10-Q 1 file001.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended May 31, 2003 Commission File No.: 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 Incorporation or Organization) (I.R.S. Employer Identification No.)
75 MAXESS ROAD MELVILLE, NY 11747 (Address of principal executive offices, including zip code) (516) 812-2000 (Registrant's telephone number, including area code) Website: WWW.MSCDIRECT.COM 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No --------- --------- As of July 11, 2003 34,620,955 shares of Class A Common Stock and 32,137,294 shares of Class B Common Stock of the registrant were outstanding. SAFE HARBOR STATEMENT This Quarterly Report on Form 10-Q (the "Report") contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Discussions containing such forward-looking statements may be found in Items 2 and 3 hereof, as well as within this Report generally. In addition, when used in this Report, the words "believes," "anticipates," "expects," "estimates," "plans," "intends," and similar expressions are intended to identify forward-looking statements. All forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from projected results. Factors that may cause these differences include, but are not limited to: o changing market conditions, o competitive and regulatory matters, o general economic conditions in the markets in which the Company operates, o risk of cancellation or rescheduling of orders, o work stoppages at transportation centers or shipping ports, o the risk of war, terrorism and similar hostilities, o availability of suitable acquisition opportunities, and o the other matters discussed in the Business Description contained in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 2002. Consequently, such forward-looking statements should be regarded solely as the Company's current plans, estimates and beliefs. The Company does not undertake any obligation to update any forward-looking statements to reflect future events or circumstances after the date of such statements. AVAILABLE INFORMATION We file annual, quarterly and current reports, information statements and other information with the Securities and Exchange Commission (the "SEC"). The public may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov. INTERNET ADDRESS We maintain a website where additional information concerning our business and various upcoming events can be found. The address of our website is www.mscdirect.com. We provide a link on our website, under About MSC -- Investor Relations, through which investors can access our latest annual report on Form 10-K. MSC INDUSTRIAL DIRECT CO., INC. INDEX
PART I. FINANCIAL INFORMATION PAGE ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Consolidated Balance Sheets May 31, 2003 and August 31, 2002 1 Consolidated Statements of Income Thirteen and thirty-nine weeks ended May 31, 2003 and June 1, 2002 2 Consolidated Statement of Shareholders' Equity Thirty-nine weeks ended May 31, 2003 3 Consolidated Statements of Cash Flows Thirty-nine weeks ended May 31, 2003 and June 1, 2002 4 Notes to Consolidated Financial Statements 5 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 9 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 16 ITEM 4. CONTROLS AND PROCEDURES 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 18 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 19 SIGNATURES AND CERTIFICATIONS 20
41272411.08 PART I. FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) MSC INDUSTRIAL DIRECT CO., INC. Consolidated Balance Sheets (In thousands, except share data)
May 31, August 31, 2003 2002 ---- ---- (Unaudited) (Audited) ASSETS ------ Current Assets: Cash and cash equivalents $ 108,764 $ 59,978 Accounts receivable, net of allowance for doubtful accounts of $3,219 and $3,114, respectively 95,572 94,322 Inventories 207,540 205,563 Prepaid expenses and other current assets 9,397 6,690 Deferred income taxes 9,645 4,339 ----------------- --------------- Total current assets 430,918 370,892 ----------------- --------------- Property, Plant and Equipment, net 107,997 112,721 ----------------- --------------- Other Assets: Goodwill 63,202 63,202 Other 9,909 16,133 ----------------- --------------- 73,111 79,335 ----------------- --------------- Total Assets $ 612,026 $ 562,948 ================= =============== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Current Liabilities: Accounts payable $ 30,743 $ 31,561 Accrued liabilities 36,800 39,858 Current portion of long-term notes payable 187 213 ----------------- --------------- Total current liabilities 67,730 71,632 Long-term notes payable 1,178 1,308 Deferred income tax liability 28,739 15,329 ----------------- --------------- Total liabilities 97,647 88,269 ----------------- --------------- Shareholders' Equity: Preferred stock; $0.001 par value; 5,000,000 shares authorized; none issued and outstanding - - Class A common stock (one vote per share); $0.001 par value; 100,000,000 shares authorized; 38,801,829 and 38,571,254 shares issued, and 34,606,829 and 34,589,254 shares outstanding, respectively 39 38 Class B common stock (ten votes per share); $0.001 par value; 50,000,000 shares authorized; 32,137,294 and 32,137,294 shares issued and outstanding, respectively 32 32 Additional paid-in capital 256,916 253,564 Retained earnings 321,267 283,348 Class A treasury stock, at cost, 4,195,000 and 3,982,000 shares, respectively (63,875) (62,303) ----------------- --------------- Total shareholders' equity 514,379 474,679 ----------------- --------------- Total Liabilities and Shareholders' Equity $ 612,026 $ 562,948 ================= ===============
See accompanying notes. Page 1 MSC INDUSTRIAL DIRECT CO., INC. Consolidated Statements of Income (In thousands, except per share data) (Unaudited)
Thirteen Weeks Ended Thirty-Nine Weeks Ended ----------------------------------- ---------------------------------- May 31, June 1, May 31, June 1, 2003 2002 2003 2002 ---------------- ----------------- ---------------- --------------- Net sales $ 215,571 $ 208,592 $ 635,896 $ 592,235 Cost of goods sold 118,709 117,888 349,555 334,146 ------------- --------------- -------------- ------------- Gross profit 96,862 90,704 286,341 258,089 Operating expenses 75,915 72,713 225,006 213,440 ------------- --------------- -------------- ------------- Income from operations 20,947 17,991 61,335 44,649 ------------- --------------- -------------- ------------- Other income: Interest income, net 328 320 773 686 Other income, net 67 (40) 114 57 ------------- --------------- -------------- ------------- Total other income 395 280 887 743 ------------- --------------- -------------- ------------- Income before provision for income taxes 21,342 18,271 62,222 45,392 Provision for income taxes 8,174 7,217 23,821 17,929 ------------- --------------- -------------- ------------- Net income $ 13,168 $ 11,054 $ 38,401 $ 27,463 ============= =============== ============== ============= Per Share Information (Note 1): Net income per common share: Basic $ 0.20 $ 0.16 $ 0.58 $ 0.40 ============= =============== ============== ============= Diluted $ 0.19 $ 0.15 $ 0.57 $ 0.39 ============= =============== ============== ============= Weighted average shares used in computing net income per common share (Note 1): Basic 66,650 69,476 66,567 69,037 ============= =============== ============== ============= Diluted 68,265 72,006 67,780 71,125 ============= =============== ============== =============
See accompanying notes. Page 2 MSC INDUSTRIAL DIRECT CO., INC. Consolidated Statement of Shareholders' Equity Thirty-Nine weeks ended May 31, 2003 (In thousands) (Unaudited)
--------------------- -------------------- Class A Class B --------------------- -------------------- Additional Common Stock Common Stock Paid-In Retained --------------------- -------------------- Shares Amount Shares Amount Capital Earnings --------- ----------- --------- ---------- ---------------- --------------- Balance at August 31, 2002 38,571 $ 38 32,137 $ 32 $ 253,564 $ 283,348 Purchases of treasury stock - - - - - - Common stock issued under associate stock - - - - - (482) purchase plan Exercise of common stock options, including 231 1 - - 3,352 - income tax benefit of $563 Net income - - - - - 38,401 --------- ----------- --------- ---------- ---------------- --------------- Balance at May 31, 2003 38,802 $ 39 32,137 $ 32 $ 256,916 $ 321,267 --------- ----------- --------- ---------- ---------------- --------------- Class A ------------------------- Treasury Stock ------------------------- Amount Shares at Cost Total --------- ---------------- ------------ Balance at August 31, 2002 3,982 $ (62,303) $ 474,679 Purchases of treasury stock 283 (2,958) (2,958) Common stock issued under associate stock (70) 1,386 904 purchase plan Exercise of common stock options, including - - 3,353 income tax benefit of $563 Net income - - 38,401 --------- ---------------- ------------ Balance at May 31, 2003 4,195 $ (63,875) $514,379 --------- ---------------- ------------
See accompanying notes. Page 3 MSC INDUSTRIAL DIRECT CO., INC. Consolidated Statements of Cash Flows (In thousands) (Unaudited)
Thirty-Nine Weeks Ended ------------------------------------------- May 31, June 1, 2003 2002 ----------------- ------------------ Cash Flows from Operating Activities: Net income $ 38,401 $ 27,463 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 11,295 11,505 Provision for doubtful accounts 1,208 1,980 Deferred income taxes 8,104 547 Stock option income tax benefit 563 1,066 Changes in operating assets and liabilities: Accounts receivable (2,458) (1,938) Inventories (1,977) 21,555 Prepaid expenses and other current assets (2,707) (2,120) Other assets 6,224 8,158 Accounts payable and accrued liabilities (3,876) (3,798) ----------------- ------------------ Total adjustments 16,376 36,955 ----------------- ------------------ Net cash provided by operating activities 54,777 64,418 ----------------- ------------------ Cash Flows from Investing Activities: Expenditures for property, plant and equipment (6,571) (5,181) ----------------- ------------------ Net cash used in investing activities (6,571) (5,181) ----------------- ------------------ Cash Flows from Financing Activities: Purchases of treasury stock (2,958) - Proceeds from sale of Class A common stock in connection with associate stock purchase plan 904 841 Proceeds from exercise of Class A common stock options 2,790 13,453 Repayments of notes payable (156) (153) ----------------- ------------------ Net cash provided by financing activities 580 14,141 ----------------- ------------------ Net increase in cash and cash equivalents 48,786 73,378 Cash and cash equivalents - beginning of period 59,978 12,466 ----------------- ------------------ Cash and cash equivalents - end of period $ 108,764 $ 85,844 ================= ================== Supplemental Disclosure of Cash Flow Information: Cash paid for interest $ 36 $ 34 ================= ================== Cash paid for income taxes $ 14,483 $ 11,329 ================= ==================
See accompanying notes. Page 4 Notes to Consolidated Financial Statements (In thousands, except per share data) (Unaudited) NOTE 1. BASIS OF PRESENTATION MSC Industrial Direct Co., Inc. ("MSC") was incorporated in the State of New York on October 24, 1995. The accompanying consolidated financial statements include MSC and all of its subsidiaries, including its principal operating subsidiary, Sid Tool Co., Inc. and is hereinafter referred to collectively as the "Company." All intercompany balances and transactions have been eliminated in consolidation. The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation (consisting of normal recurring adjustments) have been included. Operating results for the first nine months of fiscal 2003 are not necessarily indicative of the results that may be expected for the fiscal year ending August 30, 2003. For further information, refer to the financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 2002. The Company's fiscal year ends on a Saturday close to August 31 of each year. A reconciliation between the numerator and denominator of the basic and diluted EPS calculation is as follows:
Thirteen Weeks Ended Thirty-Nine Weeks Ended ------------------------------------ -------------------------------------- May 31, June 1, May 31, June 1, 2003 2002 2003 2002 -------------- -------------- -------------- ---------------- Net income for EPS Computation $13,168 $11,054 $38,401 $27,463 ======== ======== ======== ======== Basic EPS: Weighted average common shares 66,650 69,476 66,567 69,037 ======= ======= ======= ======= Basic EPS $0.20 $0.16 $0.58 $0.40 ====== ====== ====== ====== Diluted EPS: Weighted average common shares 66,650 69,476 66,567 69,037 Shares issuable from assumed conversion of common stock equivalents 1,615 2,530 1,213 2,088 ------ ------ ------ ------
Page 5 Notes to Consolidated Financial Statements (In thousands, except per share data) (Unaudited)
Weighted average common and common equivalent shares 68,265 72,006 67,780 71,125 ======= ======= ======= ======= Diluted EPS $0.19 $0.15 $0.57 $0.39 ====== ====== ====== ======
NOTE 2. FAIR VALUE DISCLOSURE OF STOCK OPTIONS The Company accounts for its stock option plans utilizing the intrinsic value method, under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No compensation expense is reflected in net income, as all options granted under the stock option plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Interim pro-forma information regarding net income and net income per common share is required by Statement of Financial Accounting Standards ("SFAS") No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, if the Company accounts for its stock options granted under the intrinsic value method. The following table illustrates the effect on net income and net income per share if the Company had applied the fair value recognition provisions, under which compensation expense would be recognized as incurred, of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
Thirteen Weeks Ended Thirty-Nine Weeks Ended ------------------------------------ ------------------------------- May 31, June 1, May 31, June 1, 2003 2002 2003 2002 -------------- -------------- -------------- ------------- Net income, as reported...................... $13,168 $11,054 $38,401 $27,463 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects................ (2,695) (3,148) (8,505) (9,261) ------- ------- ------- ------- Pro forma net income......................... $10,473 $7,906 $29,896 $18,202 ======= ======= ======= ======= Net income per common share: Net income per common share, as reported..... $0.20 $0.16 $0.58 $0.40 Net income per common share, pro forma....... $0.16 $0.11 $0.45 $0.26 Diluted net income per common share, as reported.................................. $0.19 $0.15 $0.57 $0.39 Diluted net loss per common share, pro forma. $0.15 $0.11 $0.44 $0.26
Page 6 Notes to Consolidated Financial Statements (In thousands, except per share data) (Unaudited) NOTE 3. COMPREHENSIVE INCOME The Company complies with the SFAS No. 130 "Reporting Comprehensive Income," which establishes standards for the reporting of comprehensive income and its components. For the thirty-nine weeks ended May 31, 2003 and June 1, 2002, 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. NOTE 4 . SHAREHOLDERS' EQUITY Each holder of the Company's Class A common stock is entitled to one vote for each share held of record on the applicable record date on all matters presented to a vote of shareholders, including the election of directors. The holders of Class B common stock are entitled to ten votes per share on the applicable record date and are entitled to vote, together with the holders of the Class A common stock, on all matters which are subject to shareholder approval. Holders of Class A common stock and Class B common stock have no cumulative voting rights or preemptive rights to purchase or subscribe for any stock or other securities and there are no conversion rights or redemption or sinking fund provisions with respect to such stock. During the first nine months of fiscal 2003, the Company repurchased 283 shares of its Class A Common Stock for approximately $3 million, which is reflected at cost as treasury stock in the accompanying consolidated financial statements. The Company reissued approximately 70 shares of treasury stock during the first nine months of fiscal 2003 to fund the associate stock purchase plan. The Company currently anticipates that it may make further repurchases based upon market conditions. The holders of the Company's Class B common stock have the right to convert their shares of Class B common stock into shares of Class A common stock at their election and on a one-to-one basis, and all shares of Class B common stock convert into shares of Class A common stock on a one to-one basis upon the sale or transfer of such shares of Class B common stock to any person who is not a member of the Jacobson or Gershwind families. The Company has authorized 5 million shares of preferred stock. The Company's Board of Directors has the authority to issue shares of preferred stock. Shares of preferred stock have priority over the Company's Class A Common Stock and Class B Common stock with respect to dividend or liquidation rights, or both. As of May 31, 2003, there were no shares of preferred stock issued or outstanding. NOTE 5. PRODUCT WARRANTIES The Company offers a one-year warranty for certain of its machinery products. The specific terms and conditions of those warranties vary depending upon the product sold. Generally, the Company provides a basic limited warranty, including parts and labor, for these products for one-year. The Company would be able to recoup certain of these costs through product warranties it Page 7 Notes to Consolidated Financial Statements (In thousands, except per share data) (Unaudited) holds with its original equipment manufacturers, which typically range from thirty to ninety days. In addition, the Company's general merchandise products are covered by third party original equipment manufacturers' warranties. The Company's warranty expense for the thirteen and thirty-nine week periods ended May 31, 2003 and June 1, 2002 has been minimal. The Company periodically assesses the need for a warranty liability. NOTE 6. SUBSEQUENT EVENTS On July 10, 2003, the Board of Directors instituted a policy of regular quarterly cash dividends to shareholders. Initially, the quarterly dividend rate will be $0.05 per share, or $0.20 per share annually. The first dividend is payable on August 11, 2003 to shareholders of record at the close of business on July 31, 2003. The dividend will result in an anticipated payout of approximately $13,300 per year, based on the number of shares currently outstanding. Page 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is intended to update the information contained in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 2002 and presumes that readers have access to, and will have read, "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in such Form 10-K. This Quarterly Report on Form 10-Q contains or incorporates certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and the Company intends that such forward-looking statements be subject to the safe harbors created thereby. Such forward-looking statements involve known and unknown risks and uncertainties and include, but are not limited to, statements regarding future events and our plans, goals and objectives. Such statements are generally accompanied by words such as "believe," "anticipate," "think," "intend," "estimate," "expect," or similar terms. Our actual results may differ materially from such statements. Factors that could cause or contribute to such differences include, without limitation, changing market conditions, competitive and regulatory matters, general economic conditions in the markets in which the Company operates, risk of cancellation or rescheduling of orders, work stoppages at transportation centers or shipping ports, the risk of war, terrorism and similar hostilities, and the availability of suitable acquisition opportunities. Although the Company believes that the assumptions underlying its forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, the Company cannot make any assurances that the results contemplated in such forward-looking statements will be realized. The inclusion of such forward-looking information should not be regarded as a representation by the Company or any other person that the future events, plans or expectations contemplated by the Company will be achieved. Furthermore, past performance is not necessarily an indicator of future performance. The Company does not undertake any obligation to update any forward-looking statements to reflect future events or circumstances after the date of such statements. OVERVIEW MSC Industrial Direct Co., Inc. ("MSC") was formed in October 1995 and has conducted business since 1941. MSC and its subsidiaries, including Sid Tool Co., Inc. (the "Operating Subsidiary"), are hereinafter referred to collectively as the "Company." 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 intended to satisfy our customers' maintenance, repair and operations ("MRO") supplies requirements. We offer in excess of 500,000 stock-keeping units ("SKUs") through our master catalogs, weekly, monthly and quarterly specialty and promotional catalogs and brochures and service our customers from approximately four distribution centers and 90 branch offices. Most of our products are carried in stock, and orders for these in-stock products are typically fulfilled the day on which the order is received. Page 9 RESULTS OF OPERATIONS - THIRTEEN WEEKS ENDED MAY 31, 2003 AND JUNE 1, 2002 NET SALES increased by $7.0 million, or 3.3%, to $215.6 million in the third quarter of fiscal 2003 from $208.6 million in the third quarter of fiscal 2002. This increase was primarily the result of an increase in sales to existing customers and an increase in the number of active customers. Net sales in the third quarter of fiscal 2003 were adversely affected by severe snowstorms in the Northeast and Midwest in March and April, and the Iraq conflict. These events did not occur in the comparable period in fiscal 2002. Historically, the Company generally experiences slightly lower average daily sales volume in the fourth quarter as compared to the third quarter due to summer plant shutdowns. The Company anticipates these summer plant shutdowns to be longer in duration than previously experienced due to weak economic conditions, thereby having a more significant impact on net sales in the fourth quarter of fiscal 2003 as compared to previous years. GROSS PROFIT increased by $6.2 million, or 6.8%, to $96.9 million in the third quarter of fiscal 2003 from $90.7 million in the third quarter of fiscal 2002. As a percentage of net sales, gross profit increased from 43.5% to 44.9%. The increase in gross profit as a percentage of net sales was the result of modest price increases, an increase in freight revenue from shipping and handling fees, vendor rebates, continued favorable product mix, and favorable discounts obtained from vendors. OPERATING EXPENSES increased by $3.2 million, or 4.4%, to $75.9 million in the third quarter of fiscal 2003 from $72.7 million in the third quarter of fiscal 2002. As a percentage of net sales, operating expenses increased from 34.9% to 35.2%. The increase in operating expenses in dollars was primarily the result of an increase in payroll and payroll related expenses due to annual salary increases, an increase in head count, increased medical and other benefit related costs and freight expense as compared to the third quarter of fiscal 2002. INCOME FROM OPERATIONS increased by $3.0 million, or 16.4%, to $20.9 million in the third quarter of fiscal 2003 from $18.0 million in the third quarter of fiscal 2002. The increase in dollars was primarily attributable to the increase in net sales and improved gross profit margins described above. As a percentage of net sales, income from operations increased from 8.6% to 9.7%, primarily the result of improved gross profit, offset minimally by an increase in operating expenses. INTEREST INCOME, NET. Net interest income was $0.3 million for the third quarter of fiscal 2003 and fiscal 2002. The Company had more invested cash in the third quarter of fiscal 2003, which was offset by lower interest rates. PROVISION FOR INCOME TAXES. The effective tax rate was approximately 38.3% and 39.5% for the third quarter of fiscal 2003 and fiscal 2002, respectively. The reduction in the effective tax rate is a direct result of settlements from the closing of two tax years and benefits received from the donation of inventory to educational institutions. Excluding the effect of these factors, the effective tax rate is approximately 39.5% for both periods. The Company's expected tax rate for the fourth quarter of fiscal 2003 is 38.3%. Page 10 NET INCOME increased by $2.1 million, or 19.1%, to $13.2 million in the third quarter of fiscal 2003 from $11.1 million in the third quarter of fiscal 2002. This increase was primarily the result of the increase in income from operations and the favorable change in the effective tax rate as described above. THIRTY-NINE WEEKS ENDED MAY 31, 2003 AND JUNE 1, 2002 NET SALES increased by $43.7 million, or 7.4%, to $635.9 million in the first thirty-nine weeks of fiscal 2003 from $592.2 million in the first thirty-nine weeks of fiscal 2002. This increase was primarily the result of an increase in sales to existing customers and an increase in the number of active customers. Net sales were adversely affected during the weeks of Christmas and New Year's in the fiscal 2003 period as a result of our customers extended holiday shutdown periods, and from February through April 2003 by weather due to significant snowstorms in the Midwest and Northeast, and the Iraq conflict, which did not occur in the comparable period in fiscal 2002. The Company gained market share as the number of average active customers increased by 11,000 to 340,000 as compared to 329,000 in the first thirty-nine weeks of fiscal 2002. Historically, the Company generally experiences slightly lower average daily sales volume in the fourth quarter as compared to the third quarter due to summer plant shutdowns. The Company anticipates these summer plant shutdowns to be longer in duration than previously experienced due to weak economic conditions, thereby having a more significant impact on net sales in the fourth quarter of fiscal 2003 as compared to previous years. GROSS PROFIT increased by $28.2 million, or 10.9%, to $286.3 million in the first thirty-nine weeks of fiscal 2003 from $258.1 million in the first thirty-nine weeks of fiscal 2002. As a percentage of net sales, gross profit increased from 43.6% to 45.0%. The increase in gross profit as a percentage of net sales was the result of modest price increases, an increase in freight revenue from shipping and handling fees, vendor rebates, continued favorable product mix, favorable discounts obtained from vendors, and the success of the Company's efforts to increase gross profit margins with new and existing customers. OPERATING EXPENSES increased by $11.6 million, or 5.4%, to $225.0 million in the first thirty-nine weeks of fiscal 2003 from $213.4 million in the first thirty-nine weeks of fiscal 2002. The increase in operating expenses in dollars was primarily the result of an increase in payroll and payroll related expenses due to annual salary increases, an increase in head count, increased medical and other benefit related costs and freight expense as compared to the first thirty-nine weeks of fiscal 2002. As a percentage of net sales, operating expenses decreased from 36.0% to 35.4%, primarily the result of the distribution of fixed expenses over a larger revenue base. INCOME FROM OPERATIONS increased by $16.7 million, or 37.4%, to $61.3 million in the first thirty-nine weeks of fiscal 2003 from $44.6 million in the first thirty-nine weeks of fiscal 2002. The increase in dollars was primarily attributable to the increase in net sales and improved gross profit margins described above. As a percentage of net sales, income from operations increased from 7.5% to 9.6%, primarily the result of improved gross profit, offset minimally by an increase in operating expenses. Page 11 INTEREST INCOME, NET. Net interest income was approximately $0.8 million and $0.7 million for the first thirty-nine weeks of fiscal 2003 and fiscal 2002, respectively. The slight increase in net interest income is a result of more invested cash in the first thirty-nine weeks of fiscal 2003 as compared to the first thirty-nine weeks of fiscal 2002, which was offset by lower interest rates. PROVISION FOR INCOME TAXES. The effective tax rate was approximately 38.3% and 39.5% for the first thirty-nine weeks of fiscal 2003 and fiscal 2002, respectively. The reduction in the effective tax rate is a direct result of settlements from the closing of two tax years and benefits received from the donation of inventory to educational institutions. Excluding the effect of these factors, the effective tax rate is approximately 39.5% for both periods. The Company's expected tax rate for the fourth quarter of fiscal 2003 is 38.3%. NET INCOME increased by $10.9 million, or 39.8%, to $38.4 million in the first thirty-nine weeks of fiscal 2003 from $27.5 million in the first thirty-nine weeks of fiscal 2002. This increase was primarily the result of the increase in income from operations explained above. CRITICAL ACCOUNTING POLICIES The Company's significant accounting policies are more fully described in the notes to the consolidated financial statements in its Annual Report on Form 10-K for the fiscal year ended August 31, 2002. On an on-going basis, the Company evaluates its estimates, including those related to bad debts, inventories, goodwill, contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Concentrations of Credit Risk ----------------------------- The Company's mix of receivables is diverse, with approximately 340,000 combined active customer accounts defined as customers who have purchased from MSC in the preceding twelve months. The Company sells its products primarily to end-users. No significant concentration of credit risk is considered to exist. The Company performs periodic credit evaluations of its customers' financial condition and collateral is not required. Receivables are generally due within 30 days. The Company evaluates the collectibility of accounts receivable based on numerous factors, including past transaction history with customers and their credit worthiness. Initially, the Company estimates an allowance for doubtful accounts as a percentage of net sales based on historical bad debt experience. This estimate is periodically adjusted when the Company becomes aware of a specific customer's inability to meet its financial obligations (e.g. bankruptcy, etc.), or as a result of changes in the overall aging of accounts receivable. The Company maintains the majority of its cash and cash equivalents with high quality financial institutions. Page 12 Inventory Valuation ------------------- Inventories primarily consist of merchandise held for resale and are stated at the lower of weighted average cost (using the first-in, first-out method) or market. Management evaluates the need to record adjustments for impairment of inventory on a quarterly basis. Slow moving inventory, obsolete inventory or inventory in excess of management's estimated usage is written-down, using historical data and reasonable assumptions, to its estimated market value, if less than its cost. Inherent in the estimates of market value are management's estimates related to customer demand, technological and/or market obsolescence, possible alternative uses and ultimate realization of excess inventory. Deferred Catalog Costs ---------------------- The costs of producing and distributing the Company's principal catalogs are deferred ($7.6 million and $14.0 million at May 31, 2003 and August 31, 2002, respectively) 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." These costs are charged to expense over the period that the catalogs remain the most current source of sales, which is typically one year or less. The costs associated with brochures and catalog supplements are charged to expense as distributed. Revenue Recognition ------------------- The Company recognizes revenue upon shipment of products to its customers. The Company reports its sales net of the amount of actual sales returns and the amount of reserves established for anticipated sales returns based upon historical return rates. 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, available cash reserves and available lines of credit will be adequate to support our operations for the next 12 months. Under the terms of the credit facility, the maximum permitted borrowings are $110.0 million under an unsecured revolving credit agreement. Interest on amounts borrowed may be paid at a rate per annum equal to the bank's base rate (4.25% at May 31, 2003) or, alternatively, at the bankers' acceptance rate or LIBOR rate plus margins, which vary from the per annum rate 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 payment of dividends. This credit facility also contains certain standard financial covenants. As of May 31, 2003 the Company had no outstanding borrowings under this agreement and was in compliance with all financial covenants. Net cash provided by operating activities for the thirty-nine week periods ended May 31, 2003 and June 1, 2002 was $54.8 million and $64.4 million, respectively. The decrease of Page 13 approximately $9.6 million in net cash provided by operations resulted from investment in working capital to support an increase in net sales, partially offset by fluctuations in net deferred tax liabilities and higher net income. Net cash used in investing activities for the thirty-nine week periods ended May 31, 2003 and June 1, 2002 was $6.6 million and $5.2 million, respectively. The usage of cash in the first thirty-nine weeks of fiscal 2003 and fiscal 2002 was attributable to expenditures for property, plant and equipment. Net cash provided by financing activities for the thirty-nine week period ended May 31, 2003 and June 1, 2002 was $0.6 million and $14.1 million, respectively. The net cash provided by financing activities for the first thirty-nine weeks of fiscal 2003 was primarily attributable to the proceeds received from the exercise of Class A common stock options, sales of Class A common stock in connection with the associate stock purchase plan, principally offset by the purchase of Class A treasury stock. The net cash provided by financing activities for the first thirty-nine weeks of fiscal 2002 was primarily attributable to proceeds from the exercise of Class A common stock options. The Company believes that cash flow from operations and the revolving credit agreement will be sufficient to fund future growth initiatives and meet planned capital expenditure needs in the near future. On September 26, 2002, the Board of Directors approved the replenishment of the Company's share buyback program which authorized the repurchase of up to 5 million shares of Class A common stock on the open market. The Plan allows the Company to repurchase shares at any time and in any increments it deems appropriate. During the first thirty-nine weeks of fiscal 2003, the Company repurchased 283,000 shares of its Class A Common Stock for approximately $3.0 million, which is reflected at cost as treasury stock in the accompanying consolidated financial statements. The Company reissued approximately 70,000 shares of treasury stock during the first thirty-nine weeks of fiscal 2003 to fund the associate stock purchase plan. The Company currently anticipates that it may make further repurchases based upon market conditions. The Company has adequate cash reserves to fund such future repurchases. On July 10, 2003, the Board of Directors instituted a policy of regular quarterly cash dividends to shareholders. Initially, the quarterly dividend rate will be $0.05 per share, or $0.20 per share annually. The first dividend is payable on August 11, 2003 to shareholders of record at the close of business on July 31, 2003. The dividend will result in an anticipated payout of approximately $13.3 million per year, based on the number of shares currently outstanding. RELATED PARTY TRANSACTIONS The Company is affiliated with various real estate entities (together, the "Affiliates"). The Affiliates are owned primarily by the Company's principal shareholders. The Company paid rent under operating leases to Affiliates for the first thirty-nine weeks of fiscal 2003 of approximately $1.0 million. In the opinion of the Company's management, based on its market research, the leases with Affiliates are on terms which approximate fair market value. Page 14 CONTRACTUAL OBLIGATIONS 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 2012. In addition, the Company is obligated under certain equipment and automobile operating leases, which expire on varying dates through 2003. At August 31, 2002, approximate minimum annual rentals on such leases were as follows (in thousands):
Total (Including Related Party Related Party Fiscal Year Commitments) Commitments ---------------------- ----------------- ---------------- 2003 5,880 1,620 2004 4,750 1,440 2005 3,509 1,312 2006 2,067 1,352 2007 1,694 1,352 Thereafter 4,165 3,825 ---------- ---------------- --------------- $22,065 $10,901 ================ ===============
Since August 31, 2002 there has been no material change in these obligations. The Company believes that existing cash balances together with cash generated from operations and amounts available under the Company's $110.0 million credit facility will be sufficient to meet the Company's projected working capital and other cash flow requirements for the next five years. As of May 31, 2003, the Company was in compliance with the covenants set forth in the Company's credit facility. Page 15 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's principal financial instrument is a long-term note payable under a revolving 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 consolidated net income and cash flows. The agreement allows the Company maximum borrowings of $110.0 million under a revolving credit agreement. At May 31, 2003, the Company had no outstanding borrowings under this agreement and was in compliance with all financial covenants. The agreement bears interest at the bank's base rate (4.25% at May 31, 2003), 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. The Company also has a long term note payable in the amount of approximately $1.2 million to the Pennsylvania Industrial Development Authority which is secured by the land on which the Harrisburg, Pennsylvania distribution center is located, which bears interest at 3% per annum and is payable in monthly installments of approximately $20,000 through September 2011. The Company does not make material use of derivative financial instruments to hedge against changes in interest rates or for any other purpose. In addition, the Company's interest income is most sensitive to changes in the general level of U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on the Company's cash equivalents. Page 16 ITEM 4. CONTROLS AND PROCEDURES The Company's senior management is responsible for establishing and maintaining a system of disclosure controls and procedures (as defined in Rule 13a-14 and 15d-14 under the Securities Exchange Act of 1934 (the "Exchange Act") designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer's management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. The Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures under the supervision of and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, within 90 days prior to the filing date of this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic Securities and Exchange Commission filings. Subsequent to that evaluation there have been no significant changes in our internal controls or other factors that could significantly affect these controls after such evaluation. In designing and evaluating the Company's disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934, as amended), management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. We believe that our disclosure controls and procedures provide such reasonable assurance. Page 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On August 8, 2002, the Company, its directors and certain of its officers were sued in the United States District Court for the Eastern District of New York in an action entitled Thomas Nunziata vs. MSC Industrial Direct Co., Inc. et. al (CV No. 02 4422). Plaintiff, on behalf of a class of the Company's stockholders, seeks unspecified damages based on his allegations arising from the Company's announcement that it would restate its consolidated financial statements for fiscal years 1999 through 2001 and the first three quarters of fiscal 2002. Plaintiff alleges that during the periods affected by the restatement, the Company, its directors and certain of its officers violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, by materially misleading the investing public by making false statements in order to inflate the price of the Company's common stock. On August 14, 2002, the Company and certain of its officers and directors were sued in the United States District Court for the Eastern District of New York in an action entitled Sandra Joan Malin Revocable Trust vs. MSC Industrial Direct Co., Inc. et al. (CV No. 02 4503). The allegations in this matter were substantially similar to those made in the Nunziata action. On September 11, 2002, these actions were consolidated under the caption In re MSC Industrial Direct Co., Inc. Securities Litigation, (CV No. 02 4422). A lead plaintiff, International Association of Machinists National Pension Fund, was named on November 6, 2002, and such lead plaintiff filed a consolidated amended class action complaint on December 23, 2002. The Company filed a motion to dismiss on February 3, 2003, and the Company and the plaintiffs submitted briefs. Oral arguments on the motion have not yet been scheduled. The Company intends to defend this action vigorously. There are no other material legal proceedings pending against MSC. Page 18 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits: --------
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b. Reports on Form 8-K: ------------------- The Company filed a Form 8-K on April 3, 2003 in connection with a press release dated April 3, 2003 announcing the results of operations for the quarterly period ended March 1, 2003. SIGNATURES Pursuant to the requirements 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. (Registrant) Dated: July 11, 2003 By: /s/ Mitchell Jacobson ------------------------------- --------------------------- Chairman, President and Chief Executive Officer Dated: July 11, 2003 By: /s/ Charles Boehlke ------------------------------- ---------------------------- Executive Vice President and Chief Financial Officer Page 20 CERTIFICATION I, Mitchell Jacobson, Chief Executive Officer of MSC Industrial Direct Co., Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of MSC Industrial Direct Co., Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: July 11, 2003 /s/ Mitchell Jacobson ------------------------------ Chairman, President and Chief Executive Officer Page 21 CERTIFICATION I, Charles Boehlke, Chief Financial Officer of MSC Industrial Direct Co., Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of MSC Industrial Direct Co., Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: July 11, 2003 /s/ Charles Boehlke ------------------------------ Executive Vice President and Chief Financial Officer