Applied Industrial Technologies Inc (AIT) 2010 Q4 法說會逐字稿

Welcome to the Applied Industrial Technologies, Incorporated fourth quarter and year end earnings call.

My name is Christine and I will be your Operator for today's conference.

At this time, all participants are in a listen only mode.

Later we will conduct a question and answer session.

Please note that this conference is being recorded.

I will now turn the call over to Mr.

Richard Shaw, Vice President of Communications and Learning.

Mr.

Shaw, you may begin.

Thank you Christine and good morning ladies and gentlemen.

We appreciate everyone joining us today for our 2010 fourth-quarter and year end investor conference call.

The earnings release was issued this morning before the market opened and if you have not received it can retrieve it right visiting our website and www.apply.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 you 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.

While for looking statements are based on current expectations regarding risk -- important risk factors including trends in the industrial sector of the economy, the success for our various marketing strategies, and other risk factors identified in Applied's most 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 the 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'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 the details of our financial performance.

Getting this started today is David Pugh.

Thanks, Rick.

It's good to be back.

This 11.00 AM slot seems to work better than the 4.00 PM slot, and it looks like we've got more energy in the room today so we're not all tired.

You've had a chance to look at our release.

We're pleased with the numbers.

Mark's will go over them in detail, but you know, looking back at 2010 it was a year that required a lot of things -- flexibility, adaptability, resourcefulness, nimbleness, speed, you n ame it.

All of which we exhibited to deal with a very volatile market.

If you look at it, we went on a first quarter where sales were down 19.5% year over year to a fourth quarter where sales were up 23% year over year.

In the, in the first half of the year our sales growth initiative kept our situation from being any worse than what was.

And our strong asset management initiatives helped us all year.

Especially so when the fourth quarter, when an unanticipated tailwind kicked in, economic tailwind kicked in, and, and that helped us quite a bit.

Mark's going to give you more details over that, and I'm sure you're going to have a few questions in the area.

Had you asked me in January 2010, I would have never guessed the recovery of that magnitude was in the offing, and in fact, we didn't return to a growth mode until February.

When the market recovery -- while the market recovery in the fourth quarter still left us significantly short of peaks sales on a same-store basis, it was a welcome relief.

And even, even if we concede that our fourth quarter improvement was against relatively weak comparables, the efficiencies shown in the fundamentals are indicative of the streamlining and strengthening that we achieved during the recession.

So I feel really good about the fiscal fitness of our Company.

And this is going to give us further leverage as the markets return.

So all in all, the year turned out well thanks to good sales initiatives as well as strong discipline and controlling expenses and managing the assets.

You know, the asset management efforts generated exceptional LIFO layer liquidation benefits that had that positive impact on our income statement.

You now, we have a ways to go before we return to her peak sales and profitability but we are committed to getting there and exceeding it.

In retrospect for the year I think there are three things that are important.

First, we managed our way through a, a very tough economic environment in the first part of the year.

Doing the right ,things making some tough calls, keeping our associates informed and motivated, and keeping our customer service capabilities intact.

Second, as the market have improved, we have been managing the upward trend in sales with a very close eye on our SD&A rate.

We are still committed to keeping our SD&A growth at about half of the sales growth rate.

And finally, we are actively using our strong balance sheet for growth opportunities, as our two more recent acquisitions demonstrate.

And Ben's going to talk a little bit more about the strategic importance of those additions.

So sans any double-dip in our economy, I feel good about our ability to continue to increase earnings.

Speaking to that, with 2010 successfully behind us, we're looking forward to new challenges in fiscal 2011.

The economy is going to be a challenge.

While the industrial economy in North America has definitely been improving, there is, as Ben Bernanke pointed out, some unusual uncertainty about where it's headed over the next 12 months.

Not all of the news is great.

The housing market, still in the doldrums, doesn't look to be improving.

That impacts many other industries such as the aggregate, the cement, the wood products, the appliance manufacturing.

Unemployment's still high, consumer confidence is low, industrial companies responding to this lackluster consumer demand are somewhat reticent in bringing capacity back online, so it's kind of slow and deliberate there.

But even in the face of these issues, the market is still currently offering opportunities, and we're forecasting good growth performance in 2011 with guidance of $2.05 billion to $2.25 billion in sales.

While the outlook varies by market segment, we are encouraged that manufacturing industries in general continue to do well.

We also feel that were in a position from a cost and resource standpoint to absorb the sales increases without major cost increases.

So on those very positive notes I'm going to turn it over to Ben to talk about the details of the operating performance for the fourth quarter and the year just ended.

Ben, all yours.

Thank you Dave, and good afternoon everyone.

I would like to start off today by up dating everyone on the economic indices that we track.

Industrial production rose 0.1% in June 2010 after having risen 1.3% in May and 0.3% in April.

For the June quarter as a whole, total industrial production increased at an annual rate of 6.6%, down slightly from the March quarter's 7% growth pace.

Manufacturing capacity utilization was down slightly in June at 71.6% after hitting 71.8% in May.

This index was up 5.9 percentage points from its year ago numbers, but still 6.5 percentage points below the average from 1972 through 2009.

Finally, the ISM purchasing managers index decreased in June to 56.2% after hitting 59.7% in May and 60.4% in April.

While this suggests that the manufacturing economy has lost some momentum, it is still an expansionary territory.

Overall, the indices signal that although we are still seeing overall growth, the increases have slowed from the rapid increases we saw in the last 12 months.

Looking at our top 30 industries most of the industries we track have moved into positive growth territory during the quarter, and half of them saw growth of 15% or more.

Government sales improved by more than 20% during the quarter, demonstrating good progress in penetrating at local, state, and federal levels.

For our fourth quarter, SD&A as a percentage of sales was 20.4%, improved from 22.2% in the same quarter last year.

For the full year, SD&A was 21.4%.

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

As we move forward in 2011, we expect to keep our SD&A under control by keeping its growth at, or slightly above, half of our rate of sales growth.

At June 30, 2010, our employee count was 4,468, down 261 from June 20, 2009.

Shortened workweeks reduced our full-time equivalents by another 28.

For the year, we succeeded in reducing our excess inventory to $81.4 million, primarily a reduction of bearing and dry products inventories.

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

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

As I mentioned last quarter, we achieved these reductions without affecting our ability to serve customer needs, and we feel confident that our inventories are now close to being right sized for the current level of business activity.

We have noted a lengthening of lead times on some products as a result of the economy heating up and demand increasing.

While we have seen some spot shortages of product occur, we do not believe that it is a critical issue at this point.

We continue to monitor those situations and are constantly talking with our suppliers about what they are seeing.

I'm pleased to note that we've completed two strategic positions last week.

The first, UZ Engineered Products of Cleveland, is a distributor of high-quality products for maintenance, repair, and operational needs, and is heavily involved in government sales.

This acquisition will help us provide expanded sales coverage and also add some key product groups including fasteners, cutting tools, and shop supplies.

In Canada, we acquired as the SCS Supply Group, headquartered in Toronto.

This acquisition gives us eight service centers in the province of Ontario, and supports our goal of expansion in eastern Canada.

In addition to expanding geographic coverage and expanded product lines, we're adding an experienced group of associates to our Company with these two acquisitions.

And we're very excited about the potential for growth they bring to our Company.

Finally, I would like to give accolades to all of our associates who work so hard during this past year.

Their perseverance and loyalty helped us succeed in a very difficult environment.

And as we start fiscal 2011, we have restored our 401k match, associate merit increases, full profit sharing, and for most of our impacted associates, the return to full work weeks.

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

Thanks Ben.

Good morning everyone.

Let me provide some additional insight for our fourth quarter and fiscal 2010 financial performance.

During the quarter ended June 30, 2010, our sales increased to $523.1 million, or 23% above the prior year fourth quarter.

Our sales per day run rate for the quarter increased to $8.237 million per day, which is a 6.7% increase when compared to the third quarter.

We had 63.5 selling days in both the current and prior year fourth quarter's respectively.

Our product mix during the quarter was 29.3% fluid power products, and 70.7% industrial products.

Overall for the year, our product mix was 28.3% fluid power products and 71.7% industrial products, compared to 26% and 74% in the prior year.

Quarterly sales for our service center based distribution segment increased $67.1 million, or 19.2%, from the same period in the prior year.

Quarterly sales from our fluid power business segment increased $30.8 million or 40.5% 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 in the fourth quarter from our US operations were up $81.8 million, or 22.1%.

Sales from our Canadian operations increased a total of $13.2 million, which included a favorable $9 million foreign currency translation impact.

Excluding the currency impact, their quarterly sales were up 9.5% in Canadian dollars compared to the prior year quarter.

Our Mexican operations increased $3 million, of which approximately $1.2 million is attributable to foreign currency translation.

On an overall basis, positive foreign currency translation increased sales by 2.4% in the quarter.

We merged two locations in the US and one in Canada, resulting in our North American operating facilities decreasing by three to a total of 455 at year-end.

Our gross profit percentage for the quarter was 29.3% as compared to 27.3% in the prior year's quarter.

The current quarter's gross profit was positively impacted 310 basis points, or $16.2 million of LIFO benefits, recorded in the quarter.

As you will recall we have been committed to the elimination of excess inventory specifically focused on our bearing and drives product lines throughout fiscal 2010.

We have discussed the quarterly results in previous calls, and in our third quarter call we had forecasted a total 2010 reduction of $83 million.

At an $83 million reduction level, we would have recorded LIFO benefits in the fourth quarter of about $2.5 million.

Also as mentioned in the last call, we discuss the potential impact of actual inventory reductions above our forecasts and the related additional benefits that would then flow into gross profit and improve our gross profit percentages in the fourth quarter.

We achieved inventory reductions in excess of our third quarter estimates.

Actual US bearings and drives inventories, at current costs, decreased $100 million for the year, which is $17 million greater than what we were estimating at the end of the third quarter.

As we were liquidating base year LIFO layers from the 1970's, the effective income statement benefit for these final inventory reductions was about $0.67 for every dollar of inventory reduced.

The additional $17 million reduction, therefore, generated an additional $11.4 million of LIFO benefits in the quarter.

In addition, during the fourth quarter we recorded benefits for small LIFO liquidations in US inventories of rubber products, fluid power components, and specialty products.

No benefits for these product categories were planned during the year, and accordingly the full LIFO benefit of $2.3 million relating to these liquidations was fully recorded in the fourth quarter.

Therefore, this $16.2 million actual fourth quarter LIFO benefit consists of three components.

One, our original expected LIFO benefit calculated as of March 31, 2010 of $2.5 million.

Two, additional benefits of $11.4 million from additional reductions in US, bearings and drives inventories.

And three, LIFO benefits of $2.3 million for reductions in other US inventories.

For the year, the total LIFO benefits recorded total $23.5 million, which proved an overall benefit in our annual gross profit percent of 1.2%.

These benefits more than offset lower point of sale pricing and the impact of reduced supplier purchasing incentives.

Our selling, distribution, and administrative expenses for the quarter as a percentage of sales declined to 20.4%, although they did increase from the prior year in absolute dollars by $12.2 million, or 12.9%.

This absolute dollar increase is primarily due to expenses directly related to improved sales levels, the reinstatement in the fourth quarter of our traditional profit-sharing payout levels, and increases in other performance driven expenses.

For the year, our SD&A expense, as a percent of sales, were 21.4% and in absolute dollars were $5.2 million, or 1.3% below fiscal 2009.

We expect our full year fiscal 2011 SD&A expense as a percent of sales to decrease slightly from the overall fiscal 2010 rate.

While we will experience improvements as we leverage incremental same-store sales, we also will see some offsets by the reinstatement of merit increases, our 401k match, and the return to full work weeks are our associate base, as well as the relatively higher levels of SD&A associated with our two acquisitions announced last week.

Our operating margin for the fourth quarter was 8.9% compared to the prior year quarter rate before the goodwill impairment charge of 5.2%.

The operating profit for the full year of 5.8% was slightly above the fiscal 2009 rate before the goodwill impairment.

The primary driver of improved operating margin in 2010 was the positive impact from the increase in our LIFO layer liquidation benefits.

Our effective tax rate for the year was 37.2% and we expect the overall fiscal 2011 tax rate to be similar in the 37% to 37.5% range.

Our consolidated balance sheet remains strong.

Shareholders equity as $555 million, up from $508 million at June 30, 2009.

Our strong cash flow from operations was driven by a $81.4 million reduction in inventories from our inventory management program, and lead to an increase in cash of $148 million.

Although our overall DSO's remained relatively stable, improved sales volume, particularly in the second half of the year, increased receivables by $47.6 million.

We provided annual financial guidance for fiscal 2011 in this morning's press release for sales of between $2.05 billion to $2.25 billion with earnings per share of $1.70 to $1.95 per share.

All guidance announced in forward-looking numbers include our two recent acquisitions, UZ Engineered Products and SCS Supply.

We expect approximately $40 million of revenues in fiscal 2011 from these acquisitions.

We are not forecasting any unusual operating or non-operating events, or property sales for fiscal 2011 either.

We expect overall gross profit percentage levels to decline for the year compared to 2010, as the benefits we received in fiscal 2010 through LIFO accounting from inventory reductions are not expected to repeat in fiscal 2011.

This downward pressure on gross profit margins will be somewhat offset by expected improvement in point-of-sale pricing margins and increases in overall supplier purchasing incentives.

In addition, as the supplier purchasing incentives ramp up in fiscal 2011 compared to 2010, we will see more of these initially going onto our balance sheet in Q1 and Q2.

Therefore we expect our gross profit percent in Q1 and Q2 may be slightly lower than our expectations for Q3 and Q4.

From a cash flow perspective, we expect depreciation expense for fiscal 2011 to be around $11.5 million, and for intangible amortization expense to also be around $11.5 million for the year.

Property editions are expected to be in the $8 million to $9.5 million range, consisting of additional IT spend needed to maintain and incrementally improve our current IT platforms and infrastructure.

While not included in our estimated property additions at this time, we are reviewing potential benefits and needs for utilizing a commercial ERP package to run the majority of our businesses.

We want to ensure our technology platforms continue to meet our needs into the future.

We also -- finally, we also expect to continue our modest stock buyback program, and we expect to repay all of our $75 million of outstanding debt in the first half of our fiscal year.

Now for some closing comments by Dave Pugh.

Thanks mark.

A little longer presentation than normal, but it is our year end and we wanted to make sure you were well-informed on the LIFO benefits impact for fiscal 2010.

There's still a lot of opportunity for us.

There's still a lot to be done.

There's still lot of his uncertainty.

So remaining flexible and responsive to the new challenges has been a trademark for us, we expect to continue to deliver good relative performance whatever the market conditions are.

In addition, we are going to remain active on the acquisition quest, as we seek to make use of the good cash flow that we have been generating.

I am sitting here very optimistic about our future.

And with that, I'm sure you have plenty of questions, so I am going to turn it back over to Christine to open up the lines to get started.

(Operator Instructions) The first question comes from Matt Duncan from Stephens Incorporated.

Please go ahead.

Good morning guys, and congrats on a very nice quarter.

Thanks, Matt.

The first question I've got is if you look at the month-to-month sales progression throughout the quarter and into July, did you build sales momentum throughout the quarter?

Or what did that look like if you look at sort of what your sales did month-to-month?

I think -- Matt, this is Ben.

Starting out in the quarter we had a nice jump up from the March quarter and then kind of bounced around during the quarter.

I think we were up a bit in April and May, and it came down slightly in June.

But I think what we're experiencing in July is traditionally some seasonality in the September quarter with the month of July specifically, with traditional plant shut downs and traditional vacation times for manufacturing organizations.

Okay, so then, Mark, would you think September sales may be flat with June then is the right way we need to think about it with the July vacation time for your customers?

Yes, I think that would be a fair way to look at.

I think we will see some normally seasonality in this quarter.

Okay.

If I look at pricing, you talked about this a little bit, but I'm curious to what was the impact of price on revenues in the quarter?

And then, sort of as you look ahead, both in terms of competitive price pressure and supplier price increases, what are you seeing?

And on the supplier price increasing, do you think you can get those passed through in lockset at this point?

Taking a look back at the actual quarter, we did have a couple of suppliers have price increases in the May time frame, but I believe the overall impact of supplier price increases in our quarter was relatively small, it was under 1%.

I don't have the exact number here.

And I'll tag onto that.

But I think going forward we will see more of an impact on the top line from price increases.

We saw, in the June quarter and announced increases for the September quarter, we've seen more price increases in those two quarters than we saw in the previous four.

So going forward we will have, as you stated, we will have a challenge in passing those on.

It's still a very competitive marketplace, we're seeing increased -- price increases -- from our suppliers, we're working with our customers to mitigate the impact on them and the overall, and so it's a challenge.

I wouldn't say that it's gotten any -- from a competitive standpoint -- any better or any worse at this point.

Yes I -- if you look at this, we -- pieces of it, you do see more price increases on the horizon coming from our suppliers.

You're seeing a significant amount of resistance at the end user level as they have done in the past eighteen months in the recessionary period.

And I think that the competitors are acting pretty responsibly in this.

So it's a threefold impact on the pricing front.

Okay, and then sort of sticking along this line of conversation, if I look at gross margin, and I back out the LIFO layer liquidation in the quarter, it was about 26.2%.

Mark, is that a good rate or us to use for the first half of fiscal '11 and then build off of that going forward?

I don't have a specific rate that I can give you, Matt, but I definitely think that the 26.2%, if you go back to our previous conference calls in this fiscal year in the first quarter and second quarter, that was the rate we were talking about as being sort of our core rate, excluding the LIFO situations.

Okay.

And then the last thing I've got and I'll hop back in queue is, if I look at guidance, a of couple things, what -- I guess it sounds like your price assumption is that it will be a -- maybe 1% plus for the year.

What are you assuming in terms of economic growth rate, sort of a volume growth rate, behind the business for the year?

And then, if I remember correctly, you got a $50 million piece of debt you pay back this quarter in September, and then another $25 million that's due in November, so what is your interest expense assumption for the year keeping that in mind?

Regarding the debt payoffs, yes, I mean we will be paying those off when they come due.

We do not have any borrowings in our assumptions after those items are paid off.

While I don't have the exact number in front of me, I think the overall interest expense net of interest income in our plan is, it's under $2 million.

I know that.

Yes.

So it's between $1 million and $2 million, I believe.

Okay.

And then in terms of the revenue guide, sort of what's the economic backdrop you're, you guys are expecting for the year?

I think a number of moving parts here.

And the, I think, MAPI data has, showing industrial production being up 6% in 2010 and then another 6% in 2011.

So that's really the backdrop for our numbers.

If you look at year-over-year, were looking at for fiscal 2011, numbers that are higher than that.

We think we have some good programs going on, and some good opportunity to be above that number.

Sequentially, it's going to be a challenge as we said the September quarter is -- we're going to see some of that seasonal downturn, and then in the remainder of the year, we're expecting to see some increase.

So year-over-year, we'll still have some good numbers, and above the MAPI numbers.

All right, thanks guys.

Thanks Matt.

Thank you.

The next question comes from Jeff Hammond from KeyBanc Capital Markets.

Please go ahead.

Hi, good morning guys.

Hi Jeff.

Just back on gross margins and pricing, so if I look at your gross margin fiscal '06 to '09, you are running 27%, and you kind of bumped down to this core rate of 26%, is that simply pricing pressure plus absence of rebates?

And so, to the extent we get rebates back and we get maybe more rational pricing and a healthier environment, you start to trend back towards in the low 27's?

Obviously our goal is to trend higher with those numbers.

I think the real reason for the decline is really the point of sale pricing pressures that we incurred.

As you recall, for Q1 and Q2 of this current fiscal year, the LIFO benefits, while we look at them in total, they were there and our concept was that they were going to replace the reduction in the supplier purchase incentives for fiscal 2010.

So, that was happening, and of course in Q3 and Q4 we even got more LIFO benefits so they replaced more than that.

But the thought was that, if you look at the gross profit percentage of the, in the 26.2%, if you go back to the old conference call, is that's what were saying is our run rate -- assuming we get a replacement of supplier purchase rebates.

So that's not necessarily the floor, the floor would be below that a little bit.

Okay, and then I think one of the issues on the pricing was things were pretty slow and your customers were price shopping.

As things have gotten busier, has at least that dynamic started to abate?

I would agree it started to abate.

It hasn't improved significantly, the competitive pressures are still there.

So I think we've seen some firming up of our point-of-sale pricing margins and working hard to get them moving in the positive direction.

Jeff, the other thing with that is when we headed into this period.

While the earnings that our customers were down and they were driving for any cost savings they could get, which put extensive pressure in the purchasing arena, there was a lot of inventory available.

While the inventory has been now burned off, and we are starting to see the first signs of maybe more demand than supply, it -- that could be a positive impact on moving the prices back up a little bit.

Okay, and then, Mark, you talked about temporary costs coming back, 401k, merit raises.

Is there any way to quantify fiscal '11 versus fiscal '10 and how much of a drag that's going to be?

I believe it'll be around $8 million to $10 million in total.

Okay, and that hits the SG&A line?

Correct.

Okay, great.

That's all I have.

Thanks.

Thanks, Jeff.

The next question comes from Joe Mondillo from Sidoti and Company.

Please go ahead.

Good morning guys.

Hi Joe.

Wondering what, with the guidance that you provided, what kind of inventory levels you're expecting throughout the year compared to the year end here?

Yes, Joe I think throughout the year we should have some relatively stable inventory levels.

We believe there still is some excess inventory within our system that we're continuing to work to reduce and get rid of.

That would be a downward pressure in inventories.

But we also have the offsetting of what I call an increasing pressure in inventories by the additional volume that we're selling, so we expect both those pressures to somewhat offset throughout the year so that by June of 2011, we think our inventories will be relatively close to where they are today.

And of course I say that with the -- we will be adding the inventories for the two acquisitions that we just did.

So that'll be a layer on, and we'll announce that in the September quarter, of course.

But if you just look at the same-store inventories, it should be relatively flat.

Okay, so given a flat to maybe slightly up inventory level, should we see a reversal in that LIFO benefit to an expense?

Or how -- ?

The LIFO accounting will be determined based on the supplier price increases during the year, and if the suppliers have multiple, or hefty price increases, the LIFO expense somewhat mirrors those impacts for that.

Okay.

But we don't expect the LIFO to have a negative drag on GP percent, if you look at it historically, because we've always had LIFO expense historically in our financial statements.

Okay.

And in terms of your conversations with your suppliers, and in the terms of those rebates, how have those conversations gone in terms of trying to get back those rebates?

Well, Joe, it's been a challenge.

We've had a couple of very odd years with the downturn and now the pickup.

We will have higher purchase rebates in 2011 than we had 2010, but getting back to the levels we had prior to the downturn is going to be a challenge.

Okay.

And I guess, last question I have is, have you guys started to hire yet, or how has that looked?

In the overall I would say no, but in specific locations where we've seen pockets of strength, we have added back, or increased our headcount.

But in the overall I believe we're still flat to down.

That's correct.

If you look at the March quarter and numbers of total associates compared to June, we're down.

And I think we're down about a little over 30 associates still.

So.

Okay great.

Thanks a lot guys.

Thanks Joe.

The next question comes from Brent Rakers from Morgan Keegan.

Please go ahead.

Yes.

Good morning.

Just to follow on that last question talking about headcount.

Could you give us a sense based on -- if the year progresses the way you guys think in terms of the macro side, any sense on where headcount would end up at the end of the fiscal year?

Yes, we -- I don't have the numbers in front of me, but we will not be adding -- it'll be relatively flat for the sales increase we have.

We definitely have capacity out there right now to come up with the sales increase that we -- the guidance we've given without adding headcount.

Great.

And then I think earlier on you talked about -- I think Mark estimated this $8 million to $10 million in compensation that would come back fiscal '11 versus fiscal '10, can you maybe take us through it?

Is that a $2 million to $2.5 million quarter right from the first quarter?

Or does that gradually accelerate over the course of the year?

I believe it should be pretty equal throughout the year, Brent.

It shouldn't spike up at all.

Okay.

A couple more questions.

One more housekeeping first, in terms of the assumptions for 2011 in the guidance, anything in there, any more projected LIFO layer liquidations in the assumptions for 2011?

We do not have anything built into that right now.

Okay, and then just last question, I guess just more of a strategic one.

Ben and Dave, I was hoping you'd spend a little bit more time talking about the UZ acquisition in particular in terms of strategy and integration with the Company as a whole, and kind of what the future plans are upon building upon that?

Yes, I'll take that one.

We are very excited about the UZ acquisition.

It's a great fit for the Company, from two, really two parts.

And I guess, really I'll add a third one on too, a very important one.

First part being, the focus on the government.

It fits in very well with our strategy to continue to grow our government business, and I'd say 80% of UZ's businesses is with government entities.

From a product standpoint, they do have some products and services that they offer that we do not have, and really gets us a good entree into some customers.

And, then longer-term, developing the synergies with the products we have that they don't, and vice versa, and some of the cross-selling, we see some good upside potential.

And then lastly, and most importantly, is the associates.

With the associates they have, and the experience they have, the field coverage, it's just a tremendous fit for us.

Ben, not to push this too far, but it does seem like a departure -- and I'm just trying to get a better assessment if you feel it's a niche within the overall kind of corporate plans, or if there's any kind of future plans on kind of a directional change with this deal.

Well, if you mean a directional change organic versus buying, that would obviously be a change.

But we believe it's a good fit, and for us to build what UZ has already, to build that organically would be a tremendous undertaking.

So we believe that it's a, it's an excellent fit for us and doing it through acquisition is the quickest way to get there.

Okay.

Great.

Thank you.

Thank you.

The next question comes from Jason Rodgers from the Great Lakes Review.

Please go ahead.

Hi.

Just a follow up on the last question on the government space, where did sales to that area end up for the year, and do you have a goal in mind for fiscal 2011?

I don't have the numbers in front of me.

We do have growth built into the numbers for both acquisitions, I don't have the numbers in front of me, but I know that in the -- in Mark's opening comments we have $40 million between the two acquisitions.

And we have good, healthy growth built into the budget for both acquisitions.

Okay thank you.

Thank you.

Next question comes from Jeff Hammond from Keybanc Capital Markets.

Please go ahead.

Dave, you made the comment, you're trying to keep the clamp on the SD&A costs, and you know grow it at half the rate of sales.

Do you think you can still do that with the temporary costs coming back?

Yes I do.

Like Ben said, with regard to what we think is excess capacity sitting out there right now, because when the markets -- when the sales went down as they did, there was no way we could cut costs at the same rate the sales went down.

We had excess capacity sitting there to absorb the first wave of sales increase.

So, Ben mentioned, we -- with what's forecast for the sales increase this coming year, we had very little headcount addition.

And we have -- at the detailed level, we have that built into the budget.

We have the -- all the addbacks, the benefit addbacks, built in and we're very confident in that approach.

I'll just throw one clarifier in there because the SD&A for the acquisitions for UZ and SCS, those come on without this --

Half, yes, one half.

-- beneficial ratio of same-store things.

Yes, of course.

Just, in terms of -- Mark, maybe help us out a little bit, and I know you didn't give specific guidance on gross margin, but any sense of first half versus second half?

How much of a bump should we expect in the second half as we get some of these volume rebates maybe better pricing environment?

From a gross profit percentage?

Yes.

I guess the way I look at it is, that in Q1 and Q2 the supplier incentives are going to -- some of those are going to go to the balance sheet as opposed to the income statement, but by the end of Q2 into Q3 we'll hit sort of a steady state and that'll flow through.

And our expectation is that our gross profit percentage in the second half of the year -- I don't have a difference between the second half and the first half that I can give you, but I think it -- that's going to be our run rate, basically.

And the -- starting in the second half of the year, it'll be a step down from the actual GP percent for fiscal 2010, but it won't be a full step down to the 26.2%.

I think we'll be somewhere in between there.

Okay perfect.

And then, just a follow on the acquisition comment, and maybe change direction.

You mentioned some new product offerings -- fasteners, cutting tools.

I mean, one, is there any opportunity to kind of move that into any of the other branches outside of this acquisition?

Or does this signal maybe a greater focus on broadening the product portfolio into those type of markets?

Yes, Jeff, it is -- there's definitely an opportunity there.

We're going to be careful, we're going to take a very measured approach to make sure that we don't get too far away from our core, we need to make sure that we're expanded product -wise appropriately and handling it from a channeled perspective appropriately.

But tremendous opportunity in the synergies and the cross-selling between the two companies.

Okay great.

Thanks guys.

(Operator Instructions) Brent Rakers from Morgan Keegan is on line.

Please go ahead.

Yes.

Just a, I guess, a follow up again on the line of questioning I think that was just asked and maybe mine earlier related to UZ as well.

What are the plans in terms of locating inventory within -- dispersing it amongst DCs versus branches in terms kind of the non-traditional, non-bearing PT fluid power kind of inventory within the system?

If you're talking about the new products from UZ, we don't have any firm plans right now on how we're going to integrate that into the overall applied, and said we're going to take a measured approach there.

Right now I think our product management supply chain group does a great job of positioning the inventory correctly for the marketplace, and we'll take a similar approach with the UZ product.

Yes, Brent, on the UZ piece, they are doing that very well today from their central location here.

We appreciate the way they're doing it to the extent that their folks and our logistics folks can get together and look at some sort of a blended process that would improve things.

We have that in the cards as a potential upside to this.

Dave, do you have kind of a, I guess for both acquisitions, any kind of accretion target in terms of the 2011 guidance from these two deals?

Brett, we believe that they'll be slightly accretive from the get-go.

Okay.

Great.

Thank you.

I guess I'll jump in here and make a statement also.

We've talked a lot about UZ, we've talked very little about SCS, and I was hoping we'd get a question on SCS, so I'd like to make a few comments.

From a strategic standpoint, Eastern Canada has been one of the larger geographic holes we've had in our North American strategy, and the SCS acquisition and the eight locations in the province of Ontario, are really our first entree into Ontario, which is the largest economy in Canada.

So, we believe that we have tremendous synergies there also, and again to build that as organically as opposed to buying into the market, this is a great start and we plan to continue to invest in Eastern Canada.

Our, operations in Canada up to this point have been very heavily weighted towards natural resources, and being in Ontario will give us a great footprint into the largest, more manufacturing, economy in Canada.

So we have some great expectations there, and a great group of folks up there also.

Yes, great point, Ben.

I mean, I couldn't be more pleased with the strategic fit of both of these acquisitions with regard to where we're going and almost an immediate integration.

So I really feel good about this.

The next question comes from Jason Rodgers from the Great Lakes Review.

Please go ahead.

Thanks for taking the follow up.

Just looking at some other geographic areas, I was wondering what the future plans, if any, are for the Asian economies?

Jason, Asia presents quite a few challenges.

We continue to have that on our radar screen.

We -- there's very few meetings we have with our suppliers where this does not come up as a subject of conversation.

There's not a steady stream of North American model companies beating a path over there right now because it's fairly well out of the comfort zone with regard to having a really good pathway to success.

So while it's on our radar screen, there's nothing in the immediate future for that.

Okay.

And, Mark, do you have the breakdown by industry for the year?

Or is it too early to have those figures?

I do not have those right now.

So, but we'll be having that information shortly and be able to publish that.

Okay thank you.

Gentlemen, at this time, that concludes the question and answer session.

Please go ahead with any final comments.

Great Christine.

Thank you very much, and I really want to thank all of you for being with us.

We were very pleased with our year, especially the fourth quarter.

We want to springboard off of that to a very successful 2011.

And we will keep you informed quarterly as this thing progresses.

Thanks for joining us, thanks for your questions.

We'll see you next quarter.

Thank you for participating in the Applied Industrial Technologies fourth quarter and year end earnings conference.

This concludes your conference for today.

You may all disconnect at this time.