-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AsBnhHnLOvZIkOIX2Y9HO4mLELCoO3yg9hPhHU46AS+aTJ8UhEfj3FwvoHkedX20 RVQszTe6DrZKiEqMMViCKA== 0001005477-99-005467.txt : 19991122 0001005477-99-005467.hdr.sgml : 19991122 ACCESSION NUMBER: 0001005477-99-005467 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19990828 FILED AS OF DATE: 19991119 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MSC INDUSTRIAL DIRECT CO INC CENTRAL INDEX KEY: 0001003078 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-INDUSTRIAL MACHINERY & EQUIPMENT [5084] IRS NUMBER: 113289165 STATE OF INCORPORATION: NY FISCAL YEAR END: 0902 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-14130 FILM NUMBER: 99760722 BUSINESS ADDRESS: STREET 1: 151 SUNNYSIDE BLVD CITY: PLAINVIEW STATE: NY ZIP: 11803 BUSINESS PHONE: 5163497100 MAIL ADDRESS: STREET 1: 151 SUNNYSIDE BLVD CITY: PLAINVIEW STATE: NY ZIP: 11803 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended August 28,1999 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to _________ Commission file number 1-14130 MSC INDUSTRIAL DIRECT CO., INC. ------------------------------- (Exact Name of Registrant as Specified in Its Charter) New York 11-3289165 -------- ---------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 75 Maxess Road, Melville, New York 11747 ---------------------------------------- (Address of Principal Executive Offices) (516) 812-2000 -------------- (Registrant's telephone number) Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Exchange on Which Registered ------------------- ------------------------------------ Class A Common Stock, par The New York Stock Exchange value $.001 Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| As of November 3, 1999, 33,914,048 shares of Class A Common Stock and 34,138,778 shares of Class B Common Stock of the registrant were outstanding and the aggregate market value of Class A Common Stock held by non-affiliates was approximately $271,175,894. The registrant's Proxy Statement for its 2000 annual meeting of stockholders is hereby incorporated by reference into Part III of this Form 10-K. MSC INDUSTRIAL DIRECT CO., INC. INDEX TO ANNUAL REPORT ON FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION YEAR ENDED AUGUST 28, 1999 ITEMS IN FORM 10-K
Page ---- PART I. Item 1. BUSINESS.........................................................................1 Item 2. PROPERTIES......................................................................10 Item 3. LEGAL PROCEEDINGS...............................................................10 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............................10 PART II. Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...........11 Item 6. SELECTED FINANCIAL DATA.........................................................12 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...........................................................14 Item 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......................18 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.....................................19 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........................................................37 PART III. Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..............................38 Item 11. EXECUTIVE COMPENSATION..........................................................38 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..................38 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..................................38 PART IV. Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.................39
PART I. Item 1. BUSINESS. Some of the statements contained in this report discuss future expectations, contain projections of results of operations or financial condition or state other "forward-looking" information. Those statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements. In light of the significant risks and uncertainties inherent in the forward-looking statements included in this report, the inclusion of such statements should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. General MSC 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 400,000 stock-keeping units ("SKUs") through our 4,211 page master catalog and weekly, monthly and quarterly specialty and promotional catalogs, newspapers and brochures and service our customers from approximately 100 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 $248.5 million in fiscal 1995 to $651.5 million in fiscal 1999. During this same period, income from operations increased at a compound annual rate of approximately 25% from $33.8 million to $81.8 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 $175. We have in excess of 193,000 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 or direct computer link. We operate primarily in the United States, with customers in all 50 states, through a network of three regional distribution centers and approximately 100 branch offices. MSC's distribution centers are located in Harrisburg, Pennsylvania, Atlanta, Georgia, and Elkhart, Indiana. The strategic locations of MSC's distribution centers allow for next day delivery via low cost ground carriers in 33 states located primarily in the eastern United 1 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. A new distribution facility located near Reno, Nevada was constructed during fiscal 1999 and became fully operational in November 1999. 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. Awareness of these high costs and the purchasing inefficiencies discussed above has been driving large companies to streamline the purchasing process by utilizing a limited number of suppliers which can provide adequate selection, prompt delivery and superior customer service. Customized billing practices and report generation capabilities tailored to customer objectives are also becoming increasingly important to customers seeking to reduce costs, allowing such customers to significantly reduce the need for purchasing agents and administrative personnel. 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; 2 o significant reduction in stocking decisions; o elimination or reduction of purchases for inventory; and o elimination of paper orders and invoices through our electronic ordering system. 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. As a result of this strategy, we believe we are able to lower our customers' overall MRO supplies costs by reducing administrative inefficiencies, purchasing and shipping costs, internal distribution costs and inventory investment and carrying costs. 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 400,000 products, approximately 99% of which 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 33 states located primarily in the eastern United 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, 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 4,211 pages and over 400,000 items. In fiscal 1999, our master catalog was supplemented by approximately 90 specialty and promotional catalogs, brochures and newspapers, covering such specialty areas as welding, cutting tools, measuring instruments, abrasives, industrial supply, and hose and tubing. 3 We use our database of approximately 745,000 companies and 1.5 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 6.6 million in fiscal 1995 to approximately 22.8 million in fiscal 1999. 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 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 400,000 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 electronic data interchange 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. We also have developed a website in anticipation of increased commerce on the internet. 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; o acquiring smaller local distributors to gain access to customers and consolidating the acquired operations into our existing distribution facilities; and o developing 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. During fiscal 1999, we constructed a new distribution facility located near Reno, Nevada, which became fully operational in November 1999 and which we believe will enhance our ability to service the Western United States. In addition, we have accumulated a buyer database of approximately 1.5 million individual customers and 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 176,000 SKUs over the past four years while simultaneously increasing our inventory turns. 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. 4 Selected Acquisitions. We seek to grow through acquisitions in both current and new markets. In pursuing acquisitions, we seek to gain immediate access to the acquired company's customer base while consolidating the acquired company's operations into MSC's existing distribution system, thus achieving increased revenue while incurring limited incremental operating costs. We believe that local market acquisitions of small and medium-sized suppliers of industrial products provide an attractive opportunity for expanding our customer base in existing markets. All three acquisitions completed during fiscal 1999 operate in markets where we already had in place the corporate and administrative infrastructures necessary to support such acquisitions immediately. Developing e-commerce capabilities. We believe strongly that the internet will have a profound effect on our business by enhancing the experience we provide to our customers and by making our internal operations more efficient. Our development efforts are well under way to produce a searchable on-line catalog and electronic ordering capabilities. Products We currently offer in excess of 400,000 SKUs, representing a greater than 239% increase since 1994. 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. The following is a list of product categories currently offered by MSC and the number of SKUs available in each product category: Category Number of SKUs -------- -------------- Cutting Tools 122,618 Measuring Instruments 47,140 Tooling Components 32,234 Fasteners 27,946 Flat Stock & Raw Materials 18,964 Abrasives 17,927 Material Handling 16,989 Machinery 16,776 Hand and Power Tools 15,049 Electrical Supplies 14,776 Power Transmission 14,271 Plumbing Supplies 9,224 Hose Tube and Fittings 8,893 Safety Products 8,732 Process Instrumentation 7,506 Marking & Labeling 4,931 Welding 4,381 Hardware 3,815 Pneumatics & Hydraulics 3,704 5 Janitorial/Maintenance 2,736 Lubricants 2,641 Miscellaneous 1,781 HVAC 1,618 Pumps 935 Packing & Shipping 818 Office Equipment 676 ------- Total 407,081 ======= We purchase substantially all of our products directly from approximately 2,400 manufacturers located in the United States. We are not materially dependent on any one supplier or group of suppliers. No single supplier accounted for more than 5% of our total purchases in fiscal 1999. 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 90% 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 three distribution centers for product shipment located in Harrisburg, Pennsylvania; Atlanta, Georgia and Elkhart, Indiana. In fiscal 1998, we began construction of a new distribution center located near Reno, Nevada, which will move us toward our goal of next day delivery throughout the continental United States. A new distribution facility located near Reno, Nevada was constructed during fiscal 1999 and 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 $175. 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 $500,000 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. Our strategy with respect to the large corporate segment is to develop relationships with, and supply MRO products directly to, the integrated supply providers that are hired by large corporations to manage their MRO purchasing and administrative operations. 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 for the budget-oriented customer. We have in excess of 193,000 active customers (companies which have purchased at least one item during the past 12 months). Typically, a customer's MRO purchases are managed by several buyers responsible for different categories of products. 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 6 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 approximately 370 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 270 sales representatives. These sales representatives are responsible for increasing sales per customer and servicing existing customers. Branch Offices We currently operate approximately 100 branch offices located in 37 states. These branch offices receive approximately 54% 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. In addition to opening new branch offices in support of our distribution centers, we have acquired local distributors and converted them to branch offices in new geographic locations to obtain an immediate established local market presence through use of the acquired customer base and integration of their operations. We believe that branch office acquisitions will result in more rapid growth at a lower cost. Publications Our primary reference tool is our annual 4,211 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 38 in fiscal 1995 to approximately 90 in fiscal 1999. The number of pieces mailed has increased from approximately 6.6 million in 7 fiscal 1995 to approximately 22.8 million in fiscal 1999 and is expected to reach approximately 28.5 million in fiscal 2000.
Fiscal Year Ended ------------------------------------------------------------------------- September 2, August 31, August 30, August 29, August 28, 1995 1996 1997 1998 1999 (53 weeks) (52 weeks) (52 weeks) (52 weeks) (52 weeks) ---------- ---------- ---------- ---------- ---------- Number of publication titles 38 70 80 80 90 Number of publications mailed 6,604,000 6,300,000 11,318,000 15,900,000 22,800,000
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 three operating distribution centers. Calls are received by telemarketing representatives who utilize on-line terminals to enter customer orders into computerized order processing systems. Our branch offices field approximately 54% of all telephone orders. 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 also 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. In fiscal 1998, we developed and implemented an electronic data interchange purchasing program with our customers with the objective of allowing them to place orders more efficiently, reduce order cycle processing time, and increase the accuracy of orders placed. In addition to developing the proprietary computer software programs for use in the telemarketing and distribution operations, 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, 8 and cross-referencing capability to a customer's own product stock numbers. In addition, we have developed a Windows(R)-based CD-ROM electronic catalog package and have commenced 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. Acquisitions We have completed several acquisitions and consider acquisitions as part of our growth strategy. We believe that the ongoing consolidation within the industrial supply industry is spurring smaller competitors to seek partners to increase their productivity and reduce costs. We believe that we are well positioned to play a significant role in this industry consolidation. We believe that the most beneficial acquisitions are those which can be integrated into our existing operations. Accordingly, we expect to focus on branch office acquisition prospects that can be integrated into our distribution facilities. We will also consider new market acquisitions if they are of sufficient size that we can establish a meaningful presence in those markets in accordance with our geographic growth plans. Upon completing an acquisition within an existing market, we strive to move rapidly to integrate the acquired entity into our existing operations. We believe that such integration offers a number of opportunities to improve productivity and customer service. These benefits include: o elimination of redundant facilities and services; o reduction of administrative overhead; o consolidation of purchasing power; o expanded customer services; and o and increased merchandise selection. From time to time, we have engaged in, and continue to engage in, preliminary discussions with respect to potential acquisitions. We are not currently a party to any oral or written acquisition agreement or engaged in any negotiations with respect to any material acquisition candidate. We can give no assurance that any acquisitions, when and if made, will be successfully integrated into our existing operations, or that we will be able to implement this phase of our growth strategy. 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. Employees As of November 3, 1999, we employed approximately 2,525 employees, including approximately 2,410 full-time and approximately 115 part-time employees. No employee is represented by a labor union. We consider our relationships with employees to be good and have experienced no work stoppages. 9 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) 270,000 March 1996 Harrisburg, Pennsylvania (2) 270,000 January 1997 Reno, Nevada (3) 270,000 (3) - ---------- (1) The related party lease for this facility expires on July 31, 2010. (2) This facility is owned by MSC. (3) Constructed during fiscal 1999 and became fully operational in November 1999. We maintain approximately 100 branch offices located in 37 states, ranging in size from 670 to 16,000 square feet. The leases for these branch offices will expire at various periods between November 1999 and July 2010. The aggregate annual lease payments on these properties in fiscal 1999 was approximately $4,616,000. 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. LEGAL PROCEEDINGS. There are no material legal proceedings pending against MSC. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 10 PART II. 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 31, 1997 to August 28, 1999. Fiscal Year Ended August 28, 1999 Price of Class A Common Stock * -------------------- High Low --------- --------- First Quarter......................................... $23-1/8 $14 Second Quarter........................................ 26-1/4 16-7/8 Third Quarter......................................... 21-1/2 13-3/4 Fourth Quarter........................................ 20 9-3/8 Fiscal Year Ended August 29, 1998 First Quarter......................................... $23 $18-1/2 Second Quarter........................................ 24-3/4 19-1/2 Third Quarter......................................... 27-7/8 23-3/8 Fourth Quarter........................................ 33-1/8 27-7/8 - ---------- * On April 6, 1998, MSC declared a two-for-one stock split in the form of a stock dividend, distributed May 22, 1998. The Class A Common Stock price per share information included above has been restated to reflect this stock split. On November 3, 1999, the last reported sales price for MSC's Class A Common Stock on the NYSE was $11.00 per share. The approximate number of holders of record of MSC's Class A Common Stock as of November 3, 1999 was 498. The number of holders of record of MSC's Class B Common Stock as of November 3, 1999 was 10. 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. 11 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 30, 1997, August 29, 1998 and August 28, 1999 and the selected balance sheet data as of August 29, 1998 and August 28, 1999 are derived from MSC's audited consolidated financial statements which are included elsewhere herein. The selected income statement data for the fiscal years ended September 2, 1995 and August 31, 1996 and the selected balance sheet data as of September 2, 1995, August 31, 1996 and August 30, 1997 are derived from MSC's audited consolidated financial statements not included herein.
Fiscal Year Ended ------------------------------------------------------------------- September 2, August 31, August 30, August 29, August 28, 1995 1996 1997 1998 1999 (53 weeks) (52 weeks) (52 weeks) (52 weeks) (52 weeks) ------------------------------------------------------------------- (in thousands, except per share data) Income Statement Data: Net sales $248,483 $305,294 $438,003 $583,043 $651,503 Gross profit 103,288 126,775 179,255 238,074 261,729 Operating expenses 69,532 83,666 120,498 161,899 179,958 Restructuring charge -- 8,600 -- -- -- Income from operations 33,756 34,509 58,757 76,175 81,771 Income taxes 765 5,531 23,518 30,904 31,897 Net income 31,698 28,503 36,017 47,335 48,853 Net income per share: Basic -- -- .53 .70 .73 Diluted -- -- .53 .69 .72 Weighted number of shares outstanding: Basic -- -- 67,381 67,756 67,056 Diluted -- -- 68,218 68,964 68,317 Pro forma net income(1) 19,640 20,591 -- -- -- Pro forma net income per share: (2) Basic .41 .35 -- -- -- Diluted .41 .35 -- -- -- Pro forma weighted number of shares outstanding: (2) Basic 48,000 58,910 -- -- -- Diluted 48,000 59,246 -- -- -- Selected Operating Data(3): Active customers 120 127 146 178 193 Number of SKUs 231 302 332 372 407 Orders entered 1,833 2,155 2,425 3,222 3,429 Number of publication titles (not in thousands) 38 70 80 80 90 Number of publications mailed 6,604 6,300 11,318 15,900 22,800 Revenue per employee $ 249 $ 266 $ 280 $ 282 $ 285
12
September 2, August 31, August 30, August 29, August 28, 1995 1996 1997 1998 1999 ------------------------------------------------------------------- Balance Sheet Data (at period end): Working capital $ 81,228 $163,785 $190,344 $183,750 $247,248 Total assets 139,032 265,484 334,834 401,702 514,384 Short-term debt 9,208 2,486 213 800 306 Long-term debt, net of current portion 30,969 42,191 2,744 2,430 69,468 Shareholders' equity $ 72,088 $172,571 $274,995 $321,779 $355,627
(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." 13 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; however, we are unable to quantify precisely the impact of such increase. 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 6.6 million pieces in fiscal 1995 to 15.9 million pieces in fiscal 1998. In fiscal 1998 and fiscal 1999, we refocused our marketing program in an effort to enhance our investments in recently acquired entities and new distribution centers. Accordingly, in fiscal 1999, mailings increased to 22.8 million pieces. 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 employee increased from approximately $249,000 in fiscal 1995 to approximately $285,000 during fiscal 1999. We believe that this increase in revenue per employee is indicative of our efforts to achieve higher levels of efficiency and cost savings at the employee level. The number of annual orders entered and processed has increased from approximately 1.8 million in fiscal 1995 to approximately 3.4 million during fiscal 1999. The average order size for our core business has increased from approximately $136 in fiscal 1995 to approximately $175 during fiscal 1999. 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 we have received and sales, 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. 14 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.
August 30, 1997 August 29, 1998 August 28, 1999 --------------- --------------- --------------- Net sales (dollars in thousands)................. $438,003 $583,043 $651,503 ======== ======== ======== Net sales........................................ 100.0% 100.0% 100.0% Gross profit..................................... 40.9 40.8 40.2 Operating expenses............................... 27.5 27.8 27.6 Income from operations........................... 13.4 13.1 12.6 Net Income....................................... 8.2 8.1 7.5
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. The increase in sales to existing customers was principally derived from 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. Fiscal Year Ended August 29, 1998 Compared to Fiscal Year Ended August 30, 1997 Net sales increased by $145.0 million, or 33.1%, to $583.0 million in fiscal 1998 from $438.0 million in fiscal 1997. This increase was primarily attributable to an increase in sales to our existing customers, an increase in the number of active customers and the effect of acquisitions made in fiscal 1997 and fiscal 1998. The increase in sales to existing customers was derived primarily from an increase of 11.4% in the number of SKUs offered, as well as from more focused marketing efforts. Average annual sales per customer increased 9.3%, and the number of 15 active customers increased 21.9% in fiscal 1998, as compared to fiscal 1997. Sales from the companies acquired in 1998 accounted for approximately 3.0% of consolidated net sales. Gross profit increased by $58.8 million, or 32.8%, to $238.1 million in fiscal 1998 from $179.3 million in fiscal 1997. The increase in gross profit was attributable to increased sales. As a percentage of sales, gross profit decreased slightly from 40.9% in fiscal 1997 to 40.8% in fiscal 1998. Our gross profit as a percentage of sales from our core business remained constant. Operating expenses increased by $41.4 million, or 34.4%, to $161.9 million in fiscal 1998 from $120.5 million in fiscal 1997. The increase was primarily attributable to increased sales volume, which required additional staffing and support. As a percentage of sales, operating expenses increased from 27.5% to 27.8%. The increase was primarily the result of continuous investment in new branches and other growth programs, offset in part by operating efficiencies and the distribution of fixed expenses over a larger revenue base. Income from operations increased by $17.4 million, or 29.6%, to $76.2 million in fiscal 1998 from $58.8 million in fiscal 1997. This increase was primarily attributable to increased sales and gross profit offset in part by an increase in operating expenses. Net income increased by $11.3 million, or 31.4%, to $47.3 million in fiscal 1998, from $36.0 million in fiscal 1997. The increase in net income is primarily attributable to increased sales and gross profit, offset by higher operating expenses. Quarterly Results and Seasonality The following table sets forth unaudited financial data for each of MSC's last eight fiscal quarters.
Year Ended August 29, 1998 Year Ended August 28, 1999 ------------------------------------------------ --------------------------------------------- First Second Third Fourth First Second Third Fourth Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter -------- -------- -------- -------- -------- -------- -------- -------- (dollars in thousands) Income Statement Data: Net Sales................. $135,609 $142,520 $155,098 $149,816 $155,451 $160,518 $170,492 $165,042 Gross Profit.............. 55,339 58,185 63,590 60,960 63,761 66,157 68,760 63,051 Income from operations.... 15,256 18,843 22,913 19,163 19,841 25,476 20,964 15,490 Net income................ 9,500 11,662 14,237 11,936 12,060 15,161 12,320 9,312 Net income per share: Basic................. .14 .17 .21 .18 .18 .23 .18 .14 Diluted............... .14 .17 .21 .17 .18 .22 .18 .14
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, acquisitions and facilities expansions. Our primary sources of financing have been cash from operations, supplemented by bank borrowings under our revolving credit facility, and a portion of the proceeds from our public offering completed at the end of fiscal 1997. We anticipate that the proceeds from these offerings, our 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, we have available unsecured borrowings of up to $80.0 million. Interest on amounts borrowed may be paid at a rate per annum equal to the bank's base rate (8.25% at August 28, 16 1999) or, alternatively, at the bankers' acceptance rate or LIBOR rate plus margins, which vary from 0.45% to 0.75% per annum. Our credit facility contains certain covenants limiting mergers, use of proceeds, indebtedness, liens, investments, sale of assets and acquisitions. Our credit facility also contains certain financial covenants which require MSC to maintain a minimum net worth, ratio of current assets to current liabilities, ratio of liabilities to effective net worth, minimum interest coverage ratio and positive net income, to refrain from capital expenditures in excess of certain amounts and to limit the issuance of dividends. As of August 28, 1999, the Company was not in compliance with certain financial covenants, but has received a waiver from the respective banks. As of August 28, 1999, the Company had approximately $67.5 million in outstanding borrowings under the credit facility. Net cash used in operating activities for the fiscal year ended August 28, 1999 was $5.4 million and net cash provided by operating activities for the fiscal year ended August 29, 1998 was $46.8 million. The decrease in net cash provided by operations resulted from increases in inventory commensurate with the Company's sales growth, the introduction of new products and inventory for the Company's new distribution center, offset in part by an increase in accounts payable. Net cash used in investing activities for the fiscal years ended August 28, 1999 and August 29, 1998 was $48.3 million and $51.9 million, respectively. The net usage of cash in fiscal 1999 was primarily attributable to cash paid for construction at the Company's new headquarters, expenditures related to the construction of a new distribution center and cash paid for acquisitions. The net usage of cash in fiscal 1998 was primarily attributable to cash paid for acquisitions and to the purchase of a building in Long Island, New York, which began serving as the new corporate headquarters in fiscal 1999. Net cash provided by financing activities during the fiscal years ended August 28, 1999 and August 29, 1998 was $47.7 million and $0.4 million, respectively. The increase of approximately $47.3 million is primarily attributable to proceeds received from notes payable, offset in part by the purchase in the open market of approximately 966,000 shares of Class A common stock. During fiscal 1999, we repurchased approximately 966,000 shares of MSC's Class A common stock at an average price of $19.41 per share for an aggregate purchase price of approximately $18.8 million. All shares of Class A common stock acquired are being retained in MSC's treasury and reserved for issuance upon the exercise of options granted under MSC's 1995 Stock Option Plan and 1998 Stock Option Plan. Year 2000 Compliance Plan Year 2000 Problem. The Year 2000 problem arises from the historic use of only two digits (rather than four) for the designation of a year in date information within computer programs. If not corrected, any of our equipment or software programs that perform time sensitive calculations may incorrectly identify the year `00' as 1900 instead of 2000, or not recognize it at all. This could result in miscalculations or a major failure of certain systems. We may also be vulnerable to the Year 2000 problems of our customers, suppliers and service vendors and of other companies with which we conduct business (e.g., utility companies, shippers and telecommunications companies). State of Readiness. During calendar years 1997 and 1998, we developed and began to implement a Year 2000 compliance plan using internal and external resources in an effort to ensure that our business is not interrupted by the Year 2000 problem. MSC's Year 2000 compliance plan is broken into four components: 1. Renovating internal systems and applications. Our internal systems and applications include Order Entry, Purchasing and Warehouse Management. The applications used in the Order Entry system have been re-written and were phased into MSC's call center and branch locations. This process was completed by May 1999. The applications for the Purchasing and Warehouse Management systems have been modified and our Year 2000 compliance work was completed in August 1999. Many of our applications are already Year 2000 compliant as they were written using a compliant code generator. 2. Ensuring compliance of peripheral third party systems. We use a number of third party package systems to supplement our internally developed programs. Major systems in this area are our Financial and Inventory Replenishment systems. Our Financial systems have been replaced with a new package and are running on this software. The Inventory Replenishment system has been tested 17 and appears to be Year 2000 compliant. All of our material hardware, including our AS/400 computers, telephone systems, networks, PCs, security systems and time clocks at all MSC locations have been tested as Year 2000 compliant. 3. Ensuring Year 2000 compliance by external companies that conduct business with MSC. We have contacted all of our major customers, suppliers and vendors to inquire about Year 2000 compliance. We have not received responses from all those contacted, but those who have responded do not indicate any problems at this time. In addition, we have conducted tests to determine whether those business partners with which we currently conduct business electronically are year 2000 compliant. Our tests reveal no problems at this time. 4. Implementing standards and conducting testing in an effort to ensure that MSC's existing and future systems are Year 2000 compliant. All new systems, whether hardware or software, are tested before implementation in an effort to ensure Year 2000 compliance. Cost of Compliance. We believe that the total cost of our Year 2000 compliance plan will be $1.1 million not including the replacement of the Financial system. These costs are expensed as incurred and, to date, we have incurred approximately $1.0 million of such expenses. The Financial systems replacement is a separate project which is estimated to cost approximately $6.0 million and will be capitalized. Risks. Although we believe we will have our own systems compliant prior to January 1, 2000, there can be no assurance that we will be able to do so nor can there be any assurance that, even if we complete timely our Year 2000 compliance plan, the systems, when actually implemented in full, will work properly independently or in conjunction with the systems of any business partner. In addition, we would continue to bear the risk of a material adverse affect if any of our business partners does not appropriately address its own Year 2000 compliance issues. Although we believe that our major customers are Year 2000 compliant, we are still in the process of reviewing the compliance programs of suppliers and service vendors. Our current estimates of the impact of the Year 2000 problem on our operations and financial results do not include costs and time that may be incurred as a result of other companies' failure to become Year 2000 compliant on a timely basis, which costs could be material. There can be no assurance that such other companies will achieve Year 2000 compliance or that any conversions by such companies to become Year 2000 compliant will be compatible with our computer systems. The inability of MSC or any of our principal suppliers, service vendors or customers to become Year 2000 compliant in a timely manner could have a material adverse effect on our financial condition or results of operation. Contingency Plans. We have arranged for alternative methods of placing purchase orders and for the stockpiling of certain inventory items in the event that our suppliers are not Year 2000 compliant. We do not have any other contingency plans with respect to other problems that could arise in our business as a result of the Year 2000 problem. Any of these could have a material adverse effect on our financial condition or results of operation. Item 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company's principal financial instrument is long-term notes payable under an unsecured 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 net income and cash flows. The Company has an $80.0 million revolving credit line of which approximately $67.5 million was outstanding at August 28, 1999. The agreement bears interest at the bank's base rate (8.25% at August 28, 1999), or, alternatively, at the bankers acceptance rate or LIBOR rate plus margins, which vary from 0.45% to 0.75% per annum based on the ratio of total liabilities to effective net worth, or bid note rate. 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 utilize derivative financial instruments to hedge against changes in interest rates or for any other purpose. 18 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE ---- Report of Independent Public Accountants 20 Consolidated Balance Sheets as of August 28, 1999 and August 29, 1998 21 Consolidated Statements of Income for the three fiscal years ended August 28, 1999 22 Consolidated Statements of Shareholders' Equity for the three fiscal years ended August 28, 1999 23 Consolidated Statements of Cash Flows for the three fiscal years ended August 28, 1999 24 Notes to Consolidated Financial Statements 25 19 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 28, 1999 and August 29, 1998, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three fiscal years in the period ended August 28, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of MSC Industrial Direct Co., Inc. and Subsidiaries as of August 28, 1999 and August 29, 1998, and the results of their operations and their cash flows for each of the three fiscal years in the period ended August 28, 1999 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Melville, New York October 29, 1999 20 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
August 28, August 29, ASSETS 1999 1998 --------- --------- Current Assets: Cash and cash equivalents $ 2,725 $ 8,630 Accounts receivable, net of allowance for doubtful accounts of $5,799 and $3,717, respectively 90,007 72,940 Inventories 225,542 158,050 Prepaid expenses and other current assets 4,390 3,524 Current deferred income taxes 5,379 11,251 --------- --------- Total current assets 328,043 254,395 --------- --------- Property, Plant and Equipment, net 106,750 77,493 --------- --------- Other Assets: Goodwill 67,080 58,574 Other 12,511 11,240 --------- --------- 79,591 69,814 --------- --------- $ 514,384 $ 401,702 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 23,510 $ 14,670 Accrued liabilities 56,979 55,175 Current portion of long-term notes payable 306 800 --------- --------- Total current liabilities 80,795 70,645 Long-term notes payable 69,468 2,430 Other 43 46 Deferred income tax liabilities 8,451 6,802 --------- --------- Total liabilities 158,757 79,923 --------- --------- Commitments and Contingencies (Note 11) Shareholders' Equity: Preferred stock; $0.001 par value; 5,000,000 shares authorized; none outstanding -- -- Class A common stock; $0.001 par value; 100,000,000 shares authorized; 33,902,048 and 33,683,407 shares issued, 32,761,048 and 33,508,419 shares outstanding, respectively 34 33 Class B common stock; $0.001 par value; 50,000,000 shares authorized; 34,138,778 and 34,142,028 shares, respectively, issued and outstanding 34 34 Additional paid-in capital 216,977 213,783 Retained earnings 161,687 112,834 Treasury stock, at cost, 1,141,000 and 174,988 shares, respectively (22,452) (3,699) Deferred stock compensation (653) (1,206) --------- --------- Total shareholders' equity 355,627 321,779 --------- --------- $ 514,384 $ 401,702 ========= =========
The accompanying notes are an integral part of these consolidated balance sheets. 21 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except net income per share data)
For The Fiscal Years Ended ------------------------------------------------- August 28, August 29, August 30, 1999 1998 1997 --------- --------- --------- Net sales $ 651,503 $ 583,043 $ 438,003 Cost of goods sold 389,774 344,969 258,748 --------- --------- --------- Gross profit 261,729 238,074 179,255 Operating expenses 179,958 161,899 120,498 --------- --------- --------- Income from operations 81,771 76,175 58,757 --------- --------- --------- Other income (expense): Interest expense (1,576) (52) (490) Interest income 62 1,126 723 Other income, net 493 990 545 --------- --------- --------- (1,021) 2,064 778 --------- --------- --------- Income before provision for income taxes 80,750 78,239 59,535 Provision for income taxes 31,897 30,904 23,518 --------- --------- --------- Net income $ 48,853 $ 47,335 $ 36,017 ========= ========= ========= Per share information (Note 3): Net income per share: Basic $ .73 $ .70 $ .53 ========= ========= ========= Diluted $ .72 $ .69 $ .53 ========= ========= ========= Shares used in computing net income per share: Basic 67,056 67,756 67,381 ========= ========= ========= Diluted 68,317 68,964 68,218 ========= ========= =========
The accompanying notes are an integral part of these consolidated statements. 22 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE THREE FISCAL YEARS ENDED AUGUST 28, 1999 (In thousands)
Class A Class B Common Stock Common Stock Additional ------------ ------------ Paid-In Retained Shares Amount Shares Amount Capital Earnings --------- --------- --------- --------- --------- --------- BALANCE, August 31, 1996 16,622 $ 16 46,950 $ 47 $ 145,597 $ 29,482 Secondary public offering of common stock, net of costs of offering of $3,304 (Note 9) 4,000 4 -- -- 64,442 -- Exchange of Class B Common Stock for Class A Common Stock 12,586 13 (12,586) (13) -- -- Purchase of treasury stock -- -- -- -- -- -- Cancellation of restricted common stock (24) -- -- -- (228) -- Amortization of deferred stock compensation -- -- -- -- -- -- Exercise of common stock options, including income tax benefits of $380 148 -- -- -- 1,860 -- Net income -- -- -- -- -- 36,017 --------- --------- --------- --------- --------- --------- BALANCE, August 30, 1997 33,332 33 34,364 34 211,671 65,499 Exchange of Class B Common Stock for Class A Common Stock (Note 9) 222 -- (222) -- -- -- Purchase of treasury stock -- -- -- -- -- -- Cancellation of restricted common stock (6) -- -- -- (57) -- Amortization of deferred stock compensation -- -- -- -- -- -- Exercise of common stock options, including income tax benefits of $648 135 -- -- -- 2,169 -- Net income -- -- -- -- -- 47,335 --------- --------- --------- --------- --------- --------- BALANCE, August 29, 1998 33,683 33 34,142 34 213,783 112,834 Exchange of Class B Common Stock for Class A Common Stock 3 1 (3) -- -- -- Purchase of treasury stock -- -- -- -- -- -- Cancellation of restricted common stock (14) -- -- -- (133) -- Amortization of deferred stock compensation -- -- -- -- -- -- Exercise of common stock options, including income tax benefits of $856 230 -- -- -- 3,327 -- Net income -- -- -- -- -- 48,853 --------- --------- --------- --------- --------- --------- BALANCE, August 28, 1999 33,902 $ 34 34,139 $ 34 $ 216,977 $ 161,687 ========= ========= ========= ========= ========= ========= Treasury Stock -------------- Deferred Amount Stock Shares at cost Compensation Total --------- --------- --------- --------- BALANCE, August 31, 1996 -- $ -- $ (2,571) $ 172,571 Secondary public offering of common stock, net of costs of offering of $3,304 (Note 9) -- -- -- 64,446 Exchange of Class B Common Stock for Class A Common Stock -- -- -- -- Purchase of treasury stock 28 (499) -- (499) Cancellation of restricted common stock -- -- 228 -- Amortization of deferred stock compensation -- -- 600 600 Exercise of common stock options, including income tax benefits of $380 -- -- -- 1,860 Net income -- -- -- 36,017 --------- --------- --------- --------- BALANCE, August 30, 1997 28 (499) (1,743) 274,995 Exchange of Class B Common Stock for Class A Common Stock (Note 9) -- -- -- -- Purchase of treasury stock 147 (3,200) -- (3,200) Cancellation of restricted common stock -- -- 57 -- Amortization of deferred stock compensation -- -- 480 480 Exercise of common stock options, including income tax benefits of $648 -- -- -- 2,169 Net income -- -- -- 47,335 --------- --------- --------- --------- BALANCE, August 29, 1998 175 (3,699) (1,206) 321,779 Exchange of Class B Common Stock for Class A Common Stock -- -- -- 1 Purchase of treasury stock 966 (18,753) -- (18,753) Cancellation of restricted common stock -- -- 133 -- Amortization of deferred stock compensation -- -- 420 420 Exercise of common stock options, including income tax benefits of $856 -- -- -- 3,327 Net income -- -- -- 48,853 --------- --------- --------- --------- BALANCE, August 28, 1999 1,141 $ (22,452) $ (653) $ 355,627 ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated statements. 23 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
For The Fiscal Years Ended ------------------------------------------ August 28, August 29, August 30, 1999 1998 1997 -------- -------- -------- Cash flows from operating activities: Net income $ 48,853 $ 47,335 $ 36,017 -------- -------- -------- Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation and amortization 8,730 7,302 5,314 Amortization of deferred stock compensation 420 480 600 (Gain) loss on disposal of property, plant and equipment (17) (19) 218 Provision for doubtful accounts 1,933 1,523 1,127 Deferred income taxes 7,521 1,442 2,221 Changes in operating assets and liabilities, net of effect from acquisitions: Accounts receivable (15,512) (11,148) (9,410) Inventories (64,011) 9,203 5,977 Prepaid expenses and other current assets (871) (150) (172) Prepaid federal income tax payments -- -- 4,512 Other assets (1,270) (4,279) (1,298) Accounts payable and accrued liabilities 8,875 (4,842) 673 Other (3) (92) (2) -------- -------- -------- Total adjustments (54,205) (580) 9,760 -------- -------- -------- Net cash (used in) provided by operating activities (5,352) 46,755 45,777 -------- -------- -------- Cash flows from investing activities: Purchases of property, plant and equipment (35,481) (32,456) (13,528) Proceeds from sale of property, plant and equipment 17 19 34 Cash paid for acquisitions, net of cash acquired (12,834) (19,459) (33,928) -------- -------- -------- Net cash used in investing activities (48,298) (51,896) (47,422) -------- -------- -------- Cash flows from financing activities: Net proceeds from public offerings of common stock -- -- 64,446 Purchase of treasury stock (21,431) (389) (499) Net proceeds from exercise of common stock options 2,471 1,521 1,480 Net proceeds from (repayments of) notes payable 66,544 (885) (52,330) Repayments from affiliates 161 106 287 -------- -------- -------- Net cash provided by financing activities 47,745 353 13,384 -------- -------- -------- Net (decrease) increase in cash and cash equivalents (5,905) (4,788) 11,739 Cash and cash equivalents, beginning of year 8,630 13,418 1,679 -------- -------- -------- Cash and cash equivalents, end of year $ 2,725 $ 8,630 $ 13,418 ======== ======== ======== Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 2,614 $ 110 $ 443 ======== ======== ======== Income taxes $ 21,436 $ 31,279 $ 20,669 ======== ======== ========
The accompanying notes are an integral part of these consolidated statements. 24 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 100 local MSC branches in 37 states, as well as certain other locations related to acquired entities, concentrated in the Eastern and Southern United States, and regional distribution centers in Harrisburg, Pennsylvania; Elkhart, Indiana and Atlanta, Georgia. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Principles of Consolidation The accompanying consolidated financial statements include the accounts of MSC Industrial Direct Co., Inc. and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. Fiscal Year The Company's fiscal year ends on the Saturday closest to August 31. The financial statements for fiscal 1999, 1998 and 1997 all contain activity for fifty two weeks. Cash and Cash Equivalents Cash and cash equivalents consist of cash in banks, as well as certain highly liquid investments with original maturities of three months or less. Concentration of Credit Risk The Company's mix of receivables is diverse, with approximately 193,000 active customer accounts. The Company sells its products directly to end users and, in some cases, to other wholesalers and distributors in its market areas. Inventory Valuation Inventories consist of merchandise held for resale and are stated at the lower of average cost or market. Property, Plant and Equipment Depreciation and amortization of property, plant and equipment are computed for financial reporting purposes on both the straight-line and accelerated methods based on the estimated useful lives of the assets. Property, plant and equipment are stated at cost. Expenditures for maintenance and repairs are charged to expense as incurred; costs of major renewals and improvements are capitalized. At the time property and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are eliminated from the asset and accumulated depreciation accounts and the profit or loss on such disposition is reflected in income. 25 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) The Company 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 is capitalized as part of the cost of the related buildings during the period prior to which such facilities are available and ready for use. Goodwill Goodwill shown in the consolidated balance sheets at August 28, 1999 and August 29, 1998 relates to multiple acquisitions completed during the last four fiscal years (Note 4). Goodwill is being amortized on a straight-line basis over 40-year periods. Accumulated amortization was $3,560 and $1,852 as of August 28, 1999 and August 29, 1998, 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. Management believes that there is no impairment to goodwill as of August 28, 1999. 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" ($10,413 and $9,511 at August 28, 1999 and August 29, 1998, respectively). These costs are charged to expense over the period that the catalogs remain the most current source of sales, which period is typically one year or less. The costs associated with brochures and catalog supplements are charged to expense as incurred. Sales Returns The Company reports its sales levels on a net sales basis, with net sales being computed by deducting from gross sales the amount of actual sales returns and the amount of reserves established for anticipated sales returns. Reclassifications Certain prior year balances have been reclassified to conform with current year presentation. 26 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 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. Affiliates The Company is affiliated with MSC International Korea, Inc. and various real estate entities (together, the "affiliates"). The affiliates are owned primarily by the Company's principal shareholders. In connection with the IPO during fiscal 1996, the Company acquired two affiliated companies, Primeline International, Inc. and Kaja Productions, Inc. See Note 11 for discussion of certain related party transactions. 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 28, 1999, the carrying value of all financial instruments approximated fair value. Recently Issued Accounting Pronouncements 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 ended 1999, 1998 and 1997, the Company's operations did not give rise to items includable in comprehensive income which were not already included in net income. Therefore, the Company's comprehensive income is the same as its net income for all periods presented. 27 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) Segment Reporting In fiscal 1999 the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." Pursuant to this pronouncement, the reportable operating segments are determined based on the Company's management approach. The management approach, as defined by SFAS No. 131, is based on the way that the chief operating decision maker organizes the segments within an enterprise for making operating decisions and assessing performance. The Company's results of operations are reviewed by the chief operating decision maker on a consolidated basis and the Company operates in only one segment. 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 use of derivative instruments. 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 28, 1999, August 29, 1998 and August 30, 1997, respectively:
Net Income Shares Net Income Per Share ----------------------------- ---------------------------- ------------------------- 1999 1998 1997 1999 1998 1997 1999 1998 1997 ------- ------- ------- ------ ------ ------ ------ ------ ------ Basic EPS Net income $48,853 $47,335 $36,017 67,056 67,756 67,381 $ .73 $ .70 $ .53 Effect of dilutive employee stock options -- -- -- 1,261 1,208 837 (.01) (.01) -- ------- ------- ------- ------ ------ ------ ------ ------ ------ Diluted EPS Net income $48,853 $47,335 $36,017 68,317 68,964 68,218 $ .72 $ .69 $ .53 ======= ======= ======= ====== ====== ====== ====== ====== ======
28 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) 4. ACQUISITION OF BUSINESSES: During fiscal 1999 and 1998, the Company acquired the following businesses: Business Acquired Date Acquired ----------------- ------------- Fiscal 1999 Industrial Specialty Company, Inc. October 1, 1998 Direct Line, Inc. January 1, 1999 Corbin Corporation February 1, 1999 Fiscal 1998 Holloway Bros. Tools, Inc. March 24, 1998 RMG Corporation April 10, 1998 Drake - Atwood Tool & Supply Company, Inc. April 30, 1998 The acquisitions described above were accounted for as purchases and were valued based on management's estimate of the fair value of the assets acquired and liabilities assumed with respect to each acquisition at the dates of acquisition. These estimates of fair value are preliminary and subject to adjustment for a period of up to one year from the date of the respective acquisition, and any such adjustments are not expected to be material. Costs in excess of net assets acquired of $70,640 and $60,426 were allocated to goodwill at August 28, 1999 and August 29, 1998, respectively, net of applicable amortization. Summarized below are the unaudited pro forma results of operations as though each of these acquisitions had occurred at the beginning of fiscal 1998. Pro forma adjustments have been made for pro forma income taxes and amortization of goodwill related to these transactions. 1999 1998 --------- --------- Pro Forma: Net sales $ 672,955 $ 639,661 ========= ========= Net income $ 49,195 $ 48,243 ========= ========= Net income per share: Basic $ .73 $ .71 ========= ========= Diluted $ .72 $ .70 ========= ========= 29 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) 5. PROPERTY, PLANT AND EQUIPMENT: The following is a summary of property, plant and equipment and the estimated useful lives used in the computation of depreciation and amortization:
Number of Years August 28, 1999 August 29, 1998 --------------- --------------- --------------- Land -- $ 11,429 $ 11,515 Construction-in-progress (a) -- -- 5,338 Building 40 35,788 26,772 Building and leasehold improvements The lesser of the life of the lease or 31.5 19,409 2,878 Furniture, fixtures and equipment 3-10 52,264 41,222 Automobiles 5 863 1,051 Computer systems 3-5 16,697 11,589 ----------- ----------- 136,450 100,365 Less: Accumulated depreciation and amortization 29,700 22,872 ----------- ----------- $ 106,750 $ 77,493 =========== ===========
The amount of capitalized interest, net of accumulated amortization, included in property, plant and equipment is $1,534 and $931 at August 28, 1999 and August 29, 1998, respectively. (a) In October 1997, the Company executed an agreement for the purchase of a building in Long Island, New York, which is serving as the new Corporate headquarters. The Company relocated to this new facility during the first quarter of fiscal 1999. 6. INCOME TAXES: The provision for income taxes is comprised of the following:
For the Fiscal Years Ended ------------------------------------------------------------ August 28, 1999 August 29, 1998 August 30, 1997 --------------- --------------- --------------- Current: Federal $ 20,116 $ 23,994 $ 17,575 State and local 4,260 5,081 3,722 ------------ ------------ ------------ 24,376 29,075 21,297 ------------ ------------ ------------ Deferred: Federal 6,204 1,510 1,833 State and local 1,317 319 388 ------------ ------------ ------------ 7,521 1,829 2,221 ------------ ------------ ------------ Total $ 31,897 $ 30,904 $ 23,518 ============ ============ ============
30 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) Significant components of deferred tax assets and liabilities are as follows:
August 28, 1999 August 29, 1998 --------------- --------------- Current and non-current deferred tax liabilities: Depreciation $ (8,516) $ (4,655) Prepaid advertising (4,327) (3,757) Goodwill (248) (126) -------- -------- (13,091) (8,538) -------- -------- Current and non-current deferred tax assets: Accounts receivable 1,662 974 Inventory 1,804 6,087 Deferred compensation 4,393 2,955 Other 2,160 2,971 -------- -------- 10,019 12,987 -------- -------- Net Deferred Tax (Liabilities) Assets $ (3,072) $ 4,449 ======== ========
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 28, 1999 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:
For the Fiscal Years Ended --------------------------------------------------------- August 28, 1999 August 29, 1998 August 30, 1997 --------------- --------------- --------------- U.S. Federal statutory rate 35.0% 35.0% 35.0% State income taxes, net of Federal benefit 4.5 4.5 4.5 ---- ---- ---- Effective income tax rate 39.5% 39.5% 39.5% ==== ==== ====
7. ACCRUED LIABILITIES: Accrued liabilities consist of the following:
August 28, 1999 August 29, 1998 --------------- --------------- Accrued purchases $ 14,964 $ 7,051 Accrued payroll and bonus 16,489 17,354 Accrued fringe benefits 4,784 4,205 Accrued restructuring and relocation charges 4,913 12,527 Accrued catalog 3,708 3,374 Accrued other 12,121 10,664 ----------- ----------- Total accrued liabilities $ 56,979 $ 55,175 =========== ===========
31 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) 8. LONG-TERM NOTES PAYABLE: Long-term notes payable consist of the following:
August 28,1999 August 29, 1998 -------------- --------------- Revolving credit agreement (a) $ 67,450 $ -- Term notes payable (b) 2,324 3,230 ----------- ----------- 69,774 3,230 Less: Current portion 306 800 ----------- ----------- $ 69,468 $ 2,430 =========== ===========
Maturities of notes payable are as follows: Fiscal Year 2000 $ 306 2001 67,693 2002 239 2003 236 2004 162 Thereafter 1,138 ----------- $ 69,774 (a) As of August 28, 1999, the Company had an unsecured revolving credit agreement with a bank, as agent for a group of banks, which provides for maximum borrowings of $80,000 expiring on May 31, 2001. During the term of the agreement, the Company can borrow at the bank's base rate (8.25% at August 28, 1999), bankers acceptance ("BA") rate or LIBOR rate plus margins, which vary from 0.45% to 0.75% per annum based on the ratio of total liabilities to effective net worth, or bid note rate. A facility fee of one-eighth of one percent (0.125%) per annum is payable on the unused portion of the credit. The agreement contains certain covenants including, but not limited to, restrictions related to indebtedness, net worth, capital expenditures and the payment of dividends. As of August 28, 1999, the Company was not in compliance with all covenants and accordingly received a waiver from the respective banks. (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. 9. CAPITAL STOCK TRANSACTIONS: Common Stock Offerings In September 1996, the Company completed a common stock offering of 13,000 shares of Class A Common Stock, of which 4,000 shares were sold by the Company and 9,000 shares were converted from Class B to Class A Common Stock and sold by existing shareholders. This offering generated net proceeds to the Company of approximately $64,446, which were used primarily to repay certain debt and to finance acquisitions. The supplemental effect of the repayment of debt was not material to the Company's fiscal 1997 results of operations. 32 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) In July 1997, the Company completed a secondary offering of 3,566 shares of Class A Common Stock, of which 116 shares were sold by existing shareholders from Class A Common Stock already held by those shareholders and 3,450 shares were converted from Class B to Class A Common Stock and sold by existing shareholders. The Company did not receive any of the proceeds from this offering. Stock Split On April 6, 1998, the Company's Board of Directors authorized a two-for-one stock split, effected in the form of a 100% stock dividend, that was distributed on May 22, 1998 to shareholders of record on April 24, 1998. All share and per share data included in the accompanying financial statements have been restated to reflect this stock split for all periods presented. Treasury Stock Purchases During fiscal 1999 and 1998, the Company repurchased 966 and 147 shares of its Class A Common Stock for $18,753 and $3,200, respectively, which is reflected at cost as treasury stock in the accompanying consolidated financial statements. 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. As of August 28, 1999, the Company had repurchased 1,141 shares for an aggregate cash purchase price of $22,452 (including the 966 shares of treasury stock described above). 10. EMPLOYEE BENEFIT PLANS: Savings Plan The Company maintains a defined contribution plan with both a profit sharing feature and a 401(k) feature which covers all employees who have completed at least one month of service with the Company. For fiscal 1999, 1998 and 1997, the Company contributed $497, $1,172 and $1,233, 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 6,000 shares of Class A common stock may be granted. Options may be granted to key employees, directors and consultants over terms not to exceed ten years and they generally vest ratably over 5 years. Vesting requirements other than the aforementioned are set forth by the Board of Directors when the award is granted. 33 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) A summary of the status of the Company's stock option plan at August 28, 1999, August 29, 1998 and August 30, 1997 and changes during the years then ended is presented in the table and narrative below:
1999 1998 1997 ------------------- --------------------- ---------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------ ----- ------ ----- ------ ----- Outstanding - beginning of year 3,030 $15.20 2,178 $12.25 1,512 $10.18 Granted 3,043 14.28 1,149 19.41 852 15.45 Exercised (197) 10.76 (135) 11.26 (148) 10.15 Cancelled/forfeited (59) 15.67 (162) 13.86 (38) 9.97 -------- -------- -------- Outstanding - end of year 5,817 14.69 3,030 15.20 2,178 12.25 ======== ======== ======== Exercisable - end of year 1,143 13.68 588 12.34 186 10.77 ======== ======== ======== Weighted average fair value of options granted $ 14.28 $ 19.70 $ 16.39 ======== ======== ========
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: 1999 1998 1997 ---- ---- ---- Expected life (years) 7.5 7.5 7.5 Risk-free interest rate 4.7% 4.4% 6.86% Volatility 53.1% 38.0% 35.0% Dividend yield 0.0% 0.0% 0.0% The following table summarizes information about stock options outstanding at August 28, 1999:
Number of Options Weighted Average Weighted Number of Options Weighted Outstanding at Remaining Average Exercisable at Average Range of Exercise Prices August 28, 1999 Contractual Life Exercise Price August 28, 1999 Exercise Price - ------------------------ --------------- ---------------- -------------- --------------- -------------- $ 9.50 - $ 14.25 3,848 8.4 $ 13.07 560 $ 9.83 14.26 - 21.39 1,919 8.0 17.62 574 17.23 21.40 - 28.06 50 8.7 26.59 9 26.92 ----- --- ------- ----- ------- 5,817 8.2 $ 14.69 1,143 $ 13.68 ===== === ======= ===== =======
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:
1999 1998 1997 ---- ---- ---- Net income: As reported $ 48,853 $ 47,335 $ 36,017 Pro forma 38,439 41,924 33,805 Net income per share - basic As reported $ .73 $ .70 $ .53 Pro forma .57 .62 .50 Net income per share - diluted As reported $ .72 $ .69 $ .53 Pro forma .56 .61 .50
34 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) 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 employees. Employees vest in their ownership of these shares at the end of five years, prior to which such shares are forfeited upon the departure of the employees. The value of these shares at the grant date ($2,981) is included as a separate component of shareholders' equity, and the related compensation charge is being recorded ratably over the five year vesting period. During fiscal 1999, 33 shares vested and 14 additional shares were cancelled or forfeited. At August 28, 1999, 115 and 58 restricted shares were outstanding and exercisable, respectively. 11. 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 2005. At August 28, 1999, approximate minimum annual rentals on such leases are as follows: Total (Including Related Party Related Party Fiscal Year Commitments) Commitments ----------- ------------ ----------- 2000 $ 3,882 $ 1,446 2001 3,216 1,399 2002 2,301 1,391 2003 1,965 1,354 2004 1,632 1,265 Thereafter 7,387 7,220 Total rental expense (exclusive of real estate taxes, insurance and other operating costs) for all operating leases for fiscal 1999, 1998 and 1997 was approximately $4,616, $4,795 and $4,672, respectively, including approximately $1,554, $1,702 and $2,053, respectively, paid to affiliates. In the opinion of the Company's management, the leases with affiliates are on terms, which approximate fair market value. 35 MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share, estimated lives and customer amounts) (CONTINUED) Self-Insurance The Company has a self-insured group health insurance plan. The Company is responsible for all covered claims to a maximum liability of $200 per participant during a September 1 plan year. Benefits paid in excess of $200 are reimbursed to the plan under the Company's individual stop loss policy. Group health insurance expense for fiscal 1999, 1998 and 1997 was approximately $9,881, $7,003 and $5,200, respectively. Employment Agreements The Company has entered into employment and consulting agreements with various of the Company's officers and with the selling shareholders of acquired businesses (Note 4). The future minimum commitments under these agreements are as follows: Number of Aggregate Fiscal Year Individuals Annual Amount ----------- ----------- ------------- 2000 24 $1,875 2001 7 1,147 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. 36 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 37 PART III. Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information called for by Item 10 is set forth under the heading "Election of Directors" in the Company's Proxy Statement for the annual meeting of stockholders to be held in January 2000 (the "1999 Proxy Statement"), which is incorporated herein by this reference. Item 11. EXECUTIVE COMPENSATION. Information called for by Item 11 is set forth under the heading "Executive Compensation" in the 1999 Proxy Statement, which is incorporated herein by this reference. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information called for by Item 12 is set forth under the heading "Security Ownership of Certain Beneficial Owners and Management" in the 1999 Proxy Statement, which is incorporated herein by this reference. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information called for by Item 13 is set forth under the heading "Certain Relationships and Related Transactions" in the 1999 Proxy Statement, which is incorporated herein by this reference. 38 PART IV. Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. The Company did not file any reports on Form 8-K during the fourth quarter of the fiscal year ended August 28, 1999. 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 Description No. ------ *3.01 Certificate of Incorporation of Registrant. *3.02 By-laws of Registrant. *4.01 Specimen Class A Common Stock Certificate. *10.01 Registrant's 1995 Stock Option Plan. 10.02 Registrant's 1998 Stock Option Plan (incorporated by reference to Exhibit A to the Registrant's Proxy Statement for the Annual Meeting of Shareholders held on January 1, 1998, filed with the Commission on December 5, 1997). *10.03 Employment Agreement, dated as of January 2, 1994, between Registrant and Sidney Jacobson, as amended on October 31, 1995. *10.04 Employment Agreement, dated as of August 1, 1994, between Registrant and Mitchell Jacobson. *10.05 Amended and Restated Credit Agreement, dated as of April 27, 1995, between the Registrant and the banks named therein, as amended as of August 25, 1995. 10.06 Severance and Release Agreement, dated as of March 1, 1999, between Registrant and Steven Tudor. 10.07 Agreement, dated as of January 8, 1999, between the Registrant and David Sandler. 10.08 Agreement, dated as of January 8, 1999, between the Registrant and James Schroeder. 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 28, 1999 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. 39 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 8, 1999 By: /s/ Mitchell Jacobson ----------------------------- Mitchell Jacobson Chairman, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ Mitchell Jacobson Chairman of the Board of Directors, President, November 8, 1999 - ----------------------------- Chief Executive Officer and Director Mitchell Jacobson /s/ Sidney Jacobson Vice-Chairman of the Board of Directors November 8, 1999 - ----------------------------- Sidney Jacobson /s/ Shelley Boxer Vice President, Chief Financial Officer and November 8, 1999 - ----------------------------- Director (Principal Accounting Officer) Shelley Boxer /s/ David Sandler Executive Vice President and Director November 8, 1999 - ----------------------------- David Sandler /s/ James Schroeder Senior Vice President-Logistics and Director November 8, 1999 - ----------------------------- James Schroeder /s/ Denis Kelly Director November 8, 1999 - ----------------------------- Denis Kelly /s/ Raymond Langton Director November 8, 1999 - ----------------------------- Raymond Langton /s/ Roger Fradin Director November 8, 1999 - ----------------------------- Roger Fradin
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE II To MSC Industrial Direct Co., Inc.: We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of MSC Industrial Direct Co., Inc. and Subsidiaries included in this Form 10-K and have issued our report thereon dated October 29, 1999. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. This Schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. Arthur Andersen LLP Melville, New York October 29, 1999 S-1 SCHEDULE II MSC INDUSTRIAL DIRECT CO., INC. AND SUBSIDIARIES SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS (in thousands)
Balance at Charged to Charged to Beginning Costs and Other Balance at of Year Expenses Accounts Deductions End of Year ------- -------- -------- ---------- ----------- For the fiscal year ended August 30, 1997 Allowance for doubtful accounts $1,319 $1,127 $542 (a) $958 $2,030 ====== ====== ====== ====== ====== For the fiscal year ended August 29, 1998 Allowance for doubtful accounts $2,030 $1,523 $926 (a) $762 $3,717 ====== ====== ====== ====== ====== For the Fiscal year ended August 28, 1999 Allowance for doubtful accounts $3,717 $1,933 $1,332 (a) $1,183 $5,799 ====== ====== ====== ====== ======
(a) Comprised of valuation accounts of acquired entities S-2 EX-10.6 2 SEVERANCE AND RELEASE AGREEMENT Exhibit 10.06 CONFIDENTIAL EXECUTION COPY SEVERANCE AND RELEASE AGREEMENT This Severance and Release Agreement (this "Agreement") is entered into by and between STEVE TUDOR ("Tudor") and MSC INDUSTRIAL DIRECT CO., INC. on behalf of itself and all of its subsidiaries, divisions, affiliates, successors and assigns (hereinafter collectively referred to as the "Company"). RECITALS WHEREAS, Tudor and the Company wish to terminate his employment by the Company on the terms and conditions set forth herein. NOW, THEREFORE, in consideration of the promises, releases, covenants and agreements contained herein and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged by the parties hereto, it is hereby agreed as follows: 1. Tudor hereby resigns his employment with the Company, effective as of March 1, 1999 (the "Effective Date"). Tudor further agrees that subsequent to the Effective Date he shall not represent or hold himself out as an officer or employee of the Company. 2. (a) From and after the Effective Date and until May 30, 1999, the Company agrees to pay to Tudor severance in accordance with the Company's customary payroll policy at the rate of $262,500 per annum, less applicable withholding (as required by Federal and New York State law) for income and other taxes (the "Severance Payment"). Nothing herein shall obligate Tudor to seek employment with another entity. (b) From and after the Effective Date, the Company agrees to continue to provide to Tudor, until the earlier to occur of (i) August 31, 1999 or (ii) the participation by Tudor in any other medical insurance plan, the medical and dental and hospital insurance benefits available to him upon his making of an election under COBRA, the cost of which insurance benefits shall be borne by the Company. (c) The Company further agrees: (i) to pay to Tudor an automobile allowance of $800 per month from and after the Effective Date through August 31, 1999; (ii) to pay (or reimburse Tudor for ) the rental payments on his apartment in Huntington, New York during the period from and after the Effective Date through the rental termination date of May 30, 1999; and (iii) to pay the cost (but not in excess of $4,000) of relocating Tudor to Nashville, Tennessee in accordance with the Company's customary relocation policy as in effect on the date hereof. (d) The Company hereby retains Tudor as a consultant to the Company for a period of three (3) years and two (2) months commencing on the Effective Date and ending on April 30, 2002. Tudor shall not be required to devote more than 10 hours per calendar quarter to such services, which services may be rendered from such locations, as Tudor shall determine. In 2 consideration of such services, the Company agrees to pay Tudor, in accordance with the Company's customary payroll policy, consulting fees at the rate of $2,500 per annum. (e) Subject to the strict adherence by Tudor to each of the covenants made by him hereunder, Tudor shall retain options (i) to purchase 60,000 shares of the Company's Class A common stock, par value $.001 per share (the "Common Stock"), granted to him on April 5, 1996, of which options to purchase 36,000 shares of Common Stock have not vested, (ii) to purchase 20,000 shares of the Common Stock granted to him on April 28, 1997, of which options to purchase 16,000 shares of Common Stock have not vested, (iii) to purchase 30,000 shares of the Common Stock granted to him on November 19, 1997, of which options to purchase 24,000 shares of Common Stock have not vested, and (iv) to purchase 60,000 shares of the Common Stock granted to him on October 14, 1998, none of which options have vested. Tudor acknowledges that his consultant status with the Company shall be terminated upon the earlier to occur of (1) his breach of any covenant or obligation contained in this Agreement or (2) April 30, 2002, which termination shall constitute a forfeiture of all options not vested at the time of such termination. (f) To further induce the strict adherence by Tudor to each of the covenants made by him hereunder, including but not limited to the confidentiality covenant set forth in paragraph 7, the Inducement covenant set forth in paragraph 8 and the non-solicitation covenant set forth in paragraph 9, the Company agrees to pay to Tudor, for a period of five (5) years commencing on the Effective Date and terminating February 28, 2004, compensation at the rate of $88,550 per annum (the "Inducement Payments"). The Inducement Payments shall be payable monthly in arrears, commencing March 31, 1999, and the Company shall be entitled to offset against such Inducement Payments the amount due to the Company from Tudor arising out 3 of his indebtedness to the Company referred to in paragraph 2(g). Tudor acknowledges and agrees that the payment of such amounts to him shall constitute ordinary income in accordance with applicable tax law. (g) Tudor acknowledges and agrees that he is indebted to the Company as of January 1, 1999 in the amount of $487,000, which amount, together with additional accrued interest thereon of $4,058 through the Effective Date, is due and owing in full as of the Effective Date. In consideration of the payment by Tudor of $100,000 of such indebtedness on or prior to March 31, 1999, Tudor agrees to pay, and the Company agrees to accept payment, of the remaining balance of such indebtedness, together with interest thereon at the rate of 5% per annum, in 60 monthly installments of $7,379.75 commencing March 31, 1999 and ending February 28, 2004; provided, however, that if Tudor shall breach any of his covenants or obligations contained in this Agreement, the unpaid balance of such indebtedness shall be immediately due and payable. 3. As a material inducement to the Company to enter into this Agreement and for other good and valuable consideration, the receipt of which is hereby acknowledged by Tudor, Tudor hereby irrevocably, unconditionally and generally releases the Company and each of the Company's officers, directors, and employees, and the heirs, executors, administrators, receivers, successors and assigns of all of the foregoing (collectively, "Releasee"), from, and hereby waives and/or settles any and all, actions, causes of action, suits, debts, sums of money, agreements, promises, damages, or any liability, claims or demands, known or unknown and of any nature whatsoever (collectively, "Claims") which Tudor ever had, now has or hereafter can, shall or may have, for, upon, or by reason of any matter, cause or thing whatsoever from the beginning of the world to the date of this Agreement, arising directly or indirectly pursuant to or out of his 4 employment with the Company, the performance of services for the Company or any Releasee or the termination of such employment or services and, specifically, without limitation, any Claims (a) arising under or pursuant to any contract, express or implied, written or oral, (b) for wrongful dismissal or termination of employment or violation of any public policy, (c) arising under any federal, state, local or other statutes, orders, laws, ordinances, regulations or the like that relate to the employment relationship and/or that specifically prohibit discrimination or retaliation based upon age, race, religion, sex, national origin, disability, sexual orientation or any other unlawful bases, including, without limitation, the Age Discrimination in Employment Act of 1967, as amended, the Civil Rights Act of 1991, as amended, the Civil Rights Acts of 1866 and 1871, as amended, Title VII of the Civil Rights Act of 1964, as amended, the Americans with Disabilities Act of 1990, as amended, the Employee Retirement Income Security Act, as amended, the Executive Law of the State of New York, as amended, and any applicable rules and regulations promulgated pursuant to or concerning any of the foregoing statutes, (d) for tort, tortious or harassing conduct, infliction of mental distress, interference with contract, fraud, libel or slander, and (e) for damages, including, without limitation, punitive or compensatory damages or for attorneys' fees, expenses, costs, wages, injunctive or equitable relief. This paragraph shall not apply to any claim that Tudor may have for a breach of this Agreement. Nothing herein shall be deemed to be a waiver or release by Tudor of any indemnification rights which may be available to him under the Company's By-Laws or pursuant to the Business Corporation Law of the State of New York or pursuant to any director and/or officer insurance coverage maintained by the Company. 4. Tudor represents and warrants that he has not filed, commenced or participated in any way in any complaints, claims, actions or proceedings of any kind against any Releasee with 5 any federal, state or local court or any administrative, regulatory or arbitration agency or body, and he agrees not to file, assert or commence any complaint, claim, action or proceeding of any kind against any Releasee with any federal, state or local court or any administrative, regulatory or arbitration agency or body with respect to any matter from the beginning of the world to the date hereof. 5. Tudor hereby waives any right to, and agrees not to, seek reinstatement of employment or future employment with the Company or any Releasee. Tudor acknowledges and agrees that any monetary or other benefits which are, were or may have been claimed to be due to Tudor and which he may have earned or accrued, or to which he may have been entitled, have been paid or such payments have been released, waived or settled by Tudor pursuant to this Agreement. 6. (a) By executing this Agreement, Tudor acknowledges that (i) he has been advised by the Company to consult with an attorney before executing this Agreement and has consulted and been represented by John Schwalb, Esq. of the firm of Spicer, Flynn & Rudstrom, 424 Church Street, Suite 1350, Nashville, Tennessee, 37219, in connection herewith, (ii) he has been provided with at least a twenty-one (21) day period to review and consider whether to sign this Agreement and that by executing and delivering this Agreement to the Company, he is waiving any remaining portion of such twenty-one (21) day period, and (iii) he has been advised that he has seven (7) days following execution to revoke this Agreement (the "Revocation Period"). (b) This Agreement will not be effective or enforceable until the Revocation Period has expired. Such revocation shall only be effective if an originally executed written 6 notice thereof is delivered to the Company on or before 5:00 p.m. on the seventh day after execution of this Agreement. If so revoked, this Agreement shall be deemed to be void ab initio and of no further force and effect. 7. Tudor hereby acknowledges that during his employment he has or may have acquired proprietary, private and/or otherwise confidential information of or concerning the Company or any persons or entities with which the Company transacts or transacted business, including, without limitation, any non-public financial information concerning, or any information relating to, any aspect of the operation of the business of the Company ("Confidential Information"). Tudor hereby represents and agrees that (a) he has returned to the Company or destroyed, and has not retained any copies of, all documents, records or materials of any kind, whether written or electronically created or stored, which contain, relate to or refer to any Confidential Information ("Confidential Materials"), (b) he has not disclosed any Confidential Information or Confidential Materials to any person or entity outside the scope of his employment without the express written authorization of a senior executive officer of the Company, and (c) in consideration of the Company's entering into this Agreement, he shall not disclose any Confidential Information or Confidential Materials in any manner whatsoever, except as shall be required by law. 8. Tudor hereby agrees that until April 30, 2002, he shall not, directly or indirectly, engage or participate anywhere in the United States, North America, or the European Economic Community as an owner, partner, shareholder, member, employee, director, consultant or (without limitation by the specific enumeration of the foregoing) otherwise in or with any of the companies identified on Schedule 1 annexed hereto or in or with any affiliate of any of such 7 companies; provided, however, that nothing herein shall prevent the ownership by Tudor of not more than 1% of the outstanding common stock of any of the companies identified on Schedule 1. For the purposes hereof, an affiliate of any such companies shall mean any entity in which any of such companies owns, directly or indirectly, at least fifty percent (50%) of the ownership interests therein. In the event of any breach of this paragraph 8, the time period of the breached covenant shall be extended for the period of such breach. Tudor recognizes that the territorial, time and scope limitations set forth in this paragraph 8 are reasonable and are required for the protection of the Company, and in the event that any such territorial, time or scope limitation is deemed to be unreasonable by a court of competent jurisdiction, Tudor and the Company agree to the reduction of any of said territorial, time or scope limitations to such an area, period or scope as said court shall deem reasonable under the circumstances. Notwithstanding the covenants contained in this paragraph 8, such covenants shall not be construed to extend to or prevent Tudor from continuing any employment, directorship, membership, ownership, partnership, consulting or other arrangement with any company that is purchased, taken over or otherwise acquired, in whole or in part, after the Effective Date of this Agreement by any company identified on Schedule 1. 9. Tudor hereby agrees that until February 28, 2004, he shall not, directly or indirectly, whether for himself or on behalf of any other person (a) solicit or cause to be solicited or assist any person or entity to solicit for employment any persons who (i) are, at the time of solicitation of employment, employees of the Company or (ii) were, at any time during the one-year period prior to such solicitation, employees of the Company and (b) employ or cause to be employed, or engage as a partner, contractor, consultant or otherwise, any persons who (i) are, at 8 the time of such action, employees of the Company or (ii) were, at any time during the one-year period prior to such action, employees of the Company. 10. Tudor covenants and agrees that he shall, at all times, whether during or after the expiration of his consultant status, cooperate with and assist the Company in the defense of any and all legal proceedings arising from facts and circumstances of which he had knowledge while employed by the Company. The Company shall reimburse Tudor for any out-of-pocket expenses incurred by him in connection with such cooperation and assistance. 11. Tudor covenants and agrees that he shall, from time to time, make, execute and deliver, or cause to be made, executed and delivered, such assignments, deeds, bills of sale and other instruments, acts, consents and assurances as the Company or its counsel may request for the effectual consummation, confirmation and particularization of this Agreement. 12. The parties hereto agree to maintain the terms of this Agreement as confidential and neither party, nor any person or entity acting on such party's behalf, shall disclose such terms to any third party, except to such party's spouse, attorney, accountant or financial advisor or as may be required by law. Notwithstanding the confidential nature of this Agreement, Tudor may disclose the essential terms, excluding consideration, of the non-competition provisions of this Agreement to any employer or potential employer of Tudor or as otherwise provided by law. 13. This Agreement shall not in any way be construed as an admission by the Company that it has acted wrongfully with respect to Tudor or that Tudor has any rights whatsoever against the Company, and the Company specifically disclaims any liability for any wrongful acts against Tudor on the part of itself, its employees or its agents. 9 14. Tudor agrees that neither he, nor anyone acting on his behalf, shall hereafter (i) make any derogatory, disparaging or critical statement about the Company or the business of the Company or any of the Company's officers, directors or employees or any persons who were officers, directors or employees of the Company or (ii) communicate, directly or indirectly, with the press or other media concerning the past or present employees or business of the Company. 15. The Company agrees that neither it, nor anyone acting on the Company's behalf, shall hereafter make any derogatory, disparaging or critical statement about Tudor. 16. If not revoked in accordance with paragraph 6(b), the covenants, representations and acknowledgments contained herein shall survive the execution and delivery of this Agreement. 17. This Agreement (a) constitutes the sole and complete understanding and agreement between the parties hereto with respect to the matters set forth herein and there are no other agreements or understandings, whether written or oral and whether made contemporaneously or otherwise, that are binding upon the parties hereto, (b) may not be amended unless in a writing signed by the parties hereto, (c) shall be subject to, governed by and construed and enforced in accordance with the internal laws of the State of New York and (d) shall inure to the benefit of and be binding upon the heirs, devisees, legatees, executors, administrators, successors, assigns, officers, directors, and affiliates of each of the parties hereto. 18. Tudor represents and warrants that he is able to affect a knowing and voluntary waiver and general release of claims and is not affected or impaired by illness, use of alcohol, drugs or other substances or otherwise impaired. Tudor represents and warrants that he is 10 competent to execute this Agreement, to waive any and all claims he has or may have against the Releasee and certifies that he is not a party to any bankruptcy or other proceeding which would impair his right to waive any and all claims he may have against Releasee. IN WITNESS WHEREOF, the parties hereto have executed this Severance and Release Agreement on the date set forth opposite their respective signatures. Dated: March 22, 1999 /s/ Steve Tudor -------------------------------------- Steve Tudor Dated: March 30, 1999 MSC INDUSTRIAL DIRECT CO., INC. By: /s/ David Sandler ----------------------------------- David Sandler Senior Vice President 11 EX-10.7 3 AGREEMENT Exhibit 10.07 AGREEMENT made and entered into as of this 8th day of January, 1999 by and between MSC INDUSTRIAL DIRECT CO., INC., a New York corporation (the "Corporation"), and DAVID SANDLER, (the "Executive"). W I T N E S S E T H: WHEREAS, the Executive has been employed by the Corporation in a senior executive capacity and desires to remain in the employ of the Corporation in such capacity; and WHEREAS, the Corporation desires to induce the Executive to so remain in the employ of the Corporation. NOW, THEREFORE, the parties hereto hereby agree as follows: First: Inducement Payments: A. Subject to the provisions of paragraph G of this Article FIRST, if a "Change in Control" (as hereinafter defined) shall occur, the Corporation shall pay to the Executive, in cash, the amount of $1,200,000, which amount shall be due and payable thirty (30) days after the occurrence of a Change in Control. B. If, within five (5) years after a Change in Control, the Executive's "Circumstances of Employment" (as hereinafter defined) shall have changed, the Executive may terminate his employment by written notice to the Corporation given no later than ninety (90) days following such change in the Executive's Circumstances of Employment. In the event of such termination by the Executive of his employment or if, within five (5) years after a Change in Control, subject to the provisions of paragraph G of this Article FIRST, the Corporation shall terminate the Executive's employment other than for "Cause" (as hereinafter defined), the Corporation shall pay to the Executive, within thirty (30) days of such termination, in cash, the "Special Severance Payment" (as hereinafter defined). C. A "Change in Control" shall be deemed to occur upon (a) the sale by the Corporation of all or substantially all of its assets to any "person" (as hereinafter defined); (b) the consolidation of the Corporation with any person or the merger of the Corporation with any person as a result of which merger the Corporation is not the surviving entity as a publicly held corporation; or (c) the sale or issuance by the Corporation and/or the Sale by any one or more of its stockholders in one or more transactions, related or unrelated, of the Corporation's voting securities to one or more persons (other than Mitchell Jacobson or Marjorie Gershwind) as a result of which any such person and its "affiliates" (as hereinafter defined) shall possess more than 50% of the combined voting power of the Corporation's then outstanding securities. As used herein, a "person" shall mean any individual, partnership, firm, trust, corporation or similar entity, and an "affiliate" shall mean any person that, directly or indirectly, through one or more intermediaries, controls, is controlled by or is under common control with, any other person. D. The Executive's "Circumstances of Employment" shall have changed if there shall have occurred any of the following events: (a) a material reduction or change in the Executive's employment duties or reporting responsibilities; (b) a reduction in the annual base salary made available by the Corporation to the Executive from the annual base salary in effect immediately prior to a Change in Control; or (c) a material diminution in the Executive's status, working conditions or other economic benefits from those in effect immediately prior to a Change in Control. 2 E. "Cause" shall mean a good faith determination by the Board of Directors of the Corporation that the termination of the employment by the Corporation of the Executive is necessary by reason of (i) the commission by the Executive of any act which, if successfully prosecuted by the appropriate authorities, would constitute a felony under Federal or state law, unless the Executive performed the acts underlying such felony in good faith and in a manner the Executive reasonably believed to be in or not opposed to the best interests of the Corporation; (ii) the Executive's embezzlement or intentional misappropriation of any property of the Corporation; or (iii) the Executive's having divulged, furnished or made accessible to anyone other than the Corporation, its directors, officers, employees, auditors and legal advisors, otherwise than in the regular course of business of the Corporation, any confidential information or knowledge relating to the customers, employees, operations, financial condition, revenues or projections of the Corporation, other than information in the public domain. F. The "Special Severance Payment" shall mean a lump sum payment equal to the difference between (a) the sum of (i) the product of five and the annual base salary in effect immediately prior to a change in the Executive's Circumstances of Employment or the termination other than for Cause of the Executive's employment by the Corporation, as the case may be, and (ii) the product of five and the largest annual bonus paid to or accrued with respect to the Executive by the Corporation during the three fiscal years immediately preceding the termination of the Executive's employment and (b) the aggregate of all base salary and bonus amounts paid to the Executive by the Corporation during the period commencing upon a Change in Control and ending on the date of termination of the Executive's employment. G. Notwithstanding any other provision of this Agreement, the Executive agrees that no amount shall be payable by the Corporation to the Executive hereunder if the 3 payment of all or any part of such amount shall restrict of otherwise impair, as determined by the Corporation in its sole discretion, the ability of the Corporation to utilize the "pooling of interests" method of accounting, as such term is understood under generally accepted accounting principles. Second: Tax Indemnification. A. In the event that, as a result of any of the payments or other consideration provided for or contemplated by Article FIRST of this Agreement or otherwise, a tax (an "Excise Tax") shall be imposed upon the Executive or threatened to be imposed upon the Executive by virtue of the application of Section 4999(a) of the Internal Revenue Code of 1986, as now in effect or as the same may at any time or from time to time be amended (the "Code"), or the application of any similar provisions of state or local tax law, the Corporation shall indemnify and hold the Executive harmless from and against all such taxes (including additions to tax, penalties and interest and additional Excise Taxes, whether applicable to payments pursuant to the provisions of this Agreement or otherwise) incurred by, or imposed upon, the Executive and all expenses arising therefrom. B. Each indemnity payment to be made by the Corporation pursuant to part A of this Article SECOND shall be increased by the amount of all Federal, state and local tax liabilities (including additions to tax, payroll taxes, penalties and interest and Excise Tax) incurred by, or imposed upon, the Executive so that the effect of receiving all such indemnity payments will be that the Executive shall be held harmless on an after-tax basis from the amount of all Excise Taxes imposed upon payments made to the Executive by the Corporation pursuant to this Agreement, it being the intent of the parties that the Executive shall not incur any out-of-pocket costs or expenses of any kind or nature on account of the Excise Tax and the receipt of the indemnity payments to be made by the Corporation pursuant hereto. 4 C. Each indemnity payment to be made to the Executive pursuant to this Article SECOND shall be payable within fifteen (15) business days of delivery of a written request (a "Request") for such payment to the Corporation (which request may be made prior to the time the Executive is required to file a tax return showing a liability for an Excise Tax or other tax). A Request shall set forth the amount of the indemnity payment due to the Executive and the manner in which such amount was calculated, and the Executive shall thereafter submit such other evidence of the indemnity to which the Executive is entitled as the Corporation shall reasonably request. All such information shall, if the Corporation shall request, be set forth in a statement signed by a nationally recognized accounting firm or a partner thereof and the Corporation shall pay all fees and expenses of such accounting firm incurred in the preparation thereof. D. The Executive agrees to notify the Corporation (i) within fifteen (15) business days of being informed by a representative of the Internal Revenue Service (the "Service") or any state or local taxing authority that the Service or such authority intends to assert that an Excise Tax is or may be payable, (ii) within fifteen (15) business days of the Executive's receipt of a revenue agent's report (or similar document) notifying the Executive that an Excise Tax may be imposed and (iii) within fifteen (15) business days of the Executive's receipt of a Notice of Deficiency under Section 6212 of the Code or similar provision under state or local law which is based in whole or in part upon an Excise Tax and/or a payment made to the Executive pursuant to this Article SECOND. E. After receiving any of the aforementioned notices, and subject to the Executive's right to control any and all administrative and judicial proceedings with respect to, or arising out of, the examination or the Executive's tax returns, except as such proceedings 5 relate to an Excise Tax, the Corporation shall have the right (i) to examine all records, files and other information and documentation in the Executive's possession or under the Executive's control, (ii) to be present and to participate, to the extent desired, in all administrative and judicial proceedings with respect to an Excise Tax, including the right to appear and act for the Executive at such proceedings in resisting any contentions made by the Service or a state or local taxing authority with respect to an Excise Tax and to file any and all written responses in connection therewith, (iii) to forego any and all administrative appeals, proceedings, hearings and conferences with the Service or a state or local taxing authority with respect to an Excise Tax on the Executive's behalf, and (iv) to pay any tax increase on the Executive's behalf and to control all administrative and judicial proceedings with respect to a claim for refund from the Service or state or local taxing authority with respect to such tax increase. F. The Corporation shall be solely responsible for all reasonable legal and accounting or other expenses (whether of the Executive's representative or the representative of the Corporation) incurred in connection with any such administrative or judicial proceedings insofar as they relate to an Excise Tax or other tax increases resulting therefrom and the Executive agrees to execute and file, or cause to be executed and filed, such instruments and documents, including, without limitation, waivers, consents and Powers of Attorneys, as the Corporation shall reasonably deem necessary or desirable in order to enable it to exercise the rights granted to it pursuant to part E of this Article SECOND. G. The liability of the Corporation shall not be affected by the Executive's failure to give any notice provided for in this Article SECOND unless such failure materially prejudices the Corporation's ability to effectively resist any contentions made by the Service or a state or local taxing authority. The Executive may not compromise or settle a claim which he is 6 indemnified against hereunder without the consent of the Corporation, unless the Executive can establish by a preponderance of the evidence that the decision of the Corporation was not made in the good faith belief that a materially more favorable result could be obtained by continuing to defend against the claim (or prosecute a claim for refund). Third: At Will Employment. Nothing in this Agreement shall confer upon the Executive the right to remain in the employ of the Corporation, it being understood and agreed that (a) the Executive is an employee at will and serves at the pleasure of the Corporation at such compensation as the Corporation shall determine from time to time and (b) the Corporation shall have the right to terminate the Executive's employment at any time, with or without Cause. In the event of any such termination prior to the occurrence of a Change in Control, no amount shall be payable by the Corporation to the Executive pursuant to Article FIRST hereof. Fourth: Costs of Enforcement. In the event that the Executive incurs any costs or expenses, including attorneys' fees, in the enforcement of his rights under this Agreement then, unless the Corporation is wholly successful in defending against the enforcement of such rights, the Corporation shall promptly pay to the Executive all such costs and expenses. Fifth: Notices. All notices hereunder shall be in writing and shall be sent by registered or certified mail, return receipt requested, if intended for the Corporation shall be addressed to it, attention of its President, 75 Maxess Road, Melville, New York 11747 or at such other address of which the Corporation shall have given notice to the Executive in the manner herein provided; and if intended for the Executive, shall be mailed to him at the address of the 7 Executive first set forth above or at such other address of which the Executive shall have given notice to the Corporation in the manner herein provided. Sixth: Entire Agreement. This Agreement constitutes the entire understanding between the parties with respect to the matters referred to herein, and no waiver of or modification to the terms hereof shall be valid unless in writing signed by the party to be charged and only to the extent therein set forth. All prior and contemporaneous agreements and understandings with respect to the subject matter of this Agreement are hereby terminated and superseded by this Agreement. Seventh: Withholding. The Corporation shall be entitled to withhold from amounts payable to the Executive hereunder-such amounts as may be required by applicable law. Eighth: Binding Nature. This Agreement shall be binding upon and inure to the benefit of the parties hereto, their respective heirs, administrators, executors, personal representatives, successors and assigns. 8 Ninth: Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the law of the State of New York. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. MSC INDUSTRIAL DIRECT CO., INC. By: /s/ Mitchell Jacobson --------------------------------------- Name: Mitchell Jacobson Title: President --------------------------------------- /s/ David Sandler --------------------------------------- DAVID SANDLER 9 EX-10.8 4 AGREEMENT Exhibit 10.08 AGREEMENT made and entered into as of this 8th day of January, 1999 by and between MSC INDUSTRIAL DIRECT CO., INC., a New York corporation (the "Corporation"), and JAMES SCHROEDER, (the "Executive"). W I T N E S S E T H: WHEREAS, the Executive has been employed by the Corporation in a senior executive capacity and desires to remain in the employ of the Corporation in such capacity; and WHEREAS, the Corporation desires to induce the Executive to so remain in the employ of the Corporation. NOW, THEREFORE, the parties hereto hereby agree as follows: First: Inducement Payments: A. Subject to the provisions of paragraph G of this Article FIRST, if a "Change in Control" (as hereinafter defined) shall occur, the Corporation shall pay to the Executive, in cash, the amount of $2,000,000, which amount shall be due and payable thirty (30) days after the occurrence of a Change in Control. B. If, within five (5) years after a Change in Control, the Executive's "Circumstances of Employment" (as hereinafter defined) shall have changed, the Executive may terminate his employment by written notice to the Corporation given no later than ninety (90) days following such change in the Executive's Circumstances of Employment. In the event of such termination by the Executive of his employment or if, within five (5) years after a Change in Control, subject to the provisions of paragraph G of this Article FIRST, the Corporation shall terminate the Executive's employment other than for "Cause" (as hereinafter defined), the Corporation shall pay to the Executive, within thirty (30) days of such termination, in cash, the "Special Severance Payment" (as hereinafter defined). C. A "Change in Control" shall be deemed to occur upon (a) the sale by the Corporation of all or substantially all of its assets to any "person" (as hereinafter defined); (b) the consolidation of the Corporation with any person or the merger of the Corporation with any person as a result of which merger the Corporation is not the surviving entity as a publicly held corporation; or (c) the sale or issuance by the Corporation and/or the Sale by any one or more of its stockholders in one or more transactions, related or unrelated, of the Corporation's voting securities to one or more persons (other than Mitchell Jacobson or Marjorie Gershwind) as a result of which any such person and its "affiliates" (as hereinafter defined) shall possess more than 50% of the combined voting power of the Corporation's then outstanding securities. As used herein, a "person" shall mean any individual, partnership, firm, trust, corporation or similar entity, and an "affiliate" shall mean any person that, directly or indirectly, through one or more intermediaries, controls, is controlled by or is under common control with, any other person. D. The Executive's "Circumstances of Employment" shall have changed if there shall have occurred any of the following events: (a) a material reduction or change in the Executive's employment duties or reporting responsibilities; (b) a reduction in the annual base salary made available by the Corporation to the Executive from the annual base salary in effect immediately prior to a Change in Control; or (c) a material diminution in the Executive's status, working conditions or other economic benefits from those in effect immediately prior to a Change in Control. E. "Cause" shall mean a good faith determination by the Board of Directors of the Corporation that the termination of the employment by the Corporation of the Executive is 2 necessary by reason of (i) the commission by the Executive of any act which, if successfully prosecuted by the appropriate authorities, would constitute a felony under Federal or state law, unless the Executive performed the acts underlying such felony in good faith and in a manner the Executive reasonably believed to be in or not opposed to the best interests of the Corporation; (ii) the Executive's embezzlement or intentional misappropriation of any property of the Corporation; or (iii) the Executive's having divulged, furnished or made accessible to anyone other than the Corporation, its directors, officers, employees, auditors and legal advisors, otherwise than in the regular course of business of the Corporation, any confidential information or knowledge relating to the customers, employees, operations, financial condition, revenues or projections of the Corporation, other than information in the public domain. F. The "Special Severance Payment" shall mean a lump sum payment equal to the difference between (a) the sum of (i) the product of five and the annual base salary in effect immediately prior to a change in the Executive's Circumstances of Employment or the termination other than for Cause of the Executive's employment by the Corporation, as the case may be, and (ii) the product of five and the largest annual bonus paid to or accrued with respect to the Executive by the Corporation during the three fiscal years immediately preceding the termination of the Executive's employment and (b) the aggregate of all base salary and bonus amounts paid to the Executive by the Corporation during the period commencing upon a Change in Control and ending on the date of termination of the Executive's employment. G. Notwithstanding any other provision of this Agreement, the Executive agrees that no amount shall be payable by the Corporation to the Executive hereunder if the payment of all or any part of such amount shall restrict of otherwise impair, as determined by the Corporation in its sole discretion, the ability of the Corporation to utilize the "pooling of 3 interests" method of accounting, as such term is understood under generally accepted accounting principles. Second: Tax Indemnification. A. In the event that, as a result of any of the payments or other consideration provided for or contemplated by Article FIRST of this Agreement or otherwise, a tax (an "Excise Tax") shall be imposed upon the Executive or threatened to be imposed upon the Executive by virtue of the application of Section 4999(a) of the Internal Revenue Code of 1986, as now in effect or as the same may at any time or from time to time be amended (the "Code"), or the application of any similar provisions of state or local tax law, the Corporation shall indemnify and hold the Executive harmless from and against all such taxes (including additions to tax, penalties and interest and additional Excise Taxes, whether applicable to payments pursuant to the provisions of this Agreement or otherwise) incurred by, or imposed upon, the Executive and all expenses arising therefrom. B. Each indemnity payment to be made by the Corporation pursuant to part A of this Article SECOND shall be increased by the amount of all Federal, state and local tax liabilities (including additions to tax, payroll taxes, penalties and interest and Excise Tax) incurred by, or imposed upon, the Executive so that the effect of receiving all such indemnity payments will be that the Executive shall be held harmless on an after-tax basis from the amount of all Excise Taxes imposed upon payments made to the Executive by the Corporation pursuant to this Agreement, it being the intent of the parties that the Executive shall not incur any out-of-pocket costs or expenses of any kind or nature on account of the Excise Tax and the receipt of the indemnity payments to be made by the Corporation pursuant hereto. C. Each indemnity payment to be made to the Executive pursuant to this Article SECOND shall be payable within fifteen (15) business days of delivery of a written request 4 (a "Request") for such payment to the Corporation (which request may be made prior to the time the Executive is required to file a tax return showing a liability for an Excise Tax or other tax). A Request shall set forth the amount of the indemnity payment due to the Executive and the manner in which such amount was calculated, and the Executive shall thereafter submit such other evidence of the indemnity to which the Executive is entitled as the Corporation shall reasonably request. All such information shall, if the Corporation shall request, be set forth in a statement signed by a nationally recognized accounting firm or a partner thereof and the Corporation shall pay all fees and expenses of such accounting firm incurred in the preparation thereof. D. The Executive agrees to notify the Corporation (i) within fifteen (15) business days of being informed by a representative of the Internal Revenue Service (the "Service") or any state or local taxing authority that the Service or such authority intends to assert that an Excise Tax is or may be payable, (ii) within fifteen (15) business days of the Executive's receipt of a revenue agent's report (or similar document) notifying the Executive that an Excise Tax may be imposed and (iii) within fifteen (15) business days of the Executive's receipt of a Notice of Deficiency under Section 6212 of the Code or similar provision under state or local law which is based in whole or in part upon an Excise Tax and/or a payment made to the Executive pursuant to this Article SECOND. E. After receiving any of the aforementioned notices, and subject to the Executive's right to control any and all administrative and judicial proceedings with respect to, or arising out of, the examination or the Executive's tax returns, except as such proceedings relate to an Excise Tax, the Corporation shall have the right (i) to examine all records, files and other information and documentation in the Executive's possession or under the Executive's 5 control, (ii) to be present and to participate, to the extent desired, in all administrative and judicial proceedings with respect to an Excise Tax, including the right to appear and act for the Executive at such proceedings in resisting any contentions made by the Service or a state or local taxing authority with respect to an Excise Tax and to file any and all written responses in connection therewith, (iii) to forego any and all administrative appeals, proceedings, hearings and conferences with the Service or a state or local taxing authority with respect to an Excise Tax on the Executive's behalf, and (iv) to pay any tax increase on the Executive's behalf and to control all administrative and judicial proceedings with respect to a claim for refund from the Service or state or local taxing authority with respect to such tax increase. F. The Corporation shall be solely responsible for all reasonable legal and accounting or other expenses (whether of the Executive's representative or the representative of the Corporation) incurred in connection with any such administrative or judicial proceedings insofar as they relate to an Excise Tax or other tax increases resulting therefrom and the Executive agrees to execute and file, or cause to be executed and filed, such instruments and documents, including, without limitation, waivers, consents and Powers of Attorneys, as the Corporation shall reasonably deem necessary or desirable in order to enable it to exercise the rights granted to it pursuant to part E of this Article SECOND. G. The liability of the Corporation shall not be affected by the Executive's failure to give any notice provided for in this Article SECOND unless such failure materially prejudices the Corporation's ability to effectively resist any contentions made by the Service or a state or local taxing authority. The Executive may not compromise or settle a claim which he is indemnified against hereunder without the consent of the Corporation, unless the Executive can establish by a preponderance of the evidence that the decision of the Corporation was not made 6 in the good faith belief that a materially more favorable result could be obtained by continuing to defend against the claim (or prosecute a claim for refund). Third: At Will Employment. Nothing in this Agreement shall confer upon the Executive the right to remain in the employ of the Corporation, it being understood and agreed that (a) the Executive is an employee at will and serves at the pleasure of the Corporation at such compensation as the Corporation shall determine from time to time and (b) the Corporation shall have the right to terminate the Executive's employment at any time, with or without Cause. In the event of any such termination prior to the occurrence of a Change in Control, no amount shall be payable by the Corporation to the Executive pursuant to Article FIRST hereof. Fourth: Costs of Enforcement. In the event that the Executive incurs any costs or expenses, including attorneys' fees, in the enforcement of his rights under this Agreement then, unless the Corporation is wholly successful in defending against the enforcement of such rights, the Corporation shall promptly pay to the Executive all such costs and expenses. Fifth: Notices. All notices hereunder shall be in writing and shall be sent by registered or certified mail, return receipt requested, if intended for the Corporation shall be addressed to it, attention of its President, 75 Maxess Road, Melville, New York 11747 or at such other address of which the Corporation shall have given notice to the Executive in the manner herein provided; and if intended for the Executive, shall be mailed to him at the address of the Executive first set forth above or at such other address of which the Executive shall have given notice to the Corporation in the manner herein provided. 7 Sixth: Entire Agreement. This Agreement constitutes the entire understanding between the parties with respect to the matters referred to herein, and no waiver of or modification to the terms hereof shall be valid unless in writing signed by the party to be charged and only to the extent therein set forth. All prior and contemporaneous agreements and understandings with respect to the subject matter of this Agreement are hereby terminated and superseded by this Agreement. Seventh: Withholding. The Corporation shall be entitled to withhold from amounts payable to the Executive hereunder-such amounts as may be required by applicable law. Eighth: Binding Nature. This Agreement shall be binding upon and inure to the benefit of the parties hereto, their respective heirs, administrators, executors, personal representatives, successors and assigns. 8 Ninth: Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the law of the State of New York. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. MSC INDUSTRIAL DIRECT CO., INC. By: /s/ Mitchell Jacobson --------------------------------------- Name: Mitchell Jacobson Title: President /s/ James Schroeder --------------------------------------- JAMES SCHROEDER 9 EX-21.01 5 LIST OF SUBSIDIARIES EXHIBIT 21.01 SUBSIDIARIES OF MSC INDUSTRIAL DIRECT CO., INC. CORPORATION STATE OF INCORPORATION - ------------------------------------------------------------------------------ Sid Tool Co., Inc. New York Primeline International, Inc. New York Kaja Productions, Inc. New York Cut-Rite Tool Corp. Florida D.T.C. Tool Corp. Florida Brooks Precision Supply, Inc. Massachusetts MSC Services Corp. New York Anderson Industrial Supply, Inc. Florida Dolin Supply, Inc. New York Discount Tool and Supply Company New York Drake-Atwood Tool & Supply Company, Inc. Tennessee J&S Tool Company, Inc. Tennessee Holloway Bros. Tools, Inc. Delaware RMG Corporation Wisconsin Industrial Specialty Company Incorporated Mississippi Industrial Specialty Company, Inc. of Tupelo Mississippi Corbin Corporation Ohio MSC Direct Line, Inc. New York Swiss Precision Instruments, Inc. California Enco Manufacturing Co., Inc. New York EX-23.01 6 CONSENT OF ARTHUR ANDERSEN LLP EXHIBIT 23.01 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into the Company's previously filed Registration Statements File Nos. 33-98832, 333-10833, 333-31837, 333-46273 and 333-48901. Arthur Andersen LLP Melville, New York November 18, 1999 EX-27.01 7 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MSC INDUSTRIAL DIRECT CO., INC.'S AUGUST 28, 1999 FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 1,000 YEAR AUG-28-1999 AUG-30-1998 AUG-28-1999 2,725 0 95,806 5,799 225,542 328,043 136,449 29,699 514,384 80,795 0 0 0 68 355,559 514,384 651,503 651,503 389,774 179,958 555 1,933 1,576 80,750 31,897 48,853 0 0 0 48,853 .73 .72
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