Applied Industrial Technologies Inc (AIT) 2009 Q4 法說會逐字稿

Welcome to the Applied Industrial Technologies fourth quarter 2009 financial earnings conference call. (Operator Instructions) At the request of Applied Industrial Technologies, today's conference is being recorded.

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

Thank you, Jamie. Good afternoon, everyone. Thank you for joining Applied's fiscal 2009 fourth quarter investor conference call. 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 by by visiting our Website at applied.com. A replay of today's broadcast will be available for the next two weeks, as noted in the archive information that's 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.

In compliance with SEC Regulation FD, this Webcast is being made available to the media and the general public, as well as analysts and investors. Because the Webcast is open to all constituents and prior notification has been widely and unselectively disseminated, all content of call will be considered fully disclosed. Our speakers today include David Pugh, Chairman and CEO of Applied, who will discuss our overall performance during the quarter and the year. You'll also hear from Ben Mondics, our President and Chief Operating Officer, who will discuss operational activities; and Mark Eisele, Vice President and Chief Financial Officer, who will discuss our financial performance in detail. Getting us started today is David Pugh.

Thanks, Rick. Good to be with you again. You've all had a chance to read our release and to view our numbers, so I'm not going to repeat them in my remarks. Mark is going to provide more detail in his financial report. In my overview, I'd like to focus my comments around three main areas. First, the macro economics, which reflect the worst recession I've seen in my career and I'll say this, we think this recession is far from over. Second, as a result, we have made and will continue to make increasingly tough calls with regard to the managing of Applied in this difficult time. Focusing on the task at hand, while not losing site of our long term strategy for the Company. And third and also as a result of the severe downturn, we've had to take a charge for impaired goodwill, primarily as a result of an acquisition to which we committed in April of 2008 when things were a bit rosier.

As to the business climate. You've already seen the results of a number of our largest suppliers, which accurately portray the market realities. Consumers are still concerned about the when and if of any recovery and I think they have a right to be. Job losses and unemployment remain high. Those that are maintaining jobs are experiencing pay cuts, reduced hours and reduced benefits. And while we read about projections of a 2010 recovery, they seem a bit premature. The leading indicators that we follow and the customers and suppliers with whom we talk, give us no basis to predict that a recovery is imminent. Capacity utilization is still dropping. The ISM Index is still in contractual territory and job losses continue at high rates. The best that can be said is that the rate of decline has moderated.

Having said this, recognize, our challenge is no greater nor any less than that facing the rest of industrial America. So we're not alone in this struggle. Operationally, we've focused on several items. In the face of the inevitable decline in the top line due to the industrial economy, we have exercised excellent discipline on gross margins. In order to do this, we've had to make sure that the aggressive cost controls that we put in place did not strip away the services needed by our customers, which allow us to continue to justify these margins. Cutting costs is the easy part. Running a sustainable business requires wise choices out of many alternatives. In addition to a solid focus on costs, times such as these require that asset management and liquidity be top of mind. And I assure you, they are.

Our asset management remains strong. Receivables have been well managed in a very difficult period. Even so, we're being prudent by increasing bad debt reserve as we view the risk landscape. Inventories are a bit higher than we would like them to be at year end. Attributable, for the most part, to supplier commitments that we have made for fiscal 2009. I assure you these inventories will be reduced to appropriate levels in 2010, providing us a boost to cash flow. As we review the relative shareholder value that we've maintained during this time, we derive a certain amount of comfort that the processes that we've used to make our decisions are providing above average results. And finally, as a result of this economic decline and a subsequent decrease in the value of certain assets, a goodwill impairment charge was taken in the fourth quarter, reducing our operating income by $36.6 million or a negative impact of about $0.54 per share.

The recession manifested itself shortly after we completed the acquisition of Fluid Power Resources in August of 2008. And it became more pronounced as the year progressed. This slowdown negatively impacted the operations, leading to the impairment of goodwill for our total Fluid Power businesses by the year end. Emphasizing the fact that this segment has been especially been hit hard by the industrial slowdown. While it's disappointing to incur any impairment charge, we recognize that many industrial companies have had to do the same in this economy. The impairment charge did not result in a cash expenditures, did not adversely affect our compliance with covenants under our debt agreements and did not affect the Company's cash position, cash flow from operating activities or our revolving line of credit.

Our balance sheet is still excellent and we remain steadfast in our belief that the companies obtained in this purchase are well positioned and they're going to provide us excellent value in the future. So while we face a very difficult economic environment, I am pleased with the majority of the results driven by a very strong and decisive management team and dedicated associates across the operations. Despite the very difficult economy, we have the resources and a very sound financial foundation to be able to continue to invest in the business and to make the most our of opportunities. And now, to Ben, who will give you some insight as to what those opportunities are.

Thanks Dave. And good afternoon, everyone. I'm sure the economy and its impact on our business is on everyone's mind. So, let's begin with the discussion of the key indicators. The industrial production index continued to fall during the quarter, ending with a June number of 95.4%. Overall, industrial output has dropped 15% from its peak, placing it in a class with the most severe recessions recorded. The capacity utilization rate for manufacturing and for total industry fell to record lows in June. While the rate of declines slowed somewhat from previous months, it is still a telling sign of what is happening to our customer base.

The ISM Manufacturing Index improved to 44.8 in June and the Index increased to 48.9 in July, much higher than expected. This benchmark, based on reports from purchasing managers, has been trending up since December. This is a positive improvement. However, the Index remains below the expansionary threshold of 50. We have followed this indicator for many years and our business generally lags the index by three to six months, as the business cycle improves.

In summary, we're not out of the recession yet and we don't expect to be out of it in the short-term, based upon reports from our customers. We serve a broad cross-section of industrial businesses and only a handful have shown positive trends. In fact, of the top 30 industries that we serve, 11 showed sales declines in excess of 20% for the year. Even government sales, which has grown very well for us over the past few years, were basically flat for the year. However, this business is still growing faster than our overall industrial business and we continue to make prudent investments here.

Once the severity of the recession was understood, we adjusted our expectations on operating margin and set a goal of 5% for the last half of the fiscal year. In support of that goal, we kept a heavy focus on protecting our margins in the face of intense competitive pressure and balancing our operating costs against our sales revenues. In large part, we succeeded. Our efforts to take out costs helped keep our selling, distribution and administrative expense at competitive levels. And for the year, we achieved an SD&A of 21.4%, compared to 19.9% last year.

Those efforts included; A reduction to the incentives we pay. Our incentive plans are self-adjusting and decrease in line with our drop in sales and profits. A consolidation of 17 locations which was offset by the opening of two new service centers and the addition of 20 facilities through acquisitions. We finished the year with 464 facilities. And a reduction of approximately 500 full time equivalent positions through downsizing and reduced work weeks.

Excluding the impairment charge, we achieved an operating margin of 5.7% for the year and 5.2% for the fourth quarter. All in all, we have made and will continue to make adjustments to bring our operating costs in line with the amount of business we have to support it. We are taking a measured approach to these adjustments and are closely looking at the long term ramifications to assure we can continue to deliver a high level of service for our customers.

There's continued price pressure in the marketplace, as both customers and competitors struggle to cope with the economy. In spite of that pressure, we managed to keep our gross profit margin for the year at a respectable 27%. In talking with our customers, we have yet to hear encouraging comments that a recovery has started. Most are still reducing inventories of their end products and have slowed or idled production capacity. Our long-term view is for a slow protracted recovery that will begin to influence our business later in fiscal 2010. We continue to manage our operations in a conservative manner as a result of this expectation.

We are still actively seeking and taking advantage of opportunities to grow our business. In spite of the recession, we continue to invest in information technology improvements that will help us to improve the operational side of our business. And we have also made sensible investments in training and technology for our sales force. We expect these to be a strong benefit when the economy returns to a growth mode. During the year just ended, we expanded our product offering by gaining authorization to sell products from THK, a market leader in linear motion technologies. We also developed a new strategic partnership with ORS Nasco, the largest wholesale of tools, safety products, general industrial items and welding supplies in the United States. This agreement alone added more than 80,000 items to our product offering and further reinforced our image as a one-stop shop for industrial purchasing.

And finally, we continue to look at acquisitions. In this economic environment, we see opportunities to expand our business via acquisitions. However, we continue to look for businesses that have strategic and a cultural fit, as well as reasonable valuations. I will now turn the call over to Mark Eisele for a discussion of the quarter's financial results.

Thanks Ben. Good afternoon, everyone. Before getting into our normal operational discussion, I want to address the goodwill impairment charge. This charge resulted from an interim impairment test that we performed during the fourth quarter based on current and expected market conditions, reduced operating results and a worsening economic outlook. We determined that all of our $36.6 million of goodwill associated with our fluid power businesses segment was impaired as of June 30, 2009. The remaining goodwill on our books of $63.1 million relates to our service center based distribution segment. We believe the fair value of this segment is well in excess of its carrying value.

Now, let me provide some additional insight for our fourth quarter and fiscal year end financial performance. Looking at our day to day operations, sales for the quarter ended at $425.2 million, a 19.7% decrease over last year's fourth quarter. We had 63.5 selling days in the current quarter and 64 in last year's fourth quarter. Sales at our US service centers were down 27% from the prior year quarter, reflecting the economic slowdown and its impact on our various customer sectors, as discussed by Ben. This decline was consistent throughout the quarter. Sales at our US fluid power businesses, excluding recent acquisitions, were down 32% for the quarter. Our Fluid Power Resources acquisition added sells of $33.6 million.

Sales, in local currency, at our Canadian operations decreased 9.6% over the prior year quarter. Overall, including the impact of the decline in the Canadian currency, we are showing a 25% net decline in Canadian sales. Our overall Mexican operations produced sales increases bolstered by an acquisition in May 2008. As disclosed in the press conference, on a non-GAAP basis, excluding the goodwill impairment charge, net income per share for the fourth quarter was $0.35. During the quarter, we also experienced some income tax and SD&A benefit that we believe are nonoperational in nature and are not expect to reoccur in fiscal 2010. These increased our net income per share in the quarter by $0.08.

During the quarter, our North American operating facilities declined by six to 464. And our associate count declined by 164 to 4,729 associates. The main cost control initiatives implemented this past quarter was a merger of facilities and a continued focus on personnel costs. Our product mix during the quarter was 27% Fluid Power products and 73% industrial products, compared to 20% and 80% in the prior period. The acquisitions within our fluid power business during the year account for the shift in product mix.

Our gross profit percentage for the quarter was 27.3% or 30 basis points above last year's fourth quarter. This increase reflects the impact of certain LIFO inventory layo liquidations within specific LIFO inventory pools. This benefit was partially offset by the continued downward pressure we are experiencing on our point of sale pricing to customers. Overall, our gross profit percentage for the year was 27.0%, which was slightly below the prior year of 27.2%.

Our selling, distribution and administrative expense, as a percent of sales, was 22.2% in the quarter or approximately 250 basis points higher than the fourth quarter of fiscal 2008. SD&A expenses for the quarter decreased in absolute dollars by $10.2 million or 9.8%, compared to an overall sales decrease of 19.7%. Approximately $11.4 million of our quarterly SD&A expense relates to added expenses from recent acquisitions, not included in the prior year quarter, including $2.2 million of intangible amortization expense. We also saw increases during the quarter relating to higher bad debt related expenses of $1.5 million and severance costs of $900,000. Offsetting the SD&A increases were decreases in wages due to our lower headcount and decreases in incentives and employee benefits.

Our operating margin, before the impact of the impairment charge in the quarter, was 5.2%, compared to 7.3% in the prior year's quarter. The deleveraging impact of decreased sales was a primary reason for the lower operating margin. In addition, the incremental and tangible asset amortization from fiscal 2009's acquisitions decreased our quarterly operating margin by approximately 55 basis points on a comparable basis with the prior year's fourth 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 decrease interest income from lower cash balances and overnight investing rates and additional interest expense related to the borrowings under our revolving credit facility, relating to the FPR acquisition.

Excluding the impairment charge, our effective tax rate for the quarter was 30.4%. This rate was impacted by several issues within our Canadian and Mexican subsidiaries that provided a net $1.3 million in benefits in fiscal 2009 that are not expected to reoccur in fiscal 2010. These nonrecurring tax benefits at our Canadian and Mexican subsidiaries effectively reduced our overall annual effective tax rate from 37.8% to 35.8%. On a go-forward basis, we expect our fiscal 2010 tax rate to be in the range of 37.0% to 37.5%.

Our balance sheet remains strong, with shareholders equity at $508.1 million and a current ratio of 3.4 to 1. Excluding the goodwill impairment charge, our pre-tax return on asset was 10.4% for the quarter compared to 20.1% in the prior year quarter. This decrease is due to the reductions in earnings from slowing sales and the large amount of intangible assets added to our asset base from the Fluid Power Resources acquisition. Our June 2009 inventories increased $44 million above our prior year June 30 level. $22.8 million of this increase relates to companies we acquired in the current year. The remainder of the increase relates to inventory purchases made in the fourth quarter to achieve an optimal level of supplier incentives. We expect inventory balances to decline by $50 million by the end of fiscal 2010, as we anticipate burning through our excess inventories and limiting additional purchasing to levels supported by our current sales activity.

Cash generated from operations for the quarter was $26.8 million, compared to $48.4 million in the prior year fourth quarter. This decline was due to lower operating income and the build of our inventory levels in the quarter. Full year cash provided from operations totaled $81.3 million, which is very close to our original estimate of $90 million at the beginning of the year.

We provided annual financial guidance for fiscal 2010 in this morning's press release for sales of between approximately $1.65 billion to $1.85 billion. With earnings per share in the range of $0.90 to a $1.30 per share. We are not forecasting any gains on sale of property or other nonoperating events for fiscal 2010. We expect fiscal 2010 gross profit levels to remain close to the fiscal 2009 annual rate of 27.0%. Downward pressures on point of sale margins, due to the competitive marketplace for our products, will continue in fiscal 2010 and may negatively affect our ability to maintain the gross profit margins at their current levels.

We expect supplier purchasing incentives in fiscal 2010 to be lower than what we achieved in 2009 in gross dollars and the percentage we received on purchases and in their impact on our gross profit percentage. However, it is our plan to reduce inventories over the next year, which we anticipate will result in LIFO layo liquidation benefits that should offset lower supplier rebate support. While the benefit from the LIFO layo liquidations should offset this negative impact of supply rebates on our annual basis, we may see more variability and fluctuations in each of our quarterly gross profit percentage rates throughout fiscal 2010. Our aim is to keep a continued tight control on our selling, distribution and administrative expenses in 2010. Our expectation is that while the total SD&A expense will decrease, the percentage decrease in 2010 will be smaller than the rate of our sales decrease.

Our SD&A expenditures will be continue to be influenced by investments and initiatives that will help us build future profitable growth, such as our initiative to expand sales to government entities. Our operating margins were about 5% for the last half of fiscal 2009. We expect they will come down during the first two quarters of fiscal 2010 and then rise in the latter half of the year, as sales begin to increase, as the industrial economy improves. We expect to exit fiscal 2010 with an operating margin at about the same rate we experienced in the fourth quarter of fiscal '09, exclusive of the goodwill charge. Depreciation expense should remain in the $12 million to $13 million range for 2010.

Due to our FPR acquisition in early '09, we expect the full year fiscal 2010 amortization of intangible assets to increase to $10.4 million. From a cash planning perspective, we expect property additions to be primarily in shop equipment, computers and the information technology area. with total additions of $8 million to $9.5 million. We have no immediate plans to purchase stock for treasury. And while we'll continue to monitor the quarterly dividend rate, our expectations are that it will remain stable during fiscal 2010. And now, some closing remarks by Dave Pugh.

Hi, Mark and Ben. There you have it. In some way it's good to bring fiscal 2009 to a close. The books are going to be filed and the lessons learned, they're going to serve as a lamp to light our way in 2010. We have a solid foundation from which to operate. We have a strong management team to guide. We have sound processes to control our results. There's no fear but there is prudent caution and an unyielding commitment to progress. With that, Jamie, I'll open the lines for questions.

Thank you. (Operator Instructions) Our first question comes from Matt Duncan from Stephens. Please go ahead.

Good afternoon, guys. The first question I've got, Ben, you mentioned that it sounds like the month to month sales trend was fairly flattish throughout the quarter. Has the same thing continued through July?

Yes. If you look -- let me back up a little bit on the quarter-over-quarter. We did see some acceleration from the third quarter to the fourth quarter. But month-to-month from March through July, we've been running at relatively flat, same level.

Okay. That's helpful. And then Mark, on the LIFO layo liquidations that you experienced this quarter, can you quantify for us how much that helped your gross margin in the quarter?

Yes, actually, we have that disclosed in the footnote to the income statement on the press release. And it talks about $4.4 million of gross profit improvement, which translated to about $0.06 per share.

Okay. Thanks. And a couple more things in here and then, I'll jump back in queue. As you look at the amount of SG&A cost that you've taken out of your business during this downturn, how much of those costs do you think are sustainable when volumes begin to recover? And I know it's early but have you given any thought to what kind of operating leverage that may give you in the next up cycle and what that can mean for your peak operating margins when things start to get better?

Matt, we're very confident that we will see some good leverage as the business improves but to come up with a peak, it really depends on where the total business volume goes to.

And I think, just looking at that, it really it's a headcount view of things, Matt. We want to make sure that we continually review the headcount that we have and make sure the changes that we've made with our operating processes and the reductions of the headcount that we've been able to accomplish with that, that those maintain when business comes back.

Okay. And then, last thing here. Just the impact of pricing and FX both in the quarter? And as you look at some of the supplier price increases you had before things got worse, are you holding on through those through the end customer? Just kind of looking at what the total impact of price and FX each were.

I think the total impact of the foreign exchange was around 1% and I believe the impact on pricing was under 1% from quarter-over-quarter . And of course, we really haven't seen much, if any, price increases from our major suppliers in six, seven plus months.

Sure. Thanks for the color, guys.

Thank you.

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

Hi guys. Can you hear me?

Yes.

Just back on the LIFO liquidation, what are you contemplating or what are you thinking you're going to benefit in fiscal '10 from that dynamic? And is there a point where those liquidations kind of run out?

Yes, I think what we are looking for in 2010 is a significant reduction of our inventory dollars. So we will be able to reduce a lot of our LIFO reserves. Our LIFO reserves are $100 plus million. I don't have the number in front of me right now. And I think it's over $150 million of LIFO reserves. We expect benefit that we're going to get is going to offset the reduction of supplier rebates that we get. And the view is I can get this benefit on my income statement of a lower costing product, either through purchasing products and getting a rebate or by reducing inventory dollars that we currently have in stock and getting a reversal of some of the LIFO layo liquidation benefit. And so, that's what we're choosing to do in 2010 is to really try manage the assets of the Company, reduce the inventories to the sustainable current sales levels. So that we can go forward and manage the assets better, get a better return on that. And then still have about a similar income statement impact of whether we get it from rebates or from LIFO.

Okay but -- and then, moving to inventories, why continue to purchase your inventory into year end if you have the offsets and the liquidation? I'm just trying to understand why we're not seeing a more aggressive inventory reduction up to this point?

I think the real answer to that is most of the inventory commitments and purchases that we did during the fiscal year, we actually did in our second quarter or the final calendar quarter for 2008. And that happened before the real downturn in the economy. So we had made those commitments, had those purchases out there and most of them came in by December 31. And then, we were unable to have a significant dent, reduction in those by June of '09. So, we decided to purchase through June of '09 at the levels to optimize our supplier purchase incentives and work on the reduction in 2010.

Okay. That's helpful. Then, it sounds like -- you kind of maybe took a leg down in April and then you've been stable on a daily sales basis, April through July. Anything you're hearing anecdotally from your customer that says, you go one way or the other from there? Your guide -- the low end kind of gets you to further deterioration from here, it seems. What are they telling you anecdotally?

Talking to customers. Talking to suppliers, looking at some of the economic indicators on sales and inventory by industry segment, we believe there's still opportunity for our customers to reduce inventory and get their inventory in line with their sales. So we see in the short-term, a possibility for a continued downward movement before we see the sequential upward movement.

Okay. And then, just finally on the -- just on the fourth quarter, sales came in at below your -- the low end of your range. And you said the sales came in at the low end of the range. You had the incentive accrual -- what were you kind of -- were you expecting that incentive accrual or was that a result of the lower -- I'm just trying to understand the moving pieces relative to what you were building in for the fourth quarter?

Well, from a sales perspective, if we go back and look at where we were, our thought process as of the end of March is, we were unsure whether or not A, we were seeing a stabilization of let's say same-store sales in the US industrial arena. Also, through March and looking at the March discussions, our Canadian operations in local currency were actually up for the year, for the nine months ended March. And as we talked on the call today, in this last quarter, they were down 9.6% for the fourth quarter. So that was a change for things. And maybe in the western Canadian economy, the recession took a little longer to get to them than it did in the US industrial economy.

Mark, the incentive reversals were more long term than the short-term.

And the incentive reversals, Jeff,, were really related to three year long term incentive programs for which we made some expensing in 2007 and 2008 but reversed them out at the end of 2009. And then, that's really what we were referring to in the footnote to the income statement on the press release.

Okay. Thanks.

Our next question comes from Adam Uhlman from Cleveland Research. Please go ahead.

Hi. Good afternoon, guys.

Hi Adam.

Ben, you were talking about some IT and sales force investments in your prepared remarks. And then, you also brought up the new ORS Nasco agreement. And I was wondering if you can provide a little color about some of these IT investments? And then, if you could also talk about how fast you think the ORS agreement will ramp-up and any kind of broad brush thoughts on revenue or margin of those additional SKU's?

Adam, I don't want to get into too much detail on the call here but just to add a little bit more color to the comments. We, over the years, have made a commitment that even in the down years, we would continue to invest in technology and training. And although we've had to make some tough decisions on cost control, we've continued to do that. And we have made some investments in some tools to help our both our inside and our outside sales folks and make them more efficient and bring greater value to our customers. So both the technology and then also training, we've continued to invest the majority of our training budget on training tools for our sales folks.

On the ORS Nasco piece, we have not set any targets out there with growth expectations for that group. It's a good opportunity for us. It's good for our customer base, as they want to consolidate their purchases. And we're still in a learning phase right now and taking that offering out to our customers and seeing what their needs are. And getting the word out to our own folks also and having them get out in front of the customers. So, we're still in the initial phases right now. We have good some expectations for it but we haven't set any lofty targets out there right now for that piece of the business.

And are there any investments that you need to make to support that SKU expansion?

Not -- you're talking the ORS piece?

Yes.

Not in a large way. And I think that's the unique piece of that puzzle, is we can add 80,000 products to our product portfolio without making an investment in inventory. We have some promotional investments and maybe a little bit on the training side and advertising such. But it's a very efficient way to bring new products to the market.

Okay. Great. And then Mark, when you exclude the LIFO inventory gain in the fourth quarter, it looks like the gross margin was closer to 26.3%. And I'm wondering if that year-over-year degradation in the gross margin is similar to what the Company has seen from a point of sale perspective?

I don't have those numbers right in front of me, Adam. But we definitely had a degradation in the fourth quarter and during the year in our point of sale margins, like we've talked about in each of the last four quarters. And I would think it's not quite that high of the number that you referred to. But yes, there definitely was a noticeable degradation and we continue to see pricing pressures out there.

Okay. And then, how big of a LIFO inventory benefit would you capture from taking $50 million of inventory out, do you think?

We don't have that specifically quantified here to talk about on the call. But our view is that the amount that we're going to get should offset any reduction in the purchasing incentives from suppliers that we're going to get. And then, that's basically been our target this year and that's the plans that we have put in place to accomplish that. But I don't have a number to quantify that right now.

Okay. Thanks.

Our next question comes from Joe Mondillo from Sidoti & Company. Please go ahead.

Good afternoon, guys.

Hi, Joe.

First I was just wondering if you could quantify the benefit that you're seeing from the cost cutting measures that you put in place, whenever you started doing that? What benefit you saw in the third quarter and fourth quarter? And then, what incremental benefit you'll see in 2010?

I think just on an overview basis, we've really reduced FTE headcount by over 500 associates here. And so, that's a pretty big number and I would say the vast majority of that happened in the second half of fiscal 2009. A big chunk of that happened at the end of January. But then, it's been happening month over month as we continue to refine our view of costs and refine our operations going forward. So we still have six months of this fiscal year with those headcounts not in our numbers that we will see out there. So, that's going to be a pretty big number for that. We were targeting and looking at reductions in all major categories from headcounts, which translates to salaries and wages, from benefits and for various other. Just making sure we're managing the variable costs tightly. All of those things are continuing. So, I don't have an exact number here but boy, that's -- taking 10% out of the workforce is going to be there throughout fiscal 2010. Whereas it wasn't at in all of 2009.

Did you go through most of the fourth quarter with those measures already put in place, or were they more put in place towards the back half of the quarter?

I think there was an additional reduction of about, I think I said in my comments, 160-some associates that were reduced during the fourth quarter. So of the 500, the vast majority of them happened in the third quarter. So, most of it was in the fourth quarter but not all of it. So, there's still some benefit going forward.

And then, it happened throughout the fourth quarter.

Okay. And then lastly, I just wanted to ask you in terms of acquisitions, what kind of acquisitions would you be looking at? What types of product portfolios would you be looking at? And maybe what kind of -- or what regions in North America would you be focused on?

From a product standpoint, we continue to look at those product categories that fit our current model. We continue to look at other opportunities to see if there's a fit. From a geographic standpoint, we're looking to fill out any holes we have geographically. And we're open to all types of opportunities and we have a focus on those that have the best strategic fit, as well as a cultural fit.

How is the acquisition environment would you say right now?

I'd say it's very active right now but the biggest challenge is coming up with valuations that both parties can agree to.

All right. Thanks a lot, guys.

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

Good afternoon. I wanted to follow up again on this gross margin issue. Mark, I know you're not giving us any specific numbers in terms of the LIFO liquidation numbers for next year. But could we get some sort of range? Because again, if you work off the current quarter and make six or seven adjustments to the numbers, you're getting operating numbers that are like 3.5%. So obviously there, there's a significant, 100 bips or so, contribution from the LIFO liquidation. But could you maybe frame that in terms of an EPS contribution for next year? Are we talking $0.15, $0.20 or a number greater or smaller than that?

I don't have that number here with me, Brent. But what I do expect is LIFO by definition from the accounting terms is a once a year calculation. So the majority of a LIFO benefit that you record does actually happen in the fourth quarter. We do record our LIFO calculations on a quarterly basis, although the way the inner workings of the calculations manifest themselves, it does push the benefits out into the calculation into later quarters. So my thought process and some of the things that we were talking about in the call, specifically on operating margins, is that we think that the first two quarters of the year, our operating margins will be lower than the last two quarters of the upcoming year. And I think some of that is going to be because of how the LIFO layo liquidations will roll into the income statement. Because I think we'll have a little more of that in the later half of the year than the beginning half of the year.

Mark, that's helpful. As a clarification though, again, if we work off the base gross margin impact in Q4, that was -- I think the number there was 26.3%, is there any reason to believe that would not be a low, a 26% to 26.5% kind of number during the first half, until you get those benefits in the back half of the year?

We are shooting for a 27% target for the whole year. And obviously, we're shooting for that and it's part of our plan in individual quarters as well. But there's lots of moving parts for that.

Then, maybe if I could, another clarification. The other statement that's been made is the LIFO situation will offset the pullback in rebates but it seemed to me that in this fourth quarter -- I didn't hear comments about rebates. It was more a comment about competitive pricing pressures. Did I miss something in the earlier commentary? Are there two different issues presenting a pretty big drag on the gross margins?

I think the rebate benefits that we got in the fourth quarter were consistent with our expectations and with what the business practices have been over the past year or so. So, there wasn't a big change for that.

So all of the impact on the pressure on the gross margins in Q4 was from just increased competition and softness in demand. Is that correct?

I think that's fair.

Okay. And then just another question. I think you talked about bad debt expense and I think you threw out $1.5 million number. I just wanted to clarify, if that was a year-over-year increase in bad debt expense or that was the hard dollar number for Q4?

That was the increase from the Q4 of last year to the Q4 of this year. I don't have the number right in front of me, but I believe the grand total dollar amount of bad debt in Q4 of this year is closer to $1.8 million or 1.9 million.

And Mark, you would expect that to go back down to $0.5 million or so a quarter going forward in the next year? Does that sound correct?

Well, our expectation is -- let me start over. Our receivables are in great shape. We have not seen a degradation in our DSO's. We really haven't seen a degradation in our aging in receivables. So, we feel very good about how we've been managing that process throughout the year. Obviously, we are concerned, like lots of people are concerned, about just the overall economic situation, where more companies may go bankrupt. And even if they're paying us on time and within terms, we may have a loss there. With that comment, my hope is that next year's bad debt expense will be less than this year's bad debt expense but it remains to be seen as where the economy goes. I think if the economy starts turning around and getting better in the beginning of calendar 2010, that many economists have stated, that that would be a good thing.

And then just one final question maybe for Dave or Ben. But if you could maybe talk a little bit more about the government if terms of remind us of what the size of the business is on an annual basis and what the contribution was for the quarter?

Size of the business is in the $75 million, $80 million range. And going forward, we're going to start including some of the government business we have in our fluid power subsidiaries. So you'll see that number jump in the coming quarters. But on a US service center basis, that we've been talking about, it's in that range. We have seen some solid growth, double digit growth in segments of the business with regards to the day to day federal, state, city type of business. Some of our large defense subcontractors, that business fluctuates significantly. And so, we feel good about the fact that we've grown our day to day business and the contractor business, again, continues to have some variability.

Great, thank you, Ben.

Sure.

Our next question comes from Jason Rodgers from Great Lakes Review. Please go ahead.

Yes, it's actually Greg Halter of Great Lakes Review.

Hi, Greg.

How are you guys?

Good.

I wondered if you can comment on your expectations for pension funding for fiscal 2010?

Sure. I'd be happy to do that. I believe our expectations for the cash contributions that we're going to make into our pension plan is under $2 million. So, it's not -- and it's very similar to what it's been for the last couple of years.

Okay. And I wondered if you can comment on the differences between your national accounts, which I understand are about 1/3 of the total versus the smaller sized accounts and how their relative performance was for the quarter?

Yes, Greg. The national accounts are down slightly more than the smaller accounts. And if we segment it by -- if we take it down even more granular, the smallest grouping of customers is down much less than the largest group. So, I think it's consistent with what we've seen in industrial production, some of the larger operations being shut down and some of the larger industries that we serve have suffered more than the smaller accounts.

Okay. And finally, relative to the various market sectors that you serve, are there any that are showing any sign of life currently, relative to others that may be really depressed?

Yes, the food industry, which continues to grow as a percentage of our business, continues to do well on a relative basis. And our business in the food industry is up and continues to grow as a percentage of our total business. Some of the energy markets are still doing okay and a few others. But for the most part, of the 30 industries we track, a large majority of them are still in a negative mode right now.

Okay. And relative to your customer base and the general industry, forest products, primary metals and so forth, is there any significant change on a year-over-year basis from what you had seen as a percentage of your business from the prior year?

The food industry is up as a percentage of our total business. We've probably seen small decreases in transportation equipment. Probably in forest products. There have been some minor fluctuations, a percent here or a percent there, but those are probably the big ones.

Okay. Thank you.

I'm showing we have no further questions. I'll turn it back over to David Pugh.

Great. Thanks, Jamie. And thanks for being with us today. Hopefully, the comments we've given you have been helpful to you and we're looking forward to being with you next quarter. Thanks again.

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