Applied Industrial Technologies Inc (AIT) 2005 Q1 法說會逐字稿

Good day, everyone, and welcome to the Applied Industrial Technologies first-quarter 2005 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 on how to signal for a question.

At the request of Applied Industrial Technologies, today's conference call is being recorded.

If you have any objections to the recording, you may disconnect at this time.

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

Mr. Shaw, you may begin.

Thank you, operator, and good afternoon to everyone.

On behalf of everyone at Applied, I would like to thank you for joining us on our call this afternoon.

You should have already received our earnings news release that was issued this morning.

If you have not received the release, you may retrieve it by visiting us at the World Wide Web Applied.com.

A replay of today's broadcast will be available for next 2 weeks and archive information is contained in our news release.

Before we begin 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 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 Bill Purser, President and Chief Operating Officer, who will discuss our sales and operational activities.

Here to start us off is Dave Pugh.

Thanks, Rick.

Good afternoon.

It is good to be back together again.

About a month ago, in response to a continued robust economy, we conducted a special conference call, where we raised the sales and earnings guidance for the first quarter and for all of fiscal 2005.

At that time, we elected to not take your questions due to a lack of financial details.

But we wanted to provide as much background as possible on the direction of the business.

As you may recall, I left you that day with 3 primary points.

First, we were pleased with the extremely strong start to the year. 2, that the earnings for the first quarter were exceeding our initial expectations as a result of 3 things, those things being sales above plan, some non-forecast non-recurring gains, and an abnormally low SD&A rate for the first quarter.

The third point I left you with was that, while our business will remain strong -- in fact, we're forecasting another record year, significantly above last year's record -- it is important to note that our first-quarter earnings per share will probably not be replicated in the second through fourth quarters.

You simply cannot multiply the first quarter by 4 and expect it to work for the year.

There are some reasons for that.

We are in a period of very difficult price increase time.

They are coming out in a plethora of increases right now, and they are tough to pass though on a timely basis.

In addition to that, there are rising costs in other areas.

The oil, energy, etc., medical continuing to go up. (inaudible) our first-quarter SD&A was very low; we do not expect to have that same sort of ratio each quarter for the remainder of the calendar year.

We will have fewer sales days this next quarter.

We had some non-operating non-recurring gains in that first quarter.

So there are some reasons you cannot take that first quarter and expect to multiply it by 4.

We would love to see it, but I just want to put that cautionary note out.

All of the 3 points that I made a month ago still remain relevant today.

Our first quarter was just exceptional for Applied.

Our strategic direction is in place.

It's been communicated well.

Our leaders are leading.

Domestically, a motivated and well-trained salesforce, backed up by some pretty good marketing programs to me just did a great job of capitalizing on emerging growth opportunities.

Our non-domestic operations in Canada and Mexico and Puerto Rico are showing excellent growth and profitability.

The acquisitions we have made in this arena have been exceeding our expectations.

So that continues to go very, very well.

Our fluid power business continues to show tremendous success, tremendous improvements, a great contributor to our success.

Gross margin increased from a year ago even though we were not able to pass through all of our vendor price increases in the first quarter.

So we are spending a lot of time working the margin issue.

Our expenses were tightly controlled.

You'll note that the SD&A is what I call abnormally low, in the first quarter rose by only 4.2 percent on a sales increase of 14.4.

That is well below our target of holding it to a 50 percent growth rate.

So no matter where we looked, our first-quarter results were indeed gratifying.

As you saw in the news release, our earnings were the highest generated by this Company in any quarter in the Company's 81-year history.

We feel good about that.

I have to say, I am very proud; and I use that term carefully, because I am balancing a heartfelt conviction about the actions of our associates with a mental caution of what I see out there.

But I am proud of the associates who refused to give up during the tough times; and they're just doggone getting a job done right now.

We expect business to remain strong for the rest of this fiscal year.

As we previously noted, the rate of sales and earnings growth will most likely be lower in succeeding quarters, because of the projected moderating marketplace, the fewer sales days, and tougher comparisons to stronger periods a year ago.

As we sit and meet with our suppliers today on a fairly routine basis and on a very frequent basis right now, there is a common message.

Prices must go up to accommodate significant cost increases in steel, in oil and energy, in medical cost, and in regulatory costs.

While we have every intention of passing these price increases on, we have to expect -- because of our contracts -- some short-term negative margin impacts.

All in all, there is certainly more good news than bad, and it certainly feels good saying that for a change.

I will turn the call over to Mark now to give you a few details about what is behind these record earnings.

Thanks, Dave, and good afternoon, everyone.

Let me provide some additional insight to our first-quarter financial performance.

We're very pleased with our record EPS of 65 cents per share for our fiscal first quarter.

As you may recall, on September 20 we raised our original EPS guidance from a range of 40 cents to 50 cents to a range of 60 cents to 70 cents of earnings per share.

One of the key drivers of this bottom-line improvement was the acceleration of our sales in the months of July and August.

Our original sales guidance given on August 6 was for first-quarter sales to increase anywhere from 9 to 11 percent and total 393 to $401 million.

During the month of July, our increase in U.S. service centers same-store sales was 11.5 percent.

The rate of increase improved in August to 12.7 percent, and then moderated to 9.7 percent in September.

So our overall quarterly U.S. same-store sales rate of increase was 11.3 percent.

We're also seeing October start out with a rate of increase of around 10 percent as well.

Sales for the first quarter ended up at $413.1 million.

This represents a 14.4 percent improvement over last year's first quarter.

The number of selling days in each quarter was the same at 64 days.

We believe that 5 percent to 6 percent of this sales increase percentage is due to passing along supplier price increases to our customers.

Besides the 11.3 percent improvement in the United States service centers same-store sales, we did see our Canadian operation sales improved by 30 percent, of which 4 percent 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 18 percent in the first quarter.

In addition, we continued to be pleased with Rybalsa, our Mexican acquisition, which we completed in November of 2003.

While their quarterly sales of approximate $2.7 million are not significant on overall basis, they are accretive to earnings and are matching our performance expectations.

During the quarter, our number of operating facilities declined by 1, leading us with 433 operating locations.

This decline was from a Canadian service center closing.

Our gross profit percentage for the quarter was 26.5 percent, compared to 25.9 percent for last year's first quarter.

The actual first-quarter gross profit percentage came in slightly better than original expectations.

Regarding our gross profit percentage for the quarter, we continue to have customer pushback when we pass along supplier price increases.

This is exerting some negative pressure on our margins and will continue to be a challenge to us as we see another round of supplier price increases beginning to take form around calendar year end.

We have previously stated that we expect the gross dollar amount of supplier rebates for all of fiscal 2005 to be slightly higher than fiscal 2004.

We saw this increase happen in the first quarter.

Our expectations for the remaining 3 quarters of our fiscal year are flat compared to prior year.

We also took a physical inventory this quarter and are planning to do so quarterly from now on.

Last year we performed the physical inventory 3 times.

Looking at our selling, distribution, and administrative expenses, you'll notice they decrease to 21.3 percent of sales in the quarter, from 23.4 percent in the first quarter of last year.

This is our lowest rate since June of 2000.

The absolute increase in SD&A dollars was only 4.2 percent compared to a sales increase of 14.4 percent.

We achieved our goal of limiting the SD&A increase to no more than half the rate of sales increase.

In addition, we had gains on sales of property during the quarter of $300,000.

Our operating margin increased to 5.2 percent, compared to 2.5 percent in the prior year's first quarter.

Our achievement also exceeded the fourth and third quarter of fiscal 2004's, of 4.5 and 3.8 percent and does continue our upward trend in operating margins.

This trend is driven by the increase in sales while maintaining adequate gross margins and limiting the growth in SD&A expenses.

Other income expense for the quarter was a benefit of $270,000 compared to an expense of $166,000 in the prior year.

During the quarter, we received death benefits on a corporate-owned life insurance policy of approximately $700,000.

This benefit was partially offset by a $350,000 mark-to-market loss required to flow through the income statement on our cross-currency swaps.

The effective tax rate for the first quarter was 36.3 percent, 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.

We expect our tax rate for the remainder of the year to be at 36.3 percent also.

Our balance sheet continues to strengthen, with shareholder equity exceeding $350 million and our current ratio at 3 to 1.

Overall inventory balances grew during the quarter in line with our expectation of continued strong demand.

Accounts receivable are up $10 million due to our sales expansion.

DSOs remain in good shape at around 43 days.

The cash provided from operations during the quarter was $800,000, as the cash generated from our sales activities was offset by investments in working capital, due to our sales increases.

From a cash planning perspective, we now expect property additions, which are primarily in the IT area, to be in the 10 to $11 million range for the full fiscal year.

We also continue to expect to purchase stock for treasury.

At the present time, we plan on keeping our quarterly dividend payout at 14 cents per share.

As you know, our target is to pay out approximately 35 percent of sustainable earnings to shareholders.

During the industrial downturn in 2002 and 2003, we exceeded this threshold and kept our dividend payout constant.

We increased our payout in July of 2004, based upon our improved fiscal 2004 results.

Once we get further into fiscal 2005, we will review our payout and consider changing if warranted.

We provided financial guidance for the second quarter of fiscal 2005 in this morning's press release for sales increasing 8 to 12 percent to between 388 to $402 million with EPS in the range of 42 to 52 cents per share.

Last year's EPS in the second quarter was 26 cents per share.

Therefore, our guidance is for an EPS increase anywhere from 62 percent to 100 percent, on a sales increase of 8 to 12 percent.

Now, Bill Purser will comment on sales and operations.

Thanks, Mark, and good afternoon, everyone.

As indicated in the September guidance teleconference, the increase in first-quarter sales was broadbased.

All of our top 30 customer industries with a few exceptions were up.

Higher sales to the top 30 industries increased over 11.5 percent.

Among those that have been especially strong is the aggregate industry, which we have been targeting with special marketing programs for the last several years.

Sales to mining and industrial machinery and equipment, which is our largest SIC, also increased.

The steel industry boosted somewhat by price increases, and the wood and lumber industry benefiting from the continued growth in housing, were also strong sales leaders.

Our expectation is that due to the rebuilding as a result of the hurricanes, the wood and lumber industry will remain strong at least through next quarter.

Our sales were also strong across all sales channels, as Mark indicated.

Our U.S. service centers, our fluid power subsidiaries, our Canadian, Puerto Rican, and Mexican locations all contributed to our sales growth.

We also benefited from an increase incremental sales of new products such as Vickers and Craftsman industrial tools.

Having maintained a good balanced inventory between our manufacturers, our distribution centers, and our service centers has positioned us well to take advantage of the increased demand for our products.

Also because of our focus on controlling expenses as we moved into the recession, we avoided any mass layoffs, thereby assuring our customers we were well staffed with competent associates to handle the increase in business.

I might also add that we doubled our training of associates during the downturn, again preparing ahead for the current business upturn.

Reinforcing my comments from last month, we are beginning to see a bit of a slowdown in MRO and OEM orders.

In many cases, our customers were building their own depleted inventories in anticipation of the business upturn.

Depending on how the consumer responds in the future will determine if there once again in an overstocked position.

So while we are optimistic and aggressive, we remain realistic in keeping a close watch and feel for the pulse of our customers.

As has been said by both Dave and Mark, it is important to note that we are expecting another round of vendor price increases in the December-January time frame, mainly those products with steel content, which are primarily bearing and power transmission products.

While we have made good progress in passing along the July increases, where we were able to do so, we will once again be faced with the challenge of passing these new increases along to a very resistant market.

Let me again confirm that we are resolved to do so.

We cannot afford to absorb these price increases from our manufacturers.

We will continue to pass them through at our earliest opportunity.

Now, I will turn the conversation over to Dave for some final comments.

Thanks, Bill.

While we are very pleased with this unprecedented start to our fiscal road, fiscal year, here, no one here is relaxing.

The road that we see ahead is not so clear and obstacle-free that we can take anything for granted.

We will perform with the same commitment and focus and attention to detail that have given us the current results.

We feel we still have upside opportunity on all 4 of our strategic priorities -- sales growth, margin improvement, cost improvement, and Asset Management.

The results we have seen have encouraged us.

Our associates are excited by seeing the result and benefits from a disciplined and thorough execution of clear and compelling strategies.

We are motivated to continue to pursue new heights, and we feel they are attainable.

We are unlikely to see a 170 percent increase in earnings again in the second quarter; that is a given.

But a 60 to 100 percent increase isn't all bad on sales of 8 to 12 percent increase.

Our business continues to perform well.

It's consistent with our position as a solid and reliable small-cap value stock.

We just thank you for joining us this afternoon, and we will open the floor up to questions right now.

(OPERATOR INSTRUCTIONS) Holden Lewis with BB&T.

A couple of things, I guess on sort of the guidance side of things.

First, the operating margin of 5.2 percent in the quarter.

Obviously you have kind of stated that your objective is to I guess have a full-year 5 percent number.

I think it's in '06 as sort of your goal.

But traditionally, again, the operating margin in Q1 has historically been below the full-year number.

Can you give some sense of what specifically you see that is going to sort of make that historical pattern deviate this time?

Or do you expect to reach your goal?

I think in the first quarter, like we talked about earlier, we did have some lower SD&A expenses.

We do expect the SD&A expenses -- while we will maintain them, the rate of increase in SD&A, to no greater than 50 percent of our sales increase -- we do believe that the rate of increase may go up more than what we experienced in the first quarter.

So we will be seeing that from an SD&A perspective.

Also, like for the second quarter we have fewer selling days; and that does impact the top line as well as how that leverages down to the bottom line for when we get to the operating margin from those numbers.

So we continue to shoot for our first milestone goal of achieving the 5 percent operating margin for our fiscal year.

The first quarter we were very pleased, we were very excited about achieving the 5.2 percent operating margin goal for that quarter.

We will continue to work on getting the operating margin to be as high as possible.

It just occurred to me, on the days that you are counting out, I recognize that there's 3 fewer days in Q2 than there are in Q1, but -- correct me if I'm wrong -- but there's usually a couple days fewer in Q2 than Q1, right?

So just in terms of looking at how --.

That's true too.

The other issues relate to the supplier price increases and with the volatility that they are sort of throwing into the marketplace as to what is going to happen with these price increases going forward for us.

It will continue to be a challenge.

On that, can you give me a bit, a sense -- the operating margin was up year-over-year.

I think you said that the pricing was a net negative, and that rebates were a net positive.

Can you give a sense of the degree to which those 2 things are true?

We have not given that information out in that level of detail before, and we're not prepared to give that out today.

But that is a true statement that the pricing was a slight negative and the rebates are a slight positive?

Well, like we said in the past, we are having challenges.

We continue to have challenges with passing the price increases through to our customers.

They continue to see resistance for that.

We also have contracts with our customers whereby we only have certain windows where we are able to pass the price increases through.

So those challenges with the margins do exist, and they existed in the first quarter.

Okay.

But is that largely a function of waiting for the contract business to roll over?

I'm looking at your sequential trends on price.

I think you've gone from 3 or 400 basis points up to 5 or 600 basis points here.

I don't know what ultimately you expect to get from this, but you seem to be getting some price increases, as are most industrial companies I know of that aren't serving the auto industry.

I'm just having a hard time understanding the impact that you're having from that negatively, and why you expect to maybe have a negative impact on it going forward.

I think the challenge for us with the price increases is to continue to push them through.

About 1/3 of our business is with big national, big accounts, big customers, big national accounts.

Obviously when we look at the pricing power in the marketplace, when we have small to medium accounts there is more pricing power on our side than the customers' side.

Exactly what we're trying to push forward with.

I think too, having 2 price increases this close together does present a little more pushback and resistance in the marketplace as well.

We have become accustomed in the past to 1 increase over a 12-month period.

Now we're going to have 2 within a 6-month period, or 3 in a 12-month period.

So they are coming fast and furious.

They are well documented, and we understand them, but it doesn't make it any easier in the marketplace when they come in rapid succession like that.

And to Mark's point, 30 percent of our business is contractual business, which does not necessarily allow us to pass these along immediately when we receive them from the supplier.

Okay.

I will jump back in queue.

Thanks.

Jeff Hammond, KeyBanc Capital Markets.

I guess to follow-on, on the pricing issue, would you characterize your -- having any issues passing along prices to your non-national account customers to date?

I think there's always issues, Jeff.

I think we have more pricing power with the small to medium accounts than the larger accounts.

But nobody likes price increases, and it's a big negotiation, and it is definitely something that we get pushback from everyone, whether they are buying $5,000 a year from us or $5 million a year from us.

It is still something that we need to deal with, and we need to address those situations as they come up.

We have given clear direction to our field associates and our sales force to pass on the price increases.

Remind me.

National accounts, every 6 months you can go back to them with pricing adjustments?

It depends upon how the contract is structured.

Not all our national agreements or contractual agreements allow us 6 months.

It could be a year.

Can you give a sense of how much price contributed to top line in the quarter?

About 5 to 6 percent.

So of the 14.4 percent a little under a third was because of supplier price increases.

Great.

Mark, you talked about the SD&A and how good of a job you guys managed it this quarter.

I guess I wanted to get a better sense of -- is that just -- you expect going forward it getting it back to more of that increase at a 50 percent rate to sales?

Or are you planning some increases specifically on that line, whether it be labor, etc., that you have a good feeling that that is going to indeed move up?

I think we have run very lean for the last couple or 3 years, and we will be filling some slots which will increase our SD&A from a later standpoint.

Also we can expand on that a little bit, Jeff.

The productivity improvements that we have been achieving over the last several years we were able to parlay those into reduced SD&A.

Our total headcount has decreased over the last several years; and our headcount now is relatively stable.

So the productivity improvements are being used to work on the additional sales increases.

We are investing those in additional sales dollars.

Okay.

Bill, I thought you mentioned a slowdown with some of your MRO and OE customers.

I guess if I look at the same-store sales numbers on a monthly basis, sure you are seeing a moderation in the comparison; but it seems more a function of a tougher comparison versus any true moderation.

Would that be a good characterization?

That is a good characterization as a matter-of-fact.

I think Mark made the point earlier in his remarks that we are comparing it to better -- next quarter will be compared to better numbers.

Not necessarily strong.

We're still going to get good increases, but they were better numbers than the second quarter last year versus second quarter this year.

So you are correct.

We will see the growth; the percentages may not be as large because we are comparing them against more favorable numbers.

One of the things -- the comment I made is we saw a little bit of a moderation, more in orders and bookings from the MROs and the OEs.

I think people were backing off a bit to take a look and see what was going to happen with the economy.

The consumer report in September being strong I think has given people a little more renewed confidence.

But there was a little bit of a back off there for a while we were seeing in a slowdown of orders from the MRO and the OEM sectors.

Great, thanks guys.

Dale Benson, Wells Capital Management.

I am looking at your cash-flow statement; and with the cash you have on hand at the moment you have virtually no long-term debt.

You are less than $10 million it looks like.

The increase in working capital requirements etc., your cash only declined by 6 million.

Yet you have indicated you are not going to increase the dividend.

Did I understand that correctly?

And given your modest capital expenditure forecast, cash should be generating some additional excess cash in the next year.

What is your attitude toward increasing the dividend payout rate?

I think our attitude is to keep positively looking at the dividend, to consider increasing it.

The 1 key point to keep in mind is in the economic downturn in 2002 and 2003, we did not reduce our dividend.

We maintained it at the level it was, even though the payout was at a higher percentage than our targeted payout.

So for 2004 we increased the dividend basically to hit the targeted 35 percent payout exactly at that amount.

We will continue to look at the dividend; and consider it as we go forth in the fiscal 2005; and consider whether or not we would want to increase that at some future time.

We will definitely continue to look at that, because we have not changed our overall philosophy and guidance on what we want to do on dividends, which is to pay about 35 percent of our sustainable earnings growth.

That is a great point, Mark.

Given some of the clouds on the horizon out there with oil prices, with geopolitical events, we do want to have another quarter under our belts before we make any decision.

I notice that you still have about 600 and some thousand additional shares to repurchase under your repurchase program, but you still should probably be generating a fair amount of free cash flow.

Could you talk a bit about maybe some additional acquisitions then?

You read my thoughts.

I would like to use some of that cash to maybe make some acquisitions.

Again, we are seeing M&A activity picking up.

We are seeing prices getting a little more realistic in the marketplace.

We are obviously committed to the shareholders; we're not going to overpay.

But we certainly are seeing more opportunities in the marketplace.

Good tips I think for the Company that we are actively looking at, and I would like to use some of that cash along those lines myself.

Great quarter, and I don't know whether I would be buying any stock at these levels or not, because it is such a huge premium to your book.

But good quarter, and let's look for some more coming.

Thanks.

Brent Rakers, Morgan Keegan.

I would first like to follow-up a little bit on the comments you guys made about rebates going forward.

You talked about flattish kind of with year-ago levels the next 9 months.

I guess I noted with the purchase volumes up as much as they seem to be in the first quarter, I was hoping you could comment on the rebate comments you guys made earlier.

Actually the rebates are negotiated on a 12-month basis and are pretty well fixed in place.

They are not necessarily directly proportioned the purchasing.

I think I cautioned that in our last teleconference, that I didn't want anyone to jump to the conclusion that for every additional dollar of purchasing there is going to be an additional dollar of rebates; because that is not the case.

The reason we are saying that they're basically going to be flat is because of the negotiations we have done with the suppliers looking forward on a 12-month basis.

That does not take into consideration if any -- let's say -- purchasing opportunities present themselves, which we don't have on the horizon at this point in time.

Fair enough.

I appreciate that.

I guess to follow on the lines of not being able to pass through all the earlier price increases, is it safe to conclude that possibly any price increases that have not been passed through as of yet relate only to those national account customers that only allow you a once-a-year renegotiation?

That would be my hope to say that, because I would be struggling as to why I could not pass them through if there was not some contractual restriction.

But I cannot say that for a fact.

In some cases, we may have resistance in the market, even though we should be able to pass along price increases.

I'm going to say that I think the majority of those increases that have not been passed along are for contractual reasons.

So then is it safe to assume that -- again assuming all goes well with those negotiations, I guess, in December -- that the third quarter would see potentially -- then again I guess the current increase notwithstanding, would see some gross profit percentage expansion then?

That should be, crystal-balling it, that should be correct.

Our objective always is obviously to look at the gross profit percentage and to try to grow our gross profit percentage as part of our overall strategic plan, and what we have been talking about over the past several years.

We will continue to work on that.

I think it becomes more of a challenge in this time of rising prices to see that actually happen.

But that is the challenge that we're stepping up to the plate and taking a crack at.

I guess somewhat related to that, the price increase you talk about potentially seeing on the horizon for I guess the turn of the calendar year, what sort of assumptions -- I guess I assume kind of the rollout is going to be more of a short-term timing impact?

And do you expect that the timing impact, in terms of passing these prices through the national accounts, customers could be maybe longer than the period that happened in the spring of this past year?

What are you baking into your assumptions in terms of that price increase, impact on revenue, and also your ability to pass through the price increases?

Let's talk about just the overall revenue projections right now.

As of this point in time, we do not have any future price increases built into our revenue forecasts.

Because these price increases that we're referring to are still on the horizon, there are sort of cloudy.

We're just getting the rumblings from the suppliers at this point in time.

We do not have definitive information from everyone regarding what are the increases, what is the impact on what we are buying from them, what will be the impact on what we're selling to our customers, and what the overall percentages are.

We have just basically had the conversations.

So we were unable to forecast any sales increase or impact for those price increases as to how it will impact us.

Obviously, when we get more solid information on that, we will be able to communicate that at sometime in the future.

Similarly, then, Mark, I guess you haven't baked it into the product forecast either?

Correct?

That is correct.

The projections and guidance that we have out there right now is basically based upon pricing in effect as of right now from our suppliers.

Last question on the SG&A side.

Again, you referenced the employee levels over the last several years.

Again I think at the end of June '04 again I think are 4,300 something.

Do you have a number in mind approximately 9 months from now as to where that number could go?

Are we talking 5 percent additional employees?

Are we talking 10 percent?

And are we talking necessary for further expansion and growth?

Or just the existing employee base is kind of maxed out; you need to add more support personnel?

It's a combination of things.

I don't think it will be more than a 1 or 2 percent increase.

We are filling some voids that we have been operating because of the business did not dictate that we needed to fill the voids.

We are also filling some new positions that we have not had in the Company before, in an opportunity to increase business.

So it is going to be a combination of things.

Even though we may budget an increase, it depends on the finding the right people, and being able hire that individual, and fill these positions.

So I may have openings for several and not be able to fill them.

So it really depends on if we can find the right person in the marketplace.

(multiple speakers) A couple of new situations too in several new marketing programs that are going to require additional personnel as well; and so those are some of the slots we are filling.

Somewhat related to that on the SG&A line, there is a pronounced seasonality that happens first-half of the calendar year versus second half of the calendar year.

That kind of seasonality still expected to repeat itself second quarter and then the second half of the fiscal year?

Historically the second half has been our stronger from a sales standpoint of the business year.

But it is not peak and valley between the 2; it is not a big swing between.

When you say seasonality I think more along the lines of agriculture or something like that with big swings.

I would not say ours was a big swing between first and second.

But the second half of the year is always the better of the 2.

I guess I mean not necessarily in terms of revenue, but in terms of the SG&A cost.

I would suspect that would follow, yes.

It would be the higher of the 2.

Thank you very much.

(OPERATOR INSTRUCTIONS) Holden Lewis.

Deviating a bit from the price discussion onto another subject that has come up in some other calls; have you seen anything in terms of product shortages or any risks in that regard?

We have experienced a few product shortages and some extended lead-times.

But we have been watching this very closely and we have responded and reacted accordingly.

So our customers have not seen any impact.

We are monitoring this very, very closely with key suppliers to make sure that we don't put our customers in that position.

At this point in time, I am pleased to report that none of our customers have been impacted.

What about as you look down the road?

If there’s shortages now, does that suggest that the might get more severe down the road?

What are you hearing out of your suppliers?

We are hearing some of the same, that there are going to be certain product sizes that there could be shortages.

There will certainly be longer lead-times.

We have tried to respond accordingly.

We are watching our inventories closely.

Again, it is a matter of staying very close to our key suppliers.

I think it is somewhat up in the air, particularly on the steel shortages, as to what is going to be happening after the next quarter.

The stuff that people are talking about in terms of the sizes that there may be shortages, are we talking about the fast-turn A stuff are we generally talking about larger, less in demand materials?

It is a combination.

But most of the sizes are larger sizes.

And I have to say that at this point in time they are automotive-related sizes.

Got it.

Okay.

If you could -- (inaudible) didn't delve into this enough in the last question.

But could you just give a little bit more of a sense of why the gross margin was up?

If I heard correctly I think the 2 moving pieces we talked about are plus-rebates, negative pricing.

We didn't talk about the relative impact of those 2; whether that is what caused the gross margin to go up year-over-year; or whether there are some other elements in there that are driving that.

Obviously there's a lot of components in with cost of goods sold to determine the gross profit percentage for that.

Obviously the rebates have an impact.

The pricing to the customers have an impact.

Other items are - and we have talked about this last year, relating to our physical inventory adjustment.

And we're doing that 4 times this year, on a quarterly basis.

A year ago we did it 3 times.

So a year ago at this point in time, we had not taken our first one yet.

So the 3 times we did it last year were basically impacting the second quarter, third quarter, and fourth quarter; not in the first quarter at this point in time.

So that did have a slight positive impact on our gross profit percentage this quarter as well.

The plan is for these quarterly book to physical reconciliations to help us make sure that we properly match our costs and our inventory, cost of goods sold in the proper periods.

So that we do not have at the end of the year at the big annual inventory a big improvement in earnings.

We disclosed that last year, at June 30; and we had disclosed that as a fourth-quarter earnings improvement impact.

It was the impact of the physical inventory a year ago.

Our objective is to do these on a quarterly basis, so that we will not have a big number at any one point in time.

Okay.

Could you just -- perhaps to get a sense if we do have more price increases coming down the pike, looking at the one that you put in place in Q1, in the first quarter those are instituted, when you are taking all the product to higher prices but not necessarily selling it all at higher prices, are you able to sort of burrow down and figure out what the bottom-line impact of those price increases were in the quarter they were instituted, one quarter out?

Have they had to date bottom-line negative impacts when initiated?

From the supplier price increase perspective?

Yes, pricing specifically.

Just go back to Q1; was pricing a negative to the Q1 earnings at the bottom line or a positive?

I don't have that information right here in front of me.

I think that the pricing obviously had -- of the 14 percent increase in revenues, 5 to 6 percent of that was because of pricing.

We believe directionally that we probably ended up okay with that.

But I don't have a specific study on that.

Okay.

I guess lastly, anything else in that Other line?

You mentioned that a negative impact was the mark-to-market.

How big was that?

Are there any other sort of negative moving pieces that were kind of onetime or unusual in there that I should be aware of?

The mark-to-market on the cross-currency swap was around $350,000; and that was the other big thing that was there.

The other items in there would be -- I would not characterize them as nonrecurring.

They are definitely non-operating items.

But some other items that would normally be out there.

Nothing big.

All right, thank you.

Adam Holman (ph) with Midwest Research.

I was wondering if there are any plans for any organic service center location growth for this year or next?

Do you have anything slotted?

We do have in the planning sessions some opportunities we feel -- the market voids that we're looking at.

Obviously, I don't really want to discuss those.

But we do feel there are some opportunities in some markets that we are not currently -- we currently don't have a presence; that we feel there is some opportunities for us.

Okay.

I was also wondering if you could talk about the Vickers and Craftsman agreements?

How far along are we in the rollout of these offerings?

How have they developed compared to your expectations?

The Vickers began in January of this year and is meeting the sales forecast.

I believe that I said incremental sales we guesstimated would be around 1.3 to 1.6 million for Vickers.

We are well on track for that.

We may exceed that a little bit.

A pleasant surprise, the margins have been better than we had forecast.

The Craftsman, that was a September of 2003, if I remember correctly, and that is doing well too.

I can give you big percentages because we started from zero.

But both -- that one is on track, and Vickers is a little bit ahead, but both are meeting expectations.

The last thing, I was just wondering if you could just discuss Sarbanes-Oxley compliance a little bit.

What in inning AIT is in currently?

If any items have popped up as you have gone over your procedures?

I will be happy to chat about that.

As we are a June 30 year-end, obviously we have until June 30 of 2005 for compliance with that.

Then our outside accountants, Deloitte & Touche, will provide an opinion on our internal controls and our section 404 compliance with that.

We have a full team in place and working on complying with the Sarbanes-Oxley regulations; and we continue to work on that diligently.

We provide updates.

We provided an update today to our audit committee and our Board on where we stand on that.

We feel that we are on track to accomplish what needs to be accomplished, so that we will be able to as a management team provide the proper assertions on our internal controls; and also so that we can pass an audit from Deloitte for that when they come in and do their audit for June of '05.

It is quite an effort, I will say that.

Would you say you're like halfway through it then?

Or a quarter of the way, or almost done?

I wouldn't want to put a percentage on it or even want to say what inning we are in the game, but there still is a lot of substantive work in front of us to accomplish this.

Do you have any other large expenses coming up to meet it?

Well, the expenses that we have for Sarbanes-Oxley are included in our forecast guidance and budgets.

We believe that the money that we will spend on that this year, we will not be over our budgets on that.

Okay, great.

Thanks.

This is Rick Shaw joining you again.

I want to thank you all for joining us today, and we look forward to talking with you again in January when we discuss our second quarter.

Thanks again.

Bye.

Ladies and gentlemen, this does conclude today's teleconference.

I want to thank you for your participation.

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