| MSC INDUSTRIAL DIRECT CO INC ITEM 1A Risk Factors In addition to the other information in this Annual Report on Form 10-K, the following factors should be considered in evaluating the Company and its business |
| Our future operating results depend upon many factors and are subject to various risks and uncertainties |
| The known material risks and uncertainties which may cause our operating results to vary from anticipated results or which may negatively affect our operating results and profitability are as follows: Our ability to timely and efficiently integrate the J&L business and realize the anticipated synergies from the transaction will have a significant effect on our future operations |
| VI, all of the outstanding common stock of J&L, a former subsidiary of Kennametal, Inc, for dlra349dtta5 million subject to certain post-closing purchase price adjustments which have not been finalized |
| See Note 2 to the consolidated financial statements |
| Our future results of operations will be significantly influenced by the operations of J&L, and we will be subject to a number of risks and uncertainties, including the following: · We will face a number of significant challenges in integrating the technologies, operations, and personnel of J&L in a timely and efficient manner, and our failure to do so effectively could have a material, adverse effect on our business and operating results |
| · We may not achieve the strategic objectives and other anticipated potential benefits of the acquisition, or do so in the time we anticipate and our failure to achieve these strategic objectives or 15 ______________________________________________________________________ to do so in a timely manner could have a material, adverse effect on our revenues, expenses, and operating results |
| · Transaction costs associated with the acquisition will be included as part of the total purchase cost for accounting purposes |
| Although to date transaction costs have been within our original estimates, in future quarters we may incur charges to operations in amounts that are not currently estimable to reflect costs associated with integrating the operations of two companies |
| In addition, we will continue to record additional operating expenses associated with the amortization of other intangible assets |
| These costs could adversely affect our future liquidity and operating results |
| · Both companies have the US Government and civilian and military agencies of the US Government as significant customers |
| We face risks associated with integrating the contracting activities of the expanded company, and although to date we have not received any negative indications from the US Government, there can be no assurance that the US Government will maintain existing, or enter into any new contracts with the expanded company |
| · As a result of the acquisition, we incurred debt of approximately dlra205dtta0 million |
| In addition we are subject to various operating and financial covenants under the new Credit Facility; our failure to comply with these covenants could result in the lender declaring a default and accelerating repayment of the indebtedness |
| Our failure to repay this debt when due would materially, adversely affect our financial condition and results of operations |
| · As a result of the acquisition, we are a larger, more geographically dispersed and complex organization, and if our management is unable to continue to effectively manage the expanded company, our operating results will suffer |
| · The acquisition will increase the cost and complexity of complying with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 with regard to the evaluation and attestation of our internal control systems and may increase the risks of achieving timely compliance |
| · Achieving the benefits of the acquisition will depend on many factors, including the successful and timely integration of the operations of the two companies |
| These integration efforts may be difficult and time consuming |
| Integration efforts between the two companies will also divert significant management attention and resources |
| This diversion of attention and resources could have an adverse effect on the Company’s ability to maintain its past growth performance levels |
| The acquisition of J&L has played a role in our recent growth |
| From time to time, we may consider and/or pursue selected acquisitions that either could expand or complement our business in new or existing markets, although at this time, we are not engaged in any discussions or negotiations with respect to any material acquisition candidate |
| There can be no assurance that we will be able to identify and to acquire acceptable acquisition candidates on terms favorable to us and in a timely manner |
| The failure to complete or successfully integrate prospective acquisitions may have an adverse impact on our growth strategy |
| Changes in our customer and product mix could cause our gross margin percentage to fluctuate |
| From time to time, since our formation, we have experienced changes in our customer mix and in our product mix |
| Changes in our customer mix have resulted from geographic expansion, daily selling activities within current geographic markets, and targeted selling activities to new customer segments |
| Changes in our product mix have resulted from marketing activities to existing customers and needs communicated to us from existing and prospective customers |
| As our large account customer program sales grow, the Company will face continued pressures on maintaining gross margin because these customers receive lower pricing due to their higher sales volumes |
| The Company plans to continue its efforts to buy better in order to maintain current margin levels |
| Although we have been successful in incrementally increasing our gross margin 16 ______________________________________________________________________ percentage by varying our customer and product mix over the last several years and our strategy has emphasized higher margin, lower volume orders, changes in our customer and product mix, including increased sales to our large account customer programs, could cause our gross margin percentage to fluctuate or decline from time to time in the future |
| Our industry is consolidating which could cause it to become more competitive |
| The business of selling MRO supplies in North America is currently undergoing some consolidation |
| This consolidation is being driven by customer needs and supplier capabilities, which could cause the industry to become more competitive as greater economies of scale are achieved by suppliers |
| Traditional MRO suppliers are attempting to consolidate the market through internal expansion, through acquisition or merger with other industrial and construction suppliers, or through a combination of both |
| This consolidation allows suppliers to improve efficiency and spread fixed costs over a greater number of sales, and to achieve other benefits derived from economies of scale |
| Customers are increasingly aware of the total costs of fulfillment, and of their need to have consistent sources of supply at multiple locations |
| Consistent sources of supply provide not just reliable product quantities, but also consistent pricing, quality, services and engineering capabilities |
| We believe these customer needs could result in fewer suppliers as the industry consolidates, and as the remaining suppliers become larger and capable of being a consistent source of supply |
| The trend of our industry toward consolidation could make it more difficult for us to maintain our operating margins |
| There can be no assurance that we will be able to take advantage of the trend or that we can do so effectively |
| In addition, as various sectors of the industrial and construction customer base face increased foreign competition, and in fact lose business to foreign competitors or shift their operations overseas in an effort to reduce expenses, we may face increased difficulty in growing and maintaining our market share and growth prospects |
| We operate in a highly competitive industry |
| The MRO supply industry, although consolidating still remains 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, manufacturers of MRO supplies, 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 |
| Our competitors challenge us with a greater variety of product offerings, financial resources, services or a combination of all of these factors |
| Although we have recently had success in diversifying our customer base, which we believe will assist us to better manage periodic downturns in the manufacturing industry, there can be no assurance that sales to these additional customers will offset the adverse effects of other competitive trends in our industry, including those discussed above |
| Rising commodity and energy prices may adversely affect operating margins |
| As commodity and energy prices increase, the Company may be subject to price increases from vendors that we may be unable to pass along to our customers |
| Raw material costs used in our products (steel, tungsten, etc) and energy costs have been rising resulting in increased production costs for our vendors |
| The fuel costs of our independent freight companies are rising as well |
| Our vendors and independent freight carriers typically look to pass these costs along to us through price increases |
| When we are forced to accept these price increases, we may not be able to pass them along to our customers, resulting in lower operating margins |
| 17 ______________________________________________________________________ The risk of cancellation or rescheduling of orders may cause our operating results to fluctuate |
| The cancellation or rescheduling of orders may cause our operating results to fluctuate |
| Although we strive to maintain ongoing relationships with our customers, there is an ongoing risk that orders may be cancelled or rescheduled due to fluctuations in our customers’ business needs or purchasing budgets, including changes in national and local government budgets |
| Additionally, although our customer base is diverse, ranging from one-person machine shops to Fortune 1000 companies and large government agencies, the cancellation or rescheduling of significant orders by larger customers may still have a material adverse effect on our operating results from time to time |
| Work stoppages and other disruptions, including those due to extreme weather conditions, at transportation centers or shipping ports may adversely affect our ability to obtain inventory and make deliveries to our customers |
| Excluding J&L, our ability to provide same-day shipping of our core business products is an integral component of our overall business strategy |
| Disruptions at transportation centers or shipping ports, due to events such as the hurricanes of 2005, the severe winter weather experienced during the third quarter of fiscal 2003 and the longshoreman’s strike on the West Coast in fiscal 2002, affect both our ability to maintain core products in inventory and deliver products to our customers on a timely basis, which may in turn adversely affect our results of operations |
| In addition, severe weather conditions could adversely affect demand for our products in particularly hard hit regions |
| The risks of war, terrorism, and similar hostilities may adversely affect our operating results |
| In addition to having an impact on general economic conditions, events such as the attacks of September 11, 2001 and the conflict in Iraq may adversely affect our revenues and our ability to service our customers |
| We believe that both the events of September 11, 2001 and the Iraq conflict had an adverse effect on our results of operations, although the impact of such events can be difficult to quantify |
| Disruptions of our information systems could adversely affect us |
| We believe that our computer software programs are an integral part of our business and growth strategies |
| We depend upon our information systems to help process orders, to manage inventory and accounts receivable collections, to purchase, sell and ship products efficiently and on a timely basis, to maintain cost-effective operations, and to help provide superior service to our customers |
| Any disruption in the operation of our information systems, including widespread power outages such as those that affected the northeastern and midwest United States in August 2003, could have a material adverse effect on our business, financial condition and results of operations |
| Although we utilize disaster recovery techniques and procedures, which we believe are adequate to fulfill our needs, and 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, there can be no assurance that disruptions of our information systems will not occur |
| Our success is dependent on certain key personnel |
| Our success depends largely on the efforts and abilities of certain key senior management |
| The loss of the services of one or more of such key personnel could have a material adverse effect on our business and financial results |
| We do not maintain any key-man insurance policies with respect to any of our executive officers |
| Customer fulfillment centers expansions |
| In the future, as part of our long term strategic planning, we may open new customer fulfillment centers to improve our efficiency, geographic distribution and market penetration and may make, as we 18 ______________________________________________________________________ have in the past, capital improvements and operational enhancements to certain of our existing customer fulfillment centers |
| Moving or opening customer fulfillment centers and effecting such improvements requires a substantial capital investment, including expenditures for real estate and construction, and opening new customer fulfillment centers requires a substantial investment in inventory |
| In addition, new customer fulfillment centers will have an adverse impact on distribution expenses as a percentage of sales, inventory turnover and return on investment in the periods prior to and for some time following the commencement of operations of each new customer fulfillment center |
| Additionally, until sales volumes mature at new customer fulfillment centers, operating expenses as a percentage of sales may be adversely impacted |
| Further, substantial or unanticipated delays in the commencement of operations at new customer fulfillment centers could have a material adverse effect on our geographic expansion and may impact results of operations |
| Our common stock price may be volatile |
| We believe factors such as fluctuations in our operating results or the operating results of our competitors, changes in economic conditions in the market sectors in which our customers operate (notably the durable and non-durable goods manufacturing industry, which, excluding J&L, accounted for 72prca of our revenue in fiscal 2005 and fiscal 2006) and changes in general market conditions, could cause the market price of our Class A common stock to fluctuate substantially |
| J&L does not accumulate this data, however, a significant portion of their revenue is generated from the durable and non-durable goods manufacturing sector |
| The Chairman of our Board of Directors, his sister, certain of their family members and related trusts, collectively own 100prca of the outstanding shares of Class B common stock |
| Consequently, such shareholders will be in a position to elect all of the directors of the Company and to determine the outcome of any matter submitted to a vote of the Company’s shareholders for approval |
| In addition, sales of a substantial number of shares of our common stock in the public market could adversely affect the prevailing market price of our Class A common stock |
| Sales of a substantial number of shares of Class A common stock in the public market could adversely affect the prevailing market price of the Class A common stock and could impair our future ability to raise capital through an offering of our equity securities |
| As of August 26, 2006 there were 48cmam087cmam141 shares of Class A common stock outstanding |
| In addition, as of August 26, 2006, 2cmam931cmam064 options to purchase shares of Class A common stock granted under the Company’s 1995, 1998, and 2001 Stock Option Plans remain outstanding |
| As of August 26, 2006, restricted stock or options to purchase an additional 2cmam837cmam852 shares of Class A common stock were available for grant or unissued, respectively, under the Company’s 2005 Omnibus Equity Plan |
| Approximately 245cmam293 shares may be sold through the Company’s Associate Stock Purchase Plan |
| The Omnibus Equity Plan replaced the 1995, 1998, and 2001 Stock Option Plans, and the 1995 Restricted Stock Plans (the “Previous Plans”) |
| The Omnibus Equity Plan covers 3cmam000cmam000 shares in the aggregate, and is in lieu of and replaced the unissued shares not covered by previous grants that were made under the Previous Plans, for an aggregate of approximately 500cmam000 fewer shares than were covered under the Previous Plans |
| Our Class B common stock is convertible, on a one-for-one basis, into our Class A common stock at any time |
| As of August 26, 2006, there were 18cmam839cmam874 shares of Class B common stock outstanding |
| All of the shares of Class B common stock (and the shares of Class A common stock into which such shares are convertible) are “restricted securities” for purposes of the Securities Act |
| 19 ______________________________________________________________________ Subject to the volume and other limitations set forth in Rule 144 promulgated under the Securities Act, all of such restricted securities are eligible for public sale |