00:02 Welcome to the Fiscal 2022 Second Quarter Earnings Call for Applied Industrial Technologies. My name is Shelby, 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. 00:32 I will now turn the call over to Ryan Cieslak, Director of Investor Relations and Treasury. Ryan, you may begin.

00:36 Okay. Thanks, Shelby and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing our second quarter results. Both of these documents are available in the Investor Relations section of applied.com. 00:53 Before we begin, just a reminder, we'll discuss our business outlook and make forward-looking statements. All forward-looking statements are based on current expectations, subject to certain risks, including the potential impact from the COVID-19 pandemic, as well as trends in sectors and geographies, the success of our business strategy and other risk factors. 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. 01:24 In addition, the conference call will use non-GAAP financial measures, which are subject to the qualifications referenced in those documents. Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer; and Dave Wells, our Chief Financial Officer. 01:39 With that, I'll turn it over to Neil.

01:41 Thanks, Ryan and good morning, everyone. We appreciate you joining us and hope everyone is doing well. I'll begin today with some perspective on our second quarter results, current industry conditions, and our expectations going forward. Dave will follow with more specific detail on the quarter's performance and provide some additional color on our outlook and guidance, which we raised this morning and I will then close with some final thoughts. 02:10 Overall, we reported a strong second quarter that highlights the enhanced earnings potential across Applied. We achieved record second quarter sales, EBITDA and EPS with respected growth of 17%, 36% and 49% over prior year adjusted levels. We are benefiting from a solid fundamental backdrop, as well as our team's consistent execution across strategic initiatives. These dynamics are increasing our growth momentum and returns on capital across Applied. 02:46 I want to thank our entire team for their ongoing effort and focus on optimizing and positioning the company to achieve these results. It's rewarding to see as we continue to leverage our leading technical industry position. As it relates to the quarter and our views going forward, I want to emphasize a few key points driving our performance. 03:10 First, underlying demand and sales growth accelerated as the quarter progressed. Second, our team is responding and executing well in the face of ongoing supply chain and inflationary pressures. And third, our enhanced operational capabilities and organic growth potential leave us increasingly favorable with our outlook. 03:34 In terms of underlying demand, trends will broadly positive across both segments during the quarter. Sales growth exceeded our expectation, with strength persisting each month, including strong sales activity during December. We saw a strong year end budget and capital spending across our customer base, strength was broad based across our…

11:32 Thanks, Neil. Just another reminder before I begin. Consistent with prior quarters, we have posted a quarterly supplemental investor presentation to our investors site for your additional reference, as we discuss our most recent quarter performance and updated outlook. 11:46 Turning now to our results for the quarter. Consolidated sales increased 16.7% over the prior year quarter. Acquisitions contribute 1.6 percentage points of growth and foreign currency drove a favorable 30 basis point increase. This was partially offset by one less selling day over the prior-year period, was negatively impacted sales growth by 1.6 percentage points. 12:12 Netting these factors, sales increased 16.4% on an organic daily basis. Average daily sales rates increased roughly 3% sequentially on an organic basis versus the prior quarter. As it relates to pricing, we estimate the contribution of product pricing on year-over-year sales growth was between 230 basis points and 270 basis points in the quarter. As a reminder, this assumption only reflects measurable top line contribution from price increases on SKUs sold in both year-over-year periods. 12:46 Looking at sales performance across our segments. As highlighted on Slide 6 and 7 of the presentation, sales in our service center segment increased 15.1% year-over-year on an organic daily basis when excluding the impact from foreign currency and one less selling day in the quarter. 13:05 On a two-year stack basis, segment organic sales were up nearly 5%, an improvement from fiscal '22 first quarter trends. End markets such as machinery, lumber and forestry, mining, food and beverage, and pulp and paper had the strongest growth on a two-year stack basis during the quarter. We are also seeing ongoing demand improvement across heavier industries, including primary metals, energy, and transportation related verticals. 13:33 Within our Fluid Power & Flow Control segment sales increased 22.9%…

22:12 Thanks, Dave. So to wrap up, we feel very good about the momentum building across our business today. We're delivering on our commitments and moving closer to our interim financial objectives of $4.5 billion of revenue and 11% EBITDA margins. While supply chain inflationary and COVID-19 related challenges continue to present some uncertainties entering the second half of the fiscal year, our team is executing at a high level with strong engagement and alignment, across our growth and margin strategy. 22:48 Bookings within our service center network remained broadly favorable with increasing demand across heavier and later cycle end markets, such as metals, mining and machinery. In addition, backlog within our fluid power and automation businesses is at record levels, and we continue to see incrementally positive signs emerging across longer cycle areas including specialty flow control. 23:14 We also believe our diversification and expansion in the verticals such as technology, life sciences, and hygienics are enhancing the breadth and sustainability of our growth trajectory. Greater evidence of manufacturing reassuring and investment in U.S. production capacity are other encouraging signs, this includes recent announcements for domestic capacity additions across the semiconductor space. 23:42 Our team remains focused on fully leveraging our industry position, addressable market and enhanced internal capabilities to drive stronger organic growth across our business. We are seeing this emerge in our results, providing encouraging evidence of the opportunity that lies ahead. 24:04 From critical break fix MRO support at a local level to an expanding portfolio of emerging technologies and specialized engineering solutions, our products, services, team and value proposition had never been stronger, as customers deal with an aging technical workforce, equipment optimization initiatives and increased manufacturing investment across the U.S. 24:33 Lastly, we enter the second half of fiscal 2022 with our balance sheet and liquidity in a solid position to support strategic M&A opportunities. This includes an active and building pipeline across our key priority areas of fluid power, automation and flow control. We're maintaining a disciplined approach as we focus on assets that drive strong double-digit returns on capital and enhance our competitive position, while increasing our differentiation and growth potential long-term. Overall, I'm very encouraged by what I see developing across our company. Once again, we thank you for your continued support. 25:14 And with that, we'll open up the lines for questions.

25:19 Thank you. We will now begin the question-and-answer session. Your first question is from Adam Uhlman of Cleveland Research.

25:44 Hey, guys. Good morning. Congrats on the solid performance. Couple of questions here for you. First of all, the price realizations been pretty strong. I guess, where do you see that unfolding here over the next few quarters? And then, the gross margins are expected to stay strong as well into the next quarter. I'm just wondering, if you could remind us kind of what's your longer-term goals are of gross margin expansion?

26:19 Yeah. So Adam, I'll start, and thanks. I think in the quarter just very strong execution on margins across and team executed well on point of sale in pricing. I think it goes back to good practices, leveraging our systems, focus on variation. I think we had a good understanding of inflation that was coming at us and its impacts on costing, moving average cost, replacement cost. So good execution on that side. I think contributing to margins was overall mix. I think the teams did a nice job, at supporting customers, we're seeing strength in local customers, so that's beneficial on a customer mix side. But also as we sell more technical solutions and services in that, it helped us on that product service mix in the side. I think good recognition and performance around freight and in some other areas on that. 27:19 As we look forward at margins, right, they have laid out expectations there for the second half. We could see mix from perhaps a little bit of the international market contribution be slightly less in the area, but still very good performance across the business. And then on the ongoing targets, I mean, we just target on an annual basis, continued improvement in that side and right if you go back and look at us from 2016, 2017, we increased 100 basis points in that period. In '20, we had some good performance and the ability to hold margins in those times. And we feel like we're executing very well and so gross margins will just be one of the components that will play in and contribute to our view of reaching the 11% EBITDA margins and beyond.

28:17 Okay. That's great. And then it seems like inventory availability has been a competitive advantage for you guys. How should we think about like further inventory growth here in the second half of the year?

28:32 Yeah. We would expect inventory to continue to increase in the second half, be a use of cash in the side, we think that's important as we work with our suppliers. But also look to insulate our customers from some of these supply chain dynamics. I mean, our view is, this is the opportunity, this is the need when quality distribution performs in these times. So we would expect inventory to continue to increase. But we're focused, we're engaging with our suppliers, what products make most sense, understanding backlogs, understanding SKUs, any increased lead times and productions in the side. So it's just not putting in any inventory, our SKU is to put in the right inventory across our supplier base.

29:26 Great. Thank you.

29:28 Your next question is from David Manthey of Baird.

29:34 Thank you. Hey. Good morning, guys. First question, Neil, you touched on this a bit, in terms of capital allocation. And I remember couple of years ago, you told me, prefer not to go below 1.5 times net leverage, given your opportunity set. Could we see more aggressive share repurchase in the near term or are you just tend to sit on more dry powder today, given the pipeline that you referred to?

30:05 As we think overall, I mean, one, we will continue to look at organic growth opportunities that we have and make right smart investments. With that said, the business doesn't have high, high capital intensity in those requirements but we intend to generate great returns. In the quarter, the Board -- we increased the dividend, and so that's the 13th increase since 2010, we will continue to look at that modest share repurchase activity there, really just to look at accrete or any dilution on that side. And so we think in this space there -- it is an attractive M&A time we’re busy on that front. And so we're at a healthy -- we have a healthy balance sheet, we're at a good position. We think our optimized leverage across a longer term is more 2.5 times, with the ability to go over and migrate back. We are under it right now, but we'll continue to look for right M&A and then right ongoing capital deployment as we work through the cycle.

31:22 Okay. Thank you. And second, there is a lot of positivity here around the quarter and the outlook. But as you look over the past 100 days and sort of think about the future. Were there items either internal or external, that didn't quite go as well as you planned? Just what are you focused on in terms of opportunities here over the next quarter?

31:50 Yeah. So I think about the performance and the results, I mean, there was really broad-based contribution in the side. And I've shared it with the team, there is a lot to feel good about in it. But it is a broad belief across the company. With that said, we still have many opportunities going forward. And so we think about underlying demand dialogue with our customers. I think in many respects, the mid to later cycle the heavy industries are just getting started in this similar with near shoring and re-shoring. 32:33 From that perspective, I think about the CapEx cycle, it's really below long-term contributions as a percent of GDP. I expect that to move up. I think many companies are going to be making investments in the side. So I can -- there is a good industrial end market for calendar 2022 and 2023. We talk about even infrastructure, those contributions haven't started yet and we know those monies will come in and benefit heavy industry. And then we take on our technology side, our backlog across fluid power expanding in flow control and our automation opportunities and how we can connect that to with our legacy position across many of these end-market segments. We think we're in a very good operating environment for a good period of time.

33:33 Sounds good. I suppose if Intel drops $20 billion into Ohio that can hurt either. So, best of luck, Neil.

33:42 All right. Thanks.

33:45 Your next question is from Chris Dankert of Loop Capital.

33:57 Hey. Good morning, guys. I guess looking at the automation growth, 25% organic very impressive. And I fully appreciate where the scale is today, were pretty early days. But I mean how does that 25% growth kind of compare with what the team had been expecting here? I mean, we kind of trending ahead of what you really been looking for end of the quarter?

34:15 I would say, as we think about it in the quarter, a little ahead of expectations so pleased. I think there is great engagement with customers, more ability to get on-site and commission and pull projects through with the end customers on their side. And good work between sales engineers and application engineers on new solutions and teaming with other areas of the business, whether it'd be in service centers or other aspects on working new opportunities. So I'd say a perhaps a little bit ahead, still those businesses working with some supply chain constraints at various times, that can impact project timing. Not great moves but can impact some project timing. So pleased, encouraged by the backlog in the building momentum across that space.

35:10 Got it. Glad to hear it. And then you touched on analytics is being a contribution to some of the gross margin execution here. I guess, going forward, what's kind to the additional investment in analytics that could be helpful here. I mean, AI, is it kind of helping improve the speed and cadence of repricing, are there kind of other opportunities for investment there in the medium-term?

35:33 If we talk about, I think there is greater use for automation and intelligence across the business, but aren't -- they're not going to be high, high investment requirements. And so, I mean we'd have work today with robotic process, automation in various other businesses that can help us in back office streamline and just be more productive and effective. We have the ERP systems, and data analytics to think about price and products and customers and variation, so we continue to use those on the front. So, and then the other use of analytics is around market opportunities. And where we're at with customers and geographies and how we can just bring forward more of our expanded solutions to them, to address their needs, whether it would around their aging technical workforce, their need to deal with regulations or increase productivity requirements. We're able to help on those fronts. And we're going to continue to use data and analytics to contribute to that and our teams engage with those customers on a local basis.

36:50 Got it. I mean, would you say that some of these tools have really helped apply get paid for the value-added services that you've been providing for years and know it's always been kind of a tough thing to quantify, have that actually got easier to kind of sell the value these days?

37:08 I think we've done a good job looking back, and we continue to know the value of the solutions, the problems that we're solving. And the --how to appropriately price accordingly in that. I think the analytics are helping us with opportunities in identification and then how we can accelerate those with our customers and in solving those problems.

37:35 Got it. Yeah. That makes sense. And then last one from me, I guess, generally speaking, you guys haven't had any trouble attracting and retaining talent. But I guess, just given the current market, any comments on kind of the state of play for labor and cost to keep and bring people onboard here?

37:53 I believe across the business we continue to do a very good job. We've made the investments in our HRIS, (ph) our information systems, things we do and a learning management systems for growth and development. And so I believe we're very good at appropriately the right track recruit stages. And also what we're doing for associates on ongoing development and career opportunities in that. And so across the Board, teams are doing a very nice job, we're active at universities and internships and in the space. So in physical distribution, logistics, I mean, we're not immune to it. But I contend we're performing very well in this environment and I think that shows in our overall results.

38:43 Got it. Glad to hear it and better luck in the back half year guys.

38:47 Thank you.

38:49 Your final question is from Steve Barger of KeyBanc.

38:56 Hey. Good morning, guys. This is Ken Newman on for Steve.

38:59 Good morning, Ken.

39:02 Good morning. I just wanted to first ask about the SG&A leverage, that it seems to be slightly weaker into the third quarter versus second quarter. Obviously, gross margins came in better at the second quarter. I'm curious if you can help us understand how much of the margins for third quarter is just cost catching up the price versus maybe incrementally worse mix or a roll-off in efficiency gains?

39:28 You guys have factors to play there, Ken. I mean, certainly you have the focus there is to take effect on January 1. There are factor, the deposit sequential step-up as we move from Q2 to Q3. Also, when you think about the comp issues, we were still lapping some of the prior year cost actions in Q2, that normalizes for the most part in Q3 as they start to roll-off. So a little more pressure on the year-over-year compared if there. And then they certainly see a volume impact that you see your volume setting-up pretty significantly as we move from Q2 to Q3, just given the statistical seasonality that we'd see, plus the continued stronger demand within that. So those are really the three factors that come into play along with some additional headcount investment in T&E to capitalize on some of the opportunities and drive that growth. So all of that kind of gets us to that high 180 number in terms of SG&A expectations for Q3.

40:30 Right. And when I think about the price increases that you announced for this quarter, I mean, can you rank the vendor price increases by type. I'm just, I'm curious where you're seeing the biggest increases across the portfolio?

40:44 I don't know that I have it signed any specific product category, I'd say it's pretty universal, the increases that have been coming through in the side. So I don't think there is one area that's standing out above the other.

41:04 Okay. I think someone earlier in the call, asked a question about or had mentioned the Intel plant here in Ohio. And I just wanted to know, I know it's a year or two out, but is there any way for you to kind of frame the opportunity set for a project of that magnitude? How do you envision approaching something of that size from an organizational standpoint?

41:27 Yeah. It may be a little earlier to size it, but it's going to be -- it's large size. But it's similar to other industrial investments in projects that would go on. From our standpoint, some of that will be original OE equipment and provider, so our participation would be with them, as that volume increases. And then naturally as the site is up and running over periods of time, it creates its own ongoing maintenance and break fix requirements in doing it. So it's in front of us. I think it's exciting. One, the overall investments in the semiconductor space, I think that's going to continue, whether it lands in the West and in Arizona or other markets, it's going to pull greater cloud computing requirements, 5G requirements. And in the case of living here in Cleveland, it's good to see investment that will come to Ohio and leverage the technology base and employee expertise that resides within the state.

42:36 Right. And then just last one from me, obviously, we're seeing supply chain constraints kind of persist here. We've heard customers talk and complain about the availability for bearings and machine parts. And obviously there is still complaints about electronics and semiconductors. Can you give any color as to where you're seeing the tightest availability for parts as it relates to your business? And just how you think about, if there was any revenue that's kind of being pushed out a quarter due to these -- due to the tighter conditions?

43:13 There would be areas in the backlog that I would say, we go across the product categories. We are closely linked with those suppliers on not just providing demand signals, but the right order signals to go through and work with them. And that's really been a driver in our increase in inventory from a U.S. standpoint, a 11% year-to-date. I would expect that number to continue. Now some of those orders or products that are coming in turn quickly to the marketplace, as it would go through, so we are engaged with our suppliers, but also close to our customers and understanding their needs. And not just letting demand pyramid in the side, we're meeting their needs as it goes across.

44:04 Very helpful. Thanks.

44:06 Thank you.

44:08 I'm showing we have no further questions. I will now turn the call over to Mr. Schrimsher for any closing remarks.

44:15 I just want to thank everyone for taking time, joining us today and we look forward to talking with many of you throughout the quarter. Thanks for being with us.

44:24 Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.