Applied Industrial Technologies Inc (AIT) 2004 Q2 法說會逐字稿

Hello and welcome to the Applied Industrial Technologies second quarter 2004 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 objections, you may now disconnect at this time.

I would now like to introduce Mr. Richard Shaw, Applied's Vice President of Communications. Mr. Shaw, you may begin.

Thank you, operator and good afternoon everyone. On behalf of Applied, I'd like to thank everyone for joining our call today. You should have already received our earnings news release that was issued earlier this afternoon. If you have not received the release you may retrieve it by visiting our website at www.applied.com. A replay will be available for the next two weeks and archived information is contained in our news release.

I would like to remind everyone 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 will 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 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 that the results express 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 of Applied Industrial Technologies. Any copying, rebroadcast, publication, posting, transcription or description 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. We will also hear from Mark Eisele, Vice President and Chief Financial Officer who will discuss our financial performance in detail. And finally, Bill Purser, President and Chief Operating Officer will join us to discuss our sales and operational activities during the quarter. Here to start us off is Dave Pugh.

Thank you, Rick. First let me update you on a few organizational changes that some of you will find useful. I'll begin by welcoming Mark Eisele, our new Chief Financial Officer to this call. As we have announced Mark was elected Vice President, Chief Financial Officer and Treasurer effective January 1. Mark replaces John Whitten who retired at the end of the year after 22 years of being with the company. Since old habits are hard to break, John is probably listening in right now to make sure we do this right. John, if we don't, I'm sure you'll let us know. Mark has been our Controller for the past 11 years. Many of you have met Mark and are familiar with his work. I feel very fortunate to have someone of his caliber and industry knowledge to succeed John.

Filling Mark's former role as Corporate Controller is Dan Brezovec, a six-year Applied veteran who has served as our Director of Internal Audit for the past three years. It speaks well for the quality of our success in the planning process, that we could replace both John and Mark with internal candidates. I'm sure you're going to find Mark just as approachable, candid and genuine as John was. And for those of you who need to call in, Mark can be reached, it's a new number, it's different than John's old number. His number is 216-426-4417.

Also joining our executive team since the last call is Maryann Correnti, our new Vice President for Strategic Planning and Development. Maryann came to us after a distinguished career with Arthur Anderson. She comes highly recommended by several former clients with whom she consulted on growth strategies. She has an excellent background in finance, as well as in mergers and acquisitions and she brings an unsurpassed energy level to her new job. As we begin to see signs of an economic recovery, the timely addition of Maryann will help us take a fresh look at growth possibilities to compliment the operational gains we have already accomplished.

I trust that by now you've had the opportunity to do your initial reviews on our earnings release. You can see a continuation of the trend of the past few quarters, essentially, flat sales and improved margins. This was our fifth consecutive quarter of 20% or greater increases in our earnings per share compared to the prior year's results. We've maintained our focus on operating excellence in all areas. I still believe that if we properly stress excellence, all else will follow. We continue to push our quality teams hard, and they are responding with continuous improvement. Although much progress has been made, we believe there are still gains to be made.

It's important though, that we don't get too far ahead of ourselves in expectations for top line revenue growth. Like you, I read and hear about the signs of optimism in the economy. The December ISM index was very interesting. As are the recent data on factory orders and industrial production. All of these are quite positive. Offsetting that are disappointing numbers on consumer debt, capacity utilization and consumer confidence.

Our customers have worked hard on productivity and quality over the past few years, just as we have. So there are fewer motors, shafts, and bearings producing more output. We have yet to see any material effect of the increased production on our sales. Typically, we lag these indicators by about six months. So we don't expect to see the increase until our fourth fiscal quarter, at the earliest. If it shows up sooner, great. But based upon the performance of the manufacturing economy of the past few years, we're somewhat reluctant to be aggressive in predicting when the sales increase will come.

Given the productivity gains that we've seen in this country, it's going to be interesting to see how MRO sales react to the industrial output driver versus the capacity utilization driver. That's not to say that we're sitting idly by. As Bill will report in a few minutes, we're continuing to make structural improvements in our operations, and we are pursuing new opportunities so that we're fully poised to exploit an upturn when it arrives, if it arrives.

Our SG&A showed a year-over-year increased that was purely event driven. Base costs remained at or slightly below last year's rates. Mark will provide the details of this a little bit later.

Our inventory increase for the quarter was a little bit out of character, but it was the result of well considered buys. I believe we've done a excellent job of asset plant management and planning, and we're going to achieve the economic benefit of those buys. We expect our fiscal year to end with inventory levels at or below last year's. And those inventory levels will be supportive of our on time delivery goals for our customers, and they will be sufficient, even if the market does kick up in the fourth quarter.

With that overview, I'll turn the call over to Mark now for a review of the financial details.

Thanks, Dave and good afternoon everyone. I would like to provide some additional insights on our second quarter performance. From the standpoint of sales, we anticipated the second quarter would come in slightly down with last year based upon the first quarter results we experienced. We ended up the quarter with an increase of 1.1% with sales of $359.7 million. That put us slightly above our guidance of 340 to $350 million.

With the same number of sales days in the current quarter as the prior year, our increase was driven mainly by our Canadian operations. AIT Limited continued to perform very well with sales up over last year. While a portion of the increase is due to the strengthening of the Canadian dollar, the majority of the increase relates to actual year-over-year volume increases. Same store sales in our U.S. service center operations continued to show softness, declining 1.5% in the quarter. The U.S. fluid power subsidiaries also experienced a 5% decline in sales for the quarter.

Gross margin performance was strong, as our initiatives in the area of product pricing, freight recovery, cost controls, and asset management continued to show progress. Our gross profit percentage improved over last year's second quarter by 90 basis points to 26.5%. Our benefit from improved pricing and freight recovery were somewhat offset by lower rebates from our suppliers, which negatively impacted margins.

We also recorded some beneficial cost adjustments during the quarter which, in the prior year, were incorporated into our fourth quarter annual physical inventory adjustments. These adjustments relate to our inventory cycle counting programs and interim inventory reconciliations, which continued to improve and provide us great operational data.

SG&A expenses were up from the prior year by around $2 million. The majority of the increase, about $1.2 million, reflects decreases in the gains on sale of real estate, which we receive the benefit of in the prior year. As you may recall, real estate gains were a significant factor reducing last year's SG&A, but we saw significant lower real estate activity this year.

Healthcare and other benefit expenses were up this year, too. We began to expense stock options this year in accordance with FAS B 148, which added $300,000 to SG&A during the quarter. Also note, we begun to include SG&A expense for the Rybalsa Mexican acquisition during the quarter. Aside from these items our SG&A expenses were relatively flat in the second quarter.

Wrapping this all together, our operating margin performance improved to 2.6% in the second quarter compared to 2.1% in the prior year's quarter. As reported in our press release our net income per share of 26 cents exceeded the high end of our guidance, which was in the range of 20 to 25 cents.

Shares outstanding at the end of the second quarter were 19.3 million. We only purchased 5,000 shares during the quarter and 96,000 shares year-to-date. These all related to buy backs from company equity based incentive plans. We continue to have authority for the purchase of an additional one million shares in the market place.

Our balance sheet continues to be very strong. Inventory did increase $27.3 million from our September balances, $31.5 million from the June balances and $9.5 million from last year's December inventory balances.

These increases primarily pertain to special calendar year buying opportunities. We expect the majority of these special buys to work their way through our system by the March quarter end, and to be back down to our June 30th, 2003 balances by our year-end.

In addition, other inventory increases include the $1.8 million of inventory from the Rybalsa Mexico acquisition and $2.3 million from the consolidation of i Source, our partially owned minority business enterprise, which we are now consolidating in accordance with FAS B interpretation number 46.

Our December 31 cash balance was about $30.7 million lower than last June 30th. We used cash in the second quarter primarily to build the inventory levels. We expect this trend to reverse and to generate positive cash flows from operations for the remainder of the fiscal year as inventory levels trend down towards our June 30, 2003 balances.

Our sales mix for the quarter was about 84% industrial products and 16% fluid power products. Also mid-quarter Applied Mexico acquired Rybalsa a five location Mexican distributor. In the second quarter we have included one full month of Rybalsa'a operations, which were accretive to our earnings.

In addition to the five service centers we acquired in Mexico, we also opened one service center in Canada, closed or merged five additional service centers in Canada and merged three locations in the U.S. This resulted in a net decrease of two operating locations during the quarter, down to 438 locations in total.

Our depreciation and amortization expense now includes the amortization of our stock option expenses and came in at about 4.4 million for the quarter and is expected to be 16 to $27 million for the entire fiscal year. Our next scheduled payment on our remaining long-term debt is not due until December of 2007.

We do expect to sustain our improvements in profitability. We anticipate third quarter gross profit levels to be in the range of about 26 to 26.5%. We anticipate that a decline in rebates during the remainder of the year will continue to be offset by improvements in our freight recovery, customer pricing and asset management. We expect SG&A expenses for the third quarter to be relatively flat compared to prior years. Net interest expense should come in around 5.5 million for the entire year, about the same level as 2003. We still expect the overall tax rate will continue to trend down from the prior year, and will be around 35.5% for the entire fiscal year.

We provided financial guidance in the press release, but just to reiterate, our third quarter guidance is an EPS range of 26 cents to 31 cents, and a sales range of 370 to $380 million. There is one additional sales day in the current year third quarter, and on a comparative basis, we will be benefitting from the full quarter of Rybalsa's sales, too. For all of fiscal 2004, we are reaffirming our previous guidance of EPS from $1.10 to $1.20 on sales from 1.4 to 1.5 billion.

Now, Bill Purser will provide commentary on our sales climate and operations. Bill?

Thanks, Mark and good afternoon everyone. I'll start by echoing the key point in Dave's overview. We are seeing more signs of optimism in the market place. However, the term I hear most often is "spotty". During January I visited three of our areas, talking with our management, our suppliers and our customers trying to get a fresh perspective on what's happening in the market place. It seems this economic upturn just doesn't have the legs everyone has anticipated. I looked hard for upward trends and really couldn't find any, with the exception of three industries, the semi conductor equipment industry, the aggregate industry, and the utility industry. I'm going to talk more about these industries later.

What we are seeing is that many of our customers have been patching machinery during the recession, and they've had to finally release some capital to make needed overhauls and repairs. Speaking of repairs, we were disappointed that the automotive industry did not do the major repairs that they normally do at the end of the year. Many of the plants were shutdown and as a result the level of repair activity that these plants normally perform was off considerably.

As Dave mentioned, we are getting mixed signals from some of our key indicators. While the ISM purchasers index did make a large jump, actually to its highest level since 1983, and the MCU has increased for the fourth consecutive month, we didn't see a large drop in unemployment numbers and the consumer confidence index remains low. Again, echoing Dave's remarks, these all add up, in our opinion, to flat sales for us in the third quarter, with improvement likely in our fourth quarter.

As I mentioned, we did see improvement in the past quarter in the high technology aggregate and utilities industries. Our sales to semi-conductor equipment manufacturers were up nicely during the quarter with increases forecasted during the second half of our business year. The aggregate industry has benefited from some of the states matching the federal funds which, as you may be aware, is required by the Transportation Equity Act 21. And also, a relatively mild fall has allowed an extension of road and bridge repair work this season. The gain in the utilities SIC is a result of a new in sync marketing program as well as a company focused on this industry.

As mentioned, our Canadian operations have remained strong as they serve the oil and gas and forest products industries. During the quarter we acquired Rybalsa and its five locations in Mexico. This acquisition will add approximately $8 million in annual sales.

This month we are introducing new additions of our Maintenance America catalog and our Fluid Power Connection catalog. We have added approximately 4,000 new items to the Maintenance America catalog. We have also implemented a comprehensive training and incentive program to further promote both of these catalog offerings. The two are currently contributing approximately 36 million in annual sales, and we anticipate further growth of the catalogs in the coming year.

Speaking of Fluid Power, I am pleased to announce that we have received national authorization from Eaton's Vickers Fluid Power division. We are currently beginning the ramp-up which will consist of training, inventory, and the creation of a technical support group. My conservative estimate is that we will realize approximately 1 to 1.5 million in incremental sales by the end of this calendar year.

Dave mentioned a structural change in his remarks. We have consolidated the mountain states area and split its service centers between our western area under the leadership of Don [Venez] and our central states area under the leadership of Ted [Walicki]. We feel this moves better aligns the service centers and will improve their market effort and result in some overall cost savings for our company.

In the second half of the year, as we have for the last two, almost three years, we will continue to focus on the four initiatives that are driving our organization. Just to remind you, they are margin enhancement, cost control, asset management, and profitable sales growth. I would now like to turn the call back to Dave for a wrap-up.

Thanks, Bill. We are pleased with the progress we made to date to include the execution of the basics in our business. We've set clear strategies at the top, we've communicated them well, and our guys have executed well at all levels. And we still have ample room for improvement in our current mode. We are not about to let these gains slip.

Going forward, you will be seeing more emphasis on revenue growth. We are committed to this. It's not going to come easily, it's not going for come quickly, but it will come. The Vickers authorization, the Rybalsa acquisition, the investment in catalogs are all illustrative of the actions we are taking. Also, we still feel that Canada is a fertile ground for investment.

While we see some economic points trending in the right direction, we're still holding our breath on this general recovery. I will admit to moving from the doubting Thomas to the cautiously optimistic position. We expect to have more to report next quarter. By that time, I sincerely hope that substantive economic trends will give rise to optimism for our fourth quarter sales and beyond. We will know by then if there will really be a recovery for the MRO world this fiscal year.

With those concluding remarks, I'll turn it back over to the operator and we'll field your questions.

Thank you. Today's question and answer session will be conducted electronically. If you would like to ask a question press the star key followed by the digit one on your touch tone telephone. If you are using a speaker phone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Once again, if you would like to ask a question please press star one. We will pause for just a moment to give everyone an opportunity to signal. Once again, if you would like to ask a question, please press star one at this time.

We will take our first question from Mark Kosnareck with Midwest Research. Please go ahead.

Hi, good afternoon.

Hi, Mark.

I have a question on the outlook for the third quarter. It seems awfully cautious, not so much on the top line, but just the earnings contribution that you get from that. I observed at the high end, 31 cents that's a million and a half dollars pre-tax better than what you did in the second quarter here on either a 10 or $20 million revenue pick up and you just look at how you did here in the second quarter versus the year ago second quarter, you picked up $2 million of operating income on only a 4 million revenue increase. You know, so if you use that same ratio, you would expect our earnings would be wildly better in the third quarter.

So I'm wondering what's holding earnings back in Q3?

Mike, this is Mark Eisele. In the third quarter of last year, I believe our earnings per share was 23 cents and the range we're giving is 26 to 31 cents for the third quarter this year, which continues to be a pretty nice improvement on the earnings. So, I mean, we look at this as we look at sales being relatively flat, I mean the quote, unquote improvement in sales that we're looking at relates to the one additional sales day in the Rybalsa acquisition and as we forecast our numbers out with our gross profit percentages and our SG&A run rates, we feel that 26 to 31 cents range is reasonable.

Mark, this is Dave. Be careful on the sales growth. It's not that you don't take it truly incremental because the increase of the Rybalsa sales comes with SG&A.

How much is it, by the way, on a quarterly basis would you expect in the third quarter?

It's about $8 million a year like we said so that's probably about $2 million a quarter or thereabouts.

Okay. Just let me ask the question a different way, because if you look at the mid-point of the margin that you're expecting in the third quarter, it implies about 2.9% up only 30 basis points from this quarter 2.6%, and you go to a year ago, you know third quarter versus second quarter, you had a 70 basis point improvement. So again it seems like we're not getting a lot of lift here as we move into Q3 versus Q2.

I think what we're looking at is we mention that we will be having some decline in our rebate amounts, so that is impacting us year-over-year. We have, and we anticipate that we will continue to fight through those decreases by pushing increases elsewhere with our freight initiatives, as well as our initiatives for pricing, and I think we still have a pretty nice increase from, you know, our projections for the third quarter and for fiscal '04 compared to the projections for fiscal '03.

Okay. I will get back in queue. Thank you.

We will take our next question from Holden Lewis with BB&T. Please go ahead.

Good afternoon. Thank you very much.

Hello.

Couple of questions with regards to the gross margin. Can you give a little insight on how you were able to bump the gross margin so nicely year-over-year. And I guess, I say that with sort of an eye towards, you know I was under the impression that freight this quarter probably would largely anniversary with the improvements, so the run rate improvements that you had been seeing and probably would anniversary in this quarter.

Have you seen another step-up in the benefits you are getting on the freight side sequentially, and then can you just explain the contribution of pricing and, you know, maybe other specifics that would cause that jump, please.

Well, Holden, let me answer one piece quickly and I'll turn it over to Bill. This is Dave. We really didn't start seeing the improvements last year on a comparison basis in freight recovery until our third quarter. So we had a good, you know, good comparison this quarter, it's going to be a tougher comparison next quarter. I'll let Bill talk to some of the other things.

Holden, Bill. The two keys for the rise in margin have been the pricing strategies that we have implemented. I believe these are sustainable, and to your point, freight recovery. We believe we have reached the plateau with the freight recovery and are making efforts now to move forward ahead. I think historically you always get the low hanging fruit first, which we have done, and now we're making efforts to move the process forward.

I am pleased with the direction the company's going, and I can assure you, we are focused on it. So I do believe both of those elements will continue to help us grow gross margins. But to Dave's point, the comparison becomes a little more difficult in the next quarter as it's more of an apple to apple comparison.

Holden, let me add one thing to that with regard to the question in your mind about the sustainability of pricing practices in a very, very difficult economy. You know this hasn't been wholesale across the board stuff we have been reviewing where the deficiencies were in our past practices, bringing them up to date. So what we are doing in the eyes of the majority of our customers should be fairly transparent.

Okay. But you said that the freight has kind of plateaued, at least on a sequential basis, but the pricing is continuing to ramp at this point, sequentially. Is that accurate?

That's correct. But again, with any program, we always expect a plateau to be reached and then you move ahead to the next plateau. And that's where we are with the freight recovery.

Okay. And then can you give a sense of what pricing was in the quarter? What the impact was?

I didn't understand the question.

Can you give a sense of what the impact of your pricing initiative was? How much that 90 basis point improvement, what percentage increase did you see from pricing?

Holden, I'd prefer not to give that information.

Okay. My second question related to gross profit was you just bought this huge slug of inventory, you plan on having it worked down by the end of the March quarter, I think was your comment. How does that not flow through very positively on the gross margin? I think you made comments that you were expecting that rebates would be a negative for you in the upcoming quarter.

Holden, this is Mark. What we do with the rebates, obviously, in accordance with GAAP we needed to record those rebates in our inventory as a reduction of inventory dollars right now because of the growth in inventory. They don't roll into our income statement until the inventories roll into our income statement. And we said the majority of this will happen in the third quarter. It all won't happen in the third quarter of the reduction. We anticipate in the next two quarters that the supplier rebates we got from those purchases will flow into our income statements. But with that said, we still anticipate that total rebates will be lower than the prior years.

Is that just because last year you also had a big bubble and the rebates were probably more attractive than they were this year is that probably the way to look at it?

The challenge is our sales have been relatively flat and a lot of the rebates are volume driven.

Based on improvement in the inventories, as long as you're buying the stuff whether you are selling it or not. Right? The benefit in Q3. Wasn't Q3 last year the period when you also saw a big balloon of inventory moved through and I could sort of confer that the rebates offered on that batch was probably better than the rebates offered on this batch?

Holden, I think that's a very clear because what you're looking at is the rebates and we normally get into a big discussion on this, but it's an incremental volume rebate, and to the extent that the volume is not going up incrementally, certainly you expect the rebates to be less.

Okay. What product lines were predominant in that inventory?

You know, we prefer not to discuss those. But, you know with regard to the way our vendors treat us, I think we need to keep some of that very closely held.

Okay. Thank you.

As a reminder, ladies and gentlemen if you would like to ask a question, please press star one at this time. And we will take our next question from Jeff Hammond with McDonald Investments. Please go ahead.

Hi, good afternoon. I guess I want to dig into the guidance a little bit more, you know along the same lines as some earlier questions. I think last quarter you had signaled that you weren't, or you weren't getting the signals in your vendors that you would be able to do some volume purchases and get some of those rebates. Clearly, if you look at your inventory, that has happened to at least some extent. At the same time you came in this quarter at the high, actually above the high end of your range, and you know, why you're not ready to really call a turn, it sounds like the revenue line is a little bit better, trending a little bit better, so I'm wondering why you're holding the guidance where it is today, or can you say that you have increased confidence that maybe it's closer to the high end at this point?

Jeff, this is Bill. During the last teleconference, we had not had any indication from our suppliers that year-end buys were going to be available. This is probably one of the, I'd say, years that they went a little bit later in making those decisions. So we were a little surprised, quite honestly, that we had not heard by the last teleconference, but not too long after that, we were approached. So that was one of the reasons that we did not have that in our thought process, because quite honestly, we really weren't sure whether or not the suppliers would come forward or not.

And, Jeff, with regard to some of, you do talk about some of the optimism in growth. You understand we have one additional day of sales this next quarter, plus the Rybalsa, all of which carries the normal cost with it. So with regard to, again, I want to caution anyone with regard to looking at the increase in sales on an incremental basis.

Okay. But if you look at the volume purchases and most of that coming through in the third quarter, and that was not in your previous expectation at the last conference call. I mean, is there something going the other way that would mitigate, you know, the benefit from that?

Jeff, let me try to approach that question with you. If we would not have made these purchases by year-end, we would have made these purchases in the third quarter and assuming we would have generated some rebate benefit on those in the third quarter.

So what's happening is we purchased those up front for year-end, and the rebate benefits flow through the third quarter. If we didn't purchase them up front we would have still had rebates coming through the end of the third quarter. So we did have somewhat of a match, although we did make some decisions to buy this stuff in December for some economic benefits for the corporation.

Okay. In terms of the, Dave, you mentioned, you know the focus on revenue growth, maybe talk about the M&A environment, what you're seeing. You have been fairly quiet there and maybe, particularly to the Fluid Power side. I remember, you know, you had halted kind of the growth opportunity on that side given, you know, what some of the national suppliers were, I guess saying to you, or directing to you about their willingness to go on a national distribution level. That seems to have, I guess, you know, played out a little bit with Eaton coming on with you and I think there's been some other announcements in the industry. So does that kind of change your viewpoint along those lines for the Fluid Power segment?

Jeff, let me defer to Bill on that. He is staying a little bit closer to the M&A activity as it regards to our strategic direction. Let me defer that one to Bill.

Jeff, I don't think we backed away from looking at Fluid Power opportunities. The Fluid Power opportunities were like other opportunities, there was a major gap between the expectation of the owner and the valuation that we did as a corporation, that gap we've seen a shrinking of that gap. We believe that it will continue to shrink and you're going to see more activity along the M&A.

We've continued to look at the two major platforms being the bearing and PT platform and the Fluid Power platform. As we speak, we have some companies that we're in conversation with that are in both of the platforms. So we still see Fluid Power as a very viable platform for our company, and to your point, national authorization with the Vickers line, certainly encourages us to look even stronger at the Fluid Power group.

Okay. Finally on the share buy back, I guess, you know, that did slow down in the quarter. Should we anticipate that picking up, or, you certainly have still, particularly the second half of the year, if your working capital or inventory turns around, you should generate some pretty solid free cash. I just wanted kind of an update on your thoughts on the share repurchase.

Jeff, I can't give you a definite answer on that because we will always look at what the best use of our cash would be. And if there are some nice M&A activities out there that will drive us one way, if they're future inventory buy backs it will drive us another way. Right now, as Mark said, we have the authorization to purchase one million shares. We will execute that based upon a balanced strategy for the cash usage in the company.

Okay. Great. Thank you.

Once again, if you would like to ask a question or a follow-up question, press star one. And we will take a follow-up question from Mark Kosnareck from Midwest Research. Please go ahead.

Thank you. I'm just wondering in the U.S. you said the average same store sales was down 1.5%. If we look at that by month, did December appreciate materially from that average? You know, did we exit the year at closer to a neutral, you know, can you talk about momentum in the business?

Mark, this is Dave. We just experienced our 11th straight month of down sales compared to prior year. So we had not seen that trend change from basically February on. We're still in a slightly down position each month year-over-year.

Let me add a little more flavor to that, Dave. The December decrease, Mark, was a smaller percentage decrease than we experienced, let's say in October. So we were directionally correct, but it was still a year-over-year decrease, but it was getting better.

Okay. That's encouraging. Then what sort of price, raw material or component price increases are you folks experiencing? A lot of the manufacturers that I cover seem to be pushing price rather aggressively to offset their own cost situations, and you know, what sort of environment are you in right now? What should we expect for the first part of calendar '04?

Now, Mark, this is Bill. We recently had a round of price increases, beginning in September through December from the bearing manufacturers related to their raw material increases. So we continue to receive, from our suppliers, increases where they feel that they are justified. We ask, obviously, for documentation and justification, but we are still seeing price increases coming through.

Mark, let me, you know one of the other things that keeps us a little cautious as we go ahead is, you know, rebates typically are driven a lot by the difference between real cost increases and announced price increases in the market place with regard to staying competitive. Because real costs are going up right now in the areas of energy, in the areas of raw materials, in the areas of health and welfare benefits, you know, the ability to allow for additional rebates is somewhat limited. I think you're going to see that as a challenge as we go forward.

Okay. And then finally, with regard to capturing this national authorization for the Vickers line, is that the complete line, or is that certain product categories? And can you illuminate us a little bit more on as to what the scope of that is?

That is the complete line. That's approximately 82,000 products. It's their full line.

And then,boy, if that's the case, their sales are rather significant, and you've got kind of a cautious outlook of a million or a million and a half dollars over the next 12 months, you know it seems like that's not really aiming particularly high.

Well, we are, first of all we are going through a ramp-up. We are getting inventories in place. Training is a big issue, and the technical support that I mentioned earlier, we consider critical. I don't want to get the cart before the horse. I don't want to turn the sales force loose until they know the product, we've got the proper support and inventory in place. The ramp-up here will take some time.

So '05 is really when we ought to expect more momentum then?

I would think so. I would think that toward the latter half of this calendar year, we'll see that run rate increase. But I'm giving us ample time for the ramp-up because, again, I want to be cautious that we don't get out in front of our customers until we're ready.

I see. Okay. Thank you.

We will take our next question from Dick Henderson with Pershing LLC. Please go ahead.

Yes. I had a question on the level of year-end adjustments. I believe Mark made a comment that the second quarter benefited from sharper accounting on inventories and so forth. Can you quantify that? Did I hear that correctly, and can you quantify it?

Let me add some more flavor to that. In the end report from June of '03 when we do the quarterly results information, in one of our disclosures we do show what the impact of the fourth quarter adjustments are from annual physical inventors and estimated changes in our costing factors. A year ago at June 30th, that benefit for gross profit was $4.4 million. And with the changes that we've made within our cycle count systems and our systems to reconcile the general ledger inventory dollars with the cycle count information, that we are able to record that information more contemporaneously in our costing because we do disclose it. We use estimated gross profit percentages regarding our inventory costs.

So while we can't really quantify that right now, I mean basically I will say that, you know, the traditional fourth quarter benefit will be spread more evenly throughout the year is really what we will expect to see.

Okay. I had a question kind of a follow-up on the previous question. In terms of the tremendous increases in raw materials that have taken place, and it looks like it's going to continue with global growth, especially in Asia. What happens, and forgetting about mix, if we went apples to apples, when you deal with an industry such as the automotive, which really doesn't have any pricing power, does that mean, and I guess Bill, you would probably be the appropriate one, does that mean or would you accept a narrowing of margins?

Well, our attempt to, you know, let me rephrase that. We don't want to accept any narrow margins unless we have a contractual obligation that don't allow us immediately to pass along the price increases, we will pass along price increases. Now, it could be that we have, as I said, some sort of contractual obligation that gives us windows of opportunity to pass along price increases. If that's the case, then we'll pass them along at the appropriate time where we're allowed to. But if it's not contractual, we pass those increases along. We have no control over our manufacturers increasing prices.

Dick, I kind of hear you asking...

I'm just asking if, you know, it's as your vendors operating rates go up, and their costs pressure increase, there's less incentive to discount, and you, there's that margin between you and the customer, and, you know, it gets to the point where, you know, instead of making 27% gross margin, it's somewhat less.

It's the age-old question you're asking of what happens when the irresistible force meets the immovable object.

Right.

I don't think that's ever been answered. But from our standpoint, we buy and we sell. We have to have a profit level to sustain these operations. If the end user will not accept the price increases, then a manufacturer has to make a decision.

Right. And one final question on that, Bill, your comment that you were surprised that the level of maintenance from your automotive customers. Is it your sense that that's a function of their financial condition, or is it change in the production methods, product mix, or perhaps new product programs, the level of it, can you just kind of shed a little color? Has anything changed, or is this it should straighten itself out going forward?

Dick, I think there are a couple of changes. I think in a lot of cases many of the automotive manufacturers have fewer lines. They have consolidated production where they can. As a result, there are fewer lines that are going through, you know, maintenance repair, and also I believe that it's a function of cost savings, whereas in the past some of these maintenance shutdowns were scheduled and heavy, heavy repair was done at that point in time. We've seen that it's not as frequent as it has been in the past. I can't say whether it's the exception or the rule. This is the new experience for us, so we're watching it carefully to see if this is a trend, or if this was just an anomaly for this past holiday. But this is something that's new that we've experienced.

Okay. Thank you.

Operator, at this point we have time to field one more question.

We will take our last question which is a follow-up from Holden Lewis with BB&T.

Thanks. I feel kind of bad wasting the last question on this, but I was just trying to get some of the data. I think you had said that your U.S. same store sales fell 1.5%. What is the companywide same store sales do? And I think you said Fluid Power was down 5%, what were industrial products?

Let's see. Holden, I don't have that information right at my finger tips here so I might need to get back with you on that.

Okay.

Holden, could Mark call you back on that one?

That's fine.

We'll knock that detail down for you a little bit.

Thanks.

This will conclude the question and answer session. I will turn the call back over to Mr. Shaw for closing comments.

Thank you Cynthia, you did a great job for us today. We hope the information we shared with you today proved useful and met your needs. We are always interested in feedback so don't hesitate to share any thoughts on how we can improve and meet your informational needs. Once again, thanks for joining us this afternoon and we do look forward to speaking with you again for our third quarter call in April. Thank you.

This does conclude today's conference call. We do thank you for your participation, and you may disconnect at this time.