Applied Industrial Technologies Inc (AIT) 2004 Q3 法說會逐字稿

Hello and welcome to the Applied Industrial Technologies Third 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 objection, you may disconnect at this time. I would like to introduce Mr. Richard Shaw, Applied’s VP of Communications. Mr. Shaw, go ahead please.

Richard Shaw. Thank you Amy. Good afternoon, everyone. On behalf of Applied, I would like to welcome all who are listening in to our third quarter 2004 earnings conference call. Earlier today we issued our third quarter earnings news release. If you do not have a copy of 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 in archived information that’s 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 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 and other risk factors identified in Applied’s most 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 r 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 of Applied Industrial Technologies. Any copying, rebroadcast, publication, posting, transcription, or distribution of any portion of this call without Applied’s 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. You’ll also hear from Mark Eisele, VP and CFO who will discuss our financial performance in detail, and Bill Purser, President and COO, who will provide commentary on what’s going on with our customer segments and Applied’s marketing efforts. Here to start us off is Dave Pugh.

Good afternoon. It is nice to report that we have finally experienced some long coveted economic tailwind and we have leveraged this into earnings that certainly exceeded our expectations. Our favorable settlement from outstanding tax issues were a surprise from a timing standpoint, and as such they were not forecast. If there’s one item on which we can be faulted this quarter it is our failure to forecast the improvement in sales. While a number of indices correctly modeled the increase, we had felt that the low level of capacity utilization, even increasing slightly, and the continued decrease in manufacturing employment, would mute the other indicators. In fact when we gave our initial guidance in January, sales were actually below January the prior year. Well, we were wrong and thank goodness. We’ll talk more about the sales later.

The earnings improvement is due to a compilation of many sound fundamental business practices that we have installed over time. While the sales increases magnified the impact of our efforts to improve earnings, this is not a one quarter phenomenon. In fact, this is the sixth straight quarter where our earnings per share have exceeded the same quarter of the previous year by more than 25% and most of those were essentially flat sales. Even without the tax adjustments, our third quarter earnings were double what they were last year. Our third quarter earnings per share is an all time high for any third quarter history. The fact is, we are a stronger company than we were several years ago.

Let’s look at how we’ve done that. First, we’ve put more emphasis on return on assets than return on sales. And although we found this to be one to drive a more sustainable and broad based (inaudible) we have continually identified areas of under-performing assets and we redeployed them for better gains. We judiciously managed our inventories to provide a consistently improving on time performance with a steadily decreasing level of assets. Now this also allows us the latitude to respond to our suppliers at those times when the opportunity for a special buy provides us the benefit while allowing our suppliers to balance their inventories and level load their facilities for improved efficiency.

Improved physical inventory procedures have, over time, reduced reserves to shrinkage. Heightened oversight has reduced bad debt expense in the receivables area. We’ve revamped our organization structure to provide consolidated management and ownership at the local level. And we’ve increased our training to improve job performance making our local managers more successful. We’ve done extensive reviews on customer profitability and supplier profitability and we’ve taken the requisite action to improve these problem areas. We’ve been fortunate to make some good judgment calls in either charging for or eliminating some services that have previously been bundled in product pricing.

We’ve done critical system cost versus system value diagnostics to help us understand price elasticity and to guide us in adjusting our prices accordingly. We constantly monitor the desirability of the market segments on which we focus with regard to demand and profitability and we make changes when warranted. In this quarter, for instance, we were able to effect a favorable mix contribution as we grew our business among small and medium size customers at a much faster rate than the national accounts. Last but not least, we have always pursued growth, but profitable growth. We do this first by seeking to reduce the annual rate of defections while offering consistent and reliable service. Our ongoing performance continues to rise and our error rate, as measured by credits written, continues to fall.

Next, obviously, we try to take share from our competitors who can’t make the grade. Unfortunately, this is a frustratingly rare occurrence. We have very worthy competition. While an improving economy bodes well for us, we still feel that major gains in growth will come via acquisitions. All of this has been communicated clearly, concisely, and consistently with our associates in such a way that they’re compelled to follow because they believe in the inherent benefit of doing so. We have provided them with effective analysis and planning support from headquarters and we are implementing well at the local level. We’re collaborating well with our key suppliers to consistently meet or exceed the needs of our customers.

There is no way to allocate our improvement in earnings to a specific action, They are all interdependent and it’s nice when a plan comes together. The thought I want to leave with you is that this is not a flash in the pan quarter. The advantage that we’ve gained through our purchasing efforts at the end of the second quarter has helped. It was a good business practice but not out of the ordinary for us. Buying ahead of price increases and taking advantage of special offerings from our vendors is something we’ve done historically and it doesn’t represent any attempt to unduly inflate earnings. The facts are that our rebates for the third quarter are below those of our third quarter last year. Our improved performance is driven simply by good sales and efficient operations, attention to detail. And we believe this level of performance is sustainable through this economic recovery.

Even the positive tax settlement was the result of well considered and persistent efforts to manage every element of our business for maximum gain. No one was willing to just hand this off to us. Each and every associate of this company is to be commended for our progress and is to be reminded that there is still more to be done. It was gratifying during this quarter to be named to the Forbes Platinum 400 list of best managed big companies in America. This recognition is based upon an objective review of our performance and sales and earnings over the past five year period, the quality of these earnings, and our current financial position. Subject of analysis which performed in the areas of market leadership, innovation and efficiency. In addition, Forbes used an outside financial analyst firm to wig up on accounting and governance practices. While national recognition is great, it’s even more gratifying to produce the results we did this quarter. Getting recognition without performance is a bit like an honorary degree. It’s a nice thing to have, but it lacks substance. And speaking of substance, I’ll let Mark put a bit more meat on the bones with regard to our financials.

Thanks, Dave, and good afternoon everyone. Let me provide some additional insight to our third quarter financial performance. We are very pleased with our bottom line EPS of 54 cents per share which exceeded the top end of our earnings guidance by 13 cents per share. There are three primary reasons for this. First, we had one-time nonrecurring income tax benefits of 8 cents per share primarily pertaining to resolutions of open items with the internal Revenue Service. Second, we experienced a $458,000, which is about a penny and a half per share after taxes, of non-operating income during the quarter from several small items including foreign currency adjustment, increases in cash surrender value on life insurance policies and mark to market adjustments on our foreign currency swaps. The third reason is that our quarterly sales were $6 million greater than the high end of our sales guidance. The profit on these additional sales generated 2 to 3 cents per share. These three specific items account for approximately 12 cents of why we exceeded the high end of our earnings guidance of the quarter which was 41 cents per share.

From a sales standpoint, we began to see improvements in the sales side of our business during February. These improvements have continued through March and through the March end and into April. Our U.S. service centers and the U.S. fluid power subsidiaries both experienced increases of 2.6% in same store sales per day during the quarter. We see this trend continuing.

Canadian operations remain strong and continue to post increases over the prior year. These increases, coupled with the strengthening of the Canadian dollar, resulted in another solid performance in Canada. In total, sales for the quarter increased 6.2% to $391.1 million, slightly higher than our revised guidance of sales of $380 to $385 million. We had one additional sales day in the current quarter as compared to the prior year which added approximately $6 million to our quarterly sales amounts. During the quarter, we closed one fluid power location in the U.S. and merged one U.S. service center location into another. This resulted in a net decrease of two operating locations leaving us with 436 operating locations at the end of the quarter.

Our overall sales mix for the quarter was 85% industrial products and 15% fluid power products. We continued to be pleased with the (indiscernible) acquisition which we completed in November of 2003. Although their quarterly sales of approximately $2.4 million are not significant to our overall operations, they are accretive to earnings and are exceeding our performance expectations.

Our gross profits percentage for the quarter improved to 26.7%. This is approximately 20 basis points better than last year’s third quarter as well as our recently completed December, 2003 quarter. We continue to achieve improved pricing and freight recovery. These improvements are somewhat offset by lower overall rebates from our suppliers which do negatively impact our gross profits. Even when taking into account the rebates benefits flowing to our income statement from the calendar year end inventory purchases made in December, our total rebate benefit during the third quarter is less than the benefit form the third quarter of last year.

Overall SG&A expenses as a percentage of sales decreased to 22.9% in the quarter compared to 23.8% in the third quarter of last year. The absolute increase in SG&A dollars was only 2.2% compared to a sales increase of 6.2%. We continued to actively manage our expenses in all areas. All of these items contributed to our operating margin increasing to 3.8% in the quarter and to 3.0 % year to date.

Total shares of common stock outstanding at March 31, 2004 were 19.3 million shares. We repurchased 191,000 shares during the quarter, most of these related to open market transactions made under our reproved board authorized program. An additional 841,000 shares may be repurchased under this program. Our balance sheet remains strong. Our current ratio is 2.9 to 1 and our debt, net of cash to equity, is .13 to 1. Inventories decreased 1$3 million from our December 31 balances as the calendar year end inventory buys worked their way through our system. We expect our inventories between now and June 30, 2004 will decrease by another $15 million.

Cash provided from operations was a positive $15.7 million during the quarter which brought our year to date cash provided from operations to a positive 2.4 million. We expect continued improvements in this metric between now and June 30th as well. We expect to maintain our profitability improvements. We anticipate our fourth quarter gross profits percentage to be in the 26.2 to 26.7% range. We are forecasting a continued decline in rebates during our fourth quarter as compared to the fourth quarter of last year. These reductions should be offset by our improvements in pricing, freight, and asset management.

SG&A levels should remain comparable or slightly down to what we experienced in the third quarter just ended as well as comparable to the prior year’s fourth quarter amounts. Net interest expense should remain relatively constant for the fourth quarter. We expect the fourth quarter effective tax rate to be 35.5%. This is the rate we are experiencing so far this year if you exclude the one time nonrecurring tax benefits we recorded in this quarter.

To reiterate our guidance for the fourth quarter, we expect sales to increase anywhere from 3.4% to 7.4% and be in the $385 million to $400 million range. Fourth quarter EPS is expected to come in at a range of 45 cents to 50 cents per share. Now Bill Purser will provide commentary on our sales climate and operations.

Thanks, Mark, and good afternoon everyone. Since Dave has already talked in detail regarding our operational focus, I’d like to use my time this afternoon maybe to get a little more in depth on sales. Our sales began trending upward in February and continued to gain steam through March. While we expected that an upturn in the market place was inevitable at some point, it really came sooner and with a lot more conviction than we had anticipated. I don’t want anybody to misunderstand, I’m not complaining. As Dave mentioned in his remarks, we have been doing the things from an operational excellence standpoint to prepare us for this upturn so that we could take full advantage of the opportunities that we knew would present themselves. I must say, however, that the sales over the past 30 to 60 days have been somewhat uneven. For example, overall business levels from out top 100 U.S. accounts were slightly down in the third quarter as compared to a year ago. We increased sales with 48 of those accounts and declined with 52. As Dave mentioned, we did see a more consistent growth among our small and medium sized accounts which we really attribute to our focus on the segment.

We also believe that some of these smaller accounts may have been able to react more quickly to the increased market demand than come of the larger companies. While we saw an increase in same store daily order rates in the U.S., some regions fared better than others. Our West and Central states areas were the strongest ,with the Midwest and its heavy reliance on automotive, showing a decline. The company’s healthiest sales, as Dave mentioned, came from Canada and Mexico. Sales growth trends also varied widely by industry. We saw strong increases from our customers in industrial machinery, lumber and wood products which are related to the building industry, durable goods, electronic equipment, primary metals and metals mining. Conversely, sales were flat in pulp and paper, down in automotive, and flat to slightly down in chemicals and food products.

So as you can see, success was spotty with obviously more bright spots than disappointments, What this tells me is that we have plenty of room to gain more sales traction as the economic recovery becomes more mature. In recent travels, I was able to call on the following industries to get a firsthand update of what they were seeing in the market place. I visited a cast iron pipe manufacturer, two large cement producers, a food company, an automotive manufacturer, a large OEM and a large paper manufacturer. The consensus across the group was that they all felt the economy was trending upward. However, they were all cautious about the pace, saying it was still slow. No one in the group was ready to wave the flag and declare that the down turn was over.

As Mark mentioned, our North America industrial product sales were about 85% of our sales for the quarter, with fluid power being 15% of our sales. We continue to be satisfied with the performance of our catalogs and e-commerce initiatives. Third quarter sales from catalogs increased by more than 6.5% from last year and nearly 13% from the second quarter. Both Maintenance America and Fluid Power Connection catalog sales were up with combined sales for the two running at about $3.5 million a month with strong margins. Although we see the Internet as more of a transactional and informational channel than a true sales channel, e-commerce continues to handle steadily increasing volume. We’re currently running around $10 million per month in total e-commerce volume. This includes EEI. Our biggest growth area has been the West. Management’s focus remains on the four key initiatives of profitable sales growth, enhanced margins, cost control and asset management. We feel that as customers continue to expand production and begin to free up cap ex budgets, we’ll be positioned to provide the best value for their needs. Now that we see sales increasing, we feel our organization is better positioned to serve new and expanding customer needs. And like many companies during this downturn, we’ve invested in our people. We’ve abstained from wholesale cutbacks to meet major cost cutting goals and have expanded our training programs.

Next to long time error free deliver, our customers rate our knowledgeable sales force that’s both inside and outside, as the second most important factor. As a result of our efforts, we have a solid foundation on which to build profitable sales growth. I’m sure that there is some interest among the listeners. As to the impact of the steel price increases on our company. We’ve had approximately 70 suppliers who have thus far announced or have at least announced their intentions to increase pricing. Increases began really mid-March with the heaviest in the future from mid-May to July. These increases are in the range of 3 to 5% and, as I said, are primarily due to the increased cost of steel to the suppliers.

It’s our intention to pass on these increased prices to our customers as they occur. Although the economy hasn’t completely turned around, we do feel good about what we’ve accomplished and are cautiously optimistic for the 2004 calendar year. The challenge now is obviously to maintain the momentum that we have going. With that, I will not turn the call back over to Dave.

Thanks, Bill. I guess I’ll summarize by saying good quarter, good results. We hope we’ve given you fair insight into how it happened. Before we get into the question and answer session, I would like to talk just a little bit about transparency. Your need to know versus our comfort with disclosing certain facts. We always try to answer every question with candor. However, it is important to realize that public companies are caught in what has been termed a transparency paradox. While we recognize and believe in the absolute need to be transparent in a way that gives all constituencies of the corporation the opportunity to act with maximum information, we also have to weigh this against an absolute requirement to hold some matters, for legal, competitive, and other purposes, in strict confidence. We can’t disclose information that would provide others with information they could use to hurt our business. Striking this balance isn’t easy. In fact, it is uncomfortable, but an area of important responsibility that we must shoulder to protect our shareholders. The thing in transparency that protects our investors prevents us from detailing all of our actions. We can only trust that you appreciate our position. With that being said and in hopes that I haven’t just sent all of you back to your laptops to rephrase your questions, let’s get started with our question and answer session. Amy?

Thank you. Today’s question and answer session will be conducted electronically. If you would like to ask a question, please do so by pressing the star key followed by the digit one on your touchtone telephone. If you are suing a speakerphone, please make sure your mute function is turned off to allow the signal to reach the equipment. Once again, that is star one to ask a question. We will pause for just a moment to give everyone the chance to signal. And we will take our first question from Mark Kosnarik with Midwest Research. Go ahead, please.

Good afternoon, gentlemen. Let me start of just asking you about the impact of foreign exchange to revenues and earnings in the quarter.

Yeah, Mark, this is Mark Eisele. The Canadian currency obviously was strengthened this year versus a year ago and that percentage, though I don’t have it off the top of m head, I think was around 20 to 25% strengthening of that currency. So that impact is flowing into our sales and I think that probably translated to around $4 to $4.5 million of U.S. dollar sales on a period to period basis just for currency fluctuation.

And then would that have an EPS impact as well, Mark?

Well, I mean it has an EPS impact just in that all of the other things within the income statement would also be translated at those same rates, so that would not necessarily have - - that’s not like incremental new sales that would flow directly to the bottom line. It would have the corresponding costs associated with those.

Okay, so that’s relatively modest. Great. Then with regard to the development of sales over the quarter, there was a comment that January actually was below a year ago. Can you talk about how sales or orders developed in the quarter through March and how things are stacking up so far in April?

I’ll touch on that a little bit, Mark. I think Dave mentioned earlier that in January, like when we did the previous conference call and press release, our January run rate for sales was actually down compared to the prior year of January. And we did see that continue through January. And we saw the up tick starting in February so that our sales per day rates in February increased and we saw that increase continue on through March. And it ramped up even more in the March time period. So we are seeing the increase in the run rate for March continue on so far into April and that’s how we helped develop our sales guidance of the 3.4 to 7.4 % increase in sales this year compared to a year ago’s quarter.

So if the average was 2.6% for U.S. sales, them March might be as high as 4 or even 5%. Is that a reasonable assumption?

That’s right on the money.

Okay. And then finally, I’ll let somebody take over, we had an extra day. Do we lose a day in the fourth quarter? Or is there an extra one that we just keep for the full year? How does that work?

Actually, the fourth quarter has the exact same number of sales days in it as a year ago’s fourth quarter had in it. So on a comparable purpose, it will be just spot on.

Great. Thank you. I’ll get back in queue.

And our next question comes from Jeff Hammond with Key Bank Capital Markets. Go ahead, please.

Hi, good afternoon. I wanted to kind of speak to the incremental margins. Historically I think you’ve talked about kind of low teens incremental margins. It looked like a low 20s incremental margin and I wanted to understand, besides just the regular sales volume, Dave, you had kind of mentioned you can’t really point to one thing, but maybe order of magnitude, what really was, with regard to internal initiatives, helping the most, second most, etc.

Jeff, this is Bill. I think the initiatives of pricing in the market place, driving our pricing up in the marketplace, our freight recovery, were certainly two major factors in helping us along those lines.

Coupled with that would be our attention to SG&A. We continued to have a very strong focus on controlling our SG&A costs. We continue to keep a tight rein on those and we were pleased to see that our SG&A costs really didn’t go up much at all in the quarter.

Do you think on the SG&A line, kind of that comparison you gave .6 sales plus 2 and change percent to SG&A. Do you think that’s sustainable going forward as you focus on that?

I think one of the goals that we have is that the sales increase percentages that we plan on experiencing in the future for the organic incremental growth, we should only be experiencing SG&A percentage growth of one half of that rate. So it sort of fits a little bit better in this quarter for what we were actually able to accomplish.

Jeff, this is Bill. We’ve got a very strong focus on cost containment realizing that as the economy starts an upturn, there’s a tendency to increase the expense at a faster ramp up rate than the sales. It’s just the natural tendency. If you go back to almost any downturn and you start looking at the resulting upturn, you’ll see that there is a tendency to move your expenses faster than your sales. We’re very aware of that and we make sure our associates are aware of that and we’re watching it very closely. That’s why I do believe that we’ll be able to continue the expense control that we’ve done in the downturn.

Okay, and then, Mark, maybe a question for you on the balance sheet. You saw a pretty big increase in the accounts receivable line. Does that kind of clear out in the fourth quarter? Is that kind of a timing issue or maybe a little color there?

I think a lot of that is a timing issue as basically the accounts receivable were filling up through sales increases, virtually all of those sales are current. Our DSOs for the March month end are actually better than they were in the February month end and very much like the December 31 for the quarter end that we last reported to you We’re still experiencing very good perspectives within our receivables. We expect to be able to collect these but we also expect that for the fourth quarter to still see sales increases as we go forth, so as long as we can manage and maintain the DSOs around the 42 days outstanding, we feel very good about that.

Okay and then finally, you know, looking at your balance sheet, you certainly have continued to deliver and are a bit over capitalized at this point. Dave, you mentioned acquisitions. Maybe first talk about pipeline what you’re seeing and two, absent of being able to do an acquisition, where do you stand with regard to dividend and perhaps increasing that?

Jeff, good question, and we just had our board meeting today by the way and they had the same question. Acquisitions, we do see the activity the opportunities picking up. We certainly hope to take advantage of those. We have some great hopes in doing that in the near future. We’re looking at the dividend. We’re currently within our guidelines of what we think is a fair dividend payout. Certainly if the earnings of this company continue to increase, you could expect us to give that very good consideration with regard to returning to our shareholders a portion of what we’re earning.

Let me just add another piece of flavor onto that, too. While we continue to see the acquisition market heat up, we do not expect to close any acquisitions in the fourth quarter coming forth. But we are hopeful that we may get a couple of small ones in sometime early in fiscal ‘05.

Okay, great. Thank you.

Thank you. And our next question comes from Michael Greenwell with BBNT. Go ahead, please.

Thanks, guys. Hi. How are you? I was wondering now that the freight recovery initiative has gone through and is sort of making an impact to margins, I was looking - - what is going to be your next headline initiative that’s going to incrementally take margins maybe to the next level?

Well, Mike, this is Bill. I don’t plan on abandoning what brought us to the dance as the saying goes. I think we still have upside on freight recovery, we have upside on margin enhancements. If I felt like we were completely satisfied with where we were, I’d be looking for another initiative. But I still think we have lots of upside with the ones that we’ve got going now.

Okay, so do you think the freight recovery still has some legs in it?

Oh yes.

Okay. Let’s switch here. About what level do you think? I mean, are you talking 50 basis points or 100 over the next year? Or is it 20 this year, 20 nest year maybe? Can you be a little specific about that what your hopes are?

Mike, I guess we haven’t converted that to basis points right now. We know what we are - - we have a well laid out in plan for freight recovery and we’re seeing enough dollars that we are picking up there and the percentages won’t pick up, we haven’t converted that to a basis point impact at this point. The thing to realize is that the pricing initiatives that we have put into place are not blanket, just lay a price increase across. We have been analyzing those areas where we thought we were below the norm in certain areas of elasticity and have made moves in such a way as to not create a panic in the competitive arena. So we think that we still have opportunities there and then we will also look at opportunities going forward as the general industry is putting forth price increases. Price increases should come from distribution also.

Okay great. Well thank you very much.

And our next question comes from Jonathan Biores with (inaudible)

I just had a simple question for you. Is there seasonality in your earnings results? Can I extrapolate that you’re going to be doing something like or possible do 50 cents a quarter for the next couple of quarters?

Jonathan, we don’t really look at ourselves as that seasonal. We do see some seasonal fluctuations. A lot of our earnings are driven by the number of sales days in each individual quarter and obviously in a calendar year, the first two calendar quarters have more sales days than the last two just because of where the holidays fall and also what manufacturing plants do with shutdowns and things of that nature, so I think traditionally if you look back on our history, you do see seasonality with the sales top line dollars. Our first two fiscal quarters are generally our lightest and our second two are generally the heaviest from a sales dollar perspective. And then depending upon what the sales dollars are, that leverage is down to the bottom line EPS. I guess you could say that’s a little bit of seasonality.

Jonathan Biores; Okay, that’s fair. And I guess the second question or point I’d make is that there was a month period here where your stock was trading under, close to 22 or under $22 a share. You guys repurchased, I guess, 191,000 shares in the quarter. It just seems to me that obviously you want to do acquisitions, but clearly your stock was among the best acquisitions to make. Have you thought about increasing beyond that 191,000? Did you guys discuss this or if we have another sale off of the stock, would you consider doing a larger share repurchase?

Yeah, we consider - - I mean, obviously we look at all various inputs when we make our decision as to when we’ll be doing buybacks and at what levels we’ll be doing buybacks. Obviously we thought when the stock price was, we saw the dip in the stock price in February through the beginning of March, we thought it was a very good purchase price so we went into the market and purchased some of the stock. So we would continue to evaluate that on an ongoing basis, so

Jonathan, we continue to have authorization from the board to do this with regard to making decisions on the best use of our cash and certainly we would like to use cash for growth in this company that would be long term beneficial. But as opposed to that, repurchasing our shares is a good use of cash for our shareholders, we will certainly do that.

Okay, that’s great. Thanks a lot guys.

And once again as a reminder, it is star one to ask a question. We will take a follow up from Mark Kosnarik with Midwest Research. Go ahead, please.

Thanks. A few others here. One is, can we talk about the raw material cost inflation that you saw in the quarter and how much of that you were able to offset by the price increases you spoke about? Because if you - - I’m looking at hits current quarter versus the second quarter, the December quarter and there was really very little gross margin expansion. Only 20 basis points versus a year ago third quarter compared to second quarter it was nearly 100 basis points. And you said there was that pre-buy that you invented some improved lower price point products in there that should have flowed out this quarter. So the fact that you didn’t get a gross margin increase suggested that you absorbed a general price increase. Is that a fair way to think about things?

Well, Mark, there’s another piece to it. If you remember our conversation, the rebates for the quarter were lower than the same quarter last year so the rebate structure is a little less beneficial this year than last year.

Yeah, I was kind of thinking about that. If you got 100 basis points last year, maybe the rebates, everything else held equal might have been 50 basis points this year, but yet you only saw 20 basis points improvement so it seems like something is going on. You are absorbing some increases or - -

But our rates are still going up. I mean, the overall gross profit percentage in the quarter was still higher than last quarter and the quarter before and prior years. I think some of the large steps forward you saw a year ago within the basis improvements related to us getting some of the low hanging fruit from the freight recovery initiatives and also other of our initiatives starting to really take traction at that point in time from pricing with customers and the freight recover. And those things, once those initiatives have, not that I want to say they’re mature, but they’ve been there for awhile and they’re remaining. And like Bill mentioned earlier in the conference call here, we still see upside for both of those initiatives. But obviously that upside, as we keep going down that path, it becomes more and more of a challenge for us.

That’s a great point, Mark. I mean, it’s just a tougher comparison on that freight recovery, Mark.

Yeah, I remember you guys mentioning last quarter that it was at a plateau. That’s why I was actually surprised to hear you mention that it’s still delivering savings. It sounds like you’ve breathed some more oxygen into it. But if I could just get back to this raw material cost inflation issue versus your price increases. I mean, just to ask the question a different way, would those two have been about matched in the quarter? Price increases totally offsetting the raw material cost increases you saw? Or is there a difference that will be made up in the fourth quarter?

It would be a push. In the case that you’re saying, the raw materials meaning the products themselves, the price increase in on the products themselves.

Okay, you’re finding you’re able to push through price increases relatively quickly rather than being constrained by any kind of contracts or ?

The only constraints that we would have, Mark, would be any of the contractual agreements that only have certain windows of opportunity to get a price increase though. But we have major windows of opportunity throughout the year that allow us to do so. The rest of the business, of course, we implement the price increases immediately.

Okay. Then one final question for you here is on the fluid power side of the business. Did I hear earlier in the discussion that fluid power and industrial both posted relatively same growth or was there a difference between the same?

They are the same, that’s correct.

Now should we be concerned about that? Because we’ve seen one of the fluid power companies reported yesterday, in fact your partner, Eaton, that their U.S. sales were up in the 6% range. You’re building out that product capability with them and it would seem as though as you’re capturing net sales in that arena that your sales potentially could even be higher than overall fluid power. So it just strikes me as kind of light actually. And can you address that point?

I would not read anything into that, quite honestly, as far as fluid power sales being even with the industrial sales. I understand what you’re saying about Eaton as far as being a supplier showing those types of increases. We normally, remember, would lag a manufacturer because so many of the fluid power sales go to OEMs and as a result there is a lag between what we see versus the manufacturer.

Mark, we have a very nice backlog in our fluid power systems group right now so ifs a component that we would be buying would be going into systems that we’ll sell later one. So you will see Eaton’s component sales ahead of our systems sales.

Oh okay, great. All right. Thank you.

And at this time there are no further questions. Mr. Shaw, I’d like to turn the conference back over to you for additional or closing remarks.

Well, thanks to all for listening in today and asking such good questions We’ll talk with you again in August for our year end conference call and in the meantime we’ll continue to work hard to turn strong results. Have a good evening.

Thank you and this does conclude today’s Applied Industrial Technologies conference call. We appreciate your participation. You may now disconnect.