Applied Industrial Technologies Inc (AIT) 2005 Q3 法說會逐字稿

Hello and welcome to the Applied Industrial Technologies Third Quarter 2005 Financial Earnings conference call. [OPERATOR INSTRUCTIONS] At this time I would like to introduce Mr. Richard Shaw, Vice President of Communications.

Mr. Shaw, you may begin.

Thank you Dave and good afternoon everyone.

On behalf of Applied Industrial Technologies I would like to thank you for joining our conference call today.

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

If you don’t have a copy 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 archived information is contained in that 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 certain 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 of publicly updated and revised [inaudible] any forward looking statements, whether due to the 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 the call without Applied’s expressed prior written consent is prohibited.

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 operational activities.

Here to start the talk is Dave Pugh.

Thanks Richard.

Thanks for joining us.

Good news again.

We delivered an excellent third quarter.

We have a strong economy and we executed well within that economy.

As you saw in our news release, this was the best quarter in the history of the company, in terms of both sales and operating income.

It was also our tenth consecutive quarter of year-over-year increases of earnings per share of 25 percent or more.

We thought this might be the tough one where that stream might end because of the tough comparisons.

So I have to feel good about the path that we have chosen and our execution along this path.

The earnings did include some non-operational gains but even the majority of those were the result of good foresight and planning and they certainly don’t diminish the strength of our earnings from continuous operations.

We have some one-time gains last year also.

What we saw in the most recent quarter was the continued development of everything we’ve been working toward in making this a better performing company.

I’ll just break it down by a few components:

On sales, they continued to grow nicely.

This quarter’s increase of 14.2 percent was on top of a 6.2 percent increase in last year’s third quarter, so we’re seeing growth over growth for the first time in quite a while.

The industrial economy is strong.

It remains strong and on the basis of some comparative results it looks like we may be gaining share also.

We’re going to cover some things today that I feel bode well for our future as we move into some adjacent markets where we haven’t been.

As far as good gross margins, we made some progress in passing through the recent vendor price increases, not as much as we needed, not as much as we desired.

Our year-to-date gross margin percentages are still not back to the same period margins of last year.

However, some very focused efforts did gain 100 basis points against last quarter.

We’re still seeing heavy price resistance from customers.

We’re still seeing a strong competitive environment and we’re seeing some reduced vendor rebates, so this continues to be our toughest challenge.

As far as SG&A, we’re doing well.

The SG&A rose by 6.3 percent in the quarter, which isn’t quite as well as we did last quarter, but it’s still well within our objective of restraining the rate of expense growth to a level of not more than half that of the sales growth.

And by the way, this does also include the absorption of the cost of our new acquisition in Quebec, Group GLM.

As far as operating margins; as a result of getting some price and holding expenses, the third quarter operating margins increased to 5.4 percent, and that’s up 160 basis points from last year on an equivalent gross margin and was 102 basis points from last quarter.

We did a pretty good job of managing assets also.

During the quarter, the inventories went down by a net $6 million and it’s probably closer to $10 million if you remove the inventories that we put in from Group GLM.

At the same time, while we were reducing these inventories, our on-time delivery climbed to above 96%.

So, all in all it was a solid performance on all fronts.

We tried to make it look easy, and of course, it isn’t.

With the kind of significant and sustained improvements that we have generated simultaneously in sales growth and operating efficiencies requires pretty focused execution and attention to detail.

One of the things we are pleased about is that it appears that our investments and quality processes in training our new general managers and in IT support have been well planned.

Importantly, these efforts continue to create value for our shareholders, and we were pleased to see that we were ranked by Prudential Equity as one of the top 54 most attractive small cap stocks.

Predicting the future is starting to get a little dicier.

Through nine months of the fiscal year, we have benefited from a very strong industrial economy, and we do think the economy is going to remain strong through the remainder of the calendar year.

But, there are starting to be some warning signs pop up on the horizon.

If we take a look at the surge in energy prices, it might put a drag on the expansion.

A little lower consumer confidence is going to, at some point, impact the manufacturing sector.

Interest rates are a concern.

They will probably moderate the previous rate of expansion so, there are a few things out there that we are going to keep watching, but we’re still pretty confident about the remainder of this calendar year.

The ISM Manufacturing Index currently stands at a pretty respectable 55.2, but even that’s been steadily declining since last May’s high.

So, we still see any number above 50 as an expansion, so we’re still healthy there.

Industrial production went up 0.3% in March.

It’s pretty much what was expected.

Capacity utilization went up slightly, but the manufacturing capacity utilization fell a little bit.

We think that some of the higher energy prices impacted that, and it remains to be seen whether the decline is temporary or a sign of things to come.

So, we do have some warning signs, but nothing that we’re panicking over at this point.

Bill is going to share his thoughts on our opportunities for growth and improvement a little bit later on in the call.

As I close my opening remarks, I just want to convey that the one thing that gives me the most confidence in our future is the continuous improvement culture that permeates our company at this point.

I don’t care which meeting I go to;

I don’t find anybody who’s complacent or willing to rest with the gains we’ve made.

So, this continuous improvement culture is now a way of life.

At this point, I will turn it over to Mark and let him go over some of the details with you.

Thanks, Dave.

Good afternoon everyone.

Let me provide some additional insight for our third quarter financial performance.

We are very pleased that we set a new record during the quarter of $0.53 of earnings per share, the highest quarterly earnings in company history.

Sales for the third quarter ended at $446.5 million.

This represents a 14.2% improvement over last year’s third quarter.

We had 63.5 selling days this quarter which was one-half day less than the same period last year.

We believe that around six percentage points that the sales increased is due to the impact of supplier price increases.

On a sales-per-day basis, the same store sales increase for our US service centers was 12.5% for the quarter, a slight improvement over the 12.3% increase we experienced in our second fiscal quarter.

We also saw our Canadian operation sales improve by 38% in the quarter, of which 11% related to our recent acquisition of Group GLM and 8% related to currency translation from the strengthening of the Canadian dollar compared to the prior year.

Our US fluid power operations also saw a sales increase of 20% in the quarter.

Finally, our Mexican and Puerto Rican operations had a combined sales increase of 21%.

All in all, good growth across the board.

During the quarter, our number of operating facilities increased by seven to 439 locations.

The increase consists of five new facilities in Canada from the Group GLM acquisition and two new shop facilities in the United States.

Even though the Group GLM acquisition is not material to our overall operations, I do want to comment that starting in this second month under the implied umbrella, they were profitable.

Our focused-acquisition strategy continues to payoff with solid results.

Our gross profit percentage for the quarter was 26.7%; the same as last year’s third quarter.

As Dave mentioned earlier though, the gross profit percentage for the third quarter is 100 basis points better than the second quarter.

A major reason for this improvement relates to the initial success of our gross margin initiatives we discussed during our last conference call.

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 of 2004, although lower as a percent of sales.

We did see increases happen in both the first and second quarters in line with our sales increases, but overall rebates dipped slightly in the third quarter, which caused even greater downward pressure on the gross profit margin.

Our expectations for the final quarter of our fiscal year is that net rebate dollars will remain flat compared to the prior year, which will negatively, impact our margins.

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

End of fiscal year, we perform the physical inventory only three times.

Looking at our selling, distribution, and administrative expenses, you will notice a decrease of 21.3% of sales in the quarter from 22.9% in the third quarter of last year.

This rate is consistent with our rates of the last few quarters.

The absolute increase in SG&A dollars was only 6.3% compared to a sales increase of 14.2%.

The SG&A increases primarily relate to additional compensation, incentives, and benefits which are a direct result of our improved financial performance.

We once again exceeded our goal of limiting the SG&A increase to no more than half the rate of sales increases.

In addition, we have gains on sales of property during the third quarter of about $550,000.

Our third quarter operating margin increased to 5.4% compared to 3.8% in the prior year’s third quarter.

This achievement continues our upward trend in operating margins.

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

We expect our annual effective tax rate for the year to be 36.3%.

The third quarter rate was lower at 35.95% due to the tax-free life insurance proceeds.

Also impacting our third quarter rate is the results of our tax provision to tax return true up for our fiscal of 2004 tax return.

In addition, we are still experiencing slightly rising effective foreign, state, and local income tax rates.

We expect our tax rate for the fourth quarter to also be around 36.3%.

Our balance sheet continues to strengthen with shareholder equity exceeding $382 million and our current ratio of 3.0 to 1.

As Dave mentioned earlier, overall inventory balances decreased $6.1 million for the quarter, even after taking into account the $3.6 million of additional inventory from the GLM acquisition.

We expect inventories to continue their decline through June with overall inventory levels being reduced by at least another $15 million.

Accounts receivable and day sales outstanding at 42 days remain in good shape.

Cash provided from operations during the quarter was a solid $35.5 million as we began to work down the additional investments in inventory we made prior to December 31, 2004.

We expect cash from operations for the fourth quarter to continue to be favorable.

Our expectation is for positive cash from operations for all of fiscal 2005 to exceed the level we accomplished in fiscal 2004.

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

While we were not active in purchasing company treasury stock in the third quarter, we expect to continue to purchase treasury stock in our fourth quarter.

We provided financial guidance for the 4th Quarter of fiscal 2005 in this morning’s press release.

For sales increasing from 11% to 13.5% up to a range of $450 million to $460 million dollars with projected earnings per share in the range of $0.45 - $0.50/share.

Last year’s comparable earnings per share in the 4th Quarter was $0.37/share.

Now, Bill Purser will comment on Sales and Operations.

Thanks Mark and good afternoon everyone.

I’m extremely proud of our associates and the results they have achieved this quarter.

As Dave said, this was the best quarter in the history of our company in terms of Sales and Operating income.

I hope all our associates are as proud of their efforts as I am.

This afternoon I would like to use my time to review the markets, as well as some operational aspects of the business, and then touch briefly on an initiative to develop some new business.

As Dave noted, sales levels in the 3rd quarter were very strong.

We saw double-digit sales increases to a wide range of customers, such as industrial machinery, paper, primary metals, lumber and wood, transportation, chemicals, and metal mining, just to name a few.

There were also some signs of softness in the food processing and coal mining markets, however, nothing that alarms me at this point in time.

3rd quarter growth was especially strong in sales in small and medium sized accounts.

Although, our E-Commerce and catalog sales were flat for the 3rd quarter, these programs help us attract and keep customers that want the convenience of online and catalog ordering.

Margins in these segments continue to be above our average.

I recently held planning session with each of our area vice-presidents of US, as well as our vice-president with the responsibility for Canada, Puerto Rico, and Mexico.

This is in preparation for the budget process for the new business year.

I thought you might be interested in their outlook for today’s market, as well as, what they are seeing for the future.

The consensus is the customers are still upbeat.

However, we are seeing more caution than in the past few months.

Most customers are concerned with how long the strong economy will last and what the future holds.

We are seeing some slow down already in the steel and mining industries in regard to capital expenditures.

However, all other SICs seem to be moving forward with their capital expenditure plans.

In regard to the auto industries, it is really company specific.

We are seeing some struggling while others are moving forward.

We also believe that we will continue to see consolidation with out customers, especially in those industry segments where there is over capacity.

The markets in Puerto Rico, Mexico, and Canada remain strong with Western Canada being especially strong.

This strength has been a result of the high production levels in oil and gas, which is being driven by the sharp increases in crude oil prices.

The outlook for all these markets remains strong.

While I am discussing Canada, as you are aware, we entered the Eastern Canadian market in the 3rd quarter with the acquisition of Group GLM, which is based in Northern Quebec.

We feel this acquisition gives us a good foothold for further expansion into Eastern Canada, and supports our stated strategy to grow profitably within our existing product domain within North America.

Our plans to continue to evaluate a broad spectrum of acquisition opportunities, and we will act when and where we believe an acquisition can be accretive while strengthening our market presence from a geographical product standpoint.

In our last conference call, I indicated that we were taking some initiatives to improve our process of passing through multiple vendors’ price increases.

While we know these increases are justifiable, passing them along to our customers is not getting any easier.

We have had particular issues with some national accounts, where by contract, we have had limited windows of opportunity to adjust prices.

I do feel we have made some solid progress, though, in addressing this pricing issue as the customer contracts are coming up.

By increasing the opportunities within the term of the agreement to increase prices, we feel that this will help us in passing through any vendor price increases that we see.

The price increases have obviously pressures on our margins.

We are pleased with our response of the challenge this quarter.

In the long run, we will continue to look at value added services, at product mix, at our customer mix for margin improvement; and we will continue to explore nontraditional sourcing options as well.

We just can’t allow gross margins to erode, and we will pursue all opportunities to prevent this from happening.

I will wrap up by commenting on the initiative to develop new business.

Approximately two weeks ago, Applied was approved for contractor status by the US General Services Administration.

We have been working on securing this recognition for many months.

Receiving our GSA number will allow us to enter the government market in a much bigger way than in the past.

We have targeted segments of the Government’s business, which will be our starting point.

We feel this sector offers positive, long-term sales opportunities for our company.

Although, it is a little early to predict future sales volume, or what the business will mean to us at this point in time.

It is very important that we properly handle the documentation required by the Government, and we intend to move into this arena with due caution.

In closing, I share Dave’s enthusiasm for our position in the market.

The steps we have taken to increase our operational effectiveness and efficiency, coupled with strong sales, have resulted in record earnings for our shareholders.

While we may see some moderation in the economy, we feel our excellent performance is going to continue.

Now I will turn the call back to Dave for our closing comments.

Thanks Bill and thanks, all your guys for a great quarter.

You know it is easier to be upbeat and positive when the business is strong and there are certainly more smiling faces than we have had in the past few years.

Our management team is very pleased with the progress we’ve made, but we certainly aren’t complacent.

We are far from being in the comfort zone.

Last quarter we told you we were less than pleased about the erosion of our gross margins rates.

We challenged ourselves and took some pretty tough action to remedy that.

We made some progress.

There is more to be done.

There will be more price increases coming at us.

We feel like we are better prepared to handle them now, but support from our suppliers on this front is imperative.

Over the past 3 years, we have made the always tough calls; prune the under performing service centers so that we could reinvest in better growth opportunities and improve the return of investment for the company.

I think we have exercised proper judgment.

We did what we needed to do, and today we are transacting significantly more business with fewer facilities.

We are not declaring victory, but we still have other challenges to address.

In a company of Applied’s size and scope, we are going to always have opportunities, and thank goodness we do.

So what should you expect in the future?

You can count on us to remain steadfast in our four core strategic priorities, and that is growing the sales, improving the margins, containing the costs, and managing the assets.

Doing the basics; the Lombardian approach to the game.

No one is going to be resting.

We remember how tough it gets when the tide turns.

We are optimistic for the near term.

Our optimism is reflected in the increased earnings guidance for the remainder of the year.

This is going to require continued sales growth and productivity gains to offset the anticipated gross margin challenges, and we will be updating you on the progress each quarter.

Before we head into questions, I want to step out of my normal cautionary character for a moment and tie our past to our present.

Back at the trough of the recession, when our operating margins had dipped below 2%, we had committed to you that the productivity investments we were making would help us achieve a 5% operating margin when we returned to normal sales volumes.

I am not sure all of you believed me when I told you that.

When we first made that commitment, we had not figured in the cost of expensing stock options.

We hadn’t anticipated the [importance] and cost of Sarbanes-Oxley compliance.

We had not forecast the steel and energy cost that would escalate in multiples, and we certainly hadn’t considered negative impact on gross margins from changes in supplier rebates.

There are many excuses I could sit here and give them for not meeting the commitment of the 5%, but excuses don’t wear too well around this place.

We are back to pre-recession sales volumes.

We have absorbed all of the unanticipated costs, and we have delivered the committed margins.

And more importantly, we believe that performance is sustainable at a minimum.

My hat is off to every associate of this company who made it happen.

With that we’ll get back to the moderator and let him take your questions.

[OPERATOR INSTRUCTIONS] And we’ll take our first question today from Jeff Hammond with KeyBanc Capital Markets.

I think you mentioned you thought maybe you were getting some market share gains can you maybe talk about where you might be seeing those?

Jeff , this is Bill.

We were looking at comparison between some of our competitor’s sales increases, and our increases and lead us to the conclusion that we are gaining some of the market, some market share.

We believe it’s across the board.

We think it’s from maybe some of the smaller independents and maybe some of our larger competitors as well.

Jeff that’s kind of an inexact science in this industry because we don’t have standard numbers out there so I mean everything we look at it, you take a look at comparative results and make your call.

Okay and then Dave you mentioned you know the 5% target and actually moving past that this quarter.

I guess looking forward and looking out I mean you hit that target what are you looking at longer term as kind of the next hurdle rate to shoot for?

Jeff we do not expect that at this point.

We’re working on our business plan for next year as we speak.

Certainly we’re not putting any caps on it but you know we’re going to go for everything we can get.

It’s just, we’re going to find out all the pieces coming together are going to help us.

As I mentioned earlier it seems like all facets of the business are working smoothly right now.

I’m very pleased that we are where we are.

We are ahead of schedule on hitting that number and feel very pleased that we’ve gotten there.

Okay great.

And then finally I think last quarter there was some concern that perhaps the vendors chatter from vendors about follow on price increases at some point in the year that become increasing difficult to pass along.

I guess with steel prices pulling back, are you still hearing that same chatter or is less likely that we see a future fall on price increases over the near term?

Hi Jeff, Bill.

We have, we obviously stay close to the major manufactures trying to get a handle on this.

Early on at the beginning of this calendar the talk was very strong about the price increases because of where steel was.

No set numbers, no timetable at that point in time.

I’ve really not heard of any backing down from that, but again, nothing definitive at this point in time.

But if the continued, all the things that they are facing, we’re all facing from the escalating cost in raw materials, from energy costs.

We’re going to be extremely surprised if we don’t see any increases, but at this point and time nothing definitive.

We’ll go now from a question from Mark Koznarek with FTN Midwest Securities.

Would you guys mind running through the daily sales by month during the quarter?

Oh yes, Mark, this is Mark.

I don’t have that information with me right now and we have that quarterly information that we disclosed and you know, were presented, We had 14.2% sales rate for the coal quarter and I think our projections are 11%-13.5% and little bit lower for the next quarter because of the tougher comps that we’re coming up against.

But I don’t have that monthly rate with me.

Mark we’re looking at quarter- over- quarter – I mean month-over- month increases.

Yes we’re seeing month-over-month increases.

Did you see any kind of change in rate as you went through the quarter or was it pretty steady at this kind of you know changed rate year-over-year by month – January, February, and March.

We didn’t really see any major fluctuations.

Would April so far be sort of that same quarter magnitude?

We’re still sticking with our 11%-13.5% guidance for the quarter.

Mark how much revenue was acquired for in the quarter from that Canadian operation?

It was around $3.3 million was the amount of revenue per the Group GLM for the quarter.

Okay and that will be the run rate per quarter?

Yeah and that was about two months worth of work.

So we still don’t have a full quarter in there yet.

It wasn’t a full three months in this quarter so because we did the acquisition right around the beginning of February.

Okay and then final question here.

I just want to talk about the guidance for the fourth quarter for a moment because you guys are pretty specific with the revenue expectations, the goal of keeping SG&A growing at half the rate of sales growth.

We know that gross margin will be slightly better in the fourth quarter than the third quarter.

I just went back over the last ten years and at no time over the last ten years did you have a gross margin decline fourth quarter over third, so that’s going to go up a little bit.

And the minimum earnings I get to is 50 cents and then if you go to the upper end of your revenue growth range you get closer to 55 cents.

So I’m wondering why do you have the more cautious guidance where it seems like you’re going to hit the top end if you do the minimum of the perimeters that you’ve outlined?

Mark, this is Mark here.

It’s really, let me talk about two situations here that we believe will impact our gross margins in the fourth quarter that we talked about in the conference call.

The first one is on the rebates.

Is that we are still looking at a softening in the rebates coming towards us and so that will have a negative impact on the margin percentage.

And the second thing is as we talked about before is with our quarterly fiscal inventories.

We’re doing those each quarter this year as with last year we did it three times a year, the year before it was twice and going back just a couple of years ago it was just once a year it was all in the fourth quarter.

So what was happening in the past is that the benefits that we recorded from our fiscal inventory write ups were rushing all into the fourth quarter period and we don’t expect that to happen in this year’s fourth quarter.

Do you actually think this the first time in a decade that gross margin might actually slip here in the fourth quarter versus third?

There’s a possibility for that, yeah.

I won’t necessarily call it slip, I would just say it would be a lower rate than the third quarter.

And just one final one and I’ll get back in line.

Which is the inventory reduction?

If you are successful in reducing it by $15 million in the up coming quarter won’t we hit some LIFO layers that will be more profitable?

We don’t believe that that’s going to happen.

We don’t have any thing with the LIFO liquidations forecasted in our projections.

We’ll go now to Michael Greenwald with BB&T Capital Markets.

Hi good afternoon.

It just sort of relates to pricing issue.

You mentioned that pricing vendors was up 6%.

At what rate were you recapturing that during the quarter and were you able to quantify that and is this sort of I mean is this starting to pick up in momentum of the rates you are starting to capture that and I guess is there some inability as sort of the national contracts that will rollover?

I guess I’ll give you a chance to answer.

Let me clarify one thing on the 6%.

That is the impact on our sales for this quarter versus a year ago’s quarter.

So, 6% wasn’t the impact from last quarter to this quarter.

So clearly what we have is we have two levels of price increases that are impacting our sales in the quarter just ended.

It was the increases that we saw at the calendar year-end of ’04 as well as the summer of ’04 increases that impact as comparable purposes.

And we believe that each of those increases are about the same amount so they’re both right around 3 % was that impact for, so if you want to look at it on a, how much of that 6 % is related to the increases that occurred in the calendar year-end increase, just about half of that.

So I want to make sure that we clarify that.

So the impact on our sales dollars is those amounts.

Does that answer your question, Mike?

Okay, so you’re saying that the 6% of revenue growth was from pricing, correct?

Or was it 3% is what you’re saying?

6% on comparing the third quarter this year versus the third quarter last year.

So of the 14 percentage points that are there, six of those percentage points relate to the past year’s supplier price increases and the impact of that on our sales revenue.

Okay, okay.

At what rate are you recapturing the vendor increases on the gross margin?

I mean if it’s negatively affecting you, is it, are you doing a better job as time is going on or what can we expect going forward?

Is this a…

Well, I mean, assuming prices

You don’t get another round.

Sure.

I think the answer is yes, we’re doing a better job and that was part of the work and the initiatives that we put into place for the gross profit margin but one of the challenges we have that we’ve talked about in the past is about 30% of our sales dollars are contract sales dollars, and each of those contracts have certain windows of when we can pass along the price increases to that.

And those windows can be three months, six months, 12 months; things of that nature and so we do not always have an opportunity to pass those along immediately but when those price windows happen we then pass them along at that point in time.

If we do not have a contract it is our policy to pass them along immediately, but then that’s always a challenge and that’s exactly what we’re out there, out on the front lines, out front trying to do and trying to accomplish.

Michael Greenwald.

Okay.

You mentioned in your last call that mix was a negative factor on the gross margin from the spot versus contract pricing.

Did it have less of a degree in the quarter and what do you think going forward and secondly, I’m with the other gentleman on, I’m trying to figure out how gross margin could possibly not be improved, given that in Q4 you bulked up inventory quite a bit prior to some of the price increases from the vendor and as those start to flow through I get sort of thinking that your gross margin should actually improve.

I guess both of those.

Thanks.

Mike, I’ll attempt to answer the first part of your question.

Last quarter we did see, when we talk about customer mix, it was a combination of customer mix, product mix, we saw heavy orders from a capital project standpoint coming from what we would call traditionally pricing challenged industries; heavy capital projects within the field primary of the metals group, which have traditionally lower margins than some of our other customer bases.

And that was one of the reasons that we felt like the product mix and the customer mix was applying some of the pressure and as a result, we had lower margins in the quarter.

I think that’s what you’re referring to.

Yes it is.

This particular quarter, in my comments, I mentioned that we are seeing somewhat of a lesser activity with a CapEx for primary metals, for steel, so the activity wasn’t quite as great and I don’t think we got as much of a hit from the product and customer mix in this quarter as we did last quarter.

Our next question comes from Brent Rakers with Morgan Keegan.

Good afternoon.

I guess the first question, this may be as much housekeeping as anything else, it looks like depreciation sequentially moved up about $1 million.

Is that correct?

What are you referring to there Brent?

I don’t think so.

Am I misreading that from the, I’ll follow-up later on.

That must be my error.

I think our depreciation number has been pretty stable the whole year so far.

Okay, okay.

In the past we’ve talked about depreciation and amortization and for the nine months it’s $13.1 million versus $12.8 million from a year ago at the same time period.

Okay.

Second question.

In the [inaudible] call last week they talked about that the distributor channel seems to be very healthy right now and I guess some of your competitors maybe have got their inventory positions worked out, and I wondered if you could maybe comment on if you thought that was the case first and then I guess if that is the case, second, what would be the implications, in terms of what do you think of the competitive playing field and pricing environment out there?

Brent, this is Bill.

I’m thinking through my mind.

From an inventory standpoint, I’m only aware of one major competitor that has made any kind of announcement regarding inventory.

I can’t really make a comment on that.

I just don’t have any input that would lead me to believe that there was excessive inventory or that anyone’s going through a thinning process.

I would suspect because there are some longer lead times developing within, particularly the bearing industry, that, inventory’s getting a little stronger but at this point in time nothing to panic about.

There’s a few automotive sizes that have been in short supply for four or five months or so.

Brent, it’s certainly in our planning process.

We are not taking any inventory changes by competition into consideration when we look at what we think the competitive environment’s going to be.

I mean, the competitive environment’s still going to be tough, it has been, but I don’t believe it’s inventory-related.

And then I was hoping you could talk a little bit more about this GSA contract.

I guess the first pass is maybe a potential $2 to 3 million revenue kind of deal.

Is this going to be for business-related products or more products that would flow kind of through the catalog model and then like I guess you gave us earlier, when you’ve got the Vickers line, some kind of intermediate, longer-term revenue targets to get, give us some similar type two, three, four-year out numbers for this business.

Well, first of all, when the GSA awards a contract or number, they place a guesstimate and the operative word here is “guesstimate” on the value of the agreement, which is usually five years in length and they assigned approximately $600,000 a year to the agreement and that’s where you got the $3 million.

We are not sure where the $600,000 came from, quite honestly, but as we’re looking at the opportunities, it will be very much, very similar should I say to what we did with Vickers.

That’s a very good analogy.

It will be a slow ramp up.

I really don’t anticipate seeing anything the remainder of this business year because we’re in a training mode.

We’re in the process of making sure that our system is supportive of documentation that the government requires.

We have selected target segments as I stated within the government.

We’re not trying to take that big elephant on with one bite, but very small bites and selective bites I might add, but we do believe that we’ll be able to give you some better information as this develops much as we did with the Vickers, when we acquired that line.

So, at this point in time, it’s a little premature for me to be giving any insight but as I say as we move through the process, I think we’ll be better able to tell you what we think the impact’s going to be and when.

And the last question;

I was hoping maybe you could clear up.

I am a little confused on the tax rate numbers, and I guess if the $2.5 million item is 0% tax rate and you pull that out of the numbers, you get an effective rate, I guess, of 40.5% or something like that.

Am I missing something in there?

That is close Brent.

Not all of the $2.5 million was tax-free.

The vast majority was tax-free, but a little of it we did have to pay tax on, and also we didn’t have the true up of our fiscal ’04 return that we filed in mid-March.

We did the return-to-provision true up and so we had to role those through our tax provision in the quarter-ended March 31st.

Our expected run-rate for the 4th quarter, as well as the annual effective tax rate is 36.3%.

So, it would be safe to assume when you kind of adjust, and back out, and add back some of these different items, the tax rate is kind of an above normal rate.

You might even add a penny or two back to that wouldn’t you?

Well, we did have a one-time true-up item there, and that impacted the tax rate in this quarter because of our return-to-provision true-up that happened at this point in time.

So, we expect our annual rate and the 4th quarter rate to be around 36.3%.

I believe a follow up question from Mark Koznarek with FTN Midwest Securities.

Hello again.

Actually I think the previous questioner brought up the Vickers line.

I was just wondering if we could get an update on that?

It sounds like [fluid powers] is moving ahead quite well, up 20%, and just wondering if there is more expansion of the SKU that is responsible for a lot of that and what the outlook is?

Mark this is Bill.

The Vickers line has certainly contributed to that increase.

We have just a sales forecast that we anticipated from adding Vickers and we have been able to do so at a higher margin than we had forecasted.

So, that has contributed to the fluid power increases, but the line has met expectations and really exceeded it from a gross profit standpoint.

What’s then the outlook there Bill?

Are there new lines that you are going to be bringing on, or are you able to make those product lines available across more of your branches?

Is there a certain penetration effect that we have to look forward to here?

I think it is going to be a combination of things, Mark.

We will continue to look at new lines that, you know we listen to our customers and as they are coming to us and requesting that we consider certain lines, our Marketing Department is constantly reviewing opportunities for us.

I think it is going to be a combination of things.

I think it will be further expansion of some lines that are segmented at this point in time, and it will be an addition of some new lines.

That is the constant effort within our Marketing Group.

Are there any specific dollar amounts that you can share with us of in terms of growth?

I really can’t share any of the lines that we are looking at, or any of the dollars at this point in time.

As soon as I can, you will be the first to know.

I have no doubt.

Stock option expense was mentioned.

Have you guys adopted a stock option?

Yes Mark, we adopted that in July ’03, July 1, ’03, so that we have been on stock option expensing now for, gosh, 7 quarters now.

So we adopted [inaudible] 123 early and so when [inaudible] 123-R came out this past December ’04, it really does not have much of an impact for us going forward because we have already done the things that they are asking these other companies to do at the beginning of their next fiscal years.

Oh, okay then.

I apologize for forgetting about that.

And then finally there was a comment that the E-Commerce and Catalog sales were flat.

Why should we not be troubled by that?

[inaudible] above average growth vehicles.

Well, Mark, I think one of the reasons is I think it is a plateau.

I don’t think it is permanent.

We are doing things with our MA and fluid power catalogs that stimulate sales.

We are looking at new products, opportunities.

We are looking at a little more targeting approach with those catalogs, and we really believe that it is just a temporary situation that we will move forward with.

I am not concerned.

If I were, I would say so, but at this point in time I feel pretty strong about the new initiatives that we have got going forward.

Gentlemen, there are no further questions.

I will turn the conference back over to you for any closing comments.

Thanks guys.

I appreciate your comments and hope you feel as good as we do about the quarter we’ve just given.

Looking forward to a good 4th quarter also [inaudible] our guidance.

Things are hitting on all cylinders right now.

So, looking forward to talking to you in about three months.

Good evening.

This concludes today’s conference call.

Thank you everyone for joining us.