Applied Industrial Technologies Inc (AIT) 2008 Q2 法說會逐字稿

Hello and welcome to the Applied Industrial Technology second quarter 2008 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 and Learning. Mr. Shaw, you may now begin.

Thank you, Jennifer, and good afternoon, everyone. On behalf of Applied Industrial Technologies we appreciate you joining our fiscal 2008 second quarter conference call today. You should have already receive our earnings release that was issued this morning. If you've not received it you can retrieve it by visiting our website at Applied.com. A replay of today's broadcast will be available for the next two weeks and the archived information is contained in our news release.

Before we begin I'd like to remind everyone that we will discuss Applied's business outlook during this conference call and make statements that are forward-looking. 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 SEC. Accordingly, actual results may differ materially from those expressed in the forward-looking statements. This conference call is 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'll also hear from Mark Eisele, Vice President and Chief Financial Officer who will discuss our financial performance in detail. And Ben Mondics, our President and Chief Operating Officer who will discuss operational activities. Getting us started today is Dave.

Thanks, Rick and as usual we appreciate all of you joining us. Lets get right to it. We have two very disparate discussions today and that is disparate, not desperate. First is a review of a good quarter and good first half results. Second is trying to make sense of the projections for the next six months in light of what we're currently experiencing and I'm pleased to say it was another record quarter for Applied. For the second quarter we saw the earnings per share improve by nearly 24% on sales growth of a little over 8%. That continues our year-over-year double digit earnings per share increase trend. As I view the metrics associated with these earnings, I'm confident that our management team has the operating fundamentals of this Company well under control. We were solid in all areas of key performance metrics. From an overall standpoint, we saw mixed business conditions during the quarter, while the sales of the housing related business continue to be impacted by the stress in these markets, our sales to other industries such as the metal, mining, and food production were very strong. We continue to see upward movement in our government sales. Another double digit this quarter maintains our enthusiasm for the future of that business.

As we've stated in the past we have been moving our sales focus to areas that are less susceptible to general economic cycles. Our operating margins showed continued strength due to our efforts to control cost and also to shift our mix to the less price sensitive markets and also just better managing our assets. The result was a 7.3% operating margin, exceeding the 7% mark for the third consecutive quarter, and improving on last years 6.1%. Our focus in this area will become even more important in the projected market environment.

Cost control was particularly gratifying, as our SD&A as a percent of sales came in right at the 20% mark for the quarter which is slightly below our plan for the year and it's certainly at a growth rate well below that of our sales, so this gives us further latitude to support our growth programs with the appropriate resources and still hit our cost targets. Asset management is going to remain a prime focus in this mixed market environment. For the quarter, inventories did go up as a seasonal norm, but they were managed very effectively. The year-end projections are where we want them to be. Receivables are directionally correct but they still have opportunity for improvement. This area also is going to require close scrutiny should the market move as forecasted. We're already experiencing a challenge or two here.

Our return on invested capital increased once again and continues to be better than the industry norm. This is still a key metric for us to determine how well we are aligning our assets with market opportunity. Cash generation for the quarter was nice and strong, keeping our balance sheet in good shape to support any strategic growth and productivity improvement efforts that we see. On December 17, we announced the acquisition of Vycmex, and its group of companies in Mexico. The addition of Vycmex gives us substantial expertise and capabilities in the fluid power products and systems in Mexico. We are steadily and cautiously expanding our presence in this country, as we see the Mexican manufacturing environment as a strong alternative for companies who question the risk of taking on the China challenge. As for the second half, while we've not experienced to date the level of overall decline as being forecast, we're not blind to the the fact that a lot of indicators are pointing in that direction. A recent drop in the purchasing managers index puts the ISM below its expansionary threshold of 50 and this has been a fairly reliable indicator for us as to future market conditions. Consumer confidence has been declining for some time, and that has now been followed by a drop in consumer spending. So given these warning signs, we feel it's prudent to more cautiously balance our investments with perceived market opportunity in the short run. Not getting way ahead of the market but by no means running for cover at this point.

In summary, we have a solid six months under our belts and we have some storm clouds on the horizon. We're confident that we can manage well in a changing environment should it occur. I'm going to now turn it over to Mark for more detail on the overall financial performance and I'll come back later to wrap things up.

Thanks, Dave. Good afternoon, everyone. Let me provide some additional insight for our second quarter financial performance. We were very pleased to achieve second quarter earnings of $0.52 per share. Sales for the second quarter ended at $511 million, which represents an 8.2% improvement over last year's second quarter. We had 62 selling days this quarter compared to 61 days in the same period last year. On a sales per day basis, sales increased 6.4% over last year.

For the quarter, U.S. service center sales were up 8.4% while sales at our U.S. fluid power businesses were up just over 1%. For the U.S. service centers, we estimate that approximately 1% to 2% of their increase relates to the impact of passing along supplier price increases on our sales. Sales for our Canadian operations increased by 10.8% in the quarter, primarily driven from a 13.7% increase in currency translation. In local currency, our Canadian service centers sales were down 6.7% while the Canadian fluid power businesses increased by 7.1%.

Our Mexican and Puerto Rican service center operations had a combined sales decrease of 2.3% primarily due to the impact of a strike at one of our large Mexican customers. We did acquire Vycmex, a Mexican fluid power distribution Company with five operating facilities toward the end of the quarter. The impact on our financial statements from this acquisition was not significant. During the quarter, our number of operating facilities increased by three locations to 452. Due to the addition of the five new locations from Vycmex and the divestiture of two Canadian service center locations specializing in rubber products. Our product mix during the quarter was 19.4% fluid power products and 80.6% industrial products. The gross profit percentage for the quarter was 27.3% consistent with the guidance we've provided for fiscal 2008 of 27.3%. This margin was 30 basis points lower than last year's second quarter and 10 basis points lower than the first quarter. We continue to experience gross profit margin pressures primarily due to increased sales to large national contract customers which are generally at lower margins. These pressures have been somewhat offset by higher levels of supplier support. We do not have any assurances that these higher levels of supplier support will continue for the next six months.

Our selling, distribution and administrative expense as a percent of sales was 20.0% for the quarter. This rate is 140 basis points lower than the second quarter of fiscal 2007 and is slightly lower than our go forward run rate expectations for the remainder of fiscal 2008. We continue to see benefits from our overall focus on productivity improvements and cost controls. The comparison to higher sales as well as lower employee benefit and depreciation expenses were the main contributors to the lower percentages. We plan to prudently invest additional resources for our government and other growth programs for the remainder of the fiscal year in support of our ongoing corporate strategies. The absolute dollar increase in SG&A for the quarter was only 1% compared to a sales increase of 8.2%.

Our second quarter operating margin increased to 7.3% compared to 6.1% in the prior year second quarter. This represents the third consecutive quarter that our operating margin surpassed the 7% level. The increased sales compared to the lower than expected operating expenses were significant factors contributing to the improved margin results. Our net interest expense was virtually zero. This was due to an increase in interest earned on money-market type cash investments and lower interest expense due to the retirement of $50 million of our debt near the end of the quarter. The effective tax rate for the quarter was 38.1% compared to 36.1% in the second quarter last year. The higher rate was primarily due to a higher effective rate for state taxes in this period and recent U.S. Tax law changes which have eliminated certain deductions related to foreign income.

Year-to-date, our tax rate is 37.5% and we anticipate our tax rate for the entire year to be at or slightly below that level. Our balance sheet remains solid with shareholders equity at over $470 million and a current ratio of 3.3 to 1. This ratio is above prior year levels due to the retirement of $50 million of debt in the quarter. Our pre-tax return on assets rose to 18.4% for the quarter compared to 15.8% for the prior year quarter. As anticipated, inventory levels increased $22.5 million in the quarter primarily due to special buys to achieve calendar year end buying targets. We expect this seasonal increase in inventories to mostly flow through our system during the next two quarters so that inventory levels at June year-end should be close to our June 2007 levels. In addition, we added $2.7 million of inventory related to the Vycmex acquisition. Accounts receivable and day sales outstanding of approximately 40 days remain competitive but not currently at our internal targets.

Cash provided from operations for the quarter was a solid $21.8 million compared to cash used in operations of $12.2 million in the prior year second quarter. This improvement relates to improved collections on receivables, timing of our liability payments, and improved operating income. Cash used for investing and financing and activities in the quarter included $9.7 million to acquire Vycmex, $50 million for the debt retirement, and $21 million related to our ongoing stock repurchase program. We have continued our annual sales guidance for fiscal 2008 in this mornings press release to be between approximately 2.1 billion to $2.18 billion, but have increased our earnings per share guidance to the range of $2.10 to $2.25 per share. The increase in EPS guidance is driven by two factors. The repurchase of Treasury stock accomplished during the quarter and the second quarter operating results being better than originally expected. Now, Ben Mondics will comment on sales and operations.

Thanks, Mark, and good afternoon, everyone. We are very please the with our second quarter performance. As Dave stated, business conditions are mixed. From an industry standpoint, the two areas that continue to suffer are the wood products industry due to its ties to housing and the transportation group as it relates to automotive production. Beyond those two segments we continue to see strength in many of the other industries we serve. The metal mining, cement, and food and beverage industries saw strong double digit growth during the quarter. We also saw growth in such areas as power generation, rubber and plastic products, and the primary metals industries. A double digit increase in our government sales confirms our steady progress in this growth area and we will continue to invest accordingly. Our catalog sales continued to make strides, showing a double digit increase over last years quarter, thanks in part to our new and expanded Applied branded catalog that was launched at the beginning of the fiscal year.

We also welcomed Vycmex to the Applied family adding five service centers in Mexico. As Mexico's largest independent fluid power distributer, Vycmex gives us substantial expertise and capabilities in fluid power products and systems in Mexico, thereby allowing us to provide a total product solution for Mexican industries. We feel this increases our value as a supplier and will help us expand our market share in Mexico.

As for the second half of our fiscal year, we will work to balance the projected market concerns with the opportunities that exist. We have stayed on course to control our cost and we have managed our assets very well as indicated by our SD&A and our return on invested capital improvements. This sort of discipline assures that we are well positioned for a strong or a weak economy. Many of the economic indicators have turned down in the past month. And our customer base is increasingly cautious about the general economy and specifically, the price of raw materials as well as energy costs. However, we are confident in our ability to work through these mix conditions. We benefit from serving a variety of industries in a very diverse customer base. During uncertain times like these, our customers see increased value in our training, technical assistance, value-added solutions, inventory management programs, and logistics systems. Our continuous improvement programs continue to drive efficiencies in all areas of the Company as indicated by our operating leverage and we continue to see opportunities for improvement in sales growth, market share gain, and gross margins. With these positives stacked in our corner, even in the face of a potential downturn, we have a lot to be optimistic about. I will now turn the call back over to Dave for closing comments.

Thanks, Ben. I guess I have to say and I'm very pleased with the results that the team has delivered. They've given us an excellent second quarter to complete a good first half. The projected market environment does require a degree of caution; however, there are opportunities out there for those that seek them and we plan to do just that. We do feel confident in the full year earnings guidance that we provided. I believe our strategy is still very sound and I know our operating fundamentals are strong. We're going to continue to invest wisely and we're going to continue to stress quality in every effort that we have. And we have a strong management team, and experienced veteran management team who have been through the wars before, so while we are operating at a higher level of vigilance and responsiveness, we're not operating out of fear. We're willing and able to make tough decisions when they're needed. So thanks again for your interest in this Company, and we're ready to do our best at answering your questions. Let's open the lines and get started.

Thank you. (OPERATOR INSTRUCTIONS) We'll take our first question from Matt Duncan with Stephens.

Good afternoon, guys and congrats on nice progress in the quarter.

Thanks, Matt.

The first question I've got is really kind of with regard to the outlook that you guys have been talking about here, and Ben, maybe I mean you kind of referred to this a little bit, but can you talk just a little bit about maybe just anecdotally what you're hearing from your customers about what their expectations are for the next few months? I know you mentioned they're growing more cautious on the economy but just in general kind of what do you sense your customers are feeling is going on right now in the marketplace?

Matt, I think you stated it well. I think there's caution out there but we have yet to see any downturn like you would read in the newspaper, so we're optimistic but I think like our customers, we're cautious based on all the indicators, the macroeconomic indicators we've seen, and everything you read in the media, but right now, we have not seen it as of yet.

And then maybe just to give us a better sense of the directionality of your business right now, are you comfortable talking about month to month sales trends? I know you've done it some and declined to do it some in the past but just what does the month to month trend look like and then we're three weeks into January here, how is the quarter looking so far to date?

Matt, this is Mark. We try to avoid talking about those month to month trends. I think especially in the quarter that just ended with December, with the holiday months and their week typically sees our seasonality with our sales in the month of December being with some of our lightest sales in any month throughout the entire year. So what we're really looking at is how we're doing compared to our plan and for the planned sales and I would say for the quarter just ended, we were hitting those numbers each of those months.

Matt, right now, the projections are more height than with actual results and I don't know if it's because it's an election year or what's going on but we're still seeing fairly strong demand.

I guess it would be fair to say that when you guys talk about slowing growth in the second half of the year, that's more a reaction to headlines than anything you've seen so far.

Absolutely. It's as we read the indicators, as we've read the indicators in the past. The indicators would say this possibly is happening. Now, the indicators may be influenced by the same headlines, so we just haven't seen it with regard to the day-to-day operations.

Okay, on the SG&A expense management, you guys have continued to do a very admirable job keeping those costs down and I'm curious, number one you say you expect as a percent of sales that those might creep up a little bit in the second half of the year. Can you discuss in a little bit more detail why that might be and then as a follow-on to that, how much of your SG&A expenses would you say are actually kind of discretionary in nature?

Matt, I'll tackle that question. I think the expectation is really and we've talked about this over the last several quarters is that we are in the process of adding resources to attack more of our growth areas, specifically like government sales, and we still have headcount that we would like to devote more to government sales and devote additional resources through SD&A from that perspective. And from an overall perspective, our SD&A is driven about 60 to 65% based upon personnel related expenses. So that's the real key driver for this. We continue to get more and more efficient in doing our day-to-day operations and that helps us. For instance, our headcount right now at December of '07 is 4661 people, and that includes about 60 people for the Vycmex acquisition in Mexico. So if you take that out, we're still down 30 some people from June of '07 to now. I think that reflects some of the overall efficiencies we're gaining throughout our system. Which helps the SD&A expense.

I guess to follow-up to that then, Mark, you guys have talked about the government business being up double digits. That appears to be where you're devoting the extra SD&A expenses. I know you said it's up double digits but are you in a position to quantify for us a little bit more accurately exactly how much those are up just to give us a sense for what your success rate has been there?

Matt, I think we had previously stated that last fiscal year, we saw growth of about $25 million and ended up the year at 50, and we've stated that we expect a similar growth in dollars and we're on pace to do that this year.

And then the last question I've got and I'll get back in the queue is uses of cash. If I look at your balance sheet, you paid off $50 million indebt, you bought $21 million in stock during the quarter but you're still sitting on $80 million in cash and only $25 million in debt, maybe talk a little bit about what you're planned uses for cash are, what your acquisition pipeline looks like and then what are you seeing in terms of acquisition multiples right now?

I think that what we want to do is use our cash to expand the business and we believe expansion through acquisitions is very viable. We have on an overall basis seen acquisition multiples start trending down and we continually have candidates that we're talking to for acquisitions, and we expect to continue to talk to them. Obviously we just closed Vycmex last month, and we don't necessarily project into the future how and when further acquisitions might close but we'll tell you we're working really hard on doing that.

Sure. Thanks, guys, I appreciate it. Thanks again and congrats again on a nice quarter.

We'll go to Holden Lewis with BB&T.

Good afternoon, thank you. Could you also comment sort of along the lines of a general market discussion, you're sort of seeing your allowance for bad receivables creeping up the last couple of quarters. Can you talk about whether receivables are sort of lengthening or if you're seeing anything in that that might be contributing to some sense of unease or is there nothing related to that and I guess lastly on the market conditions, about a year ago we saw the ISM's dipping below 50 as well and overall conditions just kind of stayed sluggish growth. Are we seeing anything on this dip below 50 that we didn't see in the last dip below 50 that would suggest these conditions are different.

Holden, I'll tackle the allowance for doubtful accounts. I would say as a general rule, we are seeing a slight deterioration in that, which is why we are adding to the allowances. We've been at historic lows for bad debts over the last several years and our entire customer base has been in fantastic shape when we look at our receivables agings and we have seen an uptick in some bankruptcies over the last several months with some of our customers, so that is why you're seeing increases in the allowances from our receivable perspective which obviously does flow through SD&A and then you see it on the balance sheet from that perspective. But in conclusion on that, we are still projecting to be at a normal year for bad debt expense and where our allowance is at, so comparative to the last year or two, where we were at historic lows, it's an increase, but when you look at the grand scheme of things we're just right where we always are which is generally very good. We don't have a lot of bad debt expense in in total.

At the same time, our DSO's have dropped.

DSO's continue to drop too.

And while that's the actual case right now, if you look out there at credit tightening, if the market slows, if you have some folks on a very thin capitalization, it could get tighter, and we don't plan on being the mortgage banker.

Holden, what was the second part of your question again?

I was just curious again on the sort of market you're seeing. A year ago, the ISM was below 50, much as it is in December, and really, conditions didn't really change. They maybe decelerated a bit but you still saw growth despite some sub 50 readings. Are you seeing anything and maybe the receivables is part of the answer but are you seeing anything different on this dip below 50 that suggests that this is more worrisome than the last one?

I would say no. I mean, obviously, the month of December if you go back historically is always a light month for the ISM, and so one month does not a trend make. I think we continue to be, to look into the future to say well, yes, there's a lot of like Dave said earlier a lot of storm clouds on the horizon, but so it doesn't look that bad. Things are looking okay.

Holden, at our age it's tough to think back for a full year, but I don't see anything, I don't see anything in the actual performance that would support a thought that we are moving out of expansionary territory. So again, if we have some purchasing managers, we've been reading headlines and assuming caution in that area, it could lead to their projections.

Understood. And then secondly, the SD&A number now, I mean, you're kind of approaching what has been the bottom end of the historic range. I mean, sort of prior to the 1990's or the '89, '90 downturn and prior to the 2000 downturn, you kind of got your SG&A down into this 19% range as you are now. Talk a little bit about is there some reason why that 19 can't ultimately become 16, 17 or is there some reason why that 19 has historically been the bottom and this time around, it's likely to be somewhere around that too? Just speak to the possibilities there.

I guess we continue to see opportunities to control our cost and improve our cost structure. At the same time, we continue to see opportunities for investment, so we're balancing both and trying to manage profitable growth for the Company, but we continue to see a multitude of opportunities to control costs.

Holden, the good part of this is us ratcheting down is a natural process of achieving the benefits of our investments in productivity efforts. It's not because we put a strangle hold on any of our guys. We're still a growth Company. We're still looking for growth areas, and this doesn't happen naturally. Not through some dictate from the top.

Right, but when you talk about sort of increasing the spending and you kind of cited that as a reason why maybe your SGA percentage of sales might go up in the second half, even though I would imagine that your revenue seasonally should be higher too, typically second half you see more leverage, not less, I mean, you've been investing in government. You've been investing in catalog, and you've been doing very well in the SG&A. Are you actually stepping up in a meaningful way that rate of investment which would lend itself to less leverage than you've achieved so far or how should I view that the?

I don't think we're stepping up our rate of investment there, Holden. I think that we still see investments that are out there and obviously, when we talk about investments, it's really in SG&A that once we put the ore in the water, that the expense continues on for awhile, so it sort of takes awhile to ramp up sometimes as well.

Okay. So at the rate of investment isn't increasing, I mean you're investing but the rate of investment isn't increasing and you still see opportunities to sort of control the cost and it doesn't appear to be a lot of incremental investment that needs to be made, shouldn't we see more leverage as the revenues sort of tick up seasonally?

Well, that's one of the things that happens. There are certain things that happen seasonally that counter that. For instance, at the beginning of every calendar year, we have the new social security taxes that are all, and unemployment taxes, and various things that the happen earlier in the year and then dwindle off as the year goes on as well, so those things ramp back up too. So you have some of a little bit of an offset for that, but generally, we're looking for economies of scale as well and generally, you are correct in that when the sales go up, we can't get more efficient and drive more down to the bottom line.

Because you've always had those tax patterns and things like that?

Yes, right. That's nothing different.

Okay I'll jump back in, thanks.

Thanks.

Next we'll go to Brent Rakers with Morgan Keegan.

Yes, good afternoon. You guys have hit on a lot of stuff. I wanted to, if you could talk a little bit about, I know you don't talk specifically about months but in this case, you had Christmas Eve, where I believe you're open a half day, fall on a Monday which I would assume would be very challenging in terms of sales, New Years Eve fell on a Monday as well this year. I was hoping you could maybe talk us through what you think the impact on that would have been in terms of lost revenues, maybe this year versus last year, and then secondly, you hear a little bit of talk about plant slowdowns or shut downs to a greater degree this year between Christmas and New Years, I was hoping you could address that as well?

Brent, we looked at that and it's really negligible for us, whether -- where Christmas Eve and New Years Eve fall in the week are usually down days for us no matter what.

Brent, I wouldn't consider them lost. It's just postponed so that the Christmas Eve stuff comes back a day after Christmas.

And could you maybe also comment then on the level of factory down time maybe this year you experienced between Christmas and New Years versus let's say 2006?

I don't think we -- we haven't heard any major difference between the two years.

It's a good question, but there's nothing that has popped up on our radar screen from our guys inputting to us that would lead us to indicate it's any different.

And then maybe a little more on the SG&A side. You've talked I think a lot about payroll and again reminding us to key in on the payroll and the employee numbers side of the equation. Could you talk a little bit about the non-payroll side? Is there anything else in this quarter, any kind of prior period adjustments, let's say related to insurance or something like that, that might have artificially brought that SG&A number down, on more of a one-time basis?

I think when we look at those SG&A expenses, some of the other things that we have decreases in is with the employee benefits, for instance, our 401(k) match, as we've talked about in the past, our 401(k) match is variable each quarter depending upon the Company profitability, and for the quarter just ended, our match was at $0.50 on the dollar for the first 6% of the people that were contributing into the plan and a year ago was dollar for the dollar so we did see some reductions in that. And so that changes quarter by quarter as to if that's a positive or negative or flat, so that's one item that we have. But another thing, Brent, is what we've really seen is that throughout many of our expense accounts that are out there, we've just seen good controls this year compared to last year, and we've seen small decreases all across-the-board, so it's not always necessarily just one big thing. We saw lots of little things that added up to good numbers in doing our SG&A comparisons.

And then Mark, maybe a follow-on question to that also and I know if you've tried to answer this, but I think Dave, I think for the last year and a half, you've been emphasizing that is SG&A is going to grow at a higher rate than it's actually grown at and I guess I just wonder as we go into the second half of this year, what would make the second half different than anything else we've experienced over the last year and a half?

Right now, if I had to point to any one thing I'd say we're probably below what we thought we would be with regard to staffing in the government business, simply because we're pretty, I don't know, we have some high standards on what we're going to hire over in that area, and getting those people is not as easy as we thought it might have been to start off with. So we probably have a budget that's beyond what we're actually spending in that area, and we're not taking that budget away. We want the folks to go get those folks, and if we can find them. So that would be one area where in the second half, if the opportunities present themselves we would spend more money.

And then Dave, just one last question and maybe as a follow-up to that and I guess I think that's where I probably thought you were going to go with that, but isn't part of the government model designed on not necessarily training and bringing up new talent but basically, hiring existing producers?

Absolutely.

So that really, on a percentage of sales basis, shouldn't really have a negative impact even right from the gate, should it?

I'm not sure I?

Well, there were producers in their old companies, whether they could be immediate producers in our Company, maybe some ramp up.

Okay, fair enough. Thanks a lot, guys.

Thank you.

Next we'll go to Adam Uhlman with Cleveland Research.

Hi, good afternoon.

Hi, Adam.

I was wondering if we could dig into business conditions a little bit more. Could you talk about your sales growth with small accounts versus large accounts and could you also provide some color on average order sizes and lines per order?

Adam, this is Ben. I guess the first part of your question, growth from different types of accounts we have seen stronger growth in the national account arena than we've seen in the remainder of our business, and it's been very good. Overall, both segments are up but more so in the national accounts arena. Mark, I don't know if you want to comment on that?

And for the number of lines per order, that's stayed the same for a long time and it's remained the same. It's about two lines per order or per ticket that we have, and we don't really see much change in that.

And then the average order size, has that been pretty stable as well?

Yes, it has been going up, I don't have the numbers in front of me Adam, but let's say 6 to 8% the size has been going up. But it's been relatively stable.

Okay, and then why would the U.S. Service center business be growing faster than the fluid power businesses for the most recent quarter?

The fluid power business is much -- a larger percentage of their business is tied to construction and in turn the housing industry, so they have had a challenge with the industries they serve more so than the U.S. Service centers which are much more diverse.

Okay, great. Thanks, and then the last question for Mark here, could you comment on the size of the Vycmex acquisition in terms of revenue and then perhaps is it going to be accretive or neutral to earnings this year?

Right. Well, their revenue run rate is about $1 million a month and really, we bought them right at the end of December, so we expect in January for them to kick in on the income statement to add some dollars to our performance. We do expect them to be slightly accretive but nothing significant.

Great. Thanks.

Thanks, Adam.

Next we'll go to Greg Halter with Great Lakes Review.

Good afternoon, guys. Good numbers there.

Thanks, Greg.

Relative to pricing, I know you've talked about a 1 to 2% boost historically over at least the last couple quarters. Is that something you're looking for going forward as well?

Greg, I think that the answer is yes. In the past several quarters, we've been saying it's about a 1% boost and now this quarter we said 1 to 2% because we have seen a couple of suppliers that had price increases that were a little bit larger than what we had experienced in the past, particularly some of the bearing manufacturers, so I would expect that that 1 to 2% should continue on for the next couple of quarters of seeing that boost.

Okay, and on the housing related side, on the last call, you had indicated it was down but less negative than it had been. Do you see any light at the end of the tunnel there, or have things gotten worse in the most recent quarter?

I think that that trend, Greg, continued. Last quarter was down less than the prior quarter. So the trend is moving in the right direction and hard to predict when the slide is going to end.

The rate of decline has slowed but it's still declining.

Okay. And in the SD&A number, were there any pick up, was there any pick up from facility sales in the quarter?

Yes, we did have a gain on sale and you can sort of figure that out through the cash flow statement and I think it was a little under $400,000 was the actual gain in this quarter, so I think for the whole year, it's about $1 million.

Yes, 1.1 million year-to-date.

So about 400,000 of that was this quarter.

I think it was 700,000 in the first quarter.

Yes.

And I think I asked this last quarter as well, but do you anticipate any further sale of centers down the road?

Well, there are none in our guidance, so we do not have any in our guidance for the remaining six months. Obviously, we do have properties that could be sold and we do entertain offers on those periodically whether it's from somebody coming in and making an offer on our property or if it's us deciding that we need to move to another area of that market that we're in and then having a property available for sale, but we don't have a big pipeline for that.

Okay. And we estimate your U.S. business at about 90% of the total. Is that still in the ballpark?

U.S. is yes, around probably 88, 89% total U.S.

Okay, and two last ones, really one last one. Your capital spending has been relatively minor for the last several years and just wondering if there's any reason to expect a number of more than $10 million on an annual basis going forward here?

I don't think on a significant basis, about half to two-thirds or three-quarters of the amounts we spend are IT driven and those IT expenditures on capital items are -- a portion of those are just to keep the lights on type of a thing, keep the system running but a good portion of those are for us to drive our improvements in our system which gets us more productivity improvements so we're going to continue working on those, but looking into the future, we don't see any big projects down the road.

Certainly no major overhaul of the IT programs which would be the first thing that I'd look at from a capital standpoint.

And I think you put in an IT system five or six or seven years ago that seems to be adequate for the foreseeable future if my memory serves me correct.

Well, we put in our new financial accounting system, gosh, nine years ago and that will bode us well for awhile.

Okay, and I lied, one last one. Mark you mentioned there were 62 selling days versus 61 and on an equivalent selling basis was that up 6.4%?

Yes, the difference of 62 to 61 days would have added like around 1.6 or 1.7 percentage points for sales if you're doing the calculation to get to the same-store.

Okay. Thank you very much.

Thank you.

And we'll go to Jeff Hammond with KeyBanc Capital Markets.

Just a little more -- go back to some of the end markets. One of your bigger buckets that I don't think really came up as an outlier good or bad was just kind of the general industrial factory, so I was wondering if one, you can speak to that? Two as you look at maybe Q3 versus, or I guess your fiscal Q1 versus your fiscal Q2, what markets in your mind either notably accelerated or decelerated because within, if you step back it just doesn't seem like a whole lot has changed over the last three months.

Yes. Going back to the first question there, what was the first part of your question?

Just--.

General industrial. Okay, yes.

Which is a very large, very general category was good solid growth, pretty much equal to the average for the Company, so if you look at the large population of that, that segment of the business, it was solid. And then I guess the look at comparison of Q2 to Q1, there are some fluctuations in there if you break it down by SIC code, but I don't think anything that really sticks out. The biggest decline, getting worse would being the transportation arena for the auto guys, and then our rate of decline for the lumber and wood products slowed from Q2 versus Q1.

And then just Canada, oil and gas, I mean what, maybe give us a little more color on the feedback you're getting there?

I think on the natural gas side, still depressed and not a whole lot of exploration and production going on on the oil side and the tar sand it continues to be a boom, so we're seeing more of a benefit on our hydraulics side of our business which is much more tied to the oil and our bearing and power transmission side of the business which is more tied to wood products and natural gas has suffered and we don't see that changing around in the foreseeable future.

Okay, and then just final question. It seems like outside of these pockets of Canada weakness, the housing related stuff and transportation, everything else is pretty solid. As you touch in -- as you talk about the tone change at the customer level, are there any end markets that currently are pretty good that you're more concerned about?

We have a number of markets that are good and from a concern standpoint, none that really stick out as facing a downturn.

Okay, thanks, guys.

Next we'll go to Bill Dezellem with Tieton Capital Management.

Thank you, we had a couple of questions related to Mexico and we appreciate it's small at this point, but what are you hearing from your Mexican customers and in general about the Mexican economy and thoughts about its direction moving forward?

Very similar to the U.S., maybe a little bit more, even positive than the U.S. market right now. The economy seems to be going well though it is tied directly to the U.S. economy. We're seeing some good things in Mexico.

The strike ended?

Yes, one of our largest customers Copper Mine has been on strike, and hopefully they will be back to work here soon with the end of the strike.

And then you commented in general terms about acquisitions, but specifically in Mexico, how would you characterize the acquisition landscape in terms of the companies you are seeing that are available for acquisition? And number two, the pricing relative to what you would be paying in the U.S?

Just a couple comments there. One is there are more companies there for sale than we would take a look at, for a number of reasons. We are picking our spots carefully with regard to filling out a footprint that we feel like we need within Mexico and the product line expertise that we need there to give us full offerings. We feel like we have solid management there, but the prices down there, I don't see them being a whole lot different from what we're seeing here in the states now that some of the multiples have dropped, so we still see Mexico as an opportunity for acquisitions but we're about to fill out our footprint the way we want it right now and we're not, money is not burning a hole in our pocket down there.

Great, thank you.

Sure.

Next we'll go to [Brian Carlson] with Atlantic Investments.

Hi, guys. Thanks for taking my call but my questions have been answered.

Okay, Brian, thank you.

Thanks, Brian.

And we'll take a follow-up from Holden Lewis with BB&T.

Thank you. Can you talk a little bit more about the gross margin? You haven't really covered that on this call. It was flat in first quarter, down a bit in the second quarter, just go over for us what the moving pieces are within that. You mentioned that you took some price increases from I know Bearing guys. I don't know if some others. Is that having a negative, positive, how do you expect that to play out? And then you mentioned some pre-buys. Is that having a negative, positive and how do you expect that the to play out the rest of the year? And then any other moving pieces that we should be aware of impacting that line?

Holden? Yes, this is Mark. I think when we look at the gross profit percentage going forward, we continue to see the pressures on our point-of-sale margins there, and a lot of that is because of the supplier price increases and our abilities to pass those through immediately, especially with our contract customers are sometimes challenged although we will pass them through eventually when we have our price update thresholds, so those are challenges for us. Also, as we're gaining more sales to these larger national customers, the overall margins for them are slightly lower than the average margin for the Company, which continues at that price pressure. Those downward pressures have been offset by increases that we've experienced in some supplier support. We expect the supplier support in the second half of the year to be more flattish as opposed to increases that we saw in the first half of the year, although we're going to work really hard to negotiate with our suppliers to try to maximize that.

And by supplier support, are you referring to the sort of end of year sort of inventory clear outs that you can get discounted product or are you talking about a more, for some reason, a more collaborative relationship than you had had in the past couple of years?

All of the above. Any time we can get some supplier purchasing incentives, we negotiate those with our suppliers from all sides and however we can maximize those it's all of the above.

And you think that the -- so the discount at the end of year discounted product would fall in that as well, shouldn't that the be an impact on your fiscal Q3 and Q4, because those would have been year-end clearances.

Well, we don't quite call them year-end clearances, but yes, with the purchases of the product that we had at calendar year-end, the benefits we get from the supplier incentives, they roll through to our income statement when we sell those products generally, and so that will roll through in our third and fourth quarters, but then again, in the third and fourth quarters, we will be purchasing less products in the suppliers too since we're then using the inventory we had in stock at December 31, too which is a downward thing on supplier purchase incentives as well.

Okay. And then I guess lastly, you talk about given what the you're seeing in the macro stuff, even though there's nothing in the market right now suggesting a big change but you're talking about balancing perhaps differently. What levers would you pull to sort of reduce the cost. We know what levers you want to pull increasing your cost and that, right, adding salespeople to government, that sort of thing, but what areas might there be a bit of a change in your approach that would actually reduce the cost side of things specifically?

I don't know that we have anything sitting out there that we have focus with regard to, we talk about balancing things and being somewhat more circumspect just because of some projections. Basically what we're saying is we're keeping things on a little bit of a shorter leash. We're not getting way out ahead of things, so if we find a fall off that's -- that the numbers that are projected actually happen, we don't want to be so far out that it takes us three months to recover. So basically all we're saying is, hey, the leash is just a little shorter so the puppies don't get wrapped around a tree. So that's the balancing act we're doing right now. And that's just being circumspect.

Right. But what areas -- because I would argue based on your comments earlier that the government leash has been too short because you haven't found enough people and actually it sounds like you're going to let that leash run a little bit and try to add more people to try to catch up with where you want it to be. So what leashes are you reigning in a little bit?

Well, it depends upon where the markets go. If markets drop in a certain place, we can certainly pull in people. We can, as Mark said, you look at two-thirds of this is people related, and with regard to normal attrition, are you going to fill the slots or just let the attrition flow and we'll make those calls as we go.

I think that's one of the things we've done well and one of the things you see in our SD&A, is as we have seen a downturn in the wood products or the automotive industry, we have adjusted our cost as we've gone along, so we're not sitting out there with extra cost. We've made the adjustments along the way and then to tag on to Dave's comments we do have investments that we're looking to make and if we need to delay some of those investments we'll delay those.

And Holden, let me -- I do want to remind you and everyone else that's listening, during that last downturn we didn't have any forced reductions. We went through that one with the normal attrition and absorbed that with no restructuring reserves, no reduction in force, and we have no plans of looking at that in the future.

Okay. Thank you.

That concludes the question and answer session today. At this time, Mr. Pugh, I'd like to turn the conference back over to you for any additional or closing remarks.

Great. Thanks a bunch and I appreciate the positive comments you gave us today. Good questions. It's going to be fun looking at these next couple of quarters and as I mentioned earlier, I think we have a veteran staff, been through the wars before, we know how to handle it and just trust us to pull the right punches. Thanks a bunch. See you later.