Julie A. Kho - Manager-Public Relations Neil A. Schrimsher - President & Chief Executive Officer Mark O. Eisele - Vice President, Chief Financial Officer & Treasurer.

Matt Duncan - Stephens, Inc. James A. Picariello - KeyBanc Capital Markets, Inc. Craig Bibb - CJS Securities, Inc. Garo Norian - Palisade Capital Management LLC.

Welcome to the Fiscal 2015 Third Quarter Earnings Call for Applied Industrial Technologies. My name is Tina, 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 would now like to turn the call over to Julie Kho. Julie, you may begin..

Thank you, Tina, 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 reply 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 the industrial sector of the economy, the success of our various business strategies and other risk factors identified in Applied's most recent periodic reports 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, a 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.

With that, I'll turn things over to Neil..

Thank you, Julie, and good morning, everyone. We appreciate you joining us today. The third quarter of our fiscal year presented some macroeconomic challenges, including a deceleration of industrial market demand and continued foreign exchange headwinds.

Our overall sales increase of 10% for the quarter reflects 10.6% increase from acquisition related volume, coupled with a 1.3% rise in our core underlying operations, offset by a negative 1.9% foreign currency translation impact.

Within the quarter, we had effective cost controls and we will take additional actions as we move towards completing our fiscal year. As announced this morning, we are revising our full year guidance range for earnings per share to between $2.80 and $2.95 per share on a sales increase of 11.5% to 13%.

During the quarter, we were active in share purchases, purchasing 870,200 shares of common stock in open market transactions for $37.3 million. Fiscal year-to-date, the company has purchased 1.3 million shares for a total of $59.2 million.

As noted in our press release, we are pleased our Board of Directors authorized a new stock repurchase plan which allows for the repurchase of up to 1.5 million shares, reflecting confidence in our growth opportunities and our ongoing commitment to enhance shareholder value.

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 third quarter fiscal 2015 financial performance. Our sales per day rate during the quarter was $10.8 million, 10% above the prior year quarter, and 3.2% below our rate in the December quarter. We had 63 selling days in both the March 2015 and 2014 quarters.

Acquisitions had a positive impact on sales of $65.4 million, or 10.6% during the quarter and foreign currency impacts decreased sales by 1.9%. Therefore, overall core same-store operations experienced a 1.3% increase 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 26.7% fluid power products and 73.3% industrial products. Third quarter sales in our service center-based distribution segment increased $64.4 million or 13.1%. All of the $65.4 million of acquisition impact on sales is within the service center-based distribution segment. Our core U.S.

based service center business experienced flat sales in the March quarter, compared to the prior quarter. The sales in our fluid power businesses segment decreased $2.4 million or 1.9%. This decrease was split between declines in our Western Canada fluid power operations and the impact of unfavorable foreign currency translations.

From a geographic perspective, sales in the third quarter from our overall U.S. operations were 8.2% higher compared to the prior year quarter and experienced increases of $41.1 million or 7.9% from acquisitions. Our Canadian operations had sales from acquisitions during the quarter of $19.3 million.

The core Canadian operations experienced a sales increase in local currency of 4.2% and had negative foreign currency translation impact of 11.4%, resulting in an overall combined change in sales for our total Canadian operations of $15 million above our prior year amounts.

Consolidated sales from our other country operations, which include Mexico, Australia and New Zealand had an overall increase of $4.1 million or 12.3%, which included sales relating to acquisitions of $5 million and a negative foreign currency impact of $4.5 million.

Core operation sales improved in local currency in all three countries, although the primary improvement was in Mexico. Our gross profit percentage for the quarter was 27.6%, 10 basis points below the prior year third quarter and 70 basis points below our run rate in the December quarter.

This decrease from prior year is attributed to declines in the core U.S. service center point-of-sale margins and supplier volume rebate support. Our decline below our second quarter gross margins includes the above items along with the change in our business mix.

Looking forward, we expect our gross profit percentage in the fourth quarter to be at or above 28.0%. Our selling, distribution, and administrative expenses as a percentage of sales was 21.1% for the quarter, 10 basis points below the prior year's third quarter. On an absolute basis, SD&A increased $12.5 million in the quarter, or 9.6%.

SD&A increased $17.7 million from our acquisitions, decreased $2.5 million due to foreign currency fluctuations and decreased $2.7 million from core operations. This core operations' SD&A decreased represents a 2% decrease on our core year-over-year SD&A spend.

Our effective tax rate for third quarter was 32.7%, this rate is lower than our year-to-date tax rate due to some discrete items during the quarter, which are not expected to repeat. We believe our tax rate for the remaining quarter of fiscal 2015 will be in the range of 33.8% to 34.3%.

For comparison purposes, we want to remind everyone that the prior year quarterly tax rate was lower due to the reversal of $2.8 million deferred tax liability related to undistributed earnings in Canada and a reversal of $1.1 million of other tax reserves in the U.S. due to the statute of limitations expiring for certain previously filed returns.

Our consolidated balance sheet remains strong, with shareholders' equity of $736.3 million compared to $800.3 million at June 30. This decrease in equity is due to stock repurchases of $59.3 million year-to-date and the foreign currency translation of our non-U.S. entities balance sheets into U.S.

dollars, which had a negative impact on equity of $62.8 million year-to-date. Our after-tax return on assets for the third quarter was 7.8% versus 11.3% in the prior year comparable quarter. Our asset base is higher now due to our recent acquisitions. We expect our ROA to improve slightly in the fourth quarter from lower assets and improved earnings.

Inventory at March 31 is $45.3 million above our June levels. $39.6 million of this increase relates to the impact of our recent acquisitions. From December 31 to March 31, inventories decreased $20.4 million.

Lower operational inventories throughout our network resulted in a $14.6 million decrease, with the remaining $5.8 million decrease attributable to foreign currency fluctuations. We expect continued declines in our operational inventories, upwards of another $15 million through June 30. We have $390 million of debt outstanding at March 31.

We have a $170 million of fixed-rate borrowings with a 3.2% weighted average interest rate. Our remaining debt is at variable rates, which currently have interest rates of around 1.1%. We expect the total overall borrowings and interest expense in our June quarter to be slightly lower than what we experienced in the March quarter.

Cash generated from operating activities was $38.1 million for the third quarter compared to $11.7 million in the prior year third quarter. Year-to-date, cash generation still remains slightly behind our prior year amounts. However, we do expect improved cash flows from operations in the fourth quarter.

We expect that $83.6 million of cash used to support working capital, which is shown on our March 31 cash flow statement in today's press release, to decline by about $50 million by fiscal year-end due to improved receivables collections, reduced inventory levels, and further extension of accounts payables.

We expect fiscal 2015 cash provided from operating activities to be greater than our annual net income amount. We've talked earlier in the call about our share repurchase activity through March. We expect to remain active in executing stock buybacks on a go-forward basis. Now, I'll turn the call back to Neil for some final comments..

Thanks Mark. So to summarize, Applied is well positioned with the strong foundation, expanding capabilities and a straightforward strategic plan. We're focused on meeting the product, service and solution needs of current and new industrial customers. We're active in closing this fiscal year and planning for the new year ahead.

We will be responsible and disciplined in controlling cost, also executing on our growth initiatives. In doing so, we will serve our customers and generate increased shareholder value. So with that we'll open up the lines for your questions..

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

Good morning, guys..

Good morning..

First, can you talk a little bit about the organic sales trends that you're seeing in the business, Neil? Are you seeing that change much through the quarter and into April?.

Yeah, so I'd say, in overall sales and really organic, in January and when we talked I think when we were on the call, we felt very good about sales in February. We experienced and felt the slowness and then some improvement in March. As we look forward into April on our total sales basis, they're running plus double-digit.

So, acquisitions are contributing, but underlying cores contributing positively as well, so seeing some improvement as we move to March – to April in a year-over-year basis..

Okay.

Neil, looking specifically at the acquisitions that you guys made in the energy environment, how are their businesses tracking recently? Just to kind of give us a feel for how they're being impacted by the slowdown we're seeing with rig count off 50% plus at this point?.

Sure. So, if you look from Q2 to Q3, I would say the sales decline is over 25%. We've got seasoned leaders in those businesses that's probably worked through 10 plus of these cycles in every one of those groups.

So, if we look kind of in that upstream category on the production side, they're faring better and if we look sequentially from even March to April, we would see positives on the production side. On the drilling and the new-new side, a bigger drop-off and then as we sort through that, a portion of that is in Canada with seasonality also.

So, no doubt there's reduced demand. But accessing those drillings rigs in remote location, the road bans came on earlier in March to be determined when they come off, is it going to be May or June. So we know there will be activity once those road bans are lifted, but we also know it's going to be at a reduced level.

So as we work through this, we said, hey, we knew in January it was coming and so we worked at being responsible at looking at our cost to serve in those areas and take the appropriate actions.

Okay. That's helpful. And then last thing from me.

Just looking at – put the acquisitions aside for a minute, looking at your own business, we've heard from some of the your peers that we're finding out that everyone seems to have a little more energy exposure than we thought before, because your customers obviously have that exposure and they've also got some export exposure.

Is there any way to quantify as you look at your more industry driven customer base, how you think the drop in energy may have impacted those sales if at all?.

Yeah, I don't know that we've got a great way of knowing it. We think coming into this, our participation in some of that business was lower. I think as we look at it sequentially, perhaps some of that is playing out.

But I think, undoubtedly energy reverberates in some of those support industries and our customers have grown into that business as it improved and so they will be feeling an impact. But there's also a portion of why a strong U.S.

dollar impacting some machinery OEMs that had an export side of their business, they're being impacted a little bit there as well. I think we're seeing that in some of those general macroeconomic indices and metrics in the first quarter, right, they were positive and many of them, not as positive as they have been..

Sure.

And that probably, I would assume, explains the drop that you saw in fluid power sales, correct?.

Right. So in our fluid power from a U.S. standpoint, really flattish but our look on balance of the year and going forward, we believe we have growth opportunities there because we are expanding our value-added services. So to those OEM customers, we're really doing more work and we're doing more work around some additional products.

Those solutions are getting smarter with controls. Those solutions are getting smarter with electronic interfaces and we're able to provide those capabilities..

Great. Thanks, Neil..

Thank you. And our next question comes from the line of Jeff Hammond of KeyBanc Capital Markets. Please go ahead.

Hi, guys, this is James filling in for Jeff..

Hi, Jim..

Hey. So you mentioned that you were happy with cost controls in the quarter and then that definitely showed through and then you're also maybe taking additional or looking at additional actions.

Can you maybe just speak to that? And if you could, quantify the ERP benefit versus headwind this quarter?.

Yes, so as we think about ERP, I'll start there with where we're at. So we're deployed across Western Canada, U.S. operations. We've talked about going through the financial implementation and really there from payroll to fixed assets to general ledger all complete.

We'll finish the consolidation side of it in the early part of the fiscal year, so it could turn into a little bit of fiscal 2016. So all of that goes well, that has some support costs, internal and external to it. We know that will diminish as we go forward.

So our look at SG&A is no doubt, right, we need to volume adjust around energy markets and we're doing that but we can also have opportunities for continuous improvement in kind of, core underlying support operations or functions.

And some of that will just be external cost controls and some of it would be as we get more efficient and productive internally..

Got it. And then just moving to capital allocation. In terms of M&A, you obviously announced a new share repurchase program.

How are you thinking about M&A and what's the environment like out there, right now?.

So we remain active in M&A and I'd say, we work to our priorities, think about our pipeline, we've got prospects really at each stage from initial discussions to ongoing dialogue to diligence. And, our goal is to be as active in the M&A as we were in fiscal 2014, as we were in fiscal 2015, really every year going forward.

We've been a little bit more active in share repurchase but our belief is we generate shareholder value and how we execute the business, and investments we'll make and that will include M&A and around some technology. And then returning cash to the shareholders with dividends and share repurchase..

Got it. Thank you..

Thank you. And our next question comes from Jon Tanwanteng of CJS Securities. Please go ahead..

Hi. This is Craig Bibb. I'm in for Jon.

Could you break down the components of your outlook and how much is organic and how much is M&A? And what's the implied economic growth underlying that?.

I don't have the exact percentages as we go forward into the fourth quarter for that breakdown of what you're looking at, but we do expect to have core operational growth in sales. Obviously, local currency growth within our foreign operations and we do expect some modest growth in our U.S. operations from that perspective.

I think when we look at our acquisitions, some of those are coming off starting May 1 because we purchased Reliance May 1, a year ago. So the month of April is really the last month that they're in our numbers as an acquisition item whereas in May and June, you'll have comparable numbers to compare against.

So we look at the oil and gas guys, like Neil mentioned earlier, for the folks that are dealing with upstream production, their sales seem to be stabilizing and looking better than the sales from the upstream drillers which are dealing with the Canadian seasonality as well as the downtick in activity because of the change in pricing..

Okay.

Is there something, either an event or something in your sales that would cause you to think that maybe we're going to have another shoe to drop in energy or you guys confident that we're past that point?.

I don't know that we see another shoe to drop. I mean, so, we adjust our business for the environment that we see now and as we look at it going forward, we'll stay responsive to it, both prepared for improvement but also prepared if it softens or further weakens.

Okay.

M&A, just in terms of valuations, are you comfortable with what you're seeing or – can you comment on that?.

We are. I mean, our approach is that we're going to be disciplined, we're going to be a strategic acquirer. It's going to fit to our priorities. We're going to stay a core industrial distributor and look at what's important to our customers and what will flow through our business well. So we know our priorities. That's what our pipeline represents.

And, we think we go through this process well. And we are a good fit to many of these companies..

Do you find yourself competing with private equity in the deals you're looking at?.

I would say, our real one is that we work at establishing long-term relationships with prospects and targets and why we would be the logical fit. So I'll say, I'll stop short of saying private equity is never involved but it's not a high involvement in the areas that we are involved with..

Great. All right. Thanks a lot, guys..

Okay..

Thank you. Our next question comes from the Garo Norian of Palisade Capital Management. Please go ahead.

Hi, guys. I want to just check in.

I believe one of the strategies you guys have been working on in kind of increasing the SKUs particularly maybe in the safety area, and just was curious how progress is going on in that strategy?.

Yeah. So, Garo, I'd say, maybe not so much in safety as, perhaps, overall consumables in that. And I would say good on a couple of fronts. We're just going through our kind of three-year strategy outlook.

And then as we look at our customer base and segment and stratify it, we see nice progress in the amount of products that are being bought across categories from our largest customers and even mid-sized customers. We'll have to work for opportunity, as we grow smaller customers up to medium and large customers and expand that base.

So there we've had nice progress. In our maintenance supplies and solutions business, we continue to look to connect those to just our core Applied customer base.

And we're looking at having good vendor-managed inventory solutions and how we help on what could be up to 50% of the SKU count but only 10% of the spend for more of Applied customers on the (0:27:05)..

And then just following on that, are all those products kind of available at all of your distribution centers at this point?.

I would say we do not allocate them to every one of our distribution centers, but we feel like we had very effective coverage from Southeast to West to Midwest to North Atlantic.

So – and we will evaluate where we extend those to either in our distribution centers or, perhaps, that business gets improved or augmented even around acquisitions in that space..

Okay.

And then secondly, as you guys are starting to put the plan together for fiscal 2016, can you give a sense of what kind of underlying macro assumptions are being incorporated? Is it kind of a continuation of the current environment or do you see things a little – planning for things a little bit worse or a little bit better?.

So, as we think out over the three-year horizon, I mean our approach is we believe we have size, scale capabilities, we should be 2x market. That would be my dialogue with the teams in doing that. As we think about entering into the first part of the fiscal year, we're entering that annual planning cycle right now.

And so we just finished our three-year, our long range and so we'll be working our fiscal year next year as we go in.

And so it may be a little early, but I would say, we're not going to assume a greater environment than maybe what we're operating in right now and we'll close this fiscal year that it will not just dramatically or magically turn as our fiscal year starts in July 1.

But we think there's going to be kind of a pickup as it moves through that fiscal year. At least that's what some of the macroeconomic indicators might say today and what some of the economic forecasters may have in that. But we think underlying, right, there's going to be a 2% to 3% type market would be what we would start to look at..

Great. Thanks very much..

Okay..

Thank you. Mr. Schrimsher, there are no further questions at this time. I'll turn the call over to you for any closing remarks..

All right. I want to thank everyone for joining us today and we look forward to talking to many of you throughout the quarter..

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect all lines. Thank you and have a good day..