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United Stationers, Inc. (NASDAQ:USTR)

Q3 2008 Earnings Call

October 31, 2008 10:00 am CT

Executives

Richard W. Gochnauer - President, Chief Executive Officer, Director

Victoria J. Reich - Chief Financial Officer, Senior Vice President

Patrick T. Collins - Senior Vice President - Sales

P. Cody Phipps - President - United Stationers Supply

Analysts

Daniel T. Binder - Jefferies & Company, Inc.

Jonathan Lichter - Sidoti & Company, LLC

Greg Halter - LJR Great Lakes Review

Operator

Welcome to the third quarter 2008 earnings conference call for United Stationers. My name is David and I’ll be your conference coordinator for today.

Before we begin, the management team of United Stationers would like to remind you that the information shared on this call may include forward-looking statements which are based on certain assumptions. What you hear today may be affected by the risks and uncertainties in United Stationers’ business, markets and the economy. Despite the company’s best efforts, actual results may be different from what is said on this call. To learn why this may happen please review the cautionary language in yesterday’s news release and in United Stationers’ filings with the SEC. Also remember that the information on this call should be considered current only as of today. After this please use it for your reference and know that the company has no duty to update it.

Shortly after the call ends, you may find an archived version of it on the Investor Information section of this company’s website at www.unitedstationers.com. You will also find a copy of the third quarter news release there. As a reminder, today’s call is being recorded for replay purposes.

I would now like to turn the conference over to your host, Mr. Dick Gochnauer, President and Chief Executive Officer.

Richard W. Gochnauer

Thank you for joining us. We really appreciate your participation. Here with me today is Vicky Reich, our Chief Financial Officer, Cody Phipps, President of United Supply, and Pat Collins, Senior Vice President of Sales and Marketing. We know your time is particularly valuable these days so we’ll do our best to be as efficient about giving you the information you need.

United had a strong third quarter despite credit and financial market challenges, growing global economic concerns and an active hurricane/tornado season truly due to the people of United. Their dedication, resilience and creativity are the key reasons we continue to do a great job serving our customers, winning new business and managing all aspects of the company to produce good results.

Today we are staring into unprecedented uncertainty for the world economy. However I am confident that the important changes we’ve made to our business over the last six years have put us in a position of strength.

We diversified our products, channels, customers and markets served. As a result we now have an incredibly broad product portfolio that we sell to a top-notch diverse group of customers. These include dealers, distributors, national accounts, retailers and e-retailers across multiple channels who serve large, fragmented and diverse end user markets.

We reduced our cost structure and improved our working capital efficiency, and we’ve invested for the future including acquisitions that brought new growth opportunities and talented associates to our company; IT capabilities, world-class facilities and transformational digital marketing.

Our third quarter results reflect the progress we are making in these areas and the many strengths of our company. Sales for the quarter were $1.3 billion which was up 10.5% after adjusting for one additional selling day in 2008. This increase follows a 10% improvement in sales for the second quarter and a 5% increase we saw for the first quarter.

Excluding one-time gains from the sale of two buildings, operating profit was up 8% and we improved operating margins sequentially from the second quarter to 4.2% from 3.6%. Earnings per share rose to $1.39 this year or $1.26 excluding the gains which is up 26% from the $1.00 in last year’s third quarter.

Let’s look at our sales by type of customer. Please note that the third quarter growth rates have been adjusted for one additional workday. Sales to independent retailers, which include our United Stationers Supply, Lagasse and ORS resellers as well as new channel customers, contributed over 84% of revenues and increased more than 13%. This follows a year-over-year 12% revenue rise in the second quarter and 9% growth in the first. Excluding ORS Nasco, sales to this group were up over 5% for the current quarter, 4% for the second quarter and 1% for the first.

Independent office products resellers are seeing some compression in demand but they’re finding ways to maintain and grow their share. In fact large dealers and Internet based resellers continue to see some of the strongest sales gains.

Sales to our national accounts contributed nearly 16% of the third quarter revenues and were down about 3.5%. Looking back, sales were off 1% in the second quarter and almost 11% in the first. We don’t see this trend improving in the near term but we continue to look for ways to support these customers to add value now and in the future by leveraging our infrastructure which gives them access to new product categories and lowers their capital investment.

From a category perspective our strongest revenue growth continues to come from janitorial and break room products which contributed 21% of third quarter revenues. Sales were up almost 15% compared with the same time last year consistent with the growth rate in the first and second quarters. The success of this category was driven by three factors:

First. We are making progress in converting direct sales to wholesale because we offer a more cost-effective solution and improved service. I’ll talk more about this later.

Second. Our successful office gen program is increasing janitorial and break room sales to the office products resellers. This year we added about 300 new SKUs to this offering.

Third. We increased sales by serving our new national account business gained late in 2007.

Moving on to our industrial supplies category which comes from ORS Nasco, last month we announced that Steve Schultz, who served as president of Lagasse for the past seven years became Group President of LagasseSweet and ORS Nasco. You have seen the outstanding job Steve has done in leading the Lagasse team. Because of the similarities and synergies that exist with ORS Nasco it made sense to have both businesses report to Steve.

For the third quarter industrial supplies represented 6% of our total sales. ORS Nasco had another strong quarter and remains on track to reach our 8% to 10% revenue growth target for 2008. Like Lagasse there is a big opportunity here to gain market share by helping industrial distributors to lower their total cost of product ownership by using wholesale services and free up working capital by lowering inventories.

While our janitorial and break room and industrial categories are not immune to the economic turmoil, we believe that the management teams are doing a terrific job of positioning their businesses for continued revenue growth for the short and long term.

Our technology products category contributed about 34% of revenues for the quarter and sales increased nearly 2% compared to the third quarter of 2007. You may recall that in the second quarter sales were flat and in the first quarter showed a decrease of nearly 8%.

This remains a competitive category as end consumers continue to postpone purchases of bigger ticket items. But we are making tangible progress through leveraging the competitive advantages offered by our distribution infrastructure and marketing capabilities. It’s worth noting here that most major suppliers within the printer imaging supplies category have announced price increases of approximately 5% over the next two quarters.

Office furniture contributed almost 11% of our total revenues for the quarter. Sales were down 10% from last year’s third quarter. Sales trend year-to-date includes an 8% decrease in the second quarter and a 9% decline in the first. Many businesses are holding back on discretionary purchases like furniture. When they do buy, they often turn to value priced private label brand items. This is good for our Alera brand sales which grew at a double digits clip in the third quarter.

Speaking of private brands our furniture, office products and janitorial and break room private brand offerings saw double-digit growth rates in the third quarter. This is further evidence of customers seeking high quality value priced products.

Sales of our traditional office products provided almost 27% of United’s total revenues and were up 3% from a year ago. This follows a 1% growth in the second quarter and relatively flat sales in the first. One of the bright spots here is the green products marketing initiatives. So far this year we’ve trained 300 dealers on techniques to better market these products and to position themselves as green solutions providers. This program has been so successful that use of the latest catalog has exceeded our expectations and sales of these products are outpacing other traditional office products by a wide margin.

In this challenging market we’re using four major strategies to emphasize profitable growth opportunities for United and its resellers.

First. Diversification has been key. Our LagasseSweet and ORS Nasco acquisitions have given us a leadership position in huge fragmented markets that are underserved by wholesale distributions. As you know our janitorial and break room and industrial products categories are currently two of our fastest growing. Together they account for over 27% of revenues in the third quarter. An important reason why these categories are growing is because they are helping manufacturers reach small business customers with a broad product offering at lower costs with higher service levels.

That means the growth of these two categories comes from the market share gains as well as market growth. Only 20% of the $23 billion US janitorial and break room market goes through wholesale distribution today and wholesale penetration of the $442 billion industrial products market is only about 5% so we have pretty of opportunities for growth in the years ahead.

Speaking of acquisitions we continue to look for opportunities. During the third quarter we purchased certain assets of Emco Distribution and welcome Emco’s customers to United. This acquisition is accretive to earnings and we expect its annual impact to increase sales by about $70 million.

Our second major strategy for profitable growth is to increase our wholesale penetration with existing national account customers and independent office products resellers. Now more than ever it makes sense for them to work with us versus buying directly from manufacturers. Given the current credit market, customers are focused on conserving cash and improving working capital. Two of the best ways to do this are to reduce the amount of inventory they carry and to lower their cost of transporting this inventory through the supply chain. Our volume purchasing and distribution infrastructure can substantially reduce their costs and lower their investments.

Third. We target new channels. We identify companies that distribute products or services, have a strong customer base and would benefit from offering our products as an add-on to what they already sell. Candidates range from e-tailers to distributors who serve different markets. As a result September was a record sales month for us in new channels and we have seen significant double-digit revenue growth from this channel each quarter this year.

Fourth. We continue to create marketing initiatives that help resellers build their sales. One example is our new work place wellness program which offers products such as Purell instant hand sanitizer and Clorox germicidal surface wipes which help create a healthier work environment. Nearly 400 resellers have signed up for this program and the products we offer have seen more than a 50% increase in sales over the past year.

While our third quarter sales performance was good despite the soft economy, we are mindful of the growing turbulence in the credit and financial markets and its potential effect on our customers and markets. As a result we are managing expenses and working capital with caution and discipline.

With more uncertainty in the economic outlook than we’ve ever seen, we believe it’s critical to draw on cost reduction through war on waste or WOW² and be prepared with further contingency plans. During the third quarter inflationary cost increases particularly energy related costs absorbed most of the benefit we derived from our WOW² initiative. The good news is that some of these cost increases are starting to moderate.

Vicky will now take you through the details of our performance for the quarter and then I’ll return to discuss our outlook for the balance of the year.

Victoria J. Reich

Our third quarter results conclude one item I want to highlight. In the second quarter we successfully consolidated our Northern Florida distribution centers into a new facility in Orlando. As part of that consolidation plan we sold two distribution centers in the third quarter. The gain on those sales totaled $5.1 million pre-tax or $0.13 per share. My comments today will focus on our adjusted results excluding these gains so you can get a better sense of the underlying performance for our business.

Let’s begin with third quarter sales which rose a workday adjusted 10.5%. 7% of this growth came from ORS Nasco. The contribution from the Emco acquisition was not material since this transaction closed in early September. Our organic growth rate of just over 3% reflected the category and channel dynamics that Dick discussed. As expected we saw the pace of manufacturer price increases pick up in the third quarter and the impact of price inflation on sales was about 3%.

Gross margin for the quarter was 14.8%, flat with the prior year and an improvement from the first half performance. The addition of ORS Nasco increased gross margin by about 20 basis points. The third quarter margin rate also benefited from the affects of price increases as we implemented manufacturer-announced price changes. The resulting inventory cost adjustments net of LIFO charges offset the ongoing pressure on margins from a lower margin product mix.

Customers continue to buy the basics like cut-sheet paper, ink, toner and tissue while deferring the more discretionary items. Diesel prices averaged 52% higher versus the third quarter of last year costing us about $4 million which negatively affected margins. Advertising costs were higher in the quarter reflecting timing and additional programs. Our teams did a great job on the other hand delivering on WOW projects that contributed to higher margins and offset most of the inflationary cost increases.

Operating expenses in the quarter totaled $141.2 million or 10.6% of sales, up from 10.4% last year. ORS Nasco added about $9.5 million to third quarter expenses. Excluding this, expenses were up about 10 basis points as a percent of sales to a total of $131.6 million including the extra workday in the quarter.

We increased our provision for receivable losses by about $3 million or 25 basis points higher than last year. About ½ of the increase reflected a specific dealer issue that was not related to the economy while the remainder brought our reserves to a slightly higher level than our historic norm.

Our WOW programs and cost controls delivered improvements in expenses to help offset inflation. We continued to invest in strategic initiatives including the rollout of our new e-catalog and IT projects.

Operating margin for the quarter declined from 4.4% to an adjusted 4.2%.

Financing costs versus last year’s third quarter benefited from two factors. One, lower rates with an average borrowing cost of just below 5.5% for the quarter. Two, the past year’s free cash flow which partially offset the impact of share repurchases and acquisitions.

The tax rate of 38% for the quarter is in keeping with our updated full-year estimate of about 38%.

EPS was up 26% to $1.26 from $1.00 last year. This includes about $0.11 per share net benefit from the past year’s share repurchases and about $0.09 per share net benefit from ORS Nasco.

Speaking of ORS Nasco, this business had another strong quarter with sales of about $84 million. We are realizing the planned synergies. With year-to-date accretion of $0.21 per share, this is already above our full-year target of $0.15 to $0.20.

A few comments on the balance sheet. Solid inventory management continued in the third quarter. Excluding the impact of ORS Nasco, third quarter turnover was 6.9 times flat with the prior year. Quarter end inventories excluding ORS Nasco were up $58 million or 10% versus last year. This reflected the timing of purchases made in advance of price increases, the cumulative effects of product cost inflation on inventory value, plus the acquisition of Emco’s inventory.

Accounts payable excluding ORS Nasco was flat versus last year. Our accounts payable leverage was quite strong at 75% of inventory. Last year’s 83% leverage was unusually high as a result of payment and purchase timing and it returned to a more normal range in the fourth quarter of last year.

Accounts receivable excluding the impact of ORS Nasco and the effects of securitization were up $37 million or about 5.5% versus last year. The increase reflects sales growth and the acquisition of Emco’s accounts receivable. Our receivables performance remains solid. Trade day sales outstanding were flat versus last year at 44 days. We are seeing some strains in dealer payment patterns and are monitoring credit exposures and collections very carefully.

We had a good quarter for cash flow which has been a primary focus for us. To date this year net cash from operating activities adjusted for the effect of changes in accounts receivable sold totaled $91 million. Capital expenditures were $26 million through the nine months and we’re on track to spend about $30 million this year.

We did not repurchase shares during the third quarter. Free cash flow was used to reduce debt leverage to about 2.5 times EBITDA consistent with our target.

Our cash balance was higher than usual this quarter at $42 million. This was a point in time situation at quarter end when we conservatively forecast incoming cash flows for the last few days of the quarter after daily borrowing commitments were already in place under our revolving credit facility. Given the heightened sensitivity to liquidity, it’s worth noting that we continue to maintain committed funding sources in excess of $1 billion. This excess capacity provides us with flexibility to borrow where we can obtain the cheapest cost of funds.

As a result of swaps we executed in the past year to fixed rates on $435 million of debt, we were minimally affected by the volatility in interest rates during the quarter.

Now a few thoughts on our outlook for the rest of the y ear. October sales growth is off to a slower start, up about 5% versus last year. We are seeing weaker demand in office products and furniture in particular. Fortunately strong growth continues from janitorial and break room supplies and industrial supplies.

Our gross margin for the quarter may reflect ongoing pressures from a lower margin product mix and competitive pricing in general. WOW initiatives should help reduce the impact of these factors. Gross margin should continue to benefit from inventory cost adjustments due to higher product cost inflation since many suppliers have announced price increases for the fourth quarter. We’ll be opportunistic but cautious about making inventory investment buys.

We are still striving to hold second half operating expenses as a percent of sales in line with last year excluding ORS Nasco. We have a strong focus on spending controls and ongoing WOW programs. At the same time we will continue to invest in mission critical areas like IT and marketing upgrades. We’ll be steadfast in our disciplined management of working capital and expect to hold the year-over-year working capital investment about flat including ORS Nasco.

Free cash flow should exceed $100 million for the year. This anticipates $30 million of capital spending and approximately $43 million in depreciation and amortization. When we consider how to best use free cash flow, we believe it is prudent in these uncertain times to remain at or below our targeted debt leverage of 2.5 times EBITDA. Looking forward we expect to continue balancing share repurchases and bolt-on acquisitions to create long-term value for our shareholders.

Now I’ll turn the call back to Dick.

Richard W. Gochnauer

I’d like to add my thoughts to what Vicky shared with you regarding our outlook for the next quarter and beyond.

With new reports on the global economy turning bleaker, we are managing our business to be flexible and realistic in the near term while positioning ourselves for a return to better times. Here’s what that means.

Taking care of our customers. Always the hallmark of United and even more critical today.

Focusing on growth opportunities that are not as dependent on overall market growth such as new channels, cross channel sales and conversion of direct sales to wholesale, driving our WOW² cost structure improvements and being ready with cost contingency plans should conditions get worse.

Managing for cash flow and making carefully measured decisions on customer credit and inventory investment models.

Managing our capital investments and project expenses.

Prioritizing initiatives with near term benefits while staying the course on key strategic projects.

Actively managing our financing relationships to ensure continued strength and liquidity on a cost-effective basis.

Deploying our free cash flow prudently and opportunistically.

Now that you’ve had this background, Cody, Pat, Vicky and I would be glad to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Daniel T. Binder - Jefferies & Company, Inc.

Daniel T. Binder - Jefferies & Company, Inc.

Emco was in the numbers for about a month. I’m figuring [inaudible] about 50 basis points to your growth rate but if I go to next quarter, it should contribute a bit more. I’m just trying to back into the organic growth that we’re running quarter-to-date. I’m coming up with -3. Does that sound right if you take into effect ORS and Emco?

Victoria J. Reich

A little bit better than that. About -2-ish.

Daniel T. Binder - Jefferies & Company, Inc.

On the extra day, what should we expect in Q4? Do we lose that day or is there a calendar shift at all?

Victoria J. Reich

No. In the fourth quarter we actually have the same number of days, so for the year we keep the day that we picked up in the third quarter. We’d love to have that every year but unfortunately going into next year we lose the day and that will happen in the first quarter.

Daniel T. Binder - Jefferies & Company, Inc.

Is there anything about the calendar that is unfavorable versus last year in terms of the holidays fall?

Victoria J. Reich

No. It’s just leap year this year and it’s the timing of when weekends fall and that sort of thing. Generally we have a movement of maximum one day year-over-year.

Daniel T. Binder - Jefferies & Company, Inc.

I know some years the way Christmas will fall can impact your business because of the way people vacation. Is there anything about the calendar this year that we should be concerned about?

Victoria J. Reich

No, I don’t think so.

Daniel T. Binder - Jefferies & Company, Inc.

What kind of inflation benefit would you expect to see in sales in Q4 given the price increases that you know about today? I think you said it was 3% in Q3. Is it going to be more than that in Q4?

Victoria J. Reich

It could move up modestly from there. We don’t know of all the price increases at this stage but those that we do know about I would say that we’re adding a bit more inflation versus the quarter that drops out in terms of the trailing 12-month impact. So it could move up slightly from the 3%.

Daniel T. Binder - Jefferies & Company, Inc.

I know when you talk about independents you lump a lot of other stuff in there. If you were to look just strictly at the independent sales growth rate, ex the retail channel and I think you had something else in there, what would that growth rate look like?

Patrick T. Collins

The growth rate would be slightly off what we reported but not significantly off. The independent dealers in our office products and janitorial categories had a good quarter quite honestly. The impact of new channels and some of the other customer types that are in there really aren’t that material either in total or that material to the year-over-year growth rate in this quarter. Good quarter for independents.

Daniel T. Binder - Jefferies & Company, Inc.

So the +5 ex ORS, even if I were to strip out or just look at a pure independent number, it’s still going to come in right around there?

Patrick T. Collins

It would be about a point lower.

Operator

Our next question comes from Jonathan Lichter - Sidoti & Company, LLC.

Jonathan Lichter - Sidoti & Company, LLC

How much did Emco account for the increase in inventories?

Victoria J. Reich

Very little. Most of the increase in inventories was related to the investment buys that we did to take advantage of the price increase opportunities in the quarter and just the pure effect of inflation year-over-year on the inventory. A pretty small slice of that inventory increase was related to the acquired Emco inventory.

Jonathan Lichter - Sidoti & Company, LLC

Was any of the bad debt related to Emco at all?

Victoria J. Reich

No, it was not.

Jonathan Lichter - Sidoti & Company, LLC

What was the situation there, the dealer you had mentioned?

Victoria J. Reich

The bad debt overall as we said we raised the provisions by about $3 million year-over-year. About half of that was one specific dealer situation. I can’t really discuss the details there but it was a situation unrelated to the economic conditions. Unfortunately those things happen and they pop when they pop. We took a provision on that one in the quarter.

Then the balance of the reserve increase was really just our normal process of reviewing our aging and specific accounts, and that led us to raise our reserves modestly to a level that’s slightly above our historic norm. We are seeing a little bit of slowing in payment patterns. I wouldn’t call it chronic by any means or widespread but there’s no doubt that we’re seeing some dealers feeling a bit more stretch on the cash flow.

Jonathan Lichter - Sidoti & Company, LLC

Do you expect the usual uptick in gross margins in Q4 or will that be more muted this year?

Victoria J. Reich

It’s a dynamic situation. I think it will be more muted this year. The factors going into fourth quarter gross margin are the slowing sales growth and the change in mix that we expect to continue with the lower sales of discretionary products. So those will sort of be weighing on the margin.

The upside opportunity is we will be opportunistic with the manufacturer announced price increases to do investment buys where they make good economic sense, and even without investment buys there will be certainly an uptick from the inflationary effect. And fuel costs hopefully will continue to moderate so that should be a benefit, and our ongoing WOW programs will continue to contribute. But I would say net net that fourth quarter gross margin, there’s some likelihood that it could be down modestly versus last year.

Jonathan Lichter - Sidoti & Company, LLC

SG&A, is it fair to say that it would remain relatively flat plus the ORS addition?

Victoria J. Reich

What we’re striving to do with SG&A as we said for the second half of the year is to keep the percent to sales ex ORS flat, and we were up just a little bit on that basis in the third quarter. Therefore what we’re driving for in the fourth quarter is to improve our operating expense ratio as a percent to sales. That will be a bit challenging.

We’ve got the slowing sales growth; we’ve got the usual inflationary pressures, and anticipate that perhaps the receivable reserves will continue to trend where they are in the third quarter. So what we’re doing is actively adjusting the variable costs consistent with the sales and we’re driving the WOW programs, and then we’re pacing our spending on initiatives to try to achieve that overall goal for the fourth quarter and second half.

Jonathan Lichter - Sidoti & Company, LLC

This may be way off but do you think that any of the increase in cut-sheet paper demand there had anything to do with the election?

Richard W. Gochnauer

That’s a good question. I really don’t know. It’s possible. We’ve pretty much seen that throughout the year and so I wouldn’t say there were any unusual spikes in the third quarter at all. All that’s happening there is that offices are still operating clearly and paper is one of those things that, as is ink and toner and many of the things that we sell, just have to be consumed. So I think that’s part of what we’re seeing.

Operator

Our next question comes from Greg Halter - LJR Great Lakes Review.

Greg Halter - LJR Great Lakes Review

You discussed the fuel situation and energy. I just wondered if your vehicles are more gas or diesel driven.

Richard W. Gochnauer

They’re more diesel driven and our teams are continuing to look for ways to save energy costs. One example was we instituted an idle awareness program to drive down the use of fuel. But we’re mostly diesel based.

Greg Halter - LJR Great Lakes Review

That’s interesting because gas here at least in this area is about $2.10 versus diesel at $3.50, which is a huge disparity.

Richard W. Gochnauer

Yes, that’s correct. Part of the challenge that we have is that diesel has not come down like most people’s perception of gas prices.

Greg Halter - LJR Great Lakes Review

Do you envision any more distribution center movement in the next year or so?

Patrick T. Collins

We continue to do network studies and that includes looking at where we have under levered facilities and where we can combine those operations into a larger facility. One of the opportunities we’re also looking at now with our diverse businesses is where we can help expand the footprint of some of our other businesses. There will be moves both where we’re taking businesses into existing facilities and we’ll contemplate looking at other situations where we might downsize some operations.

Richard W. Gochnauer

Let me add to that. We do not have in our plans any major investment next year as we had in 2008. Florida was a fairly significant investment for us as we consolidated three distribution centers; closed two and opened a new one.

Greg Halter - LJR Great Lakes Review

That would indicate your cap ex would be less than $30 million in ’09?

Richard W. Gochnauer

It could very well be. We are reviewing that now and trying to take a look at that in light of what 2009 might bring.

Greg Halter - LJR Great Lakes Review

How many distribution centers do you have currently?

Victoria J. Reich

67.

Greg Halter - LJR Great Lakes Review

The two that were sold, how long were those on the market and did you get what you were looking for in selling them?

Patrick T. Collins

Yes. We got what we thought was a fair price for them. I’m not exactly sure but I think they were on about six months.

Richard W. Gochnauer

Yes. It was all part of the whole transaction so the whole thing was negotiated as a lump package.

Victoria J. Reich

With the opening of the Orlando facility.

Greg Halter - LJR Great Lakes Review

The comment about the October sales to date being up 5%. Does that include ORS and the Emco and price increase as well?

Victoria J. Reich

Yes, it does.

Greg Halter - LJR Great Lakes Review

So that’s all-in?

Victoria J. Reich

Yes.

Operator

Our next question comes from Daniel T. Binder - Jefferies & Company, Inc.

Daniel T. Binder - Jefferies & Company, Inc.

A couple questions for you on the gross margin. I don’t know if you can drill down precisely but I’m just wondering if there was any benefit to gross margin on buy-ins that you did for this quarter? I know there are lots of moving parts in there but I was wondering if you could drill in on that.

And secondly, I was wondering how the vendor accruals looked for this Q3 versus last Q3? In other words, you had a pretty good spike in inventory year-over-year and you had pretty good sales. I’m assuming you probably took a bit more of an accrual. I’m just curious how that then plays out the rest of the year as you presumably try and get inventory down.

Victoria J. Reich

Third quarter margins overall were flat, 14.8%. The biggest positive factor was the benefit of the price increases that we passed through as manufacturers announced more price increases. That resulted in about 40 basis points of benefit from the inventory cost adjustments and that includes some netting out of the gross benefit because we do LIFO evaluatons.ORS Nasco we mentioned that as well as a benefit to the margin rate in the quarter. That’s been fairly consistent at about 20 basis points. And then the other major benefit of course was our ongoing WOW programs.

The offsets to all of that, the largest continues to be the sales mix which we estimate just about offset the benefit of the price increases. So that showed up just in pure pricing margin as well as the allowances since the mix of items that we’re buying and selling is less rich from an allowance and a margin perspective. Fuel costs we mentioned; that was the other major drag on margins in the quarter. That was worth about 30 basis points to the downside as well.

Daniel T. Binder - Jefferies & Company, Inc.

With regard to the vendor accruals?

Victoria J. Reich

The vendor accruals, I mentioned it. It’s one of the pieces of the sales mix equation. It was not large and the sales mix equation overall was worth about we think 40 basis points downward margin pressure. Part of that, maybe half of that, was allowance related. As you said we did have more inventory at the end of the quarter. Keep in mind that when we have inventory at the end of the quarter, the allowances as part of that are capitalized with any inventory that we have on hand. But that should flow through as we take inventories down in the fourth quarter.

Daniel T. Binder - Jefferies & Company, Inc.

I guess what I’m trying to reconcile is if I go back to your first quarter, I think one of the things that you had said was that supplier allowances were affected by actions you took to cut purchases to keep inventory in line with lower sales. I’m just trying to understand how I should think about Q4. I’m assuming you’re going to be looking to cut inventory growth in Q4 if current trends continue. If it impacted you in Q1, I’m just trying to understand if I should think about it the same way in terms of impacting Q4 as well?

Victoria J. Reich

I don’t think it will be as dramatic but yes, I think that there will be some impact in fourth quarter from lower purchases.

Richard W. Gochnauer

I think it’s more directly in line with whatever sales does in the fourth quarter. I wouldn’t equate the fourth quarter to the first quarter because there we were deleveraging in a significant way the particular high margin high rebate items. That’s not going to be the case in the fourth quarter. There will be some impact but then you also have some of the offsets of the things that Vicky talked about in the fourth quarter that’ll benefit us.

Daniel T. Binder - Jefferies & Company, Inc.

If I just look at the growth in total inventory versus growth in total sales, inventory growth did outpace in Q3. Is that a function of the inventory buys that you were doing ahead of increases that you expect?

Victoria J. Reich

Yes. It’s up about 10% excluding ORS Nasco. Roughly half of that is related to the timing of the opportunistic buys related to price increases and I would say maybe a third of it is related to just the pure year-over-year price increase valuation on the inventory. Then the balance is really the Emco inventories.

Daniel T. Binder - Jefferies & Company, Inc.

And then you said the 40 basis points on the inflation benefit was net of the LIFO charge?

Victoria J. Reich

That’s correct.

Daniel T. Binder - Jefferies & Company, Inc.

There’s a lot of chatter about deflationary trends potentially taking root next year. As I think about modeling your business for next year, I have to take the inflationary benefit you had in gross margin this year into account, not to get too carried away with potential margin opportunity. So if I were to look year-to-date, what would I see in the inflation benefit to gross margin if it was 40 basis points this quarter?

Victoria J. Reich

Year-to-date it’s less than that because as you may recall for the first half of the year we were actually running below the prior year inflation pace. So that 40 basis points that I gave you for third quarter, the comparable number year-to-date is about half that.

Richard W. Gochnauer

You will see as Vicky said you take the benefits of any year [inaudible] will show up in the first quarter of next year so you’ll have that positive impact. We’re still working our way through announced price increases so we haven’t tipped over with some exceptions. Obviously some products that are directly more tied to commodity pricing like paper or trash bags, things of that nature, will fluctuate more quickly with what the market place does.

But my general sense is, and of course this is difficult to predict, there’s been a lot of cost increases that manufacturers have not been able to pass on in prices over the last couple years so there’s a lot of catch up that’s going on. It’s hard to say but the items that are more likely to deflate if it happens are items that we tend not to carry much inventory in so the impact on us on those items is not significant.

Daniel T. Binder - Jefferies & Company, Inc.

On bonus accruals, was that a meaningful mover of SG&A this quarter one way or the other?

Victoria J. Reich

No, it wasn’t.

Daniel T. Binder - Jefferies & Company, Inc.

Do you expect it to be next quarter?

Victoria J. Reich

No.

Daniel T. Binder - Jefferies & Company, Inc.

Any sense for D&A for next year?

Richard W. Gochnauer

Down slightly probably.

Victoria J. Reich

Down slightly. We’re still in early stages but at this stage I’d say down slightly.

Daniel T. Binder - Jefferies & Company, Inc.

Again I’m recognizing that there’s a lot of moving parts from fuel to vendor allowances to mix and it sounds like you are early in the budget process. How would you suggest we think about gross margin for next year as we net out some of the headwinds with the tailwinds from WOW programs and so forth? Should we be thinking of it as a black gross margin year-over-year or directionally up a little, down a little?

Richard W. Gochnauer

There are a lot of pluses and minuses as you well know. The I suppose good news is that the discretionary purchases didn’t occur in the first quarter last year so at least we’ll be anniversarying a lack of sales in those items. We’re not necessarily anticipating them coming back this year but at least we won’t be anniversarying against a normal year. So that probably is helpful.

There is some carryover on the plus side as we were discussing from price increases that will take us into the first half of next year. We don’t know about the second half so that’s probably on the plus side. Volume as you’ve seen in October is anybody’s guess but clearly it was soft in October for not just us but for the industry. You can be thinking whatever your model might suggest there but in 2009 we’re anticipating that things aren’t going to necessarily turn around in the economy during the year. So that’s kind of our thinking. That’s on the negative side and that always affects volume.

On the positive side again, we may continue to see moderation in fuel prices. On the other hand if volumes aren’t as robust, you’ve got more challenging issue of taking your costs and offsetting whatever inflationary costs are there. Fortunately we’ve continued on our WOW initiatives which will continue to help us next year as well.

So it’s a mix issues. It always is with us. I guess the only bright spot from that point of view is at least we’re going against a tough ’08 from a mix point of view. It could always I suppose get worse but at this juncture no one knows.

Operator

That does conclude our question and answer session for today. I’d like to hand the call back over to management for any closing remarks.

Richard W. Gochnauer

In closing, we believe our company has many unique strengths that position us well to navigate in this troubled economy in the near term and to become even stronger when it improves. We greatly appreciate your support of United and look forward to giving you another update early next year.

Operator

Ladies and Gentlemen, this concludes the United Stationers’ third quarter 2008 earnings conference call. Thank you for joining and you may now disconnect. Thank you for using AT&T conferencing.

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Source: United Stationers, Inc.Q3 2008 (Qtr End 9/30/08) Earnings Call Transcript
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