MSC Industrial Direct Co Inc (MSM) 2010 Q2 法說會逐字稿

Good morning.

My name is Janita and I will be your conference operator today.

At this time I would like to welcome everyone to the MSC Industrial Direct second quarter 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 will now turn the call over to Eric Boyriven of FD.

You may begin.

Good morning, everyone.

And welcome to the MSC Industrial Direct fiscal 2010 second quarter conference call.

An online archive of this broadcast will be available one hour after the conclusion of the call and available for two weeks at www.mscdirect.com in the Investor Relations section which you can find under the tab About MSC.

Certain information pertaining to non-GAAP financial measures may arise during this broadcast and can also be found in the earnings announcement which is also posted in the Investor Relations section of our website.

In addition during the presentation management will refer to financial and operating data included under the section Operational Statistics which you can also find in the Investor Relations section of our website.

Let me 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 within the meaning of US securities laws including guidance about expected future results, statements regarding expected revenue, margin and earnings growth, expectations regarding the Company's ability to capture market share and expected benefits from the Company's investment and strategic plans.

These forward-looking statements involve risks and uncertainties that could cause the actual results to differ materially from those anticipated by these statements.

Information about these risks is noted in the earnings press release and in the risk factors and the MD&A sections of the Company's latest annual report on Form 10-K filed with the SEC as well as in the Company's other SEC filings.

These forward-looking statements are based on the Company's current expectations and the Company assumes no obligation to update these statements.

Investors are cautioned not to place undue reliance on these forward-looking statements.

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

David, please go ahead.

Thanks, Eric.

Good morning and thanks for joining us today.

With me are Erik Gershwind, Executive Vice President and COO; Chuck Boehlke, Executive VP and CFO; and Shelley Boxer, Vice President of Finance.

Today I'll cover our strategic view of the Company.

Erik will provide an update on the landscape and competitive environment, as well as the execution of our model.

And Chuck will give some detail on Q2 performance and our Q3 guidance.

I'd like to begin this call by updating what we've talked about throughout this recession and what I said just three months ago.

During the last 18 months we've lived through the most challenging economic climate of my 35-year career in industrial distribution.

We were faced with an unprecedented decline in confidence which translated into a breathtaking reduction in revenues.

This was an environment which caused every company to rethink the way that they manage their business and did cause many of our competitors to react.

As we have done throughout our almost-70-year history, we met the challenge head-on in a way that was consistent with our core values and with a focus on the long-term opportunities that dislocation would inevitably create.

We did so in a way that was consistent with our unique culture and our mission statement.

This compass has served us well through historic downturns and has done so once again.

As a result we emerge from the downturn with the best group of committed associates in our industry and are positioned to win and to win big.

Just to remind you, while we protected our associate population through reduction of hours in our volume-sensitive areas instead of implementing layoffs, we also protected our owners and balance sheet by suspending raises and incentive compensation, and generally shared the burden throughout the Company.

During Q3 almost all of those hours have been restored and we've also taken steps to restore a significant amount of compensation and benefits.

We expect this restoration to continue because, as you will see from Q3 guidance, we are experiencing rapid topline growth.

However, unlike many of our competitors, we are not scrambling to service customers as we grow.

We have the financial, physical and human assets in place to be proactive rather than reactive.

And while competitors cut back on inventory inside and outside sales staff and facilities, we kept our workforce intact, increased our service levels through extended order cut-off times, expanded our next-day reach to the entire country, enhanced our fill rates and offered help in the form of increased credit lines and longer payment terms where possible.

We also aggressively signed new business.

On our last call we branded the next couple of years for MSC as the greatest land grab opportunity in the history of our industry.

Make no mistake about it, we will be one of the most opportunistic during this once-in-a-lifetime period.

The sheer gain opportunities are even more compelling now than during the recession because we expect that as the economy recovers the smaller competitors who have already been severely impacted will struggle even more to satisfy customer needs.

We believe the weak balance sheets will crumble and service levels deteriorate further as customer demands increase.

Just as we did in the downturn, we will build upon our success in taking share through the upturn in the economic cycle, taking advantage of our proven track record of turning our human capital, our investments, our balance sheet and our ability to execute our business model into significant long term earnings growth for the benefit of our associates, customers, owners and suppliers.

We believe there has never been a more exciting time in MSC's history.

I'd like to take a moment to outline our thinking on operating margin expansion and the relationship between revenue and earnings growth, and our investment program.

Operating margin expansion is a function of three main elements -- revenue trajectory, pricing power and our growth investment plan.

The timing of these elements won't necessarily move in lockstep and we exert the most control, of course, over the pace of growth investments.

In that regard, we've chosen to take advantage of a period when we viewed opportunities to be at an historic high by increasing our investment rate even though pricing power was at an historic low.

Our goal has been and remains achieving double-digit revenue growth and earnings growth that outpaces revenues.

As revenue growth accelerates, earnings growth accelerates at disproportionate rates.

You can see this by comparing our Q2 results to our Q3 guidance.

We would describe Q2 as moderate revenue growth with earnings growth that outpaces revenues but not by a lot.

We would describe Q3 guidance as accelerated revenue growth with rapidly accelerated earnings growth.

This happens because our investment program is targeted to a set dollar amount, not a percentage of sales.

And as a result, the additional revenue growth is highly leverageable.

Should we see an inflationary environment leading to growth margin expansion, we would expect even more leverage.

All of this is why we see our story as so exciting.

With that said, I would like to provide some guidance for the third fiscal quarter.

We expect sales in Q3 to be between $436 million and $448 million.

And fully diluted earnings per share to be between $0.63 per share and $0.67 per share.

Thanks, and I'll now turn it over to Erik to review the landscape and our execution.

Thanks, David.

I'll start with what we're seeing in our customer landscape.

Consistent with a rising ISM, there's a lot more stabilization.

Layoffs have greatly diminished.

And there are now pockets of hiring.

Many companies are restoring work hours that were previously removed.

We're seeing an increase in the numbers of customers who are experiencing real growth.

To be clear, this is the most optimistic that we've been since the downturn began.

We believe that the revenue momentum is real and sustainable, as there is little in the way of inventory restocking to date.

In fact, while we see signs of spotty inventory replenishment in our large customer segment, inventories in our core customers remain at rock bottom levels.

We do continue to see extensive price competition as smaller, local competitors play one of the only cards they have left.

While the landscape has improved over the last three months, the recovery is not yet robust.

MSC, however, is growing at an increasing pace.

Q2 sales growth was 12.4%, March grew at roughly 22%, and Q3 sales growth at the middle of our guidance range is expected to be approximately 24% based on average daily sales.

The payoff from our investment programs is showing in our results as sales momentum builds.

We consider this to be strong evidence of share gains, as the upturn in the manufacturing environment is just beginning to gain traction.

Turning to the execution of our model, we continue to perform at all-time highs and to deliver an outstanding service experience for our customers.

All of our service metrics remained strong during Q2.

Our high inventory fill rates are especially critical in differentiating MSC during an economic upturn.

Customers are running lean and they depend on their distributor for off the shelf availability.

The service disruptions that are occurring daily with traditional local distributors result in share gains for MSC.

We're also executing on our investment programs.

We continue to adjust our spending by focusing on those that provide the greatest returns and yield the strongest gains for the future.

And I will touch on several of these programs without going into greater detail for competitive reasons.

First, direct mail.

This program remains at reduced mailing levels, yielding greater productivity.

In fact, we've increased the efficiency of this program by over 50% against prior year.

Our efforts through electronic channels continue to be highly effective, allowing us to accomplish these gains while maintaining our total number of customer touches.

Second, eCommerce.

We have a vibrant eCommerce program which has been very successful in both generating sales growth and improving productivity.

We're investing in our eCommerce infrastructure in order to better service customers and to significantly reduce channel costs over time.

Third, our large account program.

We're building brand, and we're benefiting from the momentum that we built during the downturn.

86% of our growth came from this program in Q2 which demonstrates the success that we're experiencing.

Fourth, buy-side investments.

Expansions of our Asian sourcing and our private branding initiatives remains an important part of our gross margin story for the future.

These investments, coupled with an improved product management approach are delivering excellent values for our customers and beginning to yield improved margins.

They are also producing share gains for our supplier partners.

Fifth, productivity.

Investments in our operations continue to gain traction as we roll our program across our fulfillment centers.

Our teams work at enhancing customer service and improving operational efficiency.

The productivity gains that we're seeing today will be magnified as volume grows and passes historic highs, providing further fuel to incremental profit margins.

And, sixth, sales force investment.

We continue to add some of the best and brightest in our industry to our sales team.

In Q2, our sales force grew to 949 associates.

And we've raised our target for the end of fiscal 2010 to a range of 965 to 975 associates.

This increase in hiring reflects our increased sales growth and our increased capacity to take advantage of the opportunities that are beginning to appear in the marketplace.

Thanks.

And I'll now turn things over to Chuck who will share the specifics of our financial performance.

Thanks, Erik.

Sales for Q2 came in near the top of the range, even though we were adversely affected by some terrible weather in February.

Gross margin was at the high end of our range.

Operating expenses remained under control and were as expected for the quarter, yielding an operating margin of 12.6%.

Earnings per share of $0.48 were $0.01 over our guidance, primarily reflecting gross margin and revenues at the top end of our guidance range.

Sales guidance for Q3 at the midpoint is approximately $442 million, which represents growth over last year's third quarter of approximately 24% on an average daily sales basis.

There is one more business day in Q3 this year than last year and consequently that would be one less business day in Q4.

Gross margin is expected to be approximately 45.5%, plus or minus 20 basis points in Q3.

We were able to sustain a modest price increase in the last week of Q2 to offset the effect of cost increases that we have taken over the past several months.

Without this price increase, gross margin guidance in Q3 would have declined modestly from Q2 levels.

Pressure from price competition continues and we are still being negatively affected by the changes in sales and product mix and from large orders, as well.

The good news is that our industrial business is growing again and continued growth will result in higher margins as the effect of increased sales of metalworking supplies is reflected in our numbers.

Operating expenses will increase sequentially in Q3, primarily reflecting volume increases from Q2.

The leverage that's inherent in our business model will begin to be seen in the results as operating margin at the middle of the guidance range will increase to approximately 14.9%.

Balance sheet metrics remain solid.

Inventory turns increased to 3.2 in Q2, and should continue to improve even as we add inventory to support our growth.

DSOs improved to approximately 41 days, and cash generation in Q2 was very good, converting approximately 90% of net income into cash from operating activities.

Thank you.

And now I'll turn it back to David.

Thanks, Chuck.

The moves we made during the downturn, which come from our time-tested and proven playbook that we've used through many cycles are delivering the market-share gains and financial performance that we expected.

As we now move through the upturn we will once again follow the playbook that has served us so well in the past.

We will continue to invest in order to capitalize on the share gain and market opportunities afforded to us by the greatest dislocation we've ever seen in all our years in distribution.

We have tremendous confidence that executing that model will result in substantial value being created for all of our stakeholders over the long term.

And for that I want to thank all of our associates for their efforts and dedication towards this vision.

Thanks and I'll now open the lines for questions.

(Operator Instructions).

Your first question comes from the line of Sam Darkatsh of Raymond James.

This is actually Jeff Cohen in for Sam.

Thank you for taking the question.

First of all, I was wondering is there any way that you can quantify the impact of the snow we saw in February?

I know you said that it negatively impacted the business but are we talking a couple of hundred basis points or is it anything more than that?

Yes, hi, Jeff.

It is Erik.

We did take a shot at estimating the impact of the snowstorms, particularly in February, roughly a range of $3 million to $5 million overall.

I will tell you that, as we saw the weather, a heavy impact on the northeast in particular, and if you look at our regional numbers you can see that reflected in growth rates.

But $3 million to $5 million overall.

Okay.

And then my other question is around the operating expense leverage.

Thanks for all the commentary there.

That's real helpful.

I know you've talked in the past about an incremental $0.11 operating expense for every dollar in sales, and I think that that's what's inherent in the Q3 guidance.

But my question is, beyond Q3 is that still the kind of range we should be looking at or if sales accelerate further, when you talk about incremental investments that you would make do you think it is something above and beyond that $0.11 or is that still the longer term range?

Jeff, I think rather than commenting on a specific number, I think probably good to step back and reaffirm, as we have, that our goal is to continue to grow revenues at double digits and earnings certainly at a faster pace, and that's going to have the natural effect of expanding our operating margins over time.

The issue of how quickly they expand, as I mentioned, really depends on the revenue trajectory, what the pricing environment looks like and, of course, our level of investment spending.

I think important to note, I referenced it in my prepared comments, that we target a set dollar amount of our investments, which really won't be variable with sales.

So that means that once revenue levels have covered the impact of our investment spending, the read-throughs on those incremental sales dollars are going to be very high.

In fact, at that point you would expect to see all of the incremental gross margin dollars reading through to the bottom line less the variable, of course, that's required to service that extra volume.

And so I think what you are going to see as we move forward is that read-throughs will accelerate rapidly as the growth increases, which is why you see such a dramatic difference between looking at EPS growth in Q2 versus what we expect to happen in our Q3 guidance.

And there's another big wildcard to this, which of course is gross margin.

We'd expect that as we see capacity utilization levels beginning to get back to normal, that pricing should firm, and in fact the likelihood is that inflation will return to the environment, as well.

As that happens, we'd expect to see significant gross margin expansion and, of course, read-throughs and the leverage that we get is that much more pronounced in that environment.

So, as this recovery gains traction, a combination of high growth at a high growth trajectory and expanding gross margins, we're confident will produce powerful read-through results.

Thanks a lot.

And congratulations.

Very encouraging.

Your next question comes from the line of Hamzah Mazari of Credit Suisse.

Good morning, thank you.

Just a couple of questions.

Could you maybe touch on your inventory levels right now and what we should expect there going forward, given that the demand environment has picked up?

Do you still expect working capital to be a source of cash as we look out over the next 12 months?

This is Chuck.

The inventory, as you've seen in our past results, are down substantially from where it was a year ago.

We're right now in the $243 million range.

This time a year ago we were at the $289 million range.

And, frankly, Q2 ended just about where we were in Q1, so you haven't seen any real significant change since the beginning of the year, although we're down dramatically from last year.

We think from here forward we are going to be adding back to inventory and certainly some of our cash flow is going to be required to finance that.

That being said, as I mentioned in some of my prepared comments, we expect inventory turns to improve, even though we'll be adding back inventory dollars to support our high service level and our sales growth.

Yes, we believe we can still generate cash but we clearly in the short to intermediate term, as we go down the curb of this growth spurt are going to be deploying a fair amount of that cash back in working capital.

But on balance, yes, we still expect to be cash positive.

Thank you.

And on pricing competition, you mentioned that in your comments, is that mostly coming from smaller private guys?

Are you seeing that across your portfolio?

Any color you can add there.

Yes, Hamzah, this is Erik.

I think, yes, you are right, you heard from our comments that we are for small local competitors, despite the economic upturn, still absolutely seeing price competition, as David talked about in his comments from many of the small competitors.

It is actually as difficult or more difficult for them on the way back up because of the working capital strain and so there are some desperate actions going on playing one of the cards they have left.

So to answer your question, yes, mostly from locals.

And just last question, if you could maybe give us detail on how your topline trended sequentially as you exited the quarter month over month on the manufacturing and non-manufacturing side, if you could.

Thank you.

We're looking right now.

Hang on just one minute as we go through this pile of paper.

Thank you.

Hamzah, let's see, sorry, manufacturing versus non-manufacturing.

Right.

So we post what happened with the quarter, just to give you a little bit of additional color.

We actually don't break it out by month.

But we will tell you that we saw the momentum building in both of those segments sequentially throughout the quarter.

Okay.

Thank you.

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

Good morning, gentlemen.

It is nice to hear David so happy.

Hard not to be, Jeff.

Anyway, on with the questions.

The sales force increase, is that largely trying to pick up established salespeople with existing books of business or is this developing younger people?

Jeff, it's Erik.

As you know, expanding our sales force has been one of our primary investment areas for a while.

What you see in the increase is a combination of us being encouraged by what we're seeing on our topline numbers and also being able to be opportunistic to really capitalize on hiring people that we otherwise couldn't have gotten in a normal environment.

So I tell you it tends to be a blend of both of what you have described.

And, again, the uptick in the numbers is reflective of the opportunity we see.

And with demand picking up, I would hope competitive pressures are abating somewhat.

Are you seeing any improvement in the selling price inflation environment, and, if so, can you quantify that?

I would describe, Jeff, in terms of the pricing environment that we're seeing, I would describe it as stable with signs that pricing is beginning to creep into the market.

And so we haven't seen a whole lot of movement, we've seen a little bit of movement and, as you know, that is a good sign for us.

We're encouraged by the initial signs of what we're seeing and if it continues it tends to bode well for us over time in terms of margin expansion in an inflationary environment.

And as we look forward, while you'll be investing in working capital and growth initiatives, what is the likelihood of some stock repurchase activity or an opportunistic acquisition?

Jeff, I think that the key there is that with the cash generation and frankly our ability to even borrow more we're very opportunistic.

We have the flexibility to do just about anything that we want right now with the cash, whether that is buyback, acquisition or some other use.

So I think the key point is we're open to it, and the flexibility is there to do what we might want to do and opportunistically take advantage of situations as they come up.

Hi, Jeff, David.

I think that as we've moved through this, we obviously wanted to be very protective and defensive of our cash very early on.

We've obviously moved through that phase.

I think that phase then led to where we are today, which is the ability to really capitalize on any opportunity that we would see out there.

And we are actively looking.

I think it has also given us a window into making sure that we have good visibility into our working capital needs.

I think we're beginning to see that, as well.

So, we're really confident with the balance sheet strength that we have.

It is going to lead to a lot of great opportunities for us moving forward.

And then my last question, based on what we saw in the fiscal second quarter and the guidance for the fiscal third quarter, it would look like we should be seeing minimum read-through incremental operating margins of 25% plus.

Am I out of line thinking that?

Jeff, this is Chuck.

I just want to make sure that I understand the question right.

Looking from Q2 to Q3, and we talked about this earlier, you have fairly rapid revenue acceleration.

On an ADS basis Q3 is actually 8.5% higher than Q2 in terms of revenue acceleration there.

So, as David had mentioned, when you get that quick acceleration, you have an opportunity for margins to firm and pricing and you can see our gross margin guidance is a little bit higher than Q2, you start to get read-throughs beyond the investment spending that we have layered in.

So the read-through calculation sequentially from Q3 to Q2 is in the 34% range.

We still don't think it's valid to compare to prior years given this is a transition year.

Last year had some compensation and benefit type things coming out.

This year they are going back in.

But as David mentioned, once you get past covering the investment spending here, you are basically seeing all of the incremental sales minus the gross margin less the variable expense dropping right through when it's plus or minus in that 34% range over Q2 sequentially.

But we won't be operating at 34% for several quarters to come?

You are talking about the absolute operating margin?

The incremental.

Do you mean the read-throughs, Jeff?

The read-throughs, yes.

I think we'd rather stay away from a specific number.

Important to remember, as we talked about, it's a transition year.

We've got the issue of our add-backs.

Yes, we have been investing.

All of those things, we think that we need to settle out.

But I think that the important point here is that, as revenues come in faster than let's say the threshold of the revenue levels that cover the impact of our investment spending, it is at that point that you can expect to see the gross margin dollars from the revenues incremental to that to be flowing pretty much to the bottom line with the exception of the variable to service it.

The other thing going on, as you know from history, that as the revenue trajectory is high, we're not even able to staff up fast enough, and that helps us to improve and to really have pretty dramatic read-throughs during those periods, as well.

As the revenues come in fast, you can't even staff the variable and you see real expansion in productivity during those periods.

And the other thing that, of course, is very helpful to us right now, is that we're getting the benefit of the leverage, of being able to leverage a fully-trained workforce since we didn't have the staff incrementally to service the volume because of the hours that we've restored by keeping our entire associate population in place.

Huge benefit and that was a huge win for everyone.

Thanks very much, and I hope that you have many happy days ahead.

Your next question comes from the line of David Manthey of Robert W.

Baird.

Hi, this is actually Kyle O'Meara on the line for Dave.

Good morning.

Looking at the growth in national accounts when thinking about these customers what was really driving that growth?

Was that signing up new national accounts, higher demand from existing customers or some level of restocking?

Kyle, it's Erik.

I think it is a little bit of everything you described.

Overall, I tell you, and you heard, you characterized the customer environment.

In general what we're seeing is stabilization, some improvement in our large account segment.

We did see some pockets of restocking although I will tell you that it was not widespread and pervasive.

So the growth that we're experiencing, I think it is more a function of two things.

An actual pickup in customer demand and, quite frankly, some of share gains from the investment programs and the investments that we've made are paying off in the form of higher than market growth.

Erik, you talked about some of your investment areas in the prepared remarks.

Are there any large additional growth programs planned as we go forward beyond where we are today?

Are there any immediate plans to begin again expanding your branch network?

Hi, Kyle.

It's David, I'm going to jump in.

Erik had described many of the initiatives that we're working on today.

Probably helpful to step back a little bit.

We're just now going into our strategic planning process, the back half of the year that's going to lead to our FY '11 plan.

We will think that we're executing upon some great programs right now.

And there's always new things in the hopper.

But we think it's better to get into process, go through our strategic planning and we'll communicate more late in this year or the beginning of next fiscal with where the programs are going to be headed moving forward.

Thank you.

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

Thanks.

As you start to build that national accounts, have you started to see your other two large publicly traded competitors more so than you have in the past?

Or is it still mostly taking share from the smaller guys?

Yvonne, I think it's a combination of both and I would say there's not been any major change in trend over the past year.

We've always, when we go into national accounts, we compete with a combination of the large nationals that you described and also with locals, and I would say that that's still the case.

Yvonne, it's David, and I'm going to jump in a bit, as well.

What's interesting about what's been happening in the landscape, which is why it is so difficult for the locals and why, frankly, those with a national platform have such an advantage, is that even when a local is doing a great job servicing a facility, when the mothership comes in, headquarters, and says, you know what, we want to consolidate our spend, we want to go on an ePro platform or whatever, the locals, even when they are successful in a plant, are often going to get displaced because they are not able to provide that national scale, they are not able to provide what a national account these days is looking for.

That's been a trend that, if anything, has been gaining steam now for a period of years.

Especially in this environment it is that much more pervasive.

And many of these national account customers have more and more control over their spend, which means that when we get awarded, or any of our nationals get awarded, frankly, we displace many of the locals that are in that local plant.

And that has been one of the prevalent landscape shifts that has really boded well for our model and one of the reasons that we're so excited about what we see moving forward.

Great.

And when you look, I know that the government is part of your business.

Has anything started to filter through that you might consider being from the stimulus?

Yvonne, we've seen very little, if anything, from stimulus and so short answer would be no.

Okay.

And then I know international was up, big number off of a real small base, but any more commentary as to what is going on there or in regard to growth plans for that business?

I guess the additional commentary that I can give you is, yes, you are right, when you look at our regions and you look at other, that's primarily the UK, they've been doing a really good job of growing organically at roughly 19%.

A difference in that number for the most part is favorable currency.

Right now we're getting the benefit of that.

And we are investing in that business.

There's a solid platform there.

An excellent team with solid leadership.

So we've begin to take advantage of what we consider to be a solid market opportunity given how fragmented that market is, and how much it looks in some ways to some of the characteristics in the US market.

So we've begun to make some moderate investments there and will continue to do so, although we don't have plans beyond that at this point.

Okay.

Does growing that business through an acquisition make sense?

I wouldn't take the option off the table, certainly.

But at the same time, the US has an awful lot of runway and I guess while it is possible, it would be more likely that we'd look domestically first.

Okay.

Great.

Thanks very much.

Your next question comes from the line of Brent Rakers of Morgan Keegan.

Good morning.

Got several question.

First just to follow up on the weather impact in February, is all of that permanently lost business or would any of that push and possibly help to maybe artificially inflate the March numbers?

Brent, it is Erik.

In general, when we see weather impact, there's a little bit of both that goes on.

There's some business that we just don't get back.

There's some that gets pushed forward.

When we gave you the range, though, of the $3 million to $5 million lost, that was our best estimate of what we actually think the true impact was of dollars lost.

Erik, and I know you guys don't typically talk a lot about regionals on a monthly basis, but when you look into what happened in the northeastern region in March and early part of April does that tell you anything about recovery or not there?

Brent, recovery specifically regarding weather you mean?

Yes, Erik, regarding the weather.

In general, when we look at the northeast, Brent, and we don't share, in terms of March, we're not going to break out the March numbers.

But looking back through Q2, I think really what is going on in the northeast is a couple of things.

Weather is a piece of the story.

The other story going on in the northeast is a high concentration of our core customer base which as you can see from the numbers just started to turn in Q2.

So we actually view that as an encouraging sign moving forward.

For all the regions, quite frankly, northeast in particular, to see the core business start to lift.

Okay, great.

And then, obviously you talked a lot about the share gain that's been going on recently and I guess go-forward.

Maybe if you can talk about specific to the manufacturing customer category, I don't know if you get any insights from your vendors or such but when you look at industrial production roughly flattish, maybe plus one year-over-year, and your manufacturing customer growing at about 12, and certainly a large portion of that is the share gain, but maybe if you can give us a sense of what you think the market is growing at, let's say, a core metalworking customer over that time, that would be helpful.

Brent, it's Erik.

Very tough for us to say.

When we look at market share metrics and the way we measure share, in a market that's this big and this fragmented we don't think there is any one metric that you can look at that is the answer.

So what we do is, we triangulate.

We have several measures that we look at.

So we'll compare our performance by segment against macro indicators, like the ones you mentioned, we'll compare them against competitive and supplier benchmarks by segment.

And then we also, we have a pretty good field intelligence process from the bottom up where we'll look at share gains, wins and losses by account, and what we do is we triangulate all of those.

To answer your question, I don't think there's any one metric that we're going to look at to give us the answer.

But we take all of those and put them together into one story.

Great.

And then just final question, just to clarify.

There was mention of a small price increase at the end of the second quarter.

I'm assuming less than a percentage point.

And then also, second related question to that is, on a year-over-year basis, I'm assuming price increase contributed modestly positive year-over-year because you had some pressure on pricing over the course of last year.

Is that correct?

Brent, a couple of questions there, let me start with your first one.

We don't break down price increases, other than the annual big book price increase that we do.

As you mentioned, it was at the end of the second quarter.

And the increase that was in response to some cost pressures, some competitive moves we saw, and it is factored into the guidance that Chuck gave for Q3.

You asked another question, I'm sorry?

Yes, Erik the second question was you guys usually break out how much price contributed in the quarter.

And as price competition went into effect through the course of last year I would assume that pricing probably was a modest positive for the quarter?

We're getting the decomposition now there, Brent.

Great, thanks, and I'm done after that.

Here are the numbers, Brent.

Total growth for the quarter was 12.4%.

Of that 10.6% came from our large accounts segment, 2.3% from the core, and actually a negative 0.5% from pricing.

So, Brent, if that was your question, just a reminder that the way we calculate that number is it's the price increases we've taken net of the cumulative effect of discounting.

And to answer your question, that is still a negative.

And I think we also put it in the data sheets this quarter -- next quarter.

Your next question comes from the line of John Inch of Bank of America.

This is actually [Karen Nile] dialing in for John.

I want to ask you about volume rebates.

You mentioned you are seeing some inventory cost pressures, so maybe you're not seeing any rebates coming back in right now but when should we expect that to start pulling in and help your gross margin?

This is Chuck.

You won't see real evidence of that probably until you get into our fiscal '11 numbers.

Rebates are done on a calendar year purchasing situation rather than our fiscal year.

You heard what we said about inventory levels, they're virtually flat really for all of this year to where we ended the year at the end of the year.

Yes, we intend to increase our inventory to support our growth here but by the time that translates through annual purchases on a calendar year basis it will really be 2011 before you can expect any kind of uptick in gross margin from that.

Okay.

And then on the hiring, it looks like the associate hiring process has slowed versus previous quarter.

Is it more of a timing issue or are you seeing more competition out there from other distributors?

Karen, no, we see a lot of opportunities out there which is why you can see, or one reason certainly, that we've raised our guidance for how our sales force will finish through the year.

So it's purely related to timing.

Okay.

Thank you.

Your next question comes from the line of Ryan Merkel of William Blair.

Thanks, two questions from me.

Number one, what is in your guidance for investment spending in the fiscal third quarter?

And does investment spending peak then in the fiscal third quarter?

Ryan, this is Chuck.

We're not going to disclose what we put in each quarter for investment spending.

There's more in Q3 than Q2, but as we mentioned when you talked about read-through, once you cover that you get to the point where the entire gross margin, less the variable expense, is reading through, so that's how we want to answer that one.

Okay.

And then my second question, I know it's early but, how are some of the newer products in the catalogue performing so far?

Ryan, it's Erik.

If you are going back to the catalog we launched in September of '09 there were roughly 21,000 new products.

We don't disclose the metrics but in general I would tell you that it's performing pretty well and particularly along with the rest of the business seeing accelerated momentum.

Okay.

And then maybe just one more.

Can you provide some color on the Web site project and how that's coming along?

Yes, sure.

As we've said for the last few quarters, Ryan, the Web remains one of our top investment priorities.

We've already seen a lot of traction and you can see it in the growth we've experienced in the Web site, and it remains, as it has been for the last few years, it remains one of our top priority investments.

It's getting a lot of mind share and attention in terms of our Web infrastructure and the product information and data that goes behind the infrastructure.

Okay, thanks, great quarter, guys.

Your next question comes from the line of Derek Jose of Longbow Research.

Can you talk about the new national account growth, how many of those firms implemented a VMI or CMI system with you?

And then a carry on to that, how many new systems overall were added, if you release that.

Derek, it is Erik.

Derek, not something that we disclose publicly.

In general I can tell you that the VMI inventory management trend has been growing and it is a vibrant program for us but it is not something that we break out separately and share numbers on.

Okay.

Can you go back to Website, the MSC direct.

How much of that in the quarter was actual new business, how much of it was existing customers, and how much of it was a transfer from your regular call business?

Derek, Erik again.

Also not numbers that we share.

Again, I can give you a general perspective on it which is that it is both a combination of what we see, business coming from the Web is a combination of there's certainly incremental business that's new customers coming to us and there also is some transfer.

As you heard in the prepared remarks, we talked about the Web being powerful on two fronts.

As a customer service enhancement and revenue driver, also as a cost savings over time, and that's a piece of what we're seeing.

Okay.

And the last one, and hopefully you'll be able to comment on this one, is in general what product categories have you seen the biggest pickup?

And has it been more one-time purchases or stuff like MRO business?

Derek, Erik once again.

In general, the way I'd characterize this one, is it's really tied to the customer segments that are performing.

As I mentioned, we're first now seeing really encouraging signs in our core business that that's starting to pick up.

You saw that with a little bit of growth in Q2.

And generally what that means for us is when we see the core business grow, our metalworking products start to pick up, so you could expect to see a correlation there over time.

As the core grows, so does our metalworking volume.

And again, as Chuck and David had mentioned, what's encouraging to us about that is the long range margin implications as we see our core grow, as we see metalworking grow, there's tailwinds on gross margin.

Okay, thanks a lot, guys.

And your final question comes from the line of Adam Uhlman from Cleveland Research.

Good morning, it is actually Erika in for Adam today.

Just one question on the customer count.

Can we talk a little bit about what you see going on there?

We've talked a lot today about share gain opportunities yet the customer count continues to decline.

When do you see this customer count stabilizing for you guys?

Hi, Erika.

I'll give you some perspective on our customer number, the customer count number, and you see it declining.

Really, this is a trend that is consistent with how we've chosen to drive our investment strategy.

Let me put a little more color on that and how we look at our customers.

We look at our customers in tiers and the tiers are based on really two factors, how much business they do with us and then, even more importantly, is the potential for growth that we see with them over time.

So what we're seeing in the customer number, virtually all of the drop-off in accounts, the drop-off accounts, are coming from our lowest tier so that means small dollar volume with us and limited growth potential.

So to put some color on that, our average drop-off account does less than $500 a year with us.

So if you've heard us over a number of calls cite the fact that it is minimal impact on revenues, that's why.

A couple of things we see happening in that tier, it's a combination of certainly the economy has impacted us, and it's also been an area that we've pulled investment away from, as you can see with some of the direct mail numbers coming down.

The flip side to that is we're really encouraged by what we're seeing in the customer tiers that we're focused on.

And the ones that we're focused on are where we see different ranges of customer volume but most importantly where we see growth potential.

So in the segments that we're focused, the tiers that we're focused on, where we see the potential, I will tell you that even through the downturn retention rates were pretty close to historic highs and we view that as a really encouraging sign given that we've been through a pretty rough recession.

So overall, if your question was around market share and how does it reconcile with the customer count, that is how.

It is really about looking at the customer base in tiers.

So is it fair to say that some new customer opportunities are focused in the tiers that you are looking at, those higher than $500 tier customers?

Absolutely.

Great, thank you.

There are no further questions.

Management, do you have any closing remarks?

Thank you all for joining us today.

We appreciate your time and attention and look forward to speaking to you again next quarter.

Thank you.

This concludes today's conference call.

You may now disconnect.