Applied Industrial Technologies Inc (AIT) 2010 Q3 法說會逐字稿

Welcome to the third quarter earnings call.

My name is John, and I will be your operator for today's call.

(Operator Instructions).

I will now turn the call over to Mr.

Rick Shaw.

Mr.

Shaw, you may begin.

Thank you, John, and good afternoon, ladies and gentlemen.

We appreciate your joining us today for Applied's fiscal 2010 third quarter investor conference call.

Our earnings release was issued this morning before the market opened, and if you have not received it, you can retrieve it by visiting our website at applied.com.

A replay of today's broadcast will be available for the next two weeks 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 marking 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 teleconference is being made available to the media and general public, as well as to analysts and investors.

Because the call is open to all constituents and prior notification has been widely and unselectively disseminated, all content of the 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.

You will 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, will discuss the details of our financial performance.

Getting us started today is David Pugh.

Thanks, Rick, and it is good to be with everyone again.

In fact, it is much better to be with you than in recent quarters.

If you saw our results, you saw that the third quarter returned to growth and increasing profitability.

We are very pleased with that; and while we will leave it to others to call the official end to the Great Recession, it does feel like to us it has finally arrived.

Certainly what we saw in February and March and what we continue to see in April feels like a very different economic environment.

At this stage of the game, we really can't point to the underlying fundamentals that are driving this improvement.

But we are not complaining.

In discussions with our customers and suppliers, they're indicating that the improvement really does seem to be more of a general recovery than any kind of a transient stimulus spike.

With that input, we are really optimistic about the remaining quarter of our fiscal year.

The question yet on the table is how long we can sustain this recovery and how vibrant it will be.

Market indicators point to good potential for the next couple of quarters, but we really lack good insight beyond that.

Our customers and our suppliers are both reluctant to forecast beyond six months of their business.

During this past quarter, we continue to see pressure on our margins from all competitors.

Excuse me.

As the recovery continues, we expect some of that pressure to release, but it is really difficult to tell you when that's going to be.

We feel that we did execute very well on the operating plan that we put in place to deal with the recession.

We cut the costs where necessary, we closely managed the assets, and we feel we have embedded these improvements into our processes.

Right now we are shifting gears to make sure that we can deal adequately with a recovering market.

We want to make sure we don't miss any upside opportunities; and at the same time, we are going to make sure that we don't backslide on any of the productivity gains we have made during the recession.

Inventories are a good example of this activity at work.

During the recession, we worked hard to reduce our excess inventory and have cut $80 million since June 30th of last year.

Ben and Mark are going to share the details of that reduction with you.

So summing it up, we are really pleased with our performance this quarter.

We are happy that the economy seems to be moving back to our growth mode.

We really believe that our balanced efforts on sales growth and margin enhancement, cost control and asset management have put us in a very strong position to leverage any continued increase in this economy to very good earnings growth.

So for more detail on the quarter, I am going to turn it over to Ben.

Thank you, Dave, and good afternoon, everyone.

Looking at the economic indices that are important to our business, industrial production continued to improve during the quarter and finished at 101.6 in March, its highest level since December of 2008 and the ninth consecutive month of improvement.

Manufacturing capacity utilization also improved in March, hitting 70.5 following a general trend of improvement since July of 2009.

Finally, the other major economic indicator that we follow, the ISM Purchasing Managers Index, increased to 59.6% in March, its highest level since April of 2006, and the eighth consecutive month that it has been an expansionary territory which is above 50.

Our sales tend to lag the capacity utilization on the upswing by about six months.

The general improvement trend gives us confidence that we should continue to see sales improvement for the foreseeable future.

Looking at our top 30 industries -- and it feels really good to say this -- 21 of the industries we track have moved into positive growth territory during the quarter.

The major segment of our business that is still in negative territory includes those industries associated with construction, such as cement and aggregate production.

Government sales improved during the quarter and moved into a growth mode.

Our efforts in growing the Government sector are a long-term play for us, and we feel we are making good progress in penetrating at local, state and federal levels.

SD&A as a percent of sales was 21.3%, improved from 22.4% in the same quarter last year.

Year-to-date, SD&A is 21.8%.

Our SD&A percent improved as a result of stronger sales and our cost control efforts.

As sales improve and we keep our costs under control, we will continue to see improvements in our SD&A percent in the coming months and quarter.

At March 31st, our employee count was 4,491, down 60 from December 31, 2009 and a decrease of 402 associates from the same period last year.

Shortened work weeks reduced our full-time equivalents by another 52.

For the year, our excess inventory reduction program hit $80.4 million, as we continue to primarily reduce bearing and drive products inventory.

That is an inventory reduction of 32% since June 30, 2009.

Mark will give you more detail on that reduction and the LIFO layer liquidation in a few moments.

I want to point out that from an operation standpoint, we have achieved these reductions while maintaining the working inventories needed to support our customers and the level of business that is out there.

We feel confident that our inventories are rightsized, even as the economy recovers.

Having said that, we are talking with some of our suppliers regarding potential spot inventory shortages, and we're making adjustments now to assure that our inventories continue to be adequate.

Our concern is that as the economy picks up, some of our suppliers may be caught short on certain products.

Please note that the product shortages we are concerned about are not related to our excess inventory reduction initiative, and we will continue to watch this situation very closely.

The recession, while never something that you would consider a good thing, did help us focus on cost control and asset management.

We made tremendous progress in these areas as we made adjustments to our business fundamentals over the last 24 months.

We do not intend to surrender these gains, but to take advantage of them as the economy continues to improve.

Overall, I believe we are well-positioned to continue our sales and earnings growth.

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.

During the quarter ended March 31st, our sales increase reflected increased net sales and same-store business.

We have seen continued improvement throughout the quarter in our daily sales run rates, and so far we see this trend continuing into April.

We have 63 selling days in both the March quarter, and the prior year quarter.

Our product mix during the quarter was 29.4% fluid power products and 70.6% industrial products.

Quarterly sales for our service center based distribution segment increased $19.8 million or 5.3% from the same period in the prior year.

Quarterly sales from our fluid power business segment increased $14.7 million or 18.2% from the same period in the prior year.

The greater percentage increase in our fluid power business was driven by a quicker economic recovery of fluid power customers in the high-tech industries.

From a geographic perspective, sales from our US operations were up $30.2 million or 7.6%.

Sales from our Canadian operations increased a total of $2.6 million, which included a favorable $6.7 million foreign currency translation impact.

Excluding the currency impact, the quarterly sales are down 9.5% in Canadian dollars compared to the prior year quarter.

Our Canadian operations are still being impacted by sluggish activity in the oil and gas and forest products industries.

Our Mexican operations increased $1.6 million, of which approximately $1 million is attributable to foreign currency translation.

On an overall basis, positive foreign currency translation increased sales by 1.7% in the quarter.

We merged several locations in the US, resulting in our North American operating facilities decreasing by 5 to a total of 458 at quarter end.

Our gross profit percentage for the quarter was 26.8% as compared to 27.1% in the prior year's quarter.

Continued downward pressure on our point of sale pricing to customers throughout all of our operations drove this decline.

The gross profit percentage for the quarter was 60 basis points above our current year second quarter run rate.

This increase was driven by the positive impact of additional LIFO layer liquidation benefits recorded in the third quarter due to increases made in our projected inventory reductions for the full fiscal year.

The quarterly LIFO liquidation benefit moved from $1.8 million in the second quarter to $4.8 million in the third quarter due to this increase.

Our expectation for the fourth quarter is to recognize a LIFO layer liquidation benefit of $2.5 million.

Since this is smaller than the third quarter benefit, we do expect this to bring the fourth quarter gross profit percentage down about 50 basis points from the third quarter rate of 26.8%.

Actual inventory levels at June 30th, 2010 could have a significant impact on our fourth quarter gross profit percent.

If increase decreased more than we are currently projecting, the LIFO layer liquidation benefit will increase and result in a higher than expected gross profit percentage.

Correspondingly, if inventories end up at a higher level than our projection, the LIFO layer liquidation benefit will decrease and our gross profit for the quarter will be less than expected.

Excuse me.

Our selling, distribution and administrative expenses for the quarter increased from the prior year in absolute dollars by $2.1 million or 2.1%.

This is primarily due to expenses directly related to improved sales levels and increases in other performance-driven expenses.

Our SD&A expenses improved 70 basis points compared to the second quarter.

We expect our go-forward SD&A expense daily rate to remain relatively consistent throughout the fourth quarter.

Our operating margin was 5.6%, an improvement over the 4.2% rate in our second quarter and the 4.7% compared to the prior year third quarter.

The improved leverage of increased sales, as well as the positive impact from the quarterly increase in our LIFO layer liquidation benefit, were the primary reasons for our operating margin improvements in comparison to the last quarter.

Our effective tax rate for the quarter was 36.6%.

We expect the overall fiscal 2010 tax rate to be around 36.7%.

Our balance sheet remains strong, with shareholders equity at $532.9 million, and a current ratio of 2.2 to 1.

Our pretax return on assets increased to 12.4% from 8.6% in the prior quarter, and compared to 9.0% in the prior year third quarter.

Our inventories decreased $27.5 million in the quarter, bringing the year-to-date decrease to $80.4 million.

This is consistent with the goals of our fiscal 2010 inventory management program, which is nearing completion.

Additional inventory reductions in the fourth quarter will most likely be less than $10 million.

We previously targeted a full year reduction in the $75 million range as of our second quarter teleconference.

Cash generated from operations continue to show significant improvements and totaled $60.4 million for the quarter and $156 million year-to-date.

This significant cash flow is attributable to our inventory reductions in fiscal 2010.

Cash used for financing activities in the quarter included $2.7 million related to our stock repurchase program.

We resumed our stock buyback program in February, and expect to make continued modest amounts of buybacks into the foreseeable future.

We purchased 117,000 shares of Company stock in open market transactions during the quarter.

Based on previous Board approval, we have authorization to repurchase up to an additional 880,100 shares.

We expect our cash generated from operations for the last quarter of our fiscal year to be less than what we have experienced in our first three quarters as our inventory reduction nears completion.

As discussed in previous conference calls, our supplier purchase incentive rebates for the current year purchases have declined.

Supply rebates flow into the income statement as the inventory is sold to customers.

For the third quarter, our LIFO layer liquidation benefits of $4.8 million exceeded the reduction in supplier rebate benefits.

Year-to-date, there has been a slight positive impact on our gross profit percentage, as we took advantage of the LIFO liquidation benefits that were in excess of lower volume rebate benefits.

Now for some closing comments by Dave Pugh.

Thanks, Mark.

I thought we lost you there for a minute.

No more mints for you during the teleconference.

Hey, thanks, Mark.

Thanks, Ben.

Folks, the last two years has been an extremely difficult struggle for most industrial companies, and we are certainly included.

Even more so for the individuals who work here.

And I would like to take a minute to thank them for their perseverance and loyalty as we have worked our way through a very difficult economy.

I want to express my appreciation for the way they have accepted some of the tough decisions we have had to make.

Throughout it all, they have maintained discipline -- they remained disciplined and dedicated to the task at hand.

They have treated our Company and each other with a lot of dignity and respect.

Overall, our morale has remained high, and good results, as we have shown this quarter, will give that morale even another boost.

We are looking forward to a recovering market that will allow us to provide a greater degree of reward and security to all of our associates going forward.

Again, thanks to all of you who have helped us persevere.

Well, John, with that, we're going to open the line up to questions.

(Operator Instructions).

Our first question comes from Matt Duncan from Stephens, Inc.

Please go ahead.

Good afternoon, guys, and congrats on a good quarter.

Thanks, Matt.

The first question I have got -- and you guys have addressed this in pretty good detail, but I just want to make sure we are clear on this.

On the gross margin, it looks to me like if I back out the impact of LIFO on both the second and third quarters, your gross margin would have been flat.

Is that correct, Mark?

Yes, if you took the incremental increase in the LIFO benefit in the third quarter, which is -- the total was $4.8 million, compared to the $1.8 million, that $3 million difference, if you took that out it would be flat.

Okay.

So I guess it appears as though pricing pressure is not getting anymore difficult, it is just not abating as of yet?

I would say quarter-over-quarter it was flat, but we did see some sequential improvement throughout the quarter.

Okay.

So then maybe things are getting better as we head into fiscal '11.

Okay.

That helps.

Things are firming up on the pricing side.

And then if I hear you guys correctly, it sounds like January -- which started a little slow -- but then February and March things picked up and that has continued into April?

Yes.

Is the rate of growth accelerated?

I think it accelerated through the quarter, and we have maintained a good growth rate in the month of April so far.

Okay.

And then last couple of things here.

First, when you look at your earnings guidance of $1.18 to $1.33, talk a little bit about the delta mark between the high end and the low end of that guidance other than the impact of the range of revenues, but would the high end require that your gross margin be better than the guidance you've given us of down 50 basis points?

Yes.

I think if the LIFO layer liquidation benefit comes out as expected at the $2.5 million in the fourth quarter, which is lower than the $4.8 million, that would have a downward pressure on the earnings.

But it really is a lot of variability as to where inventories are going to end up at June 30th.

We have an opportunity that they might continue to go down more than what we are expecting them to go down, and that would give us maybe another benefit in the fourth quarter similar to what we had in the third quarter on the LIFO, which would then push us up to the topside of our earnings.

If we do have just a standard LIFO layer liquidation benefit as planned, that would push us down more to the middle side or the low end -- so lower end side of the EPS perspective.

I mean, if you want to look at the $0.39 for the quarter of EPS and then carve out that 60 basis point for this incremental LIFO benefit of $3 million, that would get you down to around $0.34 from that on a go-forward basis.

So that is really the platform where we would be looking as to how things are going.

Okay.

That's helpful.

And then obviously once you get into your next fiscal year, you are probably going to start accruing for rebates at a higher level, so we might see the gross margin improve a little bit in the next year.

Would that be fair?

Well, I think that is a question mark; because while the overall rebate percentage will be better next year compared to this year, whether or not that will have an overall positive impact on the gross profit percentage remains to be seen.

And I also do believe that we may have some challenges in the first two quarters of next year, because when we do the purchases of inventory at these higher rates, that can only get to the income statement once we sell the product.

So we may have a little bit of delayed implementation until we get back to a steady state gross profit percentage.

Okay.

That's helpful.

And then the last thing I have got is with regard to acquisitions, you guys are obviously building a pretty nice war chest of cash here.

What is your plan for that cash and what does the acquisition landscape look like right now?

Acquisition landscape is very active.

Stay tuned.

Okay.

Thanks.

All right.

Our next question comes from Adam Uhlman from Cleveland Research.

Please go ahead.

Hi guys, good afternoon.

Hi, Adam.

Just a clarification first from the last question about the sales pace.

I think the guidance for the year implies that sales are going to be up nearly 20% in the fourth quarter.

I am just wondering if that is close to the pace of revenue growth that you are seeing as we enter into the fiscal fourth quarter?

I think that as we are looking at the fourth quarter, I don't have the exact percentages in front of me, Adam.

But we expect our our fourth quarter sales per day run rate to be a little bit better than the third quarter sales run rate.

So yes, we expect that to be the case.

I don't recall if that will be exactly 20%, but it should be a nice percentage.

Yes, it sounds pretty good.

And then, secondly, you guys have been working on some revenue improvement programs over the last several years, and one of them I wanted to ask about was the new SKUs that you are bringing on with (Inaudible).

It's probably still a little early on for revenues to be coming through, but what has been the customer reaction from that so far?

Are you gaining traction with that yet?

Adam, this is Ben.

We have a lot of activity going on in the area of adding additional products to our basket; and I wouldn't say that any one in particular is significant, but everything added up is -- it is showing some nice increases for us.

So in total, product expansion has been a good effort for us, but no particular specific manufacturer has something to stand out.

Okay.

Got it.

And then, Ben, can you talk about the difference in revenue trends that you are seeing amongst your larger customers versus your smaller customers?

Yes, for the quarter -- and we do look at that -- they're very similar; slightly better on the small customer side, but really insignificant.

Great.

Thank you.

Thank you.

Our next question comes from Jeff Hammond from Keybanc Capital Markets.

Please go ahead.

Hi, good afternoon, guys.

Hi, Jeff.

Hey, just -- we are hearing about a lot of price increases from your vendors.

Was there any price in the quarter -- are those -- are you able to pass those along?

And I guess on top of that, is it allowing you to kind of revisit your pricing pressure issues with key customers?

Yes, I don't know if we have a calculated number for the quarter, but it was small.

It would be de minimus.

Yes, and I guess to add a little bit more color to that, if you look at the last three years, the price increases that were announced in 2009 and so far in 2010 have been at a much, much slower rate than 2008 and 2007.

2008 was probably the peak of price increases; and if you can think that far back to that time period, we had tremendous activity, and in some areas, we had product shortages and lead times that were extended way out.

So we are not even back to the pace of 2007 and prior.

And I think rightly so; we have -- even though we have a number of suppliers that have not had price increases for 18 months, and some 24 months, our communications to them have been that the market is really not ready for those price increases.

So we think our suppliers are reacting accordingly, and we have had some increase and price increase announcements, but not back to the levels they were prior to the downturn.

Okay.

Thanks a lot.

Thank you.

Our next question comes from Greg Halter from Great Lakes Review.

Please go ahead.

Yes, good afternoon.

Thanks for taking the questions.

Sure, Greg.

I believe last quarter, you had a -- maybe a step forward in your option -- stock option expense.

Can you comment on what that was this quarter?

The increase in the expense last quarter related to options that were provided to our Board of Directors, and those options vest immediately, and we had to expense them all immediately.

So that happened in December.

That was about $400,000 or something.

Traditionally, that option grant has traditionally been made in the month of January, so it is normally in the March quarter.

But it did not happen; it happened the quarter before, and year-to-date, we are in the same place we were in prior years.

But we just had a little flop between the second quarter and the third quarter.

Okay.

All right.

That's helpful.

And do you have the data in terms of the operating income by the two segments, service based and fluid power?

I don't have it with me right here.

All right.

I thought I would ask.

What are your expectations for capital spending for the balance of this year, and any early indication for fiscal '11?

For the remainder part of this year, I think we will spend a little more than what we have averaged over the first three quarters.

I think we spent about $4.2 million so far.

I would expect that we would end up the year probably closer to $7 million or a little over $7 million for the full year.

As far as next year is concerned, we are in the process -- the beginning process -- of our annual budgeting exercise.

As part of that exercise, capital spending is a key part of that.

We, at this point in time, do not have a number for next year.

I will say that our expectation, just like it has been in the last several years, is that the majority of our capital spend has been IT driven, and that has been -- 50% to 75% of our spend has been IT related.

I would expect to see that continue next year.

Okay.

And of the -- I think you said there were a reduction of five locations.

Are those leased or owned?

And is there a possibility of any kind of gain on those?

I don't know the answer to that question.

I have the list of the names, but I don't recall if they're leased or owned.

I do not expect that there would be any significant -- if any of those were owned, I don't expect there to be any significant potential gains.

Okay.

And one last one for clarification.

I think that when you were talking about the SD&A, that you thought the fourth quarter would be consistent with the third quarter.

Was that in dollars, or percent of sales?

Close to percent of sales.

Okay.

Thank you.

Our next question comes from Brent Rakers from Morgan Keegan.

Please go ahead.

Yes, good afternoon.

Just -- I guess along the lines of the branch closing costs first, were there anything unusual cost tied to closing those up in the quarter, Mark?

No.

Okay.

And in terms of -- do you have a year-over-year change in bad debt expense?

And then another housekeeping one, any impact from the gross margin uplift on SG&A in the quarter?

Regarding the bad debt expense, our bad debt expense this year as well as this quarter is running much less than it was a year ago, which we're very happy to see.

I don't have the exact number in front of me, but I believe the combined reduction in bad debt expense as well as preference claim-type expenses from prior bankruptcies is a little over $1 million less this quarter compared to the third quarter last year.

Mark, do you recall what it's running as a percent of revenue by any chance, or--?

It is much closer to our traditional levels of percent of revenues, whereas last year it was much higher than the normal average.

I am thinking it is closer to the .15% of revenue which has historically been our average.

And then, the gross margin -- any impact from that uplift there on SG&A in the quarter?

The overall impact in SG&A regarding our improved results does impact various individual's incentives.

So for our field folks, when they provide more profit on the bottom line, they get some more incentives.

So we did have some additional incentive expense that is included in our third quarter expense that folks earned, whereas in a year ago, obviously we were not earning much incentives at all.

Great.

And then just a last, maybe more general question.

I was hoping you can maybe talk me through some of the compensation trends both kind of incentive comp, maybe salary, wage kind of cost of living increases and how that typically works with Applied, whether it is kind of a calendar year based program or whether it would be something that might reset on a fiscal year program?

Yes, I will chat about that.

First off, as of now regarding wage increases, we are still finishing up our wage freeze.

So we have not had wage increases for any of our associates basically over the past 12 months.

Through June 30th, that wage freeze will continue.

We are considering lifting the wage freeze as of July 1st, and so at that point in time they would -- wage increases would start.

We have not officially made that decision.

But if it is -- if we do make that decision, they would then happen ratably throughout the year, so it would not be everybody getting them in one fell swoop.

So there would be a gradual increase, because the traditional way we do wage increases is on individuals' anniversary date, so when they start, so it is ratably throughout the year.

And then, Mark, maybe related to that for bonus comp and other kind of executive incentive comp, is that done kind of on a cash basis within the individual quarters, or is that done kind of on an annual basis?

Well, for the executives and many of the other field leadership that we have out there, it's an annual program for the short-term incentive program.

As we go down through the ranks, we have some programs -- let's say for our outside sales reps, they get paid monthly their incentive.

And we do have some folks that are on a quarterly incentive plan throughout the organization.

But for like our plan for the officers, it is once a year.

Great.

Thank you very much.

Our next question comes from Holden Lewis from BB&T Capital Markets.

Please go ahead.

Thank you.

Are you all able to hear me?

Yes, Holden.

Okay.

Great.

Thanks.

Just unclear on some of these gross margin relationships.

I think you in terms of the LIFO versus rebate, you indicated -- did I hear you correctly that you indicated that the rebates -- the increase -- I am sorry, the increase due to LIFO in gross margin slightly outstripped the decrease that would have existed or that did exist from the lower rebates?

That's correct.

And if you recall, in the first two quarters we basically said the LIFO benefit and the reduction in rebates that are were flowing into the income statement basically perfectly offset each other, whereas in this quarter we got a higher LIFO benefit than the reduction in rebates.

Okay, so through the first three quarters, the LIFO is at about 140 basis points, and so it is reasonable to sort of look at rebates as maybe deducting 100 basis points, or something along those lines is kind of what meant to suggest; right?

Yes.

I don't have those exact basis point number calculations in front of me, but the concept you are discussing would be correct.

Got it.

Okay.

And then taking this pricing question in a little different angle, in terms of the price cost relationship over the course of the year and in the quarter, how has that worked out?

Obviously, for a long time materials were coming down; you might have negotiations that fix things for a period of time.

I mean, how has the price cost relationship worked out?

Has that been a net positive, a net negative this year?

Holden, I am not exactly sure what you are driving on your question, because when we are purchasing finished products from our manufacturers, it's based upon their published price lists that they have.

Within the past year, there's been very, very few of them that have had price increases, so they have been relatively stable for the past 12 months or so -- 12 to 15 months.

But -- and while we have seen some manufacturers start talking about the possibility to having a price increase, it is still relatively few of them right now.

Yes.

Well, and I guess -- so what you are suggesting is that the cost side has been relatively flat?

It hasn't gone up and hasn't gone down?

Yes.

And then so on the pricing side, though, that has been somewhat negative; right?

So --

Yes, from the margin perspective with our selling price to our customers, we have seen lots of pricing pressure throughout the past year.

Okay, and in terms of order of magnitude -- so if you had 27% gross margin in 2009, and let's say that the sort of LIFO rebate relationship was good for a positive 40 basis points -- it is a ball park number maybe, but nonetheless -- and if this year you are going to finish up around 26.4, 26.5, I mean, would that suggest about 70, 80, 90 basis points of gross margin pressure from that price cost relationship?

Is that sort of the right order of magnitude to be thinking of it in terms of?

I think that's reasonable.

I don't have the numbers in front of me, but I think that's a reasonable perspective.

Okay.

And this 26.4, 26.5 for the full year gross margin, that represents a new base, and next year, there's probably no LIFO because you're adding inventory, so it's just rebates will sort of push that up, and then hopefully you are seeing some pricing power come in, so hopefully both of those will elements will be up in 2011.

Is that a reasonable assumptions, or is there something else in the mix that we should be thinking about that could cause -- offset those two positives or maybe make those two positives not so positive?

I think it remains to be seen as to -- fiscal 2011 as to where the gross profit percentage will end up.

If the rebate benefit comes in lighter than what we have been used to getting into 2009 and before, then the GP percent will come down on an overall basis.

And if it goes up, it would go up.

I don't think we are far enough along with our major suppliers in our discussions to be able to determine where that exactly going to flush out.

But I think there's just as much concern of it potentially still going down a bit.

Okay.

And just a little housekeeping, how many days are in fourth quarter this year versus last year?

We have the exact same.

We have 63.5 days.

Okay.

Great.

Thank you, gentlemen.

Thank you, Holden.

Our next question comes from Adam Uhlman from Cleveland Research.

Please go ahead.

Hi, guys.

Not to beat a dead horse on the gross margin question, but Mark, you had indicated earlier that the first half of fiscal '11 could be softer, and what I am wondering is, is that because rebates from a supplier might be on a calendar year basis, and so you wouldn't benefit in the September and December quarters?

No.

It really depends upon -- well, let me start over.

We accrue the rebates based upon when we purchase the products from the manufacturers, and then we apply the estimated rebate percentage upon that purchase.

So if we -- when we start purchasing products during fiscal '11 and our rate of purchases are at a higher rate than what we have been doing in fiscal 2010 because of our inventory reductions, our expectation is that we will get a higher percentage.

Then that rebate benefit flows to the income statement once that product is sold.

And our inventory turnover has been between three and four turns a year; so on average I have got three to four months of rebate benefits on the balance sheet as a reduction of inventory that then will get sold.

And of course it -- that's the average.

So that is why we are saying the first two quarters we will be getting higher rebate percentage on purchases, but they won't all be going to the income statement immediately.

I hope that helps.

Okay, we can discuss it off line.

And then just a quick one for Ben.

You had mentioned that there is some spot shortages across some products.

I am wondering if you can just talk directionally about what kind of products they would be, what sort of industries would be consuming those products?

Yes, Adam, it's kind of anecdotal comments right now, but just something we wanted to note in the teleconference.

A couple of things going on.

No particular product, no particular industry; but I think everybody has gone through -- many of our suppliers have gone through an inventory destocking themselves, and we are in the phase right now where suppliers are bringing people back to work, increasing capacity.

And on some of the items that are not your standard stock items -- the items for the last 18 months have been in stock.

And even prior to the downturn, they may have been items that had lead times.

So I think the expectations were that everything is in stock, and now we are moving back to a more normal time period, where some of these have lead times and maybe some manufacturers being caught a little bit short with the uptick in the economy.

So I don't think it is a huge worry right now, but maybe for a short period of time we may see some spot shortages.

Great.

Thank you.

Thank you.

Our next question comes from Jeff Hammond from Keybanc Capital.

Please go ahead.

Hey, guys, just as we turn the corner on the economy, apparently you guys have been successful here increasing margins nicely peak to peak, and now trough to trough.

So, I guess, Dave, big picture, as we look at this next upcycle, what are you most focused on to kind of continue to raise the bar cycle to cycle on margins?

Jeff, I don't know that there's any one thing.

And again, we keep that balanced approach, and as you know, the margin is just one of the four things we that we really hammer on constantly.

Continuing to add different products to our business, continuing to have mix in the different segments are going to help us, continuing to manage contracts appropriately -- I mean, every piece of it, and to continue to put good information in the hands of our people who are doing the pricing on a day-to-day basis.

So it is fundamentals.

It's blocking and tackling.

There are no brilliant ideas out there that are going to change the game, it is just watching it day in and day out.

Thanks, guys.

Sure.

Our next question comes from Holden Lewis from BB&T Capital Markets.

Please go ahead.

Thanks.

The debt that's gone current, I assume that some of your past balances you just intend to pay that down when it comes due?

Yes.

And then related to Jeff's question a second ago, this cycle, you do look like you are going to trough out maybe a little bit less than 5%, which would be a very good trough for you guys historically in terms of the operating margin.

In past cycles, have we seen this much contribution from LIFO?

In other words, I mean, is the cycle to cycle trough -- I think in 2002 you were at a 2.1% margin, this time you're at a little less than 5% -- are those comparable numbers, or was the LIFO contribution this time much greater, and so we sort of need to account for that?

How should we look at that in terms of preparing across cycles?

Jeff -- or Holden, I don't recall right now -- I don't have the information in front of me -- but I suspect that when we came out of the last trough that the LIFO benefit was much smaller than what we are seeing today.

And then back in the '90s we had much more inventory reductions in various years and had more LIFO things back in the '90s.

But I think the last trough it would have been smaller, but I would need to look at the 2004/2003 annual reports, because it would be in the disclosures in there to see.

Okay.

In any event, there's no reason -- I mean, even if you adjusted out that accounting item, the 2010 should still come up materially better than the 2001 in terms of -- 2002 in terms of trough; right?

Yes, no doubt.

And Holden, the other thing is that there are two sides to that equation.

This time, we consciously went into this, saying there is going to be an inventory reduction, the LIFO is going to come as a result of it, we are going to forego rebates as a result.

I would have to go back and look at the last trough, whether we had continued to make strategic buys to increase rebates back then.

So it is just a different approach this time than last time.

So even if you take LIFO out, it may have been balanced with rebates before, so--

Got it, okay.

You have to go look at both sides of that.

Okay.

And so then putting just a little perspective on it, and in terms of maybe giving us a little color for what might come through the next cycle, I mean, what were the components or the major pieces in deriving what looks like about a 250 basis point cycle to cycle improvement in the trough?

I mean, to what do you lay that improvement on, and can we sort of take those pieces and assume it is just more of the same that gets you a new trough when the next cycle plays out?

I think -- Holden, I think it is a lot of things.

It is everything we have been working on for the last ten years, and seeing the results of all those efforts.

Some people put a label on it with lean or whatever, but for us it's continuous improvement, that is the label we put on it.

It's what we do every day.

Okay, thank you.

Our next question comes from Matt Duncan from Stephens, Inc.

Please go ahead.

First just a real quick modeling question to make sure I'm clear on this.

Mark, remind us what the impact of price and FX both were on sales?

In the third quarter, there was virtually no impact from pricing.

From foreign currency, we had a 1.7% benefit, so of the 7.6% increase, carve out 1.7% and net that against it.

Okay.

And then last thing, Ben, you mentioned earlier what some of the end markets were that were laggards -- some of the ones related to construction aggregates and cement.

What end markets, if any, seem to be sort of leading the charge back out of this?

There are a number of them right now, and I will mention a few.

Machinery manufacturers -- and again, I am referring to the SIC codes that we follow, the 30 that we follow -- manufacturing and manufacturers is a very large one, it is a very diverse, all-encompassing (inaudible), but it is doing very well.

Primary metals is doing well.

The paper industry is doing well.

Durable goods -- rubber and plastic products, transportation equipment and chemicals.

Okay.

Thank you.

You're welcome.

We have no further questions at this time.

Mr.

Pugh, do you have any closing remarks?

Sure do, John.

Thanks for hosting this.

Folks, again, it was great to have you with us.

It is great to have a good quarter, and it is great to have the sun still shining on the horizon for the next quarter.

So we look forward to coming back next quarter with even better results.

Thanks for being with us.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.