MSC Industrial Direct Co Inc (MSM) 2003 Q3 法說會逐字稿

Good morning.

My name is Suprika (ph.) and I will be your conference facilitator.

At this time, I would like to welcome everyone to the MSC Industrial Direct Third Quarter 2003 Earnings Call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period.

If you would like to ask a question during this time simply press "star" then the number "1" on your telephone keypad.

If you would like to withdraw your question, press "star" then the number "2".

Thank you.

I would now like to turn the call over to Mr. Eric Boyriven with FD Morgen-Walke.

Sir, you may begin.

Thank you and good morning everyone.

Thank you for joining us today to discuss MSC Industrial Direct's fiscal 2003 third quarter results.

You should have received the copy of this morning's earnings announcement.

If you have not yet received the release, please call over offices at 212-850-5752.

Also, an online archive of this broadcast will be available within one hour of the conclusion of the call and will be available for one week at www.mscdirect.com.

Certain information pertaining to non-GAAP financial measures that may arise during this broadcast can also be found at the same website in the investor relations section.

Let me take a minute to reference the Safe Harbor Statement under the Private Securities Litigation and Reform Act of 1995.

This conference call may contain forward-looking statements that are subject to significant risks and uncertainties including the future operating and financial performance of the company.

Although the company believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.

The important risk factors that could cause the actual results to differ materially from those reflected in the company's forward-looking statements are included in today's earnings release and in the company's filings with the Securities and Exchange Commission.

In addition, the information contained in this conference call is accurate only as of the date discussed.

Investors should not assume that the statements made in this conference call remain operative at a later time.

The company undertakes no obligation to update any information discussed in this call.

With that said, I would like to introduce MSC Industrial Direct's Chairman and Chief Executive Officer, Mitchell Jacobson.

Mitchell, please go ahead.

Thank you Eric.

Good morning everyone and thank you for joining us today.

With me are David Sandler, Executive Vice President and Chief Operating Officer;

Chuck Boehlke, Executive Vice President and Chief Financial Officer; and Shelley Boxer, Vice President of Finance.

I will begin with an overview of the third quarter of fiscal '03 and our expectations for the fourth quarter of '03.

David will cover our fulfillment model and Chuck will provide details on the third quarter's financials.

Following Chuck, I'll wrap up and open the line for questions.

At the start of the quarter, we noticed that our visibility was limited by the uncertain outlook for the industrial sector and the apparent effect of the war in Iraq on some of our customers purchasing decisions.

In this difficult environment, we continue to execute our plan, make it a priority to maintain our superior customer service, leverage our position as a market leader, and take share and grow.

We succeeded in the third quarter, growing sales and growing net income.

We once again exceeded our goal of converting 25% of incremental revenues into operating income achieving the conversion rate of 42%.

In addition, we achieved gross margin targets, continued to manage our assets, and generated significant amounts of cash.

Operating income grew by 16% over last year's third quarter and has reached approximately 10% of sales.

Earnings per share grew 27% to 19 cents per share.

Our successful asset management has led to our conclusion that we expect MSC to generate cash in excess of our investment needs for the foreseeable future.

With the passage of the new tax treatment of dividends, we felt that most dividend program of 5 cents per share quarterly would appropriately reward our shareholders while not impacting our ability to invest and grow.

This time, we'd like to provide some guidance for Q4.

Six weeks into the quarter, the economic indicators for the industrial sector are not encouraging.

Although MSC has continued to grow during this time, we are expecting that this summer will be like last summer and there will be extended plant shut downs and shortened work weeks.

Consequently, we expect fourth quarter revenues to be in the range of 205-210m with earnings per share in the range of 17-19 cents.

Thanks, and now I will turn the microphone over to David.

Thanks Mitch.

I would like to start by sharing what we are hearing and seeing in the field.

There has been very little in the way of positive development in the industrial sector.

Employment and inventories continue to shrink and activity is still well below the levels of 3 years ago.

The ISM continues below 50.

Our customers are telling us that while they remain optimistic and hopeful they are also saying to expect a slow summer as order levels drop, and normal summer shutdowns are extended on a similar basis to last year.

However, MSC is growing and we are executing our model and taking share.

A key part of our program is to continue to diversify our customer base away from the industrial sector.

We are achieving success in several other sectors and I am happy to report that we recently became qualified to do business with the U.S. government through a GSA contract and were also awarded the United States Postal Service MRO contract along with another national competitor.

These are important events for MSC and we will dedicate some of our resources to growing this business and capitalizing on these types of opportunities.

Initially however, these awards are not expected to generate significant incremental revenues.

We will have to work hard to convert these opportunities and are gearing up the organization to do so.

Our job will be to go out and visit these government facilities and convert the business to MSC.

We are confident that over time our values will be communicated to these customers and we will be rewarded with more and more business.

In the long-term, these customers will play an important role in MSC's diversification strategy.

Recently, I was traveling with one of our field sales associates in the Southeast and visited a factory that manufactures truck transmission.

Interestingly, this business has been doing well throughout the industrial recession, and our business has grown from 15,000-150,000 per year.

The customer has an integrated supplier onsite, but has been transitioning business to us.

They found that we can more affectively supply their needs on time, and our local branch team and field sales associate have done a great job providing with personalized service they require.

MSC's model has reduced their out of stock situations and increased their manufacturing efficiency.

Consequently, this customer has given a substantial portion of their unplanned needs to MSC while continuing to use integrator for volume buys and onsite management of their production inventory.

This is one example of why MSC is gaining share throughout the industrial sector, and over the long-term, this will result in excellent growth in sales and earnings.

Turning to the details for the quarter; once again, I am pleased to report that the execution of our model continues at very high levels and our metrics are coming in at target levels or better.

Our customers tell us that our service is the best in the business and that is one of the main reasons we gain share and ensure future growth.

Overall fill rates continue at about 99% and all DCs hit their first [pass] fill rate goals.

Accuracy levels continue to be excellent with run rates at about 1.7 errors per 1000.

Call center staffs continued their high levels as well.

The call abandonment rate was less than 1% and we averaged 61 calls per associate per day.

As we still view the marketplace with considerable caution, we will continue to manage our field sales hiring quarter-to-quarter.

We ended the third quarter with 440 associates and plan to maintain approximately this number in the fourth quarter.

Although the field sales force has declined about 7% in number from its peak, we continue to improve the quality of the sales force and remain focused on redeploying sales associates into more productive areas.

This is been successful and has resulted in higher productivity and an improved return on our investments.

We will continue to look at ways to improve productivity, not only in the sales force but throughout MSC.

In the third quarter we mailed 8.6m pieces of mail, a bit more than initially planned.

By concentrating our efforts in more productive sectors, we continue to generate excellent overall response rates.

Total active customer count was 340,000 at the end of the third quarter compared to 338,000 last quarter and 329,000 in last year's third quarter.

We expect that we will mail approximately 7.2m pieces in the fourth quarter as we will cut back on prospecting due to the slow summer season and the expected drop in response rates as businesses close down for summer vacations.

All of our regions continued to grow in the third quarter.

The Midwest continues to lead the way with 7% growth and all other regions grew in low-single digits.

Sales to the manufacturing sector were flat in the third quarter, and sales to the non-manufacturing sector grew by 14%.

It's clear to us that our diversification program is working and is reflected in the growth of the non-manufacturing sector.

The sales split was 73% manufacturing versus 27% non-manufacturing, and our average order size declined slightly to $221 in the third quarter reflecting the weakness in the economy. [MSC Direct.com] continued its outstanding growth in the third quarter.

Sales through the site grew to $23.7m, representing 11% of consolidated sales with an annualized run rate of $94m.

This represents growth of approximately 40% over the third quarter of last year.

In conclusion, I'm extremely pleased with our performance in the third quarter.

We executed our plan and grew in a very difficult environment.

However, we continue to remain cautious based on our view of the economy and what we are hearing from our customers.

I can tell you that the small distributors that control the bulk of the market are experiencing increased pressure from the economy and further drag on their customer service and financial position.

And everyone at our company would like to deliver high growth; this economic slowdown continues to be an opportunity for MSC, as it will translate into increased market share and eventually into outstanding growth.

And finally, I'll take this opportunity to express my thanks and appreciation to all of our MSC associates who continue to stay focused and execute at such high levels.

Thank you.

And I'll now turn the mike over to Chuck.

Thank you, David.

Once again we have completed an excellent quarter financially and exceeded our financial goals.

As you know we have committed to grow operating income by 25% of our sales increase in fiscal year 2003.

In the third quarter we beat the 25% yardstick generating 42% incremental operating margin on our sales increase.

We continue to manage our margin and operating expenses.

Gross margin came in at 44.9% within the expected range and should be between 44.5 and 44.8% in the fourth quarter.

Operating expenses were also as expected coming in at about 76m in the third quarter.

Turning to our balance sheet.

We continue to produce excellent results.

Cash flow for the quarter exceeded expectations as we generated approximately 36m in operating cash flow and free cash flow after approximately 3m in CAPEX was $33m.

Depreciation and amortization once again exceed capital expenditures as net fixed assets declined in the quarter.

In the fourth quarter we once again expect free cash flow to be positive.

Our free cash flow balance grew to $109m at the end of the third quarter and is currently at approximately $120m.

Since our last conference call we have not repurchased any more company stock, although, the program is still active.

Working capital excluding cash declined in the third quarter mainly reflecting an $8m reduction in inventory.

DSOs increased to 42 days in the third quarter from 40.

Inventory turns were annualized at 2.25 in the third quarter, up from 2.1 turns in the second quarter.

Our return on average equity continues to exceed our average cost of capital, as our pretax return on average equity was an annualized 16.8% in the third quarter; 20.5% excluding our cash balances.

This was slightly better than the second quarter and better than last year's pretax return of 14%.

As Mitchell noted, we have initiated a dividend program as the company's performance has improved to the point where we can continue to generate enough cash to invest in our growth programs and to also pay a dividend.

We have delivered more than anticipated 25% read through the first three quarters of fiscal year 2003.

We will do so in the fourth quarter as well.

Our year-to-date read through of approximately 38% has been significantly influenced by our year-to-date gross margin improvement of 140 basis points over last year.

While we do not have the same gross margin opportunity in fiscal year '04 we believe that the significant leverage built into our business will allow us to commit to at least 20% read through on incremental fiscal year '04 sales.

Our productivity plans for '04 will mitigate a portion of salary and medical inflation as well as investment and start up expenses associated with our diversification into the government sector.

In summary we had an excellent quarter financially; we exceeded our expectations on improved operating margin delivered excellent cash flow and continue to manage the balance sheet.

Thank you and now I will turn it back over to Mitchell for the wrap up.

Thanks Chuck.

MSC is extremely well positioned to continue to grow revenues and earnings.

Last several quarters have provided confirmation of the leverage inherent in this business.

We are excited because we know that when the manufacturing economy stabilizes and our top line growth picks up momentum we will show significant earnings growth.

On return we are executing on our diversification strategy.

The growth in the quarter was driven by the non-manufacturing sector and our new GSA and Postal service contracts represents significant milestones along our plan path to expand our presence in the non-manufacturing sectors of this economy.

This strategy will enhance our growth while removing risk.

Thank you.

And operator, I will now open the line for questions if you will.

At this time, I would like to remind everyone if you would like to ask a question press "star" then the number "1" on your telephone keypad.

We will pause for just a moment to compile the Q&A roster.

Your first question comes from David Manthey with Robert W. Baird.

Hi guys, thanks a lot.

Question on -- you already answered it to some extent here Chuck.

I am looking at the contribution margin excluding the gross profit improvement this year averaged about 18.5 I believe, so next year you think you can do a little bit better than that and I am wondering is this sort of base case, are you looking at an improving industrial economy to get to that 20% read through on constant gross margins or how do you see that working?

Yes, let me take a minute or two and I'll indulge everyone for their patience because its very important to understand this we think going forward for next year, to the point that you made, coming in really from fiscal year '02, in the fiscal year '03 we had absolute certainty that we felt our gross margins would be improving rather substantially year-over-year, and that's really the catalyst that gave us the confidence right at the gate to save us regardless of the sales increase for '03, you could count on at least a 25% read through and as you've seen year-to-date we’re at the 38% range driven largely by the 140 basis point improvement in gross margin.

As you look forward to next year as it is said in the script we really don't have that 140 basis point opportunity.

We think that gross margins will hang around this [448] we did in the third quarter and plus or minus 30 or 40 basis points due to natural reasons, mixed issues, timing and [acquiring] of discount purchases, rebates, etcetera.

We think we can get reasonably close, but can't pin it down any further than that.

Lets play it out on the downside and see what that really means and perhaps using some numbers might clarify here a little bit.

If sales were to go up 50m next year now a 25% read through on that would be about $12.5m; however, if because of the issues I mentioned we drop 30 basis points approximately in margin on the core business that would take $2-2.5m right out of that $12.5m incremental read through, net-net the way the math would work you’d end up with about $10m operating margin increase on a $50m sales increase which is the 20%, so again we’re being cautious and prudent right now knowing that we don't have those gigantic gross margin opportunities, but should the margins slip just a little bit for natural causes, you get the opposite affect as you had this year where we were significantly going up in margin, we had much higher than 25% we improve.

We have a smaller decrease in margin next year for natural causes -- we can have a 20% rates.

That's, kind of, how we arrive with that number.

Alright, thanks Chuck.

That was great.

And two more questions, first could you talk about productivity enhancement initiatives, and what some of those might be that would help you get to this level and then if you have the sales growth average daily sales by month that would be helpful too?

Thank you.

I will start with the productivity piece and Dave will comment on the sales growth.

Couple of things that are going on -- we have talked in the past about the Six Sigma program that we have in place at the [gate] this year and really kind of start up mode for us who generated some nice savings basically from some process improvement type of things we put in place.

We are going to kick it in full speed next year,have a series of programs that we think will really generate some savings to help mitigate the normal ongoing medical and [value] inflation that you see that all companies are having to deal within the market place.

So, some of it specifically relates to Six Sigma.

The other piece is a continuation from what you have seen this year and I would like to call it working smarter, not necessarily harder as we look at our direct mail and some of our other investments.

We are looking for productivity gains to continue on that front as well as we move forward in the next year.

With that, let me let David comment on the monthly sales portfolio.

Thanks Chuck.

Hey David.

Let me take you through the sales growth through the quarter.

March, I'll give you the absolute numbers and I'm going to a -- a bit color on them.

March, was approximately 7%;

April was approximately flat;

May was 3% and let me just pause there for a sec -- the March-April the way to look at them and may be to take the two together because of the [Easter comps].

Easter was in March last year and it was April this year.

So, you probably want to consider that as you look at the two months' numbers.

So for the quarter it was 3.3 and I guess I will give a bit of our visibility into June and also put some color on that as well.

June was around 5%.

June is a 5 weeks' fiscal month force David and the fourth of July was in this year's June.

It was also in last year's June, which is to add a bit more to that.

This year it fell on a Friday, last year it fell on a Thursday.

So, we think on that comp, we probably gained a bit just because of businesses more than likely being shutdown much more last year than this year because of the way that the holiday fell.

And I guess the only other thing to comment on in terms of our visibility going forward.

We are in- - we've had the last four months of negative territory for the [ISM] and you know, typically, our business lags by three months or more in terms of what we can expect as far as our impact from that ISM given that we are still so heavily concentrated in manufacturing.

So, I think that really speaks to the caution as we look out over the next few months just because of that ISM reading still staying in negative territory.

Great.

Thank you very much.

Thanks David.

Your next question comes from Yvonne Varano with CIBC.

Thanks.

I heard a couple of times on the call that you are conserving this cash on the balance sheet for growth opportunities, and I was wondering if you could talk a little bit more towards that giving a little more detail on what you are looking at doing there?

Yeah this is Chuck Yvonne.

The cash in the balance sheet right now is at the level that obviously we are comfortable and think it is certainly prudent to keep some reserves.

However, you have seen we declared dividend.

We will pay some of that out in the dividend.

Although we haven’t been active in the stock program recently, there is still an excess of 4m shares that has been authorized by the board that we could go out and buy.

And why we are not at this moment aggressively searching for acquisitions, certainly if the right thing came along and fit our parameters, we would consider using the extra cash to do something that would be accretive to our earnings and give us the kind of top line growth we would be looking for.

So that, you know, that is really what we have in mind for some of this cash.

Yvonne, it's David.

Let me add even some more to that and just talk a bit about how we have been investing through this slowdown.

You know, really over the last 3 years, we invested heavily and we accomplished a lot.

I mean if you look at where we are today versus where we were -- our SKU expansion actual SKU [count] has increased by over 75,000 items.

Our sales force has increased by almost 50%.

At the beginning of the slowdown we had just under 300 field associates, today we are up to about 440.

We've also made as Chuck mentioned earlier, you know, one of the focuses that we've had is on increasing productivity and we've made dramatic improvement in our direct mail techniques that have resulted in improved productivity while at the same time we've grown our customer base by 20% over the last 3 years, adding almost 56,000 active customers.

Let me just continue with some of the growth investments that we've made.

It was actually 3 years ago this month that we launched for the first time our website mscdirect.com prior to 3 years ago it was nonexistent.

Today almost 11% or actually -- this quarter 11% of our business is now generated through this site.

One of the investments that we've made is that we have invested heavily in our e-com infrastructure which has led to many, many alliances with procurement solutions providers such as Ariba, Commerce One, Oracle, and many others and all of that has played an important part in building out a national account strategy and is a significant factor in our growth book today in moving forward.

Just to give you a bit more, we've also invested in value-added services, we've talked a lot about our BMI program historically that's something that we've had significant success and we continue to develop and invest in more value-added services, programs that are currently under development that for competitive reasons I'd rather not lay out, and I guess finally and it probably isn’t finally if I continue to think about this we have invested heavily in customer diversification and we've talked a bit on this call today about how pleased we are with our success in securing the GSA and USPF contracts.

So, long-winded way of I guess reinforcing that -- our game plan, which we have been focused on now for sometime is to grow this business, in fact we have been growing it in a very difficult environment to continue to take market share which we are doing, and to continue to invest and grow while driving more productivity from everything that we do, which I guess you can see there is a pretty strong theme around here.

You know, ultimately we are going to leverage our infrastructure that we've built and achieve much higher levels of profitability and that's what are focus is.

We have been on plan, executing to it, and we really confident that we are delivering on our commitments and are going to continue to do so.

In looking at some of the investments that you made what would you say would be the largest chunk of cash outflow that you needed to expand to -- on any one of these items?

Yvonne really if you look the last few years the largest cash out flow from an investment point of view is been on the fixed investments we put in the business.

The investment in the sales force, investment in direct mail is [flowing] for our operating expense has been in our reported results all along but what you really see a dramatic different is difference in and this is part of our cash build up.

We think the infrastructure has been laid out in terms of DCs, in terms of website and so forth that we don't have large CAPEX expenditure things laying out in front of us now that's -- it's all been behind us and that gives us the confidence to both declare the dividend and feel like we are continuing to generate strong free cash flow partially because of the lack of having to spend so much in capital.

And just [inaudible] your sort of passed the major capital expenditure point and yet you have $4m plus your authorization out there and you haven't been in the market.

What has to change for you to be more encouraged to buyback more shares?

It really is just a matter of us deciding that we believe it's the right use of the cash at the right time; it's nothing more or less than that.

That authorization is in place and as I said it's still in excess of 4m shares and we use it accordingly when we feel its right price and the right time.

Can I just go back to the cash you said it was generated during the quarter?

You said that there was 8m in inventories?

Yes.

What else adds in there to get to your 35.8?

Okay the net--.

[inaudible] the 13.2 from [you’re net income]?

Let me reconcile it for you.

The net income is about 13m.

The depreciation is 4m, accounts receivable 4m, inventory is 8 and then our accrued liabilities which is really a reflection of our payroll accrual from some other things was an additional $6m.

That gets you pretty close to the cash for the quarter.

Some of that will come back -- the pay roll comes out when we go into to the next quarter and any accrued and final compensation that gets paid out at the end of the year would come back, but $35m is not the steady state run rate of quarterly cash flow.

There are some one-time items in there, but clearly the income, the depreciation, the receivable, and inventory management are all absolute deliverables that significantly provided for the cash flow this month -- this quarter.

That's terrific.

Last question on -- I just also noticed that your quarterly growth has slowed as the year progressed.

Is there anything that you can add on that standpoint and where you -- we expect -- we did expect it to be going forward?

You know, Yvonne -- it's David again.

Yes, I mean we–- I think the macro really speaks to—what we are seeing really speaks to the macro and what we are hearing from our customers, it’s a tough environment out there.

You’ll note that earlier in the year we had a positive and expansionary ISM in the last 4 months, we have seen that ISM contracting.

In fact, it's gone into negative territory that under the 50 mark.

And we know because our business is still so concentrated in manufacturing at 73%, while we are making great progress in diversifying towards our long-term goal.

We -- you know, we are still heavily concentrated in that manufacturing segment.

And that's, you know, it's rough out there and it has been significantly effected.

So because of you know, the fact that we lag by -- generally by at least a few months on a going forward basis and considering that it's still a negative territory, we are certainly not expecting any quick turnaround in the short term, but we are certainly optimistic long-term.

Hey, terrific.

Thanks so much.

Thank you.

Your next question comes from Holden Lewis with BB&T.

Good morning.

Thank you.

I guess a couple of follow ups to the last one to question -- just on the cash-flow, I just want to make sure I understand, you know, I mean it seems like you know the benefits, receivables, and inventories, I guess I don't know what the big jump in the other current assets are and whether that’s a cash item.

It looks like that kind of you know offsets the receivables inventory gain.

And then down on the liability section it looks like you know, the payables were back down, but the accrued and other category was largely offsetting that.

So, I guess that I'm surprised to hear that you think such a big benefit from the balance sheet [inaudible] the cash flow.

Can you give a little bit more color whether those were all cash items or what I'm missing there?

Yes.

Let me start, Holden, with the payables.

The payable change -- because the inventory was down $8m in the quarter, absolutely -- obviously a big piece of that flows through to accounts payable.

However, on the accrual front, which I just mentioned as the couple of things in there, for example the payroll it was depending on how the calendar falls [inaudible]two full weeks worth of payroll in there it’s just a matter of when the calendar falls in terms of when we -- last time we had payday versus what we have to accrue at the end of the month.

So, there were $7m for that and as we continue to accrue incentive compensation at a rate different than last year due to the performance that goes into the accrual and comes out back in November when ultimately the incentive compensation is paid out.

So those were items that they kind of drive up the accrual and offset the payables which came down due to the lower inventory amount.

On the other side of the balance sheet -- and the other assets we have what we called co-op receivable that's built up a little bit in that account and we have got movements all the time on the balance sheet relative to our big book and our catalog.

We're actually reducing assets from last year's big book.

The expenses are coming in as a deferred asset if you will for the next year's big book catalogs.

We have movements all the time coming in out of the account that relates to that.

Yes.

I'm less concerned about the specific inputs.

I just, you know, when trying to derive the cash flow, it looks like the increase in other currents largely offsets the decrease in receivables and inventories.

And then the decrease in payable is largely offset by an increase in the accrues.

So I am trying to find where the big cash flow contribution was from the balance sheet.

1m in accounts receivable, 8m in inventories, Holden.

Right, but is the increase in the other current line those aren’t cash items?

The increase in the other current is only about 1.8m.

Okay, quarterly, I thought it increased from 9.7-19, was that wrong?

Yes.

That's -- the other part is in deferred -- current deferred income tax.

Okay.

All right.

Fair enough.

On the revenue side, you sort of, I guess referred to some anecdotal evidence, you know, or anecdotal congestions that maybe markets are improving, but I guess the anecdotes that you are talking about involve your plant shutdown extended sort of you know ivacation time and things of that nature -- what exactly are the anecdotes that give you some cause for optimism?

Holden it's David, I am not sure where I transmitted the signal for cause for optimism.

I am certainly optimist long term, but if anything -- I think the picture that we see and the one that I do want to paint is cause for caution and short-term concern.

I mean there is really nothing out there that we see that would give us anything optimistic in the short term, given what we see for the ISM currently being remaining in negative territory given the fact that we are in a slow -- the slow summer months, you know the shutdowns that we typically experience and if anything we are hearing will be even more exacerbated this year late in July or early August.

So I am not sure how my message translated to short-term optimism, but that wasn’t what I wanted to convey because I don’t see anything in the short term that you know would signal optimism [inaudible] what we are seeing in the market place.

Okay.

In the text of the release you said despite anecdotal evidence of optimism, that's why I was curious.

And I guess lastly, you know, looking at the, you know, traditionally obviously Q3 is a seasonally stronger number from an EPS standpoint.

It looks like for the most part, every place delivered pretty well, perhaps the exception being you know SG&A that’s excluding the D&A component, just SG&A, you know this is the first quarter this year where you haven’t seen meaningful improvement in the SG&A as a percentage of sales, perhaps the sales increase wasn’t as great as expected, but you know you definitely saw sort of a seasonal improvement in your revenues over Q1 and Q2, yet your SG&A as a percentage of sales is actually worse, which kind of reverses the trends of last couple of quarters.

You know that’s despite the fact that your mailings are down, your employees are down, kind of curious what's kind of, you know, keeping SG&A up at pretty strong levels.

Holden, the change quarter-over-quarter is about 1m bucks from Q3 to Q2 and the sales are up $6m.

So I mean the 15% variable expense element to support a higher sales level is really what the increase from Q2 to Q3 is all about.

You know that is -- percentage wise, we prefer to talk about the number going from 75-76 from Q2-Q3 and that million dollars is required to support a $215-216m sales level versus the 210 that we achieved in the second quarter.

Yes Holden, and also, you know, as a percentage of revenues, it was 35.2%, I believe, in the third quarter, same as the first quarter 35.2.

And then, you know, actually slightly lower than the second quarter.

But slightly higher than the first quarter, but I mean none the less, traditionally your Q3, when you have it ticked up in revenues which you had, you generally see the SG&A as percentage of sales be materially lower, which you didn't see and I guess it translated in the dollar terms, you know the fact that you had, you know, call it 5-6% declines in personnel year-over-year, the fact -- as well as 5-6% declines in advertising, where are the dollars increasing materially, to sort of offset the historical trend?

This is Chuck, I mean, I'll tell you on equivocally we have offset almost dollar-for-dollar every nickel with the medical inflation this year versus last and as you know that double-digit category increase we've offset basically every dollar worth of any kind of salary inflation and other inflation that is coming to our numbers.

Year-over-year -- you're basically looking at two elements the variable expense and frankly the incentive compensation accrual is different at a 70 some cents earnings number for the year than it was 50 some cents a year ago.

And two more things, also while there maybe some difference in the sales force numbers the overall headcount year-over-year is flat, the same so you can't really look at that.

Those people who's dollars are deployed elsewhere in the organization, you know, when you ask for the direct mail expense, you know, a whole lot of advertising pieces don't add up to a whole lot of advertising dollars, you know in terms of the actual expenses.

So, you know, that's not a substantial number.

Okay.

Thanks.

Again I would like to remind everyone if you would like to ask a question press "star" then the number "1" on your telephone keypad.

Your next question comes from Joanna Shatney with the Goldman Sachs.

Hi, good morning.

I was wondering if you could help me determine how much have you incrementally extended those programs, this fiscal year versus the last year, and also next fiscal year versus this year and also whether that is included in the 25% guidance for the [inaudible] incremental margin?

I am sorry could you -- we had difficulty hearing that question, would you mind repeating that please?

Yes, can you tell me how much you had incrementally expended in growth programs this year versus last year?

Incremental growth spending this year versus next year?

Yes.

We don't talk about the dollar amount we are spending year over year and then the growth programs that we talked about in the Call, you know, obviously the new SKU expansion that continues on the direct mail, the redirection of the sales force in the more productive areas.

There are growth spending that is actually in our numbers right now and for competitive reasons we don't actually quantify those dollars versus prior periods [and so forth].

Okay.

Those incremental dollars are included in the 25% increase?

Charles BoehlkeYes our 25% read-through is absolutely a function of what you are seeing on the P&L in terms of the total operating expenses include any depreciation that might have resulted from prior period investment, any increase in the sales force, the cost to produce our catalog, the products; all that is reflected appropriately in our expense number and is part of our read-through commitment.

That's correct.

Right.

Let me ask you another question.

Are you seeing any changes in the market that [pulled out] prompt you to do more acquisitions?

Changes in the market -- I would say no changes in the market.

I would tell you this that we get lots of calls about opportunities for acquisitions; if we chose to be interested in them we could but we've not seen anything to-date that has met our pretty strict parameters for what we would like to see in terms of an acquisition candidate.

What would you like to see?

Yes, I think for competitive reason that is probably, you know, not the right place to go.

I mean just generically, as we said before, it was something that we need to be accretive and support our top line growth targets and I think that is probably all we can say.

So, it would be more of EPS accretion dilution criteria?

And that would be a piece of it, but as I said it would also have to meet some top line criteria as well.

So, again I think for competitive reason that is about all we are comfortable saying.

Then let me ask you my last question, would you go -- has anything changing, you know, in acquisition integration the way you think about it versus previous years?

We haven't done an acquisition since 1998.

So, there is really nothing to integrate right now.

Okay, thank you very much.

Thank you.

Your next question comes from Jeff Germanotta with the William Blair & Company.

Hi, good morning.

Could you give a little insights in what you're thinking in terms of capital expenditures for next year and under what market price dynamics, company performance metrics might you consider building out your branch network particularly on the West coast?

I'll take the CAPEX piece Jeff, I think our CAPEX since we've consistently said that there's nothing major on the horizon we would anticipate much like this year that the D&A would in fact increase, be a bigger number than our capital expenditures for the foreseeable future, even if some of that may be coming down as some Y2K and other type investments go away; we see no circumstance where our CAPEX would significantly out run our D&A.

So, [inaudible] is slightly decreasing net fixed assets we believe is something you can count on for going forward.

Jeff its David.

In terms of the West, I know you know that we don’t for competitive reasons you know talk about where we are in our planning.

Certainly its -- it's an important part of where we see our future going and we are very excited about the opportunity, I guess in terms of nailing down, you know, metrics to invest there I guess the best I can say is, you know, we are committed to both investing and growth, but investing and growth on a going forward basis consistent with our plan to balance that with ensuring that we deliver the kind of [read thorough] in the earnings.

So, we you know -- we deliver on both goals.

Thank you.

Again, I would like to remind everyone, if you would like to ask a question press "star" then the number "1" on your telephone keypad at this time.

At this time there are no further questions, management are there any closing remarks.

we would like to thank everyone for tuning in today and see you again in three months folks.

Thank you, bye, bye.

This concludes today's teleconference.

You may now disconnect.