MSC Industrial Direct Co., Inc. (MSM) Q2 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the MSC Industrial Direct Second Quarter 2012 Conference 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 Alexandra Tramont. Please go ahead.

Thank you and good morning, everyone. Welcome to the MSC Industrial Direct fiscal 2012 second quarter conference call. An online archive of this broadcast will be available one hour after the conclusion of the call, and available for one month 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 U.S. securities laws, including guidance about expected future results, statements regarding expected future revenue growth and operating 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 actual results to differ materially from those anticipated by these statements. 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 10-K filed with the SEC as well as in the Company's other filings of the SEC. 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.

Thanks, Alex. Good morning, everyone. Thanks for joining us today. With me are our President and Chief Operating Officer, Erik Gershwind; Jeff Kaczka, our Executive Vice President and Chief Financial Officer; and Shelley Boxer, Vice President, Finance and Accounting. I'll be providing some perspective on our performance and results for Q2, as well as guidance for Q3. Erik will continue to build upon our last call by describing our growth strategy in more detail; he’ll provide color on our vending program progress and will review the customer landscape. Jeff will provide details on Q2 financial performance and Q3 guidance. Let me start by saying that I am thrilled with the progress we are making with our growth initiatives and the exciting outlook for the future. With each passing quarter it becomes increasingly clear to us that the industry consolidation that we foresaw coming almost four years ago is entering the next phase. Customers are demanding greater levels of supply chain solutions as they recognize that need in order for their business to flourish in today's fearfully competitive environment. There is no doubt that the industrial marketplace is rewarding the narrowing field of distributors who are capable of consolidating customer spend across multiple plant locations and who can provide the technology and technical expertise's required to improve productivity and reduced their total supply chain costs. During the economic turmoil of '08, we outlined our plan to heavily invest to take disproportionate market share and that by capitalizing on the land grab opportunity we would outperform the market by a significant margin that is exactly what is being seen in our results. We will continue to position MSC to win and to win big in this highly fragmented market. As Erik will describe in more detail the drivers of our success will continue to be our organic growth programs in conjunction with the type of acquisitions you've seen for us over the past year or so. We believe that is the most effective way to capitalize on the enormous opportunity at this unique point in time. Consequently we placed a priority on locking in share gains and penetration of customers. While that has created some near-term gross margin headwinds over the longer term we expect these headwinds to abate as these initiatives early successes become more mature. The time is opportune for us to continue building on our strong momentum with these initiatives as we increase our lead in metalworking and grow our business in adjacent product categories. At this point I would like to provide some guidance for Q3. Currently we expect revenues to be between $610 million and $622 million and fully diluted earnings per share to be between $1.08 and $1.12. Thanks everyone. I'll now turn the mike over to Erik.

Thanks, David. We are very pleased with the execution of our growth plan. On the last earnings call, I outlined our longer term strategies starting with the big picture, our vision to be a $10 billion company. Today, I'll provide the next level of granularity to our growth story. We view it as a journey and there are several benchmarks or milestones that we surpassed to reach our ultimate goal. Today, I'll provide more information about the next milestone. Our plan is to double the size of our business over the next five years reaching approximately $4 billion in sales in fiscal 2016. That implies a compound annual growth rate of approximately 15%. It compares to historical CAGR during our life as a public company of roughly 14% and it also compares very favorably with industry growth that's roughly the rate of GDP over extended periods of time. As David mentioned, we plan to disproportionately benefit from the continued trend towards industry consolidation. Much of our historic growth has been organic with acquisitions being a lesser but important part of the mix, roughly 12% of our 14% CAGR came organically. Looking to our more recent past, the picture is very much the same. Out of our 20% growth in fiscal year 2011, 18% came organically and 2% through acquisition. And looking most recently, at Q2 of this year, about 3.5% of our 16.5% growth came through our recent acquisitions and the balance was organic. Over the next five years, we anticipate that once again, the majority of our growth will come organically. Acquisitions will be an important supplement providing incremental growth in metalworking, related product adjacencies and potentially new geographies and end markets. Our growth strategy starts with continuing to penetrate our core business and that's the sales of metalworking…

Thanks, Eric. Our second quarter marked the continuation of solid financial performance for the Company. Sales grew 16.5% and earnings per share grew 22% over the same period last year. I'm sure you can tell that we're very pleased with our sales results for the quarter. Our sales came in above the top end of our guidance range. The small amount of the growth about 50 basis points came from our Q2 acquisition of ATS Industrial Supply. The real driver though is the successor investment programs in this land grab environment. Of the 16.5% quarterly sales growth year-over-year, nearly 4 points came from the success of our vending program and about 3.5 points came from our recent acquisitions. The remaining points came from volume and pricing. Let me clarify that the 4 points of growth related to our vending program is measured by the total revenue growth and accounts with vending. It is an important component of our investment strategy. It's expected to continue to fuel growth in the future. Now, let me walk you through the puts and takes of gross margin in the quarter. Our gross margin of 46.1% is down approximately 70 basis points in Q2 versus the same period in the prior year. There are a series of headwinds and tailwinds affecting gross margin, but the 70 basis points decline from last year is due to approximately 50 points of dilution from the two ATS acquisitions and about 20 points of dilution related to the vending program gross margin. As you know, the acquisitions will both be accretive to EPS quickly and both will see gross margin rise over time as they have with other acquisitions in the past. And in regard to vending, this program is fuelling accelerated top line growth, although there is some…

Thanks, Jeff. Our investments are clearly paying off as we take share and outgrow the market by a significant margin. There is growing optimism in our customer base and we are well-positioned to benefit from industry consolidation. At the same time, we have never been more excited about our outlook than we are now. I'd like to thank our associates whose hard work, enthusiasm and boundless energy make these outstanding results possible. Thanks. And I'll now open the lines for questions.

(Operator instructions). Our first question comes from Hamzah Mazari of Credit Suisse.

This is Chris Parkinson on behalf of Hamzah. You touched on this a little. Can you just kind of add some further details on how to think about the incremental margins in the next two quarters, particularly kind of parsing out the acquisition effect? And then also how you expect this to go relative to your normal levels as you approach you mentioned fiscal year '13?

Sure, Chris. This is Jeff. Let me step back for a moment. Read-through, as you know, is a function of the three key variables and that's the revenue trajectory, the operating expense management and gross margin. For this quarter and the foreseeable future, we'll be very successful in terms of revenue growth to great extent driven by the success of investment programs like the vending. We are also doing very well in expense management as you heard with some of the numbers. They are investing at high levels, while achieving productivity and our OpEx as a percent of sales is declining and that's very good news. The only near-term headwind to read-through is the gross margin and this is something that we expect to abate over time. As I mentioned, the gross margin is impacted by the acquisition, dilution and the vending program margins, I mentioned, that two-thirds of the drop in Q3 year-over-year is related to that. But I should point out that both of these initiatives are delivering solid growth and its profitable business, as it is today, a very strong business. Impact to the gross margin will abate over a longer period of time as the vending customer relationships mature, as the acquisitions mature and we've shown in the past that that will improve. I should also mention though that the gross margins have been impacted by the purchase cost catch-up which is part of the normal inflationary cycle. But on countering that we also have a lot of runway on the gross margin initiatives that we've got underway such as private brand and global sourcing and this also will mitigate gross margin pressure as they grow. So, putting it all together shorter term, I expect some growth pressure to the gross margin and for it to be consistent with the seasonal patterns of the lower margin in the Q4 and then kick up following the big book price increase. Longer term, as the acquisitions and the vending relationships mature, and as we move through the inflationary cycle and we have success in our gross margin initiatives like private brand, I expect to see the gross margin pressure abate over time. But again in the short-term even though there is some gross margin pressure associated with the acquisitions and the vending its solid profitable business and its driving growth. As far as for the read-through go with the revenues rising, effective OpEx management and then as the gross margin pressure mitigates we would expect to see strong read-throughs and long-term nothing has really changed in terms of our plans to incrementally expand operating margin over time.

Okay. That’s great color. Thank you. And just a quick follow-up, can you just kind of briefly update us on your thoughts on the acquisition front and how you’re viewing your core metalworking competencies versus broadening out into complementary businesses?

Chris, it's Erik, excuse me here, I am struggling with the little cold, the rest of us in the northeast. So, Jeff gave you I think a good perspective on how we view incremental margins. I just want to touch on one thing and I know you asked about M&A, but it really ties into the overall growth story here, and hopefully you heard that come through loud and clear in the prepared remarks. We really see ourselves at a unique point in time and as much as we’re pleased with the current growth rates, that we’re seeing and certainly M&A is one of the growth initiatives, you also heard us feature vending is another one. We really think we’re in the very early stages here of the growth story and the reason is David talked about the industry consolidation, that we see just starting to heat up. This is something that quite frankly he called four years ago and used the term land grab and it’s really playing out just as we thought. We see it as the unique point of time because there is a couple of inflection point that we see occurring right now in the market; one is technology and we touched on it today with vending, we've touched on it before with our E-Com initiative, but it's really raising the bar as a distributor on the level of investments that's required and quite frankly not just investment but innovation that's need to really gain a leadership position. The other inflection point that I want to hit on is the large accounts program, and you've heard us talk about it over the years, but it's reaching an inflection point type stage because the local distributors some of whom have been recent acquisitions and some of whom are competitors are facing a tough time. Historically, they are able to develop great relationships locally with the plant in a given MSA and what's happening is more and more of the larger businesses purchasing is becoming, procurement is becoming more centralized and driving greater compliance in national contracts, which is making – all of a sudden giving us the opportunity to dislodge relationships that have been in place, and very tough to crack quite frankly for years-and-years. So, I put all of that in the backdrop because we really do see it as the unique point in time and what that means is we have our foot on the accelerator on our growth programs. And we highlighted two of them vending and M&A, there is others that we've talked about and we highlighted because they are producing exceptional results, they are resulting in some near-term gross margin headwind and that as Jeff said is the factor near-term in our incremental contribution margins, we do expect that to abate over time, but you know I think most importantly we are thrilled with growth and we are really excited by what we see as the beginning of the story here.

Perfect. Great. Thank you. And I feel better.

The next question comes from Ryan Merkel at William Blair.

Good morning, everyone. How are you? Hey, and thanks for all the extra color here. It’s really great and very helpful. Let me start with the goal to double the size of the company by 2016, it seems reasonable given all the growth drivers you talked about. Can you just speak to how that may translate in some bottom line or talk about how many more investment is required to reach these targets or I guess said in other way, if some of this growth pre-funded given the higher rate of investment we've seen in these last couple of years?

Yeah, Ryan, it's a great question. So first of all I’d tell you is, you heard us talk about – let me talk about the top line for a second. So, on the last call we gave kind of really big rallying cry. We're a growth oriented company that gets excited by a big vision, but we move in increments. So what you heard today was a pretty aggressive goal for the next five years. The balance of that is going to be achieved through organic growth and we talked about the programs and then supplemented with M&A. In terms of bottom line, what I would tell you nothing has changed in our perspective and our position has, remains and will be that over increments of time we would incrementally expand our operating margins, which means that over time read-throughs will be in access of current operating margins and really nothing has changed there. So we didn't provide a five year specific goal because it's ways out. There is a lot of factors at play, but what I would tell you is nothing has changed in our perspective and that over increments of time we would expect to expand operating margin. Ryan Merkel – William Blair: Great. And then second question is on vending, clearly a nice driver on the top line. Can you just discuss some of your competitive advantages in vending? I saw on the press release you used the language highly customized vending program. Maybe just explain upon that a bit?

Sure, Ryan. Yeah, I'll start by saying, so we did, you picked up and I'm glad you appreciated it. We wanted to provide some more color and some more tangible data for you to get your arms around on just how explosive the program has been for us. It's building in momentum and part of the reason that its building in momentum is because we have a solution that's really unique in the marketplace and it's really resonating with customers. And yeah, there is two things I point to in terms of what makes it unique. One is that it is, as we mentioned in the language, it's a highly customized solution that the technology is very much geared towards a manufacturing production environment. So without getting and boring you with a lot of detail and you can certainly go on our website and take a look at the machine in a lot more detail. It really is geared for customers than the manufacturing production environment and it's customized to that environment. The second thing I talk about is it's a program and we call it a program because it's more than just technology. It's not just about a machine, it's about all we bring to bear around the machine and there’s two things I'd point to. One is our service, our world-class service that we consider to be industry-leading and that makes it unique. And the second is the technical expertise that we bring to bear. So in addition to the machine, we're bringing in folks who are helping our customers actually take costs out on the plant floor, and that's another differentiator for us that's really resonating with customers. Ryan Merkel – William Blair: Great. Thanks for the color. I’ll jump back in line.

The next question comes from Matt Duncan, Stephens Inc.

Morning guys. First question I've got is, Erik, on the non-manufacturing customers, it looks like the growth rate accelerated a little bit there from what you've seen the two quarters before this one. Is there anything at play there? Is there any customer group that might explain that? It looks like government is still down so it's got to be something else. Just curious what it is.

Matt, you are right. Non-manufacturing did pick up a little bit and as you said, the numbers you are seeing there, so the 9.2% are way down by the slight declines in government. No specific color to give you other than that obviously we did share today, government represents 9% of the business. So the rest of the business is substantially – with that piece being slightly down is substantially outperforming the 9.2%

And Erik, as government starts to flatten out, maybe turn positive, can that growth rate in non-manufacturing customers catch-up to what you're seeing in manufacturing or is that going to probably stay a little bit lower since government will probably even if it starts to grow, might be weighing that down still?

Well, we sure hope it will pick up, Matt. So we gave you a little color on government and we'd be hopeful that if we continue to execute on the market the environment cooperates. We would hope that we could accelerate.

Okay. And then last thing I've got is on the growth plan. You're talking a lot about adding some new product categories. I'm curious how you think that's going to change the number of SKUs you guys are offering over time. Do you have to make any changes to your distribution footprint to be able to handle the extra product, because it's obvious you're going to have to carry enough safety stock and all those new product lines? And then with the one distribution center you're thinking about adding, is that enough to get you to that 2016, $4 billion revenue goal or you might need to add another one along the way?

Matt, so a couple of good questions embedded in there. The first one regarding the growth plan, so you got a sense for our – what are pretty ambitious growth goals and what we said was that there's really going to be a couple of elements, which is number one, continuing to exploit what is a pretty strong leadership position in the metalworking market and yet with still a big growth runway. And then we're going to supplement that by adding a new leg to the plan, a new leg of growth to the plan. But one of the things I want to make sure that came across in the prepared remarks is that the categories and it's why we call this such a low risk, high percentage adjacency move is that these are product lines that we already carry. So what we're talking about here and the repeatable formula is deeper penetration into a product line. Many of the types of programs that we've described that we've applied to metalworking applying it to those lines. So we're dealing with customers who are already buying from us and we're dealing with product lines that we already carry in the catalog. We've had years of experience with our suppliers and have gotten to know those businesses fairly well. So, it's actually a pretty a short part in that regard. Certainly, one of your questions was around SKU expansions, yes that – and I did mention that that continues to be and has been a growth driver for us. So what you could expect to see is that we’ll certainly add products across the board. We’ll put some focus on those product lines, but by large measure the core product offering is already in place.

Okay, that’s helpful.

Your other question was related to our CFC. Our CFC, what I would tell you there is, first thing I want to say is, really nothing new in that network planning has been and always is a part of our strategic planning process. With everything we see right now, this next one certainly supports the next leg of growth and we don't see a need to grow beyond that. And if anything were to change well up into the future of course we’d give you plenty of notice as we are doing with this one. But from everything we see now, no.

Okay. Thanks for the color guys.

Your next question comes from Luke Young at Robert W. Baird

Morning guys. First question on the pricing and some of the catch-ups that you cited here. Would you just be able to give some color whether those are things that maybe caught you off guard a little bit or is there something that is just natural derivative of the timing of your price increases to your customers versus when you get the price increases from your suppliers that will just naturally take care of itself as the new big book in September?

Luke, really it’s the latter of the two and what I mean by that is, no, this did not catch us off guard. In fact, if you go back over the past few quarters, we’ve been talking about the purchase cost catch up coming. And this is really, if you go back over periods of inflationary times throughout the Company, this is a fairly typical pattern here that early on we take pricing and we realize pricing in an inflationary environment very quickly and through a combination of good negotiating and just the fact that it takes a while for purchase cost to work its way through our P&L that this is the timing element that we fully expected and that we've seen in the past.

Okay, that’s helpful. And second, maybe more of a big picture question on vending for you guys. Obviously, you've had -- A, thanks for the sharing the information that you did today. That really helps to size up the contribution that you guys are seeing. As we look at some of your competitors also with vending solutions out in the market, do you guys feel like multiple competitors bringing this to the market helps you in that it raises awareness and that you are able to go in and sell a customized solution versus what some other competitors may be offering and that may be seen by some as more cookie cutter, if you will?

Yeah, Luke, I'll start by saying and obviously you could get a feel for just how excited we are about vending. To be honest, we are pretty – our culture is quite customer focused. So we don't pay a whole lot of attention to competitors of various vending solutions. What we do is we go in and we really want to understand our customers' needs. And what gets us so excited is that the solution that we build, which is highly customized we think is really meeting a need, an unmet need and that's evidenced by the kind of growth contribution we are seeing.

Okay. Thanks guys.

The next question comes from Sam Darkatsh at Raymond James. Sam Darkatsh – Raymond James & Associates: Good morning David, Erik, Jeff. How are you? Three questions if I might. First off and I don't want to play too big a role in this. I know these deals are fairly small, but it does seem as though acquisitions is an increasing focus for you guys. So it looks like based on your cash flow statement you paid roughly one-time sales for the most recent ATS acquisition and if my memory holds, American Tool Supply and Rutland were all about 30% to 40% of sales, was the multiple that you paid. Is that more reflective of the multiples creeping higher in the pipeline that you're looking at or is that the different level or quality of business of the ATS and the margin characteristics? Can you help put a little color on that?

Yeah, Sam, I think, let me start by saying, let me just go back to the top. What we try to get across and want to make sure is coming across is certainly M&A is a part of the formula. But not much has changed if you look at the breakout over any period of time you go by. That organic is still the priority with M&A as a very important supplement. So the second thing I’d comment on is that the funnel, the M&A funnel is full and it's robust. The third thing is I wouldn’t draw too much from looking at a ratio of purchase price time sales. There is lots of factors that go into the purchase price of a business, including the quality of the business, the earnings and so forth. So it's really a function of not necessarily the top line as much as it is the bottom line. Sam Darkatsh – Raymond James & Associates: Okay. So, on an EBITDA basis, reading between your lines, you're not seeing much of a change in terms of the multiples you are looking at?

Yes. So Sam, on multiples overall what I would say is as the market has strengthened we've seen a slight pickup in multiples. So it would be fait to say that. What I wouldn't say it's as dramatic as what you're describing based on the ratios of purchase price to sales. Sam Darkatsh - Raymond James & Associates: Understood. Second question. Erik, your long-term view of the 15% top line CAGR assuming – or would you be going to what your macro assumptions are for that level of growth over the next five years?

Yeah, that’s a good question, Sam, and again I'll just go back to we did. I just want to reinforce because you mentioned M&A again. Of the 15 we see the majority being organic and I think what we would assume is a moderate – what we prefer to is a moderate growth environment, which if you look over and we've done a lot of analysis of when we referenced our CAGR as a public company and when you smooth out that period of time includes some real downturn. It includes some strong rebounds and when you smooth it out we think a moderate growth economy was a reasonable assumption. Sam Darkatsh - Raymond James & Associates: So similar to today in an ISPMI, it's a type of environment?

Yeah. I think that's fair. Sam Darkatsh - Raymond James & Associates: Okay. Last question as it relates to vending. Could you help us understand generally speaking what percentages of your customers today have a vending solution through you and what the opportunity might be?

Yeah, sure, Sam. So we track internally a ton of metrics including how many signings we have, what the total runway is. Today we gave you what we thought were a couple of important pieces of information. We are not going to share for competitive purposes. We don't think it's in anyone’s best interest to share a lot of details. The punch line that I want to get across though is the runway is big. So we have a nice number of signings. It's obviously producing a great contribution to growth, but relative to the size of the runway analysis that we've done, it's still very low. So we anticipate the punch line as we anticipate vending to be a growth tailwind for the quarters in the years to come. Sam Darkatsh - Raymond James & Associates: Because 4% of your growth – of your total sales growth for the quarter would suggest that this is not an embryonic initiative and that you already have a fair amount of vending machines in place that are creating outsized growth. That's why I was trying to get a sense of how material, what you already have in places.

Yeah. Sam, so the way you've characterized it, it's kind of like how we think over and talked about the overall growth story. So we like what we've done today. You're right, it's beyond embryonic, but at the same time relative to the runway it's still the early innings. Sam Darkatsh - Raymond James & Associates: Okay. Thank you much.

The next question comes from John Inch of Bank of America.

Thanks. Good morning everyone. Hey Jeff, I want to go back to the gross margin issue just for a second. I heard the points right, but you did – you came in still 40 bps below the midpoint of what was the guide. The guide at the time would've included the original ATS and then the slightest ATS came at the end of the quarter. So I guess what ultimately is going on in terms of the quarter result? Was it for instance larger, I think, Erik, you mentioned more national accounts. Is that what's driving some of the mist or what?

Yeah. John, first of all, as you know we're thrilled with the growth rates that we have seen for the quarter which were above the high end of our guidance range. Obviously we were – a good deal of that was delivered by higher than anticipated vending growth and a smaller amount of that by the recent ATS acquisition, both of which again weren't assumed at those levels in terms of the time in which we provided the guidance. And again, this is all a very pleasant surprise, all very good, all very profitable business that will even become more profitable over time.

Okay. So are you assuming vending kind of sustains the trajectory? That's obviously what's – help me a little bit, like why was vending so strong in the quarter? Dd it – was there a customer group initiative that all of a sudden you delivered a bunch of machines to, or if there’s some aspect of your manufacturing profile that’s just doing that much better which is a big vending user or what was – it was totally a surprise because you have that gross margin versus your expectation. So what was it within the context of vending that was a surprise? It sounds like a good opportunity. I'm just trying to understand.

Yeah. John, it’s Erik and look I think Jeff – on the gross margin story Jeff touched on it, the punch line is that it was – first of all we have a range in there for a reason that you can’t predict it exactly on gross margin. But you are right, it was down slightly, a piece of that and really it ties back to our two growth initiatives that we highlighted on the call. One was ATS west which was a little piece of it and the other is, vending. Yeah, you are right, it’s exceeding expectations and the evidence of that is the Q3 sales guidance that we’re providing and vending being a big part of that. I’ll tell you, the answer to your question on why on vending is that it’s simply building momentum. It’s exploding as a program and it’s not one customer, it’s not – customers are really receptive to it and we think we’ve got a solution here between the technology and our technical expertise that’s really fitting a need.

Erik, were there aspects of your vertical industry exposures in manufacturing that got better? So I am not asking you for what’s your auto exposure, but as you kind of look at manufacturing which is so large, could you identify any sort of subgroup, whether it’s metal working or anything else that actually seemed to get better as the quarter progressed to help to drive the top-line beat that you saw?

John, to be honest, it was pretty much – the characterization I gave you was durable, and it was pretty strong across durables. I wouldn't go any deeper in terms of any specific pockets. We saw general strength in durables.

That makes sense. One last question. Erik, I think you actually made the point that you've got your foot on the accelerator of these growth initiatives. Clearly there is a lot of things that are gaining traction right now from vendors et cetera, government shrinking which has been a drag in proportion to the total. Let me ask you, why over the next five years do you think your growth is only going to be 15% if the past five years it’s been 14%? Like why couldn't it be better than that? You still have very, very low penetration of the overall market, for some reason it couldn't be closer to 20%?

Hey John, that's a great question and it's one that I ask of my internal team all the time and seriously I think you are right, it's certainly possible. I'll tell you, look, we are an aggressive company and you can imagine that we are a performance driven company that would set internal stretch targets for ourselves beyond what we share with you. So if we perform over the next five years I would hope we could do better.

Good answer. Thanks Erik, appreciate it.

The next question comes from Robert Barry at UBS. Robert Barry – UBS: Hi guys. Good morning. Apologies if somebody asked this already, but I wanted to see what your thoughts were about what looks like a decelerating average daily sales growth rate from February to March?

Yeah. So Rob, so if you look and I think what you are referencing just for clarification is if you look on the website, what we are showing is it's really in the growth rate. It’s not in particular sales; it's in the growth rate for March at 14.3%. A couple of things going on. One is that – really two things going on with March. One is that you had – we are coming off of a prior year very high comp, very high average daily sales spike in March. The second thing is we did see in the back half of the month a little bit of softening. Primarily we are attributing it to the timing of vacations and schedules and so forth from everything we see in the environment. We are pretty confident in what we shared with you as evidenced by the guidance that we gave for the quarter. Robert Barry – UBS: I mean the best I can back into it, I think your – the midpoint of your revenue guidance implies some modest decline in volume growth if I strip out the M&A and assume the pricing stays about flat. But not as much as you saw it decline from February to March. So it does suggest that your assuming that 14.3 improves in the next couple of months. Is that a fair interpretation?

That's a very fair interpretation. If you do math, so Jeff shared it was 15.7% at the midpoint of guidance, so right. You could do the math on the last two months. We would expect a growth rate – given the conditions we see today, we’d expect growth to be in excess of 14.3.

Rob, if you look at that same chart, look at April and May in 2011, you can see the differences and it’s really reflective of the change in the ISM trend a couple of months earlier. So we'll have a little bit weaker comps there. But that will drive higher percentage growth from where we stand now. Robert Barry – UBS: And can you update us too on the pricing? I think just based on your disclosure it looks like it added about four points in 1Q and three points in 2Q. What's the assumption in 3Q?

So Rob specifically on sale pricing you mean? Robert Barry – UBS: I'm sorry?

You're referring to sale price increases? Robert Barry – UBS: Yes.

So what we shared is that during our second quarter at holiday time we took a mid-cycle price adjustment. To-date there has not been any further adjustments. It's not baked in to any forecast assumptions. But as always we remain opportunistic and that’s something if we see an opportunity on sale pricing we wouldn't be bashful about it. Certainly the later on in the year we go and the closer we get to the launch of our big book, the less likely we'd be to do one, but it's possible but not assumed. Robert Barry – UBS: And then I think you said that the gross margin in second quarter saw the pricing offset product cost catch-up or pricing and private label offset product cost catch-up. Do you think that dynamic is going to remain the same for the next couple of quarters or become less favorable?

I think what I shared in regard to the expectations for the third quarter was that about two-thirds of the 150 basis points decline year-over-year would be driven by the acquisitions and the vending growth. The remaining 50 basis points would still be negative over prior year comps. A piece of that is driven by the higher level of rebates from last year which would imply that the product cost increase is also a bit of a negative drag net-net. Robert Barry – UBS: Okay. And then just finally on the tax rate, I just wasn't clear on why – I think you had guided to 38% last quarter and now for next quarter it's going to be 36%. How should we model that? I guess we should model 36% for 3Q, but how about for 4Q and go forward in our models and driving that down so much?

Well, actually it’s expiring statuettes that happened, the occurring in Q3 of this year the similar thing happened in Q3 of last year as a matter of fact. I think if you compare the tax rate through Q3, in terms of our forecasted tax rate with the prior year, it's actually slightly up. We also provided within my script the total year tax rate of 37.4. So I think you could determine the fourth quarter based on that. Robert Barry – UBS: And then on a go forward basis, just for working assumption, just so we’re all on the same page is like 37.5% or 38% a good number?

Going forward in the years out, is that what you're getting at? Robert Barry – UBS: Yes.

Okay. I think the best thing to look at is where we've been historically over the last several years and that's the best indication of the future. Robert Barry – UBS: Okay. Thank you.

The next question comes from Adam Uhlman at Cleveland Research.

Good morning guys. Thanks again for all the added disclosure. I think it's very helpful. Just a follow-up question on the vending initiative that it obviously sounds pretty attractive. A lot of the discussion has been around the gross margin pressure, but I might have missed it, but maybe can you talk about the overall margin profile that you're seeing with mature vending customers? Are they at your average EBIT level or better or lower?

Yeah Adam and I think this is really the exciting part of the story. So what I would tell you is that we're seeing near-term lower gross margins for the reason we described. But the opportunity to grow them over time we're seeing near-term very solid return on investment numbers that we generate in the form of incremental sales and incremental profit. And the beauty of the program is the leverage that we get because early on, so with the slightly lower gross margin, as we grow gross margin, we also see extremely high retention rates in these accounts because we’re locking ourselves in. So what you get is this picture of incremental growth driving nice contribution margins and very high retention rates. So there is very little churn that as we model out the future years on the return on investment, which is really what you are getting at beyond just gross margin, we like the picture a lot.

Okay. And then as I understand it, most of the product that is going through vending initiatives now is metalworking, which I thought was an above average gross margin product line for you. So is the issue that the growth that you're seeing now is from larger customers and so that's what pressuring the gross margin?

Adam, that’s a piece of it, the bigger piece is, what I was trying to convey on the call was we’re going in and penetrating production business at our key accounts. So that’s often time be cutting tools and metalworking, but it's really the volume that related to the production process, because this higher volume we’ve planned out, that will typically come in a lower gross margin profile. But what it does for us is we’re really getting at the heart of the customers operation. We're locking ourselves in and getting access then to the higher pull-through that's less planned that comes typically with higher margin.

Okay, got it. And then just a clarification on the – on your $4 billion revenue goal. Right now you are growing your headcount 7%, 8% year-over-year. Do you think that's enough headcount growth on the sales force to support that goal or will we see an acceleration of sales force growth?

Adam, really I’d take you back to the comment I made earlier on. Nothing has changed in our outlook and I think if you look back over the life of our public license, we talked about the 14%. We've been able to achieve those rates with a very healthy level of sales force investment, but certainly at rates less than our revenue growth. And again, nothing's really changed in our outlook going forward and how that translates into investment and hence into op margins that we would expect over time to incrementally be able to take up.

Okay, got it. And then just a quick one. Jeff, I don't remember the company ever calling out an M&A opportunity that was missed and was an expense item in the quarter. So it implies that this potential acquisition was somewhat sizeable. I know you're not to going to give any specifics, but I'm just wondering if could mention how big are the revenue type company that slip through your fingers. Is this one of your normal ones that you've been doing of less than $50 million or $100 million or $500 million in revenues? Maybe a little bit more color on that would be helpful. Thanks.

Adam, it's Erik. Obviously we can't share any information. We always sign non-disclosure agreements and we can't give you any specifics there in terms of the type of company. What I'd tell you – this is a fairly typical process for us that we’ll take a deep look at a company and for all different types of reasons choose not to pursue it. The only reason we called it out this quarter was because of the materiality on the results of roughly $800,000. It moved the needle a bit on the EPS and that's why we shared it this quarter.

Okay, great. Thanks very much.

The next question comes from Holden Lewis with BB&T. Holden Lewis - BB&T Capital Markets: Thank you. Good afternoon. Wanted to ask you when – so the vendor initiative in particular, I mean a lot of people tend to focus on the gross contribution rather than the net contribution. I understand vending, it seems like in order to put these things in, the selling process, the installation process, it's really a hands-on kind of effort by your sales force. Do you feel like getting growth out of vending comes at the expense of growth somewhere, again going back to the earlier question on how your targeted revenue CAGR isn’t all that much more than what you’ve done and saw the weaker monthly number in March. Do you feel like as much as you are getting some stuff on the front end, you have to give some up on the back end to take advantage of the resources?

Holden, it's a great question, from somebody who clearly understands vending and our sales team would emphasize with you in terms of the upfront work. But really what that points to Holden, because yeah, there is an upfront burst of work in effort and cost, what gets us so excited about that is thinking about the future, the leverage on this program because there is an initial burst. So not only is it an initial gross margin headwind, but yeah, you are right, to get one in place takes time and effort. The beauty is the growth that we see and the retention rates that we see in these accounts it’s all leveraged over time. So baked into the results that you’re seeing from us now because we’re in this land grab mode and because the program is exploding, you’re seeing some dilution from upfront investment in that as this thing matures, we're going to get more leverage on it. Holden Lewis - BB&T Capital Markets: Okay. And then I guess also right now, we can say it's bit of a land grab and it's tons of runway. So obviously you got to a lot of customers because they really haven't done this and so they are doing it anew. What happens when you start bumping into a grinder machine or Fastenal machine or an air gas machine? Do you have a vision where all of these national accounts as such are just going to have rows of machines of different vendors like they do catalog today? Or at some point are you going to have beat the Fastenal machine out or they are going to beat your machine out? How do you see that maturing? Is this the first area where you guys really going to hit head-to-head the hardest?

Holden, it's a good question. What I’d tell you is, what you're talking about is feels so far into the future that it's tough to envision because the market is just so fragmented that again when I ride with our reps and we talk about who we target, what accounts we are targeting and who are running up against, it's really not the names that you mention. So even in the case of a vending, it's typically not, it's a local distributor and we are winning because it's not just about the machine, it's the whole program that we bring to bear with the product and service offering that we have with the technical expertise that really is unmatched. So I think the answer is vending in that regard is not that much different from what we've been talking about for years which is there is so much runway because the market is just so fragmented. Holden Lewis - BB&T Capital Markets: Thank you. Oh and before I go, did you give the revenues from acquisition this quarter?

I think what we indicated 50 basis points was due to the recent acquisition and then in the previous call we indicated the percent growth from that. Holden Lewis - BB&T Capital Markets: Okay. So this quarter 50 basis points of your growth was due to M&A?

Due to the most recent acquisitions.

I think what we shared – the language from the script said and I want to make sure we get it right was in Q2, we gave you the last two, we gave you ATS East and ATS West and what we said – what I said was of the 16.5% growth, 3.5% came from our recent acquisitions. Holden Lewis - BB&T Capital Markets: Got it. Perfect. Thank you.

At this time we show no further questions. I would like to turn the conference back over to management for any closing remarks.

Okay. Well, thank you for all of the energy and interest today. We appreciate it. We'll talk to you again on the next call. Thank you.

This conference has now concluded. Thank you for attending today's event. You may now disconnect.