Ladies and gentlemen, thank you for standing by. Welcome to the Fiscal 2016 First Quarter Earnings Call for Applied Industrial Technologies. My name is Chris, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.

Please note that this conference is being recorded. I will now turn the call over to Julie Kho. Julie, you may begin..

Thanks, Chris 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 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 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 first quarter of fiscal year 2016 decreased 8.6% to $641.9 million, from $702.3 million in the same quarter last year.

Net income for the quarter was $24.3 million or $0.61 per share compared to $29.1 million or $0.70 per share in last year's first quarter. Our first quarter results reflect the continued impact of reduced demand in many industrial end markets, most notably oil and gas, as well as headwinds from foreign currency translation.

We recognize our requirements in this current environment and continue to take a disciplined approach to controlling cost and driving improved efficiencies. All our business teams recognize that we must help ourselves by leveraging our stronger foundation and our excellent capabilities to expand with current customers and serve new ones as well.

In addition, we will continue to optimize our capital allocation to dividends, share repurchases and acquisitions. We are pleased with the recent acquisition of S. G. Morris Company, a distributor of fluid power components and provider of engineered fluid power systems.

SGM has a strong strategic fit that further enhances our fluid power market leadership and provides us additional growth opportunities. The completion of two acquisitions over the past three months, further strengthening our fluid power offering and our Applied MSS capabilities are examples of how we are helping ourselves.

We are intent on continuing this level of activity, delivering on the business synergies and generating increased 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 first quarter fiscal 2016 financial performance. Our sales per day rate during the quarter was $10 million, which is 8.6% below the prior year quarter and 6% below our rate in the June quarter. We had 64 selling days in both the September 2015 and 2014 quarters.

Acquisitions had a positive impact on sales of 1.8% during the quarter and foreign currency translation decreased sales by 3.2%. Therefore, overall core same-store operations experienced a 7.2% decrease in sales, compared to the prior year.

This decrease includes 2.3% in traditional core same-store operations and 4.9% in subsidiaries serving the upstream oil and gas markets. In addition, we believe the impact of vendor price increases was minimum during the quarter. Our product mix during the quarter was 27.2% fluid power products and 72.8% industrial products.

First quarter sales in our service center based distribution segment decreased $46.6 million or 8.1%. Acquisitions added $12.9 million or 2.2% and the negative foreign currency impact reduced sales 3.3%. Core same-store operations experienced a 7.1% decrease, which primarily related to our operations that sell to the upstream oil and gas industry.

The sales in our fluid power businesses segment had a broad-based sales decrease in the quarter of $13.8 million or 10.9%, of which foreign currency had a negative impact of 2.8%. From a geographic perspective, sales in the first quarter from our overall U.S.

operations were down 4.1% or $23.2 million, compared to the prior year quarter, and experienced the positive sales impact from acquisitions of $12.9 million or 2.3%.

Our Canadian operations experienced a sales decrease in local currency of 20% and had negative foreign currency impact of 13.2%, resulting in a combined sales decrease of $32.9 million or 33.2%.

The Canadian decline in local currency was primarily in our Reliance operations, which serve the upstream oil and gas customers, whereas our traditional core operations in Canada had a 6% decline in sales in local currency.

Consolidated sales from our other country operations, which include Mexico, Australia, and New Zealand had an overall decrease of $4.3 million or 10.3%. This consisted of a sales increase in local currency of 13%, and a negative currency translation impact of 23.3% in the quarter. The local currency increase relates entirely to our Mexican operations.

Our gross profit percentage for the quarter was 28.2%, 40 basis points above the prior year's first quarter. This increase can be attributed to higher margins at the point of sale in our U.S. service center operations and improved freight management in the quarter.

Going forward, we expect our overall gross profit percent to remain above 28% and show improvement compared to the prior year for the remainder of fiscal 2016. Our selling, distribution, and administrative expenses as a percentage of sales were 21.8% for the quarter, 60 basis points above the prior-year first quarter.

On an absolute basis, SD&A decreased $8.8 million in the quarter or 5.9%. The components of this SD&A decrease are as follows. SD&A increased $3.3 million due to our acquisitions. It decreased $5.4 million due to foreign currency fluctuations and decreased $6.7 million from core operations as a result of continuous efforts to control expenses.

SD&A management included staffing actions, with overall core operational head count down 100 individuals from September 2014 to September 2015. During the December 2015 quarter, we incurred $800,000 of severance-related expense and we will continue to make appropriate staffing adjustments as needed.

Lastly, while we continue to effectively manage receivables, we did have $1.4 million of expense during the quarter to increase our allowance for doubtful accounts. Our effective tax rate for the first quarter was 35.8%, slightly higher than expectations due to a couple of discrete items that are not expected to reoccur.

We believe our tax rate for all of fiscal 2016 will be between 34.5% to 35.0%. Our consolidated balance sheet remains strong, with shareholders' equity of $710.1 million and a conservative debt to total capitalization ratio of 36%.

Our after-tax return on assets for the first quarter was 6.9% versus 8% in the prior-year comparable quarter, due to the 16.6% decrease in our net income dollars, offset by a 3.2% decrease in our average asset dollars. Inventory at September 30 is $11.6 million below our June levels.

Our core operations reduced operational inventory $4.4 million due to optimization efforts within our U.S. service center and distribution center network. This decrease was partially offset by the impact of our acquisition of Atlantic Fasteners, which added $2.9 million of inventory.

There was also a $10.1 million inventory decrease from foreign currency fluctuations. Cash generated from operating activities was $14.6 million for the quarter compared to cash used in operations of $18.1 million in the prior-year quarter. This improvement relates entirely to working capital.

In the current period, we have brought our operating inventories and receivables down, whereas in the prior year these were growing. During the quarter, we purchased 451,100 shares of common stock in open market transactions for $18 million.

We have remaining authorization to purchase 796,200 shares as of the end of September, and we expect to remain active in executing stock buybacks on a go-forward basis. In view of current markets and trends, we are revising our full-year guidance, and now expect earnings per share between $2.65 and $2.85 per share on a sales decrease of 5% to 7%.

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

Thanks, Mark. Let me close by saying we are committed to generating value in any economic cycle, through our business performance, expanding our product service and solution offering, and creating opportunities with current and new customers.

All across Applied, we are focusing on our customers, being accountable for our results, generating operational improvements and working together to deliver our business requirements. At this time, we'll open up the lines for your questions..

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

Hey. Good morning, guys..

Good morning, Matt..

So the first question I've got is just about sales trends, if you could walk us through sort of what the month-to-month trend looked like through the quarter and into October? And in addition, just sort of the big picture numbers, I was hoping maybe you could give us a little more granularity and talk about what those trends looked like in more of the traditional business versus what they look like in the oil and gas business as well?.

Okay. Hey, Matt. This is Neil. I'll start, and I'd say sequentially looking back as we worked through the quarter, I mean we had a weakness in July, some expected. That continued through August. And off of that lower base, September probably came in modestly positive.

As we look month-to-date through October, I'd say sequentially, it's around 2% decline that we would see off that period. And so as we look at, I guess, the segments across from an oil and gas standpoint, this time last year oil and gas was contributing just under 11% of sales, 10.9%. This quarter, it was 7.8% of our total sales.

And I think, as you would expect, more weakness upstream on the drilling side and while declines on the upstream production side, teams holding in, especially where our locations are and with those plays. From a service center side standpoint, there is weakness in other segments, but I think all in all the teams are doing well in that performance.

And then, I'd say the other more notable decline that we'd call out is in fluid power. And probably not surprising, when you look at the big supplier numbers, our business is a little different in that. We're more focused on midsize OEs, but that had a sizable decline.

We do say or believe, in these times, that's when customers are going to have more time, more opportunity to look at their solutions, and we've got a lot of proposals in around technology with those customers. So we think that bodes well for us going forward. We've just got to work our way through the softness that we've got right now..

Okay, Neil, that helps. And then a few things just on guidance, starting with gross margins. Mark, can you talk about what you guys are doing to drive gross margins higher? Obviously the rest of your peer group is seeing gross margin declines.

So what are you guys doing to get better point-of-sale margins right now?.

So. Hey, Matt, I know you asked Mark. I'll start because we've been working with the teams hard on this. But I think it's things we've consistently talked about. How do we reduce variation across pricing to customer groups? That's been helpful.

How do we work both with large and medium customers and smaller customers on a local basis? So customer mix can be helping us in the area.

And then also as we expand out into some of the other product areas with higher margin opportunity, product mix has helped us as well as when we are truly providing value-added service, that value-add can be recognized in the price. So I think to me those are the biggest drivers..

Okay. And so, Mark, should we expect the gross margin to – I mean you said it's going to be up year-over-year.

Is this sort of 38.2% level a good place for us to model for the time being?.

Yeah. I think what we've talked about pretty consistently over the years is that we have opportunities to improve our gross profit percent 30 basis points to 40 basis points year-over-year, and we did it in Q1. Our expectations are that we should be able to continue to do that throughout the year..

Okay. That's helpful..

Hey, Matt, I believe you asked or said 38.2%?.

Sorry, 28.2%..

We'd like that improvement, but.....

Yeah, 28.2%, yeah..

Exactly..

Okay, so sorry. And then last couple things just on the guidance.

The SG&A or SD&A cost reductions, what actions specifically are you guys taking there? What are the annual savings that we should expect? And given the sales guidance range, what should we be thinking about for quarterly SD&A costs?.

Let me start on that, Matt. As you know, managing SG&A really is managing our head count, because that makes up – 60-plus-% of our SG&A is people and their benefit costs.

And so we mentioned on the call, hey, year-over-year we're down 100 head count, but we're actually down more because we did have some head count adds after September 2014 for actions that we took earlier in the prior few months. But we continue to look at the head count; we continue to look at our run rate.

So if you look at our SD&A run rate that we ended the September 2015 quarter, our perspective is that that run rate should be flat to down, slightly down as we go through fiscal 2016. We did take some additional actions on head count during the September quarter, so those are going to fall through the numbers, let's say in the December quarter.

But as we mentioned, we're still looking at additional actions to take, so that we can make sure that we marry our expense levels to our levels of business, and we're not going to stop looking at that. So those are things that we continue to look at.

Obviously when you go outside of the personnel things, every line item is being looked at very critically to manage those expenses. And so the traditional things that you would think of that are being controlled aggressively and down like T&E expenses, overtime and things.

Yeah, we're hitting those hard, but we're hitting everything as hard as we possibly can to make sure that we're appropriately and aggressively managing expenses now and into the future..

Sure. Thanks. And then last thing just on the share repurchases.

Does the guidance account for any additional share repurchases?.

We're thinking about a relatively stable share count going forward, let's say, for the remaining three quarters. So there's not a major assumption that the shares would take a major step downward to get to the EPS numbers..

Okay. I appreciate the color, guys. Thanks..

Okay. Thanks, Matt..

Thank you. Our next question comes from the line of Jon Tanwanteng from CJS Securities. Please go ahead..

Good morning, gentlemen. Thank you for taking my questions.

Given the challenges to the organic growth, can we expect more urgency in the realm of M&A and share buybacks relative to where you have been over the last several quarters?.

So Jon, I'll start off, Neil. Let's say, from an M&A standpoint, I mean the organic environment isn't going to accelerate, isn't going to slow our activity. We're going to stay a disciplined strategic acquirer. We are busy. The acquisition pipeline is full and we would have prospects of targets at various stages.

So we would expect activity as we march through the remainder of the fiscal year. I always say, right, you don't perfectly control the timing of those, but that would be our expectations in it. And then I think Mark talked on the share repurchase activity. As we look at our capital allocation, we think we are a good dividend payer now.

We've been active in share repurchases and we plan to stay active from an acquisition standpoint as well..

Okay. Thank you.

And what are you doing in areas facing currency headwinds? Are there sufficient natural hedges in place and are you doing anything to actively manage against huge decline?.

Yeah. Jon, on the foreign currency things, for the most part within each of our countries, we are buying our product from our suppliers in local currency and then selling it in local currency, and that's not 100% true because we do have some currency losses through translation type items.

But for the most part, if they're operating within their own countries in local dollars, we're not hedging that..

Okay. Thanks a lot, guys..

Thank you. Our next question comes from the line of Jason Rodgers from Great Lakes Review. Please go ahead..

Good morning..

Morning..

Just following up on the guidance, would you give us some detail on your assumptions that you're making in your core markets as well as the oil and gas area for the remainder of fiscal 2016?.

Let me start on that a little bit. I think, within the sales guidance numbers that we have, our perspective is that our sales per day run rate, which is $10 million a day in the September quarter is going to stay relatively flat for the remainder of fiscal 2016, with the opportunity for a very slight improvement.

But that improvement may happen, let's say, in the third quarter and fourth quarter as we get more traction on some of our strategic initiatives. But we don't have a big hockey stick or anything on our sales guidance numbers.

So with that, our view is we're going to manage the business as the markets are presenting them to us today in an aggressive way.

And then with that maintaining our gross profit percent strategies and initiatives and our cost savings or cost management initiatives should be able to take that sales number and convert it into the EPS guidance number that we have presented today..

And then looking at the oil and gas markets, do you have the sequential percentage decline in those markets in the quarter?.

What I do have is I know this quarter compared to a year ago, for the oil and gas subsidiaries that we owned a year ago at this point in time, our overall sales are down 50% from them.

And like we mentioned in the call, or I think Neil may have mentioned in one of his comments, for the oil and gas focused subsidiaries that are serving producing-type wells, we've seen some stability in their sales over the last several months.

And their sales decline is smaller than the subsidiaries that are focused on drilling-type customers, and they have a much larger percentage that more closely mirrors the reduction in rig counts. But for them, we've seen some stability as well with their numbers, because the rig count has been down for so long.

Until we get to December 31, our year-over-year comparisons with our oil and gas focused subsidiaries are going to be difficult, but starting in, I guess, the beginning or mid-January is when we saw our sales numbers with our oil and gas focused subsidiaries turn around in a negative way. So our comps for the rest of the year will be more modest..

And would you mind giving the performance in the quarter for the 30 industry groups that you track?.

Yeah. I would say, overall I think 13 of the 30 would be up, so you can do the reverse math. I mean the obvious headwinds challenges around the energy markets, both oil and gas and mining, I think also in metals and some of the OEMs providing or feeding into some of those segments, so that group.

I'd say positives would be around aggregate, food, kind of lumber and even automotive, so those would be more on the positive side..

And then finally, do you still expect your cash flow from operations to exceed net income for fiscal 2016?.

I think the short answer is, yes, that we do. Obviously, with our guidance coming down, our perspective on net income is coming down a bit. But our view is we should have solid cash provided from operations each and every quarter as we march through fiscal 2016, and that it should exceed it.

When I take a step backwards and I look at our overall cycle of cash provided from operations, the first six months of any fiscal year is when our cash from operations is more modest than our second six months of the year.

And some of that reason for the modest numbers is, hey, we've got to pay our federal income taxes a little earlier with our estimated payments.

Uncle Sam makes you pay more upfront, and so that impacts cash from operations earlier in the year, and as well as some of the incentive plans that we have annual plans that we paid out in the beginning of the current fiscal year.

So those have a natural cycle that provide lower cash in the first half of the year, but then a little bit higher cash in the second half of the year, which is sort of our normal perspective..

Thank you..

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

Good morning, Neil and Mark..

Good morning..

I guess my first question, I just wanted to go back to the commentary on how the sales trended month-by-month in the quarter. And Neil, I think you were talking more on the sequential trend.

I was hoping maybe you can provide some color around the year-over-year trend through the quarter, and then particularly how October sales look on a year-over-year basis right now within the core business?.

I don't really have those. Mark, maybe you want to lead off with a little....

Yeah, I think our 8.6% year-over-year sales change that we experienced for the September quarter; we're seeing a similar situation for the month of October.

And Neil mentioned on the call that our run rate from the month of September to the month of October is down about 2%, but I think our view on the sales numbers is still similar to the 8.6% down..

And then....

Okay. So....

Hey, Ryan I'd say right. Obviously, year-over-year comps, really through the first half of our fiscal year even into January are going to be the most challenging, right, because oil and gas for us was still very good in those periods a year ago.

And so, they'll provide some year-over-year challenge until we work into that period, and then I think just some of the other segment softness will play into. But much less, and then in those cases, we are focused on helping ourselves. And we are seeing that in areas and with parts of the teams in their business units.

And so, we'll be working to narrow those gaps as we go through the remainder of the fiscal year..

Okay.

And then the sales guidance you provided for fiscal 2016, can you give us some color around how you break that out in – with regard to the segments? What are you expecting maybe directionally for the service center segment relative to your fluid power businesses?.

Let me start on that. I think in this current quarter, our fluid power business segment had a greater sales decline than the service center based business segment.

And I think, from the fluid power perspective, just like, when we look at the major manufacturers of fluid power components, when they are looking forward into the fluid power market and they're seeing that the downturn that they've experienced is going to continue into the foreseeable future, I think that's what we're seeing with the fluid power guys.

A year ago, and we've been talking about our increases in fluid power sales and had seen that for many quarters even throughout fiscal 2015, and now, we're seeing the decline that the manufacturers had started experiencing six or so months ago.

So, I think when we look forward with that, the fluid power business segment will see a continued challenging environment for that..

Yeah. And Ryan, I'd just add with that, I mean, it's going to be a challenging environment, we know it, I think we see it from the large suppliers going forward.

I think with that I mean, if we look back and even at the current results and with some of the industry forecast and such, we're performing better, doesn't necessarily feel better with the result, but we are. And the teams are working very closely with many key OEMs on adding more technology into these solutions.

So, we think that will help us in a slow softening environment, no better time to work on designs and their product offering, when there is a little bit of lull, we wish not to have the lull, but it creates that opportunities and – what I'm impressed with our fluid power group on two fronts.

They're continuing to be very aggressive on that, but they're also being near-term accountable to their costs in these environments as well..

Okay. Great color. And then, just shifting focus on the margins and the cost side of things, again nice quarter there once again through (33:58) this quarter. Neil, when I look at the guidance for the full year, if I'm getting into it right, it implies operating margins relatively stable year-over-year.

I guess I was curious to know how you think about the business today versus maybe past downturns or down cycles that if I go back, I mean generally speaking, margins also declined during softer sales year.

What's different today I guess for you guys to be able to maintain sort of the margin levels here this year, even though sales are down 5% to 7% or so?.

I think I've touched on them a little bit earlier. I'd say, I think one, we're just bringing better focus, better rigor around price and price variations. So if we can reduce the variation across products and some customer groups as we go through this, that's different and that's helpful.

The teams, especially in our service center based businesses, have a focus on current customers, mainly large ones, but also a very good heightened focus on local accounts, so that customer mix is helpful.

And then, as we go through and look to expand our product offering and our solutions around services, that's helpful and in consumables, which right those products have a typical higher or longer margin, so the better we do at that that helps us in the overall gross profit.

So, it's no one thing, no one easy lever in these it's a host of activities, but I like we've got progress, I like that we've got momentum, and that's why we believe it continues throughout in this – even in this environment throughout the fiscal year..

Okay. And then the last question for me is, on the acquisition pipeline, you recently just made that your first fluid power transactions in a while.

Just curious to know if you think about potential future acquisitions, are they leaning one way or the other in terms of product offering or the businesses that your targeting whether in fluid power or maybe even more again on the class C (36:16) type businesses that you guys are looking to grow?.

Yeah. I would say, I mean, our pipeline reflects our business. So there will be core bearing and power transmission. There will be fluid power opportunities and there will be maintenance supplies and solutions consumables in that.

And so, our preference would be to be active in all of those and I'd say with that – we would expect them to be in our served geographies as well, right, where we operate today not extensions into new geographies or play. There is many North America opportunities in that and so those are the ones that we would be pursuing.

But I want us to be active in all of those areas, because I think it's helpful and added to our business and I think we're proven to be very good from the acquisition standpoint to the companies coming in..

Okay. Fair enough. Appreciate the color, guys..

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

Hi, guys.

I just wanted to see if there is anything kind of known, I guess, in the back half of the year, kind of like you mentioned the oil and gas comps that gets easier on the currency or other end markets that start to turn easier on the comp side in the back half for you?.

Well, I think – and so, oil and gas that you mentioned probably Mark can lay out a little bit on currency. But, I think if we continue in some of these patterns, right, FX will be less of a drain in the back half of the year and do it. And so, hey, we think we're in this environment. We know it, we can't make the market, but we can respond to it.

And I think that's what we've done from a cost accountability standpoint. But we're also responding to it, where we see market opportunities. They may not turn into perfect incremental growth as we go through, but we think it narrows some of those headwinds that we're going to be having..

Okay. And then just secondly from a bigger picture perspective on guidance and communication, I mean, it's kind of the fourth consecutive year where guidance has been brought down from the initial guide.

And I know that it's been almost a perfect kind of run rate of different things that have been hitting over time as kind of heavy industrial economy as kind of peaked in 2012 and gotten worse since.

But, from a – just a communication standpoint, have you got to the point where, hey, let's air on the side of being as conservative as possible? Or is it still kind of, hey, we want to give our best guess at this point in time?.

Yeah, I don't know that I would agree with best guess. So I think a couple of things. Operating in break-fix MRO, right, we're not perfect predictors especially out of the service centers what's going on, but higher activity in those segments, higher capacity utilization, those things are helpful in bearings and power transmission.

The OEMs doing better as a segment. They're big consumers of those products that is helpful. And so, I think as we went through, we knew we had challenges to start the year. As they continued into that first quarter, I think they just – they develop more. So from our perspective, we think we have those accounted for.

We're not overly pessimistic nor are we overly aggressive and while these are our guidance, our teams are working very hard to do better than that..

Got it. Thank you..

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

Hi, guys. Good morning..

Good morning..

Clarification on the working capital targets, as you were talking about earlier, Mark.

I guess specific to inventory, how much inventory are you expecting to draw down as the year progresses ballpark?.

I don't have the exact number, Adam in front of me, but I will tell you that we do expect operating inventories to come down in our turns to improve as we march throughout the year. I just don't have a number for you here..

Okay. And then, secondly, I guess, you absorbed some restructuring charges in the quarter and I'm wondering, if there is more that is baked into the plan, that you – the updated guidance, that you've given us today.

Are there any – has there been any branch closures or do you anticipate any kind of meaningful change in the branch footprint, as we go throughout the year?.

Yeah, Adam, this is Neil. I would say, no real closures. We've taken the opportunity, like we usually do or annually do to look at where the end markets are and do we have the opportunity for consolidations. And so, there would be a modest number of those that we would have, but there is not a radical change in footprint.

I think, Mark said that, we expect there to be some expense in the coming quarter, the December quarter, around severance and such to be coming through. But all of those, then, right, will help that SG&A rate continue at that sequential movement going through the fiscal year..

Okay. Got you. Thank you.

And then, you had mentioned that your bad debt had ticked up, and would that be like largely centered on the oil and gas operations that you had acquired or has that kind of bled over into the service centers (42:55)?.

No, it would mainly be there and, hey, the leaders of those businesses are experienced. They work through mini cycles from greater than four to as many as seven or eight. So, I guess, I would – our focus, my focus, on those would be, they're an allowance, we think that's prudent, but it is not our plan for those to materialize..

Okay. Thanks very much..

Thank you. Our next question comes from the line of Chris Dankert from Longbow Research. Please go ahead..

Morning, guys. Thanks for taking my question. Just kind of back to full-year sales guidance, there have been some early conversations around extended holiday shutdowns by some of the other major OEMs.

And again it is early, but does your current guidance take into – take any of that into account in the low end?.

Yeah, I would say, it's got that into account, but also, hey, as we work closely with our customers, some will or contemplate some added time out around the holidays for adjustments of their production to what they see as their demand environment. We know in some of the other segments and we referenced them being up.

Some of them are going to work clear through. So, that's factored in. There is also the opportunity especially when we have projects with customers that are around productivity initiatives to kind of help their ongoing competitiveness, the little longer time out does create that opportunity for that work to fit in.

Now, will that overcome, added time being out, that's to be determined. But, we expect some to take more days off around holidays and the calendar year in, but we already know there is works and plans underway for some of those maintenance projects and kind of capital initiatives in those times..

Okay. That's helpful. And then, again we covered it, obviously the gross margin was pretty impressive in the quarter.

Just curious was there any rebate headwind that kept it from being even higher?.

I think the short answer is, no. Obviously, supplier support is a critical component for us with their gross profit percent and we continue to work with them on that on a daily basis..

All right. Great. Thank you..

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

Yes, good morning.

Just a couple of questions, wanted to first address the gross margin comments for the year and wanted to – I know, you've talked about rebates contribution maybe in the first quarter, but maybe if you could talk also about expectations for the year, related to the gross margins also, have you changed your stance given the reduction and inventories planned for this year on the LIFO implications? And then last question just hoping you could size this SGM deal for us?.

Yeah, Brent, let me start with this, we do not expect to have any LIFO layer liquidation benefit during fiscal 2016. So, there is nothing in our numbers that would have a boost from that. So, we think the gross profit percentages that we're talking about is, just core operations from that view.

Regarding supplier support, we expect the supplier support to be relatively stable year-over-year from a gross profit percentage perspective. We don't expect to see a big boost or a big decline from that. So, I think that's just business as usual..

Okay. And then.....

Yeah..

...just sizing how big was the S. G.

Morris deal in terms of revenue run rate?.

Yeah, I would say that that would be about maybe 1% of revenue on our annual run rate type of a thing. So, a little over 1% would be my guidance on that..

And then just maybe just last question. I think a lot of people have hit around it over the course of the call and you've addressed some of the cost-cutting measures.

But I think the piece that I'm maybe struggling with more than any within the guidance, obviously pretty significant cut in the revenue, it ends up I think being $150 million, $160 million, but a relatively less significant cut in the EPS.

So, maybe I was hoping you could talk us through what's – I mean obviously, the revenue guidance significantly changed from August to now, but maybe if you could talk through the other pieces.

I mean have you raised the gross margin percentage view from where you were three months ago? Or maybe kind of talk us through how you get that walk from 2.5 months ago to now?.

Yeah, Brent. I would say our gross profit percentage view is the same as what we've had before with this improvement that we accomplished in Q1 and what we expect to accomplish. And I would say our view on the SG&A is that we're able to make sure that we're making the appropriate moves to deal with that.

So for instance, if you look back on our conference call that we had in August when we were trying to project out on some of our SG&A going forward, at that point in time we said, hey, in Q1 we think SG&A might be lowered by $5 million versus prior year; well, we ended up being $8.8 million lower and we layered in a small acquisition on top of that too.

So we were able to do a little bit better. And so, when you think about SG&A, when you think about planning and for the guidance for fiscal 2016, with higher sales levels, we did plan for, I'd say, additional positions and headcounts that are not going to happen.

So, the moves that we make on SG&A per head count is not just trying to not have replacements when folks leave, but it's also to maybe work with not have – and have fewer open positions, I guess is what I would say..

Okay, great. Thanks a lot..

Okay..

Thank you. And our next question is a follow-up question from Matt Duncan from Stephens. Please go ahead..

Hey, guys.

Just a question on some granularity within the guidance, what are you guys thinking is going to happen with the oil and gas revenues sequentially, as we move through the year? Does the guide account for a sequential decline in that revenue as you go through the year or not?.

Let me start on this one. I believe we have a guide of a run rate from our oil and gas folks to be relatively stable. Obviously, no snap-back for an increase, but no real major decline either from what they've been experiencing the last couple months..

So, I'm curious sort of why you would have that view point. I mean, talking to people that we talked to in the oil and gas industry, it sounds like spend in the fourth quarter of the calendar year is definitely going to be down from the third quarter. And with oil prices where they are, upstream CapEx budgets are likely down in calendar 2017.

So are you guys expecting to be taking market share? Is that how it flattens out or just talk to us about sort of what's behind that flat assumption?.

Yeah. Hey, Matt, I'd say – I was just out with the teams in the business units all across Texas a few weeks ago. And so, we would agree in the fiscal second quarter towards the calendar year end, it's likely what we're in now, maybe a little softer, but there is a variation in that.

And obviously still the upstream production guys doing a little bit better in comparison. There's a fundamental belief in including with customers that I'd meet with and talk with as well. They think the first quarter is slightly better.

No, obviously no snap-back, but they think there would be some more activity as they are looking at consolidating from where they were producing to where they will continue to produce. So, we think that creates a little bit of work.

There is some weather seasonality in kind of Reliance side of the business, on the maintenance side, they will see a little bit of benefit of that in the third quarter of the fiscal year. And then we think the fourth is kind of the sequential carry-out. So, we do not have a big improvement.

We think there's a little variation around Q2 and Q3 in those timings, but that's what we have in..

Okay. That helps a lot, Neil.

And then the last thing just on the balance sheet, remind us what level of leverage you guys are comfortable carrying as we think about you doing additional acquisitions? How much debt relative to trailing EBITDA are you willing to carry?.

Yeah. Matt, obviously we would prefer this to be investment grade, which we have been and have always been. Investment grade gets you up to a 3 to 1 debt-to-EBITDA ratio. We're currently tracking about, let's say 1.7 to 1 ratio. And so, we still have lots of room to go to potentially add some debt to do additional acquisitions.

I would say when we look at our short-term interim type goals for that, we would feel extremely comfortable being closer to 2 to 1 on a debt-to-EBITDA ratio for acquisitions.

And obviously, we are not scared about going over 2 to 1, but we feel that we have a very conservative balance sheet and we have lots of capacity to expand the business, through debt on acquisitions..

And I'm assuming given what you are saying you plan to do with inventory, you're probably going to be generating a lot of cash from working capital here to manage that debt lower as well in the short-term, correct?.

I think there is opportunities for that. Yes..

Okay. All right. Thanks, guys..

Okay. Thank you..

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

Hey, I want to thank everyone for taking the time and joining us today. We look forward to talking with and seeing many of you throughout the upcoming quarter..

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