MSC Industrial Direct Co Inc (MSM) 2011 Q4 法說會逐字稿

Good morning, and welcome to the MSC Industrial Direct fourth quarter 2011conference call.

All participants will be in listen-only mode.

(Operator Instructions) After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Eric Boyriven of SCI Consulting.

Please go ahead.

Thank you, and good morning, everyone.

And welcome to the MSC Industrial Direct fiscal 2011 full-year and fourth quarter conference call.

An online archive of this broadcast will be available one hour after the conclusion of the call and available for four weeks on the homepage of the Company's website at www.mscdirect.com.

During today's presentation management will refer to financial and management data included under the section Operational Statistics, which you can find on the Investor Relations section of the Company's website.

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

This call contains forward-looking statements within the meaning of the US Securities laws, including guidance about expected future results, statements regarding expected revenue gross and operating margin and earnings growth, expectations regarding the Company's ability to capture marketshare and expected benefits from the Company's investment and strategic plans.

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

Information about these risks is noted in the earnings press release and the risk factors in the MD&A sections of the Company's latest annual report on Form 10K 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 Chief Executive Officer, David Sandler.

David, please go ahead.

Thank you, Eric.

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

With me are Erik Gershwind, President and Chief Operating Officer; Jeff Kaczka, our Executive Vice President and Chief Financial Officer; and Shelley Boxer, Vice President Finance and Accounting.

Before getting into the quarter I want to take this opportunity to say a few words about the promotions of Erik Gershwind and Ilene McGuire.

We are fortunate to have two such outstanding executives among those leading our Company.

It has been gratifying for me to watch their continued growth and development through the many years we have been together.

I have the privilege to work closely and get a firsthand view of their integrity, incredible skills and business acumen, intense focus and their passion for fulfilling our mission statement to be the best.

The long-term growth vision that MSC has for the future has never been more secure than with the team leading our Company today.

Turning to the quarter, I will give our perspective on fiscal 2011, the current economy and how we intend to manage our business during this time.

Erik will provide an update on the execution of our model, and Jeff will provide details on our financial performance.

We achieved and surpassed many important milestones this past year.

We passed a $2 billion mark in sales, and did so while delivering record levels of profitability.

We made two acquisitions in the metalworking space, our first in several years.

The business development team put in place during this past year will continue their focus on targets that meet our strict criteria with the goals of generating faster top line growth and greater share gains, becoming quickly accretive to earnings, further enhancing our metalworking capabilities, and lengthening our lead in this key market place.

The growth that we achieved reflects our marketshare gains as we continue to outgrow the market by a wide margin.

Operating margins returned to near record levels and incremental margins were strong.

It is clear that our investment program and operating plans delivered substantial results, and I am gratified that we were able to achieve all that we promised for 2011.

These accomplishments are indicative of our leadership position in the marketplace.

Now let me provide our view of the broader picture.

Like everyone, we have been concerned by recent market volatility, a moderating ISM trend, domestic and world events and how their impact might translate within our customer base.

Given the uncertainty of the current environment, I wanted to spend some time laying out what we are hearing from our customers about business conditions and then explain our approach to managing our business.

Let me start with business conditions.

As you know, we have a thorough process that provides us with field data from all markets across the country.

That process is used in conjunction with the field and customer visits regularly made by our management team to provide us with as clear a picture as possible of customer sentiment and up-to-date trends as much as possible.

We pushed hard to identify where customers might be slowing down, and how they are being affected by current conditions.

While there are always pockets of customers who are outpacing or underperforming the market, in general, we are pleasantly surprised by what we continue to consistently hear.

The clear theme is that business conditions throughout the bulk of our manufacturing segment generally remain quite solid.

Customers also broadly reiterate their focus on doing more with less, which bodes well for the MSC model and our share gain prospects.

And while we view this as very good news, customers also do express concerns over potentially slowing backlogs, their continued resistance to hiring and caution over world uncertainty and this potential impact on future business conditions.

However to date, that has not materialized in their businesses as of now, and we continue to operate in a moderate growth environment.

Our approach to managing through uncertainty in the environment remains the same.

First of all, we are proactive.

As soon as we sensed severe volatility in 2008, we began to slow down spending.

We did this early on so that we were operating on our toes, not our heels, poised to capitalize on the opportunity that invariably comes with any market dislocation.

You will hear these themes throughout as Erik and Jeff comments regarding the actions we took in Q4 and what we anticipate in Q1.

Next, we are long-term planners.

That means we realize that we must continue to invest for the future of this business.

You will see us do so to varying degree no matter what comes our way, just as we did in 2008 and 2009 during even the most extreme conditions.

Overall, we continue to invest at higher rates than any time in recent history, and we are focusing those investments in a number of critical areas including sales force expansion, metalworking capabilities, vending solutions, private brand and e-commerce, among others.

I can't remember a time throughout my 23 year career at MSC that has presented as many opportunities to our Company as those provided by today's land grab environment.

The final point I will make is that we are balanced.

Our mission statement drives us to be the best as measured by all of our stakeholders.

That means that we will always balance the long-term need to invest with the short-term need to provide acceptable returns to our shareholders.

We anticipate expanding our operating margins in a moderate growth environment or better.

Should things deteriorate, that of course becomes more difficult to do.

However, we will continue to be mindful of keeping operating margins strong while at the same time investing for the future.

The results for Q4 and of the entire fiscal year 2011 were excellent.

I couldn't be more pleased with the Company's performance, and I am very proud of our Associates, their dedication, hard work, and how well we work together as a team, which enables us to accomplish great things this past year.

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

Based on current market conditions, the Company expects net sales for the first quarter of 2012 to be between $538 million and $550 million and diluted earnings per share to be between $0.91 and $0.95.

Thanks.

And I will now turn the mic over to Erik.

Thanks, David.

I would like to start with a sincere thank you to you, to our Board of Directors, and to the entire MSC team for the continued vote of confidence and the additional responsibilities that you have granted me.

It is an honor and a privilege to lead our Company.

As well as we've performed over the past several years, I can honestly say that our future has never looked brighter.

I will now turn to the quarter.

We continue to execute well, and realized the benefit of our investments in the form of accelerated share gains.

Q4 sales growth of 15.6% included manufacturing growth of 20.3%.

Non manufacturing sales growth dropped to 3.3% for Q4, reflecting continued softness in the government sector.

While government sales increased from Q3 to Q4, we did not see the same lift that we saw a year ago, so growth rates were negative for the quarter relative to last year.

This had the effect of reducing the growth rate in non manufacturing sales for the period.

Looking ahead to the first quarter of FY 2012, the midpoint of our guidance implies revenue growth of 15%, inclusive of ATS, and 12.3% on an organic basis.

That forecast includes the assumption of continued softness in the government sector, reflecting the start of their new fiscal year in which spending restrictions are typically tight.

It also assumes continued strength in our manufacturing sales.

Our new Big Book, released on September 1, included approximately 14,500 new products, and the removal of a 17,500 underperforming, or discontinued products.

We will add an additional 20,000 products to our online catalog during fiscal 2012 as well, for a total of 34,500 SKUs for the year.

Approximately 50% of the new products that are added to the Big Book are MSC proprietary brands, bringing our total private branded offering to over 65,000 items.

Embedded in the new Big Book was a price increase of roughly 3%.

Price realization in Q1 has been solid and as expected.

Other tailwinds in Q1 include our growing manufacturing and core businesses and the benefit of our strategic programs, including private brand and global sourcing and our discount management program.

We have seen an additional headwind in Q1, which is accelerated realization of purchase cost increases due to the sustained commodities inflation that we have seen over the past year.

This is not a surprise, and is essentially a catch up for the price increases that we have taken to date.

Looking to the future, we anticipate a midyear price increase assuming that conditions hold which should mitigate the effects of those cost increases.

And Jeff will provide more complete gross margin detail in just a bit.

We were excited to bring American Tool Supply into the MSC family during the fourth quarter.

ATS has been a leading metalworking distributor and a top competitor in New England for many years.

It's reputation as a well-run Company with similar values to MSC, a customer-focused culture, a highly skilled technically-oriented team, and value-added services such as a regrinds and special fabrication of cutting tools, were all important factors that drove this acquisition.

We are even more confident in the synergies that we see between our two businesses now that we have been working closely together.

We plan to accelerate revenue growth and account penetration by bringing the best of both Company's values to our customers.

We also plan to expand gross margins by leveraging MSC's purchasing power and by generating incremental revenues through the MSC Big Book offering that will come with higher margins, while at the same time retaining the important brands that are unique to their business.

The integration of ATS is proceeding on schedule and according to plan.

ATS results were breakeven in Q4 and should remain so in Q1, and will then become accretive during Q2 when we will have completed the systems integration.

Going forward, we won't be breaking out a ATS's results separately.

As you will hear from Jeff, ATS had a dilutive effect on MSC's overall gross margin and read through this quarter.

However, we could not be more excited about the prospects for expanded profitability resulting from the ATS integration and future acquisitions that will follow.

I will take a moment to refresh you on how we think about M&A.

There are two types of acquisitions contemplated in our strategy.

One is a platform which would represent a move into an adjacency such as a product line or a new end market.

The other is a fold-in, which is a way to fuel our geographic build out and penetration of the US metalworking market.

It is tough to paint the potential platform moves with one brush in terms of operating margins as they will vary greatly based on the product line, end market, where the individual target being considered.

Those will need to be described on a case-by-case basis.

Conversely, based on our significant experience, we are able to broadly describe the characteristics of fold-ins.

As you know, virtually all of traditional industrial distribution operates at significantly lower gross and operating margins than MSC.

This means that when we buy a local distributor, it will almost certainly be dilutive to gross margin and to operating margin.

However, because these businesses are in our core, synergies are large, like the ones we described for American Tool.

Those synergies help make fold-in acquisitions accretive quickly and also served to significantly increase the target companies gross and operating margins over time.

Our acquisition program from the 1990s, 10 or more years later, now gives us a solid understanding of what we can expect for the future.

We have seen that over extended periods of time the traditional branch space acquisitions we made end up looking pretty similar to an organic MSC branch.

We are confident that our formula for acquiring and integrating these businesses will significantly expand their operating margins and is repeatable for the future.

The MSC value proposition continues to excel in delighting customers.

A recent visit to a large machine fabricator in the Northeast was another validation point for me.

I had a chance to meet with the plant manager who described to me the history of the relationship between MSC and his Company.

As he was doing so, he asked a question of me that I have to admit made me smile.

He asked, why would a metalworking shop need to do business with anyone other than MSC?

He was describing that there were several things he appreciated about MSC.

First, the combination of our enormous product offering and superior logistics which means he doesn't have to worry about keeping inventory on the shelf, nor does he have to worry about an out of stock that could affect the production run.

Second, the technical strength of our local salesperson and our metalworking specialist means in that we are providing advice on the plant floor to generate productivity and cost savings.

Third, our technology solutions, including e-commerce and now vending, as he was getting ready to install his first vending machine, streamline his purchasing process, and help take inventory out of the system.

The best part about this customer is the fact that despite high levels of satisfaction and despite the fact that this is a six-figure account for MSC, we see runway to more than double our revenues based on additional opportunities within the plant.

We continue to add to our industry-leading sales organization.

The sales force grew to 1,051 Associates at the end of Q4, including 15 top producers who joined us from ATS.

We expect Q1 sales force headcount to be roughly flat with Q4.

This flattening is to strictly a matter of timing between Q1 and Q4 and does not indicate further spending slowdown.

When taken together, our Q4 actual and Q1 projections are consistent with David's description of a gentle slowing in spending with continued investment for the future.

Thanks, and I will now turn things over to Jeff.

Thanks, Erik.

Overall, we had a great quarter and we are very excited with the way we have ended our fiscal year.

For the fourth quarter, compared to the same period last year, sales grew 15.6%, of that which ATS contributed 1.2 points of growth.

Gross margin is up 110 basis points and EPS grew 33%.

Our earnings per share was $0.93 for the quarter and this exceeded the top end of our guidance range.

The primary factors contributing to this higher than expected EPS were higher sales, favorable operating expenses, and a lower than expected tax provision.

Let's talk briefly about these.

First, our sales came in above the midpoints of the guidance range excluding ATS's contribution, thanks again to even stronger-than-expected growth from our core customer base.

We continue to realize success from our growth initiatives.

These incremental sales above our midpoint contributed about $0.015 of additional EPS.

Second, our improved operating expenses were the result of some reduced discretionary spending as well as favorable results in such areas as professional fees, payroll and freight expenses.

I should mention that a portion of the savings and professional fees is expected to be spent in Q1 and is included in our guidance.

The lower than anticipated operating expenses contributed an incremental $0.045 to EPS in Q4, and the remainder of the incremental EPS, about $0.02, came from the lower than expected tax provision which resulted form higher charitable contributions and favorable expiration of statutes.

So we had plenty of good news.

We are also pleased with the 17.6% operating margin we achieved in Q4, including 30 basis points of ATS dilution.

And I should note that the incremental margin in Q4 was 32.5%.

Our tax rate for the quarter came in at 36.5%, which was lower than expected for the reasons I mentioned earlier.

I would expect this to return to a more normalized rate in Q1.

Turning now to the full fiscal year, we achieved record sales and profitability levels.

Sales were $2.022 billion, a 19.5% increase over fiscal 2010.

Our total year operating margin was 17.3%, and incremental margin was 32.7%.

Our EPS was a record $3.43 per share.

That's 44.7% growth over last year.

Q4 balance sheet metrics remains strong.

DSOs were 44 days, unchanged from Q3, and inventory turns were 3.46, down slightly from Q3 levels, and were as expected.

Inventories increased about 7% from fiscal Q3 levels as we continue to take advantage of our liquidity and financial strength to ensure our ability to meet customer demand and enhance our service levels, as well as protecting our gross margins in this inflationary period.

The increase in inventory is expected to continue into Q1.

Cash flow conversion was outstanding.

We converted 109% of our net income into cash flow from operations in Q4, and we had approximately $96 million in cash and cash equivalents at the end of fiscal 2011.

Our current cash position stands at approximately $125 million.

During the fourth quarter, we repurchased 1.2 million shares of our common stock for approximately $66 million.

And I am pleased to report that our Board of Directors has recently approved a replenishment of the plan to a total of 5 million shares authorized for future repurchase.

The Board also approved an increase in our quarterly dividend to $0.25 per share.

Turning now to our guidance for Q1, our anticipated sales growth at the midpoint is 15%.

Excluding ATS, the anticipated growth at the midpoint is a 12.3%, both of these views reflect solid growth on top of a 20% quarter at year ago.

We currently expect gross margins for Q1 to be in the range of 46.2%, plus or minus 20 basis points.

And to be clear, this is net of 60 basis points of dilution from ATS.

Over time we would expect the gross margin dilution from ATS to moderate as we execute upon the synergies that Erik described.

Excluding ATS, our organic gross margin of 46.8 % is consistent with our expectations, taking into consideration all the factors including the product cost catch-up which is now flowing through cost of sales.

Currently we think gross margins in Q2 of fiscal 2012 will be about the same as in Q1 as the benefit of tailwinds from pricing and strategic programs will offset the headwinds from the accelerated purchase cost catch-up.

We intend to provide more color on this in our next call.

In Q1 we expect operating expenses will increase at the midpoint of guidance by about $4 million over Q4, reflecting the inclusion of the ATS's operating expenses for the entire quarter, some deferrals from Q4, and expenditures necessary to support anticipated future growth.

We expect our incremental margin in Q1 to be about 26%, and I should mention that if you exclude ATS, we would achieve 32% incremental margin.

We won't be providing incremental margin guidance for the remainder of 2012 at this time due to somewhat limited visibility and uncertainty regarding the economic environment, but we will revisit this on our next quarter.

Finally, the Q1 tax rate should be about 38.3%.

And so just to be clear, with our Q1 sales guidance at the midpoint being up $11 million from Q4 and our gross margin increasing, you might expect a sequential increase of $0.04 or $0.05 in EPS.

However, this is all essentially offset by the fact that Q4 benefited from the lower tax rate and the discretionary spending deferrals that won't repeat in Q1.

Again, we are thrilled with our results and where we are headed for fiscal 2012, and beyond.

Thanks, and now I will turn it back to David for the wrap-up.

Thanks, Jeff.

Three years ago we outlined our plan to take disproportionate share during the land grab opportunity that we saw emerging.

Our results and accomplishments for fiscal 2011 once again highlight how we have capitalized on the environment and delivered on that plan.

We see a continuation of that opportunity for fiscal year 2012.

Over the last three years the economy has taken its toll throughout the fragmented landscape comprised of thousands of local competitors.

The strongest have rebuilt their balance sheets and repaired their service models and are competing effectively.

The greater part of that population, however, has been weakened over that period.

They struggle to maintain inventory levels in a competitive service experience, especially so in today's world where customers are demanding more.

And where saving time and money from a consolidated supplier base has become the mandate.

Regardless of what the economy might have in store this year, one thing is for sure.

Expect the MSC team to be aggressively taking marketshare and expect us to continue to press our advantages and accelerate our lead as we invest in further building out our capabilities.

Thanks for your attention, and I will now open up the line for questions.

Thank you.

We will now begin the question-and-answer session.

(Operator Instructions)

Sam Darkatsh of Raymond James.

Good morning, David, Erik, Jeff, Shelley, how are you?

A couple quick questions.

Jeff, I respect that you're not going to be talking about incremental margins for the entirety of 2012, fiscal year 2012.

Could you talk, however, about what organic growth would be required in order to leverage operating expenses at this point?

Sam, it's Erik.

I will actually take it.

You heard in David's and our prepared remarks, David talked about what we term to moderate growth environment, or better, we are pretty confident in our ability to expand operating margins.

That's really the color that I give you.

Of course the question is are we in a moderate growth environment, and if you asked us right now for a snapshot of how we see things.

Right now we would say, yes, we are in a moderate growth environment and therefore we see it as likely that we can expand operating margins.

I think there the proof is in the pudding.

So you look at our Q4 performance, you look at the guidance we gave for Q1 which were strong revenue growth and expanding operating margins and really strong read-throughs, and we also hear that reflected in the customer sentiment that David described, which as a snapshot right now, is solid.

The real trick for us is our ability to see around the corner and know what is coming.

If we knew that the future could look as it looks right now, we would be able to state with a good degree of confidence that we would expect to expand operating margins.

The challenge of course is we don't know what's coming around the corner.

Two other questions.

First off, with a very heavy share repurchase, or a relatively heavy share repurchase in the quarter, does that signal a change in strategy on a go-forward basis as to usage of excess cash?

And then if you could help us, if that's the case, how that might manifest itself on a decision basis to buy stock?

Sam, David.

No change in strategy whatsoever.

I think that what you've had a window in this quarter I think it was actually a really good window into our formula in general.

So between what you saw for this quarter, buying back stock, solid M&A activity, and an increase in the dividends and then not long ago you also saw a one-time dividend.

I think those are the components that you have seen from us over time, and those are the components that you can expect us to continue to move forward with.

So, no, strategy is intact and formula is operating exactly as we would have expected.

Last question.

Your government business being down in the quarter, I don't think that's much of a surprise based on budgetary restraints.

But your largest competitor mentioned that their government business was up in the quarter.

Any sense of what is happening from a competitive standpoint?

Sam, I'll think you characterized it right sequentially from Q3 to Q4.

As we expected we did see a lift in sales but not like the lift we've seen in prior years.

So you were correct that it was negative for the quarter, and as we have said, our guidance implies included in the guidance is continued softness in government.

Tough to comment on another Company's performance.

There's lots of mix elements within government depending upon where exposure is.

What I will tell you is, we are very confident in our plan and confident in the fact that we are executing, we are achieving share gains and we are sticking with this segment, just as we stuck with metalworking in 2008 and 2009 when it was declining, knowing that, that will lead to further share gains upon a rebound.

So, we are confident in our plan.

Are you seeing the Wiska benefits yet, or not yet?

We are just starting to, yes.

Early stages of it, Sam, but we are just starting to.

Thank you, I will defer to others.

Thank you.

Hamzah Mazari of Credit Suisse.

Good morning, thank you.

The first question is just on pricing.

Could you remind us what the, given the fluctuation in commodities and your ability to adjust pricing, what the lag is associated with the product cost catch-up and whether you are getting any push back from customers on current pricing given the uncertainty out there?

Yes, Hamzah, it's Erik.

I am happy to address pricing.

For the last couple of years we have been talking about how inflationary environments are generally good for MSC and yield gross margin expansion.

And I think what you've seen play out since the downturn has been basically the formula working just as we would have thought it would work.

We are seeing gross margin expansion.

So, we have talked about our price increases.

Realization, I mentioned in the prepared comments.

Realization is strong, solid, just as we would've expected.

So to answer your question specifically, yes, we are seeing pricing stick.

When we talked in the prepared remarks about the purchase cost catch-up, essentially what is going on is there is a timing lag between a sale price.

And this is part of, by the way, the gross margin expansion opportunity that we have, is a combination of a lag between when we are able to pass along the sale price in advance of realizing a cost increase.

And also this is an opportunity for many of our strategic suppliers in inflationary environments to hold back cost increases to us which is a further way to expand margins.

That's helpful.

And then just last question on your growth initiatives, global sourcing, vending, private label and others.

Is there one where you find that you have the most running room or low hanging fruit?

How should we think about that?

Or are you thinking more of a broad-based approach to all these initiatives?

Hamzah, it's a good question.

And what I would say is we are in a fortunate position where I couldn't pick out one.

There are several, and it's the investments that we've continued to highlight in the last few calls.

We see significant runway and significant return on investment in all of the ones that we've been highlighting.

And really that's quite frankly why we've pushed them to the top of the list.

I wouldn't call out any one.

What I would say is the ones that between David and I we've highlighted on the last few calls, all good return and all significant runway.

Do you guys have any specific targets, or you don't disclose those, on global sourcing, or where you want to be on private label?

Sorry, on private brands in particular.

So, yes and yes, we do, we absolutely do have targets.

We have aggressive targets internally that our product management team drives to.

Yes, you are correct, we don't share them publicly.

You may have noticed we did share one piece of information that we had not shared before which is the SKU count of private brand which is at about 65,000.

So at least directionally that gives you a feel for the fact that there is critical mass in the program and yet there also is a heck of a lot of runway for the future.

And going forward, what we will do is annually, is we update you on the stats on the Big Book addition each year with new products.

We will give you an update on the private brand SKU count as well.

Great.

Thank you.

Ryan Merkel of William Blair.

Thanks.

Good morning, everyone.

My first question is on pricing.

Can you maybe discuss which categories you are seeing the price increases?

And then second part of that question is, what gives you the confidence that you could get a midyear price increase this year?

Okay, Ryan, it's Erik.

Pricing, we typically don't, Ryan, disclose within - - so we gave you the roughly 3% increase.

I am not going to break it out by product line.

Directionally what I would tell you is, it is in line with where we are seeing significant commodities inflation.

So you can certainly look at steels, tungsten, as another example of a raw material that has been up considerably.

Those product lines that are directly impacted by those raw materials would see disproportionately bigger increases.

Regarding your point on the midyear pricing, Ryan, there's really a couple of factors that we look at.

One is customer sentiment and pricing indices and the fact that we believe that the market still supports commodities pressure is absolutely still there.

Our customers are feeling it.

So we think the environment is ripe.

And the other thing that we talked about in the prepared remarks is that customers are doing more with less.

And in environments like that the MSC value proposition gets even stronger and the gap to the rest of the market even wider.

So we believe that we are able to command it by offering a tremendous amount of value to our customers.

Okay, makes sense.

And then second question, with one month left in your quarter, the sales guidance range suggests quite a wide range for November sales.

Anything to read into there, or is that just simply consistent with your formula?

Ryan, nothing to read into.

No, just timing month-by-month.

Nothing to read into in terms of any movement.

Thanks, I will jump back in queue.

Matt Duncan of Stephens Inc.

Good morning, guys.

Congrats on a great finish to the year.

The first question I've got, maybe this one's for you, Erik.

If you can talk about sort of the various end markets within your manufacturing customer base, where you are seeing strength?

And are there any where you are starting to see any kind of weakening on the fringes, within specifically manufacturing?

Matt, what I would characterize is we usually do is, where we are seeing the strength is within our core market which is durable manufacturing.

It's pretty broad-based strength.

As David said, it is interesting because the snapshot right now is strength.

We are not sure about what the future holds, but I would characterize it as pretty broad-based across durables.

And really I would highlight government as the one area that we have already spoken about in terms of where there continues to be significant softness due to budget constraints.

When you talk about uncertainty in terms of what the future holds, is that tied to any change in customer tone you're picking up, or is that really just what we see in the media more than maybe what you're seeing in your business?

Matt, I thought David did a good job of capturing it.

What he said is if you ask customers and we do, we are asking customers now, it's generally business conditions right now, we're solid.

There are a couple of yellow flags that could indicate an issue down the road.

Looking at order backlogs perhaps not being as strong.

Looking at reluctance to hire or invest in capital equipment indicates things might not be as strong down the road.

From a customer standpoint that's how I describe it.

And the other measure that you know we look at, and everybody does, is the ISM.

Which last few readings we kind of consider as borderline readings in terms of whether we would characterize it, are we in a moderate growth environment right now, or not.

Last few readings have been borderline.

So that's what we are looking at.

Okay, and then last thing for me and I will hop that into queue.

On the operating expenses, it sounds like there were some discretionary cuts or maybe just holding back on increases occurring during the quarter.

Obviously, you added to your sales force, so what types of operating expenses were you guys maybe sitting on a little bit this quarter and do you expect to accelerate those?

Matt, this is Jeff.

The operating expenses that were deferred really were discretionary expenses mostly on lower priority projects and associated consulting fees and so forth.

Not necessarily mission-critical.

Nothing that will materially affect us long-term.

Some of these, particularly professional fees, were on specific projects were deferred into the first quarter.

So you will see those incurred in the first quarter and that is included in our guidance.

Thanks, guys.

Thanks, Matt.

Adam Uhlman of Cleveland Research.

Hi, good morning.

Good morning, Adam.

I guess first to start I appreciate the extra disclosures you guys are providing.

That's very helpful.

But, Erik, when you were going through the acquisition strategy, I guess I'm wondering if we should expect an acceleration of acquisition activity from doing a small deal once every nine or 12 months to something more frequent and potentially larger?

Adam, it's David.

I wouldn't, we have talked about the fact that we built the plan to add the new development business development team that is now in place, very, very focused.

And I will tell you, Adam, that our funnel of opportunities is pretty full.

Having said that though, we are going to continue to maintain our discipline and our focus on really strict criteria.

So I think you will see us continue to execute here in a very measured way relative to the past several years.

Obviously, the activity has increased evidenced by two fold-in type acquisitions that we did in 2011.

I think that's probably the best way to characterize our thinking about what you might expect moving forward, and also just to let you know that the process that's been built coupled with the team that is in place gives us a lot of confidence in our ability to execute in this area.

Okay, got it.

And then a couple of clarifications.

The average transaction size jumped a lot this quarter relative to last.

Can you talk about what you're seeing there?

And then on the regional sales split, the Northeast growth rate accelerated in the quarter.

And I'm wondering what you're seeing there, if that was help from the hurricanes, or what exactly that was?

Adam, to just take then in order average.

Average transaction size was up roughly 4%.

Nothing specific to call out there.

That was strength we saw pretty much across most of our segments so I wouldn't call that anything unusual.

And regarding the Northeast, you are right.

Really what I would point to more than anything is just solid performance within our core business which is a big percentage of our Northeast segment.

So more than any one isolated event like a hurricane.

Okay, thanks.

Thanks, Adam.

David Manthey of Robert Baird.

Thank you, good morning.

First off, could you tell us what average daily sales were in September and October, excluding ATS?

I don't have it on me.

We don't give that.

Have we not given that?

No.

So, David, you have growth rate.

What you're really looking for, David, is our estimate for the first quarter, right, on ATS?

I'm just looking for same-store sales in those ATS numbers.

So, the number we can give you is the guidance for Q1.

So organic, meaning without ATS, the guidance implies 12.3% organic growth for Q1, that's all in for the three months, our projection.

So in a given month would it be a couple percentage points, or what would contribute to?

I would just about straight-line it because if you go look at the stat sheet, Dave, you will see that there's not a lot of variation going on right now.

Okay.

And then second, as you look back to follow 2008, you've gone over some of the things that you are seeing today and you can sort out the similarities and differences.

But anything else you want to touch on as it relates to this environment versus that one?

And the second question that is related, I am wondering if you're hearing any chatter among your customer group regarding year-end shutdowns or taking off extra time around the holidays which I think was something that we heard back then?

David, I guess I will start on the first and then Erik can add any color about what may be coming for shutdowns.

But in terms of the environment today versus what was happening in 2008, thankfully there are not many, if any, real similarities.

If you remember back then, the world was falling off a cliff and it was gaining momentum, and I guess the metric that probably best brings it back to specifics for our business was what we saw happening with the ISM.

Thankfully, while there's a lot of uncertainty right now and we are hearing some caution coupled with a bit of a moderating trend with ISM, etc.

And of course there's a lot of world uncertainty that's out there as well that is kind of contributing to the overall uncertainty and a bit of a lack of visibility.

We are prepared for it, but thankfully, what we saw in 2008 is very different than anything that we are seeing right now.

David, it's Erik.

First of all, just to reiterate what David said, if you went back to 2008 and looked at our comments, I'm pretty sure they were decisive in terms of what we were seeing.

As we said, we are describing them now is that if you took a look at the current snapshot it is pretty solid.

It's just much more of an uncertain picture moving forward.

To be honest, on year-end shutdowns, not hearing much talk of it at all yet.

It really, the discussions with our customers have been so focused on what's going on now, what's happening to backlog, that I don't have a good answer for you there because it's really not been the top of mine.

We will obviously give you a lot more color on that on the next call as to what we saw in December.

All right.

Thank you.

Thanks, David.

Scott Graham of Jefferies.

Good morning.

Very nice quarter.

Very nice.

Thank you.

I just had two questions for you specifically about your private label strategy and your decline in direct mailings.

I will take the second one first.

I know that the direct mailing decline is orchestrated will have you.

I'm just wondering where those resources are being redeployed?

Scott, it's Erik.

You noticed.

You saw a pretty big - - typically in Q4 if you go back over the years, you will always see a drop from Q3 to Q4 in mailings.

But you're absolutely right that the drop was more pronounced this year.

A couple things to say about that, one is in terms of where the funds get redeployed.

It's to the growth investment initiatives that David highlighted in his opening remarks.

So we are constantly - - part of our process is to redeploy money to the highest, basically moving money to what we see as the best opportunities, the highest and best use.

The other thing I will say is that another part of the story here, Scott, is the success of our electronic marketing program.

So we are getting as many or more customer touches with better performance at a much lower cost.

So this is a beautiful thing in that, yes, we are redeploying money and we don't think were giving anything up in the process.

Understood.

Thank you.

I know that private label is another strategic area for you guys, and I was just wondering, if you said this already, I got on the call a couple of minutes late.

I apologize if you said it but did you give an indication of what private label sales were up, what they were is a percent of sales?

Maybe if you could just shed some light on that for me as well as maybe a long-term target if you have one?

Okay.

So we definitely have long-term targets, we have near-term targets and their percent of sales.

We don't disclose them publicly.

As you know, for competitive reasons, we have been fairly opaque here.

We did share in the opening remarks was our SKU count on private brand.

At least that should give you a directional sense of how far penetrated we are.

That was 65,000 SKUs in the catalog that are private branded.

So what that should give you a feel for is some critical mass in the program and a ton of runway for the future.

I get it.

Thank you.

Thanks, Scott.

John Inch of Bank of America.

Thank you.

Good morning, everyone.

Good morning, John.

So, I guess my first question is, It looks like you're deferred spending was something on the order of $3 million versus what you had thought was going to be incurred in the fourth quarter.

Is that about right and is that the number that you expect to be incurred in this first fiscal quarter?

That's in the range, John, $3 million to $4 million, and in fact a portion of that would be deterred into the first quarter.

Right, I know you said $4 million was the original deferral.

I'm just trying to focus on the spending part.

That was about $3, isn't that about the number?

That's in the range John.

So, I guess my question is, I think, Jeff, you mentioned these were small projects and so forth.

Why did you actually defer them?

If the Company is doing so well now, why not - - particularly if there is a risk of a slowing coming, why not do the projects now given your earnings strength and demand strength, absorb the cost versus deferring them in case business conditions weakened.

Why did you actually defer them?

John, it's Erik.

I think what you are getting at really tracks to David's opening comments about how we like to manage the business through an uncertain time.

And the answer is that we like to be proactive.

And if we see uncertainty coming and you saw this as David said, in a of course a much more extreme case in 2008, we got ahead of it early, we took action probably faster than most, and we cut spending aggressively faster than most.

And we did that so we were proactive ant that we could be on our toes when we saw opportunities.

And that's really the formula that we followed this time, obviously to a much lesser degree.

But it's to be proactive and to get ahead of it and be positioned to be able to move when we see opportunity.

I think what you are saying, Erik, is that the project spending, if you had actually started them, would've gone on for a few quarters, and if we are facing a slowing then you if all was equal, prefer to not have that as sort of these cost headwinds in that context.

Is that accurate?

Yes, certainly, for a portion of that I think that would be a good description.

Yes.

That makes sense.

So I want to ask you guys, you are forecasting gross margins up a little bit right, sequentially?

If I go back a year ago, your gross margins went from 44.9% to 46%.

Why was there - - I mean I get it, your volumes - - this time your volumes are 15%, last year they were 23%.

You're profit conversion looks about similar.

Why were your gross margins not going up a little bit more than your forecast guidance?

If I just take the year-over-year trend of what happened from the fiscal quarter in 4Q 2010 to 1Q 2011.

Is there something about that here that makes this not as robust an opportunity for margin expansion?

John, if you look at the numbers, the gross margin numbers excluding the impact of a ATS, you would see it has gone up about 50 basis points.

And if you track last year and the last several years, an increase anywhere from the range of 15 basis points, 110 basis points occurs during that Q4 to Q1 period.

And of course there is the benefit of the Big Book price increase.

This year as Erik mentioned in his comments, we are faced with the purchase costs catch-up.

And that's the primary factor keeping it at the 50 basis point level.

I will remind you that, that purchase cost increase also was one of the things that aided us in achieving the price increases we have over the past year.

That makes sense.

Can I just ask you, finally here, if you guys can give us a little color on the impact of basically rebates?

How that affected the quarter and your outlook?

And then drop ship, what was the impact there this quarter and your outlook?

I will take the rebate portion of that.

I think during the last call we had mentioned that the rebate levels in Q4 would drop from the previous quarter, FY 2011 was an unusually high year for rebates.

We did return to those more normalized level and we would expect that to continue through FY 2012, and again, came in as expected.

John, regarding the drop ships, are you referring to some of the large order activity that we have described over time?

Yes, exactly, was that significant this quarter and what's your outlook?

Continuous of the large orders that we've described that come in at a lower gross margin percentage, continue to be part of the mix of business.

One thing I will point out with government down we've said that the large orders are more prevalent in the large account segments and one of those being government.

So with government sales being soft, slightly moderated, but still an ongoing presence, yes.

In other words that probably helped your mix a little bit, right?

Yes.

Brent Rakers of Morgan Keegan.

Good morning.

Maybe just three quick questions.

First one, maybe hoping you could explain in a little bit more detail what this purchase costs catch-up you are referencing?

That's question one.

Number two, wanted you to maybe review - - I know you have talked a lot about the government sector and some of the impact last quarter.

Could you maybe talk about it going forward?

It seems like this was the quarter, we're entering a quarter last year where the business started to decelerate pretty sharply, so I wondered about the impact of easier comps.

And then the last question, if you could maybe give the number of ATS employees?

Okay.

Brent, it's Erik.

I start with your last question first because it's the shortest answer, which is 90 on the ATS Associates.

Let me go back to your two that will take a little more time.

So purchase cost catch-up, I talked a little about it earlier.

Essentially, what you have going on is as I talked about, inflation means margin expansion for the Company because we are able to take sale prices ahead of cost increases.

And while we certainly pushback on suppliers and I think do a very good job on the buy side, given the sustained commodities pressure that has been at least a year now over a prolonged period of time on an absolute level, we do see elevated levels of purchase costs, and that takes time to bleed through the P&L.

Whereas with sale price we are getting it earlier on.

So in general, the formula has played out to produce sizable gross margin expansion, but there is a bit of mismatch in timing and that's when we talk about purchase costs catch-up.

That's what we were referring to.

Great.

And then just the question on government comps, going forward?

Yes, government comps.

Let me talk specifically about Q1 because we actually, despite the softness that we described in Q4, we actually have government average daily sales implied in our forecast to be down from Q4 levels.

The primary factor there is the year end spend of the government, which their fiscal year is end of September.

We normally see a drop-off after year end because of tighter budget restraints after the close of the fiscal.

But I would tell you is with continued pressure on federal and state governments, we are seeing, and expecting to see, an even further clamping down at the end of this year end.

I know it is time to wrap-up the call.

But just to clarify that, you said government went negative year-over-year in the August quarter.

It sounds like both in the guidance for the next quarter but also going forward, you see it being at a sustained modest-negative level for the next several quarters?

Can't talk that far, Brent.

I would certainly for Q1 that's what's implied in our sales forecast.

Beyond that, it's a bit of an unknown.

Certainly the environment is not great in government but I would not comment beyond Q1.

Great, thank you.

This concludes our question-and-answer session.

I would like to turn the conference back over to management for any closing remarks.

Please go ahead.

Okay, thank you.

Appreciate your time and all of your interest today.

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

Thank you.

This concludes today's conversation.

Thank you for attending today's presentation.

You may now disconnect your line.