Welcome to the Fiscal 2016 Fourth Quarter and Year-End Earnings Call for Applied Industrial Technologies. My name is Dina, and I'll be the 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 now begin..

Thank you, Dina. 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 various industry sectors and geographies, the success of our various business strategies, and other risk factors identified in Applied's most recent periodic report and other filings made with the SEC which are available at the Investor Relations section of our website at applied.com.

Accordingly, actual results may differ materially from those expressed in the forward-looking statements. The company undertakes no obligation to update publicly or revise any forward-looking statement whether due to new information or events or otherwise.

In compliance with SEC Regulation FD, this teleconference is being made available to the media and the general public, as well as to analysts and investors. Because the teleconference and its webcast are open to all constituents and prior notification has been widely and unselectively disseminated.

All content of the call will be considered fully disclosed. Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer; and Mark Eisele, our Chief Financial Officer. At this time, I'll turn the call over to Neil..

Thank you, Julie, and good morning, everyone. We appreciate you joining us today. Our fourth quarter and full-year results reflect an economic environment that continues to be challenging including reduced demand in oil and gas, mining and other industrial end markets.

Our net sales for the quarter were $634 million, compared to $677.5 million in the prior year. Net income was $26.1 million or $0.66 per share, compared with $28 million or $0.70 per share in last year's fourth quarter. Net sales for the full year were $2.52 billion, compared to $2.75 billion last year.

Net income for our full fiscal 2016 was $29.6 million or $0.75 per share, compared with $115.5 million or $2.80 per share in fiscal 2015. As you will recall, our third quarter results included a non-cash goodwill impairment charge of $1.62 per share and restructuring expenses of $0.13 per share.

In the fiscal year, we generated $160 million in cash from operations while returning over $80 million to shareholders via dividends and share repurchases, our second highest year of cash returned to shareholders.

We also remain disciplined in our operations, implementing appropriate cost controls and restructuring measures that lower our cost base and strengthen our competitive position, while driving improved efficiencies throughout our organization.

Across Applied, we have opportunities to advance our business in the current industrial economy and position ourselves for improvement in long-term performance. We are continuing to build on our strengths via investments in technology, talent initiatives and strategic acquisitions.

We're pleased with our recent acquisition of Seals Unlimited, an excellent addition that enhances our bearings and power transmission platform in Eastern Canada. In total, we completed four strategic acquisitions during fiscal 2016 that bolster our product and service offerings and will create long-term value for our shareholders.

All of these acquisitions have performed well since being part of Applied and we remain active in pursuing acquisition opportunities that extend our business reach and expand our capabilities with current and new customers. We're also excited about the new Applied.com e-commerce site that will launch later this month.

Our cross-functional team has been working diligently to re-platform our legacy e-commerce solution. The transformed site includes an enriched user experience with a modern, more intuitive design, enhanced search and navigation capabilities, and improved order and account management.

Now, at this time, Mark will provide more detail on the financial results, then I will return with some additional comments including our long-range strategic objectives..

Thanks, Neil. Good morning, everyone. I'll provide some additional insight regarding our fourth quarter fiscal 2016 financial performance. Our sales per day rate during the quarter was $9.91 million, 7.2% below the prior year quarter and 0.7% below our rate in the March quarter.

We had 64 selling days in the June 2016 quarter and 63.5 selling days in the June 2015 quarter. Acquisitions had a positive impact on sales of 2.4% during the quarter and foreign currency impacts decrease sales by 1.2%. Excluding the effects of these items, core same-store operations experienced a 7.6% decrease in sales compared to the prior year.

This 7.6% decline consists of a 3.9% decrease attributable to traditional core operations with the remaining decrease pertaining to sales from our operations serving the upstream oil and gas markets. In addition, we believe the impact of vendor price increases was minimal during the quarter.

Our product mix during the quarter was 27.5% fluid power products and 72.5% industrial products. Fourth quarter sales in our Service Center Based Distribution segment decreased $31.6 million or 5.7%. Acquisitions added $9.5 million or 1.7% and negative foreign currency impact reduced sales by 1.2%.

Core same-store operations in the Service Center Based Distribution segment experienced a 6.2% decrease. The majority of this decrease relates to our operations that sell to the upstream oil and gas industry, as our other traditional operations had a decrease of only 2.6%.

Taking a closer look at our operations that sell to the upstream oil and gas customers, we experienced a 50% decline in our sales from June 2015 quarter and a 15% decline in sales when compared to our March 2016 quarter.

A portion of this decline in sales from the March quarter to the June quarter reflects seasonality due to weather within the Canadian portion of the business. We expect overall sales to upstream oil and gas customers to modestly improve from the June quarter to the September quarter.

Our Fluid Power Businesses segment had broad-based sales decreases throughout the U.S., Mexico and Canada totaling $11.9 million or 9.6%. Acquisitions within this segment increased sales $6.5 million or 5.2%, while unfavorable foreign currency translation decreased sales by 0.9%.

Excluding the acquisition and currency impacts, core fluid power operations saw a sales decrease of 13.9%. From a geographic perspective, sales in the fourth quarter from our overall U.S. operations were down 5.8% compared to the prior-year quarter and experienced the positive impact from acquisitions of $15.9 million or 2.8%.

Our Canadian operations experienced a sales decrease in local currency of 12.5% and a negative foreign currency translation impact of 4%, resulting in a combined sales decrease of $12.6 million or 16.5%.

The sales decline in local currency was primarily related to our reliance operations serving upstream oil and gas customers as the other traditional broad-based Canadian operations were down 4.1%. Consolidated sales from our other country operations, which include Mexico, Australia, and New Zealand had an overall increase of $1.6 million or 4.2%.

This consisted of a sales increase in local currency of 17% and a negative foreign currency translation impact of 12.8% in the quarter. The local currency sales increase in the quarter relates to both our Mexican and Australian operations.

Our gross profit percentage for the quarter was 28.1%, 20 basis points lower than last year's fourth quarter and equal to our full-year rate for fiscal 2016. During the fourth quarter, we recognize LIFO layer liquidation benefits, totaling $2.1 million which improved gross profit percent by 33 basis points.

This improvement was offset by additional expense per inventory reserve adjustments of 25 basis points, along with declines from lower gross profit realization and our operations serving upstream oil and gas markets. Our selling, distribution and administrative expenses on an absolute basis decreased $7.9 million in the quarter or 5.5%.

SG&A related to acquisitions totaled $4.5 million and the impact of currency translation decreased SG&A by $1.6 million. Therefore, core operations achieved at $10.8 million or 7.5% reduction in SG&A. Included in the June quarter is an additional $800,000 of restructuring expense relating to severance and branch consolidations.

For all of fiscal 2016, we incurred a total of $8.8 million of restructuring charges, $3.6 million impacting gross profit and $5.2 million impacting SG&A. Overall SG&A decreased from the March 2016 quarter to the June 2016 quarter by $7 million.

We've captured approximately two-thirds of our annual estimated ongoing savings of $7.8 million from our restructuring activities in fiscal 2016, and we'll see the remaining benefits flow through our income statement beginning in July. The effective income tax rate was 35.6% for the quarter.

This is slightly higher than our projections due to lower foreign earnings which negatively impacted the rate. We believe our tax rate for fiscal 2017 will be in the range of 34.0% to 35.0%. Our consolidated balance sheet remains strong with shareholders equity of $657.9 million and a conservative debt-to-total-capitalization ratio of 33.3%.

Our after-tax return on assets for the quarter was 7.9% On a full year basis and excluding the impairment and restructuring items from the March quarter, our annual return on assets was 7.1% versus 7.9% in the prior year.

Inventory at June 30, is $8.8 million below our March levels, primarily consisting of operational inventory declines and the $2.6 million reduction from foreign currency fluctuations. Gas generated from operating activities was $70.6 million for the fourth quarter and totaled $161.0 million for the fiscal year.

This full-year cash generation is an increase of $6.5 million over the prior year amounts, relating entirely to operational working capital improvements in receivables and inventory offset somewhat by lower earnings and decreases in accounts payable.

Looking forward into fiscal 2017, we expect our gross profit percentage to continue above 28% and to improve by 20 basis points to 40 basis points throughout the year. Prudent cost controls over SD&A will continue, and our expectation is for SD&A to remain relatively flat year-over-year.

Cash provided from operating activities in fiscal 2017 is expected to be solid and should be in a similar range compared to what we accomplished in fiscal 2016. We also expect to see slightly improved DSOs and inventory turns in fiscal 2017.

Capital expenditures are expected to be between $15 million to $18 million and depreciation expense should be slightly higher than in fiscal 2016. As previously discussed in our press release, we are forecasting a sales change in the range of negative 3% to up 1% for our full fiscal year 2017.

And we expect earnings per share in the range of $2.40 to $2.60 per share. Now I'll turn the call back to Neil for some final comments..

reaching $3.3 billion in revenues, assuming modest low-single-digit organic growth, and $150 million plus of revenue from new acquisitions per year, and improving our EBITDA profitability to between 9% and 10% through sales and margin expansion and with continued discipline on cost and operational controls.

And if end markets improve over this long-range horizon, we are confident we will do even better. We recognize our requirements in this operating environment and going forward, and we are taking the appropriate actions to serve all Applied's stakeholders.

As defined in our core values, teamwork and the corresponding belief of working together, winning together is alive and well with our customers and suppliers. We're committed to performing in any environment generating long-term value for our shareholders. Now, at this time, 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 the line of a Matt Duncan with Stephens, Inc. Please go ahead..

Hey. Good morning, guys. This is Will on the call for Matt..

Good morning, Will..

Good morning. First, can you talk about the monthly trends through the fourth quarter and what you've seen, thus far, in the first quarter revenues? I see you're essentially flat sequentially, but I'm trying to get a better idea of the sales cadence over the last few months and as we've entered August..

Sure. Sure. So, I'd say, Will, our sales per day trends included declines in April and May with improvement in June. July somewhat as expected with seasonality, softer than June. And through the early days of August, we're seeing sequential improvements in that..

Okay.

And turning over to guidance from – I'm wondering what your sales impact assumption from your energy related revenues? What you've accounted for versus the total company revenue guidance range? What you're kind of thinking from the energy perspective as we look into the next fiscal year?.

Will, we expect our sales for the upstream oil-and-gas customers when you do a year-over-year comparison to the prior periods will be down year-over-year in this September quarter and the December quarter, but then the comps get better and we expect to be at or a little bit better in our March quarter and our June quarter, but like we said in our comments even earlier on this call, we do expect the September quarter to be modestly better than the June quarter that we ended..

So, as we separated and look at it, we're seeing those trends develop for the upstream portion of the business particularly on the production side in the results, and I think, as expected, the upstream drilling side is where still most of the challenge would be..

Okay. That's helpful. And last thing for me, I wonder if you could talk a little bit more about the Seals Unlimited business.

What it does in terms of annual revenue and what those end markets are that that it primarily serves in Western Canada?.

Sure. I'd say, overall, for us, acquisitions going forward are going to have impact of around 1%. So, they are in that part. Seals particularly strengthen our presence in Eastern Canada, so it's an add-on to us in bearings, power transmissions, good focus in sealing technology.

From a customer standpoint, we think there's nice complements between what we can do with existing customers in our current business plus the Seals now across those product lines both having product expansion opportunities. And we believe to our core business is going to open us up for a few more new business opportunities.

So, overall, in that Eastern Canada, we maintain on growing our presence, brings us up to 21 locations including nine in that Ontario province..

Great. Thank you, guys..

Okay..

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

Good morning..

Good morning..

I wondered if you could talk about the competitive environment and if you believe you're at least maintaining market share..

I'd say, fundamentally, yes, I think we do. We're all participating in a challenging industrial environment. Our focus is the ability to use our value-added capabilities, our scale to continue to perform well in that environment.

So, I believe, from a share standpoint, we've got many locations that are probably exceeding and we have others that are holding their own in what I think, overall, is a tough environment..

And what percent of your sales currently are generated from energy-related markets?.

In the June quarter, the sales to upstream, oil and gas customers we're a little under 5% of total sales..

And then finally, I wonder if you could just run through the performance by industry of the 30 groups that you track..

Sure. That's a – in the quarter, we would've had 12 industries showing increases. I think the positives would be around what most would expect, construction-related industries, cement, aggregate, building materials. Food would be one of the positive categories. So – and then, I think, the known ones you expect with the most challenges..

Thank you..

Okay..

Our next question comes from the line of Ryan Cieslak with KeyBanc Capital Markets. Please go ahead..

Hi. Good morning Neil and Mark..

Good morning..

Good morning..

I just wanted to go back to the question about the trend so far here in the September quarter. Neil, I think maybe you were talking more on a sequential basis on how things have trended in July and August.

Any sense of how we should be thinking about maybe the cadence on a year-over-year basis for core sales here, maybe in the first part of the fiscal year for you?.

Yeah. So, we would say across physical 2017, we would expect softer trends in Q1, some improvement in Q2, we've got one less day and then, continued modest improvements through the second half of the physical year. So, that's what – that would be our view in coming across.

So, sequentially, as expected in July, we're seeing a little bit of improvement, it's early in August. But we think it's softer in Q1 and then ramps and improves from there..

Okay. And then, Neil, what are you assuming for just generally the plant shutdowns around the holidays? So, we heard some potential extended plant shutdowns around Labor Day.

What are you guys just assuming from just a normal seasonal standpoint around the holiday plant shutdowns?.

Yeah. I don't know that we have all of those baked in. I would say from a more qualitative assessment, I think around July, and we'll see going forward customers took longer time out of their production. And I think many had less preventative maintenance productivity-type projects going on in that time period.

Now, as they're back up and running, right, we see that brake fix demand coming through. And then, it's early but the dialogue for those that would have planned downtimes, which more of that would be towards the end of the calendar year, they would be slating projects that would positively impact their uptime and their productivity.

So, we experienced it around that July time period, but I think too early to call what it may look like going forward..

Okay. Fair enough. And then on the gross margin guidance you guys gave, it's good to see that you're still assuming some consistent improvement here to this year. Maybe just talk a little bit about again what initiatives you have in place that gives you the confidence you can see that consistent improvement going forward.

And what are you assuming in the guidance for overall pricing this year as well?.

So, I'd say, overall, for us, in our gross margin improvement, our confidence around continued improvements is around using our pricing analytics, reducing variation around product groups and specific customer groups that will yield improvement.

We saw improvement last year and we expect it to continue in mix, customer mix, as our locations continue to improve and their local market participation with small, medium customers. And then, we're also getting benefit in product mix around maintenance supplies and solutions and other consumables.

And some select in the business, we could have or we have a little certain supply or rationalization just limiting the offering on some of the flow products. We think that helps us just from an operational standpoint and could create a little bit of opportunity also..

Okay.

And then just pricing, any assumptions there or pretty much a neutral impact this year as well?.

Our expectation is that supplier price increases should be relatively flat, so that the impact on fiscal 2017 compared to 2016 should be negligible..

Okay. Great. And then, Mark, just really quick, a housekeeping one. In the sales guidance you laid out for the year, is there an FX impact we should be thinking about? I mean, how that impacts the numbers here over the next couple of quarters..

Yeah, that's correct. When we look at the entire year, we think the FX impact is going to basically be zero, but it will have some impact with the individual quarters. We think we'll be having a small negative impact in Q1 and basically flat in Q2 and a slightly positive impact in Q3 and then maybe a small negative impact in Q4.

But when you add them all together, it really nets to about zero..

Okay. I'll jump back in the queue. Thanks, guys..

Okay..

Our next question comes from the line of Larry Pfeffer with Avondale Partners. Please go ahead..

Good morning, gentlemen..

Good morning..

Good morning..

So, on the consumables piece that you touched on a little while ago, could you just speak to how that portion of your portfolio is growing relative to some of the others?.

As we look at that business and trends going forward, we would see modest positive gains and we expect those to continue.

We see benefits where we have placed inventory in our common distribution centers in the past year and good cooperation and coordination across those business teams with current customers that we have today and some new ones that we would be targeting. So, we would see positive development on it going across..

Understood.

And then maybe looking at the two different kind of quasi segments between Service Center and Fluid Power, how would you look at revenue run rates on a year-over-year basis in fiscal 2017?.

Well, let's talk a little bit about the Fluid Power businesses. And what we're seeing is a little bit of solidification in their back orders with their OEM customers. And so that's obviously a good sign. So, as we go through fiscal 2017, we expect their revenues to continue to get better throughout the year.

And that's really tied to some of the back order experience that we've had in the last couple of months. And then, both the fluid Power Businesses segment as well as the Service Center Based Distribution segment, we're still challenged with the overall industrial economy like we talked on the call.

And we think the rest of calendar 2016 will be more challenging..

Understood.

So, in general, you're kind of looking at maybe low-single-digit declines in the first half of the fiscal year and then getting to flat, slightly positive in the back half?.

I think that would be a fair view. And clearly, our view is we've got the opportunity to be better and our internal plans and expectations are higher..

Got you. Thanks for taking my questions, guys..

Sure thing..

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

Good morning, guys. Thanks for taking my question. I guess, first off, in the past, you guys had mentioned there's some kind of cannibalization of parts particularly in the oil field.

I guess, have you been – continue to see that trend or is that starting to fade off a little bit?.

I would think on the amount of tilted rigs cannibalization still exist perhaps to a little bit lesser extent. And then, right? We all follow and no rig counts moving up, as we think about it from April to August some improvements.

So, as those come back, some of them are refurbished with the existing parts of those rigs and some are requiring demand coming up. So, hey we know that phenomena is out there. I think that the amount of rigs coming back aren't yet impacting all of that demand..

Got you, thanks. And then I guess, just quick on the website update, historically, you guys have highlighted very clearly some of the online models, Amazon, et cetera, can't compete with being right next to the customer once something breaks.

I guess, it's just the update for online more matter of better customer service, a cleaner experience or is there kind of some potential revenue upside out of this?.

Yeah. So, we think about it going forward, we view we've got five channels to market. And so, I agree with you, local presence and capability matters. And so that's, we will continue with the 550 plus locations. In our Fluid Power business, right, we got 65 service and repair centers and geographically spreading close to customers.

Another channel of the market for us is our catalogue, both printed and electronic. Then, we also have onsite vendor-managed inventory specialist around our maintenance supplies and solutions business. And then, we've had and we'll have a better Applied.com. So, today, we have customers that interact and buy from us across multiple of those channels.

We think, going forward, more customers will do that in this better site, better user experience, better capability is just going to help current customers that do business with us and it probably makes us attractive to another new set out there that can come in to our customer base..

That makes sense.

And then I guess, well, I'm not sure what the status is right now, but is there app-based ordering at this time?.

There would be. And so, all of that starts to come out really just later this month. And so, we're excited to get it out. And so, even for some of the analysts still on, 11 new investor relations site as well..

Fantastic. I guess just one last one, if I may.

Could you provide us the book-to-bill ratio for the quarter?.

I don't have it in front. I obviously as in our Service Center side of our business heavily in break-fix MRO, it's pretty close. In our Fluid Power business, I can say we've been encouraged by the increasing order rate that has been going on and the build of backlog that's starting.

And while let's say in any business and that business too, right? Why you never wish for us a slowdown, what it has created is the opportunity for us to be close to those mobile and industrial OEMs, be working on their products and those applications and grow our content.

So, I think we're starting to see some of that in our order rates and our backlog. And so that's encouraging to us and we think creates the opportunity for upside as we move throughout the fiscal year..

Sounds good. Thank you so much, guys..

Sure..

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

No. I just like to thank everyone for taking the time to join us today and we look forward to talking to many of you throughout the quarter..

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