Applied Industrial Technologies Inc (AIT) 2013 Q2 法說會逐字稿

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

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

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 Julie Kho.

Julie, you may begin.

Thanks, John, and good morning, everyone.

On behalf of Applied Industrial Technologies, thank you for joining us on our fiscal 2013 second 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.

Our 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 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 to 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, Applied's Chief Executive Officer, Ben Mondics, our President and Chief Operating Officer, and Mark Eisele, our Chief Financial Officer.

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

Thank you, Julie, and good morning, everyone.

We appreciate you joining with us today.

As we reported in our news release earlier this morning, our sales for the second quarter were $589.5 million; up 3.4% from the second quarter of fiscal 2012.

Net income for the quarter increased to $27 million or $0.64 per share compared to $20.9 million or $0.49 per share in the prior-year quarter.

Our modest sales increase reflects the slowing business activity we experienced in the industrial environment as we progressed through the quarter, especially in December.

In spite of this, we achieved a solid increase in earnings and profitability for the quarter; more specifically, a 30% increase in earnings per share compared to last year, and a 15% increase when adding back the one-time expenses from a year ago.

I attribute this performance to our focus on cost containment and continuous improvement throughout our operations.

We continue to be focused on driving operating performance in the current environment, while implementing the programs that support our long-range strategic plan for future growth and profitability; organically, via acquisition, and through our technology investments.

We welcomed two additions to Applied in the past two months.

On November 1, we announced the acquisition of HyQuip Incorporated, a distributor of hydraulic, rubber, and plastic industrial hose and tubing, along with some related accessories.

The company produces hose assemblies and custom kits for fluid conveyance applications and provides inventory management, stocking programs, and other value-added services.

HyQuip is a strong, established company and their addition is consistent with our strategy to build upon and strengthen our fluid power leadership.

We're excited about the growth opportunities, and the operational synergies we can realize with the addition of HyQuip.

Later in December, we announced the acquisition of Parts Associates Incorporated, or PAI, a distributor of maintenance supplies and solutions, including fasteners, fluid flow components, paints, chemicals, electrical, and shop supplies.

We gained a solid company in PAI with strong brands and a high level of expertise.

Strategically, the company is an excellent fit for our business going forward as we strengthen our maintenance supplies and solutions offering for sustained growth.

Overall, the acquisition environment remains productive and our ongoing activity demonstrates our commitment to pursuing opportunities that are aligned with our strategic priorities and generate shareholder value.

Now, I'll turn it over to Ben for some additional commentary on the quarter.

Thanks, Neil, and good morning, everyone.

First of all, I'll echo a point that Neil made in his opening comments that we did experience some slowing of demand in the industrial environment during the quarter.

What we're seeing and hearing out on the front lines, among our supplier and customer base, continues to be mixed business activity.

Although sales were sluggish in the quarter, we drove an improvement in our gross profit percentage and moved to align our SD&A with our sales.

From a macro standpoint, we do watch key economic and market indices and pay close attention to their movements, as they are typically a good indicator of the future economic environment.

Recapping the recent activity, industrial production increased 0.3% in December, following a 1% increase in November.

For the fourth calendar quarter as a whole, industrial production moved up at an annual rate of 1% after 0.4% increase in the third quarter.

For the fourth quarter, manufacturing production increased at an annual rate of only 0.2%; not a strong number, but an improvement from a decline of 1% in the third quarter.

Mining production increased 0.6%, while utilities plunged 4.8% as a result of unusually warm weather.

Capacity utilization for manufacturing rose to 77.4% in December, up from 76.9% in November and 76% in October.

The current rate is 1.4 percentage points below the long run average.

The ISM Manufacturing Index rose 1.2 points in December to 50.7; this reversed about half of November's decline.

A look back shows the index has been above the neutral threshold of 50 only three times in the past seven months.

This is consistent with the mixed conditions we've been seeing.

A benefit to us is our broad and diverse customer base, providing us opportunity and potential.

Every day, our customers turn to us for component parts and systems, technical expertise, value-added services, and a thorough understanding of their equipment and operations.

In order to meet and exceed our customers' expectations, we continue to invest in our business by expanding our product and solution offering, investing in our fluid power business and building upon our market leadership, strengthening our position in attractive vertical markets while growing in our core segments, enhancing our operational excellence, and driving continuous improvement throughout our operations.

We will continue to execute on these fundamental strategies with the goal of generating success for our customers and value for our shareholders.

I will now turn the call over to Mark to discuss the quarter financials in greater detail.

Thanks, Ben.

Good morning, everyone.

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

Our sales per day during the quarter was $9.5 million, or 1.7% above the prior year quarter.

We had one additional selling day in the December 2012 quarter compared to the prior year and an overall basis, sales increased 3.4%.

Acquisitions added 4.4% to sales and favorable foreign currency fluctuations increased sales by 0.4%.

We believe the impact of vendor price increases was less than 1% during the quarter.

Our product mix during the quarter was 27.7% fluid power products and 72.3% industrial products.

Second quarter sales in our service center-based distribution segments increased $22.2 million or 4.8%.

All of this increase was due to acquisitions.

Sales in our fluid power businesses segment decreased $3 million or 2.7% from the same period in the prior year.

From a geographic perspective, sales in the second quarter from our US operations were flat compared to the prior year quarter.

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

Consolidated sales from our other country operations, which include Mexico, Australia, and New Zealand, were $18.4 million above the prior year and all of this improvement was due to our Australia/New Zealand acquisition.

Our gross profit percentage for the quarter was 27.6%; 30 basis points above our prior year second quarter.

This increase was due to a combination of improved supplier support and the impact of recent acquisitions operating at gross margins above our core businesses.

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

Our selling, distribution, and administrative expenses as a percentage of sales was 20.8% for the quarter; 60 basis points below the prior year second quarter.

On an absolute basis, SD&A expense is flat compared to the prior year on a sales increase of 3.4%.

If you recall, in the prior year second quarter, we did separately identify and discuss $4.4 million of one-time SD&A expense items that primarily pertained to the freezing of our supplemental executive retirement plan.

If you take these prior-year items into account, our current quarter SD&A expenses increased 3.8%.

Acquisitions added more than 3.8% to our SD&A footprint, so our core operations actually had a year-over-year decline in SD&A expenses.

We continue to have a tight focus on our operating expense.

ERP spending in fiscal 2013 continues to be in line with our expectations.

Our effective tax rate for the quarter was 34%, which is lower than 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% to 34.5% range, as the impact of lower effective foreign tax rates continue.

Our consolidated balance sheet remains strong, with shareholders equity of $722.1 million.

Our after tax return on assets for the quarter was10.7% compared to 9.4% in the same period a year ago.

Inventory has increased in the quarter and year-to-date, primarily due to acquisitions and strategic purchases of inventory to support sales growth initiatives.

We believe our inventory levels should decline by up to $20 million for the remainder of the fiscal year.

Overall, receivables DSO increased, primarily due to seasonality around the December holidays.

Cash generated from operations was $5 million for the quarter compared to $13.8 million in the prior year quarter.

Expectations are for improved cash generation in the second half of the our fiscal year, consistent with our traditional cash cycle.

Fiscal 2013 should be another solid year for generating cash from operations and we expect to achieve a nice improvement from our fiscal 2012 results.

We did not purchase any shares of our stock in the open market during the December quarter, although we expect to be more active in the last half of fiscal 2013.

In summary, our second quarter financial performance reflected slightly softer environment than our original estimates.

This caused us to reflect on the impact of our full-year results with a resulting scaling back of our sales and profit expectations and the guidance disclosed in this morning's press release.

We feel we are well-positioned and focused on executing our strategy to produce solid results in the second half of our fiscal year.

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

Thanks, Mark.

From a macroeconomic perspective, our second quarter included some headwinds; however, our cost controls and continuous improvements yielded results.

While some economic uncertainty persists, we remain optimistic about the overall North American industrial economy for calendar 2013.

As we celebrate our 90-year anniversary and 90 years of strength in distribution, we have a proud past and expounding foundation to build upon.

As we enter our tenth decade of doing business, our associates remain committed to expanding value-added solutions for our customers, to accelerating our growth, and to generating benefits for all applied stakeholders.

Now we'll open up the lines for your questions.

(Operator Instructions)

Jon Tanwanteng, CJS Securities.

Does the current guidance of 4% to 7% include the effect of potential acquisitions in the next two quarters?

How does that pipeline look and are you going to increase that pace at all?

I would say the look forward does not include any acquisitions.

Year-to-date, we've closed three.

The environment's productive, we're active.

I would anticipate kind of similar activity in the back half.

You never can call them with certainty, but I think we will be as active.

As we've said before, we continue to look to raise our sights in the acquisition prospects or the targets.

If they would come in a little larger, that would be fine with us, as well.

We're active, we're busy, we don't perfectly control the timing.

But I would expect in the second half, we'll be as active as we were in the first half.

Got it.

How does that line up with the long-term target?

I think from our perspective, our long-term target, as we talked about over the summer, is to have a balance of grow through acquisitions and grow through organically.

I think we're trying to hit those numbers.

We don't look at them in just a 12-month window, but we're looking it over the three-year time horizon.

I think we feel very comfortable with the acquisitions we've done year-to-date and with the pipeline going forward, we're comfortable with that.

We are working hard on accomplishing our strategic plan.

Got it.

Thanks.

What kind of macroeconomic assumptions are you using in your guidance for fiscal '13 and maybe calendar '13, since you seem to be pretty optimistic about it?

We're looking at all the same things that everybody else is looking at from the various economists that are talking about the industrial economy in North America and I think that our view is that 2013 is going to accelerate throughout the calendar year.

I think a lot of economists are stating that.

I think that's part of the optimism we have for looking at 2013.

Jon, I would say as we looked at the start of the second quarter, it probably started the end of our first fiscal quarter and then kind of later in October and November, maybe a little more variability, but December was really the drop off.

If we look at the macro statistics, and Ben kind of walked through them, those aren't all bad in that.

Our look at, most would call GDP, industrial production, that environment continues to strengthen in '13.

Just saw something recently on Canada, I think those are similar for Canada in '13, '14, and '15 and on.

As we talked with suppliers, they would say US, North America is still probably their best region.

As we talk with customers, when they're in their macro discussions, they use the words like uncertain or cautious when they're talking about the broader economy.

But when they get to their specific business, they're more optimistic.

They're performing pretty well, they're generating cash, they're looking at things to do.

We believe that some of this December, perhaps January, hangover starts to work itself out and the economy improves, quarter one, quarter two and throughout '13.

Great.

Thank you very much, guys.

Adam Uhlman, Cleveland Research.

Can we start with the recent acquisitions?

First of all, could you size the HyQuip deal and Parts Associates and the contribution expected for the back half of the year?

Then, just tied into that, the Parts Associates deal is quite a bit different than the core business.

Could you maybe walk through your plans of how you plan to run that business along with the service centers, maybe a medium-term outlook of your thought process there?

Adam, I'll start and talk about some of the relative size on these things.

The HyQuip acquisition is relatively small.

They have two locations in Wisconsin, around 19 associates that came with us for that.

They've been in business a long time, and, as Neil mentioned, they are very strong operations and they'll complement our fluid power offering quite well.

Regarding PAI, we did not formally announce the relative size for them.

But I think their sales level will be right around 1% of the total Company sales levels to give you an idea what they're providing from their run rate when we bought them.

I'd say, Adam, on HyQuip, I think you know that this continues our outlook and views of the business in fluid power.

PAI, as we look at maintenance supplies and solutions and continuing expanding the broader product portfolio of the Company, we like the prospects.

What 84%, 85% of what we sell is bearings, power transmission, and fluid power.

If we size our $2 billion sales to the market available there, maybe $18 billion, we're double-digit share.

As we think about the other categories, at least the last fiscal year, $400 hundred million or so of sales, we think that market's probably $16 billion.

We like the growth prospects in this maintenance supplies and solution.

We can grow within businesses that exist like UZ, which is a prior business that we had.

We can grow with our platform in PAI and then, we can take those synergies across and work with our Applied associates and reach customers, those good local customers, and also strategic accounts.

We like it.

We don't think it's a far adjacency from us.

We're in these products, we're in these businesses.

There's some common supply lines.

But it will be a nice growth platform for us to start down.

Okay.

Thank you.

Jeff Hammond, KeyBanc Capital Markets.

Just a follow-on the acquisitions -- it looks like you spent $28 million in the December quarter on acquisitions, if we run through the cash flow statement.

Is that HyQuip and Parts Associates or is there some trailing acquisition spend from other deals?

You are correct.

Those are the two acquisitions in the quarter that are reflected there in the cash flow statement.

I know you didn't give us an exact size of those businesses, but it seems on a sales multiple, these are more expensive deals.

Are these higher return businesses?

What we did state in the call a little bit from our gross profit comment, that these folks do have higher levels of gross margins that we're experiencing that's helping our overall margin perspective.

We have not really talked about what's the operating profit for these things.

Obviously, we have intangible asset amortization that we need to take into incorporation for our bottom-line numbers.

But these were successful businesses and we were thrilled to get them.

Okay, but these acquisitions wouldn't have had much impact on the December quarter?

Correct.

So the gross margin impact is more from the Australia deal?

Yes.

As we said, the acquisitions so far this year, they have been better than our traditional margins.

The PAI one will continue that.

Okay.

Good.

The comment on share repurchase and being more active, is that a reflection of just where the balance sheet is or comfort with the forward look?

Why the change in tact on share buyback?

We will continue to look at our share buyback on an opportunistic perspective, as we've talked in the past.

Although, looking at our balance sheet, we obviously have the capabilities to do buybacks.

We just expect to be active during a calendar or fiscal year period and we have not been active in the first two quarters.

If you go back in our history, that is consistent with other prior times.

But we think that in these next two quarters, we will have some more activity.

It kind of fits with the overall capital allocation strategy that we have and how we've performed.

We'll continue to, in our view, pay an attractive dividend, which we've increased.

We want to be active in share repurchase.

We'll manage a creep in that and we'll continue cash generation that'll keep us positioned to be active from an acquisition standpoint.

Okay.

You mentioned gross margins slightly improving from this quarter, so it sounds like your acquisition contribution will continue.

What else is driving the better gross margins on a go-forward basis?

Some of that on the go-forward will relate to the PAI acquisition, for which we'll start basically recording sales benefits for that starting in January.

We closed that deal December 21, so that'll be a piece of that.

But we expect to see gross margin improvements in virtually all of our core operations and continuing operations.

We see the opportunities out there for that and that's part of our tight focus.

Our tight focus is not just on cost controls on the SD&A line, it's a focus on improving margins out in the marketplace.

It looks like your inventory ticked up at year-end, did you take advantage of some year-end buys?

We did increase inventory this quarter, we increased them last quarter as well.

Most of the increases are to help fund inventories for our strategic initiatives to go forward to try to grow sales.

A lot of the buying that we do with some of the programs with our suppliers are calendar year-based programs, too.

We're trying to fund inventory to help grow sales.

There's a fair amount of inventory growth from the acquisitions, also.

Yes, that's true, too.

Last question, can you give us a sense of trend into January?

Yes, so we talked about the quarter side and Ben may have -- I'd say January started maybe like Q2 ended.

I think as it's moved on, we start to see some improvement and so that kind of leads us into that sales guidance range.

If the core is flattish, we're at the low end; core performs, we're at the upper end or maybe beyond.

But that's our look at that, so we started to see the early part of January felt like December.

But as it's progressed on, we see some improvement.

Okay.

Thanks guys.

Great.

John Baliotti, Janney Montgomery Scott.

I was just wondering if we could talk about inventory, both yours as well as customers.

I would imagine that in this environment, your ability to hold inventory may be added strategically for growth.

Are you getting any better relationship or are you having a different conversation with your suppliers, because I can't imagine a lot of your competitors that carry similar products are in the same financial situation.

Is that fair?

I think that we have the capabilities to have inventory and use inventory for our customers' benefit.

Obviously, much smaller competitors, local folks, don't have that.

We believe, long-term, that we will be able to grow share.

I think having the inventory is a key part of that.

The model helps, too.

With the seven kind of North America, nine overall distribution centers that support local inventory that's also in the service centers, we plan on having what our customers need in a very quick timeframe.

I would imagine the dynamic of them probably operating hand-to-mouth and destocking a bit as the quarter went on strengthens their relationship with you, given that, they know now when they need it, they can get it from you.

Is that fair?

I think it's fair and I'm going to tell every one of my sales guys that.

It seems like there's only a certain point where they can destock to a certain point.

Once they're fully flushed and they feel more confident about things, if they don't start buying some of these things, I would imagine that what we saw yesterday in GDP would be a leading indicator of the next quarter.

It just seems, if you listen to all the distributors, each one of you does different things.

But the tone is almost identical that December was really fell off and January started that way but now it's picking up.

I would imagine that the little guys out there probably aren't feeling that.

John, from an inventory standpoint at our customer, it's not a one quarter impact.

There's been a longer-term trend here and that's where, as Neil mentioned, our logistics, and this is a big part of our value-add to our customers, our supply-chain and knowing our customers' operations and what they need and helping them to reduce their inventory.

It's been a longer-term trend that continues, especially in the industries that are seeing some challenges right now.

They turned to us and it's good to be in a position to help them out and take some inventory out of the supply chain.

Ben, are you getting the sense from them that when things stabilize that they just aren't going to go back, they're just going to use fewer, more strategic distributors like yourselves where they know they can get the products regardless of the economic environment?

Definitely.

Many of our customers are looking to us for inventory management and they're looking to reduce their supply base, so buying more products from fewer suppliers puts us in a very good position.

Right.

Okay.

Thanks very much.

Matt Duncan, Stephens Incorporated.

Mark, the first question I've got, just back on the two acquisitions to make sure I understood you correctly -- so Parts Associates is about 1% of your go-forward revenue, so I guess that implies around $25 million a year.

Did you give a number on HyQuip just so we can make sure we're getting that in our models right way?

It's a lot smaller than that number.

We haven't given that number.

I think HyQuip is under $10 million a year.

Okay.

That helps.

Maybe Neil or Ben, on the commentary and what you guys are seeing in January, it sounds like, obviously, it started slow that first week and it's picked up.

Can you quantify for us what level of growth you're seeing in the business after that slow start?

No.

I'd just say, at this point, slower start to maybe the first week, more than the first week, start to see the pickup now.

Still some variability that would be in there, so, we're focused with our teams on executing.

I still think we've got a lot of opportunities.

Matt, if you combine that with the uptick we're seeing in the ISM and the MCU, to Mark's comments, we're expecting to see a gradual increase as we go throughout the calendar year 2013.

Everything seems to align with what we're seeing and hearing along with the indices.

Typical seasonality in the business starts to ramp kind of in the February go forward time as well.

Sure.

It looks like in the December quarter, your organic revenues were probably down just a little bit, when you back out SKF and some of the smaller acquisitions you had done.

If I'm hearing you correctly, do you feel like that was probably the bottom and that things are going to accelerate off of that level going forward as we move through '13?

Is that the general tone that you expect?

I think that's correct.

Okay.

Last thing for me on the SAP install, if you could just give us an update how that's tracking?

What kind of benefits are you seeing in the locations that have gone live on that?

Maybe update us on what the dollar expense is that's flowing through the P&L this year and then, Mark, when is that going to start to top out, head back down?

When is the install in terms of the dollar spend going to be finished and roll out of the P&L?

Matt, this is Ben.

I'll hit some of the high points and the other guys can jump in here.

We're in the midst, we've shifted our focus a little bit from the build of the system to more of the deployment and we're in the midst of the deployment activities right now and as we've said before, we continue with our phased rollout.

Everything is going very well.

We're aiming for completion of the majority of our locations by the end of the calendar year, but we'll probably have some spillover into calendar 2014 as we pick up some the acquisitions we've done in Eastern Canada and finish up in Mexico.

Overall, the project is going very well.

We're within our time line, we're within our budget.

From a benefit standpoint, still too early, still in the midst of deployments and rollouts.

We'll hold off on talking about benefits until a later time.

Let me jump in here on the expense rolling through the income statement, Matt.

Over the summer, we talked in our conference call about fiscal 2013 and I think even in our annual report, information in our MD&A.

We talked about expense running through the income statement in the $15 million to $16 million range for this whole fiscal year, which was lower than the range we had in fiscal 2012; so, seeing a step backward.

We are on track for our spending.

I wouldn't be surprised if we spend a little bit less than what we talked about over the summer.

But we're really not tracking that quarter-by-quarter because a lot of these costs, as they move from the implementation, they go to the operations as to running this thing.

We're right on track, like Ben mentioned.

Mark, it sounds like you're getting a little bit about benefit within your SG&A costs, just on a year-over-year basis, the cost is running a little bit lower this year.

So, by the end of calendar '13, it sounds like the expense with putting the system in place will be by and large done, so you'll get another little bit of a benefit there in calendar '14 as you lap the costs from this year, is that right?

I would think that's reasonable.

As we've said in the past, some of these expenses will translate into continuing operating expenses for the care and feeding of the system.

Okay.

All right.

That's helpful.

Thanks for the update.

Holden Lewis, BB&T.

Just wanted to touch on the guidance really quickly.

Just using the midpoint of revenues and the midpoint of the EPS, it really, clearly, you're expecting a little better revenues in the back half than what you saw in Q2.

It looks like with the (inaudible) standpoint, maybe around the Q1 level, but you're looking at your earnings, year-over-year, going from growing nicely in the 10% to 15% range in the first half to barely growing at all, I think, in the back half guidance.

I'm just trying to get a little bit of color, does that just reflect a high-level of acquisition accounting stuff?

Or to what do we attribute the likelihood that revenues could actually improve but earnings growth become relatively minor?

Holden, I will chat a little about that.

Obviously, the earnings per share guidance range is a long range or a wide range.

The challenge is, if we're in the low end of our guidance, we will be closer to the actual results than what we did a year ago for those numbers.

If we can get closer to the higher end of our guidance, we should continue to see some leverage from the sales growth down to an EPS perspective.

We still do expect to see improvements in our EPS, but as you mentioned, it will be more modest, potentially, depending upon where everything flushes out in the second half of the year.

Again, I'm just using your midpoint, right?

Setting aside the range, I'm assuming you do your forecast and slap a range around it.

But just using the midpoint, you're talking about, again, revenues which improved from Q2 and looking a lot like Q1, I think, in terms of organic, but very little growth in earnings.

You grew 13% in Q1 against and up [2%] DSR, organic DSR, you grew 14% in Q2 against a down 2.5% organic DSR.

I'm just wondering why, at the midpoint, you would be forecasting only nominal improvements in EPS?

Are we seeing an increase in spend on ERP or is it acquisition?

It doesn't seem to make a lot of sense to me and so I'm trying to get a sense of what goes into that forecast.

All of those things are in there.

I would say from an acquisition perspective, we're layering the acquisition numbers into our numbers.

As we have stated in the past, the acquisitions are accretive, but from an earnings per share perspective, with the intangible asset amortization, it's modest.

We do have acquisition expenses to get those acquisitions closed and integrated that are one-time expenses, which do impact the first year of their operations a little bit more than on an ongoing basis.

We're seeing some of that flow through the income statement as well.

Got it.

Then, if you're flipping on over to the gross margin, can you talk a little bit about how much of the increase you saw maybe versus Q1 was a function of blending or you view as a function of blending acquisitions?

I'm also curious if you can quantify what the impacts were from you increasing inventories and pre-buying?

When you look forward, organically, do gross margins continue to move up?

Or do gross margins go down and any of the increases are because of the blending effect?

I'm just trying to get a sense of organically, how much of an impact pre-buys and that sort of thing might have had that wouldn't necessarily be sustainable through the back half of the fiscal year?

I'll address that, Holden.

We talked, after our September earnings release, that we believed that we would see improved supplier support for the rest of the fiscal year.

We did see that in our second quarter and we expect that to continue in Q3 and Q4.

That was a large portion and I don't have the numbers right in front of me, but I think it's probably the majority of the increase in our gross profit percentage is for that.

We don't see that taking a step backwards in Q3 or Q4 but at those levels.

Some of the pre-buying, as you called it, when we get supplier support for that inventory increase, that obviously stays on the balance sheet until that product rolls through to the income statement to hit the benefit for the bottom line.

We are forecasting that our inventory levels will go down a little bit for the third and fourth quarter; I mentioned in the call, about $20 million.

Some of that benefit from the pre-buying of the inventory from a supplier support perspective will flow through to the income statement and the March and the June quarters, which will help that as well.

Last housekeeping item, I had assumed by your comments that you had 62 sales days in Q2.

Can you tell me how many sales days you're having in Q3 and Q4?

Yes, Q3, we have 62.5 days and the half day relates to Good Friday for us, which is a half day holiday.

That compares to 64 days a year ago, so we'll be down 1.5 days in Q3.

In Q4, we have 64 days this year and last year we had 63.5 days, because Good Friday fell in the fourth quarter a year ago.

Got it.

Thank you, guys.

Derek Jose, Longbow Research.

I was wondering if you could talk a little bit about customer inventory levels and the opportunity you may see there for the rest of the year or going into fiscal 2014?

A lot of your distribution peers have said that customer inventory levels are at very low, historical points.

I'm just kind of wondering, is an inventory restocking cycle of any kind built into the top end of your range or is that simply a modest return in demand?

Derek, I'll jump in on this.

I think it's modest.

For the most part, our customers do not have a lot of inventory of our type of product, because it's a break/fix type business that we sell into.

We would not necessarily be selling directly to help them stock more of our product in their place of business, so that's not a big impact.

The challenge and the opportunity for us that is if our customers, when they make inventory for themselves to sell, if they're keeping that at low levels, that means they're keeping their production of all levels and therefore, their machines aren't breaking as often, they don't need the replacement parts from us.

If and when they say they're going to give back to more normal inventory stocking levels, that bodes well for production and that therefore bodes well for our opportunity to sell.

Okay.

Your assumption at the top end is just a moderate increase in production?

Yes.

Also we have stated in the past on some of these indices that are published, like the capacity utilization indices.

We've stated that we could lag that by several months, potentially.

That index has gone up in the month of November and up in the month of December.

We think that's also a good indication of our prospects for the first six months of fiscal 2013.

Okay, then, on long-term operating margins, if I'm thinking about the Company, if I'm looking at the back half of the year and I'm thinking that we're seeing minimal revenue growth, but we're still seeing improvements in gross margins and it seems like that ERP system is gradually taking hold, longer-term, do you see a normalized operating margin, say closer to 7.5% or 8% versus the 7% we've seen over the past few years?

I'll respond to that, also.

I think we expect to see improved margins.

We expect to see improved margins year-over-year.

We did state, over the summer in our three-year look forward, what I call an EBITDA margins up to the 10% level.

We still think that there's room to go for improvements.

Where do you think the biggest opportunity in terms of improvement is?

The SG&A line or the COGS line?

I think it relates to pricing.

It's all areas of the income statement.

I think the pricing the customers are buying of the products.

It's a combination.

It's a combination of scale and putting more revenue through existing operations, some improvement in gross margins, and holding the expenses in check.

Okay.

Thank you.

Joe Mondillo, Sidoti & Company.

Can you guys restate the acquisitions and currency effect on the top line?

Acquisitions were 4.4% during the quarter.

Foreign currency translation was a benefit of 0.4%.

Okay.

Thank you.

Second question, I was wondering if you could speak about your end markets; specifically that forestry products part of the business.

Are you seeing any benefit of this housing boom and also, how much does agriculture make of your business?

I'll take the first part of that, Joe, this is Ben.

Good question on the housing piece of it.

I think we mentioned on the last call that we were seeing an uptick and we were seeing it in our end markets and it's definitely continued.

We are seeing an impact on the industries we serve.

The lumber and wood products segment that we serve is doing very well.

There are a variety of industry segments that are impacted by housing overall.

It has a very large impact on the overall economy, so good growth there.

We're also seeing some good growth in transportation equipment segment.

Even though the overall activity in the December quarter was sluggish, we had 18 of the 30 industries we track were up in the quarter and housing and transportation were the two strongest.

Okay.

Thank you.

Agriculture, is that anything significant to your business?

I don't know that we've got the number in front of us.

When we think about our fluid power business and some of the services and solutions that they provide, we've got agricultural presence.

For those OEMs that are building some of those solutions, they're looking for more electronic controls on some of the equipment.

We see benefit in some of our fluid power subsidiaries that are focused on some of these ag markets and would see benefit.

But these are midsize, I don't have that as a rolled-up number in front of us.

Okay.

No problem.

My next question regarding acquisitions, just sort of bigger picture, it seems like you've spent $30 million two years ago, $15 million last fiscal year.

You've ramped it up to almost $55 million, I guess, or somewhere around there in the first two quarters of this year, so you're obviously taking more of an aggressive approach.

It seems like may be a little conservative to maybe some competitors.

But just a bigger picture, what the fragmentation of the industry looks like compared to a few years ago?

What that gives you for opportunities?

What is year annual goal internally for acquisition spend?

It's still a highly fragmented space.

If I compare industrial distribution to many other forms of distribution, it's still probably some of the most fragmented.

I think the four or five biggest players in this space are still probably only one-third of the business or the market available, so there's two-thirds that's still pretty fragmented.

There is a lot of opportunity.

We've got clear priorities from an M&A standpoint that we're executing, too, and will continue to be a disciplined acquirer as we go across.

We think we've got the opportunity to raise some of our sights on those, but we're probably not unlike some of the others on what has been or turned out to be the average size of acquisition in time.

We'll work and see if we can make that number a little larger going forward.

Are you actually trying to be more aggressive on the acquisition or is that just a coincidence of how the pipeline played out in last two quarters?

We've been active in our pursuit.

We're staffed, we work our pipeline well.

Management's involved in these.

I think the environment creates some of those.

We continue to look at what are the right fits to our priorities that we've identified geographically in our business segments and we work them.

You never perfectly control the timing, but I would say we'll likely, at least in count, be as active in the second half of the year as we were in the first half of the year.

I would expect that we continue to have the opportunity and the business performance and cash generation to be as active in our fiscal '14 as we were in '13.

Okay.

Last question, just regarding the hurricane in October, November, just wondering, you guys have a decent concentration in the New Jersey, Pennsylvania area.

Did that have any negative or positive effect, do you think?

Probably some negative.

We had some of our locations affected and were shut down for a few days.

Traditionally, we see the pick up in the following weeks.

It all happened within the quarter, so we didn't see a big impact.

I think for customers that were taken out for a while, right, we participated in their help of restoring their business and their productivity and that as well.

I'd say, for us, not a huge impact either way.

Okay.

Great.

Thanks a lot guys.

Jason Rodgers, Great Lakes Review.

Just to follow up on one of the questions of the previous caller, is there a way to estimate what percent of your revenues are housing-related?

Yes, it's a challenge.

We've talked about that and some of the segments are very easy; lumber and wood products, a large percentage of that goes in to housing.

Some of the other ones, when you get into the aggregates and asphalt and durable goods, our best estimate is we're probably about 10% of our business is impacted by housing and the activity in the housing industry.

It could be a conservative number, could be low-double digits, could be high-single digits, but roughly 10%.

That's helpful.

The only other question I had was on CapEx, if you have any change to your fiscal '13 plans?

Thanks.

No.

Our plans are still the same.

As I recall, we announced over the summer that our CapEx plan was around $13 million to $14 million for the whole fiscal year and we've spent about half of that so far.

On the other half.

Thank you.

Brent Rakers, Wunderlich Securities.

This is Anjali Voria in for Brent today.

I apologize if this has already been asked, but I was wondering if you could perhaps give us an update on your strategic growth initiatives?

Perhaps if you've made any sales personnel ads or product SKU adds outside of acquisitions or if there are any other growth initiatives you would call attention to?

We continue to work our strategic plan and our growth initiatives as we've laid out, what we look to do around our core business of selling more to current customers, reaching new customers.

We've been active in giving our field teams some electronic tools to help them do that, some data reports that would show them where some of the opportunities would be.

Mark talked earlier about some of the inventory that we're putting in place, some of the sales collateral and tools that help them from an execution standpoint.

I'd say our supplier engagement is very high, as well.

As we look to team with them to reach customers and bring some of these applications, so those continue.

We're working our own products expansion in two or three focused areas.

We outlined fluid power as a strategic initiative that we have and we continue to execute on that on the OE side with our subsidiaries and then what we do with MRO, had some addition with some specialists in that area, some technical support resources, just had the teams together, probably a week ago.

Good planning for the second half around fluid power.

We work continuous improvement and we see that in the margin and results.

Then acquisitions, we've been active and we plan to stay active and use the balance sheet and the good cash generation.

It continues, the strategic plan is just a good evolution and we're running it.

Okay.

That's great.

If I could just ask one housekeeping question, what did you enter headcount at the end of the quarter?

Also, on the other income line, is that primarily the unrealized deferred comp?

I will respond to the other income line, Anjali.

The unrealized gains or losses on our deferred compensation plan are down in that number.

It was a small number during the fourth quarter because equity markets were basically flat in the fourth quarter.

The majority of that number during our fourth quarter was currency translation expense items for that.

We'll have that detail in footnotes to our 10-Q when we issue that.

On the headcount, at the end of December our headcount was a little over 5,100 and increase over the prior-year was all from acquisitions.

Okay.

Perfect.

Thank you.

At this time, I'm showing we have no further questions.

I will now turn the call over to Mr. Schrimsher for any closing remarks.

Okay.

I want to thank you for joining us today.

We appreciate your interest, your investment in Applied.

We look forward to talking with you throughout the quarter.

Thanks for being with us.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.