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Executives

Dick Gochnauer - President and CEO

Vicky Reich - SVP and CFO

Cody Phipps - President of United Stationers Supply

Pat Collins - SVP of Sales

Analysts

Dan Binder - Jefferies

Ben Radinsky - Bear Stearns

Greg Halter - Great Lakes Review

Bruce Youngman - Investor

United Stationers Inc. (USTR) Q4 2007 Earnings Call February 15, 2008 10:00 AM ET

Operator

And welcome to the fourth quarter and yearend 2007 United Stationers earnings conference call. (Operator Instructions)

I would now like to transfer the conference over to your host for today's presentation, Mr. Dick Gochnauer, President and Chief Executive Officer of United Stationers. Please proceed, sir.

Dick Gochnauer

Thank you, Bill. Good morning, everyone. Welcome to this discussion of United Stationers fourth quarter and yearend results with a glimpse at our outlook for 2008. I'm joined this morning by Vicky Reich, our Chief Financial Officer; Cody Phipps, who is the President of United Stationers Supply; and Pat Collins, our Senior Vice President of Sales.

As you know, during each call we provide our current outlook at United's operations and financial performance and challenges and the opportunities we see. Doing this involve sharing forward-looking information. What we say may be affected by the risks and uncertainties in our business, markets and the economy. Despite our best efforts, actual results may be different from what you hear today. To learn more about why this might happen, please review the cautionary language in yesterday's news release and in our 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 understand that we assume no duty to update it.

Shortly after we conclude the webcast of this call, you can find an archived version of it on our Investor information section of our website, at www.unitedstationers.com. And if you don't already have a copy of our yearend results news release, you can find it there too.

Here is our agenda for the call. Vicky will begin by reviewing some key fourth quarter and full year financials with you, offering the important background behind the numbers. Then, I'll provide some color on the sales for 2007, give you an update on the progress we've made in our six value drivers during the year, and talk about what we see so far for 2008. After this, Vicky, Cody, Pat and I will be happy to answer your questions that you might have.

Let's begin with Vicky.

Vicky Reich

Thank you, Dick, and good morning, everyone. To summarize 2007 from a financial perspective, I'd say in the phase of challenging times, we focused on opportunities for profitable growth, we continued our disciplined management of total costs and working capital, and we deployed our cash to enhance shareholder value. These areas of focus will not change as we move into 2008.

Before we get into the figures, let me process my remarks by saying this discussion will eliminate the non-recurring items, either benefits or charges, that occurred in 2006 and 2007. I think this gives a helpful picture of our underlying performance. In addition, keep in mind that we had one extra selling day in the fourth quarter and full year 2007.

Please see the news release, and ultimately, our Form 10-K for the GAAP numbers that do include the non-recurring items. My remarks will focus on the four areas that are driving United's financial performance, our topline growth, margin management, cost management and improving the balance sheet.

Let's begin with net sales for 2007. At $4.6 billion, sales grew 2.2% from 2006. This fell short of our long-term target for 4% to 6% sales growth, reflecting the effects of a slowing economy in the later part of 2007. In a few minutes, Dick will go into greater detail on the progress across our product categories and customer channels.

Facing an economy that offers lower levels of topline growth, it becomes even more important to ensure we're selling product categories and brands that offer higher gross margins. We were able to maintain gross margins at approximately 15.2% for the year as a result of this focus, as well as other margin management initiatives.

For example, during the year, we did a thorough analysis of our stock-keeping units, or SKUs, to make sure we were offering the right products. This led us to identify about 8,000 SKUs for removal compared with the reduction of about 3,000 in a normal year, while maintaining high product fill rates and service levels. This allowed us to eliminate lower margin products and frees up warehouse space for new and more profitable products.

While our gross margin was essentially flat year-to-year, as usual, there were a number of puts and takes. The benefits from continued reductions in advertising production costs and enhancements to supplier allowance programs were essentially offset by a more competitive pricing environment and a decline in inventory related margin resulting from a lower level of inflation.

Operating expenses for the year were $6.7 million or 1.3% below 2006. Tight cost controls, lower payroll-related costs due to the headcount reductions taken in late 2006 and lower bonus accruals were the drivers behind the reduction. Importantly, despite the cost containment, we continue to invest in critical initiatives, including the development of our e-commerce marketing capabilities.

Success with our WOW-squared programs is enabling us to lower our cost structure while investing for the future. Those of you who have followed us for a while are familiar with our 'War on Waste' or WOW efforts. In 2007, we began our WOW-squared program that has a goal of reducing operating expenses and margin costs by $100 million over the next five years.

We got a good start on this in 2007, as evidenced by the 40 basis points improvement in our operating expenses to 10.8% of sales. This enabled us to improve our operating margin from 4.1% in 2006 to 4.4% in 2007 and grow our EBIT by 10.8% to $203.9 million, a noteworthy accomplishment in a year of modest sales growth.

Diluted earnings per share rose from $3.27 to $3.86, an 18% increase. Record share repurchases of 6.6 million shares or $383 million contributed to the EPS growth and helped to offset the impact of a higher tax rate of 39.1% in 2007 versus 37.3% in 2006.

Let's take a quick look at the fourth quarter financial results. We experienced a modest 0.6% increase in sales. We saw a continued strong in janitorial and break room supplies up 11%, and growth of 2% in office products, offsetting lower technology product sales down 4.5% and furniture, which was down 5%. As expected gross margin of 16.1% were down from the 2006 fourth quarter margin of 16.7% reflecting the timing of supplier allowances earned in the fourth quarter of 2006.

Operating expenses for the quarter were down 4% from 2006 reflecting lower bonus accruals and payroll expenses. Operating margin was flat versus 2006 at 4.6% and we saw a 14% increase in diluted earnings per share to a $1.12 from an adjusted $0.98 in 2006.

Turning to the balance sheet, I'm particularly proud of the progress we made during 2007. Our investment in inventory increased to $715 million, up 5% compared with 2006. The acquisition of ORS Nasco accounts for all of the increase. In fact excluding the effects of ORS, inventories were down approximately $15 million year-over-year and our annual turn over increased from 5.8 times to 6.2 times.

Accounts receivables before securitization rose about 9% versus 2006. More than half of this was attributable to the ORS Nasco acquisition. DSO for 2007 was 42 days compared with 39 days in 2006. The quality of our receivables in collections activity remains very good. We also made progress in AP leverage during the year ending at 63% versus 56% in 2006. Overall, our working capital efficiency as a percent of sales excluding ORS Nasco improved to 5.3% from 16.7% in 2006.

Our focus on working capital efficiency improvement helped us to deliver net cash from operating activities of $184 million excluding the effects of accounts receivable sold. Our strong cash flow and access to financing enabled us to repurchase $383 million of stock and complete the acquisition of ORS Nasco for about $180 million, while reaching our targeted debt EBITDA leverage of 2.5 times.

We ended the year in solid financial condition with our total debt in securitization financing just under $700 million. Our debt-to-total capitalization, which includes our securitization financing, was 55% versus 30% at the end of 2006. Actual shares outstanding were $24.6 million shares at yearend. I think it might help the share some of our current expectations for factors that will likely affect our balance sheet in 2008.

With the addition of ORS Nasco, our capital spending is expected to be in the range of $25 million to $35 million. Depreciation and amortization for the year should be in the $44 million to $47 million. This includes the estimated impact of ORS Nasco acquisition accounting.

Share repurchases to-date in Q1 totaled 800,000 shares for $44 million. We have $24 million remaining under the existing share repurchase authorization. We anticipate the Board of Directors will consider share repurchases throughout 2008, as we seek to maintain our targeted debt EBITDA leverage of about 2.5 times.

In summary, despite an economy that weakened during the year, we improved on key operational measures and posted strong earnings and cash flow results. We repurchased a significant number of shares and made an important acquisition while maintaining a strong balance sheet. Strategies that allowed us to make this progress are the six value drivers that we've incorporated into United's culture.

Now, I'll turn the call back to, Dick, so he can give you more information on the composition of our sales, the impact of our value drivers and the outlook we have so far for 2008. Dick?

Dick Gochnauer

Thanks, Vicky. Now, let's take a closer look at the components of our revenue growth for 2007. As you know, we analyze our sales performance in two ways; by the type of customer and by product category. Here is what we saw in both areas for the year.

Sales to independent dealers were up nearly 4% from last year and contributed over 80% of our total sales for 2007. Even on a time when end-consumers are very cost conscious, these dealers continue to hold there on. They can do this by offering end-consumers a single source for a broad range of products making the shopping experience an easy one and providing excellent service throughout the process.

Sales in national accounts were down low single digits and accounted for approximately 20% of our 2007 revenues. This was caused by the trends we've seen throughout the year. National accounts are focusing on their internal supply chains. As growth has slowed and they continue to optimize their supply chains, some are sourcing more of their products directly from manufacturers. We expect this trend to continue in 2008.

A continued bright spot for us in 2007 was our sales to new customer channels, where we experienced a double-digit growth. We are doing a good job of penetrating these new customer channels, which focus on the growing Small Office/Home Office market or SOHO for short. This is an area not previously serviced by our traditional independent office products dealers.

All of these customers appreciate the value proposition United brings. We have the experience and market knowledge to know what types of products they should offer and provide them a broad selection of items. And we provide a turnkey supply chain solution, which means these customers having minimal capital investment while increasing their sales to end-consumers.

Let's move on the types of products our customers purchased last year. Janitorial and break room supplies continue to be our fastest growing product category. Revenues increased 9% for the year, accounting for nearly 20% of our total sales. And once again it is our strong value proposition that creates this growth. Customers who ordered janitorial and break room supplies from us lower their invested capital, lower their cost to serve to their end-consumers, and lower their investment in inventory, all at a time when capital is at a premium. They find us -- the lower cost alternative to serve their end-consumers. These advantages combined with United's broad line and nationwide reach resulted in Lagasse, signing an important multi-year agreement with a major account during the third quarter.

Onto our largest category, technology products, which contributed over 37% of last year's revenues. Sales were up 2% between 2007 and 2006. None of this was by choice. The largest category we sell in technology products has been printer and imaging supplies. Price discounting on ink and toner cartridges is a common way to grow sales in softer economic times. One of our goals for the year was to improve the margins on our mix of products. In some instances, we decided not to participate while we were unable to realize a satisfactory margin.

Instead, we are using a number of strategies to focus on profitable growth opportunities, which are available to us because of our unique value proposition. This include new marketing initiatives for dealers, using print, electronic and online catalogues and circulars to give them multiple touch points with end-consumers. We're also are diversifying our technology product offering by adding more computer accessories, including keyboards and digital photography solutions.

Finally, continued focus on offering comprehensive printing solutions, which includes printer, imaging supplies, media and applications will allow our dealers to participate in the rapidly growing digital printing evolution within the small and medium-sized business consumer market. This approach offers higher sales and margin opportunities for United and its dealers.

Moving on to office furniture. We experienced flat sales for the year. This category provided about 12% of our total revenues. One of the reasons we were able to maintain stable sales in a slipping market over the last year was, our Alera private-label furniture brand. It posted double-digit sales growth and made a solid contribution to margins. Sales were also supported by our 2007 marketing initiatives, which include new tools to help dealers interest in consumers and their furniture offerings.

Sales of our traditional office products rose 4.5% last year and this category contributed nearly 30% of the United's total sales. The increase came from core office products category such as pads, cut sheet paper, envelopes and writing instruments, as well as higher ticket product such as whiteboards and laminators. Expanded use of buying guides and solutions selling presentations in our print and electronic marketing vehicles also contributed to our growth.

In addition during 2007, we launched a new line of Mailroom, Shipping and Packaging supplies. A company buys targeted marketing support from United, these products offer new growth opportunities for our dealers. Another important factor in the increasing office product sales is the growing interest in the United private brands.

Revenues for our private label products were up nearly 15% for the year and accounted for approximately 13% of our total sales, which is up from 11% in 2006. In softer economic times end-users look for new ways to save money. United's private label brand help us and our dealers address this marketplace demand. In addition, both the dealer and United see higher margins on these products even as in consumers pay a lower price. For these reasons we continue to expand our United and Lagasse brand offerings in 2007 to over 4,000 items. ORS Nasco adds thousands of additional products to our private label offering.

Now, I'd like to give you an update on our six value drivers. Here is the progress report on the key advances we made in each of the areas last year. Our first value driver is to deliver profitable sales growth. I'd like to share a few examples of we're doing this even in soft economy. First, we are leveraging our product category initiatives. Successful programs in 2007 include an expansion of our green environmentally friendly products and a new line of furniture.

Second, the acquisition of ORS Nasco gives us access to new lines of products such as safety supplies to sell across our various channels, as well as new customers who offer our existing products too. ORS's growth like Lagasse is more dependent on continuing to grow share and convert customers and suppliers to the advantages of wholesale and it is dependent on the overall market growth.

Third, we have numerous success stories outside of our traditional office products industry, where we have partner with companies who reach end-consumers not served by a traditional independent office products dealer. United business model makes it easy for these companies to broaden their product offerings to existing end-user customers who are not having the stock or handle additional products.

The fourth example is what we are doing to improve United's marketing care capabilities. During 2007 we took the best attributes of our major catalogs and combined them into one format representing our four primary categories. We've leveraged our investments in content management to create more compelling catalog presentations with enhanced images and more persuasive sales copy.

We are getting some positive feedback on how much easier to catalogs are to use. These catalogs are our primary consumer reference tool in an age of online purchases. Our second value driver is to drive out wastes. And as you know, last year we took our War on Waste efforts to the next level, which we call WOW-squared. Our goal is to do more than remove a $100 million of expenses from 2007 through 20011. It's about improving the customer experience at the same time. Six Sigma and Lean management tools are being used to reduce costs and improve working capital.

Our 2007 results saw a good start towards meeting our five-year goal. This is particularly impressive considering that we've got much of our low-hanging fruit in the first four years of our War on Waste program. And now we're taking on more complex projects.

As an example, the reduced costs and returns related to damage merchandise, we've establish a team to investigate the in-to-in process within the supply chain. This includes shipments from our suppliers to United and shipments from United to our dealers and to their customers. This is a significant opportunity for improvement particularly in our furniture category.

We also increased our value to United customers. Here is one example. We instituted a Mystery Shopper program through which we place orders to get a sense of the customer's experience in working with us and then identify and address the areas to improve. We'll take this effort to the next level in 2008, when we complete our first joint customer and associate satisfaction survey, which will indicate other areas that deserve our attention.

I've already spoken a bit about our third value driver to expand our United private brands. You've heard about the positive contribution this is making to our revenue and our product mix. Last year, we made some advances in the relationships and logistics that make offering these products possible. This includes very high standards for quality assurance and working with multiple suppliers to ensure products are available.

In addition, we improved our inbound logistics moving the products from manufacturers through ports and ships and freight carriers to us. In 2006, our on-time shipments from import suppliers happened about 65% of the time. In 2007, we focused on this process and the number increased to 92% of the time -- on time shipments.

Our fourth value driver is to optimize United's assets. We made strong progress on improving our balance sheet and cash flow. We took action on a number of areas in 2007. As Vicky mentioned, we improved our inventory turnover and accounts payable leverage as well as our overall working capital efficiency. Our capital spending for 2007 was approximately $19 million, after several years of reinvesting in much higher amounts in the business.

We completed the move of our IT data center on time and under budget, and invested in other IT and facility projects, paved the way for growth initiatives in 2008. We expanded our debt capacity to $1 billion and obtained favorable rates on several new components of our overall debt. These actions allowed us to generate $184 million in free cash flow, fund share repurchases and complete the ORS Nasco acquisition.

Our fifth value driver is to unlock the value from acquisitions. Our original focus here was to get the most from Sweet Paper, which we acquired in 2005. During 2007 we completed the Lagasse and Sweet Paper integration and began to see tremendous progress in driving value from this acquisition both in our Lagasse as well as our United Supply businesses.

We also evaluated the characteristics that made the Lagasse and Sweet acquisition so successful. And look for other areas where we could repeat their success formula. Where else we could experience the profitable growth we had seen at Lagasse from $80 million in sales when we bought it in 1996 to nearly $1 billion today. As a result, in December, we acquired a company we believe offers similar growth potential.

ORS Nasco met all of our acquisition criteria. It has a strong management team that is well respected by both customers and competition. It has good margins and solid growth prospects. ORS Nasco takes us into the $22 billion wholesale industrial supplies market. It has a business model that's very similar to ours. It's a market leader. ORS Nasco is one of the largest pure wholesalers in North American industrial supplies. It has synergies with our operations and opportunities to leverage our joint capability and it shares our culture, which includes a dedication to serving its wholesale distribution customers. We're off to a good start with ORS Nasco in 2008 and look forward to unlocking the value of this latest edition to the United family.

Our sixth and final value driver is to use technology to enhance our marketing capabilities. In 2007, we successfully stored all of the digital images, product specification and sales and marketing copy on every item we offer and what we call our e-content systems. The plan is to leverage this information with new search, navigation and merchandizing capabilities that improve the online shopping experience our dealers offer their end-consumers.

Last year, we began working with all of the software providers used by our dealers to embed our electronic catalogue into our dealer's e-commerce store fronts. I invite you to see an example of the results by visiting our www.biggestbook.com. This website showcases our enhanced content and images along with the new capabilities our dealers and consumers will enjoy.

With all of that said, I know you are interested in our current prospects for 2008. Like you, I read the news about the possible recession. Obviously, we faced this kind of market before. We plan to stay the course with a discipline focus on our value drivers. Fortunately, we also will benefit from the progress that we have already made reflected any more diverse customer base, lower cost, more efficient operations and more profitable product mix and a stronger marketing effort to help our dealers built their sales.

Our ongoing WOW savings will unable us to continue investing in our future. While the macro economic environment is likely to limit near terms sales growth in office products, we do see bright spots in our janitorial and break room supplies category, new channels and, of course, the addition of ORS Nasco.

We expect EPS growth will be driven by three factors; the contribution from ORS Nasco, significant share repurchase activities and a modest EBIT growth in our core businesses. Our long-term goals remain unchanged and they include annual sales growth in the 4% to 6% range with some upside in the years when macro economic growth is strong and vice-versa, and long-term EPS growth in the mid teens.

After hearing all of this, I'm sure you have some questions. Vicky, Cody, Pat and I will be happy to answer them.

Question-and-Answer Session

Operator

Thank you very much sir. (Operator Instruction)

And our first question will come from the line of Dan Binder of Jefferies. Please proceed, sir.

Dan Binder - Jefferies

Hi. Good morning.

Dick Gochnauer

Good morning, Dan.

Dan Binder - Jefferies

I have lots of questions for you. I'll just ask a few and let others get a chance as well.

Dick Gochnauer

Okay.

Dan Binder - Jefferies

First question is to address the WOW-squared, in terms of how much you were able to achieve this year, was it $20 million or was it more? And then going forward you said the, I guess some of these cost saving going to be through somewhat complex process changes. I think in the last year you had some good games out of the catalog production and some distribution efficiencies. I am just kind of curious, what you can share with us in terms of the things that you are going after in the coming year? And any thoughts on how much of that $20 million can fall to bottomline after the investments are needed to get to it?

Dick Gochnauer

Okay. I am going to ask Cody to answer that, but you did see that are our cost basis went down about by 40 basis points in '07 and that was without a whole lot of help on the topline. So that was largely driven by our WOW initiatives but Cody can give you a little more in-depth flavor for the kind of things that drove that in '07, and the kind of area that we're looking for in '08. Cody?

Cody Phipps

Hi, Dan its Cody. Answer to your question it was slightly more than $20 million you mentioned we exceed our goal that we set and we're on that of course for the $100 million over five years and just to remind you this was the first year of our Lean Six Sigma program. And we are pleased with the traction we've got. We were mostly focused on processes here at the FSC that drive wastes both here and into the field. So we did see some nice print reduction costs. We're going continue to focus there.

We also had a big focus on working capital and balance sheet management, so we directed some of our Lean Six Sigma efforts there and got great results. And we're rolling the Lean Six Sigma program to the field as we head into '08. So we'll continue to focus obviously on operating expense, working capital. Print is big driver for us. We will continue our efforts there and we are trying to balance a lot of those initiatives with things that matter to the customer too. We launched some customer engagement research last year and we're right now in the process of balancing our portfolio to deliver both quality and service improvements while hitting our costs in working capital levers as well.

Dan Binder - Jefferies

I know it's maybe simple to think about $20 million per year. But is that -- at this point, with four years to go is that still roughly weighted evenly or should we be thinking about more of it being front-end weighted or back-end weighted or--?

Cody Phipps

Dan, we typically don't really get into that level of detail.

Dan Binder - Jefferies

Okay.

Cody Phipps

We stick with our forecast of $100 million over the five-year period and we kind of track how we're doing against that. But so far good news, we are off to a good start on that $100 million. We're a little ahead of the curve after '07. And like we did in the previous WOW program, our team is now trained and understands how you go about doing this. They're motivated. And we continue to find, I think, innovative ways to take out waste while at the same time -- and this is thing that often times gets missed at the same time, it gives us opportunity to actually to improve our service, because most of the time it's taking out variation in the process and variation is the enemy of customer service. So it's actually worked nicely to go hand-in-hand with the customer service component.

Dan Binder - Jefferies

And then, on the SKU reduction sounds like that it may have helped the inventory levels a little bit and we've taken a consideration of Nasco growth. If we sort of net all that out, when you look at the inventory buys that you made at yearend which I think you spoke about in the Q3 call, were there a lot of opportunities to go on there and take advantage of some inventory building, to hit volume rebates and how does that compare to last year? I guess kind of what are you thinking about going forward in terms of the vendor programs that you have in place for the coming year? I think last year you had stepped up the variable component to that. I was just curious if that stated current levels or if you brought it down in this, in a tougher environment.

Vicky Reich

Good morning, Dan. It's Vicky. I think in terms of yearend opportunities, they were about the normal level that we would see. We were in a good position inventory wise to take advantage of programs that were out there and I think it was the normal amount that we would have experienced. Going forward looking at supplier allowances program, yes, we are consciously on a variable basis looking into 2008, which means more those dollars types of growth, I think, with the dollar amount obviously then varies with billed growth, but most of this percentage, as a percentage of our sales and it is tied more closely to our billed growth as well.

Dick Gochnauer

We do a couple of things, Dan, that has been enhancing our vendor programs. One of them is working with our suppliers and offering new marketing opportunities which they can invest in and they have been and that provides sources for funds. And then secondly, obviously like everyone else, we negotiate every year what our vendor program is and we always seek to see if we can enhance those a slight amounts. So we have those two things working on the positive side and then the rest obviously is a function of what you purchase.

Dan Binder - Jefferies

I have always been a little bit confused in terms of what happens and I know that Q4 is always -- there is always a swing there depending on whether the year was better of worse. Now, we've got a higher variable component. As I think about next year, if we assume the thing was sort of flattish in terms of organic growth, which I am not asking to predict, but I am just saying given what we're reading today, its sounds like that's probably conservative where to go. In that kind of an environment, do you see an increase in vendor dollars year-over-year or do you have to rely on other things like the catalogue, the electronics colors to build the vendor money?

Dick Gochnauer

We rely on everything that go -- to work with our vendors. We will be as we've been talking about lot an increasingly offering, particularly with electronic side, more opportunities to vendors who get their message and brand message across end-consumers. So, that will start to have a play in the second half of this year, which will be on the positive side.

And clearly, the amount inventory that you take out of the system, for example, we took out a fair amount last year and our vendor allowances variable are paid on purchases and not on sales generally. So, when you work your inventory is down that tends to work little bit against you, but despite all of that and fairly -- not a normal year of us in '07 in terms of revue growth, we were still able to turn in very strong vendor support.

So we look to do that again in '08 quite frankly. And so it continue to expand in multiple ways in which we can help the suppliers get their marketing initiatives out into the marketplace.

Dan Binder - Jefferies

Okay. Then one last question before I get off here. Is the bonus accruals that you mentioned in Q4 being lower than last year, can you quantify what that made it look like?

Vicky Reich

No. I don't really want to go there to quantify. That was one of the factors in the fourth quarter, certainly wasn't the only factor we saw. We continue to see lower total payroll cost, people cost in the fourth quarter as well as for the full year.

Dan Binder - Jefferies

And we lap the headcount reduction is that in the fourth quarter or was it more of the end of Q1?

Vicky Reich

Yes, it was in the fourth quarter of 2006.

Dan Binder - Jefferies

Okay. Great. Thanks.

Dick Gochnauer

Thanks, Dan.

Operator

Thank you very much sir. Ladies and gentlemen, your next question comes from the line of Ben Radinsky of Bear Stearns. Please proceed.

Ben Radinsky - Bear Stearns

Thanks. Good morning.

Dick Gochnauer

Good morning, Ben.

Ben Radinsky - Bear Stearns

Can you talk about any changes in seasonality due to the acquisition?

Dick Gochnauer

Okay. The industrial market and Lagasse market tend to be little bit countercyclical not that either one is very cyclical quite frankly to the office products. Office products, our strongest months are in the first quarter and for the Lagasse business its mid-year, is a little stronger and the industrial business picks up a little bit mid-year, obviously because of construction and things that occur in center part of the year. But none of our businesses are very cyclical, its just minor differences in growth rates.

Ben Radinsky - Bear Stearns

Okay. And then thinking about the accretion, I think you originally spoke to $0.15 to $0.20, I'm assuming that that's still true for '08. Should we think of that more backend loaded or is that pretty of the nearest throughout the year?

Vicky Reich

First of all, no, I would not change at this point, our estimates on the accretion which are $0.15 to $0.20 and in terms of how that will lay in by quarter, it maybe a little bit backend loaded, we're still working on the acquisition accounting effects, so we may see a little bit more negative effect of the acquisition accounting early in the year, but, otherwise, it should be fairly leveled.

Ben Radinsky - Bear Stearns

Okay. And we've heard from some folks that there was a major step-down January 1st in economic activity and I am wondering if you saw that in your business or did you not or is the term line consistent with where it was in December?

Dick Gochnauer

You have look by different segment. The Lagasse business and our ORS business as we pointed out are depended on converting customer over to wholesale model and taking market share than they are depended on the growth of the overall market. So in those two businesses they grew very nicely so far in January. With regard to the office products, we indicated that was slow. It was slow in the fourth quarter as well for us. So I wouldn't call it step-down, I would call it a continuation of what we saw in the fourth quarter.

Ben Radinsky - Bear Stearns

Okay. And then have you seen any dramatic changes in pricing in the industry specifically in more of the commoditize products and your outlook for '08 in terms of -margin -- for gross margin would it be flattish or would it be fairly improved because of the acquisition or where do you see that going?

Dick Gochnauer

With regard to margin, the question is margin in the first quarter is that what you said?

Ben Radinsky - Bear Stearns

Overall, have you seen pricing change…

Dick Gochnauer

Pricing in the first quarter?

Ben Radinsky - Bear Stearns

Correct. And then also throughout the full year, the implications for gross margin.

Dick Gochnauer

I will take a stab at pricing and Pat maybe you can jump in and add anything and then Vicky maybe you can cover the gross margin. For the most part I would say that whenever growth slows which it did in 2007, particularly the back half, it always -- everyone is looking for growth we see it and therefore pricing can factor in and that puts pressure on margins.

The biggest place that we tend to see that and the most dramatic is in our technology products. And that's why we've made comments. That's where we've seen as you saw on our report here. That's where we had the biggest decline along with furniture, at least starting in more recent times. So that's where you see the factors, is in technology and so we do see it there.

And the good news for us, I suppose, is if you don't follow it all the way down, and you walk away from some business, you do lose some topline, but it doesn't hurts you so much and actually improves your overall margin rate a little bit. Pat, do you want to add anymore color to the price question.

Pat Collins

Sure, Dick. Ben, probably the only thing I would add is, the general pricing environment got a little bit more challenging about the halfway through last year. And moving in the 2007, I think we've seen more of the same. As Dick mentioned, we did see some pressure in technology, the back part of '07. And we've seen some pressure in the furniture category. But overall, I wouldn't characterize it as a much more competitive environment than what we saw through most of '07.

Ben Radinsky - Bear Stearns

So just to be clear that would imply the gross margins to be flattish for '08?

Dick Gochnauer

Vicky, go ahead.

Vicky Reich

Yeah, let me take you through some of the, as we see the positives and negatives, as we look forward to gross margin, sales mix -- some of the sales slowdown that we're seeing is in lower margin categories, for example technology. The other side of that is, we're seeing slower sales in high margins categories like furniture. If you look art sales mix overall, ORS Nasco will be a nice plus from that perspective. Margin, as we noted, did a more competitive environment clearly and supplier allowances as we just talked about certainly becomes more challenging in a slower growth environment.

As Cody touched on before, however, we do still see cost components of margin, for example advertising, production costs being an opportunity for improvement in 2008. So there is some plusses and minuses and it really does kind of come back to outlook for core business growth and on your crystal ball is similar to ours there.

Ben Radinsky - Bear Stearns

Okay and then the last one from me. If you were to look out to your free cash flow generation it looks pretty strong for '08 and especially if things get even a little bit worse so you will throw out even some more cash. Is the exclusive use of that cash going to be for share buybacks?

Vicky Reich

Well as we look and as the Board considers buybacks in 2008, we are starting from having achieved our targeted leverage, debt-to-EBITDA of about 2.5 times at the end of 2007. So as we look forward in 2008 certainly the considerations will be earnings performance and working capital and cash flow performance that will presumably create some capacity.

As we indicated earlier, we do believe on an annual basis we should be able to generate in excess of $100 million of capacity for share repurchases or potentially for strategic investments, and as we noted we have already started the year with some share repurchases in excess of $40 million already.

Ben Radinsky - Bear Stearns

Okay. Thanks.

Operator

Thank you very much ladies and gentlemen. [Operator Instructions]. Our next question comes from the line of Greg Halter of Great Lakes Review. Please proceed.

Greg Halter - Great Lakes Review

Yes, good morning.

Dick Gochnauer

Good morning, Greg.

Greg Halter - Great Lakes Review

I wondered if you could comment on your debt. I think the last conversation we had that you were all at variable rates, but were considering maybe fixing some of that and just would like to get your thoughts there.

Vicky Reich

Yes, Greg we did achieve a swap late in 2007 at very attractive rates and that applies to $335 million of our debt is now fixed at least that I would say average around 5.5%, and then the remainder of our debt is still floating rates. Right now, those rates are extremely attractive as well, of course, that's tide to principally LIBOR and also some of that commercial paper rates.

Greg Halter - Great Lakes Review

Okay. And looking at the securitization, given the troubles in the credit markets, are you having any sort of difficulties in that regard at all.

Vicky Reich

No, we have not Greg.

Greg Halter - Great Lakes Review

Okay. And your tax rate for the fourth quarter seemed certainly lower than we thought it would be, but wondered if you could one, explain why that was, and maybe it wasn't versus your expectations? And then, what your outlook is for the tax rate going forward in '08?

Vicky Reich

Sure. Well what happened in fourth quarter is the usual process that we complete the federal and state tax returns and some of that occurs later in the year. And what we do in the fourth quarter is we true-up estimates that have been made and typically we estimate conservatively and normally that results in a catch-up in the fourth quarter, which is what happened this year. We took the full rate down from 40%, full year rate down from 40% to 39% and all of that catch-up effect occurred in the fourth quarter.

So looking forward, as I said, we usually start the year with fairly conservative estimates with the tax and at this point what I would guide you to is in the range of 38.5% to 39%, and then we'll true that up as the year goes on.

Greg Halter - Great Lakes Review

Okay, great. Thank you for that. And then you mentioned the capital spending is expected to be higher for 2008. I was just wondering if there is any specific area that you could comment on that spending will be going into or going towards.

Dick Gochnauer

There is one major project which is a facility consolidation project in Florida and Cody you might to speak to that for a second.

Cody Phipps

Yeah we had analyze our quarter network a while back determining that we were not meeting customer needs, we had a lot of small building there not able to house the right inventory. We did a strategic with Lagasse and what we're implementing is a joint Lagasse [USCO] facility which we thing will have higher fill rates, better service to the market, and that's certainly one of our larger capital investments.

We're also rolling out weight checking in our facilities, so that's a bit of a cap on investment and we're looking at some strategic use of capital around sustainability initiatives particularly lighting projects to the part of our capital budget for '08.

The other couple of things I would add to that is, we are continuing to - now that our infrastructure investment is done, each year we will start to chip away as upgrading our base software that operates the company. So we have some projects in that area. And then we have the addition of ORS into the stream, and then Lagasse continues to grow nicely and with that growth does require some additional facilities, expansion on occasion and equipment that goes with it.

So nothing I would say out of the ordinary. Our depreciation rate is I think you already indicated is in the high of $40 million range and it's our objective to try to keep our capital spending for the next several years significantly below that rate.

Greg Halter - Great Lakes Review

Okay. And you had mentioned weight checking, what do you mean by that and I guess what are you doing there?

Dick Gochnauer

What we did is we piloted this last year and we put weight checking in about six of our major facilities. It's a - the device goes in our conveyor lines and in combinations with our database of all our products attributes, we can - as the boxes pass over it can weigh it and determine whether it has the right contents, and so its investment in the database to do that. But what we found is that we’re correcting errors before they go out. As that box goes out and if there is errors then that costs us and our dealers a lot of money, and we proved ourselves that the weigh checking eliminates that, reduces the reworking, so now we’re rolling that out for some more of our facilities as part of our overall quality initiative.

Greg Halter - Great Lakes Review

Okay. And can you comment on the SAP solution which I guess is the RTS as well as the commentary in your release on the outlook working with other industry software providers embedding content into their e-commerce solutions exactly what your doing there.

Cody Phipps

Sure first on SAP; SAP is continuing to invest in their software solution. In fact I think they are putting more money into it on a monthly basis today than they have over the last couple of years. They anticipate to be able to roll out into the market place sometime around mid-year, some enhanced products for the dealers. So they are proceeding aggressively along those lines. We - at the same token our dealers also use software systems from other suppliers, and we launched in the November timeframe or December I guess it was last year, what we call our BiggestBook.com website.

It was kind of a way of looking at the new and improved content and we're going to be or in the process I should say embedding that content into - the web service to make it available to the entire market place, as a web service. So that's what's going on right now, and that will enable our dealer customers to not only experience the content but experience the search capabilities that are enhanced with it.

Greg Halter - Great Lakes Review

Okay. And do you still have 10 dealers on the system on the RTS system?

Cody Phipps

I believe they are somewhere between 8 and 10, somewhere in that neighborhood, yeah.

Greg Halter - Great Lakes Review

Okay, two quick last ones. What did inflation add in 2007 in total for the full year?

Vicky Reich

Not much. For the full year it was about 1.5%; in the fourth quarter it was nothing. And as we look out into 2008, we're not expecting a lot of change maybe a point, point and a half in that range.

Greg Halter - Great Lakes Review

Okay. And you had commented there is only $24 million left on the share repurchase authorization, and obviously it's up to the Board to reauthorize. But is that something that you would expect if you use up that remaining $24 million?

Cody Phipps

[Was]. I think Vicky commented earlier the Board will look at as we generate cash flow what's the best use of that cash flow, and our stated objective of staying around the 2.5 times on multiple. So as the year goes on and as cash fills up, the share repurchases clearly as the board has demonstrated high on their list.

Greg Halter - Great Lakes Review

Okay. Great. Thank you very much.

Operator

Thank you very much sir. Ladies and gentlemen, your next question comes from the line of [Bruce Youngman]. Please proceed.

Bruce Youngman

Hi. I'm a investor long-term and --

Dick Gochnauer

Bruce we can't hear you.

Bruce Youngman

Can you hear me now?

Dick Gochnauer

Yeah if you speak loudly I think we can hear you.

Bruce Youngman

Yeah. I'm right into the phone. I would like to get a little bit more color in understanding of the Nasco acquisition. What kind of typical margins they operate with and whether in fact they have product lines that are different in the sense of margins like our furniture business versus our standard line of paper products? Could you comment on that?

Dick Gochnauer

All right, the macro acquisition you are talking about is the ORS Nasco?

Bruce Youngman

Yes.

Dick Gochnauer

Yeah. Yes, ORS Nasco has higher margins than our average. And it's about a point or two, I think, higher margins. They do have a different product line, they sell industrial tools. For example, safety and security products which we do to some extent and one of the interesting aspects of them was they were actually a fairly large product line for them and so that expands that offering, both to the Lagasse customers as well as the United supply customers. But they also sell, which you might consider it as the MRO space, the supplies that go along with that for the industrial market. They have some specialty product areas like welding, supply area, which was one of their heritage foundations, although it has grown rather extensively beyond that, since that time.

What we're finding actually is that, as time goes on more and more of a blurring about product lines of how products get to market. And as we watched over the last several years what has happened in office products space, those dealers have continued to grow beyond the traditional office products categories, [Jan/San] being the first one of the biggest areas. Then they had break room supplies at the PREIT services area and this whole area of expanding to their customer base into the medical and into industrial customer base, we've seen a more rapid growth of that, and for example our Lagasse business, probably a fastest growing segment.

And what's happening as everyone is looking for, as they evaluate their customers and they create the relationship with the customer and an easy ordering platform with those customers. They are asking what else do you buy. And as they understand that and they can get access through a pure host of services, such as ORS or Lagasse. They can capture a larger share of that customers' business, even though it wasn't traditionally a product they sold. So, we think that's going to continue, that trend will continue overtime and products that people weren't even thinking about two years ago, they are now important products to them. And we expect that to continue.

Bruce Youngman

Okay

Dick Gochnauer

Thank you, Bruce.

Bruce Youngman

I am also a little bit perplexed at the overall margin that since the furniture end of the business is much higher margin business than the general business, why you would be sounding to me as optimistic, given the macroeconomic environment especially in white collar employment and office expansion. Its seems to me that that furniture business might be flat to down for some time, if this economic downturn gets worse?

Dick Gochnauer

Yeah, now good question and furniture as you correctly pointed out is probably the quickest indicator of when companies pull back and furniture to some extent can be more discretionary, I suppose to office supplies, because they still have to operate their business. But, what we're seeing in the industrial area and in the food service and break room supplies are slightly different dynamics. There, we have been growing for a number of years in those categories, by working closely with the manufacturers to evaluate the fact that they are selling too much direct and it's costing a money and by going through wholesale they can lower their costs and give better service to their customers. We're seeing the same thing happening in industrial. So particularly in times like this, people are looking to growing their sales and their customers are not growing, so they are saying how can I offer more products and how can I do it with less expense and that's where wholesale comes in and offers some solutions.

So we're actually seeing these as being, not bad markets for our industrial and Jan/San and food service business. The furniture business, is kind of at the other end of the spectrum and for the reasons I just described an office products to somewhere in between.

Bruce Youngman

Okay. Just wanted a little comment, I've seen some articles recently commenting on that companies that engage in stock buyback programs that do not necessarily end up having both the stock cheap enough. And since we've embarked on very aggressive repurchase program, a good deal of the EPS growth has come from the reduction in the capitalization of the stock and at what point do you not buy any additional stock, especially since the stock is up from the mid 40's, less than a month ago to where it is today?

Dick Gochnauer

A good question, Vicky might add to this. With the way we come at it, as we tend to look at what's the optimal capital structure; that is, uses the appropriate amount. Not too much, still conservative amount of leverage and then we manage to that. And so coming to that conclusion is what's driven our stock purchases and as we've commented and Vicky has commented, that will drive our thinking as we go forward and we've been pretty clear I think with everyone about, what drove that decision.

And that comes from, lot of analysis as to what the appropriate amount of leverage to give maximum shareholder return and yet appropriate amount of risk on the balance sheet or -- and not overextending, give us still plenty of room to address things that you can't foresee. And so that's the position we have taken and I think it is a, we think anyway and the board itself that it's a smart use of our cash, as a way of returning value back to the shareholder.

Bruce Youngman

Well, notwithstanding your comment now, my feeling is that we are getting pretty close to being over leveraged in a potential economic downturn that could come back to buy this. And of course, I know that the debt has increased considerably and while you feel comfortable with that. I am a little bit uneasy with the debt-to-equity ratio amount?

Dick Gochnauer

Well, I can certainly understand that comment. And one nice thing about our business and at least this has been historical perspective is that even in economic downturns, we fare fairly well. We tend -- obviously our growth rate slows and it may even get into the slightly negative territories. But when that happens you tend to throw off maybe even little more cash, because you're not reinvesting $0.15 on every $1 for incremental sales.

And so as we demonstrated it in '07, which you could see was not a particularly strong year from our revenue topline point of view. If compared to history, it's below our long-term growth rates. We did generate a fair amount of cash. So this is not the same kind of a business that has wide swings and cyclicality that other businesses do. And if it was, you would have a different view towards the risk and the amount of cash you should have on hand.

Bruce Youngman

I might point out though, that in '07 you did have a substantial reduction in your CapEx versus what you're planning to spend this year. So that's a little bit of a different swing factor?

Dick Gochnauer

That's true it's about maybe $15 million?

Bruce Youngman

Alright.

Dick Gochnauer

Thank you, Bruce.

Bruce Youngman

I thank you.

Dick Gochnauer

Okay.

Operator

Thank you very much sir, and we do have follow-up from the line of Dan Binder from Jefferies. Please proceed.

Dan Binder - Jefferies & Co

Okay, just wanted to tick off last few questions here. First on the working capital discussion, you just mentioned typically $0.15 per $1 of sales of investment. Based on what you are seeing today, what kind of working capital situation do you expect this year? Do you plan on taking additional working capital out to a significant degree that it's giving us a big cash flow bump. I mean I suspect it's not quite as big as this past year. But any thoughts on what that can provide as a source of cash this year.

Vicky Reich

Dan on the working capital as a percent of sales, that will actually move up a little bit as we include ORS Nasco in the numbers. Their working capital as a percent of sales is a little bit higher and it pushes our numbers up about 30 basis points in that range. With that being said, we do expect to continue making efficiency improvements in the core business. So probably overall the number doesn't move a lot as a result of those two factors.

Dan Binder - Jefferies & Co

It is kind of neutral?

Dick Gochnauer

It is one of our six value drivers. So just like we have on our War on Waste, we put together plans to figure out how we can increase our turns and so our targets each year are a little tougher than the year before. How do we increase our payables leverage ratios and those targets get a little tougher each year. And how do we manage the receivable side of the balance sheet. So those are as well as it's obviously our CapEx portion. So, all of those are in the equation and are part of our efforts.

A perfect example and Cody mentioned that in general, but one of the [Kizon] events, which is part of our lean initiatives, identified a long process and I think we might have mentioned this in the previous call but a long process it takes us to invoice suppliers on some of the moneys that we earn from performing different programs for them. And by simplifying that process they were able to take out some 30 days out of the invoice cycle and there was tens of millions of dollars there.

So those are the kinds of things that you can look at that are still available to us, and I will also say that this is an area where we have not been as advanced. As I would say we have been on the costs over the last several years and so we will be continuing to focus and incent our people to drive this category.

Dan Binder - Jefferies & Co

Okay. Are there any upcoming calendar shifts or are they any quarters this year where we have one less day, one more day anything like that?

Vicky Reich

Let's see in 2008, we will have one additional working day for the year and that will occur in the third quarter.

Dick Gochnauer

The same as '07, right?

Vicky Reich

It's up one day versus 2007.

Dick Gochnauer

Versus 2007.

Dan Binder - Jefferies & Co

Okay. And then, on the question of incentive selling, I know and in slower times in the past the company has been able to at times incentivise customers to buy with favorable pricing. If the order is X amount versus the typical orders, is that an option that you are exploring?

Pat Collins

Yeah, Dan, this is Pat. I'll give you a little bit of color maybe on some of the things we are exploring to drive growth in the environment we're in. First thing is, we continue to have success with new customer types for us. I think Dick, pointed out in this comments, we continue to see strong double-digit growth and we’ve got a good pipeline of potential new customers that we think give us access to a lot of incremental sales opportunities new consumers. So that will be an area of growth for us.

We continue to invest in growing independent dealers. As you might expect even with a sluggish economy, we still have customers who are doing a fantastic job consolidating their market position in their geographies and we work hard to identify them and invest in those. We'll also continue to work hard on developing our category sales opportunities particularly in the Jan San arena, particularly to office products dealers. It's not unusual for us to talk to an office product dealer and find that they are seeing a lot of success perhaps in categories that we don't sell to them or sell a lot to them break room supplies, Janitorial supplies through office product dealers is a great opportunity, and we’ve also had some success with some of our larger customers expanding our category presence with them.

Consumer promotions Dick, mentioned multiple touch point opportunities, a more traditional, direct mail, email but also moving to electronic commerce promotion opportunities is some thing that we’ve got significant investment in as well, and we expect to pay dividends in 2008. So, yes we do have a lot of initiatives other than pulling the price trigger to try to spark some growth.

Dan Binder - Jefferies & Co

So it sounds like you don’t anticipate having to do that then? I mean the price trigger there is?

Pat Collins

Yeah I would tell you that, we will always need to be responsive to what's going on competitively, but we would not anticipate in leading with that to drive growth.

Dan Binder - Jefferies & Co

Okay. And so if there aren’t any surprises during this somewhat limited integration process with Nasco, are there any cost coming up in the first, second quarter that we should be aware or if you are modeling for as part of the integration.

Vicky Reich

Dan, no there is no significant integration cost as we've said the business is essentially being run as a standalone business. There are synergies that we are working hard and we feel very good about capturing between the businesses. So beyond the acquisition accounting effects which I described, the intangibles amortization and we're still trying to firm up those numbers, there is really nothing special that you need to model there.

Dan Binder - Jefferies & Co

And the Nasco business, I'm not sure if you said it earlier. Is that still a double-digit growth business or is that something we should thinking more as high single this year.

Dick Gochnauer

It's currently running high single, but they have a lot of things in the pipeline that might drive that up, so more to come.

Dan Binder - Jefferies & Co

Okay. And then I know in tougher periods, a lot of times particularly the larger national players will go to vendors to try and negotiate a little bit tougher or get year-end money. Do you expect any added pressure from the customers this year on pricing or are you managing that pretty well?

Pat Collins

Dan, this is Pat again. We would expect some pressure. We did think we're managing it pretty well on pricing to value, where you might see that with some of our largest customers we might be more on the revenue line. We're in particularly challenging times some of them might look more to internal supply chain opportunities as a response to that.

Daniel Binder - Jefferies & Co

Okay. And then last question, in prior downturns this is I recall anyway, you do see some natural or normal defaults that occur with some other business that don't necessarily survive the downturn. Are you seeing any of that at all in the receivables today, and if not, is it something that you are planning for in the coming year?

Vicky Reich

We are not seeing defaults. At this point we are not planning for that, but we are very, very carefully of course monitoring with our customer the cash flow situation. So, so far so good, but we're on top of it.

Dan Binder - Jefferies & Co

Just as a formal reference, do you have any recollection of what that looked like in a last downturn, was it meaningful or was it just a rounding error?

Vicky Reich

Well rounding error.

Dan Binder - Jefferies & Co

Okay, good. Great, thanks.

Operator

Thank you very much, sir. I'll turn the call back over to our speakers for there closing remarks today.

Dick Gochnauer

Okay, thanks. 2007 was not one of the better economic environments that we have seen, and at this point 2008 looks challenging. But the focus we have on our six value drivers allowed us to perform well in 2007 without much help from the economy, and we believe this discipline will continue to serve us well in the coming year. In addition, we have the excitement of welcoming ORS Nasco to the United's family, capitalizing on the opportunities to create the kind of growth that we've seen at Lagasse over the past decade. Vicky, Pat, Cody and I would like to thank you for being with us today. We look forward to sharing more of our progress with you during the year, beginning with our first quarter conference call in May.

Operator

Thank you very much, Sir and thank you ladies and gentlemen for your participation in today's conference call. This concludes your presentation for today. You may now disconnect. Have a good day.

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Source: United Stationers Incorporated Q4 2007 Earnings Call Transcript
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