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 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. We distribute 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 our customers' maintenance, repair and operations ("MRO") supplies requirements. We offer over 450,000 stock-keeping units ("SKUs") through our 4,480 page master catalog and weekly, monthly and quarterly specialty and promotional catalogs, newspapers and brochures and service our customers from approximately 90 branch offices. Most of our 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. MSC's net sales have increased at a compound annual rate of approximately 27% from $305.3 million in fiscal 1996 to $792.9 million in fiscal 2000. During this same period, income from operations increased at a compound annual rate of approximately 28% from $34.5 million to $93.3 million.
Our business strategy is to provide an integrated, low cost solution to the purchasing, management and administration of our customers' MRO needs. We believe we add value to our 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. We try to achieve this reduction in MRO supplies costs in the following manner:
o Our extensive product offerings allow customers to reduce the administrative burden of dealing with many suppliers for their MRO needs.
o We guarantee same-day shipping of our core business products, approximately 99% of which are generally kept in stock, enabling our customers to reduce their inventory investment and carrying costs.
o We consolidate multiple purchases into a single shipment, provide a single invoice relating to multiple purchases over varying periods of time and offer direct shipments to specific departments and personnel within a single facility or multiple facilities, allowing our customers to reduce administrative paperwork, costs of shipping and personnel costs related to internal distribution and purchase order management.
Our customers include a wide range of purchasers of industrial supply products, from one-man machine shops to Fortune 500 companies. Our core business focuses on selling relatively higher margin, lower volume products and has an average order size of approximately $202. We have in excess of 292,000 combined active customers (companies that have purchased at least one item during the past 12 months), which are typically small and mid-sized companies. Our customers select desired products from MSC's various publications and place their orders by telephone, facsimile, the internet or direct computer link.
We operate primarily in the United States, with customers in all 50 states, through a network of four regional distribution centers and approximately 90 branch offices. MSC's distribution centers are located near Harrisburg, Pennsylvania; Atlanta, Georgia; Elkhart, Indiana and Reno, Nevada. The strategic locations of MSC's distribution centers allow for next day delivery via low cost ground carriers in 36 states. Our experience has been that areas accessible by next day delivery generate significantly greater sales than areas where next day delivery is
not available. Accordingly, our long-term strategy is to establish additional distribution centers, supported by local branch offices, to expand our geographic coverage of next day delivery throughout the continental United States.
Industry Overview
MSC operates in a large, fragmented industry characterized by multiple channels of distribution. We believe that there are numerous small retailers, dealerships and distributors, most of which have annual sales of less than $10 million, that supply a majority 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. We believe that, except in the largest industrial plants, MRO supplies inventories generally are not effectively managed or monitored, resulting in higher purchasing costs and increased administrative burdens. 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.
We believe that the administrative costs associated with placing an MRO purchase order can be in excess of $100 per order. Awareness of these high costs and purchasing inefficiencies 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. We believe that industry trends and economic pressures have caused the mid-sized customer, as well as the small shop customer to a lesser extent, to move toward the more efficient, cost saving, single supply source offered by companies such as MSC.
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. We believe 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 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.
We believe that we provide a low cost solution to the purchasing inefficiencies and high costs described above. Customers that purchase products from us will generally find that their total purchasing and shipping costs, inventory investment and carrying costs, internal distribution costs and administrative inefficiencies are reduced. We try to achieve this through:
o consolidation of multiple sources of supply into a single supplier;
o consolidation of multiple purchase orders into a single purchase order;
o consolidation of multiple invoices into a single invoice;
o significant reduction in tracking of invoices;
o significant reduction in stocking decisions;
o elimination or reduction of purchases for inventory;
o elimination of paper orders and invoices through our electronic ordering system; and
o e-commerce capabilities.
Business Strategy
Our business strategy is to provide our customers with a low cost means for obtaining and maintaining MRO supplies. The strategy includes the following key elements:
o a broad selection of in-stock products;
o prompt response and same-day shipping;
o superior, value-added customer service;
o targeted direct mail marketing; and
o a commitment to technological innovation.
Broad Selection of Products. We believe that our ability to offer customers a broad spectrum of brand name and generic MRO products and a "good-better-best" product selection alternative has been critical to our success. We offer similar products with varying degrees of name recognition, quality and price, thus permitting the customer to choose the appropriate product based on cost, quality and the customer's specific needs. Our customers are increasingly purchasing from fewer suppliers to reduce the administrative burden of ordering from multiple suppliers. By offering for sale over 450,000 products, approximately 99% of which generally are in stock and available for immediate shipment, we aim to provide a broad range of merchandise in order to become our customers' preferred supplier of MRO products.
Same-Day Shipping. Our 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. We fulfill our same-day shipment guarantee more than 99.9% of the time. Our 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 our distribution centers allow next day delivery via low cost ground carriers in 36 states.
Superior Customer Service. Customer service is a key element in becoming a customer's preferred provider of MRO supplies. Our commitment to customer service is demonstrated by our investment in sophisticated information systems and extensive training of our employees. Utilizing our proprietary customer support software, our in-bound telemarketing representatives implement the "one call does it all" philosophy. Telemarketing representatives are able to inform customers on a real time basis of the availability of a product, recommend substitute products, verify credit information, receive special, custom or manufacturer direct orders, cross-check inventory items using customer product codes previously entered into our information systems and provide technical product information. We believe that our simple, one-call method of fulfilling all purchasing needs of a customer through highly-trained telemarketing representatives, supported by our proprietary information systems, results in greater efficiency for customers and increased customer satisfaction. To complement our customer service, we seek to ease the administrative burdens on our customers by offering customized billing services, customer savings reports and other customized report features, electronic data interchange ordering, e-commerce capabilities, bulk discounts and stocking of specialty items specifically requested by customers.
Targeted Direct Mail Marketing Strategy. Our primary tool for marketing and product reference is the annual master catalog containing 4,480 pages and over 450,000 items. In fiscal 2000, our master catalog was supplemented by approximately 100 specialty and promotional catalogs, brochures and newspapers, covering such specialty areas as cutting tools, measuring instruments, tooling components and maintenance and repair, industrial supply, and hose and tubing. We use our database of approximately 864,000 companies and 1.6 million individuals, and also purchase 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, has resulted in increased productivity through lower costs, increased response rates and more efficient use of advertising space. MSC's publications mailings increased from 6.3 million in fiscal 1996 to approximately 28.8 million in fiscal 2000. We intend to continue to increase direct marketing efforts to take advantage of the additional products offered and our expanded distribution capabilities.
Commitment to Technological Innovation. We take advantage of technological innovations to support growth, improve customer service and to reduce our operating costs through more effective buying practices, automated inventory replenishment and efficient order fulfillment operations. MSC's proprietary software tracks all of the approximately 450,000 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. Our Customer Direct Access Plus 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. Our information systems have been designed to enhance inventory management and turnover, customer service and cost reduction for both MSC and our customers. In addition to internal and customer information systems, we continually upgrade our distribution methods and systems to improve productivity and efficiency. Launched in July 2000, MSCdirect.com is a searchable on-line catalog with electronic ordering capabilities designed to take advantage of the opportunities created by Internet commerce. The MSCdirect.com site offers a broad array of products, services and related information to meet the needs of customers seeking to reduce process costs through Internet e-commerce-enabled solutions.
Growth Strategy
Our objective is to become the preferred supplier of industrial products for small and mid-sized companies throughout the United States. We intend to increase sales to existing and new customers by:
o increasing the size and diversity of our customer base by expanding same-day shipping into new markets, increasing the circulation of the master catalog and expanding our targeted mail campaign;
o increasing the number of product lines and SKUs offered; and
o continually developing and utilizing extensive e-commerce capabilities, making it even easier and more appealing to do business with MSC.
Increasing the Size and Diversity of our Customer Base. Since fiscal 1997, we have shifted our principal growth strategy from increasing our offering of SKUs to increasing the size and diversity of our customer base. Our experience has been that sales in areas accessible by next day delivery are significantly greater than in areas with second day delivery. Our goal is to open additional distribution centers, supported locally by branch offices, which will expand our geographic coverage of next day delivery throughout the United States. In November, 1999, a new distribution facility located near Reno, Nevada became fully operational and has enhanced our ability to service the Western United States. In addition, we have accumulated a buyer database of approximately 864,000 companies and 1.6 million individual customers. We utilize empirical information from this database to prospect for new customers, thereby increasing the circulation of our master catalog. We supplement our master catalog with direct mailings of specialty and promotional publications to further increase customer response and product purchases.
Increasing the Number of Product Lines and SKUs. We believe that continuing to increase the breadth of our product line and providing high levels of customer service are effective methods of increasing sales to current customers and attracting new customers. Accordingly, we have added approximately 226,000 SKUs over the past five years. By expanding the product lines and SKUs offered, we seek to satisfy an increasing percentage of the MRO supplies purchases of our customers and to attract new customers.
E-commerce capabilities. In July 2000, we launched MSCdirect.com, a proprietary business-to-business horizontal marketplace serving the MRO market. MSCdirect.com offers customers full access to our catalog, which offers in excess of 450,000 SKUs, and all online orders are backed by our same-day shipping guarantee. MSCdirect.com utilizes the same highly trained sales force and support services as MSC's traditional business, emphasizing MSC's values of placing customers needs first. It is available 24 hours a day, seven days a week providing real-time inventory availability, superior search capabilities, on-line bill payment, delivery tracking status and a number of other enhancements including work flow management tools. The user-friendly search engine allows customers to order by description, vendor or brand. We believe MSCdirect.com is a key component of our strategy to reduce customers' MRO transaction costs and internal requisition time. The site also allows customers to control which of their staff are entitled to purchase products online, how much they are entitled to spend and which staff require secondary approval. The process is fully automated and integrated into our back-end systems. Every order moves directly from the customer's desktop to the distribution center floor, removing human error, reducing handling costs and speeding up the transaction flow. In fiscal 2001, we plan to launch a marketing effort for general customer awareness of MSCdirect.com including direct mailings explaining how to use the website.
E-commerce portals sell a suite of e-commerce products designed to meet the needs of businesses seeking reduced costs and increased effectiveness of their MRO/direct materials process by using Internet-enabled solutions. We have associations with Ariba, Commerce-One, Oracle and I-Procure B2B e-commerce portals.
Products
We currently offer in excess of 450,000 SKUs, representing a greater than 269% increase since 1995. We attribute a portion of our sales growth to the total number of SKUs offered. In this regard, we intend to continue to add new product categories and increase the number of products offered in existing product categories in an effort to gain new customers and increase sales from existing customers. Our core products include cutting tools, measuring instruments, machine tool accessories and fasteners. As part of our strategy of supplying an increasing portion of our customers' MRO needs, we have expanded our product mix to include plumbing supplies, process instrumentation, hardware, marking products, pumps and pneumatics equipment and have significantly increased our offering of flat stock and 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.
Our offering of specific products from multiple manufacturers at different prices and quality levels permits us to offer a "good-better-best" product selection alternative. This alternative provides 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. Our telemarketing representatives and technical support personnel are trained to assist customers in making intelligent cost-saving purchases. We believe this approach results in significant amounts of repeat business and is an integral part of our strategy to reduce our customers' MRO supplies costs.
MSC's product offering is comprised primarily of the following categories: cutting tools; measuring instruments; tooling components; fasteners; flat stock and raw materials; abrasives; machinery and electrical supplies as well as other categories.
We purchase substantially all of our products directly from approximately 2,800 manufacturers located in the United States. We are not materially dependent on any one supplier or small group of suppliers. No one single supplier accounted for more than 5% of our total purchases in fiscal 2000. Generic products, primarily machine tools, are manufactured by third parties to our specifications.
Distribution Centers
A significant number of our products are carried in stock, and approximately 87% of orders are fulfilled from the distribution centers or branch offices. Certain products, such as specialty or custom items and some very large orders, are shipped directly from the manufacturer. Our 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. We have invested significant resources in technology and automation to increase efficiency and reduce costs, and continually monitor our order fulfillment process. We currently utilize four
distribution centers for product shipment located near Harrisburg, Pennsylvania; Atlanta, Georgia; Elkhart, Indiana and Reno, Nevada. Our facility near Reno, Nevada became fully operational in November 1999.
Sales and Marketing
Our customers include a broad range of purchasers of industrial supply products, from one-man machine shops to Fortune 500 companies. Our core business focuses on selling relatively higher margin, lower volume products and has an average order size of approximately $202. We focus our 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 $50,000 of annual industrial supplies purchases, and the mid-size corporate segment, consisting of industrial entities with 100 to 999 employees and annual MRO purchases of between $500,000 and $1,000,000. We have recently established a national account program to address the needs of Fortune 1000 customers. Our strategy with respect to that portion of the large corporate segment that utilizes integrated suppliers 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.
We also offer wholesalers and other distributors the ability to create their own customized mail order catalog by offering to 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 to the budget-oriented customer.
We have in excess of 292,000 combined 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. We target these individual buyers within an organization and distribute publications corresponding to the product categories for which such buyers are responsible. We are able to implement this directed marketing strategy because of the depth of customer information contained in our information systems databases. Our customers select desired products from our various publications and place their orders by telephone, facsimile or direct computer link.
We have invested significant resources in developing an extensive customer and prospect database. This database is a key component of our growth strategy. The customer and prospect database includes detailed information, including company size, number of employees, industry, various demographic and geographic characteristics and personal purchase histories (catalog preference, product preference, order value). We believe that the variety and depth of information on our customers and prospects offers us a significant competitive advantage in increasing sales to existing customers and attracting new customers.
We rely on in excess of 500 in-bound telemarketing representatives at our call centers, distribution centers and branch offices, who are responsible for substantially all 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 our information systems databases. Our "one call does it all" philosophy is predicated on the ability of the telemarketing representative, utilizing our information systems' comprehensive databases as a resource, to respond effectively to the customer's needs. When a customer places a call to MSC, 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 SKUs offered by MSC. The customer's profile includes historical and current billing information, historical purchasing information and plant and industry information.
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. We also maintain 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.
We also employ a direct sales force of approximately 325 sales representatives. These sales representatives are responsible for increasing sales per customer and servicing existing customers.
Branch Offices
We currently operate approximately 90 branch offices located in 38 states. These branch offices receive approximately 60% of all telephone 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. We have experienced higher sales growth and market penetration in areas where we have established a branch office and believe our branch offices are critical to the success of our business strategy.
Publications
Our primary reference tool is our annual 4,480 page master catalog, which is supported by specialty and promotional catalogs, brochures and newspapers. We use specialty and promotional publications to target customers in specific areas, such as welding, electrical supply and hose and tubing. We distribute specialty and promotional catalogs, brochures and newspapers based on information in our 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 our 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 us the flexibility to alter our product offerings and pricing and refine our catalog, brochure and newspaper formats more quickly.
As reflected in the following table, the number of publication titles has increased from 70 in fiscal 1996 to approximately 100 in fiscal 2000. The number of pieces mailed has increased from approximately 6.3 million in fiscal 1996 to approximately 28.8 million in fiscal 2000 and is expected to reach approximately 35.0 million in fiscal 2001.
Customer Service
One of our goals is to make purchasing our 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 our business. Order entry and fulfillment occurs at each of our branches and main call centers located at our four operating distribution centers. Calls are received by telemarketing representatives who utilize on-line terminals to enter customer orders into computerized order processing systems. Our telephone ordering system is flexible and, in the event of a 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 MSC are shipped by United Parcel Service, and, to a limited extent, by various other freight lines and local carriers. Air freight is also used when appropriate. We have no written agreement with UPS but have been able to negotiate favorable shipping rates due to our volume of shipments. We are not dependent on any one carrier and believe that alternative shipping arrangements can be made with minimal disruption to operations in the event of the loss of UPS as our primary carrier. We believe that our relationships with all our carriers are satisfactory. We guarantee same-day shipping of our core business products 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
Our 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 our business. These proprietary information systems enable us to ship to customers on a same-day basis, respond quickly to order changes, provide a high level of customer service, achieve cost savings, deliver superior customer service and manage our operations centrally.
Certain of our 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. We maintain a sophisticated buying and inventory management system that monitors substantially all of our SKUs and automatically purchases inventory from vendors for replenishment based on projected customer ordering models. We also maintain an electronic data interchange (EDI) purchasing program with our vendors with the objective of allowing us 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, we have also developed a proprietary MRO management system, the Customer Direct Access Plus System or "CDA." CDA is designed to automate, simplify and control the administration and management of MRO purchasing by giving the customer direct access to our 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. We also provide a comprehensive EDI ordering system to support our customer based purchase order processing. In addition, we have developed a Windows(R)-based CD-ROM electronic catalog package and have begun providing product information and ordering capabilities on the Internet.
We run our systems on an AS400 platform and utilize disaster recovery techniques and procedures which we believe are adequate to fulfill our needs and are consistent with this type of equipment. We believe that planned enhancements and upgrades to the next generation of our existing operating platforms will be sufficient to sustain our present operations and our anticipated growth for the foreseeable future.
Competition
The MRO supply industry is a large, fragmented industry that is highly competitive. We face competition from traditional channels of distribution such as retail outlets, small dealerships, regional or national distributors utilizing direct sales forces, and manufacturers of MRO supplies and large warehouse stores and larger direct mail distributors. We believe that sales of MRO supplies will become more concentrated over the next few years, which may make the industry more competitive. Certain of our competitors offer a greater variety of products and have substantially greater financial resources than us. 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. We believe we compete effectively on all such criteria.
Associates (Employees)
As of October 25, 2000, we employed approximately 2,828 associates, including approximately 2,651 full-time and approximately 177 part-time associates. No associate is represented by a labor union. We consider our relationships with associates to be good and have experienced no work stoppages.
ITEM 2.
ITEM 2. PROPERTIES.
We have distribution centers in the following locations:
Approx. Operational Location Sq. Ft. Date ---------------------------- ------- -------------- Atlanta, Georgia (1) 340,000 October 1990 Elkhart, Indiana (2) 360,000 March 1996 Harrisburg, Pennsylvania (2) 370,000 January 1997 Reno, Nevada (2) 270,000 November 1999
- ---------- (1) The related party lease for this facility expires on July 31, 2010. (2) This facility is owned by MSC.
We maintain approximately 90 branch offices located in 38 states, ranging in size from 670 to 16,000 square feet. The leases for these branch offices will expire at various periods between November 2000 and July 2010. The aggregate annual lease payments on these properties in fiscal 2000 was approximately $4,461,000.
We maintain our headquarters at a 170,000 square foot facility in Melville, New York.
We believe that our facilities will be adequate for our current needs and that for the foreseeable future, suitable additional space will be available as needed.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
There are no material legal proceedings pending against MSC.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MSC's Class A Common Stock is traded on the New York Stock Exchange (the "NYSE") under the symbol "MSM." MSC'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 August 30, 1998 to August 26, 2000.
- ----------
On November 7, 2000, the last reported sales price for MSC's Class A Common Stock on the NYSE was $14.6875 per share.
The approximate number of holders of record of MSC's Class A Common Stock as of November 7, 2000 was 562. The number of holders of record of MSC's Class B Common Stock as of November 7, 2000 was 11.
MSC 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 MSC 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.
Item 6.
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 consolidated 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 29, 1998, August 28, 1999 and August 26, 2000 and the selected balance sheet data as of August 28, 1999 and August 26, 2000 are derived from MSC's audited consolidated financial statements which are included elsewhere herein. The selected income statement data for the fiscal years ended August 31, 1996 and August 30, 1997 and the selected balance sheet data as of August 31, 1996, August 30, 1997 and August 29, 1998 are derived from MSC's audited consolidated financial statements not included herein.
(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."
(4) Effective August 28, 1999 includes Enco Manufacturing Co., Inc. active customers.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
General
In recent years, we made the strategic decision to leverage MSC's strength as a low-cost, value-added MRO provider by adding new products and categories of MRO supplies, such as welding and electrical supplies, which has increased, and is anticipated to further increase, sales to existing customers and access to new customers. We believe that revenue has increased, in part, as a result of the increase in the number of SKUs. We generally add SKUs in response to the feedback we receive from our existing customers. There can be no assurance that we will be able to increase the number of SKUs offered or that the correlation between the number of SKUs offered and revenue will continue.
We significantly expanded our direct mail marketing program from approximately 6.3 million pieces in fiscal 1996 to 28.8 million pieces in fiscal 2000. Targeted mailings to customers or potential customers are designed to maximize our return in relation to our marketing expenditures. We utilize our customer databases to match specific customer profiles with an expanding selection of catalog titles which emphasize specific product categories. We believe that increasing mailings to more targeted customer segments has resulted in increased marketing productivity.
In the future, we intend to take advantage of the additional products offered and our expanded distribution capabilities by further increasing our direct marketing efforts; however, the costs associated with our direct marketing 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 our direct mail marketing program will result in new customers or an increase in sales from existing customers.
Revenue per associate increased from approximately $266 in fiscal 1996 to approximately $298 during fiscal 2000. We believe that this increase in revenue per associate is indicative of our efforts to achieve higher levels of efficiency and cost savings at the associate level.
The number of annual orders entered and processed has increased from approximately 2.2 million in fiscal 1996 to approximately 3.7 million during fiscal 2000. The average order size for our core business has increased from approximately $130 fiscal 1996 to approximately $202 during fiscal 2000. We believe that our targeted marketing campaign strategy, our 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 increase in orders and sales we have received, both from existing customers and from new customers. There can be no assurance, however, that we will be able to continue to grow at rates recently experienced or at all.
Results Of Operations
The following table summarizes MSC's historical results of operations as a percentage of sales for the three most recent fiscal years.
Fiscal Year Ended August 26, 2000 Compared to Fiscal Year Ended August 28, 1999
Net sales increased by $141.4 million, or 21.7%, to $792.9 million during fiscal 2000 from $651.5 million in fiscal 1999. This increase was primarily attributable to an increase in sales to the Company's existing customers and an increase in the number of active customers. The increase in sales to existing customers was in part attributable to an increase of 10.6% in the number of SKUs offered, as well as from more focused marketing efforts. Average annual sales per customer increased 5.9%, and the number of combined active customers increased 15.0% in fiscal 2000, as compared to fiscal 1999.
Gross profit increased by $44.7 million, or 17.1%, to $306.4 million during fiscal 2000 from $261.7 million in fiscal 1999, primarily attributable to increased sales. As a percentage of sales, gross profit decreased from 40.2% to 38.6%. The decrease in gross profit as a percentage of net sales resulted primarily from the mix of products being sold, the introduction of new products which have lower margins than certain products which the Company has sold in the past, increased promotional selling, lower selling prices on selected items, and lower margins realized from customers and product lines gained through the Company's acquisitions.
Operating expenses increased by $33.1 million, or 18.4%, to $213.1 million during fiscal 2000 from $180.0 million in fiscal 1999. As a percentage of sales, operating expenses decreased from 27.6% to 26.9%. The decline in operating expenses as a percentage of sales was primarily attributable to leveraging fixed costs over a larger revenue base. The dollar increase was primarily attributable to increased sales volume which required additional staffing and support, new distribution center opening and operating costs, increased depreciation costs resulting from the previous year's large capital expenditures, and expenditures for future growth initiatives, including increased expenses related to internal Internet initiatives.
Income from operations increased by $11.5 million, or 14.1%, to $93.3 million during fiscal 2000 from $81.8 million in fiscal 1999. The increase was primarily attributable to increased sales and the dollar amount increase in gross profit offset in part by an increase in operating expenses.
Interest expense increased by $3.6 million to $5.2 million during fiscal 2000 from $1.6 million in fiscal 1999. The increase was primarily attributable to higher long-term notes payable borrowings and higher interest rates under the Company's revolving credit agreement. The funds were used primarily for inventory purchases for the Company's new distribution center, increasing inventory to support higher sales volume, expenditures for property, plant, and equipment and investments in internal Internet initiatives.
Equity in loss of unconsolidated affiliate of approximately $0.5 million relates to the Company's non-controlling investment made in the second quarter of fiscal 2000 in an Internet joint venture accounted for under the
equity method which has been accounted for under the cost method since the Company's ownership and control were reduced in the third quarter of fiscal 2000.
Provision for income taxes and net income: The effective income tax rate was approximately 40.0 percent for fiscal 2000 as compared to 39.5 percent in the prior year. Net income increased by $4.0 million, or 8.2%, to $52.9 million in fiscal 2000 from $48.9 million in fiscal 1999. This increase was primarily the result of previously mentioned increased sales and the dollar amount increase in gross profit offset in part by an increase in operating expenses necessary in order to support the increase in volume and to invest in future growth.
Fiscal Year Ended August 28, 1999 Compared to Fiscal Year Ended August 29, 1998
Net sales increased by $68.5 million, or 11.8%, to $651.5 million during fiscal 1999 from $583.0 million in fiscal 1998. 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 during fiscal 1998 and fiscal 1999. We believe the increase in sales to existing customers was in part attributable to an increase of 9.4% in the number of SKUs offered, as well as from more focused marketing efforts. Average annual sales per customer increased 3.1%, and the number of active customers increased 8.4% in fiscal 1999, as compared to fiscal 1998. Sales from the companies acquired in 1999 accounted for approximately 3.5% of consolidated net sales.
Gross profit increased by $23.6 million, or 9.9%, to $261.7 million during fiscal 1999 from $238.1 million in fiscal 1998, primarily attributable to increased sales. As a percentage of sales, gross profit decreased from 40.8% to 40.2%. The decrease resulted primarily from the mix of products being sold and as a result of lower margins realized from customers and product lines gained through the Company's acquisitions.
Operating expenses increased by $18.1 million, or 11.2%, to $180.0 million during fiscal 1999 from $161.9 million in fiscal 1998. As a percentage of sales, operating expenses decreased slightly from 27.8% to 27.6%. The decline in operating expenses as a percentage of sales was primarily attributable to leveraging fixed costs over a larger revenue base, offset in part by expenses required to prepare the Company's new distribution center for operations, additional costs of the new headquarters and expenditures for future growth initiatives.
Income from operations increased by $5.6 million, or 7.4%, to $81.8 million during fiscal 1999 from $76.2 million in fiscal 1998. The increase was primarily attributable to increased sales and the dollar amount increase in gross profit offset in part by an increase in operating expenses.
Net income increased by $1.6 million, or 3.4%, to $48.9 million during fiscal 1999 from $47.3 million in fiscal 1998. This increase was primarily the result of previously mentioned increases in sales and gross profit, offset in part by the increase in operating expenses necessary in order to support the increase in volume and to invest in future growth.
Quarterly Results and Seasonality
The following table sets forth unaudited financial data for each of MSC's last eight fiscal quarters.
(a) Basic earnings per share for fiscal 2000 in total exceeds by $ 0.01 the sum of the applicable amount for each of the quarters of fiscal 2000 due to the impact of stock issuances on the weighted average number of shares outstanding.
We have generally experienced slightly lower sales volumes during the summer months, and we expect 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 our fixed costs during slower sales periods. Our 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
Our primary capital needs have been to fund the working capital requirements necessitated by our sales growth, adding new products, and facilities expansions. Our primary sources of financing have been cash from operations, supplemented by bank borrowings under our credit facility. We anticipate cash flows from operations and available lines of credit will be adequate to support our operations for the immediate future and for at least the next 24 months.
Under the terms of the credit facility, the maximum permitted borrowings are $160.0 million ($110.0 million under an unsecured revolving credit agreement and $50.0 million as a term loan). Interest on amounts borrowed may be paid at a rate per annum equal to the bank's base rate (9.5% at August 26, 2000) or, alternatively, at the bankers' acceptance rate or LIBOR rate plus margins, which vary from 0.65% to 1.25% per annum based on the ratio of total liabilities to effective net worth, or bid note rate. This credit facility contains certain covenants limiting mergers, use of proceeds, indebtedness, liens, investments, sales of assets, acquisitions, and issuance of dividends. This credit facility also contains certain standard financial covenants. As of August 26, 2000, the Company was in compliance with all financial covenants. As of August 26, 2000, the Company had approximately $66.6 million in outstanding borrowings under the credit facility. Available borrowings at August 26, 2000 are $93.4 million, all of which were available under the revolving credit agreement.
Net cash provided by operating activities for the fiscal year ended August 26, 2000 was $20.4 million and net cash used in operating activities for the fiscal year ended August 28, 1999 was $5.4 million. The change of approximately $25.8 million in net cash provided from operations to net cash used in operations resulted from improved net working capital requirements, due to management's initiatives to reduce working capital, higher non-cash items and higher net income.
Net cash used in investing activities for the fiscal years ended August 26, 2000 and August 28, 1999 was $31.0 million and $48.3 million, respectively. The net usage of cash in fiscal 2000 was primarily attributable to expenditures for property, plant and equipment and cash paid for investments in internet initiatives. The net usage of cash in fiscal 1999 was primarily attributable to cash paid for construction of the Company's new headquarters, expenditures related to the construction of a new distribution center and cash paid for acquisitions.
Net cash provided by financing activities during the fiscal years ended August 26, 2000 and August 28, 1999 was $11.2 million and $47.7 million, respectively. The net cash provided by financing activities for fiscal 2000 was primarily attributable to proceeds from the exercise of common stock options. The net cash provided by financing activities for fiscal 1999 was primarily attributable to proceeds received from notes payable, offset by the purchase in the open market of approximately 997,000 shares of Class A common stock.
Year 2000
Management believes that the Company mitigated its exposure relative to Year 2000 issues for both information and non-information technology systems. The Company's non-compliant systems were either replaced or modified to become Year 2000 compliant prior to December 31, 1999. The transition into the Year 2000 resulted in no significant impact to the financial position or operations of the Company. To date, the Company's suppliers continue to provide the Company with sufficient goods and services in the Year 2000.
ITEM 7A
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company's principal financial instrument is long-term notes payable under a credit agreement. The Company is affected by market risk exposure primarily through the effect of changes in interest rates on amounts payable by the Company under this credit agreement. Changes in these factors cause fluctuations in the Company's net income and cash flows. The agreement allows the company maximum borrowings of $160.0 million, of which $110.0 million is a revolving credit agreement and the remaining $50.0 million is a term loan. At August 26, 2000,
approximately $66.6 million was outstanding under the credit agreement. The agreement bears interest at the bank's base rate (9.5% at August 26, 2000), or, alternatively, at the bankers acceptance rate or LIBOR rate plus margins, which vary from 0.65% to 1.25% per annum based on the ratio of total liabilities to effective net worth, or bid note rate. If the principal amounts under the Company's credit agreement remained at this year-end level for an entire year and the prime rate increased or decreased, respectively, by 1%, then the Company would pay or save, respectively, an additional $0.7 million in interest that year. The Company does not make material use of derivative financial instruments to hedge against changes in interest rates or for any other purpose.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ----
Report of Independent Public Accountants
Consolidated Balance Sheets as of August 26, 2000 and August 28, 1999
Consolidated Statements of Income for the three fiscal years ended August 26, 2000
Consolidated Statements of Shareholders' Equity for the three fiscal years ended August 26, 2000
Consolidated Statements of Cash Flows for the three fiscal years ended August 26, 2000
Notes to Consolidated Financial Statements
Report of Independent Public Accountants on Schedule II S-1
Schedule of Valuation and Qualifying Accounts S-2
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III.
ITEM 10.
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 2001 (the "2000 Proxy Statement"), which is incorporated herein by this reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Information called for by Item 11 is set forth under the heading "Executive Compensation" in the 2000 Proxy Statement, which is incorporated herein by this reference.
ITEM 12.
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 2000 Proxy Statement, which is incorporated herein by this reference.
ITEM 13.
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 2000 Proxy Statement, which is incorporated herein by this reference.
PART IV.
ITEM 14.
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 26, 2000.
Financial statements filed as a part of this report are listed on the "Index to Consolidated Financial Statements" at page 19 herein.
a. Exhibits
Exhibit No. Description ------- ----------- *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). Employment Agreement, dated as of January 2, 1994, between Registrant and Sidney Jacobson, *10.03 as amended on October 31, 1995. *10.04 Employment Agreement, dated as of August 1, 1994, between Registrant and Mitchell Jacobson. 10.05 Credit Agreement, dated as of February 1, 2000, between the Registrant and the banks named therein (incorporated by reference to Exhibit 10 to the Registrant's Quarterly Report on Form 10-Q filed with the Commission on April 11, 2000) 10.06 Employment Agreement, dated as of June 19, 2000, between Registrant and Charles Boehlke 10.07 Agreement, dated as of January 8, 1999, between the Registrant and David Sandler (incorporated by reference to Exhibit 10.7 to the Registrant's Annual Report on Form 10-K filed with the Commission on November 19, 1999). 10.08 Agreement, dated as of January 8, 1999, between the Registrant and James Schroeder (incorporated by reference to Exhibit 10.8 to the Registrant's Annual Report on Form 10-K filed with the Commission on November 19, 1999). 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 26, 2000
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.
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 9, 2000 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.
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 26, 2000 and August 28, 1999, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three fiscal years in the period ended August 26, 2000. 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 auditing standards generally accepted in the United States. 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 26, 2000 and August 28, 1999, and the results of their operations and their cash flows for each of the three fiscal years in the period ended August 26, 2000 in conformity with accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Melville, New York October 26, 2000
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
The accompanying notes are an integral part of these consolidated balance sheets.
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (In thousands, except net income per share data)
The accompanying notes are an integral part of these consolidated statements.
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE THREE FISCAL YEARS ENDED AUGUST 26, 2000 (In thousands)
The accompanying notes are an integral part of these consolidated statements.
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE FISCAL YEARS ENDED AUGUST 26, 2000 (In thousands)
The accompanying notes are an integral part of these consolidated statements.
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 Melville, New York. The Company serves both domestic and international markets through its distribution network, which includes approximately 90 local MSC branches in 38 states, as well as certain other locations related to acquired entities, concentrated in the Eastern and Southern United States, and regional distribution centers near Harrisburg, Pennsylvania; Elkhart, Indiana; Atlanta, Georgia and Reno, Nevada.
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 subsidiaries, all of which are wholly-owned. All intercompany balances and transactions have been eliminated in consolidation.
Fiscal Year
The Company's fiscal year is on a fifty-two or fifty-three week basis, ending on a Saturday close to August 31. The financial statements for fiscal 2000, 1999 and 1998 each 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 292,000 combined active customer accounts. The Company sells its products primarily to end-users.
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 in accordance with Statement of Position ("SOP") 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." These costs are included within property, plant and equipment in the 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 Statement of Financial Accounting Standards ("SFAS") No. 34, "Capitalization of Interest Cost," interest attributable to construction of distribution centers and computer systems are capitalized as part of the cost of the related asset during the period prior to which such assets are available and ready for use.
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts)
Goodwill
Goodwill shown in the consolidated balance sheets at August 26, 2000 and August 28, 1999 relates to multiple acquisitions completed during the last five fiscal years (Note 4). Goodwill is being amortized on a straight-line basis over 40-year periods. Accumulated amortization was $5,525 and $3,560 as of August 26, 2000 and August 28, 1999, respectively. In accordance with 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. The amount of goodwill impairment, if any, is measured based on projected future operating cash flows using a discount rate reflecting the Company's average cost of funds. Management believes that there is no impairment to recorded goodwill as of August 26, 2000.
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 SOP 93-7, "Reporting on Advertising Costs" ($12,943 and $10,413 at August 26, 2000 and August 28, 1999, 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.
Revenue Recognition
The Company recognizes revenue upon shipment of products to its customers. 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.
Reclassifications
Certain prior year balances have been reclassified to conform with current year presentation.
Use of Estimates
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States, 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.
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.
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts)
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. See Note 12 for discussion of certain related party transactions.
Investments
The Company's investments in internet commerce companies are recorded on the cost method of accounting, due to respective ownership interests and the Company's inability to exercise significant influence.
Fair Value of Financial Instruments
The Company follows the provisions of SFAS No. 107, "Disclosures about Fair Value of Financial Instruments." To meet the reporting requirements of SFAS No. 107, the Company calculates the fair value of financial instruments and includes this additional information in the notes to financial statements when the fair value is different than book value of those financial instruments. When the fair value is equal to the book value, no additional disclosure is made. The Company uses quoted market prices whenever available to calculate the fair value. When quoted market prices are not available, the Company uses standard pricing models for various types of financial instruments which take into account the present value of estimated future cash flows. At August 26, 2000, the carrying value of all financial instruments approximated fair value.
Comprehensive Income
In fiscal 1999, the Company adopted SFAS No. 130 "Reporting Comprehensive Income," which establishes new rules for the reporting of comprehensive income and its components. The adoption of this statement had no impact on the Company's net income or shareholders' equity. For the fiscal years 2000, 1999 and 1998, the Company's operations did not give rise to items includable in comprehensive income which were not already included in net income. Accordingly, the Company's comprehensive income is the same as its net income for all periods presented.
Web site development costs
The Company complies with the provisions of Emerging Issues Task Force ("EITF") Issue No. 00-2, "Accounting for Web Site Development Costs," which requires companies to properly account for costs incurred to develop a web site. This standard categorizes certain costs as an internal use of software, which would be subject to the requirements of SOP 98-1, while other costs would be subject to capitalization or expense pursuant to SOP 93-7.
Recently Issued Accounting Pronouncements
Derivative Instruments
In June 1998, the Financial Accounting Standards Board 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, as amended by SFAS No. 137, is effective for all fiscal years beginning after June 15, 2000 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 hedge items 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. The Company does not presently make material use of derivative instruments. The Company adopted this statement in fiscal 2001, and the impact of adoption was not material.
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts)
Shipping and Handling Costs
In September 2000, the EITF reached a consensus with respect to EITF Issue No. 00-10, "Accounting for Shipping and Handling Revenues and Costs." The purpose of this issue discussion was to clarify the classification of shipping and handling revenues and costs. The consensus reached was that all shipping and handling billed to customers is revenue.
Further, a consensus was reached that the classification of shipping and handling costs is an accounting policy decision that should be disclosed pursuant to Accounting Principles Board Opinion No. 22, "Disclosures of Accounting Policies." The Company may adopt a policy of including shipping and handling costs in cost of sales. If shipping costs are significant and are not included in cost of sales, a company should disclose both the amount(s) of such costs and the line item(s) on the income statement that included them. This standard will require a restatement of prior periods for changes in classification. The Company currently nets its shipping and handling revenue with the related costs and includes the residual amount as selling expense. This consensus is effective for the Company beginning with the fourth quarter of fiscal 2001. The Company is in the process of quantifying the impact of its adoption, which will not change reported income from operations or net income.
3. NET INCOME PER SHARE
The Company follows the provisions of 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 following provides a reconciliation of information used in calculating the per share amounts for the fiscal years ended August 26, 2000, August 28, 1999 and August 29, 1998, respectively:
4. ACQUISITION OF BUSINESSES
There were no acquisitions during fiscal 2000. All prior acquisitions have been accounted for under the purchase method of accounting. The excess of the purchase price over the fair values of the net assets acquired for the acquisitions was approximately $70,640 and was allocated to goodwill at August 26, 2000 and August 28, 1999, respectively. In determining the value of assets, principally inventory, accounts receivable and fixed assets, management uses its judgement on fair values, which is primarily based on management's experience in collecting receivables, selling inventory and realizing value from such fixed assets.
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts)
Business Acquired Date Acquired Acquisition Cost ----------------- ------------- ---------------- Fiscal 1999 Industrial Specialty Company, Inc. October 1, 1998 $ 6,226 Direct Line, Inc. January 1, 1999 428 Corbin Corporation February 1, 1999 6,224
5. INVESTMENTS
During fiscal 2000, the Company invested approximately $2.0 million, $3.0 million and $2.0 million respectively in three internet commerce companies. The Company's interest in each company is less than 5% and, accordingly, is accounted for under the cost method of accounting. The Company's carrying value in these investments approximates fair value at August 26, 2000.
During fiscal 2000, the Company made an investment of approximately $2.4 million in an internet joint venture in the form of a non-controlling combination of voting and non-voting equity securities. The Company accounted for this investment under the equity method for the first half of fiscal 2000, whereby the Company recognized its allocable share of the earnings or losses of this venture in its statement of income as "equity in loss of unconsolidated affiliate." The Company's share of net loss of unconsolidated affiliate was $0.5 million for fiscal 2000. During the third quarter of fiscal 2000, the Company reduced its interest to 19% and otherwise restructured its ownership such that the Company does not exercise significant influence. In October 2000, this internet joint venture was merged with another unrelated entity and MSC's interest was then reduced to approximately 10% of this new entity. Accordingly, the investment continues to be accounted for using the cost method. At August 26, 2000 the Company's carrying value of this investment approximates fair value.
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:
The amount of capitalized interest, net of accumulated amortization, included in property, plant and equipment is $1,686 and $1,534 at August 26, 2000 and August 28, 1999, respectively.
7. INCOME TAXES
The provision for income taxes is comprised of the following:
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts)
For the Fiscal Years Ended ------------------------------------------------------------ August 26, 2000 August 28, 1999 August 29, 1998 --------------- --------------- --------------- Current: Federal $ 25,057 $ 20,116 $ 23,994 State and local 5,306 4,260 5,081 ------------ ------------ ------------ 30,363 24,376 29,075 ------------ ------------ ------------ Deferred: Federal 3,984 6,204 1,510 State and local 844 1,317 319 ------------ ------------ ------------ 4,828 7,521 1,829 ------------ ------------ ------------ Total $ 35,191 $ 31,897 $ 30,904 ============ ============ ============
Significant components of deferred tax assets and liabilities are as follows:
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 26, 2000 will be realized, primarily from the generation of future taxable income.
Reconciliation of the statutory Federal income tax rate to the Company's effective tax rate is as follows:
8. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
August 26, 2000 August 28, 1999 --------------- ---------------
Accrued payroll and bonus $ 19,159 $ 16,489 Accrued fringe benefits 7,011 4,784 Accrued restructuring and relocation charges 2,158 4,913 Accrued catalog costs 5,375 3,708 Accrued other 14,329 12,164 ----------- ----------- Total accrued liabilities $ 48,032 $ 42,058 =========== ===========
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts)
9. LONG-TERM NOTES PAYABLE
Long-term notes payable consist of the following:
August 26, 2000 August 28,1999 --------------- --------------
Revolving credit agreement (a) $ 16,600 $ 67,450 Term loan (a) 50,000 -- Term notes payable (b) 2,042 2,324 ----------- ----------- 68,642 69,774 Less: Current portion 244 306 ----------- ----------- $ 68,398 $ 69,468 =========== ===========
Maturities of notes payable are as follows:
Fiscal Year 2001 $ 244 2002 252 2003 244 2004 162 2005 66,747 Thereafter 993 ----------- $ 68,642 ===========
(b) In February, 2000, the Company entered into a new credit agreement with a bank, as agent for a group of banks. Under the terms of the credit agreement, the maximum permitted borrowings have increased from $80.0 million of unsecured revolving credit to maximum permitted borrowings of $160.0 million ($110.0 million under an unsecured revolving credit agreement and $50.0 million as a term loan). Interest on amounts borrowed may be paid at a rate per annum equal to the bank's base rate (9.5% at August 26, 2000) or, alternatively, at the bankers' acceptance rate or LIBOR rate plus margins, which vary from 0.65% to 1.25% per annum. This credit facility contains certain covenants limiting mergers, use of proceeds, indebtedness, liens, investments, sales of assets, acquisitions, and issuance of dividends. This credit facility also contains certain standard financial covenants. As of August 26, 2000, the Company was in compliance with all financial covenants. As of August 26, 2000, the Company had approximately $66.6 million in outstanding borrowings under the credit facility. Available borrowings at August 26, 2000 are $93.4 million, all of which were available under the revolving credit agreement.
(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
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 1999, the Board of Directors of the Company approved a plan that would allow for the repurchase of up to 5,000 shares of the Company's common stock. The plan allows the Company to repurchase shares at any time and in any increments it deems appropriate. During fiscal 2000 and 1999, the
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts)
Company repurchased 40 and 966 shares of its Class A Common Stock for $749 and $18,753, respectively, which is reflected at cost as treasury stock in the accompanying consolidated financial statements.
11. ASSOCIATE BENEFIT PLANS
Stock Purchase Plan
The Company has established a qualified Stock Purchase Plan, the terms of which allow for qualified associates (as defined) to participate in the purchase of designated shares of the Company's Class A common stock at a price equal to 85% of the closing price at the beginning of each stock purchase period. The associates purchased approximately 108 and 11 shares of common stock during fiscal 2000 and 1999 pursuant to this plan at an average per share price of $10.19 and $9.09 respectively.
Savings Plan
The Company maintains a defined contribution plan with both a profit sharing feature and a 401(k) feature which covers all associates who have completed at least one month of service with the Company. For fiscal 2000, 1999 and 1998, the Company contributed $561, $497 and $1,172, respectively, to the plan. Company contributions are discretionary.
Stock Option Plan
The Company maintains the MSC Industrial Direct Co., Inc. 1995 and 1998 Stock Option Plans, pursuant to which options to purchase approximately 10,000 shares of Class A common stock may be granted. Options may be granted to key associates, directors and consultants over terms not to exceed ten years and they generally vest ratably over five years. Vesting requirements other than the aforementioned are set forth by the Board of Directors when the award is granted.
A summary of the status of the Company's stock option plans at August 26, 2000, August 28, 1999 and August 29, 1998 and changes during the years then ended is presented in the table and narrative below:
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts)
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:
2000 1999 1998 ---- ---- ----
Expected life (years) 7.5 7.5 7.5 Risk-free interest rate 6.5% 4.7% 4.4% Volatility 58.4% 53.1% 38.0% Dividend yield 0.0% 0.0% 0.0%
The following table summarizes information about stock options outstanding at August 26, 2000:
The Company has adopted the pro forma disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." 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:
The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts.
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 associates. Associates 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 associates. 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. During fiscal 2000, 58 shares vested and no additional shares were cancelled or forfeited. At August 26, 2000, 56 and 1 restricted shares were outstanding and exercisable, respectively.
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts)
12. COMMITMENTS AND CONTINGENCIES
Leases
Certain of 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. In addition, the Company is obligated under certain equipment and automobile operating leases, which expire on varying dates through 2003. At August 26, 2000, approximate minimum annual rentals on such leases are as follows:
Total (Including Related Party Related Party Fiscal Year Commitments) Commitments - ----------- ---------------- -------------
2001 $4,967,881 $1,703,611 2002 3,949,621 1,679,362 2003 3,230,539 1,576,338 2004 2,253,366 1,521,937 2005 1,571,570 1,432,987 Thereafter 7,970,931 7,953,297
Total rental expense (exclusive of real estate taxes, insurance and other operating costs) for all operating leases for fiscal 2000, 1999 and 1998 was approximately $4,461, $4,616 and $4,795, respectively, including approximately $1,434, $1,554 and $1,702, respectively, paid to affiliates. In the opinion of the Company's management, the leases with affiliates are on terms, which approximate fair market value.
Self-Insurance
The Company has a self-insured group health 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. Group health plan expense for fiscal 2000, 1999 and 1998 was approximately $12,951, $9,881 and $7,003, 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:
Aggregate Fiscal Year Number of Individuals Annual Amount - ----------- --------------------- -------------
2001 8 $ 1,429 2002 5 908 2003 4 775 2004 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.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
To MSC Industrial Direct Co., Inc.:
We have audited, in accordance with auditing standards generally accepted in the United States, 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 26, 2000. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. This schedule (Schedule II - Schedule of Valuation and Qualifying Accounts) 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.
Melville, New York October 26, 2000
S-1
SCHEDULE II
MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS (In thousands)
(a) Included in accounts receivable. (b) Included in accrued liabilities. (c) Comprised of valuation accounts of acquired entities. (d) Restructuring charges related to, and included in the cost of, acquired entities. (e) Comprised of uncollected accounts charged against the allowance.
S-2