Applied Industrial Technologies Inc (AIT) 2004 Q1 法說會逐字稿

Hello and welcome to the Applied Industrial Technologies' first-quarter 2004 financial earnings conference call. All lines are 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 at this time. I would like to introduce Mr. Richard Shaw, Applied's Vice President of Communications. Mr. Shaw, you may begin.

On behalf of Applied I would like to thank you for joining our call today on this holiday, Columbus Day. You should have already received our earnings news release that 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 for the next two weeks and archive information is contained in our news release. I would like to remind everyone that we will discuss Applied's business outlook during this conference call and make statements that are forward-looking. Applied intends that all forward-looking statements be subject to be 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 most recent periodic report and other filings made with the Security and Exchange Commission. 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 that the results expressed therein will be achieved. Applied assumes no obligation to publicly update or revise any forward-looking statements whether due to new information or events or otherwise. This conference call is the copyrighted property at Applied Industrial Technologies. Any copying, rebroadcast, publication, posting, transcription or distribution of any portion of this call without Applied's express prior written consent is prohibited. With that said, our speakers today include David Pugh, Chairman and CEO of Applied, who will discuss our overall performance during the quarter and the year continuing. We will also hear from John Whitten, Vice President and Chief Financial Officer who will discuss our financial performance in detail. And Bill Purser, President and Chief Operating Officer who will discuss our operational activities during the quarter. Here to start us off is David Pugh.

Thanks. I trust that by now you have had the opportunity to do your initial reviews on our earnings release. The manufacturer economy continues to be weak and stagnant, most of the industry indicates such are face-to-face discussions with our key customers and suppliers confirm it, and our sales, unfortunately reflect it. While there is no significant shift downward, we've just experienced our eighth straight month of a slight decline against prior year comparison. At this point it's difficult to assess when the manufacturing market is going to recover. The way we look at it is if we can't find money to drive earnings under the current conditions, you face at least a major challenge. We are reevaluating all of our operations under this microscope. Success in this environment requires planning, discipline and patience. The good news is we are continuing to express success in driving the earnings. While our sales were at the low end of the guidance, our earnings per share reached the high end of what we felt was possible. These earnings reflected a fairly strong improvement over last year even while sales were down and while we were (indiscernible) gains from real estate sales we enjoyed last year, and while we (indiscernible) cost of expensive options in accordance with the Fast B Scanners (ph) 123 and 148. This is our fourth consecutive quarter of the year-over-year earnings per share increases of 20 percent or greater. Our guidelines indicate that we expect increases to continue. I do feel a lot of our improvements are now inbedded as based processes rather than speculative initiatives. And while we still have upside potential, but the next round is going to be a little tougher to come by. I'm going to have John and Bill add a little bit of flash to the (indiscernible) and review the (indiscernible) provided. First, John.

Rather than repeat the press release, I'm going to provide some additional insights into our performance for the quarter. From the standpoint of sales we anticipated that the first-quarter and for that matter the first half sales would be a challenge for the current fiscal year. We continued to see weakness in our U.S. service center based business that continued throughout the quarter. This weakness continued to be partially offset by strong sales performance of AIT Ltd., our Canadian operation. Offsetting the weak sales performance with strong margin performances are initiatives in the area of product pricing, recovery cost control as asset management continue to show progress. Specifically our gross profit margin for the quarter continued to improve by about 150 basis points over the same quarter last year, and while the impact of vendor rebates have flattened out, pricing initiatives and freight recovery at the margin level helped us to generate our improved bottom line results. With two fewer facilities in the same quarter last year, our sales decline per facility on a per day basis was about 2.8 percent. FD&A expenses were up about $2.4 million. Approximately $1.4 million, or 4 cents per share after tax gains were included or as an offset last year from the gains on sales of real estate. We also began expensing our stock options in accordance with SFAS 148. This added an additional 359,000 of SD&A expense for the quarter.

Our sales mix for the quarter was about 84 percent for industrial products and 16 percent for Fluid Power Products. Industrial product sales decreased by about 2.1 percent for the quarter, while Fluid Power sales decreased by about .1 percent for the same period. Our interest expense net for the quarter was up about $57,000 from last year as a result of lower interest income. Our share repurchase numbers were included in the press release. Our average purchase price per share was around $22 a share.

We currently have authorization to repurchase up to one million shares. At quarter end, we had approximately 19 points, $3 million shares outstanding. Our balance sheet continues to be very strong. Our inventory balance increased by about $4.2 million during the quarter. Our total cash used in operations was about $8.6 million as we used cash to satisfy seasonal working capital needs. We expect to be cash flow positive in future quarters and throughout the year.

Capital expenditures were about $8.7 million for the quarter, the biggest portion of that was the fact that we have exercised the $7.5 million option to purchase real estate that is currently used in the business that was previously under synthetic lease arrangements.

Our depreciation and amortization came in about $4.1 million for the quarter, and is expected to be about 15 to $16 million for the entire year. Our next scheduled payment on the remaining long-term debt that we have currently on our balance sheet is not due until December of 2007. We provided guidance in the press release, but just to reiterate that, our financial guidance for the current year is as follows; the next quarter we expect flat sales in a range of 348 million to $350 million, and earnings of about 20 cents to 25 cents a share. For the year, we expect that our sales will come in somewhere in the range of about 1.45 billion to 1.5 billion or about the same level as a fiscal 2003. We do expect however to see continuing improvements in profitability. We expect gross profit levels to be in the range of about 25.5 to 26 percent. In fact, we expect it to be closer to 26 than the 25.5. through the next quarter. We anticipate the decline of rebates during a remainder of year will be offset by improvements in freight recovery and pricing so our gross profit will be approximately the same for 2004 as 2003. Maybe a little bit higher. We expect a decline in our SD&A expenses from the elimination of losing operations that occurred during fiscal 2003. During fiscal 2003, we closed and consolidated about 25 operations primarily in the United States.

Interest expense should come in around 5 million for the entire year, about the same level as 2003. We also expect the overall tax rate will trend down somewhat and be somewhere in the range of 35.5 to 36 percent for the entire year. We also expect that our capital expenditures will be in the range of anywhere from 14 to $15 million for the entire year. As we mentioned before, a substantial portion of that occurred during the first quarter. So putting it all together, we are expecting that next year's earnings per share should come in within a range of about $1.10 to $1.20 for the entire year. We expect that about 48 to 49 percent of our sales total will come in in the first half and 51 to 52 percent will occur during the last half of fiscal 2004.

Now what I would like to do is turn the call over to Bill Purser for commentary on our sales climate and operations. Bill.

Thanks John, and good afternoon everyone. Despite the weakness in the economy, I want to make sure that everyone understands we are working hard to drive sales. In fact, we have recently started work on three new initiatives that I expect will begin bearing fruit later in this business year and should really impact our top line in FY 2005. In each case, these initiatives involve sharpening our focus and discipline in the field to better understand and serve our customers.

First we've got a customer segmentation and action program to improve profitability as well as generate new sales from existing accounts. On a company wide basis, we are examining profitability by individual customer and developing an action plan to mine opportunities in each tier of customers. Our top priority in this initiative will be to energize our team to improve sales to our best and most profitable customers. In a second initiative, we are customizing marketing programs by sales area across the U.S. Many of you are familiar with the Insync Marketing programs we began developing several years ago. Through Insync, we developed tailored marketing tools and sales programs for targeted industries. We are now in the process of taking In Sync to the next level; developing programs that can be customized for implementation in specific geographic markets. Again, it's a matter of intensifying focus in a subject where we already have significant expertise and experience.

Third, we are continuing to pursue opportunities to sales services for a fee. Our five store (ph) plus inventory management system is being adopted by more customers every quarter. Most recently we have begun offering fee-based technical training services to industrial companies under a brand we call Maintenance Pro. We've recently completed several beta tests in the training curriculum and initial customer response has been very good. These fee-for-service initiatives still are relatively small but they represent new territory for generating revenue and profit. Concurrent with these new initiatives, our field organization is keeping a lid on expenses while also maintaining high levels of service and on-time delivery. We are still looking for the first signs of recovering in manufacturing and in my travels around the U.S., I see a mixed bag when it comes to our customer's attitudes about the economy. Most of them are still being conservative in their spending, but for the first time in a long while, we are starting to see some signs of companies releasing CAPEX money. Not that there is enough there that I would call it a trend, but there is some slight encouragement for a recovery, while I still think it will be slow when it comes. At this time, I would like to turn the call back to Dave for a wrap-up.

Thanks, Bill. The improved results that we are realizing today are the culmination of some well-considered solid plans by our leadership team, good communication process from internally and externally, and persistent efforts by all of our associates. (indiscernible) and it certainly doesn't appear the competition is going to let up or that customers are going to be any less demanding in the future. We do feel that the diligent execution of quality processes will continue to carry us forward. We will always do the basics well, and we will look for the occasional major opportunity that will help change the balance of power.

Now before we head into the questions, I would like to remind you that John Whitten announced earlier this year that he would retire on December 31st. John's actions were an affirmation (ph) of trying to get off an adequate period to perform a thorough search for his replacement and to squelch any speculation about underlying reasons for his leaving at such a young age. This will be John's last conference call, in an official capacity anyway. I state it that way to leave open consultation opportunities in the future. Feel free to (indiscernible) while you pepper him with questions. With that, I'll turn it back to the operator and we'll field questions.

(OPERATOR INSTRUCTIONS) Holden Lewis from BB&T.

Good afternoon. Thank you. Could you give a little more detail on the improvement in the gross margin, specifically (indiscernible) that vendor rebates have flattened out. If I remember correctly, Q1 didn't have a lot of those last year. It seems like those comps get tougher in upcoming quarters. But how about the transportation initiative? I know that kind of plateaued about a half million quarterly. Is that showing more legs or is that kind of where that's sticking? And can you sort of quantify for us to some extent the impact that the pricing improvements are having on the gross margin, please?

Holden, just to kind of give you an idea, what we're finding is that our pricing is a lot more solid at the customer level, and we've seen some fairly good improvement at that level. And this is pretty much by design. We have spent quite a bit of time fine-tuning our pricing process, looking at what we need to do in terms of our products and the products that we could maybe inch up in terms of our pricing. So we had a very solid improvement in that area. In addition to that, we also had improvement in the area of reducing our freight costs, quite frankly. Freight cost reduction really did help us during the quarter, as well as the increased freight recovery and pre-billing (ph) to our customers.

Do you have a sense -- I mean did you get more out of the transportation this quarter, for instance, than you had gotten in the prior two quarters when it seemed to have plateaued in terms of dollar contribution?

I think it improved a little bit. I think probably the pricing probably was quite a bit more than the transportation.

Do you have a sense, if you don't want to talk about pricing in the quarter in percentage terms, how much of the gross margin improvement in basis points can you attribute specifically to the price improvements?

We have to be real careful when talking pricing as far any signaling here, but pricing, just on a macro basis that's where we feel like we have the highest opportunity for an uptick. When you're coming out of the shoot on that one, and still we did well coming out of the shoot, but I think that is where we are going to see the majority of our margin increase for the future. We're reaching maturity in the freight recovery beat. Were not relaxing, still we have not met our objective in that area. Were are certainly much further along in that area than we are in pricing.

What about pricing at the national account level? Is that still pretty challenging offsetting some of the other stuff that is going on or are you holding your own there?

It certainly is a challenge in any of the national agreements. I do believe we are holding our own. But it is quite a challenge.

Thank you.

Mark Koznarek from Midwest Research.

Could I just follow up on this pricing issue given that you are describing that as the area that has the most opportunity. I guess I'm just not clear on exactly what this is, was this a one time across the board increase that occurs every year at a certain time, or is this more a tactical pricing program where item by item you are raising price? I guess I'm wondering what is the opportunity to move it up over the remainder of your fiscal year if customers are used to seeing the price move at a certain time? Maybe you could just help me understand the strategy here.

It's more tactical in nature. We've also been providing the field with some pricing tools via the system that they've not had in the past which has given them a better opportunity to view where the margin levels were. So it's a combination of things. It's not predicated on the an annual price increase. It is really more tactical in nature.

So does that mean that you have only reviewed certain product lines and moved prices up and you have a schedule to review the remainder of your SKUs, how are you physically going to do that for the remainder of the product line?

Basically we reviewed a segment of our business. And we've looked at where the proverbial hanging fruit happened to be. And we do believe that there are upside opportunities that we are already looking, but we started with some opportunities as I said in the low hanging fruit area that we felt like systems help would enable us to get some better margins which has been the result.

Just to give you a little bit of sense of the improvements, basically what were talking about are systems that have been piloted for quite a while. We actually have just begun to see some of the benefits. I think during the mid-quarter, so it wasn't really in affect for the entire quarter.

This isn't rocket science. A lot of it is just basics. Let's look at supplier profitability, let's look at profit in product line profitability, let's look at customer profitability, and understand not only where we want to make change, but where we have to make change. And some of these that pay the docket balance issues, but in some case you make a determination what the risk is and if the reward is worth the risk.

So have you reviewed -- where are we in terms of product line reviews for these tactical programs, are you one-quarter of the way done or is it half or two-thirds?

It's much less than one quarter done. We've only really scratched the surface.

If I could ask you just one more question having to do with end markets where you are saying any pockets of strength if there is some, and any areas that might still be deteriorating?

One of the areas, Mark, that we have seen that I don't think will be a surprise is pretty strong is the lumber and the wood side. And that's related to of course, construction. That's been strong for us. Food continues to hold up. But areas such as primary metals are down quite a bit. Overall, the pulp and paper is fairly flat. Those are the drivers for us. The across the board, as far has any stellar SICs, I would probably say it wood products has been the best for us for the last twelve months.

What about that small semiconductor related piece that you guys have, any signs of life there?

Not really. It's a pretty tough market. In fact we see it going the other way.

Thank you very much.

(OPERATOR INSTRUCTIONS) Jeff Hammond from McDonald Investments.

Good afternoon. If you can just run through the working capital use in the quarter. If I look back a few years generally you are generating cash from working capital. I want to understand what was behind perhaps some of the inventory build and perhaps the major decline and other current liabilities what was going on there?

Basically, as I mentioned before, its pretty much seasonal and what we did during the quarter is we paid a lot of the -- we paid down a lot of liabilities, current liabilities. Liabilities that were classified as current during at June 30th. A portion of that we do have for example the incentive payments. Those are all paid after the end of the year. That's paid in the first quarter from the previous year. We also had reduced our tax liabilities. We had to pay our tax liabilities, and so those were all paid down during the quarter as a result of performance that we had last year. During the quarter also we had, we brought some additional inventory about $10 million, we had some special buying. $10 million in bi-programs for the quarter. We are very pleased that in spite of that or in the face of that we are still able to hold our inventories pretty much at the level we are currently holding them. So, I think it was mostly seasonal more than anything else. For example, we pay our profit sharing contribution during the quarter and we only pay that once a year and so we tend to have high demands for cash in the first quarter of the fiscal year. I think in the past we had -- we probably had a little bit more in the way of cash provided from working capital primarily from reducing inventories. (technical difficulty)

I guess back to the price. Are you giving any push back on some of these pricing initiatives and perhaps along those lines, are customers -- are you walking away from sales or losing some sales tied to that initiative?

We really haven't seen an appreciable loss of sales. There has been some, I won't kid you, but not to any great degree as a result of the initiatives.

(indiscernible) at the old price levels. What we are trying to make sure that we understand the services that our customers value and price appropriately for those services. To the extent that customers stick with this, we are retaining what they value. And this is a balancing game. We will continue to do this forever. We've asked the question pretty clearly from our guy that we have pressure on with regard to pricing activities, you know are we forcing ourselves out of the market? The answer is no.

It may be a bigger picture question. Have you been able to or what have you seen along the lines of the impact from manufacturing being permanently shuttered domestically and moving to low-cost manufacturing centers where you are not located?

This is obviously a big concern of ours. In fact, we are revisiting the potential numbers trying to get a hold on what that exodus has been. It's touched every SIC base that we deal with for the most part. We do feel there are certain SICs that will not leave the country and those are part of the programs we are looking at. But there is no question about the over all base has been reduced.

Lastly, can you give a sense of how the average daily sales rates trended July to September, did it get incrementally better throughout or vice versa, worse?

I think as we looked at the daily sales rate at least in the U.S., it seemed as though they've just got improved just slightly from one month to the next. But it really didn't come near what our daily sales rate was in the previous year. In other words, August was better than July, September was better than August on a daily sales rate basis.

But each month was below same month's prior year.

Okay.

Canada continues to be a strong but they also their performance tends to be seasonal. They tend to do better in summer months, early fall and then they kind of decline during the winter months. I think a lot of that is weather-related and industry-related to the industries that they are serving.

How much of that is being driven by oil and gas being very strong or is it just a stronger economy up north?

I think it is an overall stronger economy. The natural resource economy piece obviously helps. But its just an overall stronger economy.

That is a driver for us in that market. In western Canada particularly. The price of oil is very important and we do a good bit of OEM business in that industry.

Thanks, and John good luck to you. We will see you on the golf course in Cleveland down the road.

Thanks.

Bill Wiza (ph) from High Rock Capital.

John, I enjoyed your straightforward candor through the years and I will miss our conversations, good luck. Bon Voyage. But I guess just a little more kind of big picture stuff, because it's been a long time since I've heard you guys have anything positive to say about the U.S. economy anyway. In your opening comments, it didn't sound like you were jumping up and down. It did sound like you're starting to see some signs the companies are relaxing their stranglehold on CAPEX dollars. But then when you were walking through the end markets that didn't sound a whole lot different than what you said on past calls. I'd like a little more insight there and then I've just got one more specific question on the semiconductor end market.

What I am seeing is at the beginning of this year, calendar year, I did a rather extensive survey with our customers across as many SSCs (ph) as I possibly could. They fell into two camps at that point in time. Those that had CAPEX budgeted and approved but were waiting to see what was going to happen in Iraq, and then those that had no CAPEX budgeted for the calendar year. In both cases, neither were spending. What I've seen most recently is talk of loosening of funds. What's happening, I think, is you can only run this equipment and patch it so long and then you are going to have to replace it and you're going to have to spend some money. I think that is what is happening. I think it's been mandated to a point where it can't go any further and some equipment is going to have to be replaced. This is a little bit of the light at the end of the proverbial tunnel. I don't want to call it a trend, not by a long shot. But I haven't heard for so long any positive out in the market that maybe I'm grasping at straws.

At this point it's talk as opposed to orders, but at least it's talk.

We've seen a little bit already released. But I wouldn't say it's a trend by a long shot.

Thanks. With regard to the semiconductor end market, that also seemed a little bit different than a lot of the data points coming out of those companies seemed to be incrementally positive right now. In your comments you even indicate that things might still be slowing there, is that a market share issue or something specific to your customers?

The customer base that we deal with in that market are continuing to struggle. We are not hearing, those positive signs are not coming out of that industry in our conversation. We stay fairly close to that industry and we do business with some big players in it. We are just not hearing anything at this point in time that there has been a lot of cost-cutting in that industry. We just don't really see a lot of silver linings in those clouds.

What is happening is that the semiconductor sales are really being pushed up from the demand for laptop computers. Unfortunately it has not made its way through the food chain to the equipment manufacturers at this point.

Thanks a lot.

Holden Lewis from BB&T.

How much did IECO contribute in the quarter, I think you gave a general comment as to the environment for acquisitions that you are seeing?

It was a little over $3 million, I think $3.2 million for the quarter. Which is about what we expected it to be. So I think that kind of gives you an idea of why IECO was not there last year so that's one thing that is added to our sales. As far as the acquisition, it is pretty much unchanged.

It's a tough environment to find people who are willing to wave the white flag and go elsewhere. It's like one took place in our industry over the past quarter, but nothing huge.

Thank you.

(OPERATOR INSTRUCTIONS) Mark Koznarek from Midwest Research.

I just want to check a number on the same store sales. You said it was down 2.8 percent, is that right?

That's right.

Now in the fourth quarter, your June quarter, wasn't the commentary that that was off only 0.2 percent?

I don't have that information with me, Mark, but I think what you are saying, it does sound right.

That is deterioration, and yet your verbal commentary is more positive, you just went through that with the other questioner about some modest signs of releasing of capital dollars. So how do those two facts fit together?

I think my comments related to each month versus the previous month. And overall versus the same quarter of last year. I didn't really compare them to the fourth quarter of last year. That is one difference.

I guess I'm just observing that fourth quarter over the fourth quarter year ago you were off only slightly in the same store sales, and now on similar year-over-year comparison you are off nearly 3 percent. That sounds like things got worse rather than continue to trend of improvement?

As Dave mentioned before, we've had how many months, eight months in a row of sales that were of declines in sales in the US.

Not month over month, but same quarter, prior year.

All I am observing is that it seems like the decline is getting wider rather than narrowing. Is that correct by looking at these numbers?

You are exactly right, and maybe the eternal optimist here, if you find any one point of light in this economy, you grasp it. The numbers are correct, and we are down 2.8 on a domestic basis and every month for the past eight months has been less for the same months in prior years. This quarter was nothing to write home about. With regard to a forward look, and you see a few data points in some of the indexes starting to come together for the first time. I think we are still a good six to nine months off of really experiencing anything that we would be willing to have a party about.

So it's sort of qualitative comments or more forward looking. Actually your pricing improvement in that environment where sales are getting worse is actually pretty impressive. My hat to you on that one. It looks like the number of shares went up pretty substantially, like 300,000 if you add back what you repurchased in the quarter. What was going on there and should we expect a continued wave of increase in the share count as we go through the year?

With the improvement in the share price, we did had a number of people that exercised stock options and held onto the shares. So there was an option exercise. I think that was probably the biggest single thing. Plus we did issue shares for the employee match in the 401(k) program. So both of those phenomenon actually did have a short-term impact to increasing our numbers of shares outstanding.

The employer match is only once a year?

It's done every quarter but it tended to be higher because of the higher match. In fact just looking at the numbers outstanding, at the end of January of 2003, we had 19,020,000 shares; at September 30, we had 19,253,000, so we are only up a couple hundred thousand shares. Most of that is from the exercise of stock options and retirement savings plan contribution of treasury stock.

So if the price stays up there we might see more exercising going on -- ?

It's up to the individuals.

Thanks.

This does conclude our question-and-answer session today. I would like to turn the call over to our speakers for closing remarks.

I would like to thank you all for joining in today on this holiday and we look forward to speaking with you again in January when we report our second quarter. Thank you very much.

That concludes today's Applied Industrial Technologies conference call. We do appreciate your participation. You may now disconnect.