Applied Industrial Technologies Inc (AIT) 2013 Q1 法說會逐字稿

Welcome to the fiscal 2013 first-quarter earnings call for Applied Industrial Technologies.

My name is Christine, and I'll 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.

Good afternoon, everyone.

On behalf of Applied Industrial Technologies, thank you for joining us on our fiscal 2013 first-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 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 FG, this teleconference is being made available to the media and 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, our Chief Executive Officer; Ben Mondics, our President and Chief Operating Officer; and Mark Eisele, our Vice President and Chief Financial Officer.

At this time, I'll turn the call over to Neil Schrimsher.

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

As we reported in our news release this morning, our sales for the first quarter were $610.5 million, up 5.3% from the first quarter of fiscal 2012.

Net income for the quarter increased to $29.5 million, or $0.70 per share, compared to $26.4 million, or $0.61 per share in the prior-year quarter.

We continued to deliver solid earnings performance this quarter along with good cost control and a strong balance sheet.

While Ben and Mark will add some additional commentary, our 7.3% operating margin for the quarter reflects the plans we have in place to increase our efficiency, productivity, and profitability.

Our ongoing efforts to build upon our strong capabilities, to expand our value-add, and to generate success with our customers in conjunction with our technology investments, provide the foundation for future growth and increased profitability.

From my perspective, we have three key takeaways.

One, the core business is operating well and with good efficiency.

A 14% increase in earnings per share on 5.3% sales growth indicates good leverage and continued improvement in our productivity, and there's more we can do.

Second, we are actively deploying our strategic plan on all fronts, including leveraging sales capabilities with existing and new customers, expanding our products and solutions offerings, and building on our fluid power strength.

And third, we continue to have strong cash generation and remain debt-free, providing the financial capacity to accelerate our acquisition activity.

And with that, I'm going to turn the call over to Ben for some additional insight on the quarter.

Thanks, Neil.

Let me begin by providing a macroeconomic view of the industrial market.

Industrial production increased 0.4% to 97.0% in September, better than expected after having followed 1.4% in August.

For the third quarter as a whole, industrial production declined at an annual rate of 0.4%.

In the manufacturing sector, output increased 0.2% in September but moved down at an annual rate of 0.9% in the third quarter.

Capacity utilization for manufacturing was unchanged in September at 76.8%, a rate 2 percentage points below its long-run average.

Looking at the ISM Purchasing Managers Index, it rose more than anticipated, increasing from 49.6 to 51.5 for September.

This put the Index above its neutral threshold of 50 for the first time since May, an indication of an improving manufacturing environment.

Comparing this macro view to what we are hearing among our suppliers, the tone is consistent with moderating demand levels.

Looking across our customer base, we see a mixed bag of business activity.

We have many customers that are still very active.

Their business is good.

Their MRO purchases are steady, and they're busy planning capital projects.

And that bodes well for us as we expand on our product and solutions offerings and expand and enhance our local capabilities.

We see the opportunities and the potential that is available to us.

As evidenced by our improved SD&A for the quarter, we are doing a good job of managing our operation to the current pace of business.

As a percent of sales, our SD&A for the quarter was 19.7%, an improvement over last year's 19.9%.

We are maintaining discipline in our cost control, specifically as it relates to our resource planning and to our hiring activity as we invest in growth.

Touching on our ERP project, we continue to implement our phased rollout as planned, and we are pleased with our progress to date.

I spent several days earlier this month visiting the locations in our most recent deployment, and I can tell you that there is a lot of excitement among our teams around the power of the new system.

Its potential is becoming more apparent to us with each implementation, and we can better see the opportunities where it can help improve our business and generate profitable growth into the future.

I will now turn the call over to Mark for details on the quarter's financial results.

Thanks, Ben.

Good afternoon, everyone.

I'll provide some additional insight regarding our first-quarter fiscal 2013 financial performance.

Our sales per day during the quarter was $9.7 million, or 7% above the prior-year quarter, with one less selling day in the September 2012 quarter.

Of the total quarterly sales increase, acquisitions contributed 3.4%, and we believe the impact of vendor price increases was around 1%.

Unfavorable currency fluctuations during the quarter of $5.8 million reduced sales by 1%.

Our product mix during the quarter was 27.9% Fluid Power products and 72.1% Industrial products.

First-quarter sales in our Service Center-based Distribution segment increased $34 million, or 7.3%.

4.2 percentage points of this increase was due to acquisitions.

Sales in our Fluid Power Businesses segment decreased $3 million, or 2.6%, from the same period in the prior year.

From a geographic perspective, sales in the first quarter from our US operations were up $12.1 million, or 2.5%.

Sales from our Canadian operations increased $0.6 million, or 0.9%.

The Canadian increase resulted from $4.7 million of sales from acquisitions, partially offset by a $2.9 million decrease due to foreign currency fluctuations.

Consolidated sales from our other country operations, which include Mexico, Australia, and New Zealand, were $18.2 million above the prior year.

20% of this increase, or $3.7 million, relates to our Mexican operations.

This Mexican improvement consisted of a $6.7 million increase in local currency, partially offset by $3 million of unfavorable currency fluctuations.

Our gross profit percentage for the quarter was 27%, 40 basis points below our prior year's first quarter.

This decrease was due to a combination of slightly lower point of sale gross margin and a lower impact on our income statement in the first quarter from supplier support.

We expect our gross profit percentage to improve for the remainder of the year.

Our selling, distribution, and administrative expenses as a percentage of sales was 19.7% for the quarter, 20 basis points below the prior-year first quarter and 10 basis points below our fourth quarter rate.

SD&A expense has increased in absolute dollars from the prior year by $4.8 million, or 4.1%, compared to a sales increase of 5.3%.

Excluding the impact of acquisitions, our SD&A expenses were 0.8% below the prior year.

ERP spending in fiscal 2013 is in line with our previous estimates.

Our effective tax rate for the quarter was 34.0%, down from our historical averages due to lower effective tax rates in our foreign operations.

We expect our tax rate for the rest of fiscal 2013 to be in the 34.0% to 34.5% range as the impact of lower effective foreign tax rates continue.

Our consolidated balance sheet remains strong, with shareholders' equity of $703.1 million.

Our after-tax return on assets for the quarter increased 12.1%, compared to 11.6% in the same period a year ago.

Inventory has increased in the quarter due primarily to our acquisitions and adding of core power transmission inventories and catalog-related stock to support sales growth initiatives.

Overall, receivables DSO increased slightly although they remain in good shape.

Cash generated from operations was $23.9 million for the quarter, compared with $16.4 million in the prior-year quarter.

Expectations are for fiscal 2013 to continue to be another solid year for generating cash from operations.

We did not purchase any shares of our stock in the open market during the September quarter, and we continue to have Board authorization to buy our stock in the future.

In summary, our first-quarter financial performance provides us with a strong foundation to continue to pursue our business objectives in fiscal 2013.

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

Okay.

Thanks, Mark.

We had a solid quarter and a start to our fiscal year, and we are focused on the full year ahead, delivering value-added solutions to our customers, driving our strategic plan, and deploying our new ERP system.

While we are not immune to the macroeconomic industrial environment, we remain confident in our ability to execute our strategic plan for growth and increased profitability -- organically, via acquisition, and through our technology investments.

Accordingly, we are maintaining our full-year fiscal 2013 earnings per share guidance of $2.90 to $3.05, while adjusting our revenue growth expectations to 6% to 10%.

We have a strong foundation and expanding capabilities, and we are committed to serving our customers and to increasing shareholder value.

So, with that, we will open up the lines for questions.

(Operator Instructions)

The first question comes from Matt Duncan from Stephens Incorporated.

Please go ahead, sir.

Good afternoon.

Hi, Matt.

First question I've got may be for you, Ben, if you could talk a little bit about the month-to-month sales trend in terms of growth rates month-to-month?

What have you seen so far in October?

Has there been any meaningful shift?

Or, is it sort of just consistent at a little bit lower rate than what you had previously anticipated?

Hey Matt, this is Neil.

Maybe I can jump in a little bit with some thoughts, and Ben could add on.

But, I think as we look back at the quarter, all months had year-over-year growth and sequentially positive throughout the quarter.

October is really trending similar to the fiscal Q1.

It is early in the overall quarter, but kind of as Ben laid out, and I think others are talking about, the external demand indicators around industrial production, capacity utilization, purchasing managers' index -- those are generally favorable.

Perhaps a little more variability in some of the end markets.

I think the customer outlook is still positive.

The capital planning going on, the making of the MRO spend for their operations and their ongoing productivity, and kind of a supplier dialogue.

When they are talking North America in the industrial markets, they are more positive.

When the conversation turns a little bit more global, perhaps to Europe and China, maybe a little bit more concerned with them.

But, I think for the North American industrial, that side of it's positive so I think that's what we are really seeing overall.

Okay.

Mark, you mentioned the decline in gross margin.

Some of that was point of sale pricing.

Is there any way to sort of call out how much of that was pricing?

And, can you marry that up with your comment that you think price added a percent to the top line in the quarter?

The price on the top line adding a percentage point -- that was related to passing along the price increases that we've experienced from our suppliers throughout the year.

We do a pretty good job of doing that contemporaneously when they occur.

I think some of the challenges regarding our point of sale pricing was just larger increase in our sales mix to larger customers who generally have lower margins than some of our smaller customers.

That's very helpful.

And then, last thing and I'll hop back in queue here.

On the SG&A costs, both in the quarter and going forward, can you talk a little bit about -- you were down, I think, about $2.7 million sequentially from the June quarter to the September quarter despite having made acquisitions that were contributing to that number.

How much of that decline, Mark, is sort of offset by acquisitions?

How much of it is more lower variable cost and a little bit of a small sequential decline in total sales versus the more active cost controls that you alluded to in your prepared comments?

And, can you sort of help us sort through that?

And then, as we look at your EPS guidance, I'm assuming that the maintained EPS guide on lower sales growth is largely a function of again actively managing SG&A.

Again, how much of that is lower variable versus lower fixed cost?

You had a lot of questions in there, Matt, and I think the perspective is we do expect our gross profit percent to improve in future quarters for the rest of the year so that will be helping.

We also do expect to have our SD&A to be under control for the rest of the year.

And obviously, in delivering the earnings per share in the September quarter, by managing and controlling our SD&A cost was a big driver for the results that we have been able to deliver.

And, since we are decreasing our sales guidance for the full year, but still maintaining our earnings per share guidance due to that mix of being able to leverage the sales we do get to a good profit level is still there.

We still feel that we can continue to manage that going through the remaining quarters.

Regarding the acquisitions, the new SD&A from the acquisitions did add about $5 million in this quarter so that wasn't in the prior-year same quarter.

We do feel we were just about flat and a little bit down on our SD&A expenses, and we continually look at those to make sure that we are doing the right thing to spend the money.

We are also making sure that we are not scrimping, and so that we can spend the money on our growth initiatives, too, as we move forward.

Okay, very helpful.

Thank you for the color, Mark.

The next question comes from Adam Uhlman from Cleveland Research.

Please go ahead.

Adam?

Here we go.

Sorry about that.

Just to start I guess, first of all on the gross margin commentary, Mark -- why exactly do you think that the gross profit percentage will be going up for the rest of the year?

We think we will be able to see improvements in our gross profit percentage regarding our point of sale margins for the rest of the year.

We also believe that we had a lower impact of some of our supplier support in this quarter that flowed through to the income statement based upon the various accounting rules that we have to follow to make sure that the supplier support is there for the items that we sell to customers -- not necessarily from when we buy it, but it's when it gets to be sold to them.

We expect that we should see some improvements in the supplier support as it is flowing into the income statement and the next couple of quarters as well.

So, I think the combination of those things is making us feel comfortable that we can see some forward progress with the gross profit percentage as opposed to what we had in the September quarter.

Okay.

Are you getting any indications that there might be some year-end buying opportunities from your suppliers?

And, how should we think about the inventory levels with that?

I would say that buying opportunities may arise sometimes, but they have been more few and far between over the last several years.

We do not expect to see any real significant opportunities arising as calendar year-end approaches, but you never know.

Our view on inventory is we added some inventory strategically during this quarter to help with some sales growth initiatives, and we expect inventories to be relatively flat for the rest of the fiscal year based on our plan.

Okay, great.

Thank you.

The next question comes from Jon Tanwentang from CJS.

Hi, thanks for taking my call.

Can you talk a little bit about your revenue growth plans in light of the updated guidance?

Ex-acquisitions, it looks like we got roughly 2% to 3% organic growth in the quarter, and your guidance suggests something in the 4% to 6% range going forward.

Is that just the new normal given the macro environment, or have there been changes or challenges to the plans since you last gave us an update?

Jon, this is Neil.

I would say the macro environment led to our adjustment on the sales expectations -- kind of alluded to -- we are not immune to the macroeconomic environment.

We believe we can grow a base -- a multiple of the base economy.

We probably did a little so in the first quarter.

We think we can do even better going forward.

Our work around expanding sales with existing customers, reaching new customers.

We are doing product expansion in really some -- a few focused areas -- working fluid power.

We are making progress.

As I look around with this sales team in the areas and resources, we've probably got 10 new leaders in some key roles.

I'm encouraged that two-thirds of those are internal associates promoted with greater opportunities and one-third from the outside providing for have some added organizational vitality.

So, that's our look.

That's what we're working on.

We think we can grow a multiple of the base economy, and then, you know of the acquisitions.

Got it.

And then, on the acquisitions, I guess the strategy in the environment.

Are you accelerating your plans versus three months ago?

And, has pricing gone up or down?

Are you seeing any kind of pressure to sell ahead of potential tax law changes?

I would say, our pipeline remains robust.

We are active.

Maybe we're as busy as we have ever been in that area.

We contend and say we remain as strategic acquirer.

We're going to stay disciplined in this process.

Year-end bring some of those to closure perhaps, but the pipeline is good.

It's full, we are busy.

And, from a financial standpoint, I've got a strong balance sheet and the financial capability to be in the space.

Perhaps, right, economic environment stays a little tough for a period of time, It likely makes some of those businesses look to sell.

Okay, got it.

Thanks.

The next question comes from Jeff Hammond from KeyBanc Capital.

Good afternoon.

Just to be clear on the guidance, you're taking the top line down -- it looks like 3 points and leaving the earnings numbers.

Is it simply the SG&A cost control coming in better that allows you to keep the earnings number even though revenues are coming down, or, is there more to it?

I think it's a combination, Jeff -- the cost control as well as our expectation that our gross profit should improve a little bit in future quarters as well.

But, I would say the large amount of that work will be maintaining our control of costs.

Okay.

You weren't surprised necessarily by the gross margin dip?

I'd say no.

As you look at the timing and the year-over-year comparisons of that -- I'd say no, not surprised.

Okay.

Just as we hear other people's earnings and some of the fluid power guys, there seemed to be a disconnect and a little more caution in September in discussion that some big OEMs and manufacturing companies are kind of tightening the reins, cutting production a little bit, going through a de-stock.

That just seems like an environment where point of sale pricing maybe on the margin gets more difficult.

Jeff, you mentioned fluid power, and, one, we like the business.

We like our position both with OEs -- and we don't serve the big OEs from a direct basis, but we serve other OEs.

Also, our ability or our potential to grow on the MRO side in the activity.

Our fluid power performance, we can really circle to kind of one segment that we have talked about before that has not done so well, and it continues in that.

So, if I set that aside, fluid power is performing pretty well.

We were out at the Mine Expo, had good customer opportunities.

Opportunities in Western Canada, Mexico doing well.

I think from a fluid power standpoint on MROs, both with local customers and strategic accounts, there's good opportunities.

I was just on the call with our subsidiary guys going through reviews.

A little bit of improving construction.

For most of them, the ag markets they're talking positive on.

Those customers are looking for more controls, more integrated designs.

That's good for us from a surface -- or a service and solution standpoint.

And then, industrial machinery is not bad for them either, and that's a big segment.

So, we think fluid power is a contributor.

Okay.

I didn't hear you call this out at all as you went through the moving pieces of gross margin and SG&A.

Is it fair to say that the Australian deal had a negligible impact on gross margin and SG&A percentages?

Are those fairly comparable to the overall?

That would be fair to say.

We had two months of their activity in this quarter, and we will have three months in, obviously, the future quarters for Australia and New Zealand as we go forward.

Their results so far from a top line perspective is spot-on to what our plan was and our previous announcements as to what their annual sales run rate was of $83 million a year annually.

We saw that in this quarter.

I'd say the business is performing well.

We are on the integration.

It's early, but we are working the product expansion.

I'm going to be over with the teams in a few weeks doing the opportunity reviews firsthand with them.

We think we are off to a good start and a good product expansion opportunities that made sense for us at the start.

And then, I jumped on a little bit late here, and I don't know if you gave us an update on that ERP cost.

Is that number moving around at all, or surprising you to the better?

Is that part of the SG&A cost control?

Are those all coming in in- line?

I'd say that they're coming in in- line.

And, at our last call, we gave an overall view for fiscal 2013 of our spend on the ERP, and that has not changed.

So, we are working the plan.

Okay.

Perfect, thanks.

Next question comes from John Baliotti from Janney Montgomery Scott

Good afternoon.

Mark, in the past, regarding the ERP expense in SG&A, you had given that number out.

Should we just look at that as a pretty -- that $15 million as a pretty even spread throughout the year?

Or, should we -- does it kind of progress like it did last year.

How should we think about that?

I think it would be fair to say it's a pretty even spread throughout the year.

Okay.

And, would you mind just if you go through the industry, is there any kind of color you can give us on the different industries?

We've heard some mixed reviews from some of the suppliers -- some of the big equipment suppliers, and I don't know if it necessarily translates in exactly what you are seeing given your mix of MRO and OE-type of business.

Yes, John.

This is Ben.

20 of the 30 industries we track were up for the quarter.

11 of the top 15 were up for the quarter versus same quarter last year.

We saw strong double-digit growth in food and beverage and transportation equipment.

And, in addition, we have good sales growth in our government side of the business in spite of all the headwinds that we are seeing in the government segment and budget cuts, we had, again, strong double-digit growth there.

On the weak side, coal mining and metal mining were both relatively weak.

And I guess looking forward, we are seeing some good growth opportunities in the housing segment as well as nonresidential construction.

So, we see some good near-term prospects for lumber, wood products, cement, and the other construction related industries.

Ben, do you think as people curtail some of the big equipment -- or the big-ticket item spend on the mining side, is that -- they obviously have to keep operating a certain level of capacity utilization on those.

And, does that -- have you historically seen that shift maybe more to the MRO side of your business, or do they just maintain what they've got?

Yes, it depends on the industry.

I would say in mining right now with production turning down somewhat, that does impact our business.

On the fluid power side, some of the OE business, it affects us more on the new equipment build.

Okay, great.

Thank you.

Next question comes from Joe Mondillo from Sidoti & Company.

Good afternoon.

First question, just was wondering if you saw any one-time acquisition-related expenses in the quarter such as due diligence, inventory write-up, et cetera?

There were not anything significant or material in the quarter that I would call out as one-time.

Most of our due diligence expenses that we did for Australia were expensed contemporaneously, and a lot of that happened before the actual acquisition date.

So, there wasn't really a lot here, obviously, there's a little bit of stuff, but nothing really to talk about.

Okay.

Also, in terms of what you realized from the acquisition, was that sort of in line -- the expectations?

It seemed a little light.

You saw two-months' worth, and it was only $5 million.

Was that in line with your expectations, or is it because it's seasonally weak because it was the winter over there, or -- ?

We saw about $14.5 million dollars there, Joe.

So when I was talking about my information -- when we talk about there was an $18.2 million improvement in our other country operations which we are including Australia and New Zealand into during the quarter.

Well, $14.5 million of that was Australia and New Zealand, and the other $3.7 million was an improvement in Mexico.

So, total acquisitions was $14.5 million in the whole quarter?

It was a little bit more because we did have some of our smaller Canadian acquisitions we did this past winter that were in there so that added a little bit more to that.

About $4 million of additional revenue from that as well.

Okay, so call at about $19 million or so?

That's close, yes.

And then, I was wondering if you're able to -- you talked positively again about the ERP helping out on everything.

I was wondering if you could address any examples yet regarding how and where you are actually seeing those benefits?

I would say, Joe, right now, we are focused on the build and the deployment, getting the critical functionality in.

So, we are going through the release to build.

Ben talked about the deployment that we had in focused areas.

We will continue that phased rollout through calendar 2013.

I would say it's early, and I've kind of alluded to it before -- we are going to talk to it in our business because to point to an improvement that was ERP-related or business-related -- it's hard to assign one because they are both going to contribute to those in many areas.

We are going to be talking about it in the total business.

Okay.

I'm just trying to get a an idea with all the money that you're spending on that if it's actually visible?

Can you actually see it?

And, was wondering if there is anything that you can point to?

Joe, this is Mark.

We've done some implementation so far in our Western Canadian operations, and we have a planned rollout over the next -- let's call it, 15 months for additional rollout of the SAP system.

The real benefits will continue to ramp up over time as we roll these out, and we can bring our operations to them.

It's really premature to talk about that now.

Okay, and then just lastly, I know you have talked about in the past about how you -- big opportunity in terms of product expansion.

You mention fluid power, but you also focus -- I know it's in your investor presentation -- regarding your other section where it's you're, I guess, more or less neglecting about maybe half the industry?

I was wondering if you could talk about that and, speak on how you're trying to attack market share through product expansion and specifically trying to attack that other section of products?

I don't know that we're neglecting anything.

Probably a poor choice of words, sorry.

Fine choice of words, but with existing customers, good customers, we are looking at 14-plus product categories, building our capabilities, and what are they using -- utilizing of our products and solutions.

And, if we are not fully represented, we are talking with our sales teams and those customers about how we fill up more of those categories.

That's what we are doing with existing customers.

And we have got good visibility and trends on new customer opportunities.

Either that they've done business with us previously, or they are just new targets.

There, sales teams are using things like good opportunity funnels to how they progressed those through at each stage.

We work them ourselves.

We work them in combination with our suppliers to close those.

We are working those fronts.

Hopefully, you can't accuse us of neglecting anything

No, I certainly didn't mean that.

I apologize.

Are you referring to mostly organic growth on the product expansion through those avenues like you just mentioned?

Or, is it through acquisitions as well?

No, those would be organic in those areas, and then might we talked also about the potential that we have in Australia and New Zealand as we branch out with that footprint beyond just bearings and some core power transmission that we expand out in some those categories.

That's going to show up for a year as acquired, but some of it will occur because we are doing product expansion in those markets.

Okay, thanks.

Then, just lastly, could you -- just parlaying that question in terms of acquisitions.

Just to address the balance sheet here, and are we -- same sort of viewpoint?

And, how the deteriorating environment or the slowing environment sort of affecting your view on utilizing the balance sheet?

Thanks.

It's not diminishing our view at all, right?

There is solid balance sheet, good cash generation, no debt, and you know we've talked before.

We'll stay investment grade with the right opportunities.

30% debt to total capitalization -- that does not concern us.

Okay, thank you.

Next question comes from Jason Rodgers from Great Lakes Review.

Good afternoon.

Looking at the ERP system again, has deployment in the US started?

Yes.

We had -- within the past month, we had our first go-live in the US.

In the next few months, we are going to continue with our phased rollout across the rest of the United States.

Okay.

Looking at your three-year plan for the $3.5 billion in sales, has that changed at all given the current environment?

We haven't changed that.

We think we are well-positioned in the space, good financial capability.

We have the opportunity to grow organically via acquisitions, and we are not changing.

Okay.

And then, finally, just looking at the income statement, the other income I think of a few hundred thousand dollars -- just wondering what that was?

What that really relates to, and we traditionally disclose the components of that in our footnotes to our 10-K and our 10-Qs, and we will continue to do that when we release the 10-Q for this quarter.

But, what that amount relates to is the assets gained that we have related to the equity securities that we are holding in a rabbi trust for non-qualified deferred compensation plan.

How that works is when the equity values go up, which at the September quarter was a good return on equities in the market, those asset values get mark-to-market and so, we get a gain.

Whereas looking on the press release, if you look at a year ago, in the September 2011 quarter, the equity markets went down and our loss at that point in time was really driven by a reduction in the equity values in this deferred compensation plans -- non-qualified plan that we have there.

The overall perspective on this is all the gains and losses that are showing for this item in that other income and expense category are completely offset by an opposite impact within our SD&A expense.

So, when the assets go up in value we have a gain, and that's below other income.

But, we also have an increase in our compensation expense to associates because we owe this to our people that are working for us.

That has a corresponding increase in our SD&A expense.

The net impact for the Corporation's bottom line is a push.

Hopefully, that was clear.

Yes, thank you very much.

Okay.

Next question comes from Gregory Macosko from Lord Abbett.

Thank you very much.

Most of my questions have been asked.

But, Neil, with regard to your opening statement regarding 5.3% revenue growth and 14.3% earnings growth, and that leverage figure if I just divide one by the other you get about 2.7%.

We've looked at sort of the expectations prior to that, that leverage number was much lower something less than 2, maybe 1.8%, 1.9%, just looking at it in those terms.

The fact that you're saying you can do more suggests that you are able to vary the SG&A, particularly I think relative to the growth rate.

In other words, your growth is dependent upon the macro, the GDP growth as well as your expectations to gain share.

Give us some color on the ability to maintain some kind of a ratio over 2% going forward?

Greg, this is Mark.

I'll try to jump in.

We don't quite look at it like that ratio, but we do look at it as improving.

I would say that the opportunity for us in the future is related to this runway that we are building with our ERP system to give us the abilities to continue to leverage sales growth and to help leverage the bottom line from that to improve profitability.

We are trying to leverage every line item on the income statement to help improve our operations and drive value to the bottom line.

Yes, but you haven't really gotten the ERP system.

It's obviously coming in, but it has a ways to go, and you are still able to keep that SG&A line in line.

Is -- as we -- if we should see the economy recover -- to some extent industrial demand pick up a bit, would it be fair to say we would expect to maybe spend a little more to build out growth and enhance top line a little bit?

So, you'd maybe spend more on the SG&A line?

I think as we've said, we look at ripe, focused smart investments in forward-facing resources help us implement strategic plan, help us to grow.

We see the potential in our work processes, and also with ERP, the ability to scale more growth and have the productivity with our internal team and associates that they can handle a greater velocity of business.

And, that we can do that through our distribution centers, that we can do that through our service centers.

A common support structures and cost and more business coming through the top of the funnel creates a nice bottom line expansion.

If I could, Greg, also -- this is Ben.

I would say our teams are doing a great job of managing our expenses in line with our business activity, but some of our business units are still building for the future, still investing for the future.

We are not solely focused on cost control so we have a number of different activities going on, but the teams are doing a great job in line with the business activity at each business unit.

Okay.

Well, I must say that your ability to manage that bottom line is pretty impressive.

I look forward to seeing more.

Thank you.

Thank you.

The next question comes from Holden Lewis from BB&T.

Thank you.

Good afternoon.

I recognize that you really don't want to give too much detail, I guess, about the SAP program and the pace of improvement that you would expect based on the initiative.

But, help us out to understand if we are succeeding, or if it's taking longer than expected, of what have you?

I'm kind of curious, when would you expect to begin -- we are not talking about specific numbers.

But, when would you expect to begin seeing real tangible impacts on the ground from this SAP being rolled out?

Right now, you're incurring costs, when do you expect to start seeing benefits offsetting those costs?

What's that point?

Holden, I'll take the first shot.

Again, I don't know that I can stick numbers and timing that maybe you're looking for in it.

But, the project teams have been busy working on this release to functionality, right?

Really aimed at the deployments in the US.

We're out at locations live in October.

Strong performance by the teams in the build and the deployment.

I'm pleased and proud of the associates, and the work that's going on.

We are going to continue those phased deployments throughout calendar 2013.

I think we're doing a nice job at managing costs and the functionality changes that could go on in the system on the upfront.

And, we've got a real good focus on the organizational change management that we're doing effective training upfront to help it pull through.

And then, the right post-conversion support activities to drive the operational efficiencies and productivity.

So, that's all around deployment, and you'll see the US go live across the calendar 2013.

You set that aside is that we've got a good understanding of what the value drivers, or enablers are, what those actions are -- good teams, good owners.

We are working those ahead of time so they go sequential.

And so, some of them are system-related, and some of those are going to be business process and perspective-related in that.

So, we are working those as well.

We are going to just talk about them in the total business results going forward.

But, those are the activities and the timing that are going on.

Okay, but right now you're only incurring cost for SAP, right?

You're really not counting on there being any benefits in the mix?

I would say there are not huge benefits that would be coming specifically from SAP.

As we work our business, continuous improvement and productivity initiatives, there would be benefits that occur from that.

They occurred in the business previously, and they will occur in the business ongoing.

That's where I say that there's the difficulty of saying when is it ERP-related and when is it from other actions, and often those are blended.

I guess what we are trying to get a sense of -- because other companies are obviously putting in ERPs, and they've argued we are going to spend this much money.

We expect as things turn on, we are going to start to see benefits.

What it least gives us a sense of is when you get the turn from basically incurring maximum cost to the point where that bottoms out, and you at least begin -- even if you're not quantifying it -- you at least begin to get dwindling net costs and hopefully net benefits.

I guess I'm kind of wondering of when you hit the bottom and start climbing back out of that?

I think, Holden, right -- Mark has outlined before what the expense outlooks -- cash flow outlooks are for 2013.

And then, we talk about our overall EBITDA ranges that we want to achieve over a three-year horizon in the 9% to 10% area.

I think those are the drivers that it's in there.

Okay.

And then, as it relates to the revenue driver -- the 6% to 10% revenue guidance that you give for the year, does that include any sort of pending acquisitions, or is that based on the business that exists today?

That's in existing business.

Okay.

You sort of grew revenue in Q4 at about 5.1%, Q1 about 5.3%.

Is the increase that you anticipate for the final three quarters of the final three quarters of the year, is that primarily because you are seeing some improvement in the indicators?

Or, is it primarily because if things are the way they are today, you think that the initiatives are going to get such a grip that it's going to generate that growth.

Where is that acceleration in revenue growth coming from?

I think one of the things, Holden, is that we had one fewer selling day in the September quarter which was an impact of 1.6 percentage points.

So, if you would take that into play, we were basically looking at a 7% improvement on a sales per day basis in the quarter.

And, I do believe that with our various strategic initiatives out there that we feel that as we march forward that we will be solidly in our sales range.

Okay.

So, it's primarily because of the initiatives more than anything else?

The overall economy, I think we are still optimistic on the overall industrial economy for North America.

Sure, it's slowing, we acknowledge that.

We read the papers, too, and we see the numbers, but, I think that we are still seeing opportunities for expansion.

Some of the negative numbers that we've had in our fluid power business, as Neil mentioned even on this call, was we are still seeing negative headwinds from one customer in one of our business segments that brings that overall sales volume in the fluid power business was actually down a little bit this quarter.

But, our other fluid power businesses are showing sales growth.

So, as we look forward, we see opportunities out there progressing through the fiscal year.

I think you alluded to October is kind of running in that 5% to 6% range like fiscal Q1?

Is that what you indicated?

I think what we were saying so far -- obviously, we don't have October done.

It's early in the quarter as to where things are from that.

I don't think we were trying to apply a specific percentage.

Okay, and then just lastly, do you have the days -- is it days each quarter that you expect?

I don't have them right here.

I will get them off-line.

Okay.

Thanks.

The next question comes Derek Josie from Longbow Research.

Hi.

Can you talk about what you are seeing in terms of supplier pricing -- in terms of what they are kind of passing on to you at this point?

If anyone is being more aggressive or less aggressive?

Derek, there's nothing significant to report.

I would say price increases from our suppliers are nothing in the way of anything outrageous compared to kind of the long run, and nothing in the way of shortages of product.

Overall product flow from our suppliers is good.

Our supply base is strong, and we are in somewhat of a normalized period right now.

Okay, so if they are increasing -- so increases would probably be in a normal range of something like a 3% to 5%, correct?

Correct.

Okay.

Well then, the question is, if you are getting 1% from pricing -- obviously, it is not an apples-to-apples comparison.

I'm just kind of curious if supplier pricing when you are having a slowdown in demand, kind of creates a gross margin headwind for the Company at all?

Obviously -- this is Mark, Derek -- it depends on the mix.

The way I look at it from a rule of thumb perspective is when I hear of a supplier's announced price increases, they always say, well, gee, this price increase averages X percent.

About 0.5 of that percentage announcement is really what we eventually see that is flowing through our system based upon mix because they have very different things by each of us use for that.

We've seen stability in supplier pricing for the last year or two where it's been in this -- I'll call it 2% to 6% range, and it really just moves up a little bit or down a little bit.

I think the view right now is that it is calm.

We haven't seen many of the suppliers that could traditionally have a December 31 price increase because it's -- but it is getting close from when they should be announcing those things.

We don't hear a lot of drumbeats for a big number coming forward.

Okay.

Then, have you had -- let's just take it from the other side.

In terms of customer requirements, are they -- how much pushback are you seeing in terms of just any price increases.

Obviously, you're passing through some of it.

What is -- are you seeing anything from their end, either in terms of specific end markets or specific types of products where you're seeing a higher level of customer pushback on even just general, small, like 1% to 2% price increases?

Nothing out of the ordinary.

We are seeing the normal competitive pressures, and we continue to work very hard to prove our value to our customers.

They certainly see the value we provide.

Okay.

Just lastly then, talking about the Company's value-add proposition, given that demand is so -- has kind of come down from where it was earlier in the calendar year.

How much -- where are you seeing any specific types of services or any types of value-add that AIT provides that you know is, say, making a difference in picking up market share or just growing with the market at this point?

A lot of the value we provide is in plant.

We help our customers with productivity, increasing their uptime, decreasing their downtime, and documenting the value we provide to our customers.

That is certainly in a struggling environment for those industries that may be seeing a downturn right now.

That is definitely something our customers require, and we are well-positioned to fill that requirement.

Okay.

Thank you.

There's time for one last question.

Today's final question comes from Brent Rakers from Wunderlich Securities.

This is Anjali Voria for Brent Rakers today.

Let me begin with a housekeeping question.

What was your headcount at the end of the quarter?

Don't have the exact number in front of me, but we were up approximately 210 on our headcount, and it was all related to acquisitions.

So, our existing operations were flat to slightly down.

Okay.

Were there -- okay, that's fine.

With regards to the gain in your other income line, could you break out how much that actually was, by any chance?

It was virtually the entire number.

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

Okay.

It didn't actually exceed that number?

It's more like $0.5 million, not a $1 million-type of number?

It was like $440,000 of the $480,000 -- the number that we're showing on the income -- I'm sorry.

It was $440,000 of the $460,000 we're showing on the income statement.

Okay, that's fine.

When I break out some of these factors with the headcount, ERP, acquisition, DD&A, et cetera.

Your expense line clearly is very favorable this quarter.

Could you talk us through some of the benefits that you saw in the quarter?

I understand lower gross profit, some from the Canadian currency.

What about things like bad debt expense, or are there any factors you can call attention to that might have been lower than normal this quarter?

Anjali, the bad debt expense and our overall provision for bad debts was lower this quarter compared to a year ago in the September quarter.

That definitely was one of the items that was in the change within the SD&A perspective.

I don't really have a lot of specific items.

There's not one big thing that does this.

It is just a lot of little numbers that add up to smaller numbers.

We continue to look at our expenses with a fine tooth comb to look at all the things that we are doing.

And, this is really a byproduct of our annual budgeting process that we entered into and we worked on last spring as to identifying what expense, where to do it, what are we going to try to work on going forward into the next fiscal year.

And, I think we are seeing some of that right now this quarter.

That's great.

Thank you.

How about on the acquisition side, would you mind giving some flavor around the gross margin profile for SKF?

We really don't break that out with individual acquisitions, Anjali.

So, we are not going to do that.

Okay, that's fair enough.

All right.

Well, I appreciate it.

Thank you.

Thanks a lot.

That concludes the question-and-answer session for today.

Please go ahead with any final remarks.

Just from our side, thanks for joining us today.

We appreciate the interest and the investment in Applied, and we look forward to talking with you throughout the quarter.

Thanks a lot.

Thank you.

This concludes the fiscal 2013 first-quarter earnings call for Applied Industrial Technologies.

Thank you for your participation.

You may all disconnect at this time.