Applied Industrial Technologies Inc (AIT) 2012 Q3 法說會逐字稿

Welcome to the fiscal 2012 third quarter earnings call for Applied Industrial Technologies, Inc. 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 today's conference is being recorded. I will now turn the call over to Julie Kho. You may begin.

Thank you, Christine, and good afternoon, everyone. On behalf of Applied Industrial Technologies, thank you for joining us on our fiscal 2012 third quarter investor conference call. Our earnings release was issued this morning before the market opened. If you haven't received it, you can retrieve it from our website at Applied.com. A replay of today's broadcast will be available for the next two weeks as noted in the press release.

Before we begin, I would like to remind everyone that we will discuss Applied's business outlook during the conference call and make statements that are considered 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 reports 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 to the general public as well as to analysts and investors. Because the teleconference and its webcast are 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 Neil Schrimsher, Chief Executive Officer of Applied, who will provide an overview of 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, who will discuss our financial performance in detail.

At this time, I will turn it over to Neil Schrimsher.

Thank you, Julie, and thanks to all of you for joining us today.

Our release this morning shows our sales for the quarter were $605.5 million, up 7% over the prior-year quarter. Earnings per share for the quarter increased 13.1%, to $0.69 per share, or $29.4 million, compared to the prior-year third quarter. Our solid business performance in the third quarter demonstrates our ongoing operating discipline and our focus on operational excellence. We effectively translated sales gains into good profit contribution while continuing our asset management execution and strong cash generation. As we finalize our long-range strategic plans, we are encouraged by our organic growth opportunities and acquisition potential to generate profitable growth and to increase shareholder value.

On the acquisition front, we're pleased to announce our acquisition of two Quebec distributors this quarter, part of our continuing strategy to expand in Eastern Canada. And yesterday, we announced another exciting growth opportunity with the definitive agreement to acquire the distribution business of SKF in Australia and New Zealand. Now, SKF is one of the largest bearing suppliers in the Australia and New Zealand markets, providing an excellent foundation for growth.

Both geographies offer attractive markets, growing economies, and many common global customers. The businesses provide broad geographic coverage of Australia and New Zealand with 37 branch locations and strong positions in targeted vertical markets, including mining, steel, pulp and paper, and others.

We see significant growth prospects through the addition of complimentary product lines and solutions. And furthermore, the SKF distribution business is an excellent fit especially considering our operational and cultural similarities along with the shared commitment to providing value-added solutions to our customers. Our relationship with SKF dates back really to the origins of our Company nearly 90 years ago. The businesses are well-positioned, and we are confident about an effective, seamless transition, and the acquisition will be accretive to earnings during the first 12 months.

So, based on our performance to date, and the active industrial economic environment, we are maintaining our full fiscal 2012 sales guidance of $2.35 billion to $2.45 billion, and we're narrowing our earnings per share guidance to between $2.45 and $2.55 per share.

I will now turn it over to Ben to talk about the details of our operating performance for the quarter.

Thanks, Neil.

Let me begin by providing an overview of the industrial market. The indices we track showed continual growth in the industrial economy during the third quarter of fiscal 2012. In the March quarter, industrial production rose at an annual rate of 5.4%. Manufacturing capacity utilization for March was 77.8, up from the December 2011 reading of 76.7. The ISM Purchasing Managers' Index averaged 53.3 in the March quarter, a modest improvement from 52.4 in the December quarter, and holding above the expansionary threshold of 50.

In addition to these economic indicators, our discussions with suppliers and customers are positive and are in line with the general consensus calling for continued economic growth in 2012. Overall, we continue to see positive trends across the industrial markets and within our customer base that support our growth estimates for the remainder of the fiscal year.

From an operations standpoint, we're pleased with our third quarter gross profit of 27.7%. Our SG&A as a percent of sales for the quarter was 20.7% as compared to 20.9% in the same quarter last year. Of special note, we achieved a return on assets of 12.8% for the quarter as compared to 12.4% last year, an indication of strong operational efficiencies.

We continue to prepare for our next ERP deployment, which will take place at a group of service centers in Canada before our fiscal year-end. This is our second deployment and completes our build-out in Western Canada. Dedicated teams are involved in detailed readiness activities ahead of the upcoming launch. In addition, we have teams that are busy preparing for our first US deployment which is slated to take place before the end of this calendar year.

We will continue to implement our plan with a phased rollout for all locations. I would like to recognize our entire team, our associates working directly on the project, and our associates working in the business units, for their dedication to building and implementing the new system.

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

Thanks, Ben. Good afternoon, everyone.

Let me provide some additional insight regarding our third quarter fiscal 2012 financial performance. Our sales per day during the quarter was $9.5 million, or 7% above prior-year quarter with the same number of selling days in both the March 2012 and 2011 quarters. Of the total quarterly sales increase, acquisitions contributed 0.5%, and we believe the impact of vendor price increases was between 1% and 2%. Unfavorable currency fluctuations during the quarter reduced sales by 0.4%.

Our product mix during the quarter was 28.9% fluid power products and 71.1% industrial products. Third quarter sales in our service center-based distribution segment increased $34.8 million, or 7.7%, and sales in our fluid power businesses segment increased $4.7 million, or 4.1%, from the same periods in the prior year.

From a geographic perspective, sales in the third quarter from our US operations were up $35.1 million, or 7.2%. Sales from our Canadian operations increased $1.6 million, or 2.5%. Unfavorable currency fluctuations depressed this increase by 1.4%. Our Mexican operations sales increased $2.8 million, or 19.3%, despite an unfavorable foreign currency translation of $1.6 million.

Our gross profit percentage for the quarter was 27.7%. This was consistent with the prior-year's quarter and 30 basis points above our second quarter rate. While stable compared to the prior year, our gross profit margin experienced positive impacts as a result of higher supplier purchasing incentives, offset by LIFO benefits recognized in the prior-year quarter that did not recur in the current year. Our selling, distribution, and administrative expenses as a percentage of sales was 20.7% for the quarter and 20 basis points below the prior-year third quarter rate.

[SG&A] expense has increased from the prior year in absolute dollars by $7.2 million, or 6.1%, compared to a sales increase of 7%. Our ERP project expense included in SG&A was $5.9 million in the third quarter, and $13.9 million year-to-date. Our ERP project expense for the quarter was $2.9 million more than what we expensed in the prior-year quarter.

Total capital expenditures related to ERP for the third quarter were $1.9 million. We are forecasting additional ERP capital expenditures of between $2.5 million and $3.5 million for the remainder of the fiscal year. SG&A expenses pertaining to the ERP project are estimated to be between $5 million and $6 million for the fourth quarter of fiscal 2012.

Our effective tax rate for the quarter of 32.9% was below our guidance for fiscal 2012 due to favorable impacts of certain discrete items recorded in the quarter and lower effective tax rates in our foreign operations. We expect our tax rate for the remainder of fiscal 2012 to be approximately 35.0%, as we expect the impact of lower effective foreign tax rates to continue.

Our consolidated balance sheet remains strong with shareholders' equity of $672.2 million. Inventories increased $7.4 million, or 3.3% in the quarter, of which acquisitions accounted for $2.4 million, or 1.1% of the quarterly increase. Our annual inventory turns remained consistent with last quarter and continued to be at an all-time high. We expect inventories to be relatively stable for the remainder of the fiscal year. Overall receivables increased, while our DSOs decreased slightly in the quarter. We did not purchase any shares of our stock in the open market during the March quarter, and we continue to have Board authorization to buy our stock in the future.

Now, I will turn the call back to Neil for some final comments.

Thanks, Mark.

We are in exciting times at Applied. Closing our fiscal year. Finalizing our strategic plan and building our fiscal 2013 operating plan. We have strong business and excellent opportunities for growth, organically and via acquisitions. I, too, want to thank our 4,600-plus associates for their efforts here to date and for their commitment to serving our customers and generating increased value for our shareholders.

Now, we will open up the lines for questions.

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

Good afternoon.

Hi, Matt.

The first question I've got is just with regards to the trends you were seeing in the business in the quarter. Ben, can you talk a bit about the month to month sales trends that you saw in the quarter? And then, how is April looking so far? Was there any discernible difference between the three months of the quarter?

We had consistent sequential growth throughout the quarter and that has continued into April. So, good growth through the quarter and continue in April.

Are there any end markets, Ben, that stood out as being stronger than others?

A few. I think some of the transportation-related segments and related industries. Mining, some of the segments, we saw some weakness in -- still in the construction-related industries. Showing some signs of growth in the sub-segments of construction-related industries, but those are probably the highlights.

Okay. Shifting gears to the ERP project. You gave us a little bit of an update on the timing of the next go-live there. Remind us how many locations in Canada you have installed that in so far? And, are you learning any lessons so far in the process?

Yes, we've -- 11 locations in western Canada, and we've learned a number of lessons. And, we have made a whole range of improvements for our next go-live and the project is progressing very well.

Okay. Mark, I think last call you said that --.

As I review it with the teams -- business metrics, user productivity, all continue to go the right way. We're getting ready for the next wave of deployments in western Canada which will bring really, in essence, bring all of our western Canadian locations on. So, we're moving forward there. I am encouraged.

Okay. From a cost perspective, Mark, I think last call, you told us it was angling probably over the life of the project towards the high end of the $70 million to $75 million range you had given us. Is that still where you expect it to be?

Yes, that -- from an overall perspective, that is what we expect total spend.

Okay. And, the last thing I've got, and I will hop back in the queue. Neil, I know you're still trying to put the finishing touches on the strategic plan, but if there are any things that you can share with us today about what some of the pillars of that plan might be, we'd appreciate it.

I don't know that we would go into a ton of details. I will say -- obviously, we had the Board sessions today and had great reviews with our Board, really a constructive, productive sessions. Approvement of our directions on our strategic plan. Actions that we want to take around organic growth, around some product expansion. Good review of vertical markets that we're going to look to strengthen and participate in. And, the discussion and review of some of our acquisition activity that we've had, and a little bit of discussion on the pipeline. So, hey, for us on the business side, a really productive day with our Board.

Okay, thanks.

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

Good afternoon.

Hey, Jeff.

Hey, Neil, sticking on the growth initiatives. As I look at your growth rates over the last four or five quarters versus your larger competitor in the value-added distribution space, they've been considerably lower. I just wanted to -- when you benchmark -- how are you thinking about your growth rates versus motion and where there might be disparity and where maybe some of those targeted markets fit into catch that up? Or, accelerate the growth rate?

Sure. I would say, one, we would probably do a little bit more benchmarking, looking market back at the opportunity. I think the -- it has been kind of laid out. The industrial economic environment is good. We have been, and we will continue to grow a multiple of that. I think we've got some shared beliefs that we can sell more than our current products in existing geographies. That is going to help us generate growth that we can grow organically in vertical markets that we're doing well in today. Perhaps expanding some products and solutions that we offer to those customers and perhaps doing a little bit better in some of the other targeted vertical markets.

I'm impressed with our teams. Our tools. The capabilities that we have, and that we will translate those into results. It is powerful to pour added sales into the model and the impact that it generates on the bottom line.

Okay. Great. You mentioned the SKF deal. Can you just speak more big picture? Is this a kind of opportunistic, one-off, in a good market that makes sense with a good customer? Or, does this open the door to -- hey, we're broadening our scope, in terms of international strategy? How should we -- as analysts, should we be thinking about the international strategy as it relates to maybe this first purchase?

I think one, just talking about this one, we're very excited about it. For a lot of reasons that you pointed out. Attractive markets. Verticals that we participate in. The addition of complimentary products. A good vendor partner as we go into this one. So, it is just a great logical expansion.

And then the other, as we look at this, we have continued good growth opportunities in North America. We've been executing a plan in Canada. We think we have similar opportunities in North America, Mexico, and Latin America. And, we are open to the evaluation of the others. But with that, we have good opportunities in the markets that we are in today. This is a good addition, and I believe we have the capability to do more.

Okay, great. And then just finally, you kind of narrowed the earnings range. You have still a pretty broad range for revenues with one quarter left. Can you maybe narrow that in, in terms of maybe tightening that range, or giving us a sense of, as you trend into the fourth quarter, how should we be thinking about organic growth? In a band?

I will just jump in there, Jeff. We do expect to see sequential growth in our sales as we close out our fiscal year, just like what Ben was talking about earlier in the call where we saw growth January, February, March and continued growth in April. We're expecting growth in April, May, and June as we close out the year. We believe that the sales guidance that we gave at -- which we're still having in the press release at the beginning of the year. We're going to fall in that range.

Okay. Thanks.

(Operator Instructions) The next question comes from Adam Uhlman from Cleveland Research. Please go ahead.

Hi, Adam.

Hi. Good morning. I was wondering if you could give a little bit more color on the sales trends that you're seeing by customer size? The larger customers versus the smaller ones?

Adam, we look at it in a number of different ways, and if we look at our contractual business -- our contractual business is growing very well and above the average for the total business. But depending on how we parse the date, it's very strong across all sizes and segments of customers looking at it by sales volume. But, our contractual business is going very well.

I'd just say, it seems like there is good contribution in kind of all range of customers as we look across. Manufacturing is still healthy in the economy. With the production up, in the first quarter, the 5%-plus. We look at the history, right, 10 of the last 12 months up. 21 of the last 24 up. So, I think it is good environment. On the capacity utilization side, 8 of those 15 segments being at or near peak is healthy for us. That is either driving capital reinvestment going on in those businesses, perhaps some of the larger customers have more capital to do that. Or, they're just running harder, which is also good for us, on the MRO replacement side.

Okay. Got it. And then, I might have missed it, but the -- if I remember the numbers correctly, the fluid power business was growing a little bit, slightly lower than the branch-based business, and I was wondering if you could address that?

I think part of it -- I will jump in first. Part of it is due to some very strong numbers in the prior-year quarter. So, tougher comparables on that side. But, we have many different segments of the business, and some of the segments are doing better than others. But overall, I would say it is more of a comparable, strong comparables in the prior year.

Okay. Got it. Great. Thanks very much.

The next question comes from John [Tuangtang] from [CGS] Securities. Please go ahead.

Hi. Thanks for taking my question. Going back to the SKF acquisition, you previously said that you would like to acquire guys in the 6.5 EBITDA range? Or, something higher for a transformational one. I am assuming this is more on the transformational side, and please correct me if I'm wrong. Can you also talk about the strategy there going forward? Are you going to be more doing the tuck-in or transformational acquisitions? I've got a follow-up after that.

John, we're looking at all kinds of acquisitions that are available to us. When we look out across, I guess across the world when you look at the one for Australia, I think our views and philosophies and the ranges of multiples that we'll pay are similar. You have a range of multiples on whether or not it is going to be a core acquisition, a strategic acquisition, or a tuck-in, and it runs the gamut. Obviously, this is a new market for us, in Australia, and so those multiples generally are a little bit higher than the traditional multiple of an in-market acquisition. But, we feel that we got -- well, we're still working on this, because the projected close is near the end of our fiscal year. At a fair price for all parties.

Got it. Thanks. My follow-up is on Amazon. Can you talk about their entry into the distribution business and how that might or might not affect you?

I would say from our side, we're focused on our customers and delivering value. The value-added products, and the products and services, and really, an ongoing productivity for these customers. We sell technical products, offer solutions for complex needs, like power transmission, the [EN] bearings, in-fluid power. As we think about hey, the break-fix world of MRO, customers want geographic presence. They want access in hours, not days. From my perspective, we operate in a big space. It is performing well. We've got a lot of room to grow. And, I like our chances.

Got it. Thank you very much.

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

Good afternoon.

Hi, Joe.

The first question just has to do with the weather. I was wondering if you saw any parts of your business benefit from the warmer temperatures?

I guess we hadn't really spent much time analyzing that, but I would imagine that some of the construction-related activity, industry-wise, was stronger. Maybe hurt a little bit on the utility side. But overall, the pluses and minuses, I don't think it affected us in any large way.

And then, in terms of the -- I believe, correct me if I'm wrong. You said that the mining industry continues to remain strong for you. I was wondering what kind of customers -- what your customers are saying, and if you're worried? Or, are you going to be affected at all by sort of the downturn that we've seen in the US coal markets?

There are a number of sub-segments of the mining industry, coal mining, metals mining, and then some of the nonmetallic mineral mining, and different challenges in each one of those industries. Obviously, the coal mining industry faces some head winds with some of the pressures from natural gas prices. We continue to grow in those markets. It depends on our share in the space. We continue to see good growth opportunities even in the face of some of those head winds.

Okay. And then, in terms of the fluid power business, I was wondering what kind of -- or what's your main end markets that are exposed to that business?

It is a wide range of end markets that we serve. It is a very broad category. Everything from high-tech to mobile equipment to in-plant equipment. So, it covers the full range.

Okay. Lastly, if you could talk about -- I don't know how close you look at it. But, just the regional aspect of your business? What kind of strength and weaknesses are you seeing regionally around the continent?

It is -- nothing really stood out in the quarter as being stronger or weaker across the country.

Okay. Thanks.

The next question is a follow-up from Jeff Hammond from KeyBanc Capital. Please go ahead.

Just a couple finer point questions. On ERP, how should we be thinking about the expense portion of spending into '13 versus '12?

Hey, Jeff, I think we've kind of talked about it before. Mark talked about the planned expense for the fourth quarter and in the third quarter. We're in the process now of building our operating plans for the next fiscal year. Hey, the way I think about it is that our SG&A as a percent of sales is going to be as good, if not better, than our performance today. That will include ERP investments, growth, productivity programs that we will have in the business, and continuous improvement. That is the way I'm looking at it as we start to build this operating plan.

But, it's fair to say there is a step down in the expense portion?

Well, Jeff, we're in the process of looking at the 2013 numbers now, and of course, once the system becomes operational, you have a changeover. So, the expenses become operational. It is not that all of them become operational, but you start depreciating the system for the things that are capitalized and they start flowing through expense. And then, the amounts that you pay the software companies for their maintenance fees, once the system is operational, those maintenance fees will run through what we would just call core operations as opposed to going through the project for the build which is what they're doing now. So, there will be a shift from one to the other. And, at this point in time, we don't have that all identified because we're going through the budget process right now.

Okay. And then, just on end markets, can you -- how big is the coal piece of your business?

Total mining is about 8% to 9%, I believe. So that is -- and I'm not sure what coal is, as a part of that.

I don't have the numbers in front of me, but Mark is pretty close on the 8% to 9% on total mining.

Okay. And then Ben, you mentioned some markets in construction lifting their head up? Can you just give a little more color there?

Some of the aggregate-related industries, and again, that may be -- it may be weather-related. But, we did see a slight upturn in the aggregate industries.

But no real lift out of res, nonres construction, where we' kind of getting some better macro data points?

The forestry product segment is still struggling, so I would say that would be more the residential.

Okay. Thanks.

The next question comes from Greg Halter from Great Lakes review. Please go ahead.

Good afternoon.

Hey, Greg.

A lot of questions regarding mining and so forth. The other side that seems to be booming is the natural gas and fracking and so forth. What kind of exposure do you have into that type of area?

We do participate. It is a segment for us in those areas that are showing strength. And, we are growing our business in that area and involved in a number of aspects of it. It is an excellent growth opportunity for us.

Any venture on percent of sales?

I don't have the numbers in front of me. It is fragmented. It is reported in a number of different ways. And, even some of the feeder-type industries are reported in different segments. So, tough to aggregate it.

Okay, thanks.

Sure.

There are no further questions at this time. Please go ahead with any final remarks.

All right. Hey, we want to thank everyone for joining us on the call. We appreciate the interest in the business, and we look forward to talking to you in the near future.

Thank you for participating in the Applied Industrial Technologies fiscal 2012 third quarter earnings conference call. This concludes the call for today. You may all disconnect at this time.