Applied Industrial Technologies Inc (AIT) 2004 Q4 法說會逐字稿

Welcome to the Applied Industrial Technologies 4th 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 now like to introduce Mr. Richard Shaw, Applied's Vice President of Communications. Mr. Shaw, you may begin.

Thank you, Jessica, and good afternoon, everyone. We appreciate your willingness to join us on a Friday afternoon in August. We hope this will be a good start to your weekend. You should have already received our 4th quarter and year-end earnings release that was issued this morning. If you have not received the release you may retrieve it by visiting our website at 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 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 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 express 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 year recently ended. We will also hear from Mark Eisele, 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 operational activities. Here to start us off is David Pugh.

Thanks, Rick, and thanks for joining us, everyone. You know, I have to admit, I'm at a bit of a loss as to how to convey our performance right now, both for the quarter and for the year. I'm well aware that pride goeth before a fall, and the last thing we want to do is fall from the track that we're on, but it is hard not to feel a bit of satisfaction in our 2004 financial results. This was one of the most successful years in the history of Applied. It wasn't magic, it wasn't smoke and mirrors, I'd like to convince you that it was the brilliance of management, but it was really the hard work of many individuals. Focusing on some very basic business principles that allowed to us achieve these record results. The acceleration of sales growth was the major impetus for the 4th quarter as customers ramped up their plants to serve a higher demand. Sales improved progressively throughout the quarter and the exit rate was very good. Mark and Bill are going to give you more detail on that later. From my perspective, though, the most important number is the bottom line. In the 4th quarter we were able to convert a sales increase of 8.8% into an improvement in operating earnings of 67.5%. This was our seventh straight quarter where our earnings per share were at least 25% higher than the same quarter prior year. For the full year, the operating earnings were up 42% and the net income was up 59% on a sales increase of just 3.6%. And these aren't, you know, just the result of easy comparisons. You'll recall last year's net income before taxes was up more than 30%. This year we've put another 50% on top of that. The message you're going to hear today from us is nothing new. You're familiar with the path we're on from previous conference calls. I think we have had a great story to tell about the changing profile of our company.

And now, additionally, we're riding the wave of an improving economy. Based upon the results we've been providing the board last month increased our cash dividend by 17%, up to 14 cents per share to shareholders of record on August 15th. This new cash dividend is consistent with our stated target of targeting a 35% payout of earnings. We will continue to monitor and revise this accordingly. We have a lot to cover this afternoon, and I'm sure you've got some good questions, so I'm going to turn it over to Mark right now to walk you through the 4th quarter and year-to-date results.

Thanks, Dave, and good afternoon everyone. Let me provide some additional insight into our 4th quarter and year end financial performance. We are very pleased with our record bottom line earnings per share of 55 cents per share for our fiscal 4th quarter. This enabled us to close out fiscal 2004 with record year-end earnings of $1.60 per share. As you know, we raised our original 4th quarter guidance which was EPS of 45 to 50 cents, on July 19th, to a range of 52 to 62 cents of EPS. One of the key drivers of this bottom line improvement was the acceleration of our sales improvements in the months of May and June. Our original sales guidance given on April 15th, 2004, was for 4th quarter sales to increase anywhere from 3.4% to 7.4%, and total $385 to $400 million. During the month of April our increase in U.S. service centers, same-store sales, was in the 4 to 5% range, which is exactly how we exited March of 2004. The rate of increase improved in May and then again in June. So that our overall quarterly U.S. same-store sales rate of increase was 7%. We exited the quarter at nearly a 9% rate of increase and have seen that momentum continue into July. Sales for the 4th quarter totaled $405.1 million. This represents an 8.8% improvement over last year's 4th quarter. The number of selling days in each of these quarters was the same at 63.5 days.

Besides the 7% improvement in U.S. service center same-store sales we saw our Canadian operations sales improve by 15%, of which 7% related to currency translation from the strengthening of the Canadian dollar compared to the prior year. Our U.S. fluid power operations also saw a sales increase of 17% in the 4th quarter. In addition, we continue to be pleased with Rebalsa, our Mexican acquisition which we completed in November 2003. While their quarterly sales of approximately $2.8 million are not significant on an overall basis they are accretive to earnings and are matching our performance expectations. During the quarter, our number of operating facilities declined by two, leaving us with 434 operating locations. This decline was from two U.S. service centers merging into other existing service centers for efficiency purposes. Our gross profit percentage for the quarter was 26.9%, compared to 27.0% for last year's 4th quarter. The actual 4th quarter gross profit percentage came in slightly better than our original expectations which we communicated during last quarter's conference call. While lots of different inputs of components make up cost of goods sold, one reason for the improvement is the impact of LIFO liquidation due to reductions in our inventory levels and the fact that the calculation of the annual LIFO expense as of June 30th, 2004, was less than we had expected throughout the year. Even though we began recording physical inventory adjustments on an interim basis during the year our 4th quarter benefit for the year-end physical inventory provided a net benefit of $3.3 million. This benefit is somewhat larger than we had estimated. When we combined the adjustments recorded earlier in the fiscal year with this 4th quarter physical inventory benefit we see that approximately 44% of these adjustments benefited us in the 4th quarter.

In addition, rebates from suppliers did decline somewhat in the quarter as compared to prior year as we anticipated which somewhat offset the benefits previously discussed. Customer margins also declined slightly as we experienced price increases from all major suppliers during the quarter due to the steel surcharge issues. We have not been able to pass along all of these increases to our customers, especially those customers with contractual pricing. Many of these customers with contractual pricing have price updates as of July 1 at which time we pass these increases along. Looking at our selling, distribution, and administrative expenses, you'll notice a decrease to 22.4% of sales in the quarter from 24.0% in the 4th quarter of last year and 22.9% from the 3rd quarter. The absolute increase in FD&A dollars was only 1.4% compared to a sales increase of 8.8%. And, as you know, we began expensing stock options in fiscal 2004 which added $300,000 of expense to the 4th quarter and $1.6 million for the entire year. We had no net gains on sales of property during the quarter or for the entire year. As part of our year-end closing process we do have changes in estimates for certain annual items such as self-insurance reserves for Workers' Compensation and general liability. This benefited the 4th quarter by approximately $1 million due to the actual loss experienced during the year being less than originally estimated. The effective tax rate for the 4th quarter was 36.2%, which was slightly higher than our estimate. This is primarily due to rising effective state and local tax rates as the states tighten up various tax regulations. All in all it was a very solid quarter and an excellent year from a sales improvement and an EPS perspective. Our balance sheet and cash flows continue to be strong also. Our current ratio is 2.9 to 1. Overall inventory balances declined from our March 31 levels by nearly $19 million and remain consistent with our prior June 30th amounts even with sales ramping up which has improved our overall turns.

Receivables have increased in line with our 4th quarter sales increase and our DSOs remain in line with our past results and with industry averages. Cash provided from operations during the quarter exceeded $38 million as we ended up with a total of 44.3 million of cash provided from operations for the entire year. Our year-end cash balances grew to $69.7 million as we turned in another good year from a cash perspective. We provided financial guidance for the 1st quarter of fiscal 2005 in this morning's press release for sales increasing 9 to 11% to between $393 million to $401 million. With EPS in the range of 40 to 50 cents per share. Last year's EPS in the 1st quarter was 25 cents. Therefore, our guidance is for EPS increase anywhere from 60% to 100% on a sales increase of 9 to 11%. Our annual guidance is for sales to total anywhere from 1.57 billion to $1.61 billion with EPS at the $1.80 to $2 range. This would represent operating income improvements of 15 to 29%, EPS improvements of 12.5 to 25% on a sales increase of 3.5 to 6%. In addition, if you take into account the nonrecurring tax benefits recorded in fiscal 2004 the percentage increase in EPS looks even more impressive. We expect gross profit levels to be relatively consistent or slightly up with our annual -- in fiscal 2005 as compared to our annual rate of 26.5% in fiscal 2004. As we have discussed in the past, rebates from suppliers declined during the 4th quarter and for all of fiscal 2004. While we do not expect further declines in fiscal '05, we also do not anticipate any improvements, either, as our suppliers are experiencing real cost increases. We will continue to work our initiatives to improve pricing and freight recovery throughout 2005. We are striving also to keep the rate of FD&A growth to one-half the rate of sales growth. Our sales continue to increase, and this challenge becomes tougher to achieve. We are focused on accomplishing this objective.

For fiscal 2005, interest expense and depreciation and amortization should be comparable to fiscal '04 amounts. In addition, we expect the ongoing effective tax rate for 2005 to be 36.0%. From a cash planning perspective, we expect property additions to be primarily in the IT area and will be in the 9 to $10 million range. We also expect to continue to purchase stock for treasury and may increase the amount of purchases as compared to fiscal 2004. That gives you some perspective on our outlook for 2005. Now Bill Purser will comment on sales and operations.

Thanks, Mark, and good afternoon, everyone. To echo Dave's earlier comments, we're continuing to see results of our efforts within the four initiatives that we've been focused on for the last three years. Those being margin enhancement, cost control, asset management, and growth. Now that we're seeing a rebound in the economy, we're benefiting strongly from our efforts. Our sales increases in the 4th quarter were widespread. We performed equally well in the U.S., Canada, and Mexico. Many of our largest NAIC, which is the North American industrial classification segments, saw double-digit sales increases. This includes primary metals which was driven mostly by steel, lumber and wood products driven by the building product segment, durable goods, chemicals, petroleum, and metals mining. We've also seen significant increases in the high-tech markets we serve. At the same time, however, I would be remiss if I didn't point out that the sales surge was somewhat uneven. For example, we've seen our small and medium-size customers increasing orders significantly while our large accounts on average were flat in the 4th quarter. In terms of industry, sales to customers in paper products, food processing, and automotive have actually decreased. I can interpret this in one of two ways. Either this can be seen as a sign that the industrial economy still is a bit uncertain with pockets of softness, signaling that we still have some rough seas ahead, or I can read this as the tide is rising but not all boats are not yet moving to the top, meaning we still have some more up-side sales growth potential. I obviously prefer the latter of the two. Time will tell what will happen in the marketplace what. I see and hear as I visit with customers and our field team is lingering sentiment of caution.

While business is good for many of our customers they're still being pretty conservative when it comes to capital expenditures and scheduled maintenance. No one is willing to be bullish quite yet for the horizon of more than, say, a few months. I'm sure the upcoming election, the war in Iraq and the threat of terrorism is on everyone's mind and probably blunting their economic confidence. As Mark noted sales so far this 1st quarter of '05 have continued the up trend for the 4th quarter of '04. For the quarter as a whole we see 1st quarter sales rising in the 9% to 11% range over last year. Beginning in our current quarter, and continuing through the end of our business year, we see year-over-year sales increasing moderately -- the sales increase moderating. The reason I say this, the projection is based on the fact that we will be comparing our business year '05 sales to the improved performance we saw during the latter half of this past business year. Our non traditional sales channels continued to perform well. While our growth from catalogs has flattened a bit the margins remain excellent. Sales from maintenance American fluid power connection catalogs totaled about 40 million in fiscal 2004. For 2005, we intend to boost our catalog sales through targeted direct mail campaigns which will be aimed at new customers in select market segments. It's also important to note that Applied continued to add to our capabilities so we can better serve the customer. We actually didn't stop investing in new services in associate training during the recession. So we now feel we're in a position to build on strength. For example, we're opening a series of new industrial and hydraulic rubber hose fabrication shops within some of our distribution centers. Old shops already built in Florence, Kentucky, and Atlanta.

They should be up and running in Carlisle, Pennsylvania, and Portland, Oregon, no later than December. Also in Florence we've opened a new shafting center to upgrade our support for linear bearing products sold nationwide. We're gradually rolling out fee-based technical training seminars for customers under the Maintenance Pro brand name. And we're adding customer sites for Applied store, which is our unified inventory management system. On the training side, we've established an intensive 17-day general manager university to provide advanced skills instruction for our service center general managers. We've also developed a six-week boot camp, as we call it, designed to flatten the learning curve for our new customer sales and service representatives so they can provide meaningful support to customers earlier in their tenure in the job. I hope this gives you a flavor of some of the things that are happening inside Applied and in our marketplace. Now I'll turn it over to Dave for a final word.

Thanks, Bill. As you've heard from Bill and Mark, we have enjoyed an outstanding year. We feel we've created the proper strategies and we're executing well. We still have some good plans in the hopper moving forward. We're blessed with an exceptional team at headquarters and in the field. The thing that makes me feel good is the wells have not run dry where we have been dipping. There's more opportunity out there. We're going to continue a conservative course of action as we view these opportunities. So we are a small cap value stock and we're going to behave as one, providing stability and safety, a quality of earnings, good cash generation, and moderate growth. A key to our future earnings is going to be the performance of the industrial economy over the next 12 months. And while we're riding a good wave right now while it's robust right now, there are some clouds on the horizon. Don't like what we're seeing with regard to the oil and steel prices, consumer spending has slowed a little bit, some production numbers have tapered off, and as Bill mentioned we've got the uncertainty of the geopolitical process across the globe. We believe the guidance in our press release is realistic for the 1st quarter and for fiscal 2005 based upon the information that we're seeing. If there are changes in the marketplace that lead us to believe that that guidance should be different we'll update you with future quarterly earnings. And pre release if necessary. I want to thank all of you, as always, for your interest in Applied, and now we'll open it up to questions.

Thank you. Today's question-and-answer session will be conducted electronically. If you did have a question it is star, one on your touch-tone telephone. Again, star, one for any questions. We'll go first to Mark Koznarek at Midwest Research.

Hi, good afternoon. Can you guys hear me?

Sure can, Mark.

A little bit more on the outlook. Of course, the 4th quarter was pre announced, and so it's not as much of a surprise as it otherwise would have been but I think obviously the market today is reflecting disappointment with the outlook. I'm kind of puzzled, too. I understand that there are some clouds on the horizon, as you point out, but, you know, when you just go and look back at the previous business cycle once the recovery got going in the period '94 through '96 you guys posted double-digit organic growth on average. So I guess I'm asking for a little bit more color and also would you characterize this as sort of a worst case outlook that you've got a 90% chance of exceeding, or do you really think this is sort of the 50/50 scenario equally probable to do better than to do worse? Thank you.

Mark, this is Bill. As we did our forecasting and put our budgets -- began to put the budgets in place, still a lot of uncertainty in the market place at that point in time. We actually started the process February -- late February, early March. We saw the pickup beginning in our own minds began making some adjustments as well. To put a percentage point on whether I think we've got a 90% chance of exceeding the budgets, I don't think I'm prepared to do that. I always like to look at budgets as a worst case scenario, but, you know, those three things that we mentioned that are hanging out there has got us concerned a little bit. Maybe to the conservative point. But this is the feedback that we're getting from our customers. Again, because of those three major concerns, that being the Iraq situation, the elections coming up, and the threat of terrorism. We're just not getting the exuberance that we thought we would from the customers, and I think we're probably on the conservative side for that reason.

Mark, just a comment. This is Dave. You know, we have said 1st quarter's going to be 9 to 11% which is double digit in my book, and are planning to provide, you know, up to twice what we had from an earnings standpoint 1st quarter of last year. So, you know, we do see this 1st quarter running along pretty well. We exited the 4th quarter in pretty good shape. July turned out pretty well. So, you know, we're still, you know, pretty optimistic right now for the 1st part of our fiscal year. We have a pretty robust forecasting model here that we use based upon some, you know, our typical drivers, and we've had very good correlation with it, and the numbers that we're giving you pretty much are in line with what that forecast shows.

Just one follow-up here, and then I'll get back in the queue. What is your usual visibility, Dave, in terms of outlook, you know, in terms of orders in hand? I can't imagine it's more than about 30 to 60 days. So I don't imagine that your full-year outlook is based on a moderation in backlog or, you know, expected, you know, absolute reduction in orders inhand, anything like that. It's more your macro outlook. Would that be --.

Exactly, Mark. We're pretty much book and bill company for the most part. On the fluid power arena where we had some assemblies, we do have some backlog there, and that backlog is growing very nicely. So the fluid power business, as Mark mentioned, was up 17% in the 4th quarter. That has grown nicely. But that's still only about 15% of our total.

Yeah, okay. So we just to have wrestle with the disconnect of strong orders and outlook in the near term but then more sort of these clouds in the macro outlook. Okay. Thank you.

The clouds, the ncu, the pmi, all those used in our model. It gives us the numbers that we're giving you.

Thank you.

Thank you.

We'll go next to Michael Greenwald with DB&C Capital Markets.

Hi guys, and good afternoon. I was curious, not to beat this to death, but when I went back ten years and took out one of the outlyers and your 1st quarter, fiscal year 1st quarter usually represents about 20 to 20.5% of full year earnings, and going forward that gets you in a range of 195 to about 245 for the full year. And, you know, then I plugged in the sales guidance you gave and if you use the mid range of 10% in worst case going forward the 5%, so the out three-quarters you have to go all the way down to 3.5% which would be basically falling off a cliff from where you're going at 10% in the 1st quarter. So to make it work, if you use -- keep cost of goods sold maybe as a gross margin as a constant, your operating margins are basically flat, and I'm just curious of where -- what am I missing here? Is SG&A just going through the roof? Is it to -- to get to your $1.80 to $2. I'm just curious what I'm missing, what additional costs are in there that I'm not taking into account.

Well, Mike, I don't think you're missing any costs out there, because I think, you know, from our perspective, we are projecting that -- and we are saying that that will moderate in our 2nd quarter, but then our total annual sales guidance, 3.5 to 6%, when we look at for the 2nd half of our fiscal year, if we would have 3 to 3.5% sales growth over this year we wouldn't call that falling off a cliff. We'd call that we're continuing to scale that. Because we had some very, very good sales numbers this fiscal years that will be going on top of at that point in time so we would still see a continued improvement with those numbers so we're still looking at those as an overall improvement, you know, with sales perspective.

Well, where are you forecasting operating margins going forward, then?

We think operating margins will go up anywhere from 15 to almost 30% for operating income. Compared to what it is this year.

So operating income and not -- all right. One other thing to follow up. Thank you. I missed the inventory benefit for the quarter. What was that?

It's around 3.3 million, I think it's in one of the footnotes in the press release, too.

Okay. Great. Thank you, guys.

Sure.

We'll go next to Jeff Hammond at Keybank Capital Markets.

Hi, good afternoon. I won't ask any questions on the conservatism of the guidance. I wanted to, I guess, talk about the price increases you're seeing. If you saw any this quarter where you got some price increases through yet you still have some lower cost inventory, if there was kind of a timing benefit that goes away, or going forward do you see those price increases flowing through and offsetting the higher, I guess, cost of goods sold?

Jeff, Bill. It was a timing issue on getting some of the price increases through, mainly with our contractual customers, but our intent, of course, is to pass those along, and we're doing so as we speak.

Basically I'll just add on to that, Jeff, too, that our pricing philosophy is based upon replacement cost, not acquisition costs. So basically the day a price increase from a supplier is implemented we roll that into our system immediately, and obviously some of our customers that we have contracts in some fixed pricing for certain time frames that doesn't roll into them, which is about a third of our business, but the other two-thirds of the business, you know, those price increases take into effect on day one.

Okay. Then I guess in terms of the incremental returns looked again very solid this quarter. Maybe some of that is the inventory adjustments, but I wanted to get a sense of, you know, the internal initiatives that you talked about, Bill, you know, where do we stand? Are we kind of through the low-hanging fruit? Does it get more difficult to, you know, get incremental benefit out of those initiatives? How early or how late are we in the game here with some of those initiatives?

Jeff, we do feel that probably most of the low-hanging fruit has been picked with the initiatives, and to your point it does become tougher once you get past that phase. This is not a surprise. We knew this would happen when we put the programs in place. It means that we'll have to keep the pressure on, we'll have to continue to work hard to get to that next phase, but I would say there's lots of upside opportunity. If you're comparing it to ball game, whether we're in the first inning or the ninth inning, we're probably about the fifth inning. We've got a lot of opportunities left. So we'll continue to push those initiatives with our field folks.

Let me add some additional flavor to that, Jeff, also. When we talk about freight recovery, which we've talked about a lot for the last couple of years, in each of our quarters in fiscal '04 we saw improvements over the prior year quarters and the overall freight recovery percentages that we were getting. So we continue to March forward. Those increases were moderating somewhat because as Bill said the low-hanging fruit has been taken, but we were still improving throughout the year and we even so you improvements in our 4th quarter where our net freight recovery percentage was better than it was a year ago.

Okay. Thank you.

We'll go next to Sharene Quadry of Highland Advisors.

Hi there, guys. This is Dan Erinson speaking for Sharene. Earlier you mentioned weakened market, industries, I missed that. Could you repeat them?

This is Bill. Dan, is it?

Yes, sir.

Yeah, this is Bill. What I was referring to are the markets that we've seen that have been strong and the ones that have been weak in our particular case. What we're seeing, as far as strong markets, are primary metals, which is, I don't think, a surprise, it's been mainly driven by the steel industry for us. Lumber and wood product which is driven by the building product segment, durable goods, chemicals, petroleum and metals mining, and we've also seen significant increases in the high-tech markets that we serve. On the other side of the coin, the markets that we've seen either flat or some slight decrease was paper products, food processing, and automotive.

The industry that you just mentioned, the paper, the food, and the auto, have they -- were they weak all quarter? Did they start off strong and get weak? Is there any color you could add to sort of the progression of the weakness?

The paper products have been weak pretty much the entire business year. Food processing has been flat to a slight downturn. Automotive started out strong and then had some downturn.

Any speculation on -- as to why these three industries are down?

Well, I can speak to the paper products, I think it's an issue of overcapacity. And as the consolidation of that industry continues, that a lot of the products that we sell are being taken out of use, so to speak, because of lines being closed, entire mills being closed. As far as food processing, it wasn't really a major downturn, so I'm not really that excited about what's happened in the food processing. That one doesn't have a lot of peaks and valleys, which is one reason that we focused on that industry, whereas the steel industry, paper industry, has a lot of peaks and valleys. This particular industry does not. So just a slight downturn, food processing. I'm not really concerned about that one. Automotive really hit us kind of midyear and I think one of the reasons there was the normal lengthy shutdowns that happen around the end of the year, around December, the automotives were not doing that in lots of cases the lines that they had closed they were not bringing back up. Even though the sales, you know, are holding up nicely in the automotive industry, I think we had a case of some of the inventory was built up fairly significant with some of the manufacturers, so while they were selling cars they weren't necessarily building inventory. So we didn't see the normal shutdowns in December that we've seen in past years.

To give a little more flavor on that automotive thing, Dan, we've seen more of a decrease with the big three and their related suppliers than from the transplants. So the transplant plants are doing well, and the big three ones are not doing well.

Okay. All right, I appreciate it. Thank you.

You're welcome.

You, too, Dan.

We'll go next to Brent Rakers at Morgan Keegan.

Yes, good afternoon. I guess to return to harping on the guidance a little bit more for a second, was hoping could you give a better sense of what sort of macroeconomic assumptions would be backing the forecast, particularly on the 2nd half of the year.

Okay. Brent, Bill. In putting the budget process together, it's a top-down, bottom-up process. What we were getting from our feel was concern about some of the major industries about the intensity of the come-back. Industries such as the paper industry and the steel industry, primary metals industry, which is one of our high percentage industries, as far as our business is concerned, also general industry, which just covers the myriad of different manufacturers, as we see productivity that has increased in these facilities we don't really see a lot of these companies reopening lines. We see them attempting to, with the lines that they have, produce more products. That's obviously impacts us, because anytime a line goes down, it's rolling equipment which we don't have any more potential for. So what we've seen is that this high productivity numbers that you're seeing is resulting in less product for us to be able to sell.

From the way -- I appreciate that. From the way that your guidance is spread, does it make an assumption of a -- an economic cyclical peak with your customers? Given the lead time in your business traditionally, sometime in the next two, three months or so? Is that kind of what you're implying by the guidance?

Not necessarily so. Couple of things. We see higher percentages coming out of the, you know, the beginning of the year because we're comparing them to, obviously, lower numbers. As we move in, I think, Mark made the point earlier, as we move into the 2nd half of our business year we're comparing our numbers against some better performing months from a revenue standpoint than it makes the percentages somewhat smaller. Also, we track the key indicators, the mcu, the pmi, consumer confidence, we track indicators within our leading business segments, and our model is showing a bit of a flattening out in the 2nd half of the business year, so robust coming into the beginning of the year, some moderation going into the 2nd half of the year, and using that model is what drives our forecasting and our budgeting process. So it's not really geared on seasonality, as far as a customer is concerned, really only the agricultural group would really cause any swings from a seasonality standpoint.

That's great. And then I guess a couple of housekeeping things. I think, Mark, you gave a percentage on this adjustment number, and if I'm doing the math right, I think it means 13 cents was the adjustment in the 4th quarter, so that means the cumulative, the other three quarters the adjustment was 16 cents? Is that correct?

Well, I think the -- you're adding in the LIFO impact of that 13 cents?

I should only work off the 11 is what you're saying?

That is correct. That is correct. So 44%, you know, that 11 cents represents 44% of the annual benefits if you add up all the benefits from the previous quarters that we've done, and as we mentioned in previous conference calls, we've started doing inventories more on a interim basis and have been adjusting our cost of goods sold for that on an interim basis, and so we pushed a lot of that earlier in the year, and these were all just strict operating improvements for us, and the 4th quarter was a little bit bigger than what we were expecting it to be because we booked more earlier in the year, and giving you the 44% gives you a flavor for how much should be, you know, in any one quarter, and you'd theoretically think almost 25% per quarter if you were to assume a straight-line thing but with the more sales in the 4th quarter a higher percentage would be in the 4th quarter than not.

Okay. And I may have missed this but you talked a lot about the impact of some of your contract oriented customers, steel prices. Did you quantify what the impact was either gross margin to revenues, or even to the bottom line?

No, we did not quantify that, but we have said in the past, and what has happened with the average price increases from our suppliers that have basically the bearing suppliers and the dry product suppliers, we saw price increases in the range of 3 to 5% in the 4th quarter. And those price increases rolled in anywhere from early April through mid-June. So they happened throughout the quarter. And, you know, we did see a negative push down a little bit with our overall operating profit for customer profitability on pricing because we couldn't pass all of those through to all of our customers immediately.

I guess the last question, has the environment with your vendors, has that stabilized, you know, with some steel price movements recently, or do you expect potential for further increases being passed on from them to you over the future months?

This looks like we've seen, you know, there's -- appears to be stability there at this point in time. Subject to, you know, what might happen, but from what I'm hearing from our suppliers, particularly the bearing suppliers, there appears to be some stability there.

Great. Thanks a lot.

Sure.

We'll go next to Jonathan Yorse with Alliance Private Client Services.

Yea, hi guys. Most of my questions have been answered but I just wanted to get a sense about the cash that you think you're going to generate next year and whether or not you see continuing to do smaller acquisitions or what size of stock repurchases you might consider.

Okay, Jonathan. This is Mark. I'll try to knock those off. I think from a cash flow perspective, we are projecting to have another good year of cash provided from operations, but I think that's going to be -- it's going to be similar to what we've done in the past year and also in other years past, is that our 1st six months of the year are not as robust on cash provided from operations as our last six months, and I think we'll see that continue this year so that in our 1st two quarters on cash provided from operations, you know, it may not be robust but it should be comparable to prior year numbers. But I think we're going to end up pretty close to the numbers that we ended up with this year on cash provided from operations. Regarding stock repurchases, obviously we look at the market from time to time, and, you know, we're in the market as appropriate, as we're permitted to. Our stock repurchases in '04 were lighter than they had been in the past years, and we believe that we will be increasing those purchases somewhat in the fiscal '05. And -- oh, and acquisitions.

Today would be a good day for that.

Yea, right. We can't do it today. And on the acquisitions, yeah, we continually look for profitable growth, and within our industry, the whole industrial distribution industry is what I call is a gradually consolidating industry, and so there are opportunities out there for a lot of small or regional distributors for us to acquire and we are in discussions with several, and they're at different points down -- related to completion, but we would expect to complete, you know, complete an acquisition or two during this fiscal year.

All right. And let me just ask you, just a follow-up question about some of your end markets. Do you -- when we talk about productivity improvements, do you see people just are being cautious now and it's conceivable that as the economy recovers they may actually open those lines, you know, that aren't restarted right now, or do you think that, you know, there's been such a strong emphasis in this last down cycle that companies are just operating a lot more efficiently right now?

Jonathan, this is Bill. I'll give you my opinion. I do believe that there is a conscientious effort on the customers that we deal with to keep those productivity numbers high. I don't see lines reopening unless the economy really comes back a lot stronger than what we're seeing at this point in time. Again, that's just my opinion. One of the things that we track as a key indicator is temp hires and overtime. That gives us a good indication of whether or not plants are looking toward bringing people back on a regular basis. When those start going down, it usually means they are hiring permanent associates, employees. We aren't seeing that at this point in time. So I do believe personally that most of our customers are going to continue to strive for the high productivity levels that they have now.

All right. And is there room in your operations for continued margin improvements?

Always.

Glad to hear that.

Always.

Okay. Thank you. That's all I have. Thank you.

Thank you.

We'll go next to Mark Koznarek with Midwest Research.

Just a couple of wrap-ups here. First of all, on the price pass-through, if we were seeing sizable increases in bearings, pricing and presumably other products in the 4th quarter some of your 8.8% revenue growth is the impact of you passing through your customers' price increases. So I'm wondering, have you guys split out actual volume growth and what price the impact of price was in the quarter and the year?

When we look at that, Mark, obviously we have those, you know, built in our numbers, and, yeah, we do have some volume, and there is some pricing and we look at that as about 50/50 for the improvement in the sales right now.

So it's 4 or 5% volume, 4 or 5% price?

On an overall basis, yes. Probably a little bit lower on the price, but around 4 percentish on the price.

In your guidance, then, 3.5% to 6% overall revenue for fiscal '05, how much price recovery would be embedded in that, you know?

Well, when you look at it overall obviously it's the bearings and the drive folks that had the price increases which is what I was speaking to on how much was price versus volume but we didn't see much price increases at all in our fluid power or our rubber or other specialty products. So when you aggregate all of those in total it's -- price is a smaller thing in total for us for the corporation. I don't have those numbers with me right now. But I can get those and maybe we can chat in a day or so.

Okay. Good. I'll follow up on that. A second wrap-up I had, actually you mentioned fluid power. You guys captured the authorization for Vickers on sort of a company-wide basis right at the beginning of the fiscal year and it was going to be kind of a gradual rollout as you added FKUs to the branches. Can you talk about what the success was in the -- you know, in the regular branches generating fluid power activity? And then I think when you first talked about that you suggested that '05 would be more of an acceleration year based on the pace of rollouts, so what can we expect for this upcoming year for that particular category?

Mark, Bill. What I had -- I believe what I said in previous teleconference was that my anticipation was that we would increase our sales about 1.6 million in the calendar year 2004 as a result of this new Vickers program. If you remember, we only started the program in January, and the first two months, January and February were literally flat. I didn't really see any great movement until we started in March, then it went up in April, we doubled our sales in May and June, and right now we're on track to be in that 1.6 to 1.8 as far as this calendar year is concerned. The more important thing about that is our margins are higher now with this new program than they were prior to the program. So we're on track from a sales standpoint. We're ahead of the curve as far as the gross margin dollars are concerned.

Okay. Yeah, I must have misunderstood early on. I thought that the one to two million was fiscal year '04 and we'd get more in '05.

No, I had based that on a 12-month, because I anticipated the first three or four months building inventory, training positions, we created a special technical help desk for our internal associates. So all these things I anticipated we probably wouldn't start seeing any kind of return until the middle of the calendar year. So I based it on a 12-month forecast when I talked about that 1.6 to 1.8.

So this business is not really enough to move the needle on the overall performance of the company even in fiscal '05? It's still going to have a gestation period?

It will. I do anticipate that latter half of our business year seeing that continue to grow, and as we move forward we'll probably have some better feel for what that's going to be. But right now it's not significant. In fact, it's tracking exactly where we thought it would be.

Okay. Great. And then just a final wrap-up on share repurchases. Would the goal here for '05 be to strictly offset dilution in options creep, or is there an expectation you would try to actually reduce overall shares outstanding?

We don't have a specific target for that, Mark, but I think the way we're looking at things is that, you know, we would like to offset the dilution effect to that. I don't know about if we would go any further than that.

Okay. So more or less that's the broad area to think about. Okay. Got it. Thank you.

Once again, ladies and gentlemen, it was star, one if you did have a question at this time. We move next to Mark Ravitz with Grace and White.

Good afternoon.

Hey, Mark.

Couple of things, I guess, absolutely amazed at the stupidity of the market here. In looking at your -- actually, let me just skip ahead. I assume that the LIFO liquidation was somewhat a product of the very strong sales in the 4th quarter that you really didn't see coming and that inventory was lower than you have planned. Is that a correct assumption?

Yeah, we were projecting inventories to go down but they actually went down by 19 million, and that was greater than our expectations and projections of what they thought they'd go down to. We thought they might only go down around 10 millionish.

And going forward for your year's guidance, I'm assuming you're seeing no LIFO liquidation.

We have none built into our plan.

Right. So also looking at the gross profit, or gross margin, actually, for the 4th quarter, when you adjust it for the LIFO liquidation, you actually did have an improvement in your margin. Basically 26.07 versus 25.79%.

If you adjust the LIFO liquidation out of both years?

Right.

That could very well be. I haven't done that calculation.

So on an apples to apples -- it's not quite a FIFO FIFO, but the margin was actually better.

Fiscal '03 the liquidation amount was bigger than in fiscal '04, so that might work.

Okay. Thank you. Keep up the great work. I appreciate it. You know, maybe you can get a special dispensation and enter the market right now.

That would be nice, Mark. Thank you much.

Thank you.

We'll go next to Jim Marrow with Barrington Investor Group.

Good afternoon. My question, I come in late on the conference call, looking at the cash, almost 70 million, I'm just wondering what are your best opportunities for the cash, and at this point your net debt is almost zero. I'm just wondering, sounds like a big opportunity to even improve on your forecast for next year.

Jim, you know, the use of cash varies with the opportunity. And I'll go back to a comment I made earlier.

I'm asking for the best use of the cash that you have, you could probably do about most of it, I would think.

I would love to use to the grow the company but we are -- we are a value stock.

No, I'm wondering what your best use, you know, if you ranked uses for next year, for the new fiscal year, where are the best opportunities to use that cash?

I think we have three big targets there, Jim, that we're looking at. We still are looking at acquisitions, and we think we'll have, you know, one or two acquisitions completed in fiscal '05 which we would use cash for.

And that's roughly what kind of return? Are you talking about plus 15 or more? Plus 15% or more?

Well, I mean, I think when we look at the returns that we get from acquisitions we're looking at certain targets. We're looking at, yeah, we'd like them to be accretive to earnings, we want them to help us improve our operating margin percentage on an overall basis, but if you're saying will those acquisitions generate a 15% operating margin percentage, I would say no.

No, return on investment. Return on the $70 million.

Yeah. Well, we want to make sure that they are accretive and that they fit our strategic plans that we can help grow profitably. 15% would not be a bad return for us. We're also still looking for the cash for stock repurchases, we increased the dividend payout and also we want to be able to invest in the business.

Okay. It just seems like the cash is excessive for your needs. And that, you know, that's one way to improve on your forecast for next year.

Well, Jim, the point earlier, if the opportunities were there, you're absolutely right. But we're not -- you know, we're not in a position to where the money is burning a hole in our pocket to where we're going to go out and try to act like a growth stock when we're a value stock.

Okay. Well, I just thought I'd make that point. Thank you.

Thanks, Jim.

Gentlemen, with no other questions standing by, I'd like to turn the conference back for any additional or closing remarks.

Thanks for being with us this afternoon. Mark, thank you for your kind remarks with regard to our performance. We felt like it has been a good year. Interesting reaction today, but that's life in the big city. We will continue to perform well. We think that the aspects of our company that has allowed us to turn in this year are still employed, and we're looking forward to turning in another good year. The projections we have for next year indicate such, and we're going to play it to its fullest. Thanks for being with us. We'll talk to you in one quarter.

Ladies and gentlemen, this will conclude today's conference. We do thank you for your participation, and you may disconnect at this time.