Applied Industrial Technologies Inc (AIT) 2009 Q2 法說會逐字稿

Hello and welcome to the Applied Industrial Technologies second quarter 2009 financial earnings conference call. All lines will be in a listen-only mode until the formal question-and-answer session. At that time instructions will be given. At the request of Applied Industrial Technologies, today's conference call is being recorded. If you should have any objection, you may disconnect at this time. I would now like to introduce Mr. Richard Shaw, Applied's Vice President, Communications and Learning. Mr. Shaw, you may now begin.

Thank you, John, and good morning, everyone. On behalf of Applied Industrial Technologies, I would like to thank you for joining our fiscal 2009 second quarter conference call this morning. You should have already received our earnings release that we issued this morning before the market opened. If you have not received it, you can retrieve it by visiting our web site at applied.com. A replay of today's broadcast will be available for the next two weeks, as noted in the archive information, thats contained in the 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. 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 -- most recent periodic report, and also with other filings made with the SEC. Accordingly, actual results may differ materially from those expressed in the forward-looking statements. This conference call is the copyrighted property of Applied Industrial Technologies, and any copying, rebroadcast, publication, posting, transcription or distribution of any portion of the call without Applied's expressed, written prior 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 David Pugh.

Thanks, Rick. And good morning, looks like we have a pretty healthy group listening this morning. Let me open with a mild disclaimer, because this is a different environment in which we are operating. Today you will not be receiving the level of definitive information to which you've grown accustomed, simply because its unknowable at this juncture. And that's not an apology, it is just fact, because we're not alone. In a recent survey of 270 leading CFO's, 70% of them said they couldn't forecast beyond the current quarter with any degree of accuracy. And almost 20% of those guys said they couldn't see beyond two weeks, and an equal amount said they were currently in the dark as to what would be happening. So, this does not really scare me, because I feel we are agile enough to continue to identify and maximize opportunities quickly. So, if we seem to be in an abbreviated mode today, its for good reason.

Having said that, if you looked at our news release this morning it -- as we indicated the industrial economy in our second quarter continued to decline at a continually increasing rate. The economic indices that we normally track such as the purchasing manager's index, the industrial production index, the manufacturing capacity utilization, you know, have all fallen to levels we haven't seen in over 25 years. And reflecting that slowdown, our sales for the quarter, excluding acquisitions were down 11.9% from the prior year, and even with the acquisitions, we were still down by 1.7%. The consumer demand continues to decline and there are inventory adjustments occurring throughout the supply chain. At the risk of sounding like the master of the obvious, this is a very difficult business climate, and the economic indicators that we watch would suggest the market has yet to hit bottom. There are various forecasts out there of new economic events that would take the market even lower. As a result, we're making appropriate adjustments to our cost structure, while maintaining a high level of customer service. Our efforts are focusing heavily on asset management, and maximizing subsequent cash flow. To protect the interest of our shareholders as we navigate through an increasingly turbulent storm. In conditions like this, the time lines for improvement in marginal assets, including suppliers and customers, necessarily shrinks.

In spite of the tough economy, our operating margin of 5.7% was very good in our eyes. You know, our goal, and what we're targeting is to keep that operating margin at 5% or better during these difficult times. Another positive was our continued success with government sale,s which continues its double-digit growth. Since we started that initiative about three years ago, we continue to grow it very, very quickly. And today, we're in an excellent position to benefit from increased government spending on any economic stimulus program aimed at creating jobs. So, we're going to continue to push this effort, as we continue on in our planning. Ben is going to add more details about the market segments and their effect on our top line in his comments.

But I want to just assure you, in this uncertain time that we are operationally strong, and we are committed to continuous improvement, it's in times like this that I truly appreciate the quality of our processes and controls that have been in place for our oversight. Overall the company is stable, our balance sheet is strong, and we have an effective basis to weather the current economic challenge. Having said that, I'm going to turn it over to Ben for a few thoughts about the markets and where he thinks things are going.

Thanks, Dave, and good morning, everyone, as Dave indicated the economic indicators we follow took a serious downturn during our second quarter and we experienced a similar downturn with in of our customers. During the quarter the purchasing manager's index fell from 43.5 in September to 32.4 in December, a drop of 25%, and the lowest score since June of 1980. Generally any score below 50 indicates a contracting economy. Adding to that the manufacturing capacity utilization for December of 70.1, is the lowest it has been since February of 1983, and well below the 80% benchmark that is considered expansionary. Housing starts dropped to a 50-year low with a seasonally adjusted annual rate of 550,000 in December. This rate was 15.5% below the November 2008 rate of 651,000 units. All in all, these are tough numbers that look a lot like the recession of the early 1980s. Economic indicators show there is more to come before we hit bottom. Ultimately the questions are, when will we hit bottom, and how fast will the recovery be? We can't give you any real incite in to those questions, but we may know more by the end of our third quarter.

In our US-based service center business 13 of our top 30 industries, declined by double-digit percentages from last year. These included major retreats by primary metals, cement, forest products, transportation equipment, and fabricated metal products. In total, 21 of the top 30 industries declined. On the positive side of our performance were coal mining, power generation, and food, all achieved moderate growth. Our government sales continued to improve during the quarter, showing a double-digit increase, and our sales efforts continued to expand into all types of government entities, including local, county, state, and federal government. In our last teleconference, we indicated that we thought there was a slowdown in the works. Unfortunately the slowdown was much greater than our original expectation. Customer demand has declined rapidly and there are inventory adjustments occurring throughout the supply chain. Many customers have delayed capital projects until business starts to pick up. We believe that going forward, we can keep our operating margin at 5% or greater. That's our target. To deliver that level of performance, we are making adjustments in several areas of our business. For example, we have reviewed all planned projects, and have eliminated or delayed a substantial number of them. We have instituted tight spending controls and have eliminated any discretionary spending. We have reduced work weeks in some locations, as we faced reduced demand from customers, and we have reduced some of our work force where we felt it was absolutely necessary. All in all, we have made, and will continue to make adjustments to bring our labor costs in line with the amount of business we have to support it. We are taking a measured approach to the adjustments we are making, looking at the long-term ramifications and assuring that we can continue to deliver a high level of customer service.

Additionally, we are making investments where they are appropriate. While we have merged four service centers in the month of January, for example, we have also added three in the months of December and January. One, through the acquisition of Cincinnati Transmission in December, and two, to service national agreement customers. As businesses struggle with the recession, there is some pressure on pricing. Although commodity prices, steel, scrap, fuel, have fallen, and in some cases dramatically, we have not seen any movement by our suppliers to reduce their prices to us, and we will continue to watch this situation closely. I will now turn the call over to Mark Eisele for a discussion of the quarter's financial results.

Thanks, Ben. Good morning, everyone. Let me provide some additional insight for our second quarter financial performance, which resulted in earnings of $0.38 per share. The sales for the quarter ended at $502.4 million, a 1.7% decrease over last year's second quarter. We had 62 selling days in both this and last year's second quarter. We estimate that sales were positively affected by approximately 1% to 2% from the impact of passing along supplier price increases. Sales at our US service centers were down 13% from the prior-year quarter, reflecting the economic slowdown and its impact on our various industrial sectors as discussed by Ben. This decline did accelerate throughout the quarter. Sales at our US Fluid Power businesses, excluding recent acquisitions were down 8% for the quarter. Our overall US Fluid Power sales, however, increased significantly, due to incorporation of $45.2 million of sales from the Fluid Power resources acquisition closed in our first quarter. We were very pleased to see sales in local currency at our Canadian operations increase 7.3% over the prior-year quarter. Due to the impact of the decline in the Canadian currency, for US-reporting purposes, though, we are showing a 7.4% net decline in Canadian sales. Our same-store Mexican operations had about a 20% sales increase during the quarter also. Our overall Mexican operations like our US Fluid Power operations also produced significant sales increases bolstered by our acquisitions of Vycmex in December 2007 and Enol in May of 2008.

At quarter's end our North American operating facilities remained at 474, and our full-time associate count was 5,203 associates. Our product mix during the quarter was 27.9% Fluid Power products, and 72.1% industry products. Compared to 19.4% and 80.6% in the prior period. The recent acquisitions within our Fluid Power business account for the shift in product mix. Our gross profit percentage for the quarter was 27.0%. In line with our comments from our first quarter conference call. This 27% margin is 30 basis points below last year's second quarter, which reflects the ongoing challenges of passing on supplier price increases to our large contractual customers as well as price competitiveness in the marketplace related to overall economic conditions. Our selling, distribution, and administrative expense, as a percent of sales, was 21.2% in the quarter, or approximately 120 basis points higher than the second quarter of fiscal 2008. SD&A expenses for the quarter increased in absolute dollars by 4.3% compared to a sales decrease of 1.7%. Approximately $13.7 million of SD&A including $2.4 million of intangible amortization expense related to recent acquisitions not included in the prior-year quarter.

We also saw increases during the quarter relating to higher healthcare costs under our self-insurance programs. Partially offsetting the SD&A increases, were decreases in accrued liabilities for several performance-driven accruals for incentives and benefits. Our operating margin in the quarter was 5.7%, compared to 7.3% in the prior-year's second quarter. The decrease sales, lower gross profit percentage, and the increase in the SD&A, were the primary reasons for the lower operating margin. In addition, the incremental intangible asset amortization from the recent acquisitions decreased our quarterly operating margin by 50 basis points. Our net interest expense for the quarter increased $1.3 million from the same period in the prior year. This net increase is attributable to lower interest income from lower overnight investing rates, and lower cash balances, and to additional interest expense related to the borrowings under our revolving credit facility. The weighted average interest rate on our $111 million of bank debt at December 31, was 2.2%. While the effective tax rate for the quarter was 35.9%, compared to 38.1% in the second quarter last year, we anticipate our tax rate for the entire year to be in the 36.5% to 37.0% range. Our balance sheet remains solid, with shareholders equity at $504.9 million and a current ratio of 2.4 to 1. Our pre-tax return on assets was 11.2% for the quarter, compared to 18.4% in the prior-year quarter. This decrease is primarily due to the large amount of intangible assets and goodwill added to our asset base from the fluid power resource acquisition as well as lower operating results.

Our December 2008 inventories increased $26.3 million during the quarter, and was in line with our anticipated seasonal increase previously disclosed in our first quarter conference call. This increase, as historically has been the case, is expected to be reduced in our third and fourth quarters, so that after adjusting for acquisitions, inventory levels at year end, should be close to our prior-year levels. We are adjusting our inventory purchasing strategies to take in to account the effects of slowing customer demand. Cash used in operations for the quarter was $16.4 million, compared to cash generated of $21.8 million in the prior-year second quarter. As we noted in the first quarter, we took actions to accelerate some cash collections into the first quarter that traditionally were in the second quarter. Year to date, cash generated from operations was $32.5 million, compared to $50.7 million in the same period in the prior year. The decrease in the operational cash is driven by lower net income of $9 million, compared to the prior year, and $15 million of a larger increase in inventory purchases compared to prior year. Our expectations for the last half of our year are for solid cash flows from operations as inventory levels decline between now and June 30.

Our forecast for the remaining two quarters of fiscal 2009 is for our gross profit percentage to be close to 27%. We continue to investigate and implement cost-cutting measures to help offset the challenges from the significant sales declines we are experiencing. We expect these efforts to lower our SD&A run rate in excess of 10%. After these reductions, we anticipate our operating margins for the last half of the year to be around 5.0%. Adjusting for the additional amortization expense impact of 50 basis points discussed earlier, we are in the 5.5% range for an apples-to-apples comparison with our fiscal 2008 operating margin of 7.3%. Because of the lower-than-expected results in the first half of the year, and the continued downturn in the US and world economies, we have reduced our sales guidance for fiscal 2009 to $1.95 billion to $2.1 billion and have decreased our annual earnings per share guidance to a range of $1.30 to $1.70 per share. And now some closing remarks by Dave Pugh.

Thanks, Mark. Thanks, Ben. I don't think there is any doubt that we are now in a substantial recession, one that has the potential to (inaudible) on anything I have seen in my career. In response, we have raised our sense of urgency and we have taken and continue to take steps that keep our cost structure in line with the business opportunities. Our current financial strength is a plus, so while there's -- really, no sense of panic here, we're going to continue to take those steps that are prudent to protect the interest of our share holders. And certainly with more of a short term focus. The key to me is to continue to increase our agility in such a dynamic market. With that John, I'm going to open it up to questions. If you'll get us going, thank you.

We will now begin the question-and-answer session. (Operator instructions) And your first question comes from Matt Duncan from Stephens Inc. Please go ahead.

Good morning, guys.

Hi, Matt.

I understand obviously that -- on forecasting things are a little bit tough here. So, maybe if we can focus on what you've seen so far. And I know you typically don't talk about month-to-month trends, but I don't know if you would be willing to right now, since things are changing so fast if you could kind of help us understand what you guys have seen month-to-month throughout the December quarter, I think that would be helpful.

Yes, we have seen an acceleration throughout the December quarter, and I would say that basically what we're seeing throughout January, so far, has been similar to the month of December, so we haven't seen any further acceleration of the downturn.

Okay. And then -- you know, Dave, I guess if I look at the guidance, the $1.95 billion in revenue looks like to me like that assumes 20% plus organic sales declines, and $1.30 looks like it assumes an operating margin below the 5% you're targeting? Am I right in both of those cases, and sort of is that kind of your view on the worse case? Or talk to us about how you kind of came up with the low end of the guidance range, maybe?

Yes, Matt, I would think that's a fair statement. Obviously, you know, what we're targeting and the actions we're taking, you know, are to try to accomplish operating results that we think are appropriate in this manner, but there's lots of uncertainty out there, and what -- you put a stake in the sand of where you'd like to try to come out with, but you could have variability plus or minus on that stake in the sand too. So, we're working hard to manage things, and as this downturn continues, we'll continue to take actions as needed and as appropriate, to continue to adjust costs as we see fit.

Okay, and you know, another question I guess to that point would be, you know, at what point during the quarter did you guys get more aggressive with your cost cutting? And sort of what kind of work do you guys think you have left from that point of view?

Hello, Matt, this is Ben. We -- probably the end of the September quarter, we started to take some actions with regards to the basic stuff, and then accelerated throughout the quarter, and we're still in the midst of that today. So, definitely the actions we took accelerated in the month of December and continue in January.

Yes, Matt, if you take a look at it, you know, we had some falling going in to the quarter, but I think we, like everybody else, saw November and December get substantially more difficult. December is a tough month to take a bunch of actions with the holidays, vacation stuff in there. So, while we did some things then, I think we then moved the needle a little bit more as we started in to January. So, you're going to probably see more effect of our planning in the next quarter.

Okay. So, it sounds like that stuff is going to be accelerating. I guess, Ben, then if I look at branch closures. I know you alluded to four of those, I guess you said, since the end of the quarter. Is that something that you're thinking about potentially getting more aggressive with or are you really trying to do it more with shortening the work week and reducing work force for the time being?

It's a combination. And we look at it on a location by location basis. For example, if we have a large customer that has shut down operations permanently, and it's a significant portion of that location's business, then those are the types of -- those are the situations where we look at merging that location with one that is close by. If business is down overall, we have, in some cases, reduced the work force, and in others we have reduced work week. So, we're looking at each one individually and taking all of those actions on a case-by-case basis.

Okay. Last thing, then I'll jump back into queue here, just a small item. Mark, can you tell us what's in the other expense line that ticked up a little bit here?

Yes, Matt, there's two things that are included in there. About 0.3 of the dollar amount relates to foreign currency translation items in the quarter for the Canadian and Mexican currencies. And the other 0.6 is in there, relates to situations for non-qualified benefit plans for which we have assets funding those plans. The changes in market value of those assets, you know, roll through this other expense line and therefore, since the market had declines during the quarter, we had to show those as an expense right here on that line item.

Okay. Thanks for the answers, guys. I appreciate it.

Thanks, Matt.

Our next question comes from Jeff Hammond from KeyBanc Capital. Please go ahead.

Good morning, guys, this is actually Josh (inaudible) filling in for Jeff here.

Okay, Josh.

Just wanted to touch a little bit on the gross margins here. I know that traditionally you were able to hold the line as input costs decline. I know you reiterated the 27% target for the rest of the year similar that you did in first quarter. You know, maybe comment if you guys are seeing any pressure there, you know, from your customers to kind of get back some price, particularly on the national accounts, and, you know, how you're viewing the -- you know, how you're viewing that number versus last quarter?

Hello, Josh, this is Ben, and yes, we are experiencing a lot of pressure in the marketplace, and we are doing our best to manage through that and work with our customers to continue to bring, you know, the total value that we provide, and also work with our suppliers, so it's a balancing act for us, and it's -- it also falls in that kind of cloudy area of what the market is going to be like for the next 5.5 months, so we'll continue to manage our way through that, and that's our best estimate at this time on how we'll do for the year.

Perfect. And just as a follow-up, you know, when you guys talk about the well water mark kind of being around 5%, I'm assuming that's kind of over a period of time that we may see that dip below for a quarter, and still be on track for the rest of the year? Particularly, say, if you know, third quarter is more weak than the fourth quarter.

I think, Josh, the 5% is our goal.

Okay.

And hopefully when we look at this, that would be the low water mark, but as things develop, as we look into the future, we'll have to continue to adjust and meet the needs that we have to based upon what the economy is doing.

Alright. Thanks, guys.

Our next question comes from Joe (Mondo) from Sidoti & Company, please go ahead.

Good morning, guys.

Hi, Joe.

First off, I was just wondering if you could -- looking at the last downturn, you saw 90% decline in EPS, 2% operating margin, just wondering if you could give more of a sense in where you come up with the 5% operating margin, and how things are different from the last downturn where you can hold that 5% operating margin?

Yes, Joe, I'll speak to that. I think that, you know, what we're looking for with the operating margin is we -- we really have viewed how we have been running the company for the last 5 plus years as, you know, fundamentally changing how we approach managing our business, and by those changes, we were able to improve our operating margins in the up times to a 7.3% level for fiscal 2008. And we saw steady increases year-over-year. Those same disciplines and operating methods will enable us to have the low-water mark in a downturn to be higher than the last one, and, so that's exactly what we're doing is we're marching to the same drum and doing the same business principles and therefore, we should have better results on our low water mark compared to previous low water marks, just like we've had better results on our high-water marks when times were good.

Could you just mention a couple of specific things that have enabled you to increase that (inaudible)?

Joe, just right off of the bat the number 1 thing is our attention to pricing philosophy, and pricing discipline. In the last downturn, I think we fell pray to some of our own preconceived notions that prices had to fall even when our costs were not falling, so we have done a very good job of price discipline and putting information in the hands of our people throughout this subsequent period that has been one of the strongest reasons that we've been able to grow the margins, and I think that by itself is the strongest factor we're going to have in going through this next decline.

Okay. Great. Thanks a lot. Secondly, your inventory ticked up -- inventory ticked up, and I thought that was a little odd just going in to this years downturn. Could you just talk on that?

Yes, Joe. Traditionally we do have seasonal increases in our inventory right around the calendar year end. And as we expected, and as going in to this quarter as well as going in to this fiscal year, that we would see that exact same thing happen, and the dollar amounts that we anticipated in our forecast was a $25 million increase. It ended up being a little over $26 million increase, so, you know, things happen that were -- we expected. We expect to have those inventories, you know, reducing between now and June 30. Obviously with the acceleration of the sales decline, you know, we're pulling some different levers with managing inventories to take that into account, so that we can properly manage that asset.

And, Joe, to be brutally honest, we probably didn't move quickly enough on inventory in this quarter.

Okay.

And that's unusual for us, and we do not see that occurrence going forward. So, we will get this under control.

Alright. And then last thing, could you just -- on CapEx going forward for the rest of the year, do you have a -- I'm not sure if I missed that, or -- do you have a guidance on that?

You know, the guidance we provided at the beginning of the year over the summer was -- I don't have the numbers exactly in front of me, but I thought it was like $8 to $10 million of CapEx, so I think we are on target to do that -- or a little bit lower than that. I will say that over the last couple of months, what we have done for the CapEx that we have not spent, but that we had approvals for, that we did last April and May, when we were coming up with the fiscal 2009 budget, that we haven't spent the money, we've basically asked all of the business unit heads to get all of those projects re-approved, so that we can make sure that we still want to spend that money. So, you know, the expectation is for CapEx is to be maybe on the low end of the range you know, we give at the beginning of the year, and it will still be significantly below our depreciation expense that we're incurring.

Okay. Great. Thanks a lot, guys.

Thank you.

Our next question comes from Brent Rakers from Morgan Keegan. Please go ahead.

Good morning. I just wanted to follow-up on -- I think Mark, I think you talked earlier about what the SG&A had done on a year-over-year basis, excluding the acquisitions, and by my calculations I think that shows SG&A down 9% year-over-year, on a revenue -- internal revenue growth of down 12. Could you maybe -- it sounds like a lot of these initiatives were done maybe late in the quarter, and maybe are more relevant for the March quarter than this December quarter. So, maybe if you could talk me more specifically through the variable to fixed-cost mix and why that SG&A dropped at the rate it did in the December quarter?

I think one of the things in the December quarter that we saw that reduced our SG&A expenses, Brent, related to some of the accrual adjustments we had for incentives and benefit plans, you know as things were changing in the operating environment, you know, those are natural levers that sort of pull themselves. As our performance goes down, our expenses and the anticipated expenses we have for those plans go down as well. So, we did have some true-ups in the December quarter for items that were accrued previously for expected payouts for let's say annual programs or even long-term, you know, programs. So, those impacted the December quarter and provided a lot of reductions for that. You know, I think the expectation is for these additional levels that we're pulling for additional SG&A reductions for this -- an additional 10% run rate reduction. Those are the things that we're doing in December and are doing in January that will help those continue to be managed.

Mark, could you maybe -- and I think that's probably fairly significant to have an understanding on how much those accruals are. Could you give us a better sense of, are we talking a couple million dollars, maybe additional, that maybe theoretically should have been put in the September quarter had you known then what you know now?

Well, the expense adjustments happen in the proper quarters when things are happening. If you go back and say if there's perfect knowledge in the future in other quarters, yes, there is probably a couple million dollars in there, Brent, I don't have the exact numbers here to give that breakdown.

Perfect, okay. And then, if we could maybe expand a little bit on the headcount. It looks like you reduced the headcount about 50 people sequentially, but you also talked a lot about cutting back work weeks and number of hours. Could you maybe elaborate and maybe quantify a little bit more? I mean, do you an extensive number of part-time employees that you're cutting back on? And then could you elaborate on just the work week changes that you mentioned earlier?

Yes, Brent, don't want to give, you know, a lot of detail on -- on exactly what we're doing, but if you look at it from a full-time equivalent standpoint, in -- in the month of January, we have made significant progress, much more than the -- the 50 that we show for the December quarter, so looking at it over all from a full-time equivalent standpoint, you'll see a much greater impact in the March quarter.

And then just final question, you're talking about a 10% reduction -- I guess -- in the SG&A run rate. Just to clarify, is that -- is that related to -- is that working off of this December quarter number? And then, secondly, how do we account for the typical seasonality of SG&A in the -- in the third and fourth quarter relative to what we just saw here in December?

Yes, and Brent, we've taken, you know, both of those things into account. You know basically looking at the December run rates. You know, thats -- that was probably the primary driver for looking at the numbers, and obviously we do look at the seasonality within the SG&A as well, and, you know, taking those things into account to come up with our projections going forward. But, you know, the expectation, you know, is -- you know, if you want to look at it from a very high level is for a 10% reduction in -- in the SG&A levels, you know, going forward.

Great. Thanks a lot, guys.

Thanks, Brent.

(Operator instructions). And our next question comes from Greg Halter from Great Lakes Review. Please go ahead.

Good morning, guys.

Good morning, Greg.

Wondering if you could comment on your pension expense going forward? It is probably already set for this year, but what would you envision looking out ahead, given the market challenges?

You know, Greg, our -- our -- you know, we have two defined benefit plans. One is a small funded plan that -- and another is a unfunded plan for a SERP type things, and I don't anticipate significant changes in our expenses going forward, although, you know, we use outside experts and actuaries to help determine what those costs are, and obviously all of the assumptions are critical in determining which way the wind is going to blow on those, and, you know, it all depends as to what is going to happen with discount rates, as -- as we go forward in to the future, and I can't predict what is going to happen with those. I believe the assumptions that we utilize and we will continue to utilize are very middle of the road as well as more conservative, you know, so that -- you know, we're -- we're recording the expense, you know, appropriately when people are spending the time working.

Okay. And your -- the rate on the debt, that 2.2%, is that a floating rate?

Yes. Yes, it -- our bank debt has several traunches of borrowings, and, you know, the primary way we're doing our borrowings now is for the most part, based upon one-month LIBOR at various dates, and, then you know, that has to get renewed. Whenever you take a borrowing -- in essence its fixed for 30 days and then you need to reborrow, and whatever LIBOR is at that point in time, then you'd be re-borrowing at that rate. And, as of now, I'm not sure exactly today what the rates are, but one-month LIBOR is around 50 basis points right now. So, it's very attractive. So, some of the bank debt is based upon LIBOR. Some of it is based upon prime, and we also do have -- entered in to an interest rate swap in September, as we talked about in the last conference call, that, you know, converts $50 million of that bank debt to a fixed rate of about 3.3% for the next two years. So, we look -- we're very pleased with our borrowing rates, and we think we've a great bank facility, and we feel fortunate that we're able to have interest rates as low as they are based upon what is happening out there in the economy.

That sounds good. And on the other side, obviously your cash of $46 million plus is probably not earning much these days. Just wondering where that is invested, in what geographic area, US or elsewhere, and then what it is invested in?

Yes, that money is basically in Canada, and it's basically in short-term overnight, like, money market type things with very -- you know, very -- safe principal as how we look at things, as opposed to enhanced overnight borrowings. So, that's rated. If the money was in the US, we would be able to utilize that to pay down debt.

Okay. So, you can't bring it back without a repatriation penalty?

That is correct. And, you know, the thought process that we have is for the money in Canada, is to keep it there for continued acquisition expansion opportunities in Canada.

But if the new administration came in with some sort of new rate or amnesty or whatever, you could bring that back and then pay down your debt? Yes. I mean, if there is a repatriation holiday, we would look hard at that. Okay. And wondered if you could comment on your receivables, it looks like the balances on a year-over-year basis is in pretty good shape. I think it's only up slightly year-over-year basis, but just wondered if you could comment on the quality?

Right. Yes, we have seen some slight deterioration in our overall aging, but the amounts of past-due receivables that are 61 days past due or older hasn't -- has only deteriorated like 10% from where it was, you know, 6 months ago or a year ago. So, we've seen some slight deterioration, we haven't seen a major deterioration. I mean, our issue in our bad debt exposure, really, is when companies file bankruptcy, as opposed to when companies just don't pay their bills. For the most part, you know, our customers, you know, pay us first, because we're providing them the replacement parts to keep their plants operating to keep them alive.

And one last one, if you could comment on the national account business versus your smaller accounts in terms of percentage of the total and how those did in the quarter?

Greg, our business -- our national account business typically runs about 0.3 of our total business, and that was where we ran for the quarter, so not a big change there.

Okay. And any comment on the -- if the nationals were up more than the average or smaller as it were, or vice versa?

I think in general slightly down -- down slightly more than the total business.

For the national?

Yes. We experienced a number of plant shutdowns in the last half of -- the month of December.

Okay. Alright. Thank you.

Our next question comes from Holden Lewis from BB&T. Please go ahead.

Good morning,thank you.

Good morning.

Getting back to the inventories, you referenced a couple million dollars, perhaps in accrual true-ups that might have hit the SG&A. Were there any offsetting, sort of true-ups as it relates to, you know, rebates in the cost of goods line at all? Or what are you seeing in rebates? What are you anticipating there?

Yes, Holden, the specific question is there were no unusual items in rebates during the quarter. Obviously for inventory purchases and for the increase in inventory dollars, if some of those dollars had rebates attached to them, those rebates would go on to our balance sheet, and then would roll through the income statement when those inventories are sold. I think the rebate arena in the negotiations and discussions with our suppliers, as we talked earlier today, is one of our, you know, big challenges, and that's -- with the change in the economy, and for us managing our inventory dollars and managing the gross profit dollars, that's something that we're working hard at going forward to try to make sure we have the appropriate management of our assets from the balance sheet perspective as well as managing the gross profit from the income statement perspective. And it's a delicate balancing act.

Okay. But to this point you saw no reason in Q2 to have to sort of true-up rebates in any way?

No, there were no major true-ups, all of the accruals had been pretty much spot on you know through December 31.

And then as is relates the inventory increase -- and I hear what you're saying about the typical seasonal increase, but, of course, typically you would expect, you know, the second half to be seasonally stronger than perhaps you're forecasting now. I guess you know you kind of said maybe you just didn't react as quickly as you might have likes, but have you seen a bunch of, sort of, you know, steeply discounted inventory that maybe you've been able to take advantage of, or has that not be particularly unusual this time around?

I think the short answer is we have not seen a lot of discounted inventory yet from the suppliers.

Can you maybe just sort of speculate on why that would be? I mean everybody is talking about this desire on the part of OEMs to cut their inventory levels, and de-stock, and yet, I think we're having a hard time to finding many distributors who might be natural outlets for that at the right price who have built up much in the way of inventory. It just seems to be somewhat conflicting I guess, I'm curious if you might have some opinion as to why that might be?

Holden, just a couple of things, one is in uncertain conditions like this, we tend to conservative cash, in trying to predict when an inventory buildup will turn with regard to generating that cash is very difficult. The other thing, and -- you know, I'm surprised it hasn't even come up in the discussions here, but that ugly D word is sitting out there, so, you know, we want to make sure that we're not getting into inventories that might go the other way.

So is inventory on offer to you? You're just opting not to take it?

You know, it -- I'd have to go back and ask that question, because the guys who typically see that on the front end understand where we're guiding from the -- you know, the top levels, and they probably -- you know, I'll just say it hasn't been brought to our attention.

In any significant dollar.

Right.

Okay. And then just to get a sense of the acquired revenues, I think you said 45.2 was from the FPR, can you just maybe just give an aggregate sense, since you know one of these is sort of (inaudible) all that. You know Vycmex and Enol in aggregate, how much revenue did that contribute in the quarter?

I don't have those numbers right in front of me, but it was in the -- I would say $7 million range, something like that. And I'm not sure from a -- with the currency translation, you know, what the impact is before translation, but that would be for the US dollar impact.

Okay. So, US dollar -- $7 or $8 million from those two deals.

Yes.

Is the right number? Okay. Alright, great. Thanks guys.

Thanks, Holden.

Our next question comes from Brent Rakers from Morgan Keegan,, please go ahead.

Yes, just a couple of follow-ups on the SG&A. I guess first you talked about some modest headcount reductions. Any severance costs in the quarter or any severance expected as you go into the March quarter?

In the December quarter there was a very -- you know, small -- limited amount of severance. In the -- in the January quarter, you know, we have considered -- or the quarter starting in January, we have considered severance, and when we're looking at our savings and the SG&A reductions going forward, that they -- those have already been taken in to account in our numbers, in our projections of a 10% decrease in SG&A.

Mark, did you ever or Ben, did you ever talk more specifically at all about headcount? I mean, again, we've brought that down to 50 already. Did we ever get a sense within this 10% reduction how much more that might be?

No, we didn't mention that. We -- we're looking at everything all summed up, the combination of all of our actions, and we did not give a headcount number.

And then, I guess just a final question. You mentioned earlier you had some headwinds in the December quarter from healthcare costs. Could you maybe elaborate on whether that relates to some unusual claims or just the -- kind of general healthcare inflation rate or what?

I think it's both of those things, Brent. I will say that from our perspective we thought we had a larger number of relatively large dollar claims, than we would expect based upon our population and talking to our experts that we utilize -- you know, we seem to have been running high with the number of those claims. You can't forecast what's going to happen in the future, but it would be, you know, you could somehow say in the last couple of years, maybe we were running low, and it all sort of reverts back to a mean, but, you know, healthcare expense is -- you know, we continue to actively manage that, and to look at our opportunities as to what we can do to best manage the program.

Yes, and I mean -- and it's not something that we would forecast continually going up, because if you look at the aging of our work force, its actually gone down a little bit.

Okay. Great. Okay. Thanks.

And our next question comes from Holden Lewis from BB&T. Please go ahead.

Thank you, two things. First, I think you have been operating pretty lean throughout the cycle for the most part and now you're kind of talking about you know, maybe shutting a couple of branches -- letting some folks go. I guess what are -- on what basis are we making the decision on who and where to let go? Is it just sort of the lowest performers, you know, are sort of being cut out? And, you know, is there sort of any abandonment of revenues or anything like that -- that comes with this? And I guess the question is really, I mean to what extent are we cutting in to meat? Because I don't think you had a lot of fat on there to begin with.

Yes, you are right, Holden, we don't have a lot of fat, and we've been very diligent since the last downturn in making sure that we don't have operations where we have any fat, and -- so you won't see the large number of mergers or closures like you did in the last downturn. We look at every market and make sure that there is a market there to support a location, and there -- there's a much smaller number, so you are not going to see great numbers and closures. When we look at, you know, reduction of the work force, you know, we look at -- we take a little bit more of a midterm -- long-term view of where the market's going in that area, and make the appropriate adjustments, whether it's a reduced work week or eliminate some positions.

Okay. And then on the pricing issue, I mean, you were about -- you were 100, 200 basis points last quarter. You were 100, 200 basis points this quarter. You talked about pressure, I guess, but I mean it seems like it's been pretty stable. The guidance on the gross margin, if that 100 to 200 becomes zero or minus one, you know, is the gross margin guidance still doable or is implicit in the gross margin, you know, the assumption that price willing be stable at 100 to 200 basis points?

I think, Holden, when we look at the impact of the supplier price increases on our business, we're not looking at that as anything that's going to either increase or decrease our gross profit percentage when we sell that product to our customers, since we'd be -- you know, our expectation is to pass that -- that through, and so -- and so I don't expect that to have much of a change at all.

Okay. So if -- if you have -- so you don't expect to have to cut price in effect unless your customers cut their -- their cost of material to you?

That's our expectation.

Okay.

The margin still remains the same.

Right. No, understood. And are you seeing your discounting in the market -- are you seeing the discounting on the part of those competitors, stable, getting better, getting worse? What's kind of the environment out there?

It's a mixed bag, Holden. Generally, with the economy being what it is, yes, you would -- we're seeing what you would expect to see, that there is some degradation in the marketplace.

Okay. And that has not improved over the last month or two, right? The thought being that they're willing do discount when there's volume to be had -- if there's no volume to be had then nobody is going to discount, because you can't give away both volume and price? But that hasn't dawned on the smaller distributor in the chain yet?

Not that we have seen, no.

Alright, great. Thanks guys.

Thanks, Holden.

We have no further questions at this time. And I will now turn it back to Dave for closing remarks.

Hey, John, thanks a bunch. Thanks. Good questions. I think we're all sitting in the same boat right now, as we are watching to see what is going to occur over the next quarter, hopefully there will be some positive things that will happen to start turning this thing around. But we will have, certainly have better information, when we come back to you in April. Thanks for joining us, we'll talk to you then.

Thank you, ladies and gentlemen, this concludes today's conference. Thank you for participating. You may all disconnect.