MSC Industrial Direct Co Inc (MSM) 2008 Q1 法說會逐字稿

Good morning.

My name is Bobbie Joe, and I will be your conference operator today.

At this time, I would like to welcome everyone to the MSC Industrial Direct first quarter conference call.

(OPERATORS INSTRUCTIONS) After the speakers' remarks, there will be a question and answer session.

(OPERATORS INSTRUCTIONS) Thank you.

I would now like to turn the call over to Mr.

Joyce.

Sir, you may begin your conference.

Thank you and good morning everyone.

I would like to welcome you to the MSC Industrial Direct fiscal 2008 first quarter results conference call.

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

If you have not received a copy, please contact our offices at 212-850-5752 and a copy will be sent to you.

Online archive of this broadcast will also be available one hour after the conclusion of the call, and 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 on the same website and in the Investor Relations section.

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

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

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

Important risk factors can cause actual results to differ materially from those reflected in the company's forward-looking statements included in today's earnings release and in the company's filings with the Securities & Exchange Commission.

In addition, the information contained in this conference call is accurate only to 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 on this call.

That said, I would like to introduce MSC Industrial Direct's President, Chief Executive Officer, David Sandler.

David, please go ahead.

Thanks, Bob.

Good morning, everyone, and thank you for joining us today.

With me are Chuck Boehlke, Executive Vice President and CFO, and Shelley Boxer, Vice President of Finance.

I thought that it made sense to change the format a bit today as I know that our shareholders are concerned about a potential slowdown in the industrial economy.

I want to be sure that we do our best to articulate our vision for success should the weak data continue, and that we clearly express our confidence and excitement in the future of our company.

I have been active in industrial distribution for more than 30 years.

I love this industry and remain very excited about the long-term consolidation opportunity.

What I know is that there are, and likely always will be, cycles in our segment.

What I have learned is that how we manage during a downturn, if that is where the economy is headed, is critical to value creation when the cycle inevitably turns.

I want you, our partners, to understand how we will prudently invest to enhance our customer experience while driving productivity with even greater focus, thus enabling us to continue to improve earnings.

I will also provide some of the usual details about the quarter.

Chuck will provide details on the financial results and on Q2 guidance.

After my closing remarks, we'll open up the phones for questions.

I have said on numerous occasions that our expertise as in operating this business, not making the big macro call on the economy.

However, what we can offer is directional data that we gather on a regular basis which enables us to drive initiatives in the near term.

Our customers tell us that market conditions are mixed.

While there continues to be many pockets of strength, there is less optimism in general and more concern over cost inflation, especially in raw materials and energy costs.

What is somewhat recent is the degree to which our customers mention the possibility of a recession.

That psychology is more driven by the macro news on housing, retail and job creation, but the expectations are beginning begin find their way into our customers plans for CapEx and job creation.

While this is, of course, a concern, it does bode well for our high service level model which enables us to gain share as customers reduce inventory.

In terms of macro indicators, the weak durables orders, declining ISM numbers, and the recent employment report are also indicative of a slowing market.

I have spent my entire career in industrial distribution, worked through a number of cycles, and understand what they look like.

I know that when things are busy, the down cycle will inevitably come and that when customers believe the economy will never recover, the boom cycle is never too far away.

What I don't know, of course, is when.

We have told you that in an environment of single-digit revenue growth, we can grow earnings while continuing to prudently invest in our future.

Our activities thus far are consistent with that commitment.

In order to protect one of our most significant assets, our customers, we have invested in our inventory where we thought prudent.

By doing so, we impacted short-term cash flow but will recover that cash over the next few quarters.

We will continue to invest in an enhanced customer experience through this period of slowing economic growth so that we are positioned to take even greater share when the direction of the economy reverses.

Over the course of fiscal year '08 you will see us moderate the incremental year-over-year growth investments if the economy continues to deteriorate.

MSC is very well positioned to take share, and we do not expect to see any material decline in our operating margin.

We are a very different company than in the last recessionary period of 2001 and 2002 when we had just completed a program of national expansion, filled three fulfillment centers and a completely new IS system, including a formidable internet site, opened many branches, doubled our sales force, had significant excess capacity and were burdened with an enormous fixed cost.

That's not the case today.

Much of those investments have been depreciated, and we carefully manage our capacity.

We know how to quickly change course in our growth investments and our head count.

Our larger size and much more efficient systems have helped us to increase our operating margin dramatically over the past several years.

We are in a better position than ever to prudently invest in the business, protect our associates and customers, drill down even harder on productivity, continue to grow earnings and generate significant amounts of cash.

Turning to the quarter, first quarter results were solid.

We continue to make progress executing our growth plan and on our plan to sell MRO products and other MSC brands to our J&L customer base.

Our West Coast initiative is making solid progress and continues to meet our goals.

Our new sales offices in Seattle, Portland, and Salt Lake City are now open.

We grew our sales force to 854 associates at the end of Q1 and expect that we will reach 860 by the end of Q2.

However, due to timing, in Q1 the sales force continued to grow at rates well in excess of our sales growth.

Q1 reflects spending in other growth areas as well.

At the same time we have increased our focus on managing our overall expense levels and we're pleased with the resulting Q1 operating margin.

I would like to give some guidance for the second quarter.

Chuck will add some details about this in his section.

At this point, we think the sales will be in the range of 430 million to 436 million, and diluted earnings per share will be in the range of $0.68 per share to $0.70 per share.

Thanks and I will now turn the mic over to Chuck.

Thanks, David.

In Q1, sales came in roughly in the middle of our guidance range and earnings came in at the upper end as we we executed on our plans and controlled operating expenses tightly.

Sales projections for Q2 incorporate the effect of external indicators such as lower durables orders, decline in the ISM index, increasing feedback from customers concerned about slowdowns, and the effect of the timing of the Christmas and New Year's holidays.

Our revenues were impacted by the timing of this year's holiday season.

The holiday week brought more in the way of shutdowns than last year, and the timing of the holidays on Tuesday, rather than on Monday as in the prior year, meant that we experienced significantly weaker sales on the business day before Christmas and New Year's than last year.

In fact, more customers this year decided to do shut down for the entire week.

We estimate that the change in the timing of these two days probably cost us between $4 and $5 million in sales in Q2.

Gross margin in Q1 came in within our guidance range, and we continue to forecast gross margin in the range of 46.3% plus or minus 20 basis points.

Operating expenses have been under tight control even as we've continued to incrementally invest in our future at historically high levels.

Operating metrics remain solid as the most balance sheet metrics.

We experienced a slight increase in receivable DSOs to 44.7 days from 43 days in the prior quarter.

This appears to be mainly seasonal, and we would anticipate a lower number at the end of Q2.

We also built inventory during Q1.

There are several reasons for this.

The primary reason was to ensure the best possible service experience to the J&L customer base as they transitioned from J&L's fulfillment system to MSC system and to also ensure that same experience for all the MRO SKUs that will be offered to them as well.

We also plan to build inventory to support a higher sales level and protect our fill rates.

That inventory build started last summer and peaked in Q1.

We plan to adjust our inventory to the right size over the remainder of the fiscal year.

Free cash flow, which we define as cash provided by operating activities less capital expenditures, was $29.4 million for the quarter and was adversely affected by the growth in inventory and receivables.

We will convert a higher percentage of net income into cash provided by operations over the balance over balance of the year.

Capital expenditures were $2.6 million, somewhat lower than expectations due to timing.

In Q1 we also purchased $24.4 million of our stock in the open market.

Thank you, and now I will turn it back over to David.

Thanks, Chuck.

I know that every quarter is important to our shareholders.

I think that this team has prove its ability to translate revenue and cost control into earnings and cash flow, and we fully intend to continue to do so in the future.

We are mindful of our partners and take seriously our job of enhancing shareholder value.

Our partners want a team that can execute in the short-term yet has the vision and the drive to deliver short-term performance while keeping its eye on the prize of long-term value creation.

Our company has done so since its founding by Sydney Jacobson in 1941.

We will invest in and continue to enhance the experience for our associates and our customers through a downturn, if that's where we are headed.

A slowdown will permit more time for us to focus on productivity and eliminate non-value add costs.

We will do so relentlessly.

We have a vision.

It is a clear one.

We have a plan.

It is tight, and it is aggressive.

Our team is committed and very clearly focused on the prize sox execute, execute, execute during the slowdown and position our business to leverage during the recovery.

If it sounds familiar, it is.

We know that a slow growth economy requires real focus on the cost side.

I can say with absolute confidence on behalf of the entire MSC team that we are prepared for the challenge.

I will now open the line for questions.

(OPERATORS INSTRUCTIONS) Your first question comes from the line of Dan [Wong] from Lehman Brothers.

Yes.

Good morning.

First question was you talked about the changing sentiment of the customers and their different pockets of strength out there.

Could you go into a little bit more detail about perhaps more details around the industries where you're seeing the different signals?

Dan, it is David.

We don't like to signal specific industries that are up and down.

Part of how we actually adjust our plan and focus our sales force is spending a disproportionate amount of their time in the areas that we see the greatest opportunity as well as servicing our entire general customer base.

I guess to characterize a bit across-- related across the regions, is that we are clearly being affected by softness in the industrial economy.

The greatest areas of slowdown are concentrated naturally in the durables sector more than any other sector, and within manufacturing, light manufacturing as we refer to it, is actually growing faster to that segment as well.

Basically, the mix that we're seeing is really spread throughout all of our regions where we're seeing pockets of strength and weakness throughout our varying customer segments, and also you see that western region continues to grow strongly and outperform as we expect, given the significant investments we've made into our expansion program there.

Okay.

And to follow up, I think you had comments in your release about customers, the current environments, minimizing the MRO inventory levels.

Where are we in this process as the customers adjust their inventories?

I guess should we interpret this obviously as kind of a near term negative impact but once they reach a certain optimal level of lower inventory that you will continue to see it as an opportunity for market share growth and so forth?

We absolutely see it as an opportunity for market share growth, Dan.

We think that some of the tone that we're seeing has just -- we've seen it, but it is getting a little bit more pronounced.

I wouldn't say that we're seeing anything dramatic in that respect, and I don't feel like the buildup of inventory or there has been a significant buildup of inventory.

I think in general (inaudible) has been more cautious than historically given some of how they were burnt many, many years ago, but to the extent that customers are more and more cautious or become more and more cautious about inventory and want to reduce their levels, they'll want to rely on a supplier where we're perfectly positioned to actually help them to take their inventory levels down, rely on ours, and that's where our model really begins to get traction as customers become more cautious in that regard.

Okay.

Great.

Thank you.

I will hold to those questions for now.

Thanks, Dan.

Your next question comes from the line of Yvonne Varano from Jefferies.

Can you just address the slight increase in the tax rate in the quarter and what we should be forecasting going forward?

Yvonne, it is Chuck.

It is just a slight tweak in the tax rate as outlook on earnings and so forth changes, there is lots of variables that go into that.

We have six elements of our tax rate, in terms of deductions and credit, that has become a different tax percentage depending on how the net income plays out.

There is underneath that that's moved it substantially.

I think the planning at 3816, which is the actual tax rate for the quarter, is sufficient for the rest of the year.

And then I know we've continued to add sales people here, but if, I guess what has to change or in the overall outlook for the environment to for you to slow that growth?

Yvonne, it is David.

We'll continue to monitor that very carefully.

We've always talked about that balance between short-term profitability and long-term growth investment, and kind of tweaking the dials.

You have seen us really beginning this quarter to do a little bit of that tweaking so we'll continue to adjust to maintain that balance depending on what we see coming down the pike.

And then you did announce a pretty sizable share buyback.

Given your projections for free cash flow, over what time period do you think it would be reasonable to potentially complete something of that size, and I know it is partially depending on the share price, but just looking at the price today?

Yvonne, this is Chuck.

We've not telegraphed our strategy for when and how much we would buy back.

It is a big allocation for us to go do so.

You mentioned the cash flow.

We would project that net income converted a much higher percentage of cash flow than we experienced in the second quarter as we burn off the inventory and the receivables come back in line, so the cash flow will be there to support it, it is just it will be more opportunistic, and we generally don't telegraph when and at what price we would do it.

Okay.

Great.

Thanks.

Thanks, Yvonne.

Your next question comes from the line of Robert McCarthy from Banc of America.

Hi, everyone.

Hey, Rob.

The first question I guess we already have been kind of in a Fed easing environment.

From your historical perspective, given the fact that we're kind of anticipating a pretty significant slowdown here, thinking about the back half of the year in terms of the comparison and given the fact we're already in kind of an easing environment, how do you think about how the back half of the year kind of treats you Q3, Q4 qualitatively?

Obviously, you don't give guidance until you don't know until you roll out quarterly guidance, but do you have any flavor for the compare and what would you expect, in terms of the impact of in the back half of the year?

Robert, we don't give guidance beyond what we see given the limited visibility that we have.

I guess the best that I can say is that we've got an absolute plan to continue to adjust, be really opportunistic in this environment, take share.

You've seen some of the adjustments that we've made with our salesforce guidance.

We've also made some adjustments with our direct mail program.

That's something we post, and we're constantly looking there.

We'll continue to invest prudently.

We'll continue to really balance and take advantage of the what comes along in this environment for us, but we really don't want to go further in what we see as the back half of the year other than that we've got a plan to continue to adjust and continue to ensure that we're balancing the delivering our short-term earnings coupled with investing for growth in the future.

I think you've also reaffirmed your margin targets.

You don't see much deleverage in the near term or on the earnings front.

I think it is still positive earnings.

I think it contemplates a relatively shallow recession.

Is that fair to say?

If you saw 5 to 10% declines in North America, would there be an update?

What is the underlying economic assumption for the decline?

I think that speaking to a shallow recession, Rob, which is what you've just talked about, I think the way to think about is certainly the way that we do, listen, we've grown through every recession in our 66, 67 odd-year history really with the exception of the tumultuous times that followed 9/11, and we believe that given our tremendous positioning today and the progress that we've made in the last many years with our business, that frankly, and you mentioned a shallow recession, that we'll grow through a recession.

You know what, unless it is extraordinary, in terms of depth and duration, and as we're growing through the recession, what we would expect to see happen is that as maybe low single-digit growth that we would expect to continue to invest, but that we would invest in a way that our earnings would grow somewhat faster than our revenue growth and to the extent that revenue growth would grow more quickly than our earnings will grow more quickly, in terms of the delta with how much faster earnings will grow than revenue and to the extent that they moderate, then that delta will shrink.

And finally, thank you for that, and finally, this may not be something you really want to talk about at this juncture, but any incremental flavor for what we saw in December?

Yes.

No.

We're happy to talk about it actually.

December was -- boy, I will tell you, the vacations and the way that they fell, the holidays the way they fell were very difficult.

The last year the holidays fell on a Monday.

This year they fell on a Tuesday.

Effectively what that meant was that the two Mondays we've done work to quantify them.

We think that December actually got hit to the tune of 4 to 5 million which, if you factor that back into what December growth would have looked like, we estimate that it would have been in the 7 to 8% range if holidays have fallen differently, and I guess in addition to that we did see more customers shutting down in that month, but we think that just because of the positioning of the holidays, it probably cost us a few points in growth to the tune of maybe even 4 or 5 based on what we lost there.

And I guess just to go beyond December, when you think about that in the context of the midpointed of the guidance we're giving for Q2, we think that -- which is currently 7%, we think when you factor in the loss in December, it probably would have pushed us closer to 8% had the holidays been in a different position.

So you really haven't seen core deceleration in December due to this compare, there was nothing underlying that aside from the compare is what you would say?

I think that's fair.

I think that when you consider that, it means that December was pretty closely in line to what we've been saying, but what's important is that we really wanted to telegraph a slight slightly different tone.

Right.

That may or may not go well depending on what happens moving forward, meaning if the ISM continues to go down, if the sentiment continues to build, then we're signaling caution for revenues in the back half of the year and beyond to the extent that that changes, which it very well could, which we can't predict, then that's a different story.

That's very helpful.

One more question, and I will pass it on because you've been very indulgent.

I think for the Q4 fiscal year '07 results or is it one additional week, right, that is the one compare we have to think about going into '08, correct?

Correct.

Obviously when we get the comps for the fourth quarter, we need to talk about that as to how that week impacted this year versus last year, absolutely with an extra week worth of sales and profit associated with that in the last quarter of last year.

Like the comp, does it work its way just on a [rata] basis through the first three quarters then in terms of incremental benefit?

Do you see what I am saying?

Or is that --

No.

It is a pure fourth quarter -- David talked about the holidays and those types of things, and maybe during the quarters there is a shift in day from quarter to quarter, but that would not be related to the extra week.

Purely I think the extra week knees to needs to be viewed in the fourth quarter.

Any issue with Easter this year?

With what?

Easter holiday.

We're looking to see when Easter is.

March 23rd, I believe.

Yes.

We would have to get back to you, Rob.

We don't have Easter on the radar with the data in the room.

That's Catholic, not Greek orthodox.

I will leave it there.

[ Laughter ] Thank you, Rob.

The next question is from the line of David Manthey from Robert W.

Baird.

Good morning.

Hi, David.

My question is mainly related to I think Chuck you made a comment about the percentage of your cost structure that was fixed back in the early 2000, and I am wondering if you can give us an idea, if not a magnitude, maybe a relative percentage to say it was X percent fixed back then and today it is less so by what percentage?

Dave, I think what might help is we look at, and we talked about this in the past a little bit, that the out of pocket variable is plus or minus 10%, and I think you can get to the same place of where you're going there.

When we look at incremental sales volume and so forth, plus or minus, we generally consider with the freight costs, the warehouse, pick costs, the cost to take the order up front and so forth plus or minus about 10%.

That should help you get where you need to go.

How does that differ from what it was back in fiscal say '01, '02?

We've had a pretty regressive cost down program that included attacking the freight cost as well as order entry costs which is a piece of the variable.

You can see from some of the things we've done increasing the percentage of our sales that go through the website and everything else, we've driven down the variable costs.

It is down several hundred basis points from where it used to be, in terms of -- and that has been a major focus because obviously it is it is spread across the entire sales base.

And your fixed cost as a percentage of total costs is also down because total costs in general as a percentage of sales is down, Dave.

Thank you.

And the second question is in the recession earlier in the millennium here, your sales in some months were down pretty significantly, and what I am wondering is how do you plan to mitigate that type of weakness this time around if we do go into a garden variety recession, given that I suppose over the past five years or so the model hasn't changed that much on the sales side, and I am just wondering what would you do in terms of changing your sales tactics and then also I think you addressed a little on the cost side, but if there is anything else you want to add there?

Sure, David.

It is David again.

Actually I think things have changed pretty dramatically in the last several years, so maybe talk a little bit about what we think happened and just a step back.

I guess, the regrounding, our motto as you know is designed to take share from smaller distributors to our value creation model with our customers, and we think that share gains actually accelerate during a business slowdown as we out compete the small distributors who really are going to struggle to service their customers.

During the period we'll balance short-term profitability with long-term investment spending, and we'll also focus relentlessly on reducing our costs.

That means that we'll continue to invest in the salesforce and in many of our other growth drivers albeit at slower rates than during expansionary times.

We'll also stay very focused on enhancing the customer experience, continuing to build our value basket through enhanced service, continuing to build out our technology solution, our huge product SKU base and so on, and I think it also importantly it gives us the opportunity to devote more of our time to cost-down programs, things like our fulfillment center optimization program, taking that across our other centers, really focusing more of our time and our associate's efforts on (inaudible) and lean-type programs, taking nonvalue-added costs and waste out of the business and things that don't enhance customer value coupled with a real -- and even further focus on productivity.

So we expect to convert our net income into free cash flow at increasing levels as we concentrate on asset management, and we utilize our cash to further our stock buyback program, our dividend program, and if there is an acquisition candidate or candidates out there we think that that type of environment likely we'd see increases, and if it were long in duration, likely we would see valuation levels moderating as well which could be very opportunistic for us as part of our how we think about our strategic plans.

I guess the other thing I would say is that once we come to the other end of all that, once the direction of the economy would change, and the what I will call the inevitable expansionary cycle begins, we're going to be perfectly positioned to grow sales and earnings just dramatically as well as gain a ton of share, we'll have increased our total growth driver investment base, we'll have a business that's much more lean with lower operating costs, and you followed us for a long time, what I described isn't a new plan.

It is one we've executed on before, and I am confident in our ability to do it again.

Okay, David.

Thank you very much for the color.

Thanks, David.

The next question comes from the line of Jeff Germanotta from William Blair.

Good morning.

Hi, Jeff.

A couple of questions.

The first one, can we talk a little bit about the sources of inventory build, whether it is price increases, freight in, expanding the products in the catalog, more sales people, locations, or something else?

Which is Chuck.

The inventory build really isn't much of any of those things.

It was really a defensive play to take care and absolutely ensure that we protected service levels through a major shift in systems and so forth for us, so it is really two fold.

It was to protect the J&L fill rate as well as the MSC fill rate as we went through a pretty significant systems conversion.

Also, with the advent of the J&L team having access to the MRO items, we want to make sure that was a good first-time buying experience for the J&L customers, so it was really that kind of defensive play.

We believe it is peaked.

In fact, we're confident it has peaked, and I think you'll see as we progress throughout the year we'll burn in any growth scenario frankly we'll burn a good bit that far inventory off and end up in a better spot by year end.

So we should be generating a lot of good free cash flow in the year ahead?

Absolutely.

Share repurchase.

If you look at historically the last three or four years, we've converted nearly dollar for dollar net income into operating cash flow.

That wasn't the case with the results for this quarter, and it was because of primarily the inventory build was some contribution to the receivables bill.

We expect those those metrics to improve as we move forward through the rest of the year which will lead to much higher conversion of our net income into operating cash.

So let me be clear.

For fiscal 2008, do you think operating cash flow will be 1:1 or do you think it will be a little better than where you've been in the past?

I would say given we've got to burn off this inventory and go through -- this is not going to be a one month or one quarter and done.

It is going to take some time to do that, but I expect by year end you would see metrics for the year-end result similar to what we've done in the past.

In other words, instead of as we did this quarter 67% conversion of net income to cash, I think you'll see a higher metric throughout the rest of the year approximating the historical levels as we get near the end of the year.

And the next question has to do with CapEx and investment spending, whether it is facilities, IT, mailings or sales people.

Can you give some relative indications of what you're thinking for this year vis-a-vis the year past?

Again, a lot of our investment spending, Jeff, for everybody's edification, investment spending for us is often on the OpEx side with salesforce expansion, direct mail.

Specifically from the CapEx side we see numbers we believe similar to last year's CapEx spending in the $25 million range.

We have costs down opportunities that we've talked in the past about our optimization project at our Harrisburg fulfillment center.

We have the opportunity to roll that similar type program out to other fulfillment centers, and we would start to do that during this year which requires some CapEx, so it is a combination of maintenance CapEx, some facility expansion, as well as some cost down optimization projects that will be kicking in throughout the year.

And in terms of mailings or sales people, is that going to remain rather fluid or how should we -- or more consistent with historical levels?

Jeff, David.

Yes.

I think that being a bit fluid is probably a good way to describe it.

We're going to keep our hands on the controls and frankly on the dials and watch very carefully to the extent that we continue to see a deteriorating economy.

You'll see us invest, but you'll see us moderate those levels, and to the extent that we see debt going the other way then we'll ramp is up a bit more.

So we'll always keep a thread of investment going, but we're going to be very mindful of that short and long-term balance, and we're going to watch it very carefully.

You have seen us make a few modest adjustments actually in this quarter leading into Q2 with our direct mail estimate being slightly down as well as our salesforce expansion being slightly rachetted as well, given how well we did in actually over achieving our goals and our expansion targets for Q1.

And you opened three locations recently.

Your thoughts -- well, one, how are they performing, and, two, your thoughts regarding more location expansion going forward?

The west is a really exciting program for us.

It is still early in the game.

It has been about three years, but we still think that's very early.

Seattle, Portland, and Salt Lake City exciting to have the new members of our team digging in, and we're excited.

It is obviously very early in terms of talking about any meaningful results there, but it is very additive to our program.

We still see a lot of opportunity there, and we think that the runway is long for investments, whether it is branch or expansion opportunities with new sales associates both inside and outside.

And the focus, in terms of adding sales people and/or locations, will be on the West Coast in the year ahead?

The West Coast will certainly be one of our kind of centerpiece investment areas.

It is not the only area that we're investing in because we don't like to broadcast that too much, but certainly it will be an area that we continue to focus on.

Thank you.

Thanks, Jeff.

(OPERATORS INSTRUCTIONS) You have a question from the line of Brent Rakers from Morgan Keegan.

Follow up on the question about the sales additions.

Looking back, it looks like this first quarter was one of the -- maybe it was the most number of sales people you've added in any one quarter.

You've talked before about the timings of hires during a quarter to give us a better sense of what the operating costs might be going forward.

Could you give us a sense for this first quarter?

Brent, hi.

It's Chuck.

Actually it is not only the first quarter, Brent, but I think if you look at some of the statistics we put on the web, the second half of the last year we hired significantly more faster more folks, if you will, than we hired in the first quarter of last year.

What that does obviously until the folks anniversary, you have the OpEx of people that were hired in Q3 and Q4 of last year as brand new incremental OpEx, Q1 of this year versus Q1 of last year, and it will happen again in Q2.

You add to that the large number of hires we had in Q1 which just to pick the mid-point you had a half a quarter's worth of salary.

You'll have the full salary in the OpEx for Q2, so we actually think investment spending because of kind of the process I described here will probably peak in Q2 doesn't mean we won't be hiring and adding folks for the rest of the year, it just means we anniversary a significant piece of those folks that were hired in the second half of the last year as well as fully absorb first quarter of this year.

Great.

And then maybe further comments on the direction of spending in terms of hiring the new sales people.

You see that obviously through a significant ramp for the last I think two or three years or so, and you see continued contraction, though, in terms of your direct mail.

I think your number for next quarter I think is down 15 to 20% or so year-over-year.

Anything to read into on a strategic sense from those decisions there?

I think, Brent, strategically on direct mail, it continues to be an important part of our program.

It is one of the areas that we kind of turn the dials on and moderate our spending.

Specifically, what we do in an area like that is that we try and focus on cutting out say the part of the program that has the longest returns.

Doesn't mean it is not a good investment, it just takes longer for that investment to produce, so that's actually where we moderate.

The other thing you've seen in direct mail and you continue, it is not really evident in our numbers, but it is something we work on here, is continuing to find better ways to reach our customers through that vehicle and make the program that much more productive, so we've been very successful in doing that and frankly getting more from less.

We detected many things that some work, some don't, which we then implement across the program, and we're continuing to do exactly that, so strategically we absolutely will continue with that program.

Of course another element of it is that over time more and more will fall into our electronic channels.

Having said that, we get the question all the time about is paper still going to survive both in the big book and our brochure program, and we don't see anything in the near or frankly the long-term that will replace that.

Okay.

And then two more questions.

One is housekeeping.

I guess first a housekeeping.

In terms of the number of shares you purchased during the quarter, could you give us that number, and then also maybe a sense for if you continued being active in the market in December and the first part of January?

I can tell you for the first quarter we bought roughly 600,000 shares for $24 million.

The rest of your question, just like I answered earlier on, we don't advertise our strategy, wouldn't comment on what we've done since the end of the quarter.

Okay.

Fair enough.

And then last question, a lot of people using the R word quite often now.

Just wondered if you can compare what you're seeing now to what you saw October/November/December of 2006?

We had a pretty significant factory slowdown there, we call it a soft patch I guess now.

I was wondering if you could compare the conditions then to your current business conditions now?

We're actually looking.

I am trying to get what the ISM data points looked like back then.

I think it touched maybe a low of 49 I think at one point in there.

Which is pretty consistent with what we've been seeing for trending in the last few months was coming down to right on the cuff of expansion and contraction.

I will tell you that the tone in the last several months has been pretty decent actually in the marketplace.

It has still been in expansionary territory.

I think that we had touched down and kind of tweaked contraction a bit.

Of course, right now our most current data point, we don't know where that is going to go is in contractionary, pretty significant contractionary territory at the 477 that just occurred, but remember that it takes time, that what we see for current data point generally takes a series of months before it comes out before we actually see that in customer's buying behaviors.

So, I would say that what we saw back then was -- was reasonably solid, and what we're seeing right now has been roughly the same, and we're going to wait and see if the tone and a little bit of what's creeping into the tone actually converts into buying buying behavior.

David, is it a fair conclusion, then, to make that a lot of your more cautionary tone than maybe the last time around really rests pretty heavily on that last ISM number?

It is a combination of the ISM, as you know is one important data point that we watch, but it is not the only data point.

Okay.

We watch all the macro, and probably the most important, and it is anecdotal, but it is really something we spend a lot of time on is getting out with our customers and really gauging from them how they're doing in their business and what their psychology and sentiment is and while there is still a lot of strength out there, we are seeing that psychology creeping more and more into the customer base probably just based on what people read in the newspaper every day, what you get blasted with in the news every night when you get home.

When that's going to change, don't know, and how much further that would get into customer's psyches, and ultimately would affect their business, we just can't call that, but whatever happens, we're prepared for it.

Thanks a lot, David.

Thank you.

Your next question comes from the line of Holden Lewis from BB&T Capital Markets.

Holden, are you there?

Holden, your line is open.

Maybe try again, Holden.

Okay.

He seems to have disconnected.

Your next question comes from the line of Adam Uhlman from Cleveland research.

Thanks.

Chuck, a question for you on the earnings guidance.

What share count are you using in the earnings forecast?

Does that incorporate the number of shares that you ended the quarter with or does it incorporate your expanded repurchase authorization?

Well, a couple things.

For sure it incorporates which we talked about for Q1, the 600,000 shares we bought, but I think as you know the stock price and how that affects diluted shares is pretty significant element to determining the absolute value of shares.

So what's been baked in there right now is known purchases in Q1 and a stock price that's similar to what it is now.

That's basically it.

Okay.

And then a couple of questions on the revenue performance for the quarter.

Could you break out what the contribution of sales growth was from pricing and from your large account programs?

Sure, Adam.

It is David.

Happy to.

On the large account front, roughly half of the growth or about 4.25% of the 8.8 that we reported came from that segment.

About just under 2%, about 1.75% came from pricing, and the balance came from our core which was about 2.75% all based on average daily sales.

Okay.

And then could you give us a little more color about the growth that you're experiencing on the West Coast?

It has slowed in recent quarters.

Could you talk about how that region has performed versus your budgets or your plan and with the investments that you're making out there now, should we expect double-digit sales growth to continue out there or is that going to slow as well to a single-digit range?

Could you give us more color on that?

Sure.

Listen, I am not going to predict or forecast.

Of course we have our internal plans which we don't share, and I am not going to forecast what the growth rates specifically out west may be in the future.

The west is no different than the rest of the country in terms of being exposed to a slowing industrial economy.

There is the combination of manufacturing both light and durables out there, and all the things that all of our other regions are kind of subject to holds true for the west as well.

I guess what's different is that out west we have put a disproportionate amounted of focus and investment there which we think is driving disproportionate growth, and we would expect to continue to see disproportionate performance, significant performance, outperforming other regions moving forward.

Okay.

And then the last question for you, David.

You talked earlier about customers being concerned about inflationary pressures.

What are you hearing from your vendors regarding potential price increases for 2008, and when you look at your volumes for 2008, how much of that do you think your price protected in this year's big book?

Yes, Adam.

Good question.

I am not going to give the specifics of tracking to how much it is protected in the big book because I wouldn't want to give away any specific strategies that we have in that regard, but I will certainly be able to give you color on what we're seeing in the macro, which is really we have begun to see a bit of an uptick in volatility in that pricing environment.

I will give you a couple of primary drivers there.

One is on raw materials, and the other is what we're seeing on our Asian products, specifically our product source from China.

On the raw materials front, we're seeing continued pressure on petroleum-based products.

That has remain una baited, and if that continues to escalate, raw materials like, it moves around a bit, but raw materials like copper, tin, carbon, steel, and metals like tungsten and aluminum we've also seen increasing of late.

On the China sourcing side, those products which we source there have been under cost pressure, really two factors.

One is due to currency and the other is a back tax imposed by the Chinese government.

What's really good news there for us is that our team has done just a tremendous job of being able to offset some of the effects of those increases by executing our purchasing strategies in that area.

I guess I will throw in a couple of other on a positive note, we're taking advantage of, you see it a bit in our inventory, taking advantage of opportunity buys which we've continued to see in the marketplace and that that we've got suppliers that are slower, especially slower in other segment that is are down that are coming to us with great deals, and another component of our program is that suppliers who invest in MSC, which touches a bit on what you said earlier about protecting the price, those suppliers that invest in our company really they gain a disproportionate advantage with us in the way that we position them as they prefer the flier, and I guess finally the net of all this importance of the punch line is that we've given you some gross margin guidance both for the quarter and for the balance of this year, which is 463 plus or minus 20 basis points, and there is so many things that factor in our margin.

The net of all of those moving parts is that we are staying rate right on point with the guidance that we've given.

Okay.

Thanks.

Just a clarification.

You had mentioned opportunity buys in the quarter.

Was that a material piece of the pickup in inventory in the quarter?

I think the biggest piece is what Chuck had described.

We always got an opportunity divide factored into our inventory plan and the most significant certainly was protecting our fill rates, especially with our new customer --J&L customer base.

Great.

Thanks.

Sure.

Your next question comes from the line of (inaudible) from Bear Stearns.

Hello?

Hi.

I am sitting in for Scott Graham at Bear Stearns, and I just have two questions.

The first question actually was on your sales now if you can give some flavor on your progress in selling MSC products to J&L customer base?

Hi, it is David.

Yes.

We've trained our sales force on selling the products, the MRO product line and the MSC offering.

We've expanded that training from the field through our telesales and our entire team.

We're really pleased with the progress that we're making, but as we've described we said that that would be a kind of a slow assimilation in build as customers get more comfortable and change their buying habits to move their product from a competitor to now moving it to MSC and J&L, and so we're pleased with the progress that we're making, albeit that for this year we don't expect the sales to be significant, and it will build in '09 and beyond.

Okay.

Thanks a lot.

The next question was on your gross margin like the number which you gave, 46.3 plus or minus 20 basis points, now was that for fiscal '08?

Yes.

That is for -- we're giving that guidance actually for the coming Q2, but that we also see that playing out for the balance of the year being in that range.

Okay.

And how are your national account and (inaudible) sales going to weigh on gross margin?

Yes, we've always said that that is one of the segments o our business that actually puts pressure on our gross margin, and that's consistent with our planning, and that's factored into our guidance.

Okay.

Thanks a lot, guys.

Thank you.

Your next question comes from the line of Holden Lewis from BB&T.

Back this time, Holden.

You know, I had the wrong key.

Very good.

Welcome to the call.

I am glad that you're able to answer questions while I was able to get back in queue.

The average order size of about 302 is up about 4%.

Can you just talk sort of about the components moving upwards and downwards that's affecting that?

To what extent is that price, new SKUs, any other element that is might be affecting that and how you expect the element to say play out as the year progresses?

I think one of the biggest impacts, the J&L orders actually are dilutive to that average order size.

Our large customer strategy are accretive to it, and that's probably net net a large customer average order size is the thing that's the primary driver there, Holden.

Okay.

So as we continue to disproportionately grow that program, that will continue to impact average order size favorably.

Okay.

What about the elements of price and new SKUs and things of that sort?

Are those having meaningful impacts?

I can't say that we break it out quite that way, though we do look at our core.

We do look at the impact of our internet orders through our varying portals.

So the core of our business, as you would imagine, that as things potentially slow down that there will be pressure on average order size on kind of our core which is historically what we see anyway as customers squeeze that order, but that's offset by what we're seeing on our large customers.

Okay.

And are you seeing anything -- any sort of internal indicators of erosion such as lines per order or on the receivables side people having difficulty paying, any internal indicators like that that are shifting in a notable way?

On the -- we're not seeing -- there is no internal metrics in the business that we're seeing eroding.

Chuck will probably want to talk a little about what we're seeing on the AR side because we are getting a few -- we are seeing a little bit of a tone change there, but certainly with average order size, number of lines per order, things like that, we're not really seeing erosion in the underlying metric.

Chuck can talk a bit about what's --

I just saw aging up a little bit or anecdotally more questions about can you extend me another 15 days, the normal type of stuff that sometimes come when things are slowing down a little bit, nothing that's outrage us and completely different from any other time when the possibility of something slowing down exists.

It is anecdotal you hear that from the customers, "can I have 15 more days," but it's not pronounced, it's not across the board, it's just pockets of it that the pockets really didn't exist four or five months ago.

Okay.

And then lastly you commented about branch up in Seattle and that sort of thing.

Maybe this has changed, but there was a time when you really didn't have next-day service into sort of the northwestern point of the Pacific Northwest.

Have you found a way to sort of extend the next-day service all the way up the coast and now that's really covered or how does that sort of history jive with putting branches and people now up --

You're right on.

History still holds true although our team in the last many years has gotten very creative in how we actually are able to reach what would have historically been two-day and beyond territories into one day.

We're not able to reach every location, and you mentioned Seattle, our far west.

While we made tremendous progress there, we don't reach our entire West Coast customer base, although we are continuing to expand the number of zips that is we are able to convert from two-day or more to one-day, and I am confident that we're going to continue to progress in that direction.

Fortunately, our model while we get -- while it is optimized when we're able to reach our customers one day, we are still getting very good experience and traction even when we've got two-day service levels.

Okay.

Great.

Thank you.

Thanks, Holden.

At this time there are no further questions.

Management, you may proceed.

Okay.

Thank you all for your time and attention today.

We appreciate all the interest, and we look forward to speaking to you next quarter.

Bye bye now.

This does conclude today's conference call.

You may now disconnect.