Applied Industrial Technologies Inc (AIT) 2009 Q3 法說會逐字稿

Hello and welcome to the Applied Industrial Technologies third-quarter 2009 financial earnings conference call.

All lines will be in a listen-only mode until the formal question-and-answer session. At this time, instructions will be given.

At the request of Applied Industrial Technologies, today's conference call is being recorded. If you should have any objections, you may disconnect at this time.

I would like to introduce Mr. Richard Shaw, Applied's Vice President-Communications and Learning. Mr. Shaw, you may begin.

Thank you, Jaime, and good afternoon to all of our listeners today. On behalf of Applied Industrial Technologies, I would like to thank you for joining our fiscal 2009 third-quarter conference call this afternoon.

You should have already received our earnings release that we issued this morning before the market opened. If you've 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 archived information that is 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 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. Any copying, rebroadcast, publication, postings, transcription or distribution of any portion of the call without Applied's express written consent is prohibited.

Our speakers today include David Pugh, Chairman and CEO of Applied, who will discuss our overall performance during the quarter. You will 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. It's good to be with you guys again. I wish it were in better market circumstances.

We're going to be somewhat brief in our remarks today because the macroeconomics of what we don't control greatly overpowers the macroeconomics of what we do control, and those macroeconomics are already visible for everybody to see.

Let me just start by saying that this is as tough an environment as I've seen in my 38 years of business. This morning, we released our 2009 results. Under the circumstances, it was a decent performance. There were no real surprises for us. The rate of market deterioration for the quarter met our worst expectations; it is in line with indicators, but it was pretty poor.

On our January conference call, we said we were operating in a difficult economic environment and that forecasting beyond the quarter with any degree of accuracy was nearly impossible. I could just say ditto to that, without any fear of contradiction, for this quarter.

You know, although the majority of our markets are in decline right now and while it is difficult to see where things are going to stabilize, I still believe that we are agile enough to continue to identify and to maximize new opportunities quickly. Financial strength and strategic agility are what we are stressing in dealing with a situation that I say is still in total flux.

You know, the best that can be said is that the rate of market decline, or the second derivative, may be slowing. We haven't seen nor can we see a return to growth at this point. The economic indicators that we follow still show a contracting market, and we lag that market in a recovery.

As one would expect, margin pressures have accelerated as we are experiencing more demands from our customers while our suppliers have no room to move, as their unit prices rise with a drop in volume. This is a tough squeeze that our industry must handle well now in order to protect the future.

So sales continue to decline. The fear and uncertainty driven by job losses, the decimation of personal savings, and the lack of affordable credit has caused a consumer withdrawal which has had a big impact on our markets.

When things do begin to return to our growth mode, we don't see a bounce but rather a slow and gradual recovery. I expect consumers to be somewhat skeptical as they reenter the market.

Keeping in mind we generally lag a recovery by three to six months, I think that we are looking to at least the first quarter of calendar 2010 before we see things even start to improve. So that leaves us, like a lot of other companies, with the challenge of creating earnings in an environment without an economic tailwind. But you know what? We've been there before, and we have good managers who know how to operate in this type of a climate.

Cost controls are going to be vital in response to the unavoidable drop in sales. We have made and we will continue to make appropriate adjustments to our cost structure while working to maintain the critical mass that we need to service customers in the short-term and to assure our ability to maximize our position for recovery over the longer term.

Staff reductions, reduced work hours, cuts in travel and other expenses and closed or consolidated facilities are all part of the effort that we've made to maintain profitability. These moves have been made in response to similar actions taken by our customer base.

During this period, we are strongly focused on asset management to maximize our cash flow. I really think we succeeded well in that regard this quarter. Additionally, our operating margin of 4.7%, while below our recessionary target of 5%, was decent and we have plans to improve on that going forward, barring any further major sales decline beyond expectations.

But let me be very clear. In an economy such as the one that we are facing, there are no legitimate actions which can be taken to preserve legacy profit levels.

Now, Ben is going to share more details about what's going on in the markets that we serve and how that has impacted us, but I want to assure you that, in this uncertain time, we are still operationally strong. Our balanced approach to sales growth, cost controls, asset management and margin enhancement, combined with a sincere empathy for our employees, will provide the foundation to allow us a solid future.

Overall, the Company is stable, our balance sheet is strong, so we have a solid base on which to weather the current economic challenge.

Now, I want to turn it over to Ben for a few thoughts about the markets and where he thinks things are going.

Thanks, Dave, and good afternoon, everyone. Let's begin by looking at the economic indicators we follow and how they performed during the third quarter.

The industrial production index continued to fall during the quarter, ending with a March number of 97.4%. Output dropped at an annual rate of 20%, which was the largest quarterly decrease of the current economic contraction and is the lowest level since December of 1998. The capacity utilization rate for total industry fell to 69.3%, a historical low for this metric, which was first tracked in 1967. Those two indicators are a telling commentary on what happened to our manufacturing customer base during the quarter.

The Purchasing Managers Index registered 36.3, up from 35.8 in February. The good news is that March was a trend in the right direction after having hit a low in December of 32.9. The bad news is that the PMI indicates that the manufacturing economy failed to grow for the 14th consecutive month. It is still well below the 50% level that signals an expanding manufacturing sector.

In general, we can conclude that the recession still hasn't run its course and there is more to come before we hit bottom.

Of our top-selling SICs in our US-based service center business, only four are seeing positive sales growth. The rest are seeing major declines with 15 of the industries seeing a sales decline of 20% or greater. Our government sales grew about 2% for the quarter, below our initial target for the year but well above the remainder of our business. Going forward, we still have a target of 5% operating margin or greater and will continue to make adjustments in several areas of our business to that end.

Our controls on spending continue to work well for us, and we are being prudent with our spending on CapEx. We continue to operate with reduced workweeks in some locations, and we have reduced some of our workforce where we felt it was absolutely necessary. Most recently, we announced to our employee associates that we will not be granting wage increases for the foreseeable future.

During the quarter, we consolidated five service centers and opened one to service a major national account. We expect to see a similar adjustment in our fourth quarter.

All in all, we have made and we will continue to make adjustments to bring our 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.

We have a strong team of knowledgeable associates and valuable supplier partners. While we are seeing competitive pressures in the marketplace, we continue to find innovative ways to assist our customers in reducing their total cost of operations.

I will now turn the call over to Mark Eisele for a discussion of the quarter's financial results.

Thanks, Ben. Good afternoon, everyone. Let me provide some additional insight for our third-quarter financial performance, which resulted in earnings of $0.27 per share.

Sales for the quarter ended at $451.6 million, a 14.8% decrease over last year's third quarter. We had 63 selling days in the current quarter and 63.5 in last year's third quarter. We estimate that sales were positively affected by approximately 1% from the impact of passing along supplier price increases. Sales at our US service centers were down 24% from the prior-year quarter, reflecting the economic slowdown and its impact on our various industrial sectors, as discussed by [them]. This decline did accelerate throughout the quarter.

Sales at our US Fluid Power businesses, excluding recent acquisitions, were down 27% for the quarter. Our overall US Fluid Power sales were positively impacted by sales of $37.5 million from the Fluid Power Resources acquisition that became part of Applied in our first quarter.

We were pleased to see sales in local currency at our Canadian operations increase 2.4% over the prior-year quarter. Although due to the impact of the decline in the Canadian currency, for US reporting purposes, we are showing a 16.4% net decline in Canadian sales.

Also, our same-store Mexican operations had about a 10% sales decline during the quarter. Our overall Mexican operations, like our US Fluid Power operations, also produced sales increases bolstered by an acquisition in May of 2008.

At quarter's end, our North American operating facilities declined by 4 to 470 and our associate count was 4,893 associates.

We've also implemented a short work week for many of our hourly associates during the quarter. Adjusting our associate count to reflect the impact of this decline in work hours brings our full-time equivalent status down to 4,734 associates, a 9% decline from December 31, 2008.

Our product mix during the quarter was 27% Fluid Power products and 73% Industrial products, compared to 20% and 80% in the prior year's period. The recent acquisitions within our Fluid Power business account for the shift in product mix.

Our gross profit percentage for the quarter was 27.1%, in line with our comments from our earlier conference calls. This 27.1% margin is 20 basis points below last year's third quarter, which reflects price competitiveness in the marketplace and overall economic conditions.

Our selling, distribution and administrative expense as a percent of sales was 22.4% in the quarter, or approximately 230 basis points higher than the third quarter of fiscal 2008. SD&A expenses for the quarter decreased in absolute dollars by 5.2%, compared to an overall sales decrease of 14.8%. Approximately $13 million of SD&A expenses relates to a recent acquisitions not included in the prior year quarter, including $2.4 million of new intangible amortization expense. We also saw increases during the quarter relating to higher healthcare costs under our self insurance programs, and one-time severance costs. Offsetting the SD&A increases were decreases in wages due to our lower headcount and decreases in incentives and other employee benefits.

Our operating margin in the quarter was 4.7% compared to 7.1% in the prior year's third quarter. The deleveraging impact of decreased sales was the primary reason for the lower operating margin. In addition, the incremental intangible asset amortization from the recent acquisitions decreased our quarterly operating margin by 55 basis points on a comparable basis with the prior year's third quarter.

Our net interest expense for the quarter increased $0.9 million from the same period in the prior year. This net increase is attributable to lower interest income from lower overnight investing rates and cash balances and to additional interest expense related to the borrowings under our revolving credit facility.

The weighted average interest rate on our $100 million of bank debt at March 31 was 2.1%.

While the effective tax rate for the quarter was 41.5%, we anticipate our tax rate for the fourth quarter to be in the 37.0% to 37.5% range. This quarter's tax rate increase primarily relates to a one-time recording of the net US tax impact of repatriating a portion of our Canadian earnings. While we are still studying this, our expectation is that up to US$30 million would be transferred back to the US prior to our year-end.

Our balance sheet remains solid with shareholders equity at $505.3 million and a current ratio of 2.7-to-1.

Our pretax return on assets was 9% for the quarter, compared to 19.8% in the prior-year quarter. This decrease was 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 March 2009 inventories decreased $16.4 million during the quarter and were in line with our expectations. We expect inventory to decrease another $10 million to $15 million by June year-end. Projected inventory levels at year-end should be close to our prior-year levels after adjusting for acquisitions. We are continuing to adjust our inventory purchasing strategies to take into account the effects of slowing customer demand.

Cash generated from operations in the quarter was $22 million, compared to $11.3 million in the prior-year third quarter. We expect another solid cash flow quarter in June, similar to or slightly better than the March 2009 quarter.

Our forecast for the June 2009 quarter 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. After these reductions, we anticipate our operating margin for the fourth quarter to be around 5%. Adjusting for the additional amortization expense impact of 55 basis points discussed earlier, we would be 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 nine months of the year and the continued downturn in the US and world economies, we expect to come in at or close to the low end of our sales guidance for fiscal 2009 of $1.95 billion or $2.1 billion. We are maintaining our annual earnings per share guidance of $1.30 to $1.70 per share.

Now, some closing remarks from Dave Pugh.

Thanks, Mark. Thanks, Ben.

So before we take your questions today, I do want to make the point that our experienced management team from top to bottom senses the urgency and the need to perform in these challenging times. In conditions such as these, the timeline for making decisions necessarily shrinks, so it's vital that we stay on top of the market dynamics and ahead of the power curve.

We are seeking out new market opportunities, and we are actively managing our company to keep our cost structure in line with our business levels. We are financially strong, and we're going to continue to take the steps that will protect the interest of our customers, our shareholders, our associates, and our suppliers.

With that, Jaime, I'd like to open the lines for questions.

Thank you. We will now begin the question and answer session. (Operator Instructions). Matt Duncan, Stephens Inc.

The first question I've got really kind of gets at the inventory destocking that I'm sure you guys are seeing going on with your customers. I'm just curious. Based on conversations you're having with your customers and other data points you guys see, where do you think we are in this inventory destocking process? Are we in the middle innings? Are we towards the end of it, or is it just too difficult to tell?

Matt, this is Ben. I would say it is the latter. It's really too difficult to tell at this point. It really depends on the industry. There is definitely destocking going on out there in the industry. As production lines shut down, there isn't a need for the amount of inventory that our customers are holding, let alone the amount of inventory that we are holding. So, throughout the supply chain, there is a lot of that destocking going on, and it's really tough to quantify right now.

Okay. Ben, if you look at the month-by-month sales trend this quarter, I think you indicated that it actually -- did you say it got worse each month as the quarter went on?

Yes, I said that, Matt. This is Mark.

Yes, March was worse than January, but I think, as Dave stated in his opening comments, the rate of decline has decreased. So the slope of the line has started to flatten out, but it is still a downward trend.

Has that trend continued into April, the flattening of that slope?

The rate -- Matt, the rate of the indicators has started to decrease. Our rate of decline in March was actually worse than February/January with regard to sales. But what we are saying is the rate of the market indicators -- rate of decline of market indicators has started to flatten out a little bit, which would help us overall. But again, we are going to lag that by six months.

Sure, okay. Then maybe asked a different way, are you guys seeing any signs at this point of things getting better on the horizon, or is it really just still very, very difficult, no signs out there that we are anywhere near a bottom as far as you can tell?

We have not seen the bottom yet, Matt, and I think, if you look at the MCU and the way we track against that -- and we have a certain amount of lag, whether it's three or four or five months lag -- when we start to see that indicator bottom out, then I think we will feel comfortable with predicting the bottom.

Okay. Then just a couple of housekeeping items and I will jump back in queue -- first, Mark, the impact of price on the quarter. I think you mentioned the impact of FX but if you could repeat that? Also, total acquired revenues, so [MPR] (inaudible) also we can look at an organic sales decline, what that rate was for the quarter. Thanks.

Yes, Matt, you know, we believe the impact of price from supplier price increases was around 1% for the quarter. Most of that relates to price increases that happened many months ago that we are now passing along to our contract customers.

Regarding the overall impact of the acquisitions, I don't have that number right in front of me. But the [Eanol] acquisition was relatively small from a dollar perspective, especially then with the Mexican currency changes also. That probably was around $3 million to $4 million.

Okay, and then last, Mark, just FX -- again, what was the impact of currency translation from Canada?

Well, it took them from -- I don't have the exact figures but it took Canada from the 2% actual increase in Canadian dollars to a 16% decline in US dollars. Canada is about 10% of our sales, so you could do the calculation based upon that information. I just don't have that here. I wouldn't want to do it quickly.

Okay, thanks, guys. I appreciate it.

Jeff Hammond, KeyBanc Capital Markets.

Just back to pricing, I mean it seems like you got some price in the quarter and the gross margins held up, but I think you talked about pushback from customers and pricing competition. I just wanted to get a sense of what you are seeing from your competitors on the pricing front. As this demand downturn progresses what, do you envision in terms of pricing pressure or price-downs from your vendors?

I guess, on the competitive pressures out there, you are right, Jeff. It is a very competitive marketplace right now. Customers are obviously looking for ways to reduce their purchase price as well as their total cost of operations. And our team has done a great job of continuing to sell the value we provide and balance that with our customers' needs. We also work well with our suppliers on any of those issues on a one-by-one basis.

We, I think to your last question, we have not seen price reductions from our suppliers. On the price increase side of it, we've seen a major slowdown in the announced price increases.

Then it sounds like to indicate -- your comment on the [seconded] derivative is more a function of the indicators that you are seeing out there, but as you look at your business, are there any end-markets or pockets regionally where you are seeing more signs of stabilization or glimmers of hope or sequential improvement?

There are some regional differences right now, and I think it really is the general economy in some of the parts of the country. We track unemployment by state, and there are areas of the country, if you look at the south-central part of the US is doing better than the upper Midwest, as an example. A lot of that is related to the industries in those areas, whether it is automotive or anything energy-related in the south-central part of the US or mining. So it tracks the unemployment rate; it tracks the industrial -- the industries in those states.

Okay. Then just a final question -- on government sales, there would seemingly be an opportunity around some of the stimulus money. What's kind of your approach on the government sales side as it relates to the stimulus dollars?

We have -- our government team is working very diligently on identifying where those opportunities are going to crop up. We have not seen a lot of that stimulus money break loose yet, but we have a team of folks that are ready to identify the opportunities and take advantage where we can.

Adam Uhlman, Cleveland Research.

I was wondering if you could dig into the gross margin trends a little bit more because it would seem that, as the years progress, the gross margin rate has actually improved. So could you talk about the impact from your larger customers buying smaller quantities? Is that helping the gross margin percentage?

Then, Mark, could you also talk about the impact from lower supplier rebates as you reduce inventories?

I will take a stab at that, Adam. From the gross margin perspective, we think we've been relatively flat for all three quarters this year. It has nudged up a little bit, I agree, on each of the quarters but basically we look at that as stable from a gross-margin perspective.

Regarding from supplier support, that's obviously one item that is a key risk area for us as we look at our margins and negotiate them with our suppliers and that is a component for things. You know, they've been holding up so far, from a percentage perspective, while the total dollars are down due to the decline in the volumes that we have. If the percentages stay up, we will end up okay from that perspective. You know, so far, they are staying up. We are in process of negotiating and talking to our suppliers about our fiscal 2010 programs. Those have not all been finalized yet.

If I could tag onto that, Adam, our larger customers, more of our contractual customers, are typically at a lower margin than the remainder of our customer base. That business is down slightly more than our non-contractual customers. So the natural effect would be it would help to prop up our margins overall.

Okay, great. Thanks. That's very helpful.

Then, Ben, could you talk about what you are hearing from the smaller base of competitors out there? You know, it would seem that many smaller distributors are struggling in this environment. Are you hearing any anecdotal comments from vendors or your folks in the field on how your competitors are faring right now?

I don't really like to comment on petition, but anecdotal stories, we have not seen any major shift in our competitors. We still have the same general amount of large/medium/small competitors out in the marketplace, and everybody is out there and struggling to maintain the sales line.

Okay. Then, Ben, just a last follow-up here -- you had mentioned that four markets are showing growth in the US. Could you talk about what those are? And then Canada seems to be growing right now; what is behind that?

For the four industry market segments, our food industry continues to do very well and it's still a positive number on a comparable basis; power generation continues to do well, segments of the mining industry, and then the government sector.

Canada seems to -- is holding up well this year. They had a tough year last year, so on a comparable basis, they are doing better than our US-based business. There are pockets of the Canadian business, whether it is potash mining, some of the agricultural business up there is doing well, and there are parts of their markets that are doing poorly, also. Anything related to gas drilling right now and some of the oil sands business is, on a comparable basis, probably doing worse than the prior year.

I got it. Great, thanks.

Joe Mondillo, Sidoti & Company.

A lot of my questions were actually answered prior, so I just have a couple here. First off, your SG&A as a percent of sales, it's declined over the last couple of quarters, which is obviously expected with sales declining. It's at 22.4% for the quarter. How can we look at that going forward, at least for the next couple of quarters? Do you see that declining or sustaining, or how do you see that playing out?

Joe, this is Mark. Actually, we are right in the beginning of our budget process for fiscal 2010 right now. Through that process, we are looking at all of the expenses that we have, and how we go to market with those expenses. We will continue to look at SD&A expenses and our service in the marketplace critically and we will make adjustments as appropriate in fiscal 2010. But as of right now, we can't share any information with that.

To tag onto that, Joe, we did not see the full impact in the March quarter of some of the reductions that we made. We had some severance costs in there also. So we should see a full impact of that in the June quarter. Then really the SD&A percentage is really dependent on the direction of the sales.

All right, thanks. Secondly, do you guys have how much FPR's inventory added to your inventory for this quarter?

Joe, I don't have the exact number with me for what it is as of March 31, but in the SEC filings we've had in the past, it is around $26 million. So I'm sure it's close to that at March 31. I may be off $1 million or so.

I guess what I'm getting at is you guys mentioned, on the last quarter call, that you accidentally ramped up your inventory. I was wondering how that looks year-over-year now, I guess organically, and if you are expecting that to affect gross margins any time going forward.

Yes, I think, from an inventory perspective, if we look at what we had at June 30, 2008, we had $210 million of inventory. Let's say the FPR acquisition added $26 million to that to get to $236 million. The inventories we came in at, at March 31, 2009, are $249 million. We mentioned on the call that we expect that to come down $10 million to $15 million by June 30, so we will be sort of right at the adjusted June 30, 2008 numbers. I think our expectation is that we have opportunities for inventory management in fiscal 2010, which will most likely result in further reductions in inventory during 2010, based upon the sales situation.

Okay. I think that's it, guys. Thanks a lot.

Jason Rodgers, Great Lakes Review.

Good afternoon. Looking at your national account customers versus the smaller accounts, I was wondering which did better for the quarter.

The smaller customers did better than the larger national account-type customers.

Okay. There were no sheer repurchases in the quarter, were there?

No, there were not.

Okay. Accounts receivable was down, so it looks like you may be having some progress with your collections. We noticed one of your competitors talked about progress they had made in collections by implementing electronic billing. I was just wondering if you are doing anything in that area.

Jason, we've been doing electronic billing with customers for a long time, through EDI for many, many years. But also we've been doing electronic billing through the Internet for probably the last three-plus years through that. So, we actively encourage as much electronic billing as we possibly can with our customers to link up with them. But we haven't seen any big shift, let's say, within this fiscal year as to how much electronic billings we are getting or doing.

Okay. Looking at your guidance, you've got some precise figure targets for the growth in operating margins. I was wondering why you are keeping such a wide range. You know, you haven't changed your guidance for the full year but that is a pretty wide range for earnings for the quarter. I'm just wondering what the rationale there was.

So the big thing is we are still in such a state of flux on what the economy is going to offer from a topline standpoint, and we also have not finalized all of the moves we are making with regard to our SD&A as a result of what we are seeing on the topline. So you know, which piece hits at which time, from a timing standpoint, could throw this around a little bit. So, we are comfortable leaving that range out there, but we will come in somewhere in that range.

Okay. It may be too early to answer this, but you talked about the wage freezes for the workforce. I was just wondering what impact that has had thus far on employee turnover.

We have not seen -- we are very cognizant of that. If you look at all of the cost-cutting moves we've made, we've been very careful and very prudent in how we've made those and we have not seen any turnover because of that.

The morale still is staying very high. We are keeping a good, close look on that. The moves that we are making are in line with what's going on in the industry. We are certainly not being a bleeding-edge person with regard to things that we're doing to our employees. That is something that we watch very, very closely.

With regard to anyone's backing off of wage increases right now, I think the Consumer Price Index on a rolling average for the last three months has been down, so disposable income should not be being impacted too badly there. We do have a real empathy for our people for that, and we watch that closely.

Brent Rakers, Morgan Keegan.

I guess, first, on both the headcount reductions in the quarter and also the reduction in hours, could you maybe give me a better sense of how that was implemented over the course of the quarter in terms of timing, and then what has been put in place in the first three weeks of April?

Brent, I don't have the breakdown on when all that occurred, but suffice it to say that a number of those things occurred the latter part of January. So net of severance, we may have seen a 1.5 months, 2 months of the reduction. Net of severance, we had less than, probably less than 50% of the impact.

Ben, do you have the severance cost number for the quarter?

I do not. I don't know if you have it, Mark.

Yes, I do not have that right here, Brent, but think it was a little over $0.01 a share.

Then if you could also talk about the increased healthcare costs year-over-year, maybe even on kind of a constant-head basis, and then also what the bad debt expense was on a year-over-year basis.

Yes, from the healthcare costs, we are self-insured, so our costs are just rising. We've had, prior to this fiscal year, we've had several great years from a healthcare expense perspective. In the current year, we are experiencing, from what our actuaries tell us, a higher-than-normal rate of large claims. They define a large claim as $50,000 or more for a healthcare incident. So we are still seeing that, although that is -- the impact on that is getting smaller. We saw a larger impact in our first two quarters than in our third quarter.

Regarding the bad debt expense for the quarter, it did rise during the quarter. Our overall allowance for doubtful accounts has risen and it is now 3.2% of our total receivable dollars, whereas, at December, it was 2.8% of the dollars, and then at last June of '08, it was 2.4% of the dollars. I don't have right in front of me, Brent, the exact dollar amount of what it was in the quarter, but it was north of $1 million.

You said the increase was north of $1 million, year-over-year?

The expense was north of $1 million because, of course, the change in the reserve reflects the impact of what you are expecting, as well as some items that are written off from bankruptcies and stuff that actually happened during the quarter, too.

Okay. Just to clarify on the healthcare cost item, does that tend to be isolated? This is not a general inflation rate; you are talking just in terms of the claims. So is that something that should extrapolate necessarily into the fourth quarter?

Not necessarily. Although we are not necessarily expecting a decline in our healthcare expense in the fourth quarter, because of the impact of -- with the reduction in force, there is a several-month impact of the IB&R claims coming in. So those will still be coming in for several months. So we would expect to have an impact on healthcare expenses basically starting in the end of the June quarter but basically we will see that in fiscal 2010.

Okay. I guess just a final question -- you've obviously done a phenomenal job, I think, controlling some of these operating cost lines. Obviously, payroll is the largest of those. Do you have a sense, on an organic basis, what the payroll decline has been on a year-over-year basis?

Dollars? Or --?

Yes, I'm sorry, in terms of dollars or I guess even on a percentage basis would be fine.

I don't have that here, and I wouldn't want to hazard a guess.

Then just one follow-up to that is any sort of accrual adjustments here, Mark, that have impacted this quarter? It just seems like a fairly substantial drop from where we are used to here.

There is not many, but there are some. Obviously, as we go through the year-end and we adjust our accruals as appropriate based upon the knowledge we have at that point in time, but we don't have huge amounts. We had more in the last quarter than we had this quarter.

Okay, great. Thank you.

Holden Lewis, BB&T.

The first thing is, on the gross margin, I'm just trying to get a little bit of color there. You've done a good job maintaining the rate. Is it really just as simple as you are continuing to get the 100 basis points of price and yet you are not seeing any more increase? Because obviously the cost of goods is primarily purchased product and product sold. I mean, is that really just the answer for why you've been able to maintain it? Do those dynamics look like they may change in any way in upcoming quarters?

Then the second question is this is seasonally I think where you should see sort of the DSRs and all of that picking up. Would we expect to see a step-down from these levels in the first half of next fiscal year, just for seasonal reasons, or is there some reason that the seasonality may be playing out differently at this time? Thanks.

Those are interesting questions, Holden. Regarding for the daily sales rate in the June quarter, that usually is our stronger quarter. But even with that, we are still seeing these declines that are coming from the decline in the indicators and things. We don't necessarily expect to see any uptick or turnaround in those rates during this quarter, so we still expect sales to be impacted in a large way, negatively, because of the economy with the June quarter sales.

Regarding the gross profit percentage, you know, we have seen a decline in the number of suppliers that are putting forth gross profit or putting forth price increases. So when you look at this over a one-year period, if you are not adding in new increases that for certain contract customers we can't immediately pass along but we are able to pass along some of the old increases as those contract periods expire, that will have a slight improvement in the gross profit percentage.

I think some of that we would see in these numbers as well as our mix, as we talked about earlier, is our mix is getting more for the small and medium accounts versus the large accounts too, so that helps as well.

Okay. Back to the revenue side of the question, I guess what I'm curious about is less about the year-to-year change and more about, say, the daily sales rates. In dollar terms, would you expect to see, just for seasonal purposes, the daily sales rate in the first half of fiscal '10 dropping down from what you are experiencing in the first half of -- I'm sorry, in the second half of fiscal '09? I'm just trying to get a sense of what you would expect in terms of the dollars that we are looking at, not the rates of growth.

Holden, if you just look at the indicators, where the markets are still in contraction. So one would say, if you follow the indicators, you would expect the daily sale rates to be a challenge.

Yes. All right. Thanks, guys.

Thanks for being with us today. Again, a tough challenge. I think we have managers who are tough enough to face the challenge, and we hope to give you better information next quarter. Right now, as we look at the indicators, we don't have a tail wind, but we're going to try to make the most out of it.

Thanks again for being with us.

Thank you, ladies and gentlemen. This concludes the Applied Industrial Technologies third-quarter 2009 financial earnings. Thank you for your participation. You may all disconnect.