Applied Industrial Technologies Inc (AIT) 2003 Q2 法說會逐字稿

Hello and welcome to the Applied Industrial Technologies second quarter 2003 financial earnings conference call. All lines will be in a listen-only mode until the formal question-and-answer session. At that time, instructions will be given. At the request of Applied Industrial Technologies, today's conference call is being recorded. If you should have any objection, you may disconnect tilt. I would like to introduce Mr. Richard Shaw, Vice President of Communications of Applied Industrial Technologies. Mr. Shaw, you may begin when you're ready.

Good afternoon. Thank you operator, and good after everyone. On behalf of Applied Industrial Technologies, I would like to thank you for joining our second quarter 2003 earnings call. You should have already received our earnings news release which was issued this morning. If you have not received the release, you may retrieve it by visiting www.applied.com. A replay of today's broadcast will be available at the following phone number: 888-203-1112, starting at 6:00 p.m. today, through midnight on January 17th. You may also access a replay shortly after this teleconference through the Applied Web site.

I would like to remind everyone we will discuss Applied's business out look during this conference and make statements that are forward-looking. Applied intends all forward-looking statement be subject to the Safe Harbor of the Private Securities Litigation act of 1995. All forward-looking statements are based on current expectations regarding important risk factors, including trends in the industrial sector of the economy, the success of our various marketing strategies, and other risk factors identified in Applied's more most recent periodic report and other filings made with the Securities and Exchange Commission.

Accordingly, actual results may differ materially from those expressed in the forward-looking statements and the making of such statements should not be regarded as representation by Applied or any other person but the results expressed therein will be achieved. Applied assumes no obligation of publicly update or revise any forward-looking statements, whether due to new information or events or otherwise. This conference call is the copyrighted property of Applied Industrial Technologies. Any copying, rebroadcast, publication, posting, transcription or distribution of any portion of this call without Applied's expressed prior written consent is prohibited.

With all of that said, our speakers today include David Pugh, Chairman and C.E.O. of Applied, who will discuss our overall performance during the quarter. We will also hear from John Whitten, Vice President and Chief Financial Officer who will discuss our financial performance. And Bill Purser, president and chief operating officer who will discuss our sales, marketing and operational activities during the quarter. Here to discuss second quarter business developments is David Pugh.

Thanks, Rick. As usual, it's good to be with you, folks. I assume everyone has seen the earnings that we put out this morning. We continue to be profitable, to generate cash. The numbers are pretty much where we had forecast, indicating that things are under control. There are areas where our initiatives are providing the progress that we've been looking for, and others where our expectations for results have not yet been met. And we will take a little bit more time. From that standpoint, it's always nice to be profitable and still have an upside opportunity.

The sales climate remains very competitive. Bill will discuss that in a few minutes. Rebuilding sales volume will remain a priority for us as the economy improves. For the present, without any major geo political events, we are optimistic that quarter after quarter declines in sales are behind us. Our controllable costs are well managed. The medical and insurance costs continue to rise disproportionately and they are being addressed. Acquisitions continue to be few and far between in our industry. As the misalignment between buyer and seller expectations remain significant. Improving our operating margins is still a primary focus.

As you can imagine, increasing margins in a sustained down economy is not a simple task. But we are patient, and we have the perseverance and the tools to make steady progress. I do feel the initiatives that we have in that regard are well conceived. Like any CEO worth his salt, I would like to see them move faster. But as you know, the pace of change in our industry is anything but volatile. With that being said, I want to ask John to update us on the first quarter numbers with details.

Thank you, Dave, and good afternoon, everyone. What I'm going to do is highlight certain items in our press release that we sent out this morning and give you some flavor for what happened in the second quarter and the first half of the fiscal year. Our second quarter sales of $356 million were 2.3 percent higher than the same quarter last year. Net income for the quarter increased by 32 percent to $3.9 million from $2.9 million in the same quarter of the previous year.

Earnings per share increased by 33 percent to 20 cents per share versus 15 cents last year. Our six-month figures for the six-month ending December 31, 2002, our sales increased by 1.1 percent to $723.7 million, from $715.5 million in the previous - in the same period last year. Net income was $7.8 million or 40 cents per share versus loss of 4.3 million or 23 cents per share last year. Prior half year earnings include the affect of a non-cash charge of $12.1 million, or 63 cents per share from impaired goodwill that resulted from the initial application of FAS 142 associated with the company's fluid power business.

Same-store sales were up 1.3 percent versus the same quarter last year. While there was a reduction of 10 facilities in the U.S. and Mexico, these were offset by the acquisition of certain assets of AICO (ph) industrial equipment company with 16 facilities in western Canada. At December 34, 2002, we had a total of 455 facilities versus 449 at June 30, 2002. Our sales mix first half was about 85 percent industrial and15 percent fluid power. Industrial product sales for the quarter increased about two percent and fluid power sales increased by about six percent.

Gross margin for the quarter was 25.6 percent an increase of 120 basis points for the first quarter and 60 basis points higher than the second quarter of last year. That increase was principally the result of lower costs due to various initiatives. SG&A (ph) expenses increased by approximately $2.9 million from the same period last year. Increases in personnel benefit and insurance costs during the quarter were reduced by net gains of1.3 million or four cent per share after tax on real estate transactions and other property transactions during the quarter.

Year to date, the company has realized approximately $2.6 million or eight cents per share in real estate and other property gains during the six-month period. Our interest expense for the quarter in year to date decreased by $400,000 and a million dollars respectively as a result of lower average borrowings and more effective interest rates. For the year, we have purchased 128,000 shares of common stock at a cost of $2.2 million. That was for the quarter. For the year to date we purchased 232,000 shares for a total of $3.9 million. We have ongoing board authorization in place to purchase 579,000 shares and we currently have approximately 19 million shares outstanding.

On October 4, Applied Industrial Technologies acquired the assets of industrial equipment company, AICO (ph) a western Canadian distributor of bearing PC (ph) and fluid power products for approximately $12 million. This acquisition was paid for from existing cash balances. Our balance sheet continues to be strong. Our current ratio at December 31 was 2.9 to one and our net debt to equity was .18 to 1. Our inventory balance increased by $15.7 million from June 30th, but it was also - however, it was also down about $23.2 million from December 31 to the prior year. Inventories were increased during the quarter from seasonal buying opportunities that should enhance earnings (ph) in future periods.

Turning to our cash flow, total cash flow provided from operations was $22.6 million for the six-month period compared to $29.7 million for the same period last year. Capital expenditures were about $5 million for the six months. For the entire year, we expect our capital expenditures to come in within a range of between $9 and $11 million. Our annual depreciation and amortization for the entire year should come in around $15 million. We have also made - scheduled long-term debt payments during the quarter of $5.7 million. This by the way was the final payment on some debt that we took out about 10 years ago. The next scheduled payment on remaining long-term debt is now not due until December of 2007.

We expect sales in the quarter, the next quarter, with regard to guidance, to improve over the prior year and be in the range of $365 to $375 million for the quarter ending March 31. We also expect continuing pressures on gross profit and operating margins. Interest expense for the entire year should come in around $5 million and we expect our overall tax rate to be in the area of 36 percent for the entire year. The financial guidance that we're providing in this press release, in addition to that, we expect that, for the full year, our sales will come in in the range of $1.45 to $1.5 billion (ph).

We were pleased that we finished the first six-month period slightly ahead of the first six months for the prior year. While we're encouraged to see some signs of recovery we are concerned with the continued low factory utilization rate. That has been with us for some time. So putting it all together, we're expecting that our current fiscal year's earnings per share should come in within a range of 75 cent to 95 cent a share. Next quarter's EPS estimate is - we expect to be in the range of 15 to 20 cent per share. That completes the detailed financial review. Now I'll turn it over to Bill Purser, our president for an operations and marketing review. Bill?.

Thanks John. Good afternoon, everyone. I are use my time today for two purpose else. Firstly provide updated information as to what I am seeing and hearing out on the frontlines. Then I will talk to you about a few specific operational and marketing initiatives that I believe will be of interest.

First of all, having just returned, the marketplace for MRO and OEM products remains challenging to say the least. Spending by our customers is sporadic and difficult to predict. Normal spending patterns that we have recognized in the past are becoming just that, a thing of the past. Some of the less cyclical industries, such as food processing are cutting back spending due to the price pressures they're facing in the marketplace.

Capital spending has been being done on an essential basis only. Our customers are telling us there will be little capital spending this calendar year. Even the spending that has been budgeted may be held to see what the economy is going to do. Most are really taking a wait-and-see attitude, when it comes to the coming year. As you can imagine, in this type of environment, price pressure is extreme. We have actually lost some sales where we would not meet these low margin demands.

However, in the midst of it all, we are holding our own by continuing to concentrate on the four things that I have discussed with you during previous teleconferences, just as a reminder, those are the margin emphasis, cost control, asset management, and sales growth, with strong emphasis on protecting our margin. Over the past couple of years we have been working towards operations excellence by improving our logistics, customer service, delivery, training and support. During this time, we have also instigated new methods to gather information and assure that we understand the changing needs of our customers. We believe it's the attention to detail that will allow us to compete in this highly competitive market.

I'll now highlight a few specifics in our operations and marketing. Our new Maintenance America catalog for 2003 will be shipping in February. We have enhanced this edition by adding another 4500 items. Also our 2003 fluid power catalog will ship at the end of January. Over 250,000 customers will be receiving these new catalogues. Current sales for these two catalogues are approximately $3.5 million a month, at better than average margins.

E-commerce continues to be integral to our business. I think most of us know the Internet has really fueled a thirst for information. Many of our customers now expect detailed specifications and digital images of products in order to assist them in their buying decisions. Our applied access and companion sites provide this information. We have recently increased the product information to include over 400,000 SKU's with rich content. We will continue to improve the functionality and content on our sites. Aside from the tradition EDI (ph) channels, E-commerce accounts for approximately $3 million per month in sales revenue.

Along the technology front, we have implemented a new customer billing system that allows for invoices that contain more information and are easier to read as well as being less expensive to produce. We are also rolling out a new network of net PC's to all of our service centers. We have approximately 50 locations in beta test. They have been in beta test over six months now and we feel these PC's will improve productivity as well as customer service effectiveness. The rollout is scheduled to be completed by early summer.

John mentioned earlier, our acquisition of AICO (ph) in Canada. We're pleased they're coming aboard smoothly. As you will recall, AICO (ph) is a distributor operating throughout the BC and Alberta provinces. Their product folio matches well with AIT Limited, our Canadian subsidiary that operates 52 locations and 1 BC and five provinces in western and central Canada. The acquisition of AICO (ph) added 16 locations to that base. The results to date are positive and in line with our expectations. That covers the two purposes I wanted to discuss today. With that, I will return you to Dave for some final thoughts.

Thanks, Bill. I noted in the beginning our numbers for the quarter with regard to expectations were kind of unremarkable, and there's a good side to that. That means we're steady. We're profitable. We're consistent, and we're pretty doggone solid right now. The microeconomics of operational excellence are still being heavily outweighed by the macroeconomics of the marketplace. But this is a company that is moving forward, and we're doing a great many things right. We're well financed and well-positioned. And, yes, we will all be happier when the economy comes back, but in the meantime, we will be focusing on the upside opportunities we have in a few key fundamental areas. I want to thank you all for calling in today. That concludes our prepared remarks. We will turn this back to the operator to field questions from the audience.

Thank you. The question-and-answer question and answer session will be conducted electronically. If you would like to ask a question, please press the star key followed by the digit one on your touch-tone phone. If you're using a speaker phone please be sure your mute function is tuned off to allow your signal to reach our equipment. Again, that's start one to ask a question, and we will pause just for a moment. We will take our first question from Jeff Hammond (ph) at McDonald Investments.

Good afternoon, gentlemen. I wanted to dig in on the gross margin line and also the SD&A line. First, on gross margin, John, if you could provide with us a little more color on where you saw the the improvement in terms of some details on those cost initiatives and then, if you can also address, you know, the vendor price increase issues. You saw the vendor price increases. There was some question whether those increases were getting passed through. I was wondering if you could give us an update on how that is moving along, as well as an expectation for what you're seeing down the road in terms of additional vendor price increases.

Yes, Jeff. Just to give you - maybe a little flavor for it. We have a number of initiatives that we, of course, have been working on to improve our gross profit margin, and I think we had help from a number of those to help our margin. But, in addition to that, we have also, you know, done a number of things in the area of product mix and, you know, supplier purchasing and so forth to actually help us. So it's really hard - hard to really single out, you know, individual items that really helped us in an open forum like this. OK?.

OK.

Again, that is star one if you would like to ask a question. Star one to ask a question? We do have a question from John Dempsey (ph) at Bearington (ph) Research.

Good afternoon, gentlemen.

Hi, Nick.

Good work there, good quarter.

Thank you.

John Dempsey What's the head count currently?

Nick, this is Bill. Currently actual head count 4,512 associates versus 4,441 last quarter. 4,637 last year.

OK. Thank you. And the break do you know between the depreciation and amortization? I thought that was carried on one line ...

It is, it is substantially all on one line, Nick. And it's mostly depreciation. I would say the amortization piece of that is very small now.

And your tax rate was lower for this quarter. Is that reflecting your lower expectation for the full year or is that the real estate?

It does reflect our expectation for the rest of the year. We have had - you know, we were able to benefit from the change in the tax law that went into effect that this is the first year we were able to benefit from. Basically we're allowed now to take a deduction for dividends paid to, you know, to our employees' savings plan and that is a permanent difference that we're able to reflect in our tax rates and that has helped us reduce our overall tax rate.

OK. And you have had some real estate gains. Are they going to be continuing?

Well, we don't know. It has been higher - our real estate gains have been higher than we experienced in the past. We always have ongoing - you know, as a result of having over 400 locations, you have transactions, real estate - you know, as an ongoing part of our business. We have had more gains this year than any year I can recall. Usually we have anywhere between half a million and a million and a half in gains. This year, of course, there they're a lot higher, $2.6 million for the first half of the year, primarily because we were able to find (ph) for facilities that were no longer needed, a good market for those. But we don't expect, going forward, that we're going to have any substantial amount of significant gains from real estate.

John, you gave out the interest expense. Can you repeat that? I didn't pick it up.

It was a $400,000 reduction for the quarter and a million dollars for the year, from the previous year.

OK. And that's the net interest or the interest expense?.

That's net, net interest. And we expect that for the full year we will come in around $5 million.

OK. I don't suppose you're earning much interest these days? Nobody is.

No. No. One good thing, just to highlight one thing, as far as of the - is concerned, we have experienced a fairly good decline in DSO's from our receivables and it's possible maybe a little of that is due to the fact that because companies are no longer earning as much on overnight money, they decided to pay their bills so we maybe a beneficiary to that.

Yes, no benefit to carrying it.

Right.

How many days were - selling days were in the quarter and then the current quarter?

62 days. And we're double checking it, but I believe it was like one more this year than last year. We will double check that to make sure.

OK. And what's it going to be for the current quarter and next? If you have that?

Let me pull that out. If you want I can get that for you.

Sure.

Actually it's the same this quarter as the last quarter.

Just one correction. We had 62 days this year in the second quarter and 62 days last year in the same quarter, so we had the same number of days in both quarters. And for the next quarter, we will have 63 sales days versus 62 and a half in the previous year. A lot of that has to do with the timing of eastern. But it is 63 this year versus62 and a half last year.

OK. And how about bad debts? Do you have anything coming along?

Last year, there was no real major change in bad debt in this year versus last year.

That's encouraging. Or was last year the year you had the big quarter.

We have managed that very well and I think we put some really good controls own that.

OK. Good, good. I think that will do me for the moment. Thank you.

OK, thank you.

We will take our next question from Brian Rell (ph) at Midwest Research.

Good afternoon. I just had a couple of quick questions on the pricing issue, talking earlier about the price increases that you're getting from your vendors. I was wondering what your experience has been with being able to, you know, pass that price on to your customer base?

Brian, this is Bill. Obviously it's our intention to price - pass along all price increases we received from the manufacturer. Again, with a conference like this being open, I don't know that I really want to discuss the strategy that we're using, but just to say that it is our intent to pass the price increases along.

Fair enough. One other question. You said that you had some good seasonal buying opportunities that, you know, will help margins going forward. I'm assuming that vendors are passing on these prices. So are those seasonal buying opportunities, you know, a little less favorable this year than they were last year?

I think they were just - they were pretty much, you know, comparable to the previous years.

OK. So there was ...

You know, it obviously in - encourage like that we do - we do that when it's opportunistic to improve our return on assets.

... the same deals are also available to our competitors, so I don't think it puts us in any overwhelming favorable position, but we do take advantage of it. Our balance sheet has allowed to us do so.

OK, so the - but the pricing you're getting for your vendors, you know, it was favorable last year, too, at this time. The little bit of price increases you're getting from your vendors, are they, let's say the vendors increased theoretically prices by two percent, are the seasonal buying opportunities in this quarter two percent less favorable than they were last year or are they about the exact same per unit price basis?

That's a hard question to answer. I think just based upon the comparability, you know, they're probably a little bit better, but I think for the most part, they're ...

On a relative basis, based upon, you know, market price levels out there, on a comparative basis.

OK. Thank you very much.

Just a reminder, if have you a question, please press star one and we will take a follow up from Jeff Hammond (ph) at McDonald investments.

Hi, guys. Apparently I got cut off there. One last thing on the price increases, are you anticipating any further vendor pricing increases moving into calendar'03?

Jeff, this is Bill. We had some toward the latter part of the calendar of last year. If - there have been no announcements or guidance from suppliers as to increases over the next six months. I'm not saying we're not going to have any, but at this point in time we haven't had any guidance along those lines.

On the SD&A line I want to understand sequentially the increase. I mean, you had a drop in terms of sales volume sequentially, although they did hold up pretty nicely year over year, yet you had a pretty substantial, you know, increase in the SD&A line, and I'm wondering, are you seeing - you know, was there a sequential increase in those benefit costs or is it something else?

Well, Jeff, there are a couple of things you hit on there, too, and, you know, we continue to invest in areas where the immediate returns may not be realized but where we think they're going to be real long-term customer benefits and we picked our spots in some of these. We continue to have short-term fluctuations and in volume and margins, as we make strategic decisions aimed at this long-term profitability.

So to look at this quarter and look at SD&A, you know, I don't know that, you know, you're going to put anything on there that says that every quarter is going to be exactly the same.

Oh, sure. But I guess the comment with regard to, you know, benefits and insurance costs, that's more related to a year-over-year impact?

Yes.

OK.

We're still feeling the effects of 9/11, OK, with regard to insurance costs.

OK. Can you give me the same-store sales number again? I missed that.

Right. I believe - let me just pull it out here. Overall, our sales were up 2.3 percent and same store was up1.3 percent.

And what was the contribution - so the difference would have been AICO (ph)?

And location. Most of the difference is AICO (ph). You know, there might have been some locations that were opened, you know, during the period. that were not opened for last year. But most of it was AICO (ph).

And if you look at your guidance of 75 to 90 cents, you put that out really at the beginning of the fiscal year or when you reported your year-end results.

Right.

I guess when you officially put those out, what did you have inherent in those numbers in terms of the real estate gain?

We thought for the year we would probably have --probably not more than four cents per share. And it just turned out that the market for pieces of real estate has been very favorable for us to be able to sell those, so we have taken advantage of that opportunity. So the gains are greater than we anticipated.

OK. Then my last question, Bill, on the end market front, you mentioned some slowing, I guess, on the food processing side. Are you seeing any trends positive or negative or is it kind of just flat or no change, you know, over the past couple of months.

Well, the industries which we track the leading indicators, Jeff, we have got four that are showing an upward trend. I have to be a little cautious in three of them because when you start from the bottom, it's easy to show some upward trend. Automotive is trimming up. But the three that I'm referring to that we're showing an upward trend that is coming really from, like I say, a low base is primarily - primary metals, paper, and the high-tech. I think it's too early to say they're trends, but we are seeing some upward movements. But again, starting from very low basis because those three markets have been very depressed.

I guess then back to the auto, there's obviously a big question moving into '03 where that goes. What are you guys planning in terms of - I mean that still seems to be trending up. Are you expecting that to slow at all or ...

Well, the concern is whether or not the rebates and our zero financing will continue to drive the consumer to the automotive showplaces and continue to buy the product. I think that's a major concern in the housing market and in the auto market now as to how that is going to fair out.

If you look at how you sell into the auto market, would you say it's more impacted by capital spending trends, you know, on the factory floor, by the auto makers, or is it more on, you know, auto production?

Well, if the plants - you know a lot of the plants are still running at 60 and 65 percent capacity. There's where - the advantage to us is those plans are running over 80 percent capacity. The capital expenditures eventually reach the plant floor. But we need those auto plants running full bore and at least at 80 percent capacity for us to realize our gains from the MRO products that we sell.

OK. Thank you.

We will take at a follow up from John Dempsey (ph) at Bearington (ph) Research.

Yes, could you give a little more historical information on your catalogues and the E-commerce, what they were last quarter or last year, just so I can see the trend here?

Bill - let me see if I can pull those numbers for you. We have - let me give you this information that may be of help to you. The maintenance America catalog - remember the fluid power catalog is still relatively knew for us. We have a little more history with the maintenance America catalog and I believe it is up, I believe, this year and has increased over 30 percent in sales.

One other comment, too. The E-commerce, of the web-based ordering is growing at a faster rate than our sales in general.

Whoa.

Which is a good picture. The height was way ahead of the actual usage. But that's a good picture for us, because we do have the installed base of investment to handle that. I think we have one of the best Web sites out there in our industry. It certainly is an efficient means of doing business for us, and to the extent that customers become less inhibited, in using that, that will be a benefit to us from a strategic and a cost-standpoint. We're looking forward for that to go faster.

Do you have the I number for what it did in the last quarter?

I don't I don't have that handy. But it's growing - it's still a small piece of business but growing faster than the business in general. The trend is what I like, the willingness to start ...

I'm trying to get at that. What is the trend?

John will be able to give you that on the callback. We just don't have it right here.

You know, in total, it's less than two percent of our sales but it has been trending up.

OK. I appreciate that, John, if you could. Thank you.

Once again that's star one to ask a question. And Mr. Shaw, it appears there are no further questions at this time.

Thank you operator.

: Great, Amber, thanks very much. Thanks to all of you who participated today. It was good to put forth these earnings and looking forward to having another good one next quarter. Thank you very much.

That concludes today's conference. We thank you for your participation and you may now disconnect.