MSC Industrial Direct Co Inc (MSM) 2008 Q2 法說會逐字稿

Good morning.

At this time, I would like to welcome everyone to the MSC Industrial Direct second quarter 2008 conference call.

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

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

(OPERATOR INSTRUCTIONS).

Thank you.

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

Eric Boyriven of FD.

Sir, you may begin.

Thank you, and good morning, everyone.

I'd like to welcome you to the MSC Industrial Direct fiscal 2008 second quarter results conference call.

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

If you have not received a copy, please contact our offices at 212-850-5600 and a copy will be sent to you.

An 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 in the Investor Relations section.

I will now 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.

They can give no assurances that such expectations or any of its forward-looking statements will prove to be correct.

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

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

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

David, please go ahead.

Thanks, Eric, and good morning, everyone.

Thank you for joining us today.

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

Results for our fiscal second quarter were better than expected.

We were able to outperform our own guidance due to solid execution of our business model, as we continued to take share, maintain our focus on driving gross margin, and keep tight control over our expenses.

Additionally, we were also able to take advantage of a very good opportunity to buy our own stock at attractive prices.

We bought just over 2.5 million shares at an average cost of $38 in Q2.

This was accretive to earnings in the quarter and will be more so in Q3.

We intend to continue to opportunistically buy our stock while ensuring that our balance sheet provides us the flexibility to pursue attractive transactions.

However (multiple speakers) -- we're going to check that line.

Just a minute.

Sorry, we'll check that and continue momentarily.

Operator, we're getting cross-talk on the line.

Yes, sir.

We're locating the line now.

Okay.

Sorry, folks.

We're going to -- we'll pick it up from here.

We were saying that we were able to take advantage of a very good opportunity to buy our own stock at attractive prices.

We bought just over 2.5 million shares at an average cost of $38 in Q2.

This was accretive to earnings in the quarter and will be more so in Q3.

We intend to continue to opportunistically buy our stock while ensuring that our balance sheet provides us the flexibility to pursue attractive transactions.

However, please remember that our criteria for acquisitions will remain high, as our internal growth opportunities continue to be very exciting.

I'd like to share with you what our customers are telling us and provide some color on today's marketplace.

Customers are generally indicating that order flows are relatively stable.

Of course, a portion of our customers are noting deterioration in their order books.

In addition, customers are becoming more cautious and there is a growing sense of apprehension over future business conditions and more talk of a looming recession.

Increases in raw material costs and in transportation costs are eroding the margins in our customers' businesses.

In order to generate cash, customer MRO inventories are kept at low levels.

We continue to operate in a very fragmented market dominated by small to medium sized private companies.

These smaller distributors typically do not have strong balance sheets.

They are experiencing much harsher business conditions than previously, and are reducing their inventories in order to preserve cash.

These lower inventories, combined with deteriorating cash positions and margins, often result in significant declines in the service levels they are able to provide to their customers.

When this occurs, their value proposition erodes, forcing them to use price as the only tool to maintain their business.

This puts further strain on their finances, does not allow them to build inventories, and provides MSC with a huge opportunity for share gain.

This is a cycle we've experienced many times in the past, and we have always gained significant share from those struggling, poorly capitalized competitors.

As we mentioned, our customers are reducing their MRO inventories as well.

When customers operate with reduced inventories and their local distributor cannot support them, they need to partner with a supplier who has the products they need in stock and can deliver them very quickly.

It is these economic realities that creates a tremendous opportunity for share gains.

This is when the MSC model, with its broad and deep inventory, 99% flow rate and same-day shipment, take share from these small, traditional distributors.

Additionally, a slowing economy presents a terrific opportunity for us to hire great people and to gain mind share with our suppliers.

We will continue to exploit all of these opportunities.

We continue to execute on our West Coast expansion plan, investing in new sales associates, taking share, and growing.

Please keep in mind that the Western region is the smallest of our regions in terms of total sales, so that while changes there may affect the entire business only minimally, they're exaggerated in scale and have a more pronounced effect on the West Coast metrics.

In Q2, we saw the sales growth rate in the West decline.

This is primarily due to the maturation of some of our earlier sale successes, as we annualize strong comps in those high growth rate customers, as well as the effect of pruning some low margin businesses that we acquired with J&L.

All of our regions have been affected by slower economic growth, and the resulting decline in the productivity of our growth investments, as has been the case historically, when economic growth slows.

Our expectations and our optimism for the West region have not changed.

Once we get through this low patch and the cycle turns up, we will see increasing growth throughout MSC and especially in the West, a region that is still virtually fallow ground for us.

Our sales force grew to 857 associates in Q2, and we expect to finish the third quarter at approximately 855 sales associates.

I'd like to give some guidance for the third quarter.

At this point, we think that sales will be in the range of $457 million to $463 million, and diluted earnings per share will be in the range of $0.77 to $0.79 per share.

And last, but certainly not least, I'd like to thank our entire team of associates and recognize their outstanding efforts in a year in which we are facing some significant economic headwinds.

Thanks.

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

Thank you, David.

We were very pleased that sales exceeded the top of our guidance range.

We are very focused on taking share from the competition and are seeing the results.

I'd like to remind everyone that Q2 sales were adversely affected by Christmas and New Year's Eve falling on a Monday this fiscal year.

We estimate that this reduced our sales growth rate in the quarter by about 1%.

This year, Q3 will have 64 business days versus 65 business days in fiscal '07.

Based on average daily sales, forecasting approximately 8.4% sales growth in Q3 at the midpoint of our guidance range.

The switch in the Good Friday holiday from April in fiscal year '07 to March in fiscal year '08 resulted in a lower sales growth rate in March.

MSC is open for business on Good Friday, but sales are greatly reduced.

This will reverse itself in April.

Excluding Good Friday, we estimate that March sales grew at approximately 8%.

We saw a small decline in the number of active customers in Q2.

We had made a proactive decision to reduce mailings to low-volume customers in order to improve contribution margins in those accounts.

As expected, we saw a fall-off in our total number of active accounts.

We also saw a decline in active accounts due to our own credit decisions, although a significant portion of those came from the clean-up of old J&L accounts.

Gross margin at 46.5% in Q2 came in at the top of our guidance range.

We expect gross margin to be 46.3% plus or minus 20 basis points for Q3.

At this point, Q4 gross margin is too uncertain to forecast due to the increasing volatility in the marketplace.

Due to the run-up in raw material and other commodities costs, we expect to see more cost increases from our suppliers in the coming months.

While we remain confident in our ability to pass along these increases, as David mentioned, the opportunity for any margin enhancement will be limited by the weak economy due to pricing actions taken by local competitors.

We continue to manage our expenses.

Our internal processes to monitor hiring and other types of spending are operating effectively.

We continue to invest heavily in growth, although as expected, productivity of growth investment is not as robust as it is during better economic times.

Balance sheet metrics are solid.

Inventories declined by more than 14 million in Q2, and we remain on plan to continue to work down our inventory levels.

Cash flow was excellent in Q2.

Free cash flow, which we define as net cash provided by operations less CapEx, was $32 million versus $8.6 million in Q2 of fiscal '07.

We made two tax payments in Q2, totaling $52 million.

And as noted earlier, we spent $96 million to buy MSC stock.

We expanded our revolving line of credit from $75 million to $150 million to accommodate these cash needs.

Borrowing is under line of credit in Q2 at $104 million and has since declined to $60 million today, as we have paid down the debt from our continuing cash flow.

We expect cash flow to continue at high levels as we convert more of our net income into cash, as we continue to execute on our inventory plan.

Thank you, everyone, and now I would like to open up the line for questions.

(OPERATOR INSTRUCTIONS).

John Baliotti, FTN Midwest.

Chuck, I have a question for you about -- you mentioned in the earnings release that you continue to make investments in growth and you also talk about how you're continuing to work the inventories down from the J&L acquisition and need to show progress in those turns in the second quarter.

I'm wondering, can you give us any sense of how you expect those turns to progress through the balance of the year?

I'll give it to you in a couple of ways, John.

Number one, I would say for the back six months of the year, we would expect us to convert a much higher percentage of our net income rate into operating cash flow.

And that is going to be, in large, driven by obviously, the profitability, but B, continued progress on the inventory reductions that we've laid out there.

So, we would expect inventories to come down from the current levels.

They peaked in December.

Without giving you a specific turn metric, we've got the dials and the radar up on the inventory that we'll be able to react very quickly to any changes, and would expect, from where we are today, that inventory level to come down further.

And I think where you'll see that, of course, again, is going to be an improved operating cash flow as a percentage of the net income that we report each quarter.

Okay.

And then with respect to receivables, is that slight tick down there, is that a function of sales growth or do you (multiple speakers) --?

Seasonality quarter-over-quarter.

You may have -- we commented, I believe, on the last call that we thought inventories would come down and receivables return to a more seasonally adjusted number, that happens pretty much every time this year.

So that was more seasonal than it was any significant shift in business.

David Manthey, Robert W.

Baird.

Wondering if you could give us some information on pricing, Chuck?

In terms of last quarter and the quarter to come here, what do you think the percentage growth contribution will come from pricing actions?

And then second question, and I'll hop off here -- in the past slow-down, let's go back to either early 2000 timeframe, you had months where your sales growth rate, average daily sales growth, was [finding] double digit rates.

But this time, even though -- I think it's probably assumed during a recession, here you are, you're growing at a pretty nice clip.

Wondering if you could talk about the complexion of the business?

What's different this time around?

Or are we just at a different point in this downturn?

What's different this time versus last, if you would?

David, let me start with the customer piece and then Dave Sandler will comment on the pricing.

I think -- you talked about sales growth.

One of the major differences is the makeup of our customer mix.

Going back and you alluded to very early 2000, the business was essentially all the small and medium size accounts.

The large national accounts that do exporting certainly have a different level of volatility than some of the smaller businesses that we had primarily back then.

Obviously, the government is a significant piece of our business as well right now.

And they're virtually unaffected by any type of slowdown in the economy.

So, the customer mix, I think, is a significant piece of the equation from a sales point of view.

From a profitability point of view, very different company.

We're on a leverage curve now at a very different point than we were back in early 2000, after we just made significant capital investments.

We had built out our infrastructure in terms of the 4DCs being onboard and a very different leverage point on the curve.

So I think there are some substantial differences for where we are now and this type of slowdown than we were back then.

Thanks.

I guess the only thing I'll add, which was the first part of your question, David, was on pricing.

Probably helpful to just give you the breakout of growth in the quarter for where the growth came from.

Beginning with pricing, which was about 1.2% of the 7.9 that we reported in Q2.

So that's about 15%.

And what I'm giving you is all on a ADS basis, and the pricing that really that's the cumulative effect of all pricing actions in the quarter was about 1.2%.

Just so everyone has it, large accounts accounted for about 60% of our growth in the quarter or 4.8% of our 7.9%.

And the balance of the business, our core and volume, was roughly 1.9% or about 25% of our growth.

Adam Uhlman, Cleveland Research.

Wondering, Chuck, if we could dig into the gross margin a little bit more.

Pretty strong performance for the quarter.

And you just noted that almost 5 points of the revenue growth in the quarter came from those large customers that typically pressure gross margins.

So, could you talk about the pluses and minuses that unfolded from that line item?

Yes.

There are a couple of things [there].

First of all, when we talk about larger accounts, that piece of the business typically would have lower gross margins than the Company average, but we believe at or better operating margins overall because of the cost of doing business is so much less with them.

The real issue or real change now that we see in this quarter and moving forward is really on the cost pressure side with commodity inflation having being fully rejuvenated.

You know, traditionally, those costs come across us and we can pass them along.

This time, we think that will still be the case, but we're looking at a situation where the local competitors, the people who account for 70% of our competition, those are the ones that play the only weapon they have often in a slowdown, which is price, price, and more price.

And while we say we don't sell on price, we certainly try to remain competitive.

And those forces are at work in the marketplace that we see would probably limit our ability to significantly increase margins to the upside.

So, second quarter was 20 basis points or so better than the first.

The guidance, frankly, we've given for Q3 was the same guidance that we gave for Q2.

So, we see it basically for right now kind of being stable, although with different elements at work in the marketplace here -- significant inflation coming, passing that along but moderated by the price competition, if you will, from the small local distributor.

Adam, it's David.

I guess I'll just add a little bit.

We specifically mentioned in the script that while we've given you guidance for Q3, we are cautioning a bit for Q4; meaning that given the fact that Chuck talked about, we're definitely seeing increased pressure on the cost side, and pressure coming from the marketplace, that our visibility for Q4 is murkier than it has been.

So, we didn't want to go out for the balance of the year, though our process is tight for what we're seeing for the coming quarter.

Just related to that, one tool that MSC does have that perhaps some smaller distributors don't is that good, better, best product selection.

Could you talk about if there's been any shift in customer demand towards the lower priced goods that are maybe a higher gross margin product for you, but is there any trading down occurring that you can see?

You know, Adam, we don't break out specifically what the movements are, although we do talk a lot about -- within our gross margin line, there's so many different components.

One of the whole good, better, best and, in particular, our private label and our movement towards more generics and more private label products, is one that enhances the customer shopping experience, gives them more choices, gives them more quality choices, and frankly, is an important component of our value basket as a competitive differentiator and a weapon for us, while being a win for the customer, while at the same time, those products often come with higher gross margins for us.

So when you put all that in the mix, that is one of the ways that we're able to offset some of the dilutive effect of customer mix and all on our margin.

That's an area that has more of an accretive effect for us.

And that all goes into the mix.

So, it is a program that we continue to put a lot of focus on.

Adam, I think it is fair to say, though, that there's been a pickup, and call it price-shopping, if you will, relative to where we were a few quarters ago.

So while we don't break out the sales and the trends towards lower price and this and that, certainly, when you listen to some of our -- the calls coming in, you certainly detect that there's a trend for some more shopping going on for price, more so than may have been prevalent just a couple of quarters ago.

Great.

Thanks for the color.

Holden Lewis, BB&T.

Can you comment first, I guess, on collections rates?

I think last quarter you commented maybe your collections had lengthened a little bit more as an indicator of sort of where you are in the economy.

Comment on where you're seeing those?

Holden, Chuck.

They're about where they were last quarter.

There's no alarming trend that things are getting stretched beyond reason right now.

No real trend change quarter-over-quarter.

As I said before, one of the other questions was about the DSOs, the change there and then the past due percentages that we track internally was more seasonal in nature rather than economic.

Can you also comment, particularly with your comments about continuing to reduce inventory from, I guess, the Q2 level, if I'm reading that right, what implications should we be assuming that would have on rebate activity?

I guess, relative to expectations or relative to last year?

Holden, David.

It's a very good point.

Rebate activity is something that our team works very hard on and not only models out but is working closer with our supply communities.

It is a component of gross margin.

It's not one that we're going to breakout specifically, but it is one that contributes in gross margin.

And you're right, to the extent that we're not able to replace those purchases, there will be pressure on rebates.

Our purchasing team are working closely with our supplier community and they're very focused on it.

But I'd rather not -- and comfortable that we're going to be successful in terms of our ability to continue our long-term growth programs with our suppliers, of which a rebate is a component of them; especially for those suppliers that further invest in MSC and are focused as a partner on us with growth.

So, I wouldn't want to share the specifics, but it is something that our team is acutely focused on.

And it's a good question to ask.

Okay.

And when I look at it, I mean, obviously you bought less inventory in Q2.

And then again, you're [sending] Q3, but -- yes, your Q2 gross margin was obviously strong and your guidance about Q3 gross margin is strong.

I mean, would we -- is there a potential that we could have a nasty surprise in Q4 because maybe you have accrued some stuff that you can't ultimately deliver?

Or I mean, just -- obviously, in Q2 and Q3, we haven't seen any rebate impact lower inventories.

I'm just curious about whether that's because these things are accrued and you haven't adjusted or whether we shouldn't be overly alarmed?

Holden, it's Chuck.

You shouldn't be overly alarmed.

A couple of points.

Number one, there's average inventory costs in here.

So what we buy in a quarter doesn't necessarily -- that's not -- and the price we pay in any given quarter doesn't necessarily end up in the gross margin line in that particular quarter.

Number two, the rebates -- we're constantly looking at what our full year estimate is and making appropriate adjustments throughout the year, so it's not all back end loaded and all of a sudden, we're way of track in any given quarter at the end of the year.

So, it's -- any impact would be hopefully mitigated by a realistic estimate where we expect to be.

And that's baked into the numbers every quarter as opposed to one big adjustment at one time.

Okay.

And so does the actual Q2 gross margin and the anticipated Q3 gross margin include some actual changes to original expectations in them?

The answer is yes.

If there were changes to be assumed, they would be baked in.

We're not going to go down the path of what we had in our budget and our plan, but as David said, we wouldn't break that line out separately anyhow.

But to answer your question, yes.

Q2 and the guidance we gave for Q3 would have any all known and estimated changes plus or minus to the rebate line baked in.

Holden, David.

I guess just one last follow-up on that.

The point that you are pushing on and raising is a very good one.

And it's one really that we're mindful of for fiscal year '09 rather than '08, based on what Chuck described.

And as a result, that's something that our product team has been out in front of and working very closely throughout this year to have a successful next year, focused on growth programs with our suppliers.

So, if you're telling me it's fiscal '09, you wouldn't be coming off this J&L buildup.

I mean, you might have growth then in inventory to be able to bargain with, right?

I'm sorry?

Actually, yes, on the rebate line, yes.

And Holden, I think the other thing that we didn't point out this time -- we have in the past, by the way -- when things slow down, we have an opportunity to cut deals with suppliers.

And our balance sheet allows us to take advantage of things.

While you may not call that specifically -- call it out as a rebate, the opportunity to do quantity buys in a slower environment is usually a plus factor.

There's many factors in gross margin, but that's something that would be on the plus side that we haven't talked about yet.

And you could construe that, to some extent, a rebate as well.

Well, I mean, listen, the other couple of things that are going on, part of it relates to opportunity buys.

And if you take a look at the macro, what's going on in the business right now, more and more of the traditional distribution base, which is 75% of the market, are starting to frankly hurt.

You couple that with some of the specific industries that have been really hammered -- automotive and construction-related -- fortunately, which we have little exposure to.

But those suppliers are now looking to replace that volume.

And frankly, we're at a great place and a great opportunity (technical difficulty) safehaven to give those types of suppliers growth and the ability to take share and grow, perhaps in an alternative channel than what they've been experiencing.

So, all of those things are what we tap as part of working with our suppliers to develop successful programs for next year.

Okay.

And then last thing, then I'll jump in the queue.

It's somewhat unusual to see a jump in your average order size like you did sequentially in Q2 over Q1, going from 302 to 307.

It seems like an unusual jump, just looking at history.

Can you give some -- provide some detail as to sort of what's behind that sequential change?

And how that may carry forward into Q3, Q4?

Holden, David again.

I mean, the biggest driver -- there's several different moving parts, but the biggest dial mover, needle mover -- say that three times fast -- the biggest needle mover there is resulting from national accounts, our continued success and growth in national accounts, as well as, as you know, they've got a larger than average order size.

And that's really the primary driving force behind expanding that margin -- that average order size, excuse me.

What is the role of your clients moving down from 390 to 384?

Are those also smaller clients?

Would that have had a needle-moving effect on that?

The customer account you're referring to, Holden?

Yes.

The culling of -- this would have been the culling of -- some small unprofitable accounts would not have been -- that wasn't significant enough to move the needle on the average order size.

All right, thanks.

I'll jump back in.

Scott Graham, Bear, Stearns.

Very nice quarter.

Two questions for you, and I'm certainly not trying to poke a hole in the quarter, but maybe a little bit on the customer count one more time.

Because the drop -- I understand your explanation for it, but it was 6,000 was a pretty big number.

Based on the tracking that I've done for four, five years now, we've never seen a plus or minus move of that magnitude.

Is it possible that some of these customers may have left because of your own personal price disciplines?

Could that have been a factor?

Or do you think it's completely attributable to what you've laid out?

This is Chuck.

A couple of things going on there.

One thing -- and we'll share this with you, it's a metric we track internally.

Our customer count is basically -- is based on strictly on bill-to's.

If you look at -- and we don't publish it, so you couldn't -- but we know internally, our ship-to's actually expanded.

So, as we deal with more of these large government/national accounts, we count them as one customer.

We usually refer to the Post Office as one customer, but there's multiple ship-to's.

And the ship-to metric that we track internally has actually grown.

The second piece would be -- and frankly, this is a clean-up of a lot of the J&L accounts.

We're finished cleaning up the last few stragglers or the last accounts that were left over with small accounts receivable balances and so forth.

They were in the customer count metrics.

We've now taken care of that and cleaned that up, and that was part of the contributing factor as well for the quarter.

So, we don't feel -- again, particularly because on the internal metric on the ship-to accounts actually showing some expansion and some growth that it's an alarming statistic that should draw negatively into the quarter.

Understood.

And the calls per day does support what you're saying as well.

The other question is regarding mix.

Obviously, with manufacturing sales, continuing to trail non-manufacturing, there's a mix impact there.

Yet you were able to drive your gross margin up a little.

But could you -- I was just hoping you might be able to get a little bit more granular on the puts and takes of gross margin, recognizing that certainly mix was a put.

Any way to put some numbers around that?

Or at least just give us a puts and takes, if you wouldn't mind.

Scott, we don't put numbers around it publicly, although as you've seen from our ability to manage the gross margin and also talk about successfully giving you forecasting on it, that we've got a very tight process in place.

There are an awful lot of moving parts.

Certainly there's customer mix.

Not only is there customer mix, so that you've got larger customer segments driving it, you've got small customers that are within that mix as well.

You've got Web channel mix that flows into it.

You have the pricing component, which is another.

And then as we talked about briefly, there's also this whole product mix, and private label and the higher gross margin items that are flowing through our product mix as well.

So I think it's fair to say that there's a lot of complexity to this line.

We've got a team that focuses on it as part of our standard operating procedure.

What we've raised on this call also is that there's kind of another component, which is that competitive market pressure that you typically see it in an economy like this, where smaller competitors are using more of a price weapon, which is the only tool that they have in order to try and retain or maintain their business.

And we're seeing some additional pressure on gross margin, which would obviously have a dilutive effect when you put it all into the blender.

All right.

That's very helpful.

Just one last question, if you don't mind.

You got 1.2 points of price.

Did that cover raw materials and increases from suppliers?

A couple of things.

First of all, that 1.2, remember, is the cumulative effect of what you're seeing that actually took place in Q2.

We don't specifically talk about what's happening with our costs -- how much of our costs actually were embedded in the quarter or embedded in our results.

But typically, what you see happening is that we've got many, many of our suppliers that work with us, many that have a preferred position.

Oftentimes, that may be taking an increase that generally hits the broader market, and that may either not hit us at all or hit us to a smaller degree.

So, our team has actually been extraordinarily successful in ensuring that basically our costs versus our sell is a strong contributor to our margin.

Having said that, as I said, the costs that we're seeing, given the inflationary environment being escalating and a more competitive environment from some of the pricing actions that we're seeing from those small competitors, we do think that it's going to have an effect on margins.

We projected that effect in Q3.

And we're cautioning that we haven't quite figured it out for Q4 and going forward, but we have said that our visibility is a little murkier.

So, our guidance then was focused on Q3, but don't get carried away with just taking that data point and running it out.

Elliot Fruchter, Merrill Lynch.

I think we've worked through J&L -- has your appetite to do other deals in the near-term increased?

And can you talk about the acquisition pipeline and the attractiveness of valuations out there?

Elliot, David.

You know, we, our appetite -- I guess I'll start with -- there's definitely activity that we're seeing.

There is a pipeline and opportunities out there.

Not close enough to really comment on what some of the valuations are, although historically, the tougher things get, the more that our valuations may become attractive.

What we're looking at right now is, we think that we've got a very attractive organic growth plan.

We're executing to that plan.

And the way that we're going to evaluate an acquisition is similar to the way we did J&L, which is it's got to pass a pretty healthy hurdle rate and threshold for doing the deal to come off of our organic growth opportunity.

And ultimately, position us years down the road to be better than if we just stayed in the context of our plan.

So, we're going to stay very open and very opportunistic and we think that's one of the great advantages that we have, especially in this environment, because while -- we'll just stay open to those opportunities.

Okay, thanks for the comments.

And can you tell us the share count at the end of Q2 and perhaps your expectation for the weighted average share count in Q3?

Yes.

For Q2 -- you're talking about the actual share count?

The actual share count was 63.2 million and factored into our guidance for Q3.

And I will say that we do not anticipate on purpose -- doesn't mean we wouldn't do it.

But when we give our guidance, we don't anticipate buying shares back in the market place and what price.

This would be basically the run-out of the activity you've seen so far and the activity from Q2, our estimate for Q3 is about 63.7 million shares.

So just, Chuck, just to be clear on that in terms of anticipating, we always give it with whatever the share count is for the current quarter, irrespective of whatever buying activity may occur in that future quarter.

Right.

Again, we don't factor in share buybacks.

If we were or weren't going to do them, we wouldn't be in the numbers.

So running out the activity again, for that's already taken place that we just talked about, the 2.5 million share purchase in Q2 and nothing else, the weighted average shares are roughly 63.7 million for Q3.

Jeff Germanotta, William Blair.

With respect to gross margin, have your efforts to increasing direct foreign sourcing had a material effect on this quarter?

Or is that still more early development?

Jeff, David.

Yes, it is early development.

And actually, you've raised something that is a really exciting opportunity for us for future gross margin.

A component of our margin is our import program and our private label.

But as you know, we're focused more and more heavily on building that program out, increasing our private label products.

But that takes time.

That is in the works now and we think that that's going to have a really exciting effect on '09 and even more importantly, outlier years of '09, '10 and the future.

So, little incremental effect, [probably] but is something that we're working on internally to continue to fuel future gross margin.

Tim Burrow, Value Holding.

Does the 63.2 million include dilutive equivalents of about $900,000?

No.

No, the question was what are the actual shares?

So the 63.2 million, which you'll see in the [10-Q], that will be the number that will be in the [10-Q].

The actually dilutive weighted average shares were 65.2 million for the second quarter; 63.2 million is the actual share count outstanding.

Okay.

CapEx is down 60% through the first six months.

Are you still planning to spend $25 million for the year?

It will be close to that before year-end.

There's a lot of projects that have been approved that the cash hasn't flowed yet, but has been approved and will be approved in the next month or two.

So we are anticipating in that $23 million to $25 million range for CapEx.

And one final thing and I may just be making something of nothing here, but for years in your press release, you always described the Company as one of the premiere distributors of MRO supplies to industrial customers.

In this quarter, for the first time, you described the Company as one of the premiere distributors of metalworking and MRO to industrial customers.

Is this part of a change in business plan, perhaps to go after a larger market share in metalworking?

Or just making something of nothing?

Personally, I'm not aware of the change.

I don't know if Shelley has any comments --

Yes --

-- but that -- I mean, nothing has changed in our -- we've always been a metalworking in -- metalworking has been in our roots for 57 years.

In the last 15 years or so, we've added a build-on on MRO products.

So Shelley, any adds there?

Yes, there's a one-word answer -- lawyers.

That's why.

(OPERATOR INSTRUCTIONS).

Sangam Sogani, Goldman Sachs.

Thanks a lot for taking my call.

Two quick questions.

The first one, what was the cost savings from reduced mails -- direct mailing in the quarter?

I'm not sure I fully heard it, but was the question the cost of direct mailing?

Yes, what was the cost savings in that?

Because you mailed 6 million versus 7.5 million in the last quarter -- 7.7 million in the last quarter.

Right.

We, we actually -- while we publish the direct mail stats, we don't actually publish the spending on a breakdown of our growth drivers.

So, that isn't something that we share.

Okay, that's fine.

Second question on bad debt -- you didn't have any bad debt reserves in this quarter.

This is the first time I've seen that over the last several quarters -- last 10, 12 quarters.

Is anything going on that we should understand?

You didn't see any bad debt where?

Provisions in your cash -- the way you could track that is in your cash flow statements.

It's buried in the cash flow.

Right, but there wasn't any change between the last quarter and this quarter.

We're checking that out.

We'll see if we've got the information now or we'll have to get back to you.

(multiple speakers)

It's right there on the cash flow statement in cash flow.

Yes, I know, provision for [debt was at 839].

Right.

And you had the same provision in the cash flows the last quarter.

So that means there wasn't any provision made in this quarter.

We'll have to check it and get back to you.

We'll have to check it.

I can only give you the answer right now.

But I can tell you from a business point of view, which would be the real question, there's nothing unusual going on about it.

I was just wondering if you were seeing lower bad debt or this is some adjustment because --

No, there's no change to our normal process, which is to book a percentage of sales and then evaluate the actual needs for the reserve at the end of each quarter.

So there's nothing unusual going on last quarter to this quarter.

Got you.

Thanks a lot.

Holden Lewis, BB&T.

Just sort of on the prior question, expanding on that a little bit, I mean, this is a quarter where your rate of growth really didn't change all that meaningfully.

I mean, it went from, call it 9% down to 8%, so still healthy overall growth; but it was the first quarter where your spending on advertising pieces was down dramatically year-over-year.

And your number of sales associates that you added was relatively minor.

And I guess that the change or the improvement in the operating margin and the incremental margin really was the same as you saw in Q1, despite the fact that revenues were kind of in the same ballpark and costs seem to scale back a bit.

Are there some offsetting effects that would have prevented us from seeing maybe higher incremental margins or a greater sort of step-up in the year-over-year margin pace?

Holden, nothing -- I'll tell you, year-over-year, we're definitely spending more on growth investments.

The numbers you see in any individual quarter, when we talk about total growth spending, folks that were, let's say, added in third and fourth quarter of last year obviously would be in the actual for Q2 of this year and not last year.

So, our growth spending is definitely ramp-up until that heavy hiring, if you will, in the latter part of last year annualizes itself.

So, the quarter itself compared to last year -- don't forget, you've got the J&L savings baked in this year that, from an accretion point of view, weren't available last year.

There's a change in the tax rate, if you look at year-over-year.

There's lots of things that would have helped fuel some of the upside, offset in part by more significant spending on growth driver investments, particularly in the area of people.

Yes -- I'm sorry, Holden, just to add, while you noted that Q2 specifically was down a bit in direct mail and that sales headcount was down a bit in the metric that we report, there's a whole bunch of underlying growth driver spending and value-added services, you know, building out our [ECOM], our product expansion, many other sales programs and things that we're focused on and that we're investing in, but that we don't publicly break out.

So whereas you slowed the highly visible advertising and sales associate adds, have you accelerated other things that are less visible?

Yes, I think you could -- I think that there is spending that takes place.

And I'm only caution to myself accelerating because while there is other spending that takes place, I wouldn't want to -- without seeing some of the specifics behind it, I wouldn't want to characterize it as steady or accelerating.

I'll just point out, Holden, that there are 100 more sales associates in the metrics this year at the end of Q2 than Q2 last year.

So, I think you ought to be careful when you talk about the rate in Q1 and so forth.

If you're comparing to last year, there's a full 100 more sales associates onboard than there were this time a year ago.

And that's maybe when you're doing year-over-year comparisons, part of maybe what you're not fully accounting for.

There are no further questions at this time.

I'd like to turn the call back to management for any closing remarks.

Okay, well, thank you all for joining us.

And we look forward to speaking to you again next quarter.

Take care, all.

This concludes today's conference.

You may now disconnect.