Applied Industrial Technologies Inc (AIT) 2007 Q4 法說會逐字稿

Hello, and welcome to the Applied Industrial Technologies fourth quarter 2007 financial earnings conference call. All lines will be in a listen-only mode until the formal question and answer session. At that time, instructions will be given. At the request of Applied Industrial Technologies, today's conference call is being recorded. If you should have any objection, you may disconnect at this time. I would like to introduce Mr. Richard shaw, Applied's Vice President of Communications. Mr. Shaw, please go ahead.

Thank you, Stacy, and good afternoon, everyone. On behalf of Applied Industrial Technologies, I would like to thank you for joining our fourth quarter year end call today. 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 our Web site at Applied .com. A replay of today's broadcast will be available for the next two weeks on our Web site and by dial-in, specific details are 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 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 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, our President, and Ben Mondics, our Executive Vice President and Chief Operating Officer who will discuss operational activities. Dave Pugh will now start us off. Thanks Rick.

And it's good to be with you folks again. As you've seen from the news release we have completed another strong quarter, to cap another strong year. So, there were some unexpected events during the year, [such as the slump in the][technical difficulties] housing market which gave us some challenges, but I think overall we reacted well to that. (Inaudible) to steal a common phrase these days, our cheese moved a little bit, but we moved with it. So, we don't have any room for whining or excuses, just results. Our sales volume ended the quarter and the year at the low end of our original expectations. Several of the key markets in which we have been historically strong players shifted on us. And Ben is going to comment on that a little bit later on. We countered that with some strong annual growth in our government and fluid power segments, and by expanding our product portfolio. We are going to continue to seek markets that are less susceptible to the cyclicality of the general industry, and we're going to continue to add complimentary and adjacent products to our core domain.

Now, support from our suppliers have been very good in this regards. And our strong relationships and our joint planning sessions with these suppliers are vital to our continued growth. Our margins have continued to move upward. As we push to be paid for our value-added services, as we change our mix of business, as we arm our associates with better systemic pricing information, and as we continue to review and make adjustments to any of the underperforming assets. Our associates have really done a good job in maintaining this upward momentum in a slowing economy. And speaking of assets, our management in this area continues to be excellent. With the exception of receivables, our progress is very good. Receivables, though they are in line with industry averages, are still in what we consider less than optimal territory. But I am convinced that we can hit our targets here. By the way, if you're hearing a roar in the background, we're having a torrential downpour here, so that's just coming from the outside. We can't control that.

Our return on invested capital has been exemplary. We hit 22% in fiscal 2007 and that represents a compounded annual growth rate of 40.5% for the past five years. So, we feel like we've done a pretty good job of selecting the right opportunities against which to apply our assets. And we consider this to be a key metric in measuring the efficacy of our strategic planning. Our cost control also remains excellent. While making sure we are investing for the future, our discipline in curtailing the unnecessary spending and maintenance mode areas, has been very good. Our consistent investment in information technology continues to provide us with productivity improvements, and we certainly haven't run out of opportunity here. All of this attention to detail is given the consistent results you've seen over the past five years, and our shareholders continue to be the key beneficiaries. I think exceeding the $2 billion sales level for the year, and achieving a 7% mark in quarterly operating margin for the first time, were key milestones for us, and be sure there are others ahead. As I sit back and view Applied today, I feel good about the fundamental operating strength of this company. Our key quality and customer satisfaction metrics remain high. Disappointments in areas that we can't control, such as the economy, is not going to distract us from continuing to improve in the areas where we can. We are poised to maximize any return of the key markets that are slumped on us, even as we seek out new ones. Now, I am going to let Mark add a few financial details before Bill or Ben discuss the operations.

Thanks Dave. Good afternoon, everyone. Let me provide some additional insight for our fourth quarter and fiscal year end financial performance. We were very pleased to achieve fourth quarter earnings of $0.56 per share. This enabled us to close out fiscal 2007 with record earnings of $1.93 per share. Sales for the fourth quarter ended at $528 million. This represents a 4.7% improvement over last year's fourth quarter. We had 63.5 selling days this quarter, which was the same as last year. For the quarter, total US service center sales were up 5.0%, and fluid power operation sales were up 2.3%. We estimate that approximately 1 to 2 percentage points of this increase, relates to the impact of passing along supplier price increases on our sales. Sales in our Canadian operations improved by 5.2% in the quarter. This represents a 4.8% increase from volume, mix, and pricing, and a 0.4% increase due to currency translation. Our Mexican and Puerto Rican operations had a combined sales increase of 18.7%.

During the quarter, our number of operating facilities was reduced slightly to 445 locations, due to the merger of some of our minor shop locations to better utilize our assets. Our product mix during the quarter was 19.6% fluid power products, and 80.4% industrial products. Our gross profit percentage for the quarter was 26.9%, at the high end of the guidance we provided last quarter, which is 40 basis points higher than last year's fourth quarter, and 10 basis points lower than the third quarter. Our selling, distribution, and administrative expense as a percent of sales was 19.6% for the quarter. This rate is slightly lower than what we had been experiencing over the past several quarters, and a slightly lower than our go-forward run rate expectations for fiscal 2008. The absolute dollar increase in SG&A for the quarter was only 0.7%. Compared to a sales increase of 4.7%. We continue to see benefits from our overall focus on productivity improvements, and cost controls.

SG&A expenses received the benefit from year-end cost adjustments, for our self insurance reserves, for health care, worker's comp, and general liability insurance, and for our vacation liability. The adjustments to our self insurance liabilities were unanticipated and were driven by annual studies from our actuaries and other experts which lowered our expenses on a one-time basis in the fourth quarter. Our fourth quarter operating margins increased to 7.3%. Compared to 6.0% in the prior year's fourth quarter. This represents the first time our quarterly operating margin surpassed the 7% level. The effective tax rate for the quarter was 35.7%, which was also our overall fiscal 2007 rate. This was slightly lower than originally expected, primarily due to an increase in the amount of tax exempt interest income earned on our cash investments. Our balance sheet remains solid with shareholder's equity at $450 million, and a current ratio of 2.6 to 1. This is slightly below prior year levels, due to the classification of $50 million of debt as a current liability. We plan to pay off that debt upon maturity in December, 2007. Our pre-tax return on assets rose to 20.1% for the quarter, and 18.1% for the year, compared to 16.7%, and 16.1% for the prior year quarter and year respectively. Our June, 2007 inventory balances were $9.3 million higher than last year's June 30 levels, primarily due to continued expansion of our product offerings to our customers. Accounts receivable and days sales outstanding, of approximately 41 days, remain competitive, but are not currently at our internal targets.

Cash provided from operations for the quarter was a solid $38.2 million. For the year, cash generated from operations was $70.9 million. Cash flow from operations was reduced on a year-over-year basis by two factors. First, we changed our funding of the company match to our 401K plan to a cash contribution, instead of contributing treasury stock. We feel this is a good use of our cash, and helps us add to shareholder value. Second, certain supplier purchasing incentive programs were converted from calendar year end to fiscal year end, which in this transition year extends the receipt of these funds into our next fiscal year. At June 30, we had approximately $120 million of cash on hand. In July, we announced an increase in our quarterly cash dividends of 25% to $0.15 per share. We have raised our dividends 181% over the last three years reflecting the improved profitability of our business. During the year, we also repurchased 1.4 million shares of our common stock on the open market for approximately $34 million. That's about 3% of our shares outstanding.

We provided annual financial guidance for fiscal 2008 in this morning's press release, for sales increasing 5% to 8%, to between approximately $2.1 to $2.18 billion. With earnings per share in the range of $2.05 to $2.15 per share. Therefore, our guidance is for an EPS increase of up to 11.4%, on the sales increase of up to 8%. We are not forecasting any gains on sales of property or other nonoperating events for fiscal 2008. We expect fiscal 2008 gross profit levels to be relatively consistent throughout the year, with the annual rate of 27.2% from fiscal 2007. The rate of supplier price increases is somewhat uncertain at this point, and any escalation over what we experienced last year could impact this. We expect to realize purchasing incentives from suppliers at a rate similar to those achieved in 2007. We will continue to work our initiatives to improve pricing and freight recovery throughout 2008.

While our aim is to keep a continued tight control on our selling, distribution, and administrative expense growth in 2008, our expectation is that SG&A, as a percentage of sales, in fiscal 2008 will approximate the annual rate we achieved in 2007. The overall growth in SG&A is being influenced by continued investments in initiatives that will help us build future profitable growth, such as our initiative to expand sales to government entities and our investigation of opportunities beyond our current north American focus. For fiscal 2008, interest expense, net of interest income, should be lower due to the planned payoff of $50 million of debt in 2007. Even with this debt payoff, we expect to have higher amounts of cash invested at higher rates, too. We expect our overall tax rate for 2008 to rise to around 36.5%, primarily due to recent US tax law changes which have eliminated certain deductions related to foreign sourced income. Depreciation expense should remain in the $12.5 to $13.5 million range for 2008, and amortization should be somewhat higher than 2007 amounts.

From a cash planning perspective, we expect property additions to be primarily in the computers and information technology area, with total additions in the $8 to $10 million range. We expect to continue to purchase stock for treasury periodically throughout the year depending on market conditions, and we will continue monitoring our quarterly dividend rate for consideration of further increases. We will also pursue acquisitions that match our stated growth strategy of growing profitably, in North America, within our current product domain. Now, Bill Purser and Ben Mondics will comment on sales and operations.

Mark, before we move to Bill and Ben, let me make just a couple of comments. As we have announced Bill is going to retire at end of this calendar year and while everyone would like to keep him in the saddle forever, he has earned this (inaudible) to enjoy time and a more relaxed settings with his family. And although I think the grand kids may be more of a challenge than the job. Our succession planning has been orderly and efficient and Ben brings us skills from both an educational and an experiential and background that are equal to the task and that will only grow stronger as we move ahead. And since fiscal 2008 is going to be his to own, Ben is going to handle the majority of our operational comments today. Bill is going to be fully engaged for the next five months, so, you can trust that we are in good hands. We will turn it over to Bill at this point.

Thanks, Dave. And good afternoon to all of our listeners. It is always a pleasure being you with and sharing good news and our latest quarter results are certainly that. I'm pleased to be here today to support Ben in his first teleconference presentation. I will continue to support as I pass the baton and assist him during this transition to my retirement in December. Although I will not be giving a presentation today, I will be glad to answer any questions that you might have for me during the Q&A. With, that I'm going to turn the operations presentation over to the Ben.

Thanks, Bill. I appreciate your guidance and mentoring over the past six months. And really over the past 10 years. I am delighted to be here today to report our progress to our shareholders and financial analysts. Especially since we have good results. I was very pleased with our quarter, and for that matter, our entire business year. While economic growth wasn't as strong as it was in 2006, our associates worked hard to deliver good sales and earnings. As we move forward into our new business year, we carry momentum from several programs that I feel are sustainable for the new business year as well as an economy that we believe will be in a growth mode.

First, let's look at the industries that were strong for this business year, and then I will make a few comments regarding our thoughts for 2008. For the quarter and the year, industries connected to energy production did well. We continued to see strong sales performance to the coal mining and power generation industries. Primary metal production, food products, chemicals and allied products, metal mining, printing and publishing, and amusement and recreation services also did well for the quarter. Some of this is due to account mix, but the industries as a whole are doing well. Growth of the paper and allied product segment slowed when compared to 2006. However, we expect this segment to return to a normal rate of growth in fiscal '08. Lumber and wood products are down double digits, as you might expect, from the slowness in the housing industry, making it our poorest-performing segment. We are not looking for much improvement here until the housing market improves. During the quarter, sales to the aggregate segment grew at a rate less than our overall sales trend. This may also be related to the housing slowdown. Finally, for both the quarter and the year, business in the transportation equipment segment, especially light vehicles, has been sluggish and that may continue into next year.

During the past year, several marketing programs contributed to our growth. Our major sales and marketing programs focused on state, local, and federal government accounts. I'm pleased to share that we increased our government sales by over 80% this year. Our plan is to have a similar rate of growth in fiscal 2008. In April, the general services administration, GSA, elected Applied as their large business contractor of the year, which has helped us garner attention from government buyers. Our capability to provide needed technical advice and additional services helped us win this award. On supplier authorizations, we signed a new agreement with wire belt company of America and received full authorization by Sumitomoto at all US locations. Additionally, we formally launched the Rust-Oleum and 3M product lines, on which we gained authorization in 2006, and continued the rollout of Parker Hannifin Pneumatic products.

On July 1, 2007, we issued a new, 1100-page, Applied branded catalog that provides information on nearly 40,000 parts from more than 100 suppliers. This catalog combined the best of our two previous catalogs, Maintenance America and Fluid Power Connection, as well as thousands of new bearing and power transmission parts, in this larger, more complete resource for our customers. Looking forward to the new fiscal year, key economic indicators show a stronger economy over the near term. Manufacturing capacity utilization in June rose to 80%, which was the highest performance since December. Industrial production also rose in June by 0.5%. The purchasing manager's index, while down a little in July, to 53.8, is still well into expansion territory. These indicators point to stronger manufacturing activity, which is a good indicator for our business. We've seen that optimism reflected in our manufacturing customers, and we expect to see steady production increases in most of the markets we serve for 2008. Our customer's inventory positions have improved over the past two quarters, and are in line with sales. Capital spending has been lower than expected, however we believe that should improve in the coming months.

Just when it seems like the housing market is going to get back on its feet, the sub prime mortgage issues come to light. We haven't seen where this is going to end up yet, however the recovery in the housing market will likely be delayed. This may have an impact on consumer confidence, and consumer spending, it could impact a variety of industries. Raw material prices continue to be a concern for many of our customers, and the tight labor market continues to put pressure on labor costs. Overall, we see an optimistic economic mood and an improving manufacturing segment. All of these efforts should support, as Mark previously mentioned, sales growth in the 5 to 8% range for fiscal 2008. We expect to see continued improvement in profitability through our margin enhancement efforts and our productivity improvements. I have a strong belief that we have ample opportunity for continuous improvement, better ways to run our company, for the benefit of our shareholders. We've made a lot of progress in our efforts to improve our annual operating margin over the last five years, improving from 2.5% to 6.7%.

Much of that improvement was generated by improved use of our assets, as well as the hard work of all of our associates. That effort will continue in fiscal 2008, and will help make us even more successful. Our operations in the United States, Canada, Mexico, and Puerto Rico, as well as our fluid power subsidiaries, have all contributed to this past year's success, and I thank all of our associates for their efforts. From a sales and operations standpoint, we will continue to drive our four cornerstones in 2008 and we expect improvements in profitable sales growth, margin enhancement, cost control, and asset management. Keeping our focus on value creation, we expect to see a good year ahead. I will now turn the call back over to Dave for closing comments.

Thanks, Ben. And thank you, Bill. There you have it. There's been -- there's five years of solid performance, topped off by this year of good top line growth, excellent margin management, solid earnings growth, and asset management. I think that kind of fits the bill for continuous improvement. The question is, how do we keep it going? The first thing is that the same thing we've been doing , a lot of hard work and close attention to the blocking and tackling that it takes to run our business. By anticipating and adapting to changes in the environment. By moving in the markets with less variability.

It's possible the economy may slow a bit more in 2008 but it still looks like a good year to us, and I can promise you, we don't intend to back away from our commitment to improving our operations and continuing our push for profitable growth. And more importantly, we're in the afraid to make the tough decisions on what is best for our decision. We're going to do what is right for the benefit of the shareholders with a proper blend of short term and long term actions. We are going to continue to judiciously repurchase our shares and adjust dividends that the situation warrants and to maximize our total shareholder return. By the with way, on shareholder return, if do you the math, we have provided a compound annual return of over 30% to our shareholders, for the past five years. So, look for us to have solid earnings this year, to provide the same stability you come to expect, but also look for us to make some solid investments to assure that the years beyond provide the opportunity to continue that earnings growth. We are excited about 2008, we look forward to making even more improvements in our business. I want to thank you for your interest. And now we will open it up to questions.

Thank you ladies and gentlemen. (OPERATOR INSTRUCTIONS) We will take our first question from Matt Duncan from Stevens, Inc. Mr. Duncan, your line is open.

Good afternoon, guys. Congratulations on a nice quarter.

Hey, Matt, thanks.

The first question I've got is a little bit on the revenue side. Can you give us some feel for exactly what percent of your revenues you feel like are exposed to housing right now?

This is Ben, Matt. I guess if you look at the lumber and wood products segment, alone, which is the largest segment affected by the housing industry, it is probably about 6% of our business, roughly. And then if you look at related industries, we may be pushing 10%.

Okay. Fair enough. Guys, very nice cost containment here in the quarter. I was impressed by the SG&A as a percent of sales. Mark, first of all, can you quantify -- you mentioned that there was some adjustments that helped you out on that line. Can you put those into dollar terms just so we can get a sense what that line might have looked like without those?

Matt, I think really what I would like to refer to is in the conference call, we said that our expectation of SG&A expense as a percent of sales for fiscal '08 will probably be comparable to the annual rate that we had during fiscal '07, as opposed to the fourth quarter run rate. So, that will be slightly higher. So, I think that is really the thought process that we had to help give you guys an idea regarding, you know, some of the one-time benefits that we got from the fourth quarter adjustments. Okay.

Fair enough. On the government sales, you talked about those being up 80% year-over-year on past conference calls you have given us some idea of what the run rate is for those, can give us an update there?

Yes, if we just sort of go back and look at the history, you know, we basically said in fiscal '06, we had about $25 million of government sales. For fiscal '07, we had stated previously that we were projecting to hit about $50 million in sales. And in fiscal '08, we expect, you know, another relative improvement from those dollars, about another increase of, you know, $25 plus million. And thats in fiscal '08.

Okay. And then two final things here. First on the buyback, the stock is down, you know, a decent amount, over the last few weeks. Have you guys been active in the market with the stock down?

We have not, obviously, since we had, you know, inside information with our year-end results and things, so, our window was not open for us -- for the company to be buying stock at this point in time based upon our -- the guidelines that we used.

So would we be safe in assuming that with the stock down here, that it would look like an attractive investment to you?

We would take that -- we look at the stock price, and we will opportunistically buy stock in the future.

Okay. And then last thing, Mark, I missed your comment on pricing, just that housekeeping item and then I will get back in queue.

The sales growth -- yes, about 1% to 2% was related to supplier price increases.

Okay. Thanks, guys. Congrats again.

Thank you. (OPERATOR INSTRUCTIONS) And we will move next to Jeff Hammod with Keybanc capital markets.

Hello, good afternoon, gentlemen.

Hello, Jeff.

Just maybe going back to the SG&A item, you know, because I think people are trying to just get at real operating results, is there any way you can quantify that? Or I mean, should we look at fourth quarter as kid of in line with the first three quarters of the year on average to get to a -- I guess I'm just trying to understand, you know, what the one-time benefit would have been from that reserve adjustment.

I mean some of the things that we had there, Jeff, regarding the items that would be one-time, it would be, you know, a couple pennies per share, for things, and not huge, but not small, it was big enough to talk about. We try not to quantify the exact dollar amount --

Okay. No, that's helpful. I mean kind of using your SG&A run rate, it looked like a bigger number than a couple of pennies but that's helpful. Any read -- I mean certainly very exceptional growth in the government sales. Why do you think you came in below target there?

The target being 100% improvement coming in at 80% versus 100%?

Yes.

It was a very aggressive target, Jeff.

Okay.

And we're going to continue to set very aggressive targets.

So, is 80% growth in '08 an aggressive target and what would be reflected in guidance? Something more conservative than that or -- ?

This is Mark, Jeff. I think when we look at our sales growth, obviously the guidance, you know, has a pretty wide range there, 5% to 8% sales growth. So, we would have, in the guidance, the range of, you know, accomplishing our goal, next year, let's say, for 80% sales growth, and as well as maybe accomplishing the goal of just increasing it by the similar dollar amount, so, about $25 million, you know, last year, would be a good range to say that was contemplated when we came up with our sales growth.

Okay. And then I think you cited, looking at -- you were looking at some other opportunities outside of North America, can you maybe just give a little more color around there? And then also just give us an update on HVAC, which I think was another kind of target market.

Jeff, let me talk about the outside of North America. As we mentioned many times, we still covet eastern Canada and will continue to look at opportunities to get in there. You know, the China issue, we are making investments on investigating. And that way, we not -- we're not [put] assets into the country. We are spending a fair amount of money on making sure we understand if and when we do, we know the right place to put them and how to put them there. So, you know, we're continuing to look at the typical places where the market opportunity exists. And want to talk about HVAC?

On the HVAC piece, we have sales and marketing efforts in a number of different industries to help diversify our business in HVAC is one, and we continue to put efforts into that.

Dave, just to clarify on the China (inaudible), is that more of a sourcing strategy? Or you know, the view that maybe some day you you want to have a footprint there?

Well, we would definitely think about having a footprint there, and whether that is just to supply industry there, or use it as a sourcing point, that's still under the investigative process. Right now, we don't feel like we need it as a sourcing point, because all of our key suppliers who supply us here in the states have manufacturing locations there.

Okay. And then final question. You know, on the SG&A line, I mean it looks like you're looking for kind of flat SG&A on an annual run rate and I guess given a -- a kind of slower growth environment, given what seems like a pretty good job managing the SG&A line the second half of fiscal '07, it seems like that that would maybe be an area that you would be targeting more. I mean is that -- you know, maybe some conservatism there, or is there some investments maybe I'm not thinking about that --

Jeff, this is Mark. Obviously, we look at the SG&A and our management of that is being very cost conscious going forward. We are going to continue to look at that really hard. And try to manage that as best we can. We think we've seen, you know, good results from the last two quarters on our SG&A management. We expect good results from that in the future as well. So --

And Jeff, your question, I'm not sure we heard it totally well enough, you asked whether we're being conservative on our SG&A estimates for next year, and I would say no, because we've definitely want to make sure that we convert our government opportunities to the maximum. We have some very aggressive long-term targets there as we have gained awareness, you know, as getting this award for the large contractor of the year, it opens up opportunities for us to make additional man power investments and have them pay off for us over time. So, we're going to continue to invest in government and as I mentioned earlier, we're investing in understanding what our opportunities in China might be.

Okay. That's helpful. Thanks, guys. Bill, congratulations.

Thanks a lot, Jeff.

Thank you. (OPERATOR INSTRUCTIONS) We'll go next to Brent Rakers with Morgan Keegan.

Good afternoon. I wanted to follow up again, if I could, Mark, on these SD&A items. You know, the first methodology you went through to kind of disclose what some of these quote, maybe one time or true-ups were and if my calculations are correct, it looks like about $0.06 a share and you've come back to answer the question a couple pennies a share. Can you maybe connect the dots a little bit more between those numbers?

Well, I think the couple pennies per share related specifically to the items we identified in the call being, let's say, the true-ups for our self insurance reserves, things like that, from the actuarial studies, and from the other experts. Those studies are done on an annual basis. And of course, the accounting requirements are that we need to book to those numbers, and so that's why they were sort of unanticipated, because we weren't necessarily planning those outside experts to come back with saying we need lower reserves for those, from our thought process on the liabilities. And that's why we stated that. And that's probably just a couple of pennies. Obviously, other SG&A items are just from us, you know, looking at -- real hard at our cost controls.

Okay. Well, let me follow up on the self insurance then. On a go-forward basis, I mean how do you -- how do you model that internally going forward? Do you extrapolate the trends over the course of the year and kind of this new lower run rate or do you go back to the higher assumptions you were using earlier?

I think the adjustments we had for the self insurance reserves really, truly are one time and cannot necessarily be used in the on -- go-forward model, because we don't expect those to continue. We just think that they were adjustments that relate to self insurance layers from prior years that we had reserves for that are not needed any more, but that doesn't mean I'm going to get any benefit in the future for that. I mean the adjustments were made, and at the reserves we have in place right now, are our best estimates that -- what we're actually going to spend right now, to settle those reserves, those liabilities in the future. So, I don't think there is -- there's not a spreading, there is nothing like that to be taken into account.

All right and just to clarify, I think you also referred to worker's comp and general liability. Are you including those under the self insurance tag here?

Yes, those are all self insured for us, the health care self insured, worker's comp, general liability, those are all self insurers for us.

And then the follow-up, just in clarification of kind of the differential in the SG&A as a percentage of sales, in Q4, versus your seemingly higher guidance for next year. Do you connect the dots there with this investment spending on government and things like that? Or are we connecting that through other one-time items that may have taken place in this fourth quarter?

I think a lot of that relates to some of the additional investments we're doing and initiatives like the government sales, and you know, items like that, that have been brought up through our budget processes as we're going forward, to invest in the future of the company.

All right. And would you maybe talk a little bit about government in terms of maybe the number of sales people you have on staff right now, or the number of personnel you have devoted to that end market? And maybe what your target is, in terms of hiring levels, lets say, you know one year out from today?

This is Dave. Let me -- I would like to back off from that, with regard to giving any actual numbers that are sitting out there, but let's just say that our investment in that category is certainly much higher than the norm for our investment in people for the rest of the company, you know, areas of the company. You know, I hate to put those kind of numbers out there in an open conversation.

And then maybe just one last question, on the consolidation of the catalogs and the opportunities there, can you put a number at all around maybe incremental costs incurred as a result of this? Potential cost savings, in the future from this? Or maybe revenue opportunities you hope to gain from this?

Hey, Brent. This is Ben. Form a -- from a cost standpoint, it's not going to have a big effect. From a revenue standpoint, we expect to see an increase in our catalog sales, but you know, not a significant number to report.

Great. Okay. Thank you.

Thank you. (OPERATOR INSTRUCTIONS) We will go next to Alan Mitrani with Sylvan Lake Asset Management.

Hello, thank you. Can talk about one of your customers, you know [Baldor], recently bought the Reliance Dodge business, they (inaudible) product for you. Can you see how that benefits you in terms of them for them to offer Dodge products through you system and whether you're seeing any uptake from the categories that they're selling?

We were supplying Dodge products before [Baldor] bought them. And I'm not sure where that adds any level of advantage by having [Baldor] providing the same products from the same manufacturing locations. We distribute the [Baldor] products and we distribute the Rockwell products and we've been doing that for some time.

So, there is no difference in terms of [Baldor] -- I mean Dodge I know was looking to bring on its own sales force to be able to sell the products, getting a little more efficiencies in the products. You haven't seen any change then in terms of distributing Baldor or Dodge or Reliance products at all?

Alan, this is Bill. I think it is too early in the game right now. We haven't seen any major changes at this point in time with the acquisition. We've really had our first management meeting a couple of months ago and at this point in time, we haven't seen any major changes.

Okay. Great. And then you referenced in your earlier -- in your -- I guess your script early on about certain industries slowing towards the end of the -- towards the end of the quarter for you. It seems like cap utilization -- or excuse me, manufacturing capacity utilization is close to historic highs. What gives you the sense -- I know your customers are saying things are okay, but -- and everybody is asking about residential construction, but it seems as if people should be a bit worried about commercial or non-RES construction give the tendency of some of this to spread into it, if financial markets seize up a little. Are you seeing any indications that commercial or non-RES has slowed markedly in any of your areas? I know mobile mini the other day, made the comment that they seeing slow downs in certain markets like Arizona, or Florida, or California, in terms of leasing products. Can you talk about what you're seeing from some of your customers in the commercial non-RES side?

Bill again. I haven't personally seen it from our customers but my son is in that business so I'm somewhat up to speed and there is some concern about the amount of capital that is going to be available, and some of the potential restraints as far as capital that is going to be available. And that as the residential is going down, commercial was still pretty hot. We have not seen that feedback as of yet, and we expect our customers would probably lag that somewhat, but at this point in time, we really have not seen it from customers.

Alan, that segment, the nonresidential segment does not -- we don't play in that directly.

Right.

Indirectly, the aggregate segments, you know, we did mention we saw a slowdown there. So that would be the major segment for us where we would see it.

And one last question, if I can. Which sectors, besides aggregate towards the end of the quarter or maybe into this quarter, you know, have slowed more, or are you more worried about? I guess some of it's a the big power project for a long -- much more longer cycle and can you just talk though, you know where you're seeing some of that slowdown besides the transportation equipment. That you referenced?

I think really the three segments that we mentioned were the lumber and wood products, aggregate, and light vehicles.

And Alan, I don't believe we, you know -- we didn't necessarily see slowdowns throughout the quarter. These were just slow in the quarter, compared to the prior periods, and so we necessarily haven't seen any acceleration in any slowdown in those areas, either.

Got it. Okay. Great. Thank you.

Thank you, we will move next to Greg Halter with Great Lakes review.

Good afternoon, guys. Congratulations on the good results.

Thanks, Greg.

Nice to see your return on invested capital continuing to move up. We're showing about a 34% calculation here, which is a pretty good increase. Relative to your balance sheet, which obviously is in great shape now, I wondered if you could discuss the opportunities you're seeing in the acquisition area, whether or not prices have changed any, given these recent changes in the market?

I haven't seen it change quite yet, just had some interesting discussions yesterday, with regard to expectations that it might -- it might impact some of the private equity money. But you know, we know we've got money on the balance sheet, had good discussion with our board about that today, and we're certainly looking for places to invest that to maximize our return.

Okay. That's all I really had. Thanks.

Great. Thank you.

Thank you, we will move next to Brent Rakers, Morgan Keegen.

Hey again. I know you guys obviously have always relied pretty heavily on the MCU, and industrial production to kind of provide your internal framework for guidance. Can give me a better sense of what you're looking for in terms of industrial production for the next fiscal year for you guys?

I will take a stab at that one, Brent. Obviously, we believe that our sales lag, you know, those indices, and so those indices are relatively stable let's say, for the last several months, and you know, we still expect our sales and sales growth to be relatively stable going forward for the next several months. Then when we look at beyond that, we look at some macro economic items just like a lot of other folks look at the macro economic items, and we see, looking into the future, that the growth in the economy should be about normal growth. Let's say in calendar 2008, or thereabouts. But our crystal ball is just as cloudy as others' crystal balls when you look out there and you know, so we're not sure.

Brent, this is Bill. If that MCU stays around the 80% mark, that is a pretty good indicator for us that things are alive and well. That's sort of a rule of thumb. If it starts dropping too much after that, then there's concern. Also, watching the employment numbers to see that there is productivity there as well. And you can see all the indicators that we watch.

Okay. Great. And I guess maybe let me phrase it another way. When we talk about kind of corporate initiatives, to drive revenue, obviously that the governments, the real high profile one. You know, are we looking at kind of the core bread and butter MCU, you know, minus let's say a percent and a half or so of growth from government driving the numbers to your targeted range of revenue? Are there a component or two or something I'm missing in there?

(Inaudible) There are certainly no acquisitions in those numbers that we've given you. We are expecting the 5% to 8% to come without acquisitions, so we think that's core business.

And what about -- you kind of made some vague comments earlier about pricing, it sounds like there is some uncertainty with what is going on with the power pricing and all of that. Let's take the scenario that current prices, that are out there right now, remain in place for the remainder of the year, and what is the contribution, do you think for fiscal '08 in terms of price inflation.

I think our expectations, Brent, going forward, are similar to what we've had during fiscal 2007.

1 to 2%, Mark? Is that kind of --

Yes, exactly. And while we don't know what all of the suppliers price increases are in the future are going to be, our expectations and how we built our plan was that they would be at a comparable level than they've been in in the past year, on an overall basis.

And then just, one final question. I think on the last conference call, you kind of brought up a little bit on the gross margin side some competitive price pressures and I don't know even from -- I guess from then to now how is that transitioning. Is it about the same? Getting a little better? Getting a little worse? Can you maybe give us a sense on the gross margin side there?

Yes, I think from that the last teleconference, I think the comment may have been made about growth in some areas of the business, you know, maybe margins that were lower than the average and we continue to have a number of initiatives to work on those margins and I think our results show that we've been successful and we plan to do that continuing into '08.

Okay, great. Thank you.

Thanks, Brent.

Thank you. Ladies and gentlemen, that will conclude today's question and answer session. I would like to turn the conference back over to Mr. Dave Pugh for any additional or closing remarks.

Great, thanks. And thanks for joining us. Thanks for helping us celebrate another good year. Looking out to 2008, you know, we're going to have keep our shoulders to the wheel, there are going to be some challenges out there, but we certainly don't think that's any disaster is waiting to happen at all. So, we're looking forward to making the most advantage of it, as we continue to put the results up that we've been putting up. Thanks for joining us today. We will talk to you again in October.

Thank you, ladies and gentlemen. That will conclude today's conference. We do thank you for your participation, and you may disconnect at any time.