MSC INDUSTRIAL DIRECT CO INC (MSM) FY 2023 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Overview

MSC is a leading North American distributor of a broad range of metalworking and MRO products and services. We help our customers drive greater productivity, profitability and growth with approximately 2.4 million products, inventory management and other supply chain solutions, and deep expertise from more than 80 years of working with customers across industries. We continue to implement our strategies to gain market share, generate new customers, increase sales to existing customers, and diversify our customer base.

Our experienced team of more than 7,000 associates works with our customers to help drive results for their businesses, from keeping operations running efficiently today to continuously rethinking, retooling and optimizing for a more productive tomorrow. We offer approximately 2.4 million active, saleable SKUs through our catalogs; our brochures; our E-commerce channels, including the MSC website; our inventory management solutions; and our customer care centers, customer fulfillment centers, regional inventory centers and warehouses. We service our customers from six customer fulfillment centers, 10 regional inventory centers, 38 warehouses and four manufacturing locations. Many of our products are carried in stock, and orders for these in-stock products are typically fulfilled the day on which the order is received.

Our business model focuses on providing overall procurement cost reduction and just-in-time delivery to meet our customers’ needs. We focus on offering inventory, process and procurement solutions that reduce MRO supply chain costs and improve plant floor productivity for our customers. We will seek to continue to achieve cost reductions throughout our business through cost-savings strategies and increased leverage from our existing infrastructure, and continue to provide additional procurement cost-savings solutions to our customers through technology such as our VMI, CMI and vending programs. Our field sales and service associate headcount was 2,572 at September 2, 2023 compared to 2,536 at September 3, 2022 and 2,398 at August 28, 2021.

The chart below displays a two-year comparison of our net sales from fiscal year 2022 through fiscal year 2023:

(1)Pricing and other is comprised of changes in customer and product mix, discounting and other items.

(2)Fiscal years 2023 and 2022 had 252 and 258 sales days, respectively.

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Highlights

Highlights during fiscal year 2023 include the following:

•We generated $699.6 million of cash from operations compared to $246.2 million in fiscal year 2022. The increase was primarily from the $300.0 million Receivables Purchase Agreement (the “RPA”) entered into during fiscal year 2023.

•We had net payments of $340.0 million on our credit facilities, private placement debt and shelf facility agreements compared to net borrowings of $9.5 million in fiscal year 2022. Proceeds from the RPA were primarily utilized to pay down debt on our credit facilities.

•We repurchased $95.8 million of MSC’s Class A Common Stock, par value $0.001 per share (“Class A Common Stock”), compared to $27.4 million in fiscal year 2022.

•We paid out an aggregate $176.7 million in regular cash dividends, compared to an aggregate $167.4 million in regular cash dividends in fiscal year 2022.

•In January 2023, we acquired Buckeye and Tru-Edge for aggregate consideration of $22.4 million, which includes cash paid of $20.5 million and the fair value of contingent consideration to be paid out of $2.3 million, net of a post-closing working capital adjustment in the amount of $0.4 million received from the sellers.

•We incurred $7.9 million in restructuring and other costs compared to $15.8 million in fiscal year 2022. Restructuring and other costs primarily consist of consulting-related costs and associate severance and separation costs associated with the optimization of the Company’s operations and profitability improvement.

Recent Developments

Progress on Mission Critical

As previously disclosed, we initiated a Company-wide project, which we refer to as “Mission Critical,” to accelerate market share capture and improve profitability over the period through fiscal year 2023. To realize growth, one of our Mission Critical initiatives, we began and expect to continue investing in our market-leading metalworking business by adding to our metalworking specialist team, introducing value-added services to our customers, expanding our vending, VMI and in-plant solutions programs, building out our sales force, and diversifying our customers and end-markets. We also are focused on improving profitability through the implementation of various pricing strategies and critical structural cost reductions in order to improve return on invested capital. We anticipate that the cost reductions will be comprised of savings in the areas of sales and service, supply chain and general and administrative expenses, and include initiatives to optimize our distribution center network and real estate footprint, renegotiate supplier contracts, and redesign our talent acquisition and retention approach. While Mission Critical was tied to three-year financial targets ending in fiscal year 2023, the key focus areas of Mission Critical, including profitable growth, an improved operating model, and technological improvement, remain critical and ever-evolving initiatives at the Company. Maintaining a continuous improvement mindset remains a key tenet of our strategy going forward.

Impact of Economic Trends

The United States economy has experienced and continues to experience disruptions in the supply of certain products and services and tight conditions in the labor market. These disruptions and conditions have contributed to an inflationary environment which, while falling, remains elevated and has affected the price and, at times, the availability of certain products and services necessary for the Company’s operations, including fuel, labor and certain products the Company sells or the inputs for such products. Such disruptions and conditions have impacted, and may continue to impact in the future, the Company’s business, financial condition and results of operations.

As a result of recent high inflation and periodic supply chain disruptions, the Company continues to implement price realization strategies in response to increased costs the Company faces and has invested in improved warehouse automation to mitigate the effects of labor inflation. The category line review process initiated in the second quarter of fiscal year 2023 continues to progress and shows early signs of improvements in supply chain efficiency, customer experience and supplier engagement. Furthermore, in light of disruptions to availability and increased or uncertain shipping times, the Company is maintaining higher purchasing levels than it did prior to its fiscal year 2020 in order to ensure sufficient inventory supply to meet customer demand.

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Reclassification

On January 31, 2023, the Board of Directors of the Company (the “Board”) received a proposal (the “Proposal”) from the Company’s controlling shareholders, the Jacobson / Gershwind family, to exchange each of their shares of Class B Common Stock, par value $0.001 per share (“Class B Common Stock” and, together with Class A Common Stock, “Common Stock”), for shares of Class A Common Stock, reclassify the Class B Common Stock and the Class A Common Stock into a single class of common stock and eliminate the current dual-class share structure (the “Reclassification”). The Board formed a Special Committee composed entirely of independent and disinterested directors to evaluate the Proposal, which was advised by independent financial and legal advisors.

On June 21, 2023, the Company announced that it had reached an agreement with the Jacobson / Gershwind family with respect to the Reclassification, in support of which, the Company entered into a Reclassification Agreement, dated as of June 20, 2023 (the “Reclassification Agreement”), with Mitchell Jacobson, Erik Gershwind, other members of the Jacobson / Gershwind family and certain entities affiliated with the Jacobson / Gershwind family (collectively, the “Jacobson / Gershwind Family Shareholders”).

In October 2023, we completed the Reclassification as contemplated by the Reclassification Agreement. Pursuant to the Reclassification, each share of Class B Common Stock issued and outstanding immediately prior to the time that the Company’s Amended and Restated Certificate of Incorporation was duly filed with the Secretary of State of the State of New York was reclassified, exchanged and converted into 1.225 shares of Class A Common Stock. The issuance of Class A Common Stock in connection with the Reclassification was registered under the Securities Act pursuant to the Registration Statement on Form S‐4.

As contemplated by the Reclassification Agreement, a number of corporate governance changes were implemented, including the following:

•the Jacobson / Gershwind Family Shareholders have the right to designate two individuals for nomination for election to the Board so long as the Jacobson / Gershwind Family Shareholders own 10% or more of the issued and outstanding shares of Class A Common Stock and to designate one individual for nomination for election to the Board so long as the Jacobson / Gershwind Family Shareholders own less than 10% but more than 5% of the issued and outstanding shares of Class A Common Stock;

•the Jacobson / Gershwind Family Shareholders have each granted an irrevocable proxy authorizing the Company to vote such pro rata portion of shares of Class A Common Stock beneficially owned by the Jacobson / Gershwind Family Shareholders or their permitted transferees in excess of 15% of the issued and outstanding shares of Class A Common Stock in proportion to the votes of other holders (i.e., excluding any Jacobson / Gershwind Family Shareholders and their permitted transferees) entitled to vote and that do in fact vote;

•certain standstill and lock-up provisions for the Jacobson / Gershwind Family Shareholders;

•the transition of the approval standard for certain significant transactions (including mergers, asset sales, share exchanges and dissolution) from a two-thirds supermajority to a majority of the issued and outstanding shares of Class A Common Stock entitled to vote thereon; and

•the transition to a “majority of the votes cast” standard for any election of directors that is not a contested election.

Acquisition of Buckeye and Tru-Edge

In January 2023, the Company acquired certain assets and assumed certain liabilities of Buckeye, an Ohio-based metalworking distributor, and Tru-Edge, an Ohio-based custom tool manufacturer. Buckeye primarily serves the metalworking needs of large manufacturers. MSC Industrial plans to build on Buckeye’s technical, high-touch relationships and value-added services by offering customers access to its extensive product portfolio to support customers’ full metalworking and MRO needs. Tru-Edge brings new capabilities to MSC Industrial, including the design and manufacture of parts from scratch with a strong focus in the automotive and medical markets. The Company expects to drive revenue growth in its existing Midwest manufacturing customer base by leveraging the services provided by Tru-Edge. The Company believes the technical expertise and value-added services provided by Tru-Edge will support its effort to drive cost savings for its customers.

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Our Strategy

Our primary objective is to grow sales profitably while offering our customers highly technical and high-touch solutions to solve their most complex challenges on the plant floor. Our strategy is to complete the transition from being a spot-buy supplier to a mission-critical partner to our customers. We will selectively pursue strategic acquisitions that expand or complement our business in new and existing markets or further enhance the value and offerings we provide.

Business Environment

We utilize various indices when evaluating the level of our business activity, including the Industrial Production (“IP”) Index. Approximately 66% and 68% of our revenues came from sales in the manufacturing sector during the quarter and year ended September 2, 2023, respectively. Through statistical analysis, we have found that trends in our customers’ activity have correlated to changes in the IP Index. The IP Index measures short-term changes in industrial production. Growth in the IP Index from month to month indicates growth in the manufacturing, mining and utilities industries. The IP Index over the three months ended September 2, 2023 and the average for the three- and 12-month periods ended September 2, 2023 were as follows:

The average IP Index for the 12 months ended September 2, 2023 of 102.8 increased from the adjusted average from the prior fiscal year of 101.8, which indicated growth in manufacturing during fiscal year 2023. Favorable conditions exist in certain end markets and volume remains stable. Despite improvements in certain areas, economic uncertainty remains driven by higher interest rates and continued elevated levels of inflation. Recently, the United States economy has experienced supply chain disruptions and significant levels of inflation. The Company has implemented price realization strategies in response to increased costs the Company faces. As we see the IP Index continue to fluctuate, we will monitor the current economic conditions for the impact on our customers and markets and assess both risks and opportunities that may affect our business and operations. See “Impact of Economic Trends” above.

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Results of Operations

Fiscal Year Ended September 2, 2023 Compared to the Fiscal Year Ended September 3, 2022

The table below summarizes the Company’s results of operations both in dollars (in thousands) and as a percentage of net sales for the periods indicated:

(1)N/A is Not Applicable.

Net Sales

Net sales increased 8.6%, or $317.4 million, from the prior fiscal year. The $317.4 million increase in net sales was comprised of $160.5 million from improved pricing, inclusive of changes in customer and product mix, discounting and other items, $136.0 million of higher sales volume and $113.5 million of net sales from recent acquisitions, partially offset by $92.6 million in sales attributable to six fewer selling days during fiscal year 2023. Of the $317.4 million increase in net sales during the fiscal year ended September 2, 2023, national account customer sales increased by $123.0 million, sales to our public sector customers increased by $122.1 million and sales to our core and other customers increased by $72.3 million.

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The table below shows, among other things, the annual 2023 average daily sales (“ADS”) by total company and by customer type compared to the same periods in the prior fiscal year:

(1)ADS is calculated using the number of business days in the United States for the periods indicated. The Company believes ADS is a key performance indicator because it shows the effectiveness of the Company’s selling performance on a consistent basis between periods.

(2)Percent reflects the change from the 2022 fiscal period to the 2023 fiscal period.

We believe that our ability to transact business with our customers through various electronic portals and directly through the MSC website gives us a competitive advantage over smaller suppliers. Sales made through our E-commerce platforms, including sales made through EDI systems, VMI systems, Extensible Markup Language ordering-based systems, vending, hosted systems and other electronic portals, represented 61.1% of consolidated net sales for fiscal year 2023, compared to 61.7% of consolidated net sales for fiscal year 2022. The decline was primarily attributable to large sales to a public sector customer that did not transact through our E-commerce platforms.

Gross Profit

Gross profit increased 5.4% to $1,643.0 million in fiscal year 2023, as compared to $1,558.2 million in fiscal year 2022. Gross profit margin was 41.0% in fiscal year 2023, as compared to 42.2% in fiscal year 2022. The increase in gross profit was primarily a result of a higher sales level as described above and gross profits from our recent acquisitions. The decrease in gross profit margin was primarily attributable to large sales to a public sector customer during the third and fourth quarters of fiscal year 2023 which were transacted below our typical public sector customer margins, as well as unfavorable customer mix as sales to our national account and public sector customers are growing at higher rates and are typically at lower gross margins than the business as a whole.

Operating Expenses

Operating expenses increased 6.2% to $1,151.3 million in fiscal year 2023, as compared to $1,083.9 million in fiscal year 2022. Operating expenses were 28.7% of fiscal year 2023 net sales, as compared to 29.4% for fiscal year 2022. The increase in operating expenses was primarily attributable to an increase in payroll and payroll-related costs and increased professional fees associated with the Reclassification. The decline in operating expenses as a percentage of net sales was related to our cost savings programs and productivity improvements resulting from our Mission Critical initiatives.

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Payroll and payroll-related costs were approximately 56.1% of total operating expenses for fiscal year 2023, as compared to approximately 57.5% for fiscal year 2022. Payroll and payroll-related costs, which include salary, incentive compensation, sales commission, and fringe benefit costs, increased by $22.9 million for fiscal year 2023. The majority of this increase compared to the prior fiscal year was due to increased salary expenses and fringe benefit costs, including higher insurance-related healthcare reserves due to recent higher healthcare claims, partially offset by a lower incentive compensation accrual.

Freight expense was $156.8 million for fiscal year 2023, as compared to $155.5 million for fiscal year 2022. The primary drivers of the increase in freight expense were increased sales volume and higher fuel-related charges. Fuel-related surcharges began to taper off during the second half of fiscal year 2023.

Depreciation and amortization was $74.7 million for fiscal year 2023, as compared to $69.9 million for fiscal year 2022. The primary drivers of the increase in depreciation and amortization were increased capital expenditures related to vending programs and Mission Critical projects.

Professional fee expense was $47.9 million for fiscal year 2023, as compared to $30.3 million for fiscal year 2022. The primary driver of the increase in professional fee expense was fees and other expenses associated with the Reclassification, which included legal and advisory fees, printing and mailing expenses for the associated proxy statement / prospectus, Reimbursable Expenses (as defined in the Reclassification Agreement), and filing and other fees paid to the SEC. See “Reclassification” above for additional information.

Restructuring and Other Costs

We incurred $7.9 million in restructuring and other costs for fiscal year 2023, as compared to $15.8 million for the prior fiscal year. Restructuring and other costs primarily consist of consulting-related costs and associate severance and separation costs associated with the optimization of the Company’s operations and profitability improvement. See Note 14, “Restructuring and Other Costs” in the Notes to Consolidated Financial Statements for additional information.

Gain on Sale of Property

During fiscal year 2021, the Company entered into a Purchase and Sale Agreement to sell its 170,000-square foot Long Island Customer Service Center in Melville, New York. During fiscal year 2022, the Company disposed of the building with a sale price of $25.5 million, which resulted in a gain on sale of property of $10.1 million after the settlement of certain closing costs and fees, which is included in the Consolidated Statement of Income for the fiscal year ended September 3, 2022.

Income from Operations

Income from operations increased 3.2% to $483.7 million in fiscal year 2023, as compared to $468.7 million in fiscal year 2022. Income from operations as a percentage of net sales decreased to 12.1% in fiscal year 2023, as compared to 12.7% in fiscal year 2022. The decrease in income from operations as a percentage of net sales was primarily attributable to a lower gross profit margin and the impact of six fewer selling days during fiscal year 2023, both as described above, partially offset by an improvement in operating expenses as a percentage of net sales from the prior fiscal year and the prior fiscal year gain on sale of property which did not recur during fiscal year 2023.

Total Other Expense

Total other expense increased 56.9%, or $10.0 million, to $27.6 million for fiscal year 2023, as compared to $17.6 million for the prior fiscal year. The increase was primarily due to higher interest rates on our credit facilities and fees incurred associated with the RPA, partially offset by the recognition of $6.6 million of Employee Retention Credit funds. See Note 8, “Income Taxes” in the Notes to Consolidated Financial Statements for further information.

Provision for Income Taxes

Our effective tax rate for fiscal year 2023 was 24.8%, as compared to 24.5% for fiscal year 2022. See Note 8, “Income Taxes” in the Notes to Consolidated Financial Statements for further information.

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Net Income

The factors which affected net income for fiscal year 2023, as compared to the prior fiscal year, have been discussed above.

Liquidity and Capital Resources

As of September 2, 2023, we had $50.1 million in cash and cash equivalents, substantially all with well-known financial institutions. Historically, our primary financing needs have been to fund our working capital requirements necessitated by our sales growth and the costs of acquisitions, new products, new facilities, facility expansions, investments in vending solutions, technology investments, and productivity investments. Cash generated from operations, together with borrowings under our credit facilities and net proceeds from the private placement notes, have been used to fund these needs, to repurchase shares of Class A Common Stock from time to time, and to pay dividends to our shareholders.

As of September 2, 2023, total borrowings outstanding, representing amounts due under our credit facilities and notes, as well as all finance leases and financing arrangements, were $454.3 million, net of unamortized debt issuance costs of $1.0 million, as compared to total borrowings outstanding of $794.6 million, net of unamortized debt issuance costs of $1.4 million, as of September 3, 2022. The decrease in total borrowings outstanding was driven by higher net payments under our credit facilities, private placement notes and shelf facility agreements. Debt payments were primarily funded through the RPA entered into during fiscal year 2023. See Note 10, “Debt” in the Notes to Consolidated Financial Statements for more information about these balances.

We believe, based on our current business plan, that our existing cash, financial resources and cash flow from operations will be sufficient to fund anticipated capital expenditures and operating cash requirements for at least the next 12 months. We will continue to evaluate our financial position in light of future developments, particularly those relating to changes in macroeconomic conditions, including variations in foreign currency exchange rates, commodity and energy prices, labor and supply costs, inflation, and interest rates, and to take appropriate action as it is warranted.

The Reclassification required significant cash outlays during fiscal year 2023. We incurred $12.4 million of non-recurring costs and expenses for fiscal year 2023 in connection with the Reclassification. Furthermore, we repurchased and immediately retired 645,256 shares of Class A Common Stock for $64.4 million during the fourth quarter of fiscal year 2023. We expect to continue repurchasing shares throughout fiscal year 2024, while considering market volatility and our liquidity and financial position.

The table below summarizes information regarding the Company’s cash flows for the periods indicated:

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Operating Activities

Net cash provided by operating activities for fiscal years 2023 and 2022 was $699.6 million and $246.2 million, respectively. The increase was primarily due to the following:

•a decrease in the change in accounts receivable primarily attributable to the RPA entered into during fiscal year 2023, which resulted in a decline in accounts receivable of $300.0 million; and

•a smaller increase in the change in inventories as compared to the prior fiscal year.

The table below summarizes certain information regarding the Company’s operations:

(1)Working Capital is calculated as current assets less current liabilities.

(2)Current Ratio is calculated by dividing total current assets by total current liabilities.

(3)Days’ Sales Outstanding is calculated by dividing accounts receivable by net sales, using trailing two months sales data.

(4)Inventory Turnover is calculated by dividing total cost of goods sold by inventory, using a 13-month trailing average inventory.

Working capital and the current ratio both decreased compared to September 3, 2022. The decreases were primarily due to a decrease in accounts receivable resulting from the RPA entered into during fiscal year 2023. The RPA reduced the accounts receivable balance by $300.0 million.

The decrease in days’ sales outstanding as of September 2, 2023, as compared to September 3, 2022, was primarily due to the RPA entered into during fiscal year 2023.

Inventory turnover as of September 2, 2023 remained consistent with September 3, 2022.

Investing Activities

Net cash used in investing activities for fiscal years 2023 and 2022 was $112.7 million and $94.5 million, respectively. The use of cash for both fiscal years was primarily due to expenditures for property, plant and equipment mainly related to vending programs and Mission Critical projects. The use of cash for fiscal years 2023 and 2022 also included cash outflows due to acquisitions, Buckeye and Tru-Edge in fiscal year 2023 and Engman-Taylor Company, Inc. and Tower Fasteners in fiscal year 2022. In fiscal year 2022, investing outflows were partially offset by the net proceeds received from the sale of the Company’s Long Island Customer Service Center.

Financing Activities

Net cash used in financing activities for fiscal years 2023 and 2022 was $580.4 million and $148.1 million, respectively.

The components contributing to the use of cash for fiscal year 2023 were primarily the following:

•$176.7 million of regular cash dividends paid during fiscal year 2023 compared to $167.4 million of regular cash dividends paid during fiscal year 2022;

•net payments under our credit facilities, private placement debt and shelf facility agreements of $340.0 million during fiscal year 2023 compared to net borrowings of $9.5 million during fiscal year 2022;

•$95.8 million in aggregate repurchases of Class A Common Stock during fiscal year 2023 compared to $27.4 million in aggregate repurchases of Class A Common Stock during fiscal year 2022; and

•proceeds from the exercise of Class A Common Stock options of $28.7 million during fiscal year 2023 compared to $34.7 million during fiscal year 2022.

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Debt

Credit Facilities

In April 2017, the Company entered into a $600.0 million revolving credit facility, which was subsequently amended and extended in August 2021. As of September 2, 2023, the Company also had three uncommitted credit facilities, totaling $203.0 million of aggregate maximum uncommitted availability. See Note 10, “Debt” in the Notes to Consolidated Financial Statements for more information about our credit facilities. As of September 2, 2023, we were in compliance with the operating and financial covenants of our credit facilities.

Subsequent to fiscal year 2023, the Company made additional payments of $15.0 million through October 6, 2023 on its revolving credit facility. The current unused balance of $559.7 million from the revolving credit facility, which is reduced by outstanding letters of credit, is available for working capital purposes if necessary. See Note 10, “Debt” in the Notes to Consolidated Financial Statements for more information about these balances.

Private Placement Debt and Shelf Facility Agreements

In July 2016, we completed the issuance and sale of unsecured senior notes. In January 2018, we entered into two note purchase and private shelf facility agreements. In June 2018 and March 2020, we entered into additional note purchase agreements. See Note 10, “Debt” in the Notes to Consolidated Financial Statements for more information about these transactions. During fiscal year 2023, the Company paid $50.0 million to satisfy its obligation on the 3.04% Senior Notes, due January 12, 2023 and $75.0 million to satisfy its obligation on the 2.65% Senior Notes, Series A, due July 28, 2023.

Leases and Financing Arrangements

As of September 2, 2023, certain of our operations were conducted on leased premises. These leases are for varying periods, with the longest extending to fiscal year 2031. In addition, we are obligated under certain equipment and automobile operating and finance leases, which expire on varying dates through fiscal year 2029.

From time to time, we enter into financing arrangements with vendors to purchase certain information technology equipment or software.

Capital Expenditures

We continue to invest in sales productivity initiatives, E-commerce and vending platforms, customer fulfillment centers and distribution network, and other infrastructure and technology.

Future Liquidity Outlook

As of September 2, 2023, our future contractual obligations were as follows (in thousands):

(1)Certain of our operations are conducted on leased premises. These leases (most of which require us to provide for the payment of real estate taxes, insurance and other operating costs) are for varying periods, with the longest extending to fiscal year 2031. In addition, we are obligated under certain equipment and automobile operating leases, which expire on varying dates through fiscal year 2029. See Note 11, “Leases” in the Notes to Consolidated Financial Statements for additional information on our operating lease arrangements.

(2)As of September 2, 2023, the Company had entered into various finance leases for certain IT equipment, which expire on varying dates through fiscal year 2026. See Note 11, “Leases” in the Notes to Consolidated Financial Statements for additional information on our finance lease arrangements.

(3)Excludes debt issuance costs.

(4)Interest payments for long-term debt are based on principal amounts and coupons or contractual rates at fiscal year-end.

As of September 2, 2023, the Company had recorded a non-current liability of $5.3 million for tax uncertainties and interest. This amount is excluded from the table above, as the Company cannot make reliable estimates of these cash flows by period. See Note 8, “Income Taxes” in the Notes to Consolidated Financial Statements.

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We have not entered into any off-balance sheet arrangements and there are no commitments or obligations (including, but not limited to, guarantees; retained or contingent interests in assets transferred; contractual arrangements that support the credit, liquidity or market risk for transferred assets; or risk related to derivatives or other financial products related to our equity securities), including contingent obligations, with unconsolidated entities or persons that had during the periods presented herein or are reasonably likely to have a material impact on the Consolidated Financial Statements.

Critical Accounting Estimates

We make estimates, judgments and assumptions in determining the amounts reported in the Consolidated Financial Statements and accompanying Notes. Estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The estimates are used to form the basis for making judgments about the carrying values of assets and liabilities and the amount of revenues and expenses reported that are not readily apparent from other sources. Actual results may differ from these estimates. Our significant accounting policies are described in the Notes to Consolidated Financial Statements. The accounting policies described below are impacted by our critical accounting estimates. More information on the critical accounting estimates can be found in Note 1, “Business and Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements.

Allowance for Credit Losses

We perform periodic credit evaluations of our customers’ financial condition, and collateral is generally not required. The Company considers several factors to estimate the allowance for credit losses in accounts receivable, including the age of the receivables and the historical ratio of actual write-offs to the age of the receivables, and also reflects the adopted accounting standard related to current expected credit losses. See Note 1, “Business and Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for more information.

Inventories

Inventory is reflected at the lower of weighted-average cost or net realizable value considering future demand, market conditions and the physical condition of the inventory. We write-down inventories for shrinkage and slow-moving or obsolete inventory. The analysis includes inventory levels, sales information, historical write-down information, and the on-hand quantities relative to the sales history for the product.

Goodwill and Other Indefinite-Lived Intangible Assets

The purchase price of an acquired company is allocated between the intangible assets and the net tangible assets of the acquired business with the residual of the purchase price recorded as goodwill. The determination of the value of the intangible assets acquired involves certain judgments and estimates. These judgments can include, but are not limited to, the cash flows that an asset is expected to generate in the future and the appropriate weighted-average cost of capital. The Company annually reviews goodwill at the reporting unit level and intangible assets that have indefinite lives for impairment in its fiscal fourth quarter and when events or changes in circumstances indicate the carrying values of these assets might exceed their current fair values.

Income Taxes

The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax basis of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. The tax balances and income tax expense recognized by the Company are based on management’s interpretations of the tax laws of multiple jurisdictions. Income tax expense reflects the Company’s best estimates and assumptions regarding, among other items, the level of future taxable income, interpretations of tax laws and uncertain tax positions.

Other

Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. Policies such as revenue recognition, depreciation, intangibles, long-lived assets and warranties require judgments on complex matters that are often

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subject to multiple external sources of authoritative guidance such as the Financial Accounting Standards Board and the SEC. Possible changes in estimates or assumptions associated with these policies are not expected to have a material effect on the financial condition or results of operations of the Company. More information on these additional accounting policies can be found in Note 1, “Business and Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements.

Recently Adopted Accounting Pronouncements

Refer to Note 1, “Business and Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements.