Welcome to the Fiscal 2016 Second Quarter Earnings Call for Applied Industrial Technologies. My name is Christie, 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.

Thank you, Christie, and good morning, everyone. 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'll discuss Applied's business outlook during the conference call and make statements that are considered forward-looking. All forward-looking statements, including those made during the question-and-answer portion, speak only as of the date hereof and are based on current expectations that are subject to certain risks, including trends in the industrial sector of the economy, the success of our various business strategies, and other risk factors identified in Applied's most recent periodic report and other filings made with the SEC, which are available at the Investor Relations section of our website at applied.com. Accordingly, actual results may differ materially from those expressed in the forward-looking statements. The company undertakes no obligation to update publicly or revise any forward-looking statement whether due to new information or events or otherwise. In compliance with SEC Regulation FD, this teleconference is being made available to the media and the general public, as well as to analysts and investors. Because the 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 President and Chief Executive Officer, and Mark Eisele, our Chief Financial Officer. At this time, I will turn the call over to Neil.

Thank you, Julie, and good morning, everyone. We appreciate you joining us today. To recap our news release from this morning, our sales for the second quarter of fiscal year 2016 decreased 11.8% to $610.3 million from $691.7 million in the same quarter last year. Net income for the quarter was $23.9 million or $0.61 per share compared to $29.7 million or $0.72 per share in last year's second quarter. Our second quarter results reflect a continuation of the economic and market headwinds that have been affecting our business, including reduced demand in oil and gas and other industrial end markets, as well as negative impact of foreign currency translation. We will continue our disciplined approach to controlling cost and driving improved efficiencies across our business. Our teams remain fully committed to generating shareholder value in any economic cycle through our business performance, expanding our product, service and solution offering, and creating opportunities with current and new customers. In addition, we will continue to optimize our capital allocation through dividends, share repurchases and acquisitions. In this morning's release, we announced the company's board of directors declared a $0.01 increase in the quarterly cash dividend to $0.28 per common share. This marks the company's seventh dividend increase since 2010, representing a cumulative increase of more than 85% in the quarterly dividend over this six-year period. We were also active in share repurchases during the quarter with the purchase of 250,000 shares of common stock for $9.8 million. These actions demonstrate confidence in our ongoing cash generation and profitable growth strategies, as well as our steadfast commitment to increasing shareholder value. We're pleased with the recent acquisition of HUB Industrial Supply and we're active with the integration process. HUB is a distributor of consumable industrial products and is an excellent strategic fit that further strengthens and diversifies our Maintenance Supplies & Solutions business. The addition of HUB marks our third acquisition of fiscal 2016 and our second MSS addition of the fiscal year following Atlantic Fasteners in August. Acquisitions are an integral part of our overall growth strategy. And we will remain active pursuing strategic opportunities that extend our business reach and enhance our capabilities to expand with new and current customers. I'll now turn the call over to Mark for more detail on our financial results.

Thanks, Neil. Good morning, everyone. I'll provide some additional insight regarding our second quarter fiscal 2016 financial performance. Our sales per day rate during the quarter was $9.8 million, 11.8% below the prior-year quarter and 1.6% below our rate in the September quarter. We had 62 selling days in both the December 2015 and 2014 quarters. Acquisitions had a positive impact on sales of 1.8% during the quarter, and foreign currency impacts decreased sales by 3.1%. Therefore, overall core same-store operations experienced a 10.5% decrease in sales compared to the prior year. In addition, we believe the impact of vendor price increases was minimal during the quarter. Our product mix during the quarter was 26.3% fluid power products and 73.7% industrial products. Second quarter sales in our Service Center Based Distribution Segment decreased $61.6 million or 10.8%. Acquisitions added $6.6 million or 1.2%, and the negative foreign currency impact reduced sales 3.2%. Therefore, core same-store operations in the Service Center Based Distribution Segment experienced an 8.8% decrease. The majority of this relates to our operations that sell to the upstream oil and gas industry, as our other traditional operations had a decrease of only 1.6%. Taking a closer look at our operations that sell to upstream oil and gas customers, we experienced a 53% decline in our sales run rate from the December 2014 quarter and a 14% decline in sales from the September 2015 quarter. Our Fluid Power Businesses Segment had a broad-based sales decrease throughout the U.S. and Canada, totaling $19.7 million or 16.1%. Acquisitions within this segment increased sales $6 million or 4.9% while unfavorable foreign currency translation decreased sales by 2.9%. Excluding the acquisition and currency impacts, core operation saw a sales decrease of 18.1%. From a geographic perspective, sales in the second quarter from our…

Thanks, Mark. To summarize, we are committed to winning every day in any economic environment by focusing on our customers, being accountable for our results, generating operational continuous improvements, and working together all across Applied. It's our mini value-add capabilities that distinguish Applied, such as positively impacting our customers' owning and operating cost; providing engineering, design and systems integration for industrial and fluid power applications; and leveraging our expanded MSS offering and capabilities. We recognize our requirements in this operating environment, and going forward, we are taking the appropriate actions to serve all Applied stakeholders in this fiscal year and beyond. So, at this time, we'll open up the lines for your questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from the line of Matt Duncan [Stephens, Inc.]. Please go ahead.

Hey, good morning, guys.

Good morning.

Good morning.

First thing, Neil, can you talk about just the sales trends you are seeing in the business? And I'm particularly interested in what's going on in energy. Did you see the declines accelerate as you got towards the end of the year and maybe your customers' upstream budgets start to kind of run dry and might have put a little extra pressure on things? Just how did the trend line look through the quarter?

Yeah. I'd say from an oil and gas standpoint, our upstream on the producing side would have been in the mid 30s year-over-year decline. Our upstream on the drilling side probably in the low negative 60% year-over-year comparisons off pretty high marks that we would have seen. I think we anticipated there was going to be some timeout around with some of those operations and customers going through. So we did see – did see that softness and we're focused in and working with those producing operations, especially where we're better positioned in geographies like Permian Basin to continue to serve the work that is there. I'd say broadly across the company, we would have said or see October and November sales were consistent with the September quarter and then the sales per day decline in December was more consistent with what you'd expect with seasonal trends and holiday timeout. So, for us, looking forward into January, it's running similar to December. We've got some volatility across the segments and geographies, I think including some weather-related impacts, but I mean, we know – if you look at them more broadly over a time period, we have weather every year. So we think those work their way out as we progress through these final few days of January and on throughout the quarter.

Sure. Okay. Thanks. I appreciate that color. And the last thing from me and I'll hop back in queue. Just on gross margin, you guys continue to do a very admirable job there, especially when you compare what's going on with your gross margins to a lot of your peers who are seeing declines. How do you think you've been successful at keeping those sort of flat to up a little bit? And is there maybe a benefit from you having better data now that the SAP installations done and maybe that's helping you manage things a little better and offset some of the pressures? Just talk on what's going on there.

Yeah. I think – it's no one thing. Right? So data helps, discipline helps, try to have better guides and matrices and – as we talk, just reducing the variants across transactions is helpful. Knowing our value-add, knowing our cost to serve at each area, we believe, is important. And then we would have benefit from product mix as we expand out and we believe we have a customer mix benefit too, right, as we grow and participate and serve those local markets as well as larger accounts. We think all of those – not one thing but all of those contribute and help.

Okay. Thanks for the answer, Neil.

Thank you. Our next question comes from the line of Ryan Cieslak [KeyBanc Capital Markets]. Please go ahead.

Good morning, Neil and Mark.

Good morning.

Good morning, Ryan.

Neil, I was wondering if you could maybe first provide maybe some more color on what you guys are expecting or what's implied in your updated guidance for the back half of the fiscal year with regard to the oil and gas headwind on top-line trends.

Yeah. I think we would look at perhaps consistence. So I'll talk about overall. If we look at the low end of guidance, it's got a sequential rate from the second quarter at a 3%, 3.5% type decline. At the upper end of the range, it has less than 1% positive in there. We know traditionally we do see a second-half improvement, but we're not counting on that to occur. So we're very focused on how we help ourselves with current customers and expansion efforts but also reaching and serving new customers. I mean, our dialog in our business, slowing times also create opportunities, especially in our engineering-related businesses, those teams then have the opportunity to take time and step back and look at technologies and solutions that we can be engineering in. And so we're seeing that work go on in our Fluid Power Businesses right now. And then on our MRO side, customers can still be performing well and have cash for productivity projects. It's our jobs to be in there connecting and bringing more of those forward, and we'd be looking to do that in traditional bearing and power transmission but also fluid power for those MRO customers.

Okay. And Neil, those percentages that you quoted, those are from the end of the December quarter. Is that right? Did I hear you right on that?

Correct.

Okay. And then the other question I had, Neil, when thinking about the MSS business that you guys have, obviously some acquisitions are helping there, but what can you maybe give some color around the organic sales trends you're seeing in that business? And are you – do you feel like there's some cross-selling opportunities now that you are building that out, that are coming to fruition, following the last several acquisitions you made in MSS?

Yeah. I would say there is some segment in some of the businesses that we don't – or that we're not serving. So I've set those aside, which I don't give the teams to pass for that, but if I set some of those aside, we are seeing growth. And then as I think about the business, I like our opportunity to have a vendor managed served (21:50) solution. I like our customer managed serving options that we have. We are enhancing our electronic capabilities to serve those customers, and we started to participate in what would be the MRO production side of it. So, for manufacturers using some of those supplies and components and fasteners in the production of those products. And we could define this space really big. Right? It can be a $30 billion market. So, in many respects, we think we're just getting started and we are seeing synergies across where we have good representation as traditional Applied with customers to be bringing in those products, services and solutions now with maintenance supplies and solution. So those are not cold calls for those type of businesses in serving operations.

Okay. Great. And then the last question I have is on the HUB Industrial acquisition that you made. Maybe just some color on the size of the business, maybe the margin profile. I think there was some commentary about its ecommerce platform and how you guys look to leverage that going forward. I would be interested to hear maybe some detail around that. Thanks.

Yeah. Kind of work backwards. They do have a very good ecommerce platform. Perhaps there's some leverage, I would say, hey, right (23:15), we continue or we'll work our own in that. And so we'll work it separately and decide or look forward to where there is – where there's some synergies. I think size-wise, probably the way to look at it is roughly a 1% type sales impact a day. Obviously, we're going to want to grow that going forward, and then from a margin side compared to our traditional margins, it's accretive.

Yeah.

Thanks, guys.

Okay.

Thank you. Our next question comes from the line of Adam Uhlman [Cleveland Research]. Please go ahead.

Hi, guys, good morning.

Good morning, Adam.

I guess, Mark, the first question for you. I think you mentioned that you brought up inventories in the quarter to participate in some supplier incentives perhaps. Could you maybe talk through that – if that is correct and then how we should be thinking about gross margin through the remainder of the year as you release some of those incentives?

Yeah. I think – let's talk first about the gross margin. I mean, our expectation is that our gross profit percentage, as we go forward for the remainder of the year, will be stable, but we see upside opportunities with both customer pricing strategies as well as supplier support for those things. And supplier support comes in many ways. Some of the specific inventory acquisitions that we did around calendar year-end is to help partner with certain strategic suppliers and it's not necessarily going to provide us an overall improved gross profit percent going forward, but it helps us maintain the stable gross profit percent and also gives us an opportunity for potentially doing better.

Okay. Got you. And then, on the operating expenses, I think you mentioned that they're running down about 12% year-over-year, excluding the acquisitions, which is pretty strong considering that Applied is a very lean company to begin with. Should the economic conditions deteriorate further from where we're at right now? I'm just wondering how much room you have left to reduce expenses if demand gets quite a bit worse from where we stand right now.

Adam, I'd say, we continue to have operating reviews with the team. We've got accountable, responsible leaders. You look at all of your cost and look for opportunities for the environment that you're in. So – and what I'd say is we're not without opportunity, and so we'll be mindful of our cost like we have been, but we think we also have other opportunities to help ourselves in even a slowing environment around sales and around margin too. But some might say you can always take a bite out of the cost apple, and we'll be responsible in our spends and our cost.

Okay. Got you. And then just a clarification. Could you remind us how big the MSS business is today on a run rate basis with all the acquisitions folded in? Thanks.

When you factor in the run rates of the acquisitions, they are just short of $100 million.

Okay. Thank you.

Thank you. Our next question comes from the line of Charles Redding [BB&T Capital Markets]. Please go ahead.

Hi, good morning, guys. Thanks for taking my call.

Good morning.

I just wanted to clarify to make sure we couldn't expect any changes to full-year CapEx spend and then maybe how we think about your desire to spend for operational efficiency in the current environment.

I'll start with the CapEx there, Charles. Our perspective is, we spent a little under $6 million in the first half of the year. We expect to spend a similar amount in the second half of the year for CapEx, and no huge changes with that.

Okay. And -

And I think on the – on the operational improvements, I would say, no significant investments to do that. Obviously some may have, but we're very focused with those teams. Right? You time (28:18) to the benefit and to make sure that you get the appropriate return, but there aren't huge investments we're making (28:27) there.

One other thing just to mention that we've talked about in the previous calls and things is that we are investing in the new applied.com platform. And so that's one thing that we would expect to have, let's say, up and running sometime over the summer, and you could view that as a nice operational improvement going forward too.

But that -

Got it.

In the numbers (28:53).

Built in our numbers already.

Yeah.

Got it. And then I know previously you've discussed you need to expand internationally kind of as a strategic objective. Just based on the current environment, has this objective evolved? And really what's your current take on major foreign markets relative to the U.S. right now?

If I look market back at U.S., North America and really Australia and New Zealand, our served markets, we have a lot of opportunity to run our businesses from an organic standpoint and we'll have acquisition opportunities in those served markets. We continue to look and have dialog in, I would say, near-adjacent markets in those. But if I had to look going forward, not necessarily in this environment, but at this time, I'll look going forward with the opportunities, our pipeline is a lot more U.S., North America and in our current served markets to our priorities in businesses that we're in and around, then it would be going to new-born markets.

Understood. Thanks again.

Thank you. Our next question comes from the line of Brent Rakers with Thompson Research Group. Please go ahead.

Yes. Good morning. Maybe as much, just clarification of couple earlier questions and comments, but – you guys talked about the monthly sequential patterns, I think November, December and then December to January. I was hoping you might be able to frame that a bit differently and maybe talk a little bit more about organic year-over-year trends in December and then if you're seeing any change on the year-over-year pattern in the January month.

I'll start with that, Brent. I think January is looking a lot like December. I don't think we've seen a lot of change in that. Like Neil mentioned earlier, you have some of that seasonal impact in December for the year-over-year things, but we're not seeing a big difference there in the month or for the quarter.

Okay. Okay. And that, Mark, implies that the – I mean, I assume December is probably the weakest daily sales month of the year. Is that fair or -?

That's a fair statement. Yes. One of the weakest. I can't say it's the absolute weakest, but definitely one of them.

So, by saying that the – you say sequentially that the dollars are the same. Does that imply that January on a percentage basis is weaker or are you talking about the growth rate being comparable?

Yeah. I would say, Brent, as we look at it, we've talked to volatility and that coming across. So I'd say it is running similar to December. Obviously, we get in behind it. There are businesses and geographies that are showing positives and then they're showing declines. And so we've got a round of operating reviews that we will be going through right at the end of January, just to understand. But as we watch it, some guys are caught a little bit more with weather than others. Some are caught as we look at some end customers taking perhaps some extended timeout from end of their calendar year to start their calendar year. And I think we've got customers that are looking at their own capacity or their manufacturing footprints. And they're not necessarily taking all capacity out, but where they're going to do what, I think customers are making some choices right now as depending on the end markets they serve and kind of that overall industrial outlook or market that we're participating in right now. So we think that's all into that January-type result that we're seeing so far.

Okay. Okay. Great. And then switching back again to the oil and gas businesses, and I know you didn't own many of them to show an organic growth rate in the second half of fiscal 2015, but obviously that's kind of the time that the oil and gas business started to first really weaken. So I was hoping you could maybe give us some color on Reliance and Knox in particular, the second half of 2015, to kind of see what the levels of decline were last year, just so we get a better understanding of what we're working against from a comparison basis there.

Yeah. Let me start with that. The December 2014 quarter for our oil and gas focused subsidiaries was their largest sales numbers that we saw. As we rolled into January a year ago, we did see a small decline in their December run rates, but it wasn't off the cliff in the month of January. It was down 10%, 15%, let's say. And then we saw that decrease continue throughout the March 2015 quarter. And from that point in time, we saw the sales for our subsidiaries that focused on selling to producing well type customers relatively stable for several months going forward, whereas the subsidiaries that focused on selling to drillers, they continued to see a drop-off in their sales even as we got past March 31. And their sales run rates today really are mirroring what the rig counts are. Rig counts are down in the mid-60 percentages, and so that's where we're at too for those folks.

And so I guess the follow-up to that, Mark, so the producer side of your business, that held pretty stable to the March quarter. Did you see the weakness there start occurring in the June quarter?

Well, the producers did see a decline through March, but I would say that they are currently running about 30 – mid-30 percentages, like 35% down from the prior-year peak. And the prior-year peak was the December 2014 quarter. We got down to that run – close to that run rate through March and that was relatively stable through September of 2015, but then they saw a 10% reduction from the September through the December 2015 quarter from their numbers.

Okay. Great. And I'm sorry, just one last just housekeeping question. Do you have the quarter-end head count numbers for the company?

Yeah. At December 31, 2015, we stand at 5,716 associates.

And that does not include HUB yet, correct?

That is correct. They were purchased January the 4th.

Okay. Great. Thanks a lot.

Thank you. Our next question comes from the line of David Stratton with Great Lakes Review. Please go ahead.

Good morning. Couple of housekeeping questions for you. With your new facility, your credit facility, what does that leave you with the percentage of fixed to variable rate debt?

Yeah. David, we didn't really change that for the actual debt that's on the books, because while we increased the capacity from $250 million to $375 million, we didn't really increase our borrowings. So, today, we're about 50/50 for the actual borrowings outstanding about how much is fixed rate and how much is variable rate. The total amount of fixed rate debt is $170 million, and we're around $360 million to $370 million of total borrowings. So the remainder is variable rate borrowings. So the new bank facility didn't change that percentage. It just gives us an opportunity – when we need to do further borrowings, then the variable rate percentage would increase.

All right. And then the average interest rate, is that still around the low 3%s?

For the fixed rate debt, it's 3.2%. The variable rate debt took a small increase during the month of December when the Fed increased the interest rates. We're running at about 1.35% today for that debt.

Thanks. And then one last thing. Would you mind updating us on the 30 industry performance variables you track?

Yeah. I'd say, overall – let me see. 14 of the 30 industries had growth in the quarter. I think you would see that in the ones you would expect around construction-related industries, like lumber, wood products, aggregate, building materials, along with transportation and food. So those would be the ones – or some of the ones with the positives.

All right. Thank you.

Okay.

At this time, I'm showing we have no further questions. I will now turn the call back over to Mr. Schrimsher for any closing remark.

Thank you very much for joining us today, and we will look forward to talking with many of you throughout the quarter.

Thank you, ladies and gentlemen. This concludes today's conference. Thanks for participating. You may now disconnect.