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Interline Brands, Inc. (NYSE:IBI)

Q1 2008 Earnings Call Transcript

May 6, 2008 9:00 am ET

Executives

Tom Tossavainen – CFO

Michael Grebe – Chairman and CEO

Bill Sanford – President and COO

Analysts

Sean Connor – BB&T Capital Markets

Jen Consoli – JPMorgan

Keith Hughes – SunTrust Robinson Humphrey

Jeff Germanotta – William Blair

Dan Leben – Robert W. Baird

Matt McGary [ph] – Centennial Assets [ph]

Operator

Good morning, my name is Wanda and I will be your conference operator today. At this time I would like to welcome everyone to the Interline Brands first quarter 2008 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. (Operator instructions)

I would now like to turn the call over to Mr. Tom Tossavainen, CFO of Interline Brands. Mr. Tossavainen, you may begin your conference.

Tom Tossavainen

Thank you, Wanda. Good morning and thank you for joining us today for the Interline Brands first quarter 2008 earnings call. On the call today are Michael Grebe, our Chairman and Chief Executive Officer, who will provide an overview of the current market environment and our strategic plans for the year. 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 the statements made today will be forward-looking and are made under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected or implied due to a variety of factors. We will also discuss certain non-GAAP financial measures which are described in more detail in the earnings release. We refer you to recent Interline Brands filings with the SEC for a more detailed discussion of 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 Web site.

I would now turn the call over to our Chairman and Chief Executive Officer, Michael Grebe.

Michael Grebe

Thanks, Tom. I would like to begin my discussion with some perspective on the current market environment, a period of time that has proven to be one of the more challenging in recent memory. Then I would like to tell you how we are managing the business, both in the short term to ensure we successfully navigate the current environment and the long term to take advantage of opportunities to build a stronger, more profitable business that can be fully leveraged when market conditions improve.

We entered 2008 with what we felt was a fair amount of realism regarding the condition of the markets we serve. We expect that our pro contractor and specialty distributor markets would remain weak, but that weakness would be offset by high single-digit growth in the facilities maintenance markets. Daily sales for the first two months of the year, which were essentially flat with the prior-year periods were consistent with those initial expectations. However, revenues in March took an unexpected and significant downturn in all three of our major markets.

Sales to facilities maintenance customers, which grew strongly in 2007 and the first two months of 2008 grew only 1.3% in March. At the same time, revenues from the pro contractor and specialty distributor markets were at their lowest levels since March of 2004.

April results, however, improved over the prior month. Net sales were essentially flat in April compared to the prior-year period, but this compares to March when net sales were down 5% on a consolidated basis. While we are encouraged by stronger results in early Q2, we know that one month does not make a trend. We are still impacted by low visibility, particularly as we look beyond the second quarter.

Accordingly, we are adopting a cautiously optimistic outlook for our markets in 2008 until visibility improves to more normal levels. While we sort out the meaning of the market's mixed signal over the last few months, we know exactly what we need to do from a strategic and execution standpoint.

With this backdrop, let me share with you what our plans are for the remainder of 2008. In the short-term, we will focus on carefully managing our business and adjusting to changing markets. We have mobilized our senior management team to aggressively reduce current expenses and implement cost containment initiatives.

Labor and CapEx are the two primary cost levers at our company. Our team has been here before and we know what to do. We are also leveraging our flexible operating model to continue to shift our resources to areas presenting the best opportunities. For example, we've identified several locations in our network that are either redundant or performing poorly. In these situations, we have the ability to close these locations and shift our service operations to other distribution points. These actions will allow us to save money on a net basis without significantly compromising customer service or fill rates. While we feel good about our facilities maintenance markets today, there are also numerous actions we can take there if conditions were to soften.

While we adjust our spending and improve our distribution network, we will continue to invest in promising opportunities such as the AmSan brand and our related integration efforts. The integration process is proceeding according to plan and we expect to have all AmSan locations on the Interline platform by year end. These conversions are paramount to our ability to cross sell our products.

And while we are still early in the process, we are building traction. For example, we recently launched a targeted MRO product offering under the AmSan brand allowing their customers to purchase commonly used plumbing, electrical and HVAC products. We have also added cleaning and janitorial products to our national accounts offering in the institutional facilities markets and we are seeing some customer adoption there. Once the integration and conversion process is complete, we expect our cross-selling activity to ramp up more quickly.

Finally, we opened two Greenfield AmSan locations during the quarter which provide us an opportunity to penetrate and cultivate several key untapped geographies. While we're taking steps to tightly manage the business in light of the current economic environment, we are steadfast in our commitment to managing the business for the long term.

We have one of the stronger operating models in the industry already, but we think we can make it even stronger and more profitable. To do this, we are reaffirming our commitment to the 2008 investments we discussed last quarter. Most importantly, we will continue to consolidate and streamline our logistics network in major markets, including those slated for 2008, which are Richmond, Boston and Salt Lake City.

Our Salt Lake City facility will provide us with a second national distribution center that will help us reduce lead times, reduce freight costs and facilitate our West Coast sales penetration efforts. In Richmond and Boston, we are building brand new regional distribution centers that will ultimately replace smaller, less efficient centers.

As we said before, our larger distribution centers generate better economics, including reduced costs per shipment, improved working capital management and ultimately higher profit margins.

Let me give you an example. Labor and occupancy expenses at our large distribution centers run between 5% and 6% of sales. This would mean for a distribution center that ships over 20 million in annual sales. At our smaller distribution centers, labor and occupancy can run as high as 11% of sales. Additionally, we turn our inventory almost three more times per year at the large centers compared to the smaller ones.

Currently we operate a dozen of the smaller centers across the country and feel that we can improve performance considerably as we transition to the larger format over the next few years. We also are moving ahead with our plans to upgrade our information systems capabilities including the installation of a new generation telecommunications and PBX network to improve our national call center operations. The new system will allow us to route calls nationally, reduce customer wait time and improve responsiveness. We converted our largest call center operation over this past weekend without a hitch and can see significant benefits once all of our call centers are converted. We expect this particular project to be completed by the end of the year.

Lastly, the current credit environment has shrunk the field of competitors for acquisitions that we are interested in. Valuations in our industry are becoming more attractive and there's a growing pipeline of acquisition opportunities. As we demonstrated in the past, we will continue to remain selective yet opportunistic in evaluating these opportunities.

Our disciplined approach to evaluation has served us well over the last several years. Although it sometimes meant that we were watching from the sidelines, we didn't do anything that we regretted later and we are positioned well now to compete for deals. We will continue to focus on attractively valued companies that will integrate well into our existing platform, create tangible operational synergies and present significant incremental cross-selling opportunities.

In addition, some acquisition opportunities will help us meet our objectives of diversifying our geographic footprint, penetrating new markets and improving speed and service to our customers. So, despite operating in a difficult economic climate, our business is solid and our market position is strong. Our flexible operating platform has allowed us to focus our attention on the opportunities that can deliver the best returns for Interline shareholders.

And while we are clearly navigating in choppy waters, our financial strength, distribution scale, strong cash flows, and unique value proposition to customers will ensure we not only weather the storm, but more importantly take market share from our competition. With the investments we are making to strengthen our operating platform, we feel we will emerge from this period of economic uncertainty a stronger, more profitable organization with the ability to take advantage of more growth opportunities for the long term.

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

Bill Sanford

Thanks Mike. First, a quick review of first quarter performance in our three major customer markets. Sales to facilities maintenance customers increased 4.5% for the quarter. Sales in this market increased approximately 6.7% in the first two months of the year, but growth decelerated to 1.3% in March. April growth was back up to 4.7%, so we are guardedly optimistic that March was an unusual month. Sales to professional contractors declined 15.2% in the first quarter with a similar March downturn. The April sales decline was less significant at 11.8%. Sales to specialty distributors declined 12.6% and improved slightly to a decline of 9.6% in April.

In this very competitive market, however, we've been able to maintain price discipline as evidenced by an improvement in gross margin of 10 basis points. We continue to walk away from sales, especially on commodity type items that do not meet our profit objectives.

As you would expect, we are in constant communication with our customers to gauge changes in buying patterns and overall market conditions. While recent feedback certainly covers a wide spectrum, we would like to share with you some of our findings from discussions in the various markets we serve. Our primary objective in the market is to gain share through new customer acquisition and deeper penetration of existing customers through the business cycles. All of our sales, marketing, national accounts and supply chain programs are developed with this central objective.

In our discussions with customers over the last several weeks, it is clear that these programs are working and that we are gaining market share with these types of customers. We have a lot of visibility into the apartment market where we generate over a third of our revenue and have an enormous amount of property level data that validates market share gains.

In the pro contractor space, on the other hand, measuring share is very challenging, especially in a turbulent market. Our national accounts and supply chain relationships give us additional visibility and we are confident that we also continue to gain share with these customers. In the multi-family market, we are still seeing above-market growth rates, albeit lower than the high teens growth we saw in 2007.

Rents and occupancy rates are relatively flat compared to the first quarter of 2007. However, the credit crisis is clearly impacting the development and redevelopment activities of owners, which puts additional pressure on the operations managers to keep costs at a minimum.

In addition, many of our largest institutional apartment customers are putting properties in secondary markets up for sale in order to concentrate on core markets, while others are temporarily suspending major upgrades to their portfolios. That said, the macroeconomic trends in the multi-family industry remain positive. We feel that our Wilmar brand which services the multi-family industry is on top of its game and we continue to build a solid pipeline of candidates for our supply chain and national accounts program.

Additionally, our renovations division is performing well with sales up over 50% in the first quarter. Their pipeline remains strong and we feel that we will continue to take share in this sub market. Sales to institutional customers, including health care, government and educational facilities, were flat in the first quarter. Health care and education were both below plan with many customers citing budget constraints. We do see positive trends in the national accounts area and are beginning to get traction from the numerous initiatives launched in the janitorial supply market over the last 12 months.

Our pro contractor and specialty distributor markets, which are both dependent on residential construction and remodeling activity, remained weak in the quarter. As Mike mentioned earlier, revenues in both of these markets were at their lowest levels in over four years. We have spent a lot of time analyzing customer trends in these markets and feel that we are maintaining customer share.

For example, we studied first quarter trends at vendor-managed inventory locations. These are typically larger, regional plumbing, HVAC or electrical contractors that operate between 30 and 100 service vehicles and that focus on service as repair – and repair as opposed to new construction. Because we are operating on site and own all of the inventory, we naturally have 100% market share and can get a good read on how the economy is impacting the service contractor's business.

In the first quarter, this group of customers purchased slightly less than in the first quarter of 2007 and in interviews, the business owners said that they expected 2008 revenues to be down up to 10% compared to 2007. This would support the recent leading indicator for remodeling activity report issued by Harvard University's Joint Center for Housing Studies, which predicts that remodeling activity will continue to decline throughout 2008 and end the year down 4.8%.

Our initiatives in supply chain management continue to gain momentum in the pro contractor space. We opened three new vendor-managed inventory locations during the quarter and have a healthy pipeline of planned implementations for the remainder of 2008. As the contractor's business slows, our value-added services become even more compelling as we help our customers keep their costs low.

With that I'd like to turn the presentation over to Tom Tossavainen, our Chief Financial Officer.

Tom Tossavainen

Thanks, Bill. In the first quarter of 2008, we generated net sales of $281.9 million, a 2.1% decline compared to the prior year period. As a percentage of total sales, our end markets represented the following concentration; 68% from facilities maintenance, 20% from professional contractors and 12% from specialty distributor.

Gross margin for the first quarter 2008 came in at 38.1%, a 10 basis point improvement over gross margin in Q1 '07. Selling, general and administrative expenses for the quarter were $85 million, essentially flat on a dollar basis with the same period of 2007. As a percentage of net sales, first quarter 2008 SG&A expense was 29.4%, up about 50 basis points over the first quarter of 2007. The increase in SG&A was primarily driven by higher occupancy costs resulting from our change in logistics network.

Overall, we are actively managing and reducing our operating costs with the objective of improving our operating efficiencies in a challenging market. Interest expense of $7.7 million in the quarter was down nearly 10%, reflecting a lower LIBOR rate.

Taking all of this in consideration, operating margin for the first quarter of 2008 was 7.3%, a decline of 61 basis points over the prior year. Net income for the first quarter of 2008 was $8.7 million or $0.27 per diluted share, an 8% decrease compared to net income of $9.4 million or $0.29 per diluted share in the same period of 2007. These results were also lower than our guidance of $0.29 to $0.31 that we provided in February, primarily due to softer March revenues than we had expected. However, as Mike mentioned, we are aggressively managing our business and are confident that our team will continue to move quickly to right-size our operating cost structure to emerging market conditions.

Moving to the balance sheet, as you know, 2007 was a banner year from a networking capital days perspective. During the first quarter, we continued to efficiently manage our working capital and have reduced our networking capital days to 81 days as of the end of March. This is a one-day improvement from last quarter and in line with the first quarter of 2007.

The largest improvement on our balance sheet has been driven by our inventory management where we continue to deliver improved inventory turns. Our inventory days for the quarter were 57, a 2 day improvement from last quarter and 3 days improvement compared to the first quarter of 2007.

In the coming quarters, you should expect to see an increased inventory level as we stock our new West Coast national distribution center in Salt Lake City and as we hedge against the possibility of a West Coast port strike. The 2 day improvement in inventory dates from year-end was offset in part by slowing accounts receivable days sales outstanding, which came in at 48 days at the end of March compared to 47 at year end.

Accounts payable days remained consistent with the prior quarter and prior year quarter at 24 days. In the second half of 2007 and continuing into 2008, we saw some slowing of customer payments due to the general economic slowdown, which resulted in $250,000 in higher bad debt provisions in the first quarter. We will continue to monitor our day sales outstanding closely as we prepare for a more challenging collections environment. We continue to look for ways to improve our overall collections efficiencies including technology solutions that we are implementing over the next two quarters.

Moving on to our cash flow, we continue to generate strong results that support our growth. Cash flow from operations was $29.1 million, slightly below an exceptionally strong Q1 '07 where we generated $30.4 million of cash from operations. Consistent with our investment plans for 2008, capital expenditures in the quarter were $6.5 million, up $3 million from the prior year. This spending represents 2.2% of sales for the quarter, compared to 1.2% of sales in the same period last year.

As we progress throughout the year, we expect capital expenditures to end up within the 1.5% to 2% range for the full year. Our liquidity position continues to be strong with over $160 million, comprised of $90 million of capacity available under our revolving credit facility and $70 million in cash. Our strong financial position leaves us in good shape to support the growth and acquisition programs Mike discussed. We continue to generate strong returns on our capital in line with our performance in 2007. Our return on tangible capital was 41.2% this quarter compared to 42.2% in the first quarter of last year.

As we discussed in our last call, the slowdown in the pro contractor and specialty distributor end market has negatively impacted returns compared to prior years. However, working capital efficiency has never been better, driven by strong inventory management.

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

Michael Grebe

Although our performance in the first quarter of 2008 was below our guidance, we continue to feel that our market position is strong. We participate in very attractive markets, as you know, and we remain highly confident in our ability to grow sales and earnings over the long term. As is our practice, we are providing you with as much insight as we can into our expected performance in the current quarter and our expectations for 2008.

We expect our facilities maintenance business to continue to grow at above market levels in 2008. We feel very good about the operating performance of AmSan and the progress of our integration efforts. The Wilmar brand is a formidable leader in the multi-family housing market and we believe it will continue to perform at a high level.

We are building a solid pipeline of candidates for our supply chain and national accounts programs and we expect to continue generating strong growth in our renovations division. However, our expectations are more guarded at this point, given visibility is as low as it has been in quite some time. Development activities and portfolio renovations appear to be slowing in the multi-family housing market while budgets are getting tighter in most of the facilities maintenance markets we serve.

In addition, we continue to expect weakness in the professional contractor and specialty distributor markets for the remainder of 2008, similar to the levels we saw in 2007. 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 feel we will benefit when customers resume more normal purchasing patterns.

For the second quarter, we expect our business performance on a relative basis will be similar to the first quarter. Further, our outlook for the second quarter reflects that the majority of the logistics and information technology investments that we outline for 2008 will occur in the second quarter and will cost us roughly $0.03 per share in one-time costs, including moving expenses, overlapping lease payments and so forth. We therefore expect earnings per share for the second quarter of 2008 to be between $0.30 and $0.35. As we look to the second half of the year, there are several factors that support our expectation that earnings performance will improve relative to the first half.

First, the second half of the year and Q3 in particular is typically stronger due to seasonality. Last year, for example, we generated 58% of our earnings in the second half of the year and at this point, we expect similar seasonality for the remainder of 2008.

Second, we will not have the $0.03 per share impact related to our 2008 investments that we will incur in Q2. And third, there are numerous cost saving measurements we have just implemented and are in the process of implementing, which could reduce our expenses between $0.05 and $0.09 compared to our initial cost expectations.

Taking all of these factors into consideration, we now expect earnings per share for the full year 2008 to be between $1.45 and $1.61. We are closely managing our operations to ensure we navigate through the current environment while we remain focused on the initiatives that will build a stronger, more profitable organization when we emerge from this period of economic uncertainty.

Moderator, you may now open the lines for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Matt Mccall with BB&T Capital Markets.

Sean Connor – BB&T Capital Markets

Good morning. This is actually Sean Connor for Matt.

Michael Grebe

Good morning, Sean.

Sean Connor – BB&T Capital Markets

Question I guess on the institutional side of your facilities maintenance segment, I know you guys commented that the multi-family remained fairly strong through the quarter. Do you have any additional color on what the January and February performance was on the institutional side versus March and then again in April?

Michael Grebe

It followed a pretty similar path, Sean, that our multi-family did. It was a little better in January and February, off in March and back up in April. I guess the other color I would provide on our institutional business is, it is in a very wide range of vertical markets with no significant concentration, I mean ranging from schools, nursing homes, hospitals, prisons, just a wide smattering. So we didn't see any specific trends at the end customer level that jump out at us, but very similar patterns to the multi-family base.

Sean Connor – BB&T Capital Markets

Did March still show growth in that area, in the institutional area, or did it decline at all?

Michael Grebe

It was down a little bit in March.

Sean Connor – BB&T Capital Markets

But you are seeing – you did see growth again in April?

Michael Grebe

Yes.

Sean Connor – BB&T Capital Markets

We heard another distributor and they play in different end markets admittedly, but they said that a lot of the national account type customers have been aggressively pursuing the manufacturers themselves as opposed to the distributors. Have you guys seen similar trends with any of your end markets or customers?

Michael Grebe

There are a handful of large manufacturer partners that we do business with that also go direct and have historically gone direct. That is not a significant portion of our business. It's really limited to perhaps one or two large manufacturers in a couple of sub markets for us and I would say that any time you hit some tough economic times, certainly customers are trying to sharpen their pencils and sales organizations try to sharpen their pencils.

So, there is maybe some additional level of price pressure in those particular markets or maybe those business partners are maybe taking shipments that they wouldn't otherwise have been interested in some time ago, but I wouldn't say that that impact on us at this stage is very, very dramatic because that's a very small portion of our business that can go direct and it tends to be with larger equipment items like maybe GE would sell to a customer a trailer load of appliances or something like that for a large redevelopment effort.

So, we can see it in those types of arenas, but by the same token, those suppliers also tend to be very, very good business partners for us and even though they do go direct, our sales growth with them over the past few years has been very positive and sometimes larger than our sales growth with other suppliers. And I'd say maybe there's a little bit more of that, but it's not dramatically impacting us at this time.

Sean Connor – BB&T Capital Markets

Okay. So your pace, I guess, of acceptance or conversion to the national account program for these other supply chain management or the VMIs are not being impacted by anything like that? It would be a different customer base from the ones that you're trying to convert to those higher wallet share relationships?

Michael Grebe

I would say, Sean, that the spend that a large customer has on a national account basis, a very small percentage of that customer spend is involved with a supplier who's going to want to sell direct. I mean it's just very, very small. If you think about a large multi-family apartment REIT, for example, our average order size is $350. We're selling items that break every day. I mean, there's constant replenishment that the supply chain expects there. And so, there's just not a large opportunity for a significant amount of manufacturers to get direct in that kind of environment. So, no, we don't see that as a big threat at this stage.

Sean Connor – BB&T Capital Markets

Okay. And then on your – on I guess the transactional type businesses, trying to move up into a more meaningful relationships, I know you said your pipeline, you are putting good opportunities in the pipeline. Are you seeing them flow through at a solid pace as well, starting to realize any benefit of the additional or increased level of those more value added relationships?

Bill Sanford

Hi, it's Bill Sanford. This is something that is very much of an ongoing process across all of our brands and essentially what we're trying to do is become a primary supplier as opposed to a secondary or tertiary supplier and we have a number of different methods for getting that relationship to shift. I would say that the changes we've made recently have been that we're much more selective, we're putting fewer resources in the weaker markets and more resources in the stronger markets. And in our case, that would be instead of having a bunch of high-paid national accounts reps running around in a contractor space, we're working very selectively with large regional customers that want to do supply chain with us. And instead, we're shifting over into multi-family and other stronger markets to work with customers there. But it's – there are continuing customers shifting from one phase to another, and if you've seen our IR, we have numbers on that and I would say all those numbers are still moving in the right direction.

Sean Connor – BB&T Capital Markets

Okay. You guys mentioned the $0.03 I guess in one-time costs expected in Q2 being from the IT and logistics conversion. Last quarter you talked about $0.10 to $0.18 of total type of investment EPS pressure. Is that still the overall outlook for the year?

Michael Grebe

We expect, as we said on that conference call, that we have somewhere between $0.10 and $0.16 of investments and that we would adjust that as business conditions warrant throughout the year. Certainly, we feel that those business conditions are warranting adjustment. And so, you heard me say earlier that we expect to save somewhere between $0.05 and $0.09 in the second half of this year relative to our initial cost expectations and some of those cost savings to plan come out of that $0.10 to $0.16 cents, if you will. So we are paring that back. We're paring that back in areas that we think we can live with and defer and go after perhaps next year or defer permanently. But the portion of that $0.10 to $0.16 again that we're very committed to are these three large national distribution centers that are opening this year – excuse me, national distribution center and two regional and then this telecommunications investment.

Just a little more color on that $0.03, that is literally the cost of picking up inventory, moving it from one location to another. These are multi-million dollar moves in terms of the inventory that's moving, it's often coming from three or four different locations, a lot of freight expense and then again one-time expenses. So, that's really what that $0.03 is and again was expected. We weren't sure at the beginning of the year exactly what quarters all of our buildings would be available and it turns out a lot of it is hitting in Q2.

Sean Connor – BB&T Capital Markets

Okay. And the $0.05 to $0.09 that's coming from, I guess, the delay of some of the other investments, is that about 50/50 delay versus other type of actions?

Michael Grebe

No. What you're hearing us talk about there are really just a lot of cost adjustments that we're making. One of the areas that we feel we've always excelled at as a management team is adjusting to emerging economic conditions. And again, we said at the beginning of the year that we would adjust our plans as necessary. Starting at the top, we are continuing to maintain our pricing discipline in what is a very unique inflationary environment. We continue to walk away from low margin business, but we're trying to make sure that we improve our margins over time, but let me give you a feel for what I mean by that $0.05 to $0.09.

It really comes from several different areas. I mean, one is just the continued right-sizing of our SG&A compensation costs to properly match our performance expectation. These are the costs that are varying with sales, distribution center labor and so forth. As a couple of examples, we reduced our selling labor costs in the pro contractor market by 15% from prior-year levels. Our overall headcount is down over 2% since the beginning of the year and we'll continue to make adjustments.

Another area that's included in that $0.05 to $0.09 is just straightforward belt tightening in areas of general marketing, supply costs and so forth. I mean, for example, our marketing expenses are down 30% on a year-over-year basis or almost $0.01 a share and our supply costs through running new processes with our suppliers and so forth are down about $0.07 to $0.08. Some of that adjustment, that $0.05 to $0.09 in the second half of the year will come off of that initial investment spend that we've been talking about.

And then finally, there's several new profit initiatives that we've launched in our business and are currently gaining traction. A lot of them are centered around further, faster review of underperforming operations and what we need to do there, and a combination of all of those categories of four – those four categories of cost items, that's what really gets you to that $0.05 to $0.09.

Sean Connor – BB&T Capital Markets

Okay, great. Thank you very much.

Operator

Your next question comes from the line of Michael Rehaut with JPMorgan.

Jen Consoli – JPMorgan

Hi, it's Jen Consoli on the line for Mike. Good morning.

Michael Grebe

Good morning, Jen.

Jen Consoli – JPMorgan

Just a question on the March decline, was there something unique to that month that was going on that really caused a slowdown and then you saw a slight rebound in April or was it more a case of typical seasonality, do you think?

Michael Grebe

First of all, Jen, it's hard for us to totally get our arms around it. I mean it was unexpected, it was significant, and again, it's rebounded in April, so I would be less than honest if I said I had the precise answer. And it's one of the reasons that we've given a wider range in our guidance than perhaps normal because we do lack that visibility. We don't think that it was normal seasonality. If it were, we would have baked that into our plans and sort of expected it. So it's a little bit hard to say that.

I guess one of the things that we've looked at very carefully, for example, is what's happening within the multi-family housing market. If you look at the published reports, they only come out for the quarter. The vacancy rate in the fourth – excuse me, in the first quarter was a 10 basis point improvement over Q1, but a 20 basis point sequential degradation from the fourth quarter. So, the economic trends are hard to discern. We don't get monthly vacancy rates and so forth.

We did, however, see a fair amount of cautionary commentary by some of the large multi-family housing REITs and some of that was coming out in March, some of it we've seen in April, and obviously reflected what people were doing in that margin in March. As we distill that information, we heard several recurring themes. One is that some of the large operators are repositioning assets instead of purchasing new properties. We've heard that certain large markets such as Las Vegas, Phoenix, San Diego, the Sunbelt and so forth are becoming increasingly challenging. We heard that – we are hearing that debt financing for properties has obviously been a little bit harder to come by and maybe that's trickled down to operations at the field level.

Now, in our experience, you can only do that for so long. There can be a move to rein in quickly, but if you're repairing an apartment, you can only defer repairs for so long. So, I guess that's sort of some anecdotal commentary that we're hearing from people. Again, we can only be focused in on the numbers, and beyond that, it's hard for us to say exactly – it's hard for us to discern a true pattern which again is why we're saying we have such low visibility.

Jen Consoli – JPMorgan

Okay. And I think on the last conference call you guys mentioned you were targeting like a high single digit type growth rate for facilities maintenance for this year. Given that March was slower and you're seeing some softening trends there, what type of growth are you looking for, for the year now? Should we look for low single digit type growth?

Michael Grebe

I think the number that we had mentioned, if I recall correctly, Jen, on that first conference call was that we were expecting the multi-family growth rates to be in the high single digits. I think that was in response to a question. So far in April, for example, we've seen multi-family growth rates a little bit higher than that, so we still – I'm not sure I would go as high as high single-digits, but in general, our facilities maintenance growth rate for April was about 5% and our expectations for the rest of the year are really kind of at the low end of our guidance, are based on a combination of what we saw in February, March and April combined, and that's kind of how we ran out that low end of our guidance. If we see improvement in – excuse me, March is an aberration, we would expect to move up in that range and that's kind of the way we looked at sales in multi-family and in facilities maintenance.

Jen Consoli – JPMorgan

Okay, great. And the last one, you guys mentioned that you were being disciplined as far as pricing goes. In light of commodity costs rising, I know you guys don't have a high commodity exposure, but what are your customers' reactions or what have they been to price increases and how much pushback are you getting?

Michael Grebe

Well, I'm always intrigued when somebody says that the distribution market is under pricing pressure or not under pricing pressure. To me, I've never seen a moment in time when you weren't under pricing pressure. I mean, we deal with a lot of sophisticated customers. We've got to deliver value all the time. And so, I would say that pricing is always a challenge. Now, with that as a backdrop, we also think this is especially a challenging environment because just take yesterday, for example, I believe copper prices hit an all-time high at a moment when the U.S. economy and the housing market, which is using – would normally use a lot of copper is certainly struggling, right? So you really hit that combination of high prices and low demand, which obviously is driven by demand in China and so forth. So there certainly are some examples there that are very challenging.

Again, I would also say that as a business rule, we are continuing to walk away from sales, particularly of commodity items that don't meet our profit objectives. That said, our gross margins for the quarter were up 10 basis points. That's, as usual, driven by a lot of different puts and calls. We had some advantages in our merchandising programs, our national distribution center is operating well, but we at this stage feel pretty comfortable with where our selling margins are holding. So, I guess that to me is the bottom line as to how we look at pricing. But, I would say that it's always challenging, but I would agree that it's even more challenging as commodity prices rise, copper and crude oil for that matter, but the economy is struggling a little bit, at least with respect to housing. So I guess that's my – that's kind of how we look at pricing.

Jen Consoli – JPMorgan

Alright, great. Thank you very much.

Operator

Your next question comes from the line of Keith Hughes with SunTrust.

Keith Hughes – SunTrust Robinson Humphrey

Thank you. You've made some commentary about institutional MRO. Does that include AmSan, those numbers that you've talked about?

Michael Grebe

Yes. So, it would be our AmSan business, it really would be all of our facilities maintenance business, Keith, not including the multi-family housing space.

Keith Hughes – SunTrust Robinson Humphrey

And to summarize, that business was flat in the quarter, is that what you said, the non multi-family housing?

Michael Grebe

Yes, it was essentially flat in Q1 and we were up 3.4% in Q2 through the first week of May, just to reset those numbers.

Keith Hughes – SunTrust Robinson Humphrey

And in your guidance for the year, you still anticipate multi-family housing outpacing that segment, is that fair to say?

Michael Grebe

That's fair to say, yes.

Keith Hughes – SunTrust Robinson Humphrey

Okay. And the – I guess that's it for me. Thank you.

Operator

Your next question comes from the line of Jeff Germanotta with William Blair.

Jeff Germanotta – William Blair

Good morning.

Michael Grebe

Good morning.

Jeff Germanotta – William Blair

My question relates to your guidance. If we look at the low end of the old and the new range, it's about a $0.16 differential. A few cents of that came from the first quarter shortfall, $0.03 of that comes from the logistics in IT spending you talked about in the press release. But, can you shed a little more insight into that remaining $0.10? I assume some of that is from less sales volume, some of it is due to other costs. Can you share with us more insight on that?

Michael Grebe

Sure. I guess, Jeff, whenever we develop the guidance, we try to kind of wash the board clean and reset and say, okay, let's go from the ground up and zero-based budgeting and where are we and what does that translate back for you guys. So I guess I'm not in a position to sort of reconcile the $0.10 for you, but what I can give you is maybe a little more color and try to summarize kind of how we got there and hopefully that helps.

I guess from a sales perspective, and some of these questions have been asked, but maybe to try to put it all together, we expect that the multi-family industry will continue strong and we expect mid single digits or slightly above that for the rest of the year. The facilities maintenance brands again slowed quite a bit in the first quarter due to budget constraints in certain end markets, and we again expect pro and specialty will remain soft for the rest of the year and probably have even build in further declines in the second half than maybe we did in that initial guidance. We had never expected a recovery, but we had maybe some expectations since the third and fourth quarter of last year were so challenging that maybe there would be some pickup in that, not a plus number for the second half in those markets, but it would at least be less of a decline, if you will, and we've probably been a little bit more conservative in that number in giving this guidance.

Again, from a standpoint of comparing first half to second half and so forth, we've got that seasonality, we're at 58% of the business is next year or in the second half of the year, we've got the various different cost-saving measurements, which compared to those initial expectations, should add back $0.05 to $0.09. So, on balance, we feel that to be – to match the visibility that we have, we felt the range we gave of $1.45 to $1.61 was the best visibility we have.

Jeff Germanotta – William Blair

And I just want to clarify one more thing, the $0.05 to $0.09 of cost savings, that will be fully realized in 2008?

Michael Grebe

In the second half, that's correct.

Jeff Germanotta – William Blair

Okay. Thank you.

Operator

(Operator instructions) Your next question comes from the line of Dan Leben with Robert W. Baird.

Dan Leben – Robert W. Baird

Great, thank you, good morning. First on March, is there any impact from the moving of Easter (inaudible) from last year in April to this year in the March?

Michael Grebe

There's clearly some impact there, Dan. We had felt that we had accounted for that though in our expectations and sometimes based on where holidays fall, you can see more or less of an impact, so there is some impact there, but we don't think that explains fully what happened in March.

Dan Leben – Robert W. Baird

Okay, great. And then the second question is, just of the $0.03 charge in the second quarter, was there any portion of that that you were previously expecting in terms of the expenses and moving and whatnot later in the year that's been moved forward, or is that all new one-time events?

Michael Grebe

There's some move forward of that. I think the NGC, for example, in our initial plans we thought might not be available until Q3 or Q4, when we actually got some building done there faster than we had thought and we're ready to go and so we are going to take advantage of those opportunities, so a little bit of move around there.

Dan Leben – Robert W. Baird

Okay, great, thanks, guys.

Operator

Our next question comes from the line of Matt McGary [ph] with Centennial Assets [ph].

Matt McGary – Centennial Assets

Good morning, guys.

Michael Grebe

Good morning.

Matt McGary – Centennial Assets

I don't know if you have this number at your fingertips or if you disclose it, but just sort of curious, as you're talking about paring back some of your variable costs going forward in light of the economic environment, how much room do you have left there? What is your sort of fixed cost basis look like relative to variable at this point? I'm sort of curious what your thoughts are.

Michael Grebe

Well, I guess we mentioned or Tom mentioned in his earlier remarks that a significant portion of our OpEx increase was related to rent and occupancy and costs like that which are typically fairly significant. I guess the biggest buckets of costs that we tend to look at as either variable or actionable are freight expenses first, for example, which can run anywhere from 5% to 7% of costs of our P&L. It depends on whether you include freight to customers or freight in or what buckets of freight there are. So that is – that cost comes at us in millions of different transactions, and so we're always focused on those areas a lot.

We've got well over 400 vehicles and a lot of drivers that are delivering our products, over 50% of our sales are delivered on our own products. So there's a fair amount of opportunity to act in those particular areas. From a selling expense standpoint, those type of numbers vary significantly based on our various different brands, but those expenses can be anywhere from 2% to 8% of sales depending on the brand. So that's a very large actionable category of our P&L.

And then finally, if one of the other largest areas of our operation is the cost of running our distribution centers, and ex the cost of occupancy and rent, distribution center, labor and management can run anywhere from 3% to 11% of sales depending upon the distribution center, right? So, if you look at that kind of range of expenses that I just threw out there, that can be as much as 20% of sales, depending upon the brand or the distribution center and so those are the buckets of cost that whenever we hit an environment like this and we want to take a hard look at, those are the types of categories that we're looking at.

Now, that said, obviously you always want to make the right short-term adjustments, but we also want to make the right long-term investments as well. There are certain markets, particularly in institutional space, where we want to be more aggressive and we think we can take market share and obviously that's the trade-offs and the balancing act that the management team here is very focused on.

Matt McGary – Centennial Assets

And just lastly, you mentioned – that was very helpful, thank you. You mentioned, had some very positive comments on the M&A environment. Just sort of curious what the deal flow has looked like for you guys and I also wonder, as you sit back and think about capital allocation, considering kind of where your stock is today and the outlook for the company longer term, does it make sense to consider a buyback in that calculation?

Michael Grebe

Well, let me talk about acquisitions first. I mean obviously, we won't comment on kind of any specific transactions, but as you probably know, acquisitions have always played a key strategic part in our growth strategy. We feel that we've built a great operating platform and one where we can quickly take advantage of synergies in a very favorable acquisition environment.

Just to comment a little bit on the space and multiples and so forth, acquisition activity in the space clearly slowed in 2007 compared to 2006, in part because seller expectations in some cases were very unrealistic, and we found over the years it can take several quarters before seller expectations catch up with the realities of the market. So I would say that with respect to your question of kind of what are we seeing right now, we are starting to see more properties and more good companies either come to market or being willing to talk about coming to market.

And with respect to multiples and price discussions, clearly those vary by the type of company that is for sale, strategic value that it represents and so forth. So, there's no one clear-cut answer to a question of what we're seeing and obviously the best companies command more. But, I would say that on an apples-to-apples basis, it would appear that multiples in this space are down one or two or more full terms compared to a year or so ago. So that's kind of what we're seeing generally in the space. And obviously, if we have something to announce, we would announce.

With respect to capital allocation, let me say that we are constantly evaluating all of our options with respect to our capital allocation strategy, including opportunities that might present themselves with respect to a share repurchase. This is something that we watch very carefully and we have continuing discussions with our Board on the subject. We consider numerous different options. As always, we have as our goal to increase long-term shareholder value. Obviously, with respect to capital allocations, acquisitions are a possible use. We also consider our debt leverage levels and the state of the credit markets which as you know are very choppy at this time.

From a leverage perspective, by the way, our net debt to EBITDA ratio was 2.7 at the end of Q1, if you include and consider the $70 million of cash that was on our balance sheet. So in general, we feel like we have the right capital structure in place and we're comfortable with the leverage levels that we have. Based on these and other factors, we've not implemented a share repurchase program at this time. However, that's a question that we'll continue to very carefully evaluate.

Matt McGary – Centennial Assets

Thank you. Good luck.

Michael Grebe

Thank you.

Operator

At this time, there are no further questions. Mr. Grebe, are there any further remarks?

Michael Grebe

No, thank you very much and thank you for attending the call.

Operator

Thank you. This concludes today's Interline Brands first quarter 2008 conference call. You may now disconnect.

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Source: Interline Brands, Inc. Q1 2008 Earnings Call Transcript
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