Interline Brand Q4 2007 Earnings Call Transcript

Feb.22.08 | About: Interline Brands, (IBI)

Interline Brand, Inc. (NYSE:IBI)

Q4 2007 Earnings Call

February 22, 2008 9:00 am ET

Executives

Thomas J. Tossavainen – Chief Financial Officer

Michael J. Grebe – Chairman of the Board & Chief Executive Officer

William E. Sanford – President & Chief Operating Officer

Analysts

Yi-Dan Wang – Lehman Brothers

Analyst for Michael Rehaut – JP Morgan

Keith Hughes – Suntrust Robinson Humphrey

Matthew McCall – BB&T Capital Markets

Kyle O’Meara – Robert W. Baird & Co., Inc.

Presentation

Operator

Good morning. My name is Regina and I will be your conference operator today. At this time I would like to welcome everyone to the Interline Brand fourth and fiscal year 2007 conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question and answer period. (Operator Instructions) I would now turn the call over to Tom Tossavainen, CFO of Interline Brand. Mr. Tossavainen you may begin your conference.

Thomas J. Tossavainen

Good morning and thank you for joining us today for the Interline Brand’s fourth quarter and full year 2007 earnings call. On the call today Michael Grebe, our chairman and chief executive officer will provide an overview of our business model and financial results; Bill Sanford, our president and chief operating officer will review sales trends in our key customer markets and then I will review our financial results in more detail. We will then open the call to your questions.

Before beginning today’s call, let me remind you that some of today’s statements will forward-looking and are made under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projects or implied due to a variety of factors. We will also discuss certain non-GAAP financial measures which are described in more detail on last night’s earnings release. We refer you to recent Interline Brand’s filing with the SEC for a more detailed discussion for the risks that could impact the company’s future operating results and financial condition. These factors are also described in greater detail in the press release and on the company’s website.

I would now turn the call over to our chairman and chief executive officer Michael Grebe.

Michael J. Grebe

We have just completed our third full year as a public company and I am happy to report that Interline Brands has achieved record annual sales and earnings as well as record cash flow from operations. Since our IPO in December, 2004 we have increased sales over 65%, grown pro forma earnings per share between 16 and 23% annually and have achieved strong returns on tangible capital. Once again, we have consistently executed on our strategies to profitably grow our business both organically and through strategic acquisitions. I would like to thank the entire Interline Team for their hard work and dedication despite a very challenging market environment. As we wrap up the year and look forward to 2008, there are three key topics I could like to address on today’s call. First, I will share with you the benefits of our diversified portfolio of businesses which continues to help offset persistent weakness in the residential housing market. Then, I will discuss our unique flexible operating model which allows us to efficiently utilize our internal resources to generate improved profitability and returns. Finally, I will comment on the necessary investments we are making in the business throughout 2008 to support our long term growth and profitability objectives.

Let me now share some details on each of these three topics. Interline Brand boasts a highly diversified portfolio of businesses with the MRO space. Our diversification has allowed us to generate consistent top and bottom line results throughout business cycles. The highlight of 2007 was the exceptional performance from our facilities maintenance business which now contributes 67% of our revenue. Under Fred Bravo’s leadership our facilities maintenance brands grew 12% in the fourth quarter, 35.9% for the full year and 14.2% on an average organic daily sales basis. The strength of our performance reflects not only a robust apartment market but also continued execution on our national accounts and supply chain management initiatives. These initiatives among others, allow us to capture market share gains during 2007. As we look forward to 2008 we expect the trends in the apartment market will remain favorable and we will focus our efforts on achieving market share gain as we execute on our various initiatives in the institutional MRO space and complete the integration of AmSan which is proceeding according to plan.

Solid execution in our facilities business offset continued weakness in our pro contractor and specialty distributor markets. After nine straight quarters of growth between 11% and 19%, sales to pro contractors and specialty distributor customers began to decline in the fourth quarter 2006 and were both down roughly 10% in 2007. Despite challenging market conditions, our management team took advantage of the company’s unique operating platform to deliver record levels of profitability and solid returns. As we saw certain markets continue to worsen during the year our management team was able to move quickly to reduce expenses and shift gross investments to our more robust facilities market. For example, headcount in our contractor telesales group is down by one third compared to this time last year. Some of our best sales professionals were transferred to a new telesales group supporting on institutional facilities growth initiatives. This is the way our model is supposed to work and we believe is what sets Interline Brands apart from other companies.

I would like to turn now to our investments in the business for 2007 which are primarily focused in the facilities maintenance markets as well as infrastructure investments designed to support our long term growth objectives. First, let me address our plans for expansion into the institutional facilities market. When you include the AmSan market, customers purchased more than $30 billion worth of maintenance repair and operation products annual. The market is very diverse and includes education, lodging, healthcare and government facilities. Ken Sweder and his team have developed a strategy for addressing this market in 2008 by adding over 6,000 stock keeping units of electrical HVAC and security products. Since this is the most new SKUs we have added in several years we will also be expanding our distribution footprint to provide next day service to a greater number of our institutional customers. Additionally, we plan to open Greenfield AmSan locations utilizing existing Interline distribution centers to complement the one new Greenfield AmSan location we started last quarter in Pittsburgh. Additional investments in the institutional area will include adding staff to our sales and marketing department as well as merchandising and product sourcing in order to give our customers the service they’ve come to expect from Interline Brands.

On the operation side, our plans include continuing capital investments in informational technology and logistics. On the technology front, as always we are making enhancements to our IT platform including the insulation of a new PBX network which will allow flexibility to our national call center operations and improve response time to our customers. This PBX installation is just one example, will cost us approximately $2 million in cap ex or $250,000 in depreciation and $200,000 in additional operating expenses in 2008. However, once fully operational, we believe this will be a very high ROI project that will improve our operating margins. On a logistics front we also have numerous investments planned. You may recall that in 2007 we combined three smaller distribution points including two Interline facilities and one AmSan location into one larger 150,000 square foot state of the art distribution center in Atlanta. Operating larger distribution centers in regions of the country where we have significant scale enables us to leverage and optimize our management talent, delivery capabilities and technology investments to generate stronger returns by operating more efficiently on lower levels of inventory.

In 2008 we plan to open two additional regional centers of this size. These larger regional distribution centers give us significant scale advantage and allow us to close smaller less efficient centers. Over the long term we expect to focus on eliminating the redundancies in our distribution network created by our acquisition program and continue our consolidation efforts by combining our logistics capabilities in roughly two to three regions per year. The AmSan acquisition which we completed in 2006 provides a great example. To date, we have converted roughly half of the AmSan sales and operating centers onto the Interline platform and plan to have the remaining integration completed by the third quarter this year. This is right on target with the plan we set out at the start of the integration process. Our 2007 conversion efforts included the consolidation of five AmSan locations into existing or new Interline facilities in Houston, Cleveland, Denver, St. Paul and of course, Atlanta. We plan on consolidating two more locations in 2008 and up to five other locations in future periods.

We also plan in 2008 to open a second national distribution center in the western United States during second half of 2008. This investment has been in our plans for several years and will enable us to support our long term growth and provide a platform that will more cost efficiently fill our west coast distribution centers. For example, today we bring product from our overseas supplier partners into ports on the west coast, transport these products cross country to our national distribution center in Nashville, Tennessee, break the products down for redistribution across the country including right back to distribution centers on the west coast. With a new west cost NDC we will be able to save significant freight and labor cost by handling inventory needed on the west coast directly from our ports in the west. Collectively we expect our 2008 investment projects will impact earnings per diluted share by $0.10 to $0.15.

So, why are we making these investments at a time we are seeing potentially challenging markets? Our investment philosophy with respect to major investments in projects require several key characteristics. They are number one, improving speed and service to our customers. Two, helping us penetrate new markets and therefore increase our sales. Three, reducing our operating costs and therefore improve our operating margins. And four, reducing our working capital needs and therefore improve our return on tangible capital. All those projects that we have on the docket for 2008 fit at least two of those requirements and will help make us a bigger, better, more profitable and valuable company in the long term.

Let me spend just a little more time talking about the results from our Atlanta distribution center that we built in 2007 as a proxy for the two regional distribution centers that we will be opening in 2008. These larger regional distribution centers require somewhere between $1.5 and $2 million capital to start up mainly in the area of racking and new material handling equipment. Additionally, each one of these projects can require somewhere between $0.01 and $0.02 per share in moving and start up and onetime costs. As we analysis the Atlanta project we saw considerable benefits in the area of distribution center labor due to the efficiencies inherent in running one distribution center versus three. We see additional benefits from significant reductions in the inventory as a result of being able to combine safety stocks. Finally, we also see significant sales opportunity as a result of having all of our regional inventory in one location and therefore being able to cross sell through our entire product line to customers in that region. We believe that the IOR on a net after tax cash basis for a project like Atlanta will be well over 30% over a five year period. Our two major distribution center projects in 2008 which are in the Boston and Richmond areas will have similar types of investments in IOR characteristics. From a tactical standpoint with respect to distribution centers this may sound simplistic but we have several key leases expiring in 2008 that we do not want to renew. The new model regional centers are much larger and often built to spec requiring longer lead times. With regards to the west coast NDC, our capacity in the NDC east and Nashville is tight and we need to expand now for growth and to accommodate our NDC plans for AmSan.

So, as we enter 2008 we are positioned well to benefit from our scalable platform, strong customer relationships, diverse revenue sourcing and comprehensive product suite. Our solid operational execution and strong balance sheet management affords us the opportunity to make these investments in order to support our long term goals and provide the greatest long term return to our shareholders.

With that, I’ll turn the call over to Bill.

William E. Sanford

Interline’s facilities maintenance business performed exceptionally well in the fourth quarter. Sales in this market increased 12% for the quarter, 39.5% for the full year and 14.2% organically. The apartment market remains strong and our customer penetration strategies which include national accounts and supply chains as well as our rapidly expanding renovations supply business are driving the majority of this growth. As we have discussed in the past, our focus on increasing revenue per apartment per year is a very profitable way to grow because as revenue per apartment unit increases so does our average order size. These strategies have gained by acceptance in the apartment market because they also help customers lower their operating cost and give them more visibility into their supply chain.

We launched a new government sales platform in the fourth quarter which targets educational facilities, military and government housing properties and defense facilities. This is a market that is underrepresented in our portfolio but one that is very large and shares numerous attributes with the apartment market. We are piloting several supply chain concepts with customers and also feel that our AmSan capabilities will make us a more viable supplier to government customers.

As Mike mentioned, both the pro contractor and the specialty distributor market were down 12.5% for the quarter and 10% for the year. In our discussions with customers and suppliers in this market, it is clear that these conditions are impacting all areas of residential construction and remodeling and we continue to have very low visibility. However, despite these market conditions our national accounts and supply chain programs are continuing to perform well albeit on a small base. We have a healthy backlog of vendor managed inventory implementation at large service plumbers, electricians and HVAC contractors. The VMI program is gaining in popularity because it helps customers lower their inventory investment and reduces inventory shrinkage.

We’ve also taken advantage of slower market conditions to reevaluate our selling model on the contractor side much like we have in the apartment space over the last five years with the goal of optimizing customer penetration at our best customers, service and repair contractors and positioning Interline as the first supplier to this sub segments of the market. The supply chain programs we have introduced over the last three years have given us significant insight into the specific product and service needs of the repair plumber, electrician and HVAC contractor. We are using that information to build profiles of our various types of customers to identify high potential selling opportunities and to make sure that the right products are in stock at the right price and that our sales reps are properly targeted to get maximum wallet share.

We feel that our contractor bands will emerge from the market slump with a much stronger value proposition for our customers. Now, Tom Tossavainen will discuss key financial metrics.

Thomas J. Tossavainen

From a financial performance perspective the team has continued to perform well. Our fourth quarter performance racked up a record year for Interline. For the full year net sales were a record $1.2 billion, a 16.1% increase over 2006 and consisted of 12.4% acquisition growth from our July, 2006 purchase of AmSan and 3.7% organic sales growth. Growth profit for 2007 increased 15.9% to $473.9 million as compared to $408.9 in 2006. Our gross margin percentage for the full year was within 10 basis points of the prior year at 38.2%. Our merchandizing and sales team has effectively managed the impact of rising fuel costs, fluctuations in commodity product costs and other impacts on sales price and product cost in a very challenging market in a very challenging market.

Operating income for 2007 increased 12.2% to a record $114.1 million compared to $101.7 million in 2006. For 2007 adjusted EBITDA was a record $130.5 million or 10.5% of sales. Finally, net income for 2007 was a record $51 million or $1.56 per diluted share, a 16% increase over adjusted pro forma net income of $44 million or $1.34 per diluted share for 2006. For the fourth quarter net sales were $300.2 million a 2.4% increase over the prior year period. Our gross margin percentage was 65 basis points higher in the fourth quarter than the prior year period. This improvement was a result of a combination of economically advantageous yearend inventory buys and a favorable sales mix. This impact associated with stronger facility maintenance sales and soft pro contractor and specialty distributor market sales.

Selling, general & administrative expenses as a percentage of net sales were 28.3% a 10 basis point improvement over the fourth quarter of 2006 which was 28.4%. You may remember that during the first half of 2007 SG&A expenses as a percentage of sales were 113 basis points higher than the prior year. As our sales growth slowed the team moved quickly to right size our operating costs structure. Continued operating expense control along with disciplined investment spending helped keep our costs in line in the second half of the year. As a result, SG&A expenses as a percentage of sales for the second half of 2007 were 16 basis points lower than last year. That’s 129 basis points better than the first half of 2007.

Net income for the fourth quarter of 2007 was $13.6 million or $0.41 per diluted share a 17% increase in EPS compared to net income of $11.4 million or $0.35 per diluted share for the same period of 2006. Again, strong fourth quarter gross margins along with operating expense control resulted in a 17% increase in diluted earnings per share. Our operating margin was 9.8% an improvement of 70 basis points over the prior year.

Moving to the balance sheet we continue to efficiently manage our working capital and have reduced our net working capital day sales to a record 82 days as of the end of 2007. This is a one day improvement from 2006 and three days improvement from 2005. The largest improvement has come from inventory management. We are currently benefiting from some of the best inventory turn levels in our company’s history. Our inventory days have come down three days since the prior year which is especially strong given that we are also delivering consistently high levels of customer service and fill rates to our customers across the country. This three day improvement was partially offset by a slowing of one day on our accounts receivables days sales outstanding to 47 days and a decrease of one day in accounts payable related to faster supplier payments in the fourth quarter. Like many other distributors we have started to see some slowing of payments on accounts receivable particularly in the pro contractor market. This trend was not unexpected given the general economic slowdown and has noted on our last call we will continue to monitor this situation closely.

Strong operating performance and working capital efficiency contributed to record cash flow from operations of over $57 million in 2007, almost double what we generated in 2006. Capital expenditures for the year were $14.9 million or 1.2% of sales, this is slightly higher than in the past but in line with our expectations as we support our infrastructure projects including or AmSan integration efforts. Free cash flow, or cash provided by operations less capital expenditures was a record $42.8 million for the year compared to $22.1 million on 2006. As a result we ended the year with cash and short term investments of $53.5 million and we continue to generate strong returns on tangible capital which was 41.7% at the end of the year. The company’s balance sheet and its liquidity position is as strong has it has ever been. Today we have well over $150 million of capacity including $87.9 million of capacity on our revolving credit facility. We have over $70 million in cash and short term investments and we’re continuing strong cash flow. Our working capital management, the efficiency of which is measured by our net working capital day performance is at record levels and our net debt position is the lowest in our history.

At this time I would like to turn our call back over to Mike to discuss our business outlook.

Michael J. Grebe

I would like to again thank my teammates at Interline, our customers and our supplier partners for helping us make 2007 a very rewarding year. We move into 2008 with high confidence in the underlying strength of our diversified business model and our strategic position in the markets we serve. Disciplined financial management and cost control combined with record liquidity and a strong balance sheet positioned us well to execute on our strategy to grow our business both organically and through acquisitions. As I touched on earlier our expectations for 2008 center on several key trends and investments. First, we see continued strength in the facilities maintenance market. We expect to continue to benefit from favorable trends and strong sales execution in the multifamily housing market where one third of our revenue is derived. We believe that this market where we supply a very deep product offering of common everyday maintenance and repair parts will continue to benefit from good market conditions and activity associated with the slowdown in residential housing market as well as the related challenges inherent with a difficult credit market.

Second, we expect activity in our contractor and specialty distributor market where another third of our sales are based to remain weak throughout the year. Year-to-date sales in these markets are 12% below the same period last year. Despite this short term weakness these are very attractive end markets that will eventually recover. Within these large fragmented markets we have strong and durable customer relationships and we will benefit when customers resume more normal purchasing patterns. However, we are not expecting a recovery in these markets in 2008. My teammates and I are accustomed to managing through these business cycles and we are keeping a very tight focus on cost control.

The remaining one third of our business comes from institutional customers in the facilities maintenance market. As I mentioned earlier this $30 billion market is very fragmented and offers significant opportunities for growth. We are convinced that now is the time to aggressively go after these markets. As we increase our product offering, expand our geographic footprint and integrate our acquisitions, we expect this market to be a long term driver of organic growth. In 208 our investments will be focused on driving operating efficiency, improving our logistics platform, expanding into higher growth markets and aggressively seeking acquisitions that complement our portfolio. In turn, we are offsetting our investment spend with measured cost reductions and expense containment specifically in markets that are currently not performing as well. So, while we continue to invest in our business, we are mindful of making sure that we are balanced in our approach.

Given the combination of all of these factors, we believe we can achieve earnings per share for 2008 of between $1.61 and $1.68 and earnings per share for the first quarter between $0.29 and $0.31. Both sets of numbers are, of course, excluding acquisitions.

With that, I’d like to turn the call open for questions. Moderator you may open the line.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will be from the line of Yi-Dan Wang of Lehman Brothers.

Yi-Dan Wang – Lehman Brothers

First question was regarding your comments about the continued strong programs of investment in 08 and I think you talked about the $0.10 to $0.16 dilutive effect in 08. I’m just trying to see how that compares to the dilutive effect of all your investments in 07. If you can clarify that, that would be great.

William E. Sanford

Dan, we are at a higher rate of investment in 08 than in 07 particularly on some of these large distribution center projects. So that’s probably somewhere between $0.05 and $0.08 greater than what we invested in 07.

Yi-Dan Wang – Lehman Brothers

Obviously, generally we expected continued pace of investments but certainly not an acceleration. It seems like you have confidence in the outlook for facilities maintenance for that to continue to be strong. What are you hearing from your customers regarding the outlook as they plan their activities into 08 from the facility maintenance group there?

Michael J. Grebe

I guess the biggest area Dan that we can get our arms around in terms of data and commentary is in the multifamily space. Vacancy rates there have been between 5.5 and 6% in 2007 and have generally decreased from 6% at the end of the first quarter to 5.8 at the end of the second to 5.6 in the third and the fourth. So, those trends are generally favorable right up to this point. The other data point that we look at extensively are effective rents which is the amount of money of course that the read operator is getting for the apartment whether he’s been able to rent it or not. The effective rents are up for the fifth consecutive quarter in a row. New construction completions were something like 26,000 units which was up just slightly over the third quarter. Now, as we look at the data going forward the Reese publication sort of indicates that vacancy rates may rise slightly in 2008 to 6% and there’s been some slightly mixed commentaries from the public reads with respect to their outlook for profitability growth or as they look at it as FFO, continuing funds from operations. But even those levels of predictions are at historically favorable vacancy rates so we feel that those trends are pretty good for us. The other institutional markets that we’re doing business in, our facilities maintenance markets tend to be schools, hospitals, healthcare facilities, government operations, they’re could be some economic impact there but generally speaking there isn’t kind of the very strong fluctuations you would see with a commercial enterprise and an economic cycle. So, we think that those end markets are going to still continue to be fairly attractive in 2008.

Yi-Dan Wang – Lehman Brothers

Sounds good. My one last question you talked about the government sales program that I think you said started in the fourth quarter. Has that started contributing to the P&L? Or, if not when do you expect that to happen? Then maybe just some additional details around that whole opportunity in that whole government space.

Michael J. Grebe

Dan, the government space is very, very large and there are some statistics out there that show that the average distributor in the United States can get anywhere from 10 to 40% of their sales from government type facilities. I can tell you as a whole we’re nowhere near those types of numbers so in general we think it’s a great opportunity for us. We’ve got the products in stock, we have the distribution points where we need to have them but that’s really a startup program for us and really contributed very, very little incremental growth, if any in the fourth quarter. That will really be ramping up throughout the year.

Operator

Your next question will be from Michael Rehaut of JP Morgan.

Analyst for Michael Rehaut – JP Morgan

I just wanted to get some color as the gross margins, you had a nice lift in the fourth quarter, I know you said it was due to positive mix. I’m just wondering, is this a run rate that we can expect going forward as a result of some of the AmSan synergies? Or, should we expect this to perhaps decline as a result of some of the investment initiatives? And, basically how the investment initiatives fall out as far as gross margins versus SG&A, if you could give us a general idea of that?

Michael J. Grebe

As usual, there are numerous puts and calls that make up the trends in our gross margins but, let me give you a little feel for some of the underlying currents that we look at. On the up side, we saw some lift in our selling gross margins in part due to mix by brands or across our different segments and I guess what I mean by that is our facilities maintenance business generally has higher gross margins that are pro contractor and specialty distributor business and obviously the facilities maintenance business is growing at a much faster rate than pro and specialty. I would also say that in the pro and specialty business we are walking away from some low gross margin business just because it doesn’t meet our profitability objectives. So, there’s a mix benefit that’s occurring kind of across our markets. Within the markets or within each brand, our product mix at the SKU level if you will is always shifting somewhat, often times driven by internal sales growth initiatives. So, we really don’t have anything truly notable there to note.

The other upside on our margins for the quarter is that again Ken Sweder, our new chief merchandizing officer and his team have done a great job working with our outstanding supply partners to assist us on the cost side and some tough markets. So, those are really the sort of major puts and calls there. I would say that in terms of how to look ahead, I would say Q4 was probably an exceptionally good gross margin quarter, probably not one for example that we’re excepting to duplicate in the first quarter for example. And, as we look out to the future and those various different investments, again those investments are geared to the facilities maintenance business which generally has higher gross margins than our pro and specialty. So, that could have some long term benefit.

In terms of the investments that we’re making, those investments will really show up for us on the depreciation line because there’s a fair amount of capital that we’re investing in, in 2008 and then it will show up in the operating expense line in terms of onetime costs and so forth. But, you shouldn’t necessarily see a large impact at the gross margin line with the one exception being that, as I mentioned, we are starting up NDC west in 2008 and the cost of operations of our NDC do go through our gross margin line. In a startup mode, we do expect to see some EPS deterioration probably for at least the first two quarters that that business is being started up which will be essentially for 2008. But, once we get into 2009 we think they’re will be a net benefit. So, that will be the one cost element that would probably hit us at the gross margin line.

Analyst for Michael Rehaut – JP Morgan

Okay. NDC west, that’s going to be operational did you say in the third quarter?

Michael J. Grebe

We haven’t stuck a date on that fully yet but we expect it will be right around that third and fourth quarter. There’s a lot of startup work that has to happen there including some long lead time sourcing of product and so forth. But, I’d say for now we would say third or fourth quarter.

Analyst for Michael Rehaut – JP Morgan

Just to be clear, the $1.61 to $1.68 guidance for FY08, that’s inclusive of all these charges, correct?

Michael J. Grebe

That is correct. It’s included, those expenses, that’s correct.

Operator

Your next question will be from Keith Hughes of Suntrust.

Keith Hughes – Suntrust Robinson Humphrey

You had a fantastic year in facilities maintenance, is putting up another double digit year, is that a possibility in this year? Or, is the comparison just going to be too difficult?

Michael J. Grebe

Keith, we have as we mentioned, moved a lot of our growth initiatives into this space. As we look at our earnings guidance and sort of again the puts and calls that we’ve put into our earnings guidance, we’re looking for at least high single digit growth in that marketplace overall. Whether we can get into double digits or not will really be depended upon the traction that we get in some of the growth initiatives that we’re really driving out in 2008 specifically adding those 6,000 new SKUs to our mix, how fast can we do that, how fast can we hit customers with that and also what additional traction we can get as a result of our AmSan integration. As we have mentioned on several of the calls here we still feel very, very positive about that business. We know that as we get them fully integrated on our platform we’ll be able to go after national accounts which we essentially don’t do at any great coordinated way today. We’ll also be able to expand across the US. So, certainly we’re going to be shooting for big numbers there. Again, we’ve got baked into our guidance probably high single digits in facilities maintenance and whether we can do better or not will depend on the traction we get from those growth initiatives.

Keith Hughes – Suntrust Robinson Humphrey

Okay. You had mentioned earlier on the call a $30 billion number for MRO. What end user markets are made up in that $30 billion number?

William E. Sanford

It’s really government, education, healthcare are the three big drivers there.

Keith Hughes – Suntrust Robinson Humphrey

So that does not include multifamily housing?

William E. Sanford

No it doesn’t.

Operator

Your next question will be from Matt McCall of BB&T Capital Markets

Matthew McCall – BB&T Capital Markets

You spoke to your outlook for the facilities maintenance business, can you talk about what’s built into the guidance for pro and specialty?

Michael J. Grebe

Sure. We’ve really not planned on any significant lift in that market at all. We haven’t provided any kind of specific sales guidance there Matt but we are clearly expecting that market to continue to be down throughout the year. The numbers, as I mentioned earlier, to date are down 12% and we anticipate being somewhere between 3 and 12% down for the rest of the year. So, we’re not counting on any rebound in that market really at all.

Matthew McCall – BB&T Capital Markets

And you brought up earlier some of the comments about the benefits for 09. I know it’s early but can you talk about what may be on the horizon from a spending or investment standpoint in 09? Are we going to return to kind of 07 levels? Or, are there more things on the horizon?

Michael J. Grebe

We would expect to continue at a similar type of pace in terms of investing in these regional distribution centers. If I could just give a little color on that for a minute. Now, these figures are very, very broad brush but, our distribution centers that have over $20 million in sales turn inventory over five times on average while distribution centers that are less than $20 million in sales turn inventory somewhere between two and 3.5 turns. Similarly, total distribution operating expenses which for us include labor, freight, occupancy and are going to run somewhere in excess of 10% of sales will run between 60 and 100 basis points lower in our larger distribution centers. Now, I guess no surprise there, bigger is better. But, we’ve got lots of experience showing us that these moves to the larger regional distribution centers are the right one for the company.

We’ve got a lot of experience opening, closing, right sizing distribution centers for many years and we think this type of pace is right which quite frankly, we try to time to these expiring lease tails. So, I guess you can get a logistics analyst that will tell you there’s a million different ways to figure out how to consolidate. We tend to be very adverse to having some big cash charge for an expiring lease so our pace Matt will somewhat follow how major leases expire because again, we find that’s the right period to tick it off. Sitting here right now we think that this kind of two to three larger regional distribution centers per year is probably about the right pace going forward but obviously, we haven’t provide any kind of specific outlook for 09.

Matthew McCall – BB&T Capital Markets

Okay. That’s one of the initiatives that you talked about. Can you tell us what the total impact there is? You gave us $0.10 to $0.15, how much of that is from those regional DCs?

Michael J. Grebe

It’s pretty significant, it’s probably running around the 50% mark, something like that of those types of numbers Matt. In addition to those investments I mentioned that we’re going through this PBX system project in 2008 which we think is very important. We’re also making some other upgrades to our IT platform which, as you may recall we have a best of breed IT approach which enables us to take significant portions of our business and tack on a great piece of software and see some tremendous downstream improvement. We’re taking on a project in 08 which will focus in on the accounts receivable area. So, sitting here right now I don’t know if I have a similar type of IT project that I could site for 2009 but, I wouldn’t be surprised if there were because we’re always making those types of investments which again, we think are pretty crucial for us.

Matthew McCall – BB&T Capital Markets

One final question, I think in the past you’ve talked about some of the success in the national accounts and supply chain programs specifically giving some penetration in your end markets. Can you give us any metrics about the growth of those initiatives? Maybe customer penetration in 07 versus where you ended 06? And then, maybe your outlook about what the potential is for 08?

William E. Sanford

I think what you’re referring to is the information we provide in our investor relations presentation which shows that the customer’s, the multifamily area for example that are using the supply chain program, revenues to those groups of customers has grown over the last three years in the high teens compared to a lower rate for customers that have transactional rates with the company and who are not involved in any kind of way to improve their supply chain. On the pro contractor side, the number of customers that are using supply chain programs is relatively small so the majority of our pro contractors and specialty distributor customers do business with us on a transactional basis and that business tends to go up and down with the market. I can say that where we are doing supply chain programs with contractor customers, our revenue growth is positive for those customers, our national account and supply chain customers despite the down market. The question is how many of those customers that are transactional customers we can convert over to the new model and that’s something we’re very focused on but, it’s really not something you can apply metrics to going forward.

Operator

Your next question will be from Kyle O’Meara of Robert W. Baird.

Kyle O’Meara – Robert W. Baird & Co., Inc.

On the pro contractor business, could you talk a little bit about how those margins have changed since the first half of 06 as things have slowed and presumably a little GP pressure offset by some of the cost cutting that you’ve done on the headcount? Then, how do you feel about that business right now? Is that right sized or are there any more reductions that you’ll be doing there going forward?

Michael J. Grebe

With respect to gross margins, we feel there’s certainly been some competitive pressures there, no question that whenever you hit a market that is very challenged and you’re up against a lot of small mom and pop type of distributors you’re certainly going to get competition from people who are trying to keep their cash flow going and so forth. Now, as a whole we have tried to stay away from those types of situations. We think we’ve done a pretty good job of maintaining our gross margins, obviously you can tell from our Q4 numbers that we haven’t seen those numbers fall dramatically but certainly there’s been some pressure there, some of which we’ve been able to withstand and some not. So, I’d love to tell you that we’re so disciplined from a sales point that we walk away from every low gross margin transaction but, you have to maintain your relationships with your customers and sales reps being sales reps don’t want to lose so sometimes you get into those lower gross margin situations.

In terms of right sizing and so forth again, one of the biggest drivers of our cost structure within the pro contractor arenas is, of course, the cost of our sales force. Again, that sales force has been downsized by about a third from a telesales sales point from the beginning of the year. So, I wouldn’t want to say that there’s no additional moves that we could make in any of our markets, we’re always paying attention to that. But, we think that we’re right about the right size that we should be today given the market conditions. I would also say that some of the moves, the right sizing moves that we have made in 07 will provide additional cost benefit in 08 because they were made towards the end of the year. I guess that’s my way of saying that we think we’ve right sized to about the right spot and we’ve got some great people here and we think we are about where we want to be.

Operator

(Operator Instructions) Your next question will be from Michael Rehaut from JP Morgan

Analyst for Michael Rehaut – JP Morgan

Just a quick follow up, regarding cap ex you know is at an elevated level this year, can you give us an idea of what you’re expecting for 2008 given the additional investment initiatives?

Michael J. Grebe

We expect our cap ex to run somewhere between 1.2 and 1.5% of sales in 2008. The reason we give a range there by the way, and we gave a range for that $0.10 to $0.16 is because obviously there’s some level of these investments that we can draw back on if we need to, if market conditions deteriorate further. So, that’s kind of the range of cap ex expenditure we expect in 2008.

Operator

There are no further questions at this time.

Michael J. Grebe

Moderator thank you again and we’d like to thank everyone for attending our call. Again, to my teammates, our customers and our supplier partners, thank you for helping us make 2007 a very rewarding year.

Operator

This concludes today’s conference call. Thank you for your participation. You may disconnect at this time.

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