Welcome to the Fiscal 2018 Second Quarter Earnings Call for Applied Industrial Technologies. My name is Kristina, 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. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Julie Kho. Julie, you may begin.

Thank you, Kristina, and good morning, everyone. Our earnings release was issued this morning before the market opened. If you haven't received it, you could 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 this 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 various industry sectors and geographies, the success of our various business strategies and other risk factors provided in our press release and 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 notifications 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 Dave Wells, our Chief Financial Officer. I will now turn the call over to Neil.

Thank you, Julie and good morning, everyone. We appreciate you joining us. I'll begin with a brief recap of our results. Our sales for the second quarter grew 9.7% to $667.2 million from $608.1 million in the same quarter a year ago. Net income for the quarter increased 28.5% to $31 million from $24.1 million, and earnings per share rose 29.5% to $0.79 per share compared to $0.61 per share in the prior year quarter. Our second quarter results reflect broad-based execution across our business groups and a productive economic market environment. Overall, we’re off to an exciting start to the calendar year and our fiscal year second-half, celebrating 95 years of leadership and industrial distribution, and further strengthening our position with the definitive agreement to acquire specialty flow control provider FCX performance Incorporated. Just yesterday, we were granted early termination of the Hart-Scott-Rodino waiting period with respect to the pending acquisition of FCX. We’re pleased with this latest development and now expect to close the transaction on January 31, 2018. Also today, we announced that our Board of Directors raised the quarterly cash dividend at $0.30 per common share, demonstrating our cash generation and commitment to increasing shareholder value. Now with a closer look at our financial performance for the quarter, here is Dave.

Thanks, Neil. Good morning, everyone. I’ll now move on to provide some additional insights on our second quarter fiscal 2018 financial performance. Starting with top-line, our daily sales rate improved 1.2% sequentially from the September quarter, and was 9.7% higher than the prior year quarter. Acquisitions had 0.9% positive impact on sales and foreign currency translation provided a 0.8% benefit. The number of selling days in the quarter was consistent year-over-year. Looking now at segment results. Second quarter sales in our service center-based distribution segment increased $41.3 million or 8%. Acquisitions within this segment increased sales by $0.9 million or 0.2%, and favorable foreign currency translation increased sales by $4.7 million or 0.9%. Excluding the impact of acquisitions and currency translation, organic sales increased $35.7 million or 6.9%. The most recent quarter service center segment results benefited from positive growth in all businesses and geographies. Sales from our U.S. fluid power business segment increased by $17.8 million or 19% year-over-year. Acquisitions within this segment drove 5.1% of the sales increase. Excluding the impact of acquisitions, sales increased by $13 million or 13.9%. From a geographic perspective, sales from the quarter for our U.S. operations were up 9.5%, including a positive impact from acquisitions of 0.9%. Excluding the impact of acquisitions, U.S. sales were up 8.6% organically. Sales from our Canadian operations increased 8.5% with favorable foreign currency translation generating 5.2% of this increase. Consolidated sales from our other country operations which include Mexico, Australia, New Zealand and Singapore increased 14.2% compared to the same quarter in the prior year. Acquisitions drove 2.3% of this increase in favorable foreign currency translation increased other country sales by 3.8. Excluding the impact of acquisitions and currency translation, other country sales were up 8.1% compared to the same quarter in the prior year. Our…

Thanks, Dave. Through our business execution and strategic investments, we continue to strengthen our differentiated industrial distribution capabilities. Including our critical core products offering, expanding value added services, leadership and engineered fluid power solutions, growing geographic reach and channels to market. At 95 years, Applied is well-positioned as the technical MRO distribution leader, and we're committed to generating profitable growth and enhancing value for all our stakeholders. With that, we'll open up the lines for your questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Ryan Cieslak from Northcoast Research. Please go ahead.

Thanks. Good morning, guys. My first question Neil, maybe you can just provide some detail how the quarter progress with regard to the sales growth rate, and any color you can give on January so far? I know there has been some weather impact, it seems like for some distributors, any color around that and what you guys are thinking so far here, I guess year-to-date?

Sure. On the sales per day trends in Q2, we know it improved overall around a 120 basis points. Really the development from October to November, we had improvements and really throughout most of November just right up until or between the holiday period. Then month [ph] a day January has continued as expected, mid-single-digit increase year-over-year of low single-digit compared to kind of the December and but again not surprising given the quarter-end closing around December in that site. So, for us this time a year right, you get weather, and we just working our way through it. We got good weather geographies in some of our markets too, and we'll look to make them most of those.

Okay. And then on pricing Dave if I heard you right you said you are seeing supplier inflation come through, maybe just talk a little bit about maybe the magnitude of that inflation that you are seeing right now and if you have been able to sort of pass that along successfully. And what type of benefit should we expect maybe on the top-line from pricing and just for larger inflation here going forward?

Sure. Again, I'm going to remind you about the variability and you can have quarter-over-quarter, year-over-year SKU sales, it's really less than a quarter of those that repeat year-over-year but looking at the -- we do have a like match, just to understand the impact of both the supplier price increases and we've been able to pass on in terms of that price. We're seeing about to have a low three in terms of inflationary impact income 3% up in terms of the supplier price increases. Those seem to be starting to level off at this point in terms of what being passed on to us. Here again, we work to pass those on and are largely offsetting those through a combination of pricing and work with our suppliers on supplier programs et cetera, where we can't get that price immediately. So, I'd say kind of doing a good job in the business and offsetting that impact, and see that inflationary impact starting to stabilize, as we move to the quarter.

Okay, great. And then, I guess my last question and I'll hop back in the queue. So, the gross margins, it sounds like it was some impact there from changes in LIFO in the way you are counting there with regard to the inflation, and certainly some of the mix impact as well. How do we think about the back half of the year now for gross margins in the context of some of the growth you’re seeing there for those large accounts and pricing? And Neil is the expectation that you still have the ability to see that I think in the past, you talked about 20 to 30 basis points or so of margin improvements, that still good bogey, once things settle out? Thanks

Yeah, right. I'll start, and I would say, we still have the objective to grow margin 20 to 30 basis points a year, and clearly view we have the potential to do that. So, flat sequentially as we move through. We understand Dave talked about some of the rising inflation and given the LIFO treatment that came in. I think all-in-all across our business groups, many good job of matching and passing through we increases as we think about the point of sale side of it. And then the mix that he alluded to or talked about a little bit, I think we just had the nice growth with some larger accounts. We also had nice growth with all other accounts as they would go in that just slightly higher in this quarter with a few of the larger accounts. And so, going forward, team has got the right line of sight, and we know we have opportunities around point of sale, reducing variation and customer groups and across product types and we believe continued growth, customer mix can help us also product mix can help us as we go through in that, so that what we would say, it is the right goal, it is the right objective for us to have. And then, I think about in some of our groups with value added services that margin potentially exist there as well.

Thanks, guys.

Okay.

Your next question comes from Jason Rodgers from Great Lakes Review. Please go ahead.

Could you talk about the oil and gas markets and how much that contributed to the sales increase in the quarter and what your outlook for that market is going forward?

Sure, on the oil and gas markets, continue to be productive for us, for the quarter that did drive just over a point of our overall growth. We expect as we continue to see and look across the next couple of quarters, continued productivity, probably here it gets the tougher comps, selling out in a kind of mid-teens increase year-over-year for the back half of the year, which is good drive within the oil and gas focused service centers, a full year increase of about 20% to 25% year-over-year sales growth.

And, I wonder if you could give an update on the 30 industry groups you track and the performance there for the quarter?

Sure, so the sales performance in the top 30, we had 20 industries with increases, gap a little bit from the last couple of quarters, positives around oil and gas also aggregates primary metals, so positives with the machinery OEMs and also chemicals, kind of a bounce back, we had some softness in the last quarter and I think that was more timing around hurricanes then, so we saw that positives of that coming in this quarter and also food.

And would you mind giving us an update on the efforts you talked about last quarter to improve a receivable collection?

Sure. We’ve worked through -- I think we alluded to last quarter. In the process of compiling and building out the shared services function for our U.S. based receivables collections for the service centers, completed within the quarter to build out of that organization, really continuing to hone the standard work in terms of the interaction with the field and with the management team to successfully drive collections. So, continue to hoarder on there on that front end expect to drive your benefit as we move forward as we work these consistent processes, utilize some of the new tools to drive efficiencies and the collections activities.

And then finally, would you mind repeating the expectation for the tax rate for 3Q and 4Q?

Sure. Q3 in isolations going to be in 28% to 29% rate, given the 28% statutory effective tax rate for the balance of 2018, our fiscal 2018. Q4 in isolation will be in a range of 34% to 34.5%, given the further re-measurement than of our certain deferred taxes and liabilities will take place as we transition then from that 28% blended rate for this year to the 21% of effective statutory rate for fiscal 2019.

Thanks very much.

Your next question comes from Chris Danker from Longbow Research. Please go ahead.

Hi. Good morning, guys. Thanks for taking my questions. I guess to clarify first off, how do we think about FCX in terms of guide to that baked in at this point, or will that be kind of rolled in once the deal closes officially? And kind of any new thoughts on how we should think about for fiscal 2019 at this point?

No, new thoughts kind of beyond what we guided as we announced the transaction. Here again, what we will do is upon announcing the close of the transaction, as we indicated now, now anticipated for the 31st, we will provide updated guidance to include the FCX and the packs on both the fiscal 2018 and any update in terms of our forward thoughts around the business. But no changes, and we continue to work through the integration planning efforts in terms of our view on what that business will add in the next 12 months.

Got you. And then just any commentary on current bidding activity in addition to what the fluid power backlog looks like right now?

It continues to be very productive. I would say maybe looking back there is a little acquisition impact in it. But it's at a high level, it's at a historically high, high level in that. So, we feel good about that. And the work going on across those Fluid Power Groups of connecting with these mobile and in OEM customers and the technical solutions that we're bringing to them.

We have backlog about 15% to Fluid Power business within the quarter. So, continued strong order intake.

Perfect. Thanks. And then just finally if I could. Obviously, it's -- no matter where you go with just in time inventory environment now. But have you guys seen any restocking benefit given kind of how some of these industries have seen a step change in demand?

I don't know if there is so much restocking as I think across industries right now. Activity is good, and so therefore the product requirements in the services and solutions to them are, we are increasing at a good pace. So good activity going across, including heavy industries which can chew up mechanical part to require them. And so, I think that's good for the broader industrial economic environment.

Got it. Thanks again, and congrats on the quarter, guys.

Thank you.

Thanks, Chris.

[Operator Instructions]. Your next question comes from Adam Uhlman from Cleveland Research. Please go ahead.

Hi. Good morning.

Good morning, Adam.

I wanted to start with some of the gross margin commentary that you have. I guess you had mentioned that you took advantage of some purchasing program, supplier incentives, I guess that's pretty typically. And in December, but in inflationary environment, I would think that that should start to release your potential gross margin benefit for Applied in the second half of the year. Do you think that's going to come through on the gross margin line over the next two quarters, or is it too small to really move the needle?

I'll start, and Dave can come in. But I would say it contributes, but it contributes like it has in the past. And it really contributes when we have ready to sale to go through and do that. So, it will start as a capitalized and then when we have sale activity, it would get attached to those products and sales. So, we will see benefit, but this has occurred in past years as well.

No, marked change from a prior year phenomenon, you may have seen, Adam.

Got you, okay. And then to the discussion of the top 30 industries, what is declining year-over-year now for Applied versus kind of the pressure and I guess within that group, where do you feel better about maybe the momentum is changing, and we could have more than 20 industries growing?

I think we could be close to more of them hitting growth of, I think there's more around the zero line, which sometimes can be perhaps there is noise in the classification and what perfectly segments that they fall into. I think in this last one as we look at, maybe some of the either paper connected, or wood industries could have been a little lighter but again not by big numbers. So, I think about it going forward, I think there is a good potential that it's going to be higher than 20 number as we think about future quarters.

Okay, got you. And just quickly last on the FCX acquisition, I guess, you have already provided some numbers in terms the dilution that’s expected for the fiscal years and absorb a lot of one-time costs and it would seem that a lot of those are non-cash charges and the accretion from the acquisition, I mean just for the balance of the fiscal year to be over 10% cash, I guess doing the rough numbers we have -- I'm just wondering on a run rate basis, how we should think about the cash contribution from the acquisition putting all the non-cash charges aside.

You’re right, I mean the nature of the charge is such that they are more non-cash weighted. I would say the characteristics of the FCX business in terms of cash generation, the cash profile are very candid out of Applied, so not at all capital intensive, nice conversion in terms of receivables and not a significant impact in terms of inventory carrying. So, I think you see a very nice combination as we bring the businesses together. We will get back with specific guidance as we make the announcement here at the end of the quarter but expect to certainly tighten that range in terms of the magnitude even that the one-time cost versus what we are initially contemplating.

Okay. Thank you.

Your question comes from Steve Barger from KeyBanc Capital. Please go ahead.

Good morning, guys.

Good morning. Steve.

Going back to the price cost considerations in the back half, incremental operating contribution margins have been about 15% in the past two quarters, is that a good run rate we should be thinking about for the base business in the mid-single-digit growth environment?

Yes, certainly. What we’re targeting in terms of when we think about those incremental dollars and the follow-through that we would expect on those, so would not see any characteristics that would change that in the back half of the year.

Okay, and you have talked a little bit about FCX, but is that reasonable to think that incremental there are higher than the base business just given the higher gross margin maybe the mix of businesses or is that not necessarily right?

It would tend to be higher than what we would see, just given the incremental gross margin profile in that business.

Yes. With volume trends picking up across a lot of industries now, can you talk about current inventory levels relative to demand and are you seeing any hitches in the supply chain in terms of lead times pushing out for any types of products?

We feel good about our inventory levels. We stay close with really are key or all of our suppliers and we know their service or their performance. And we both have high expectations that we’re always on our game, but if we anticipate there is going be issues or concerns on those sides, those will be ones that will look at, how do we productively deal with some early. I think it’s also a benefit that we get as we think about how we have inventory across our large DC network then that would be a corresponding amount of service centers. So, there can be some adjustments that we make across some of those DCs, as we link with supplier. But we're working very hard with them on clear signals and then how we leverage the I guess the productive pull through of both businesses that we're focused on serving these customers.

Got it. And then last one from me. When you look across the product lines, and I'm, this is an inflation-oriented question. Are you seeing bigger increases based on things with high steel content or things that are highly engineered? Just trying to get a sense from where the upstream pricing pressure is across those products?

I think on those maybe they all tend to still group together. I think the largest increases are on the ones that are more despite we'd like to do the more to become off-fleet. And so, some of that maybe to drive that behavior, that they're either harder to make or they have. They have replacement capabilities in other offerings. So, older and legacy products, can we have a higher increase attached to them versus some of the others.

Understood. Thanks.

Okay, thank you.

Your next question comes from Ryan Cieslak from Northcoast Research. Please go ahead.

Hey, thanks. Just one quick follow-up. I think the last quarter you've talked about some incremental employee cost are rolling through in the back half of the year as well as some IT investments. Is there a way to maybe quantify what the incremental cost headwind will be here in the back half of the year? Thanks.

You bet. Just the good reminder Ryan, that yes, we did have taking place January 1 the focused merit increases, which would increase kind of our employment cost and average 3%. So, given that that's about 70% or so of our SG&A cost base. We expect to increase in the range of $3 million to $4 million. As you look at the that impact from the merit to another inflationary increase as well as some of the IT spend that we discussed.

Okay. Thanks, guys.

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

I just want to thank everyone again for taking the time to join us. And we look forward to talking with many of you throughout the quarter.

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