cash used in investing activities for the fiscal years ended
August 29, 1998 and August 30, 1997 was approximately $51.9 million and $47.4
million, respectively. The increase of $4.5 million is primarily attributable
to less cash paid for acquisitions in fiscal 1998 than for those in fiscal
1997, offset by the purchase of a building in Long Island, New York which will
begin serving as the new corporate headquarters in fiscal 1999. The remaining
20
cash used in investing activities in fiscal 1998 was for expenditures related
to the construction of a new distribution center.
Net cash provided by financing activities during the fiscal years
ended August 29, 1998 and August 30, 1997 was approximately $353,000 and $13.4
million, respectively. The change of $13.0 million is primarily attributable to
the difference between the proceeds received from the completion of the
Company's Second Offering, net of the repayment of existing long-term debt from
such proceeds in fiscal 1997.
During fiscal 1998, the Company repurchased approximately 147,000
shares of its Class A Common Stock at an average price of $21.77 per share for
an aggregate purchase price of approximately $3,200,000. Subsequent to August
29, 1998 and through October 30, 1998, the Company has purchased an additional
897,000 shares of Class A Common Stock for $17,314,000. All shares of Class A
Common Stock acquired are being retained in the Company's treasury and reserved
for issuance upon the exercise of options granted under the Company's 1995
Stock Option Plan and 1998 Stock Option Plan.
Disclosures about Market Risks.
The Company's market risk sensitive instruments do not subject the
Company to material market risk exposures.
Year 2000 Compliance Plan
Year 2000 Problem. The Year 2000 problem arises from the historic use
of only two digits (rather than four) for the designation of a year in date
information within computer programs. If not corrected, any of the Company's
equipment or software programs that perform time sensitive calculations may
incorrectly identify the year `00' as 1900 instead of 2000. This could result
in miscalculations or a major failure of certain systems. MSC may also be
vulnerable to the Year 2000 problems of its customers, suppliers and service
vendors and of other companies with which MSC conducts business (e.g., utility
companies, shippers and telecommunications companies).
State of Readiness. During calendar year 1997, MSC developed and began
to implement a Year 2000 compliance plan using internal and external resources
in an effort to ensure that its business is not interrupted by the Year 2000
problem. MSC's Year 2000 compliance plan is broken into four components:
1. Renovating internal systems and applications. The Company's
internal systems and applications include Order Entry, Purchasing
and Warehouse Management. The applications used in the Order
Entry system have been re-written and are being phased into the
Company's call center and branch locations. This process is
expected to be completed by May 1999. The applications for the
Purchasing and Warehouse Management systems are in the process of
being modified and completion of Year 2000 compliance work is
scheduled for March 1999. Many of the Company's applications are
already Year 2000 compliant as they were written using a
compliant code generator.
2. Ensuring compliance of peripheral third party systems. MSC uses a
number of third party package systems to supplement its internally
developed programs. Major systems in this area are its Financial
and Inventory Replenishment systems. The Company's Financial
systems are being replaced with a new package, with a scheduled
implementation date of May 1999. Two of MSC's subsidiaries, Enco
and Primeline, are already running on this software. The Inventory
Replenishment system has been tested and appears to be Year 2000
compliant. All of the Company's material hardware, including its
AS/400 computers, telephone systems, networks, PCs, security
systems and time clocks at all MSC locations have been tested as
Year 2000 compliant.
3. Ensuring Year 2000 compliance by external companies that conduct
business with the Company. The Company has contacted all of its
major customers, suppliers and vendors to inquire about Year 2000
compliance. The Company has not received responses from all those
contacted, but those who have responded do not indicate any
problems at this time. For those business
21
partners with which the Company currently conducts business
electronically, the Company will be conducting tests to determine
Year 2000 compliance in 1999.
4. Implementing standards and conducting testing in an effort to
ensure that the Company's existing and future systems are Year
2000 compliant. All new systems, whether hardware or software,
are tested before implementation in an effort to ensure Year 2000
compliance.
Cost of Compliance. MSC believes that the total cost of its Year 2000
compliance plan will be $900,000, not including the replacement of the
Financial system. These costs are expensed as incurred and, to date, the
Company has incurred $423,000 of such expenses. The Financial systems
replacement is a separate project which is estimated to cost approximately
$4,000,000 and will be capitalized.
Risks. Although MSC believes it will have its own systems compliant
prior to January 1, 2000, there can be no assurance that it will be able to do
so nor can there be any assurance that, even if the Company completes timely
its Year 2000 compliance plan, the systems, when actually implemented in full,
will work properly independently or in conjunction with the systems of any
business partner. In addition, the Company would continue to bear the risk of a
material adverse affect if any of its business partners does not appropriately
address its own Year 2000 compliance issues. Although MSC believes that its
major customers are Year 2000 compliant, the Company is still in the process of
reviewing the compliance programs of suppliers and service vendors. MSC's
current estimates of the impact of the Year 2000 problem on its operations and
financial results do not include costs and time that may be incurred as a
result of other companies' failure to become Year 2000 compliant on a timely
basis, which costs could be material. There can be no assurance that such other
companies will achieve Year 2000 compliance or that any conversions by such
companies to become Year 2000 compliant will be compatible with MSC's computer
systems. The inability of MSC or any of its principal suppliers, service
vendors or customers to become Year 2000 compliant in a timely manner could
have a material adverse effect on MSC's financial condition or results of
operation.
Contingency Plans. If MSC's suppliers are not Year 2000 compliant, MSC
may have to arrange for alternative sources of supply and the stockpiling of
inventory in the fall of 1999 in preparation for the Year 2000. The Company
cannot estimate at this time the cost or effect on the Company's financial
condition of any stockpiling of inventory. The Company does not have any other
contingency plans with respect to other problems that could arise in its
business as a result of the Year 2000 problem. Any of these could have a
material adverse effect on MSC's financial condition or results of operation.
The foregoing contains forward looking statements and there can be no
assurance due to changes in local, regional or national economies and the
availability of acquisition opportunities, among other things, that the
foregoing shall be the case.
22
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MSC INDUSTRIAL DIRECT CO., INC.
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public Accountants 24
Consolidated Balance Sheets as of August 29, 1998 and August 30, 1997 25
Consolidated Statements of Income for the three fiscal years ended August 29, 1998 26
Consolidated Statements of Shareholders' Equity for the three fiscal years
ended August 29, 1998 27
Consolidated Statements of Cash Flows for the three fiscal years ended August 29, 1998 28
Notes to Consolidated Financial Statements 29
23
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To MSC Industrial Direct Co., Inc.:
We have audited the accompanying consolidated balance sheets of MSC Industrial
Direct Co., Inc. (a New York corporation) and Subsidiaries as of August 29,
1998 and August 30, 1997, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three fiscal years in the
period ended August 29, 1998. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of MSC Industrial Direct Co.,
Inc. and Subsidiaries as of August 29, 1998 and August 30, 1997, and the
results of their operations and their cash flows for each of the three fiscal
years in the period ended August 29, 1998 in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Melville, New York
October 30, 1998
24
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
August 29, August 30,
ASSETS 1998 1997
------------ ------------
Current Assets:
Cash and cash equivalents $ 8,630 $ 13,418
Accounts receivable, net of allowance for doubtful accounts of $3,717 and $2,030,
respectively 72,940 55,348
Inventories 158,050 163,003
Prepaid expenses and other current assets 3,524 3,007
Current deferred income taxes 11,251 9,237
------------ ------------
Total current assets 254,395 244,013
------------ ------------
Property, Plant and Equipment, net 77,493 49,658
------------ ------------
Other Assets:
Goodwill 58,574 34,270
Other 11,240 6,893
------------ ------------
69,814 41,163
------------ ------------
$ 401,702 $ 334,834
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 14,670 $ 11,459
Accrued liabilities 55,175 41,997
Current portion of long-term notes payable 800 213
------------ ------------
Total current liabilities 70,645 53,669
Long-term notes payable 2,430 2,744
Other long-term liabilities 46 108
Deferred income tax liabilities 6,802 3,318
------------ ------------
Total liabilities 79,923 59,839
------------ ------------
Commitments and Contingencies (Note 12)
Shareholders' Equity:
Preferred stock; $0.001 par value; 5,000,000 shares authorized; none outstanding -- --
Class A Common Stock; $0.001 par value; 100,000,000 shares authorized;
33,683,407 and 33,331,966 shares, respectively, issued and outstanding 33 33
Class B Common Stock; $0.001 par value; 50,000,000 shares authorized;
34,142,028 and 34,364,400 shares, respectively, issued and outstanding 34 34
Additional paid-in capital 213,783 211,671
Retained earnings 112,834 65,499
Treasury stock, at cost (3,699) (499)
Deferred stock compensation (1,206) (1,743)
------------ ------------
Total shareholders' equity 321,779 274,995
------------ ------------
$ 401,702 $ 334,834
============ ============
The accompanying notes are an integral part of these
consolidated balance sheets.
25
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except net income per share data)
For The Fiscal Years Ended
------------------------------------------------
August 29, August 30, August 31,
1998 1997 1996
-------------- ------------- --------------
Net sales $ 583,043 $ 438,003 $ 305,294
Cost of goods sold 344,969 258,748 178,519
-------------- ------------- --------------
Gross profit 238,074 179,255 126,775
Operating expenses 161,899 120,498 83,666
Distribution center restructuring charge (Note 5) -- -- 8,600
-------------- ------------- --------------
Income from operations 76,175 58,757 34,509
-------------- ------------- --------------
Other income (expense):
Interest expense (52) (490) (1,534)
Interest income 1,126 723 647
Other income (expense), net 990 545 412
-------------- ------------- --------------
2,064 778 (475)
-------------- ------------- --------------
Income before provision for income taxes 78,239 59,535 34,034
Provision for income taxes 30,904 23,518 5,531
-------------- ------------- --------------
Net income $ 47,335 $ 36,017 $ 28,503
============== ============= ==============
Per share information (Note 3)
Net income per share:
Basic $ .70 $ .53 $ .48
============= ============= =============
Diluted $ .69 $ .53 $ .48
============= ============= =============
Pro Forma Basic $ .35
=============
Pro Forma Diluted $ .35
=============
Shares used in computing net income per share:
Basic 67,756 67,381 58,910
============== ============= ============
Diluted 68,964 68,218 59,246
============== ============= ============
Pro Forma Basic 58,910
============
Pro Forma Diluted 59,246
============
The accompanying notes are an integral part of these consolidated statements.
26
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE THREE FISCAL YEARS ENDED AUGUST 29, 1998
(In thousands)
Class A Class B
Common Stock Common Stock Additional
--------------------- --------------------- Paid-In Retained
Shares Amount Shares Amount Capital Earnings
--------- --------- --------- --------- ---------- ---------
BALANCE, September 2, 1995 -- $ -- 48,000 $ 48 $ 8,010 $ 64,030
Initial public offering of common stock, net of
costs of offering of $10,352 (Note 10) 15,050 15 -- -- 132,616 --
Exchange of Class B Common Stock for Class A
Common Stock 1,050 1 (1,050) (1) -- --
Issuance of restricted common stock (Note 11) 314 -- -- -- 2,981 --
Cancellation of restricted common stock (2) -- -- -- (10) --
Amortization of deferred stock compensation -- -- -- -- -- --
Issuance of common stock for acquisition of
subsidiary 210 -- -- -- 2,000 --
Net income -- -- -- -- -- 28,503
Distributions to shareholders (Note 10) -- -- -- -- -- (63,051)
--------- --------- --------- --------- --------- ---------
BALANCE, August 31, 1996 16,622 16 46,950 47 145,597 29,482
Secondary public offering of common stock, net
of costs of offering of $3,304 (Note 10) 4,000 4 -- -- 64,442 --
Exchange of Class B Common Stock for Class A
Common Stock 12,586 13 (12,586) (13) -- --
Purchase of treasury stock -- -- -- -- -- --
Cancellation of restricted common stock (24) -- -- -- (228) --
Amortization of deferred stock compensation -- -- -- -- -- --
Exercise of common stock options, including
income tax benefits of $380 148 -- -- -- 1,860 --
Net income -- -- -- -- -- 36,017
--------- --------- --------- --------- --------- ---------
BALANCE, August 30, 1997 33,332 33 34,364 34 211,671 65,499
Exchange of Class B Common Stock for Class A
Common Stock (Note 10) 222 -- (222) -- -- --
Purchase of treasury stock -- -- -- -- -- --
Cancellation of restricted common stock (6) -- -- -- (57) --
Amortization of deferred stock compensation -- -- --
Exercise of common stock options, including
income tax benefits of $648 135 -- -- -- 2,169 --
Net income -- -- -- -- -- 47,335
--------- --------- --------- --------- --------- ---------
BALANCE, August 29, 1998 33,683 $ 33 34,142 $ 34 $ 213,783 $ 112,834
========= ========= ========= ========= ========= =========
Treasury Stock
----------------------------- Deferred
Amount Stock
Shares at cost Compensation Total
--------- --------- ------------ ---------
BALANCE, September 2, 1995 -- $ -- $ -- $ 72,088
Initial public offering of common stock, net of
costs of offering of $10,352 (Note 10) -- -- -- 132,631
Exchange of Class B Common Stock for Class A
Common Stock -- -- -- --
Issuance of restricted common stock (Note 11) -- -- (2,981) --
Cancellation of restricted common stock -- -- 10 --
Amortization of deferred stock compensation -- -- 400 400
Issuance of common stock for acquisition of
subsidiary -- -- -- 2,000
Net income -- -- -- 28,503
Distributions to shareholders (Note 10) -- -- -- (63,051)
--------- --------- --------- ---------
BALANCE, August 31, 1996 -- -- (2,571) 172,571
Secondary public offering of common stock, net
of costs of offering of $3,304 (Note 10) -- -- -- 64,446
Exchange of Class B Common Stock for Class A
Common Stock -- -- -- --
Purchase of treasury stock 28 (499) -- (499)
Cancellation of restricted common stock -- -- 228 --
Amortization of deferred stock compensation -- -- 600 600
Exercise of common stock options, including
income tax benefits of $380 -- -- -- 1,860
Net income -- -- -- 36,017
--------- --------- --------- ---------
BALANCE, August 30, 1997 28 (499) (1,743) 274,995
Exchange of Class B Common Stock for Class A
Common Stock (Note 10) -- -- -- --
Purchase of treasury stock 147 (3,200) -- (3,200)
Cancellation of restricted common stock -- -- 57 --
Amortization of deferred stock compensation -- 480
Exercise of common stock options, including
income tax benefits of $648 -- -- -- 2,169
Net income -- -- -- 47,335
--------- --------- --------- ---------
BALANCE, August 29, 1998 175 $ (3,699) $ (1,206) $ 321,779
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated statements.
27
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For The Fiscal Years Ended
------------------------------------------
August 29, August 30, August 31,
1998 1997 1996
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 47,335 $ 36,017 $ 28,503
----------- ----------- -----------
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization 7,302 5,314 3,087
Amortization of deferred stock compensation 480 600 400
(Gain) loss on disposal of property, plant and equipment (19) 218 29
Provision for doubtful accounts 1,523 1,127 1,019
Deferred income taxes 1,442 2,221 (7,811)
Changes in operating assets and liabilities, net of effect from
acquisitions:
Accounts receivable (11,148) (9,410) (7,758)
Inventories 9,203 5,977 (59,866)
Prepaid expenses and other current assets (150) (172) 510
Prepaid federal income tax payments -- 4,512 (1,397)
Other assets (4,279) (1,298) (1,334)
Accounts payable and accrued liabilities (4,842) 673 14,523
Other long-term liabilities (92) (2) (781)
----------- ----------- -----------
Total adjustments (580) 9,760 (59,379)
----------- ----------- -----------
Net cash provided by (used in) operating activities 46,755 45,777 (30,876)
----------- ----------- -----------
Cash flows from investing activities:
Purchases of property, plant and equipment (32,456) (13,528) (26,886)
Proceeds from sale of property, plant and equipment 19 34 10
Cash paid for acquisitions, net of cash acquired (19,459) (33,928) (10,530)
----------- ----------- -----------
Net cash used in investing activities (51,896) (47,422) (37,406)
----------- ----------- -----------
Cash flows from financing activities:
Net proceeds from public offerings of common stock -- 64,446 132,631
Purchase of treasury stock (389) (499) --
Net proceeds from exercise of common stock options 1,521 1,480 --
Net proceeds from (repayments of) notes payable (885) (52,330) 11,616
Repayment of subordinated debt to shareholders -- -- (11,778)
Repayments from (advances to) affiliates 106 287 (138)
Distributions to shareholders -- -- (63,051)
----------- ----------- -----------
Net cash provided by financing activities 353 13,384 69,280
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents (4,788) 11,739 998
Cash and cash equivalents, beginning of year 13,418 1,679 681
----------- ----------- -----------
Cash and cash equivalents, end of year $ 8,630 $ 13,418 $ 1,679
=========== =========== ===========
Supplemental disclosures of cash flow information: Cash paid during the year
for:
Interest $ 110 $ 443 $ 2,022
=========== =========== ===========
Income taxes $ 31,279 $ 20,669 $ 12,376
=========== =========== ===========
Supplemental schedule of noncash investing and financing activities:
Issuance of stock for purchase of subsidiary $ -- $ -- $ 2,000
=========== =========== ===========
Issuance of stock for restricted stock plan (Note 11) $ -- $ -- $ 2,981
=========== =========== ===========
The accompanying notes are an integral part of these consolidated statements.
28
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
1. BUSINESS:
The Company is a distributor of industrial equipment and supplies
with headquarters in Plainview, New York. The Company serves both domestic and
international markets through its distribution network, which includes
approximately 100 local MSC branches in 34 states, as well as certain other
locations related to acquired entities, concentrated in the Eastern and Southern
United States, and regional distribution centers in Harrisburg, Pennsylvania;
Elkhart, Indiana and Atlanta, Georgia.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The accompanying consolidated financial statements include the
accounts of MSC Industrial Direct Co., Inc. and its wholly-owned subsidiaries.
All intercompany balances and transactions have been eliminated in
consolidation.
Fiscal Year
The Company's fiscal year ends on the Saturday closest to August 31.
The financial statements for fiscal 1998, 1997 and 1996 all contain activity
for fifty two weeks.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash in banks, as well as
certain highly liquid investments with original maturities of three months or
less.
Concentration of Credit Risk
The Company's mix of receivables is diverse, with approximately
178,000 active customer accounts. The Company sells its products directly to
end users and, in some cases, to other wholesalers and distributors in its
market areas.
Inventory Valuation
Inventories consist of merchandise held for resale and are stated at
the lower of average cost or market.
Property, Plant and Equipment
Depreciation and amortization of property, plant and equipment are
computed for financial reporting purposes on both the straight-line and
accelerated methods based on the estimated useful lives of the assets.
Property, plant and equipment are stated at cost. Expenditures for
maintenance and repairs are charged to expense as incurred; costs of major
renewals and improvements are capitalized. At the time property and equipment
are retired or otherwise disposed of, the cost and accumulated depreciation are
eliminated from the asset and accumulated depreciation accounts and the profit
or loss on such disposition is reflected in income.
The Company capitalizes certain payroll costs associated with the
development of internal computer systems. These costs are included within
property, plant and equipment in the
29
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
accompanying consolidated balance sheets. These costs are amortized on a
straight-line basis over the estimated useful lives of the related computer
systems, not to exceed five years.
In accordance with the provisions of SFAS No. 34, "Capitalization of
Interest Cost", interest attributable to construction of distribution centers
is capitalized as part of the cost of the related buildings during the period
prior to which such facilities are available and ready for use.
Goodwill
Goodwill shown in the consolidated balance sheets at August 29, 1998
and August 30, 1997 relates to multiple acquisitions completed during the last
three fiscal years (Note 4). Goodwill is being amortized on a straight-line
basis over 40-year periods. Accumulated amortization was $1,852 and $581 as of
August 29, 1998 and August 30, 1997, respectively. In accordance with Statement
of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of",
the Company periodically reviews long-lived assets, certain identifiable
intangibles and goodwill related to those assets to be held and used for
impairment whenever events or changes in circumstances indicate that the
carrying amount of those assets may not be recoverable. Management believes
that there is no impairment to goodwill as of August 29, 1998.
Deferred Catalog Costs
The costs of producing and distributing the Company's principal
catalogs are deferred and included in other assets in the Company's
consolidated balance sheets in accordance with Statement of Position ("SOP")
93-7, "Reporting on Advertising Costs" ($9,511 and $5,349 at August 29, 1998
and August 30, 1997, respectively). These costs are charged to expense over the
period that the catalogs remain the most current source of sales, which period
is typically one year or less. The costs associated with brochures and catalog
supplements are charged to expense as incurred.
Sales Returns
The Company reports its sales levels on a net sales basis, with net
sales being computed by deducting from gross sales the amount of actual sales
returns and the amount of reserves established for anticipated sales returns.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
30
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
Income Taxes
The Company provides for income taxes in accordance with SFAS No.
109, "Accounting for Income Taxes". Under the asset and liability method
specified by SFAS No. 109, the deferred income tax amounts included in the
balance sheet are determined based on the differences between the financial
statement and tax bases of assets and liabilities as measured by the enacted
tax rates that will be in effect when these differences reverse.
Differences between assets and liabilities for financial statement
and tax return purposes are principally related to inventories and depreciable
lives of assets. Deferred tax assets and liabilities, which were established in
the second quarter of fiscal 1996 due to the Company's taxation as a subchapter
"C" Corporation since the closing date of the IPO in December 1995, resulted in
a credit to the provision for income taxes of $3,966 during fiscal 1996.
Affiliates
The Company is affiliated with MSC International Korea, Inc. and
various real estate entities (together, the "affiliates"). The affiliates are
owned primarily by the Company's principal shareholders. In connection with the
IPO during fiscal 1996, the Company acquired two affiliated companies, Primeline
International, Inc. and Kaja Productions, Inc. See Note 12 for discussion of
certain related party transactions.
Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities." This statement establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999 and will not
require retroactive restatement of prior period financial statements. This
statement requires the recognition of all derivative instruments as either
assets or liabilities in the balance sheet measured at fair value. Derivative
instruments will be recognized as gains or losses in the period of change. If
certain conditions are met where the derivative instrument has been designated
as a fair value hedge, the hedged item may also be marked to market through
earnings thus creating an offset. If the derivative is designed and qualifies
as a cash flow hedge, the changes in fair value of the derivative instrument
may be recorded in comprehensive income. While the Company periodically engages
in certain international transactions, it does not presently make material use
of derivative instruments.
In February 1998, the FASB issued SFAS No. 132, "Employer's
Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132
requires additional information about the changes in the benefit obligation and
fair value of plan assets during the period, while standardizing the disclosure
requirements for pensions and other postretirement benefits. SFAS No. 132 is
effective for fiscal years beginning after December 15, 1997.
31
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
In June 1997, the FASB issued SFAS No. 131 "Disclosure about
Segments of an Enterprise and Related Information". SFAS No. 131 establishes
standards for the reporting of operating segments in interim and annual
financial statements, as well as requiring related disclosures about products
and services, geographic area and major customers. This standard is effective
for the Company's fiscal 1999 consolidated financial statements.
In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of financial statements.
The Company's consolidated financial statements will be required to include
comprehensive income disclosures if any, beginning with the first quarter of
fiscal 1999. Restatement of prior information, if any, will be made for
comparative purposes.
SFAS No. 132, 131 and 130 expand and modify financial statement
disclosures and, accordingly, will have no impact on the Company's results of
operations or financial position.
In March 1998, the American Institute of Certified Public
Accountants issued SOP 98-1 "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use". SOP 98-1 provides guidance on
accounting for the costs of computer software developed or obtained for
internal use, and is effective for fiscal years beginning after December 15,
1998, with earlier adoption encouraged. The Company is required to adopt this
SOP in fiscal 2000, but expects to adopt the provisions of SOP 98-1 in fiscal
1999. The Company does not expect the effect of the adoption of this
pronouncement to be material.
Reclassifications
Certain prior year balances have been reclassified to conform with
current year presentation.
3. NET INCOME PER SHARE:
Effective December, 1997, the Company adopted SFAS No. 128, "Earnings
Per Share". Basic net income per common share ("Basic EPS") is computed by
dividing net income by the weighted average number of common shares
outstanding. Diluted net income per common share ("Diluted EPS") is computed by
dividing net income by the weighted average number of common shares and
dilutive common share equivalents and convertible securities then outstanding.
SFAS No. 128 requires the presentation of both Basic EPS and Diluted EPS on the
face of the consolidated statements of income. The impact of the adoption of
this statement, which was retroactively applied to all periods pursuant to the
provisions of SFAS No. 128, was not material to all previously reported EPS
amounts.
32
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
The following chart provides a reconciliation of information used in
calculating the per share amounts for the fiscal years ended August 29, 1998,
August 30, 1997 and August 31, 1996, respectively:
Net Income Shares Net Income Per Share
------------------------------------- ---------------------------------- -------------------------------
1996 Pro 1996 Pro 1996 Pro
1998 1997 1996 Forma 1998 1997 1996 Forma 1998 1997 1996 Forma
---- ---- ---- --------- ---- ---- ---- --------- ---- ---- ---- ---------
Basic EPS
Net income $47,335 $36,017 $ 28,503 $20,591 67,756 67,381 58,910 58,910 $.70 $.53 $ .48 $ .35
(a)
Effect of
dilutive
employee - - - - 1,208 837 336 336 (.01) - - -
stock ------- ------- -------- ------ ------ ------ ------ ------ ---- ---- ----- -----
options
Diluted EPS
Net income $47,335 $36,017 $ 28,503 $20,591 68,964 68,218 59,246 59,246 $.69 $.53 $ .48 $ .35
======= ======= ======== ======== ====== ====== ====== ====== ==== ==== ===== =====
(a)
(a) For fiscal 1996, net income, on a pro forma basis which gives pro
forma effect to a Subchapter "C" corporation income tax provision (Note 7), was
as follows:
Income before provision for income taxes $ 34,034
Pro forma provision for income taxes 13,443
------------
Pro forma net income $ 20,591
============
There were no common share equivalents outstanding in the period
prior to the IPO in fiscal 1996.
4. ACQUISITION OF BUSINESSES:
During fiscal 1998 and 1997, the Company acquired the following
businesses:
Business Acquired Date Acquired
----------------- -------------
Fiscal 1998
Holloway Bros. Tools, Inc. March 24, 1998
RMG Corporation April 10, 1998
Drake - Atwood Tool & Supply Company, Inc. April 30, 1998
Fiscal 1997
Brooks Precision Supply, Inc. November 1, 1996
Dolin Supply, Inc. January 1, 1997
Anderson Industrial Supply, Inc. January 1, 1997
Enco Manufacturing, Inc. February 1, 1997
Discount Tool and Supply Company August 1, 1997
The acquisitions described above were accounted for as purchases and
were valued based on management's estimate of the fair value of the assets
acquired and liabilities assumed with respect to each acquisition at the dates
of acquisition. These estimates of fair value are preliminary and subject to
adjustment for a period of up to one year from the date of the respective
acquisition, and any such adjustments are not expected to be material. Costs in
excess of net assets acquired of $60,426 and $34,851 were allocated to goodwill
at August 29, 1998 and August 30, 1997, respectively, net of applicable
amortization.
33
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
Summarized below are the unaudited pro forma results of operations
as though each of these acquisitions had occurred at the beginning of fiscal
1997. Pro forma adjustments have been made for pro forma income taxes and
amortization of goodwill related to these transactions.
August 29, 1998 August 30, 1997
--------------- ---------------
Pro Forma:
Net sales $ 607,588 $ 514,355
============= =============
Net income $ 47,804 $ 37,076
============= =============
Net income per share:
Basic $ .71 $ .56
============ ============
Diluted $ .69 $ .55
============ ============
5. DISTRIBUTION CENTER RESTRUCTURING CHARGE:
In May 1996, the Company announced that it would be relocating its
multi-location Long Island, New York warehouse and distribution center
operation to a new, single-location, Company-owned facility near Harrisburg,
Pennsylvania. The Pennsylvania distribution center commenced shipping and
became fully operational in January 1997. The cost associated with the
relocation of the Company's existing Long Island facilities was approximately
$8,600, which is primarily comprised of personnel relocation and severance,
lease abandonment costs, moving and disposal costs, and this amount has been
reflected as a charge to income from operations for the year ended August 31,
1996. Costs of approximately $8,064 primarily relating to labor, rent for
vacated facilities and equipment disposals associated with the move were
charged against the liability as of August 29, 1998 and the remaining liability
of $536 is included in accrued liabilities in the accompanying consolidated
balance sheet as of August 29, 1998 (Note 8).
6. PROPERTY, PLANT AND EQUIPMENT:
The following is a summary of property, plant and equipment and the
estimated useful lives used in the computation of depreciation and
amortization:
Number of Years August 29, 1998 August 30, 1997
--------------- --------------- ---------------
Land - $ 11,515 $ 2,949
Construction-in-progress (a) - 5,338 -
Building 40 26,772 16,083
Building and leasehold improvements The lesser of the life
of the lease or 31.5 2,878 2,847
Furniture, fixtures and equipment 3-10 41,222 35,912
Automobiles 5 1,051 725
Computer systems 3-5 11,589 8,493
------------- ---------
100,365 67,009
Less: Accumulated depreciation and amortization 22,872 17,351
------------- ---------
$ 77,493 $ 49,658
============= =========
The amount of capitalized interest included in property, plant and
equipment is $931 and $944 at August 29, 1998 and August 30, 1997,
respectively.
34
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
(a) In October 1997, the Company executed an agreement for the purchase
of a building in Long Island, New York, which will serve as Corporate
headquarters. The Company intends to relocate to this new facility during the
first quarter of fiscal 1999. The Company did not capitalize nor incur any
interest related to the purchase.
7. INCOME TAXES:
The provision for income taxes is comprised of the following:
For the Fiscal Years Ended
----------------------------------------------------------------
August 29, 1998 August 30, 1997 August 31, 1996
------------------- ------------------- -------------------
Current:
Federal, net of state income tax benefit $ 23,994 $ 17,575 $ 10,744
State and local 5,081 3,722 2,598
------------ ------------ ------------
29,075 21,297 13,342
------------ ------------ ------------
Deferred:
Federal, net of state income tax benefit 1,510 1,833 (3,128)
State and local 319 388 (717)
------------ ------------ ------------
1,829 2,221 (3,845)
------------ ------------ ------------
Subchapter "C" impact of SFAS No. 109 -- -- (3,966)
------------ ------------ ------------
Total $ 30,904 $ 23,518 $ 5,531
============ ============ ============
The provision for income taxes for the year ended August 31, 1996
reflects "S" corporation taxation through the date of the public offering, and
"C" corporation taxation thereafter (Notes 2 and 3).
Significant components of deferred tax assets and liabilities are as
follows:
August 29, 1998 August 30, 1997
--------------- ---------------
Current and non-current deferred tax liabilities:
Depreciation $ (4,655) $ (1,224)
Prepaid advertising (3,757) (2,113)
Goodwill (126) (139)
----------- -----------
(8,538) (3,476)
----------- -----------
Current and non-current deferred tax assets:
Accounts receivable 974 642
Inventory 6,087 3,670
Restructuring charge accrual 212 1,089
Deferred compensation 2,955 2,800
Deferred stock compensation 158 158
Other 2,601 1,036
----------- -----------
12,987 9,395
----------- -----------
Net Deferred Tax Assets $ 4,449 $ 5,919
=========== ===========
The Company believes that, based upon its consistent history of
profitable operations, it is more likely than not that the net deferred tax
assets generated through August 29, 1998 will be realized, primarily from the
generation of future taxable income.
35
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
Reconciliation of the statutory Federal income tax rate to the
Company's effective tax rate is as follows:
For the Fiscal Years Ended
------------------------------------------------------------
August 29, 1998 August 30, 1997 August 31, 1996
----------------- --------------- ---------------
U.S. Federal statutory rate 35.0% 35.0% 35.0%
State income taxes, net of Federal benefit 4.5 4.5 4.5
Income from "S" corporation period taxable to shareholders - - (11.9)
Subchapter "C" impact of SFAS No. 109 - - (11.7)
All other, net - - 0.4
------ ------ -----
Effective income tax rate 39.5% 39.5% 16.3%
====== ====== =====
8. ACCRUED LIABILITIES:
Accrued liabilities consist of the following:
August 29, 1998 August 30, 1997
--------------- ---------------
Accrued purchases $ 7,051 $ 10,237
Accrued payroll and bonus 17,354 12,555
Accrued fringe benefits 4,205 1,681
Accrued restructuring and relocation charges 12,527 4,949
Accrued catalog 3,374 2,318
Accrued other 10,664 10,257
----------- -----------
Total accrued liabilities $ 55,175 $ 41,997
=========== ===========
9. LONG-TERM NOTES PAYABLE:
Long-term notes payable consist of the following:
August 29, 1998 August 30, 1997
--------------- ---------------
Revolving credit agreement (a) $ - $ -
Term notes payable (b) 3,230 2,957
----------- -----------
3,230 2,957
Less: Current portion 800 213
----------- -----------
$ 2,430 $ 2,744
=========== ===========
Maturities of notes payable are as follows:
Fiscal Year
-----------
1999 $ 800
2000 309
2001 291
2002 243
2003 251
Thereafter 1,336
-----------
$ 3,230
===========
36
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
(a) As of August 29, 1998, the Company had an unsecured revolving credit
agreement with a bank, as agent for a group of banks, with no outstanding
borrowings. The credit agreement provides for maximum borrowings of $80,000
expiring on May 31, 2001. During the term of the agreement, the Company can
borrow at the bank's base rate (8.50% at August 29, 1998), bankers acceptance
("BA") rate or LIBOR rate plus margins, which vary from 0.45% to 0.75% per
annum based on the ratio of total liabilities to effective net worth, or bid
note rate. A facility fee of one-eighth of one percent (0.125%) per annum is
payable on the unused portion of the credit. The agreement contains certain
covenants including, but not limited to, restrictions related to indebtedness,
net worth, capital expenditures and the payment of dividends. As of August 29,
1998, the Company was in compliance with all covenants.
(b) The term notes payable consist primarily of a note payable to the
Pennsylvania Industrial Development Authority which is secured by the land on
which the Harrisburg, Pennsylvania distribution center is located and which
bears interest at 3% per annum and is payable in monthly installments of
approximately $20 through September 2011.
10. CAPITAL STOCK TRANSACTIONS:
MSC Industrial Direct Co., Inc. ("MSC" or the "Company") was
incorporated in the State of New York on October 24, 1995 as a holding company
for the purpose of (i) issuing 15,050 shares of Class A Common Stock in an
initial public offering ("IPO") and (ii) issuing 48,000 shares of Class B
Common Stock to the shareholders of Sid Tool Co., Inc. (the "Operating
Subsidiary") in exchange for their then outstanding 30 shares of common stock
of the Operating Subsidiary immediately prior to the effective date of MSC's
IPO.
Common Stock Offerings
On December 20, 1995, the Company consummated the IPO relating to
the offer and sale of 16,100 shares of Class A Common Stock, 15,050 of which
shares were offered by the Company and 1,050 of which shares were offered by a
principal shareholder of the Company, at a price of $9.50 per share. The 1,050
shares offered and sold by a principal shareholder were converted to Class A
Common Stock from previously issued Class B Common Stock. Net proceeds received
by the Company were approximately $132,600. As a result of the IPO, the
Operating Subsidiary no longer qualified as a subchapter "S" corporation, and
became subject to subchapter "C" corporation taxation. Prior to the offering,
the Operating Subsidiary declared an "S" corporation dividend to the then
existing shareholders in the aggregate amount of approximately $63,000, which
amount was equal to substantially all previously taxed, undistributed "S"
corporation earnings. The Operating Subsidiary paid the "S" corporation
dividend by delivery to the then existing shareholders of promissory notes in
the principal amount of such dividends, which notes were repaid with a portion
of the net proceeds from the offering. The provision for income taxes for the
year ended August 31, 1996 reflects "S" corporation taxation through the date
of the public offering, and "C" corporation taxation thereafter (Note 2).
In September 1996, the Company completed a common stock offering of
13,000 shares of Class A Common Stock, of which 4,000 shares were sold by the
Company and 9,000 shares were converted from Class B to Class A Common Stock
and sold by existing shareholders. This offering generated net proceeds to the
Company of approximately $64,446, which were used primarily to repay certain
debt and to finance acquisitions. The supplemental effect of the repayment of
debt was not material to the Company's fiscal 1997 results of operations.
37
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
In July 1997, the Company completed a secondary offering of 3,566
shares of Class A Common Stock, of which 116 shares were sold by existing
shareholders from Class A Common Stock already held by those shareholders and
3,450 shares were converted from Class B to Class A Common Stock and sold by
existing shareholders. The Company did not receive any of the proceeds from
this offering.
Stock Split
On April 6, 1998, the Company's Board of Directors authorized a
two-for-one stock split, effected in the form of a 100% stock dividend, that
was distributed on May 22, 1998 to shareholders of record on April 24, 1998.
All share and per share data included in the accompanying financial statements
have been restated to reflect this stock split for all periods presented.
Treasury Stock Purchases
During fiscal 1998 and 1997, the Company repurchased 147 and 28
shares of its Class A Common Stock for $3,200 and $499, respectively, which is
reflected at cost as treasury stock in the accompanying consolidated financial
statements.
During fiscal 1998, the Board of Directors of the Company approved a
plan that would allow for the repurchase of up to 3,000 shares of the Company's
common stock. The repurchase program took effect immediately and is authorized
to continue for at least one year. Subject to applicable rules, the plan allows
the Company to repurchase shares at any time during the authorized period in
any increments it deems appropriate. As of August 29, 1998, the Company had
repurchased 130 shares for a cash purchase price of $2,812 (included in the 147
shares of treasury stock described above). Subsequent to August 29, 1998, the
Company has purchased an additional 897 shares of treasury stock for $17,314.
11. EMPLOYEE BENEFIT PLANS:
Sid Tool Savings Plan
The Company maintains a defined contribution plan with both a profit
sharing feature and a 401(k) feature which covers all employees who have
completed at least one month of service with the Company. For fiscal 1998, 1997
and 1996, the Company contributed $1,172, $1,233 and $216, respectively, to the
Sid Tool Savings Plan. Company contributions are discretionary.
Stock Option Plan
In connection with the IPO, the Company adopted the MSC Industrial
Direct Co., Inc. 1995 Stock Option Plan, pursuant to which options to purchase
4,000 shares of Class A common stock may be granted. Options may be granted to
key employees, directors and consultants over terms not to exceed ten years and
they generally vest ratably over 5 years. Vesting requirements other than the
aforementioned are set forth by the Board of Directors when the award is
granted.
38
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
A summary of the status of the Company's stock option plan at August
29, 1998, August 30, 1997 and August 31, 1996 and changes during the years then
ended is presented in the table and narrative below:
1998 1997 1996
------------------------ ----------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------- -------- -------- -------- -------- --------
Outstanding - beginning of year 2,178 $12.25 1,512 $10.18 - $ -
Granted 1,149 19.41 852 15.45 1,706 10.27
Exercised (135) 11.26 (148) 10.15 - -
Cancelled/forfeited (162) 13.86 (38) 9.97 (194) 11.00
-------- -------- --------
Outstanding - end of year 3,030 15.20 2,178 12.25 1,512 10.18
======== ======== ========
Exercisable - end of year 588 12.34 186 10.77 -
======== ======== ========
Weighted average fair value of options
granted $ 19.70 $ 16.39 $ 10.46
======== ======== ========
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:
1998 1997 1996
---- ---- ----
Expected life (years) 7.5 7.5 7.5
Risk-free interest rate 4.4% 6.86% 5.9%
Volatility 38.0% 35.0% 35.0%
Dividend yield 0.0% 0.0% 0.0%
The following table summarizes information about stock options
outstanding at August 29, 1998:
Number of Options Weighted Average Weighted Number of Options Weighted
Outstanding at Remaining Average Exercisable at Average
Range of Exercise Prices August 29, 1998 Contractual Life Exercise Price August 29, 1998 Exercise Price
- ------------------------ ----------------- ---------------- -------------- ----------------- --------------
$ 9.50 - $ 14.25 1,021 7.3 $ 9.94 366 $ 9.85
14.26 - 21.39 1,934 8.9 17.57 222 16.43
21.40 - 28.06 75 9.6 26.98 - -
----- --- ------ --- ------
3,030 8.4 $15.20 588 $12.34
===== === ====== === ======
39
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
The Company has adopted the pro forma disclosure provisions of SFAS
No. 123. Accordingly, no compensation cost has been recognized for the stock
option plans. Had compensation cost for the Company's stock option plans been
determined under SFAS No. 123, the Company's net income and net income per
share would approximate the following pro forma amounts:
1998 1997 1996
---- ---- ----
Net income: As reported (a) $ 47,335 $ 36,017 $ 20,591
Pro forma 41,924 33,805 19,446
Net income per share - basic As reported (a) $ .70 $ .53 $ .35
Pro forma .62 .50 .33
Net income per share - diluted As reported (a) $ .69 $ .53 .35
Pro forma .61 .50 .33
(a) As reported net income and net income per share amounts for fiscal
1996 are pro forma (Note 3).
The effects of applying SFAS No. 123 in this pro forma disclosure
are not indicative of future amounts. SFAS No. 123 does not apply to option
awards granted prior to fiscal year 1996, and additional awards in future years
are anticipated.
Restricted Stock Plan
The Company also adopted the Restricted Stock Plan in fiscal 1996,
whereby the Company awarded 314 shares of Class A Common Stock to various
employees. Employees vest in their ownership of these shares at the end of five
years, prior to which such shares are forfeited upon the departure of the
employees. The value of these shares at the grant date ($2,981) is included as
a separate component of shareholders' equity, and the related compensation
charge is being recorded ratably over the five year vesting period.
1998 1997 1996
---- ---- ----
Outstanding - beginning of year 256 312 -
Granted - - 314
Exercised (88) (28) -
Canceled/forfeited (6) (28) (2)
--- --- -----
Outstanding - end of year 162 256 312
=== === =====
Exercisable - end of year 33 58 -
=== === =====
Weighted average market value on grant date - - $9.50
=== === =====
40
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
12. COMMITMENTS AND CONTINGENCIES:
Leases
The operations of the Company are conducted on leased premises, some
of which are leased from affiliates. The leases (most of which provide for the
payment of real estate taxes, insurance and other operating costs) are for
varying periods, the longest extending to the year 2010. At August 29, 1998,
approximate minimum annual rentals on such leases are as follows:
Total (Including
Related Party Related Party
Fiscal Year Commitments) Commitments
----------- ---------------- -------------
1999 $ 4,361 $ 1,606
2000 3,238 1,401
2001 2,630 1,354
2002 1,877 1,354
2003 1,594 1,349
Thereafter 8,869 8,587
Total rental expense (exclusive of real estate taxes, insurance and
other operating costs) for all operating leases for fiscal 1998, 1997 and 1996
was approximately $4,795, $4,672 and $3,290 respectively, including
approximately $1,702, $2,053, and $2,519, respectively, paid to affiliates. In
the opinion of the Company's management, the leases with affiliates are on
terms which approximate fair market value.
The Company is obligated under certain equipment and automobile
operating leases, which expire on varying dates through fiscal 2003. At August
29, 1998, approximate minimum annual rentals on such leases are as follows:
Fiscal Year
-----------
1999 $ 1,164
2000 335
2001 155
2002 3
2003 2
Guarantees
As of August 29, 1998, the Company was a guarantor on loans made to
affiliated real estate companies aggregating approximately $1,390.
41
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share, estimated lives and customer amounts)
(CONTINUED)
Self-Insurance
The Company has a self-insured group health insurance plan. The
Company is responsible for all covered claims to a maximum liability of $200
per participant during a September 1 plan year. Benefits paid in excess of $200
are reimbursed to the plan under the Company's stop loss policy. In addition,
the Company also has an aggregate stop loss policy whereby the Company's
liability for total claims submitted cannot exceed a pre-determined dollar
factor based upon, among other things, past years' claims experience, actual
claims paid and monthly accumulated aggregate deductibles. Group health
insurance expense for fiscal 1998, 1997 and 1996 was approximately $7,003,
$5,200 and $4,100, respectively.
Employment Agreements
The Company has entered into employment and consulting agreements
with various of the Company's officers and with the selling shareholders of
acquired businesses (Note 4). The future minimum commitments under these
agreements are as follows:
Number of Aggregate
Fiscal Year Individuals Annual Amount
----------- ----------- -------------
1999 20 $ 2,207
2000 15 1,633
2001 7 1,147
2002 5 1,095
2003 5 908
Thereafter 4 575
Litigation
The Company is subject to legal proceedings and claims which arise
in the ordinary course of its business. In the opinion of management, the
amount of ultimate liability with respect to these actions will not materially
affect the financial position or results of operations of the Company.
42
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
43
PART III.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information called for by Item 10 is set forth under the heading
"Election of Directors" in the Company's Proxy Statement for the
annual meeting of stockholders to be held in January 1999 (the "1998
Proxy Statement"), which is incorporated herein by this reference.
Item 11. EXECUTIVE COMPENSATION.
Information called for by Item 11 is set forth under the heading
"Executive Compensation" in the 1998 Proxy Statement, which is
incorporated herein by this reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information called for by Item 12 is set forth under the heading
"Security Ownership of Certain Beneficial Owners and Management" in
the 1998 Proxy Statement, which is incorporated herein by this
reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information called for by Item 13 is set forth under the heading
"Certain Relationships and Related Transactions" in the 1998 Proxy
Statement, which is incorporated herein by this reference.
44
PART IV.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
The Company did not file any reports on Form 8-K during the fourth
quarter of the fiscal year ended August 29, 1998.
Financial statements filed as a part of this report are listed on the
"Index to Consolidated Financial Statements" at page 23 herein.
a. Exhibits
--------
Exhibit Description
No. -----------
--------
*3.01 Certificate of Incorporation of Registrant.
*3.02 By-laws of Registrant.
*4.01 Specimen Class A Common Stock Certificate.
*10.01 Registrant's 1995 Stock Option Plan.
10.02 Registrant's 1998 Stock Option Plan (incorporated by reference
to Exhibit A to the Registrant's Proxy Statement for the Annual
Meeting of Shareholders held on January 1, 1998, filed with the
Commission on December 5, 1997).
*10.03 Employment Agreement, dated as of January 2, 1994, between
Registrant and Sidney Jacobson, as amended on October 31, 1995.
*10.04 Employment Agreement, dated as of August 1, 1994, between
Registrant and Mitchell Jacobson.
*10.05 Amended and Restated Credit Agreement, dated as of April 27,
1995, between the Registrant and the banks named therein, as
amended as of August 25, 1995.
21.01 List of Subsidiaries
23.01 Consent of Arthur Andersen LLP
27.01 Financial Data Schedule
- ------------------------------
*Filed as an Exhibit to the Company's Registration Statement on Form S-1,
Registration Statement No. 33-98832, as amended.
b. Financial Statement Schedules
-----------------------------
For the three fiscal years ended August 29, 1998
Page
----
Report of Independent Public Accountants on Schedule II .............S-1
Schedule II - Valuation and Qualifying Accounts .....................S-2
All other schedules have been omitted because the information
is not applicable or is presented in the Financial Statements
or Notes thereto.
45
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
MSC INDUSTRIAL DIRECT CO., INC.
Dated: November 12, 1998 By: /s/ Mitchell Jacobson
-----------------------------------------------
Mitchell Jacobson
Chairman, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Mitchell Jacobson Chairman of the Board of Directors, President, November 12, 1998
- -------------------------------------- Chief Executive Officer and Director
Mitchell Jacobson
/s/ Sidney Jacobson Vice-Chairman of the Board of Directors November 12, 1998
- ---------------------------------------
Sidney Jacobson
/s/ Shelley Boxer Vice President, Chief Financial Officer, November 12, 1998
- --------------------------------------- Principal Accounting Officer and Director
Shelley Boxer
/s/ James Schroeder Senior Vice President-Logistics and Director November 12, 1998
- --------------------------------------
James Schroeder
/s/ Denis Kelly Director November 13, 1998
- ---------------------------------------
Denis Kelly
/s/ Raymond Langton Director November 16, 1998
- ---------------------------------------
Raymond Langton
/s/ Roger Fradin Director November 16, 1998
- ---------------------------------------
Roger Fradin
46
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE II
To MSC Industrial Direct Co., Inc.:
We have audited, in accordance with generally accepted auditing standards, the
financial statements of MSC Industrial Direct Co., Inc. and Subsidiaries
included in this Form 10-K and have issued our report thereon dated October 30,
1998. Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. This Schedule II is presented for
purposes of complying with the Securities and Exchange Commission's rules and
is not part of the basic financial statements. This schedule has been subjected
to the auditing procedures applied in our audits of the basic financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
Arthur Andersen LLP
Melville, New York
October 30, 1998
S-1
SCHEDULE II
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Balance at Charged to Charged to
Beginning Costs and Other Balance at
of Year Expenses Accounts Deductions End of Year
---------- ---------- ---------- ---------- -----------
For the fiscal year ended August 31, 1996
Allowance for doubtful accounts $ 877 $1,019 $235(a) $812 $1,319
======= ====== ==== ==== ======
For the fiscal year ended August 30, 1997
Allowance for doubtful accounts $1,319 $1,127 $542(a) $958 $2,030
====== ====== ==== ==== ======
For the fiscal year ended August 29, 1998
Allowance for doubtful accounts $2,030 $1,523 $926(a) $762 $3,717
====== ====== ==== ==== ======
(a) Comprised of valuation accounts of acquired entities
S-2