Applied Industrial Technologies Inc (AIT) 2019 Q2 法說會逐字稿

Welcome to the Fiscal 2019 Second Quarter Earnings Call for Applied Industrial Technologies.

My name is Mariama, and I'll be your operator for today's call.

(Operator Instructions) Please note that this conference is being recorded.

I will now turn the call over to Julie Kho.

Julie, you may begin.

Thank you, Mariama, and good morning, everyone.

This morning, we issued our earnings release and supplemental investor deck detailing latest quarter results.

These documents are available in the Investor Relations section of our website at applied.com.

A replay of today's broadcast will be available for the next 2 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 include those made during the question-and-answer portion, speak only as of the date hereof and are based on current expectations that are subject to certain risks, including trends in various industry sectors and geographies, the success of our various business strategies and other risk factors provided in our press release and identified in Applied's most recent periodic report and other filings made with the SEC, which are available at the Investor Relations section of our website at applied.com.

Accordingly, actual results may differ materially from those expressed in the forward-looking statements.

The company undertakes no obligation to update publicly or revise any forward-looking statement, whether due to new information or events or otherwise.

In addition, the conference call includes the use of non-GAAP financial measures.

These measures are explained in our press release and in the supplemental presentation material and are subject to the qualifications referenced in those documents.

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 Dave Wells, our Chief Financial Officer.

I will now turn the call over to Neil.

Thank you, Julie, and good morning, everyone.

We appreciate you joining us.

I'll start by providing an overview of recent developments, then Dave will follow up to review our financial results in more detail and also cover our updated guidance.

As referenced in our press release, we're pleased to post year-over-year increases in our fiscal '19 second quarter results; however, our sales and earnings were below our planned performance.

We understand the key performance drivers which included: One, decelerating growth through the quarter culminating in significantly weaker sales in the final week of the calendar year.

More specifically, we went from December 21 month-to-date sales that were within the 5% to 7% full year guidance range to core year-over-year sales growth of less than 1% for the full month of December.

Second, we had some softness in project timing delays in our fluid power businesses, including lower demand from technology markets, primarily electronic equipment and component manufacturers.

And lastly, we experienced an adverse impact on our margins from a $2.7 million LIFO inventory charge related to more pronounced inflation experienced in the quarter.

In light of the softer top line and inflationary headwinds, we initiated appropriate cost measures, alongside our continued actions to drive efficiencies and execute our business plans.

Our revised full year fiscal '19 guidance issued this morning reflects the moderating industrial environment and current fluid power market dynamics, with the sales guidance assuming nearly 2% to 4% increase in second half daily sales rates compared to the first half, excluding acquisitions.

Further broken down, this assumes second half Fluid Power and Flow Control daily sales rates remaining essentially flat with the first half of the fiscal year, and a 3% to 5% increase in the second half daily sales rates in our Service Center segment.

During the quarter, we were pleased to welcome Fluid Power Sales to the company.

Announced in November, FPS is a manufacturer and distributor of fluid power components, specializing in the engineering and fabrication of manifolds and power units.

Their addition provides a strong strategic fit that further enhances our fluid power market leadership, which includes the broadest product range in the industry and one-stop shopping for all fluid power needs from design to repair.

Additionally, we're proud to recognize the 1-year anniversary of FCX Performance acquisition and movement into engineered specialty flow control, with their premier brands, innovative products, custom solutions and high-tech -- high-touch technical service.

I could not be more pleased with the FCX team members and our progress to date.

We're more excited about our ongoing growth prospects entering our second year together.

Our combined resources are positively impacting customers and delivering on our synergy plans across the work streams, including revenues, operations and profitability.

Looking forward, we will remain active in acquisitions, as we move through calendar 2019, pursuing strategic additions that extend our business reach and enhance our capabilities with new and current customers.

Overall, we continue to strengthen our position as a differentiated industrial distributor and the technical distribution leader with our critical core products offering, expanding value-added services, leadership in engineered fluid power and flow control solutions, growing geographic reach and multiple channels to market.

Now at this time, I'll turn the call over to Dave for additional detail on our financial results.

Thanks, Neil, and good morning, everyone.

Before we move on to cover further details on our most recent quarter financial performance, a reminder that the supplemental investor deck issued this morning recapping key financial and performance talking points is available for your reference on our investors site.

Turning now to our second quarter results.

Sales for the quarter ending December 2018 increased 25.9% over the prior year quarter, with acquisitions driving a 21.3% year-over-year increase.

Organically, sales grew 3.7%, while the impact of foreign currency exchange decreased sales by 0.7%.

There was 1 extra selling day in this year's quarter, which generated a 1.6% benefit to reported organic growth.

Second quarter sales in our Service Center Based Distribution segment increased by $33.7 million or 6.1% year-over-year.

Excluding the adverse impact of foreign currency translation, sales increased by 6.9%.

This includes a 1.6% benefit from 1 additional selling day in this year's quarter.

As previously mentioned in our Service Center Based Distribution segment as well as our Fluid Power and Flow Control segment, we saw the adverse impact of 2018 holiday timing, including reduced year-end shutdown maintenance activity.

Overall, Applied organic sales growth was up nearly 6% through December 21, but finished up less than 1% for the month of December after the final week of the calendar year.

Moving to our Fluid Power and Flow Control segment.

Second quarter sales increased $139.2 million or 124.7% as compared to the prior year.

Acquisitions within this segment, namely the addition of both FCX Performance and more recently Fluid Power Sales, increased sales by 127.4%.

Excluding the impact of acquisitions, sales were down $3 million or 2.7% as a 4.4% decline was partially offset by the 1.7% benefit of 1 additional selling day in the quarter.

Our Fluid Power and Flow Control segment growth was down from recent quarters given the tougher year-over-year comps, timing of larger projects and lower demand from technology markets as well as some adverse impact of supplier performance.

Excluding FCX and the most recent Fluid Power Sales acquisition, the legacy fluid power organic backlog at quarter end remained strong, with a further modest increase to backlog in the quarter.

From a geographic perspective, sales in the quarter for our U.S. operations were up $170.2 million or 30.5% year-over-year, with acquisitions driving $142.2 million or 25.5% of this increase.

Excluding acquisition impact, organic sales growth from U.S. operations reflected a 5% increase, which included a 1.6% benefit from the extra sales day in this year's quarter.

Sales from our businesses outside of the United States grew 6.7% organically, with solid performance across all geographies.

The extra sales day in this year's quarter drove 1.7% of this growth.

Foreign currency impact, however, was a 4.3% headwind, resulting in a reported 2.4% sales increase in our foreign markets as compared to the prior year quarter.

Moving on to gross margins.

Our gross profit percentage for the quarter was 28.9%, up 68 basis points year-over-year.

Acquisitions drove 93 basis points of margin expansion year-over-year.

Excluding this accretive benefit, gross profit margin for the core business was 28%, 26 basis points lower than prior year, driven by an increase in purchase costs in the quarter.

This inflationary impact generated a $2.7 million noncash LIFO inventory charge for the quarter, which represented a 32 basis point headwind for the quarter and a 16 basis point adverse year-over-year impact.

This equates to $0.05 per share adverse EPS impact.

We expect margins to normalize in Q3 as we pass on the recent supplier price increases.

Our selling, distribution and administrative expenses on an absolute basis increased to $40.3 million or 28.4% when compared to the same quarter in the prior year.

Acquired businesses accounted for $36.4 million or 25.7% of year-over-year SD&A growth, while fluctuations in foreign currency rates decreased SD&A for the quarter by 0.8% compared to the prior year quarter.

Excluding the impact of acquisitions, the nominal 2.7% year-over-year increase in SD&A expense included a 120 basis point increase in our self-insured medical cost attributed to several major medical cases, along with the impact of annual merit increases.

The effective income tax rate was 23.2% for the quarter, resulting EPS for the quarter was $0.99 per share, up 25.3% year-over-year.

Excluding the benefit of lower effective tax rate, pretax income increased 13.1% year-over-year.

Our consolidated balance sheet remained strong with shareholder's equity of $890 million, representing more than a 9% increase year-to-date.

Cash generated from operating activities was $53.8 million for the quarter, which represents a $42 million improvement from the prior year quarter.

Quarter results demonstrated continued traction generated by operating working capital management initiatives.

We continue to extinguish the additional debt assumed to fund the FCX Performance acquisition with net leverage based on our existing credit facility covenants, now just over 2.8x EBITDA as of quarter end.

In our first quarter, as previously communicated, we fully extinguished $112.5 million initial draw taken on our $250 million revolving credit line to fund the FCX acquisition.

There was no utilization of our revolving credit line in the most recent quarter.

As noted in our press release, today we announced that our Board of Directors raised the quarterly cash dividend to $0.31 per common share.

This represents the 10th dividend increase since 2010 and underscores our strong cash generation and commitment to delivering shareholder value.

To recap, while our second quarter performance reflects some of the inflationary impact and economic conditions, which have played out in the recent quarter, we remain focused on continued execution of our strategic priorities in any environment.

EBITDA for the quarter was $76 million or 9.1% of sales, a 58 basis point improvement, and we generated strong cash flow in the quarter.

Our Fluid Power and Flow Control segment backlog position remained strong, and we continue to see broad-based opportunities for growth in all businesses and geographies.

As we neared the 1-year anniversary of the FCX Performance acquisition, we remain pleased with the contributions of the business.

FCX contributed another $0.06 per share to year-over-year growth in earnings per share in the quarter.

Transitioning now to our revised outlook.

Given the current moderating industrial environment and business conditions, we are revising our full year fiscal 2019 sales and earnings per share guidance to between $4.45 and $4.65 per share on a sales increase of 12.5% to 15%, with full year sales from our legacy operations forecasted to be in a range of up 2% -- [2% or 3%] year-over-year.

While showing a softer top line, our guidance still assumes a 2% to 4% step up in daily sales rates second half versus first half excluding the benefit from the recent FPS acquisition.

We are assuming second half Fluid Power and Flow Control daily sales rates remained essentially consistent with what we saw in the first half and a 3% to 5% increase in second half daily sales rates in our Service Center segment.

This would generate 4% to 6% second half organic growth in our Service Center segment, with a 5% to 7% sales decline in our legacy fluid power business, given continued tech-driven softness and tougher second half comps.

Additionally, our guidance assumes a 15 to 30 basis point step up in second half margin performance, driven by pricing and other margin expansion initiatives.

SD&A and interest expense favorability will partially offset the adverse impact of lower top line.

With that, I will now turn the call back over to Neil for some final comments.

Thanks, Dave.

Moving into our 96th year of doing business, we know our individual and team responsibilities to deliver our fiscal '19 commitments, including a continued focus on our 5 strategic elements: core growth, product expansion, Fluid Power and Flow Control, operational excellence and acquisitions.

As we move through the second half of fiscal '19, we will maintain an emphasis on profitable sales growth, driving our core business growth with current customers, reaching new end-users and leveraging our value-added capabilities.

On margin expansion, mitigating the inflationary pressures, SD&A management, maintaining diligence in our operational spend and continued working capital improvements, strengthening our business and fueling future investments.

We have a strong foundation, expanding business capabilities and outstanding potential and we're working to win each and every day.

And with that, we'll open up the lines for your questions.

(Operator Instructions) Your first question comes from Jason Rodgers with Great Lakes Review.

So just talking about the deceleration here and the weakness in the last week of the quarter.

Was that widespread or concentrated mainly in the fluid power technology area?

And also along those lines, I wonder if you could talk about the commentary you're hearing from customers?

They think this is a beginning of a trend.

And then the sales so far in January?

All right.

So I would say the last week really all aspects of the business participated.

If you think about it specifically, December 24 is a half day for us of work, as is 12/31.

And if I look back -- or if I look at that performance back to the past few years, we were less than half efficient or productive or sales output on that day this year and that was across.

And on the 12/31, we were roughly 60% of what we had been.

And while they were half days, the rest of the week more productive.

But with those 2 days being in essence almost nonexistent, it had an impact.

And so in talking with customers and really the teams, I think many took advantage of weekend to extend it between the holiday not to be as -- not to be opened or operational on those days.

And then as we work with and plan with our customers on preventive maintenance-type projects, I think more either just took the timeout or would have 2- to 3-day type projects and maybe not the longer ones that could last 5 to 7 days.

And so if I look forward what does that mean, it could mean more break-fix activity in the first half of the year.

It could mean additional 2- to 3-day projects going on in the first half of the year or some of those longer preventative maintenance activities occurring in July or the midyear time frame as we get there.

And then looking forward or now in the January, overall we're performing in the mid-single digits sales rate.

And it looks like the guidance is assuming none of these delayed fluid power technology projects are realized in the second half.

Wonder if you could just talk about how much visibility you have around that?

And if you could provide some figures around that fluid power backlog?

So our fluid power backlog, sequentially, had a little bit of improvement in the quarter.

And if we look at it year-over-year, it's probably up or single digits higher.

But if we get into it and really look at the fluid power company performance, we have over half the group that is growing.

Out of the remainder, 25% of those are very close.

And then we'll have 25% that are a little further off.

And a couple of those projects are linkage to some of these industries, including higher technology.

We expect that to continue, as we work through the second half.

Many of those are other projects.

We will continue to book bill projects and we'll have productive output there.

But given that impact around those technology segments, that's impacting our guidance or our outlook into the second half of the fiscal year.

Your next question comes from Chris Dankert with Longbow Research.

I guess, to kind of build on that a little bit further, could you give us the total top 30 market breakdown?

And kind of what you're seeing across energy and some of the other -- other markets besides technology?

Sure.

So in this past quarter, we would have had 20 industries showing increases.

So that's down sequentially.

I look back, I think, in Q2 of last year, we would have had 20 up.

So positive continues around primary and fabricated metals, aggregate, oil and gas, building products and such.

In the quarter and especially later in December, I think, machinery OEM softened up.

I think some of that could be around the timing.

And then the more weaker comparables were around lumber wood products, some durable goods, the computer and electronic manufacturing segment that we called out, and coal mining would be as well.

Got it.

That's very helpful.

And then just on pricing a little bit more, could you kind of just -- broad strokes kind of what the impact was in the quarter?

And do you still expect kind of a similar level in the first -- or the back half of '19 here?

So our look going into the second half is that we can and we will expand margins.

If I set aside and we don't, from a result standpoint, but if I set aside LIFO, business performance, teams' performance and seeing inflation come in, our handling of tariffs whether it be the 232, which we really processed on steel and aluminum and the various list of the 301 tariffs, I think we're doing a very good job of matching.

At year-end or building up to it, we would see some additional manufacturers coming in with the increases that we will process going forward.

But if I look at how we do in our local businesses and local accounts, we're matching very, very well.

And with the other segment of our business, those will be phased in as we work through this quarter right now.

So from that, I feel like we have and we will continue.

I'm a fundamental believer, especially on the tariff side of it.

Right?

The end customer, the end household, the end user has to pay.

We've shared, at times, when they come in large and lumpy, that they don't perfectly get through in a period, but we're committed that they do in pretty fast order.

Got it, got it.

And then just last -- one last one, if I could.

I know it's difficult to break out, but did any of your managers or anyone highly destocking as a negative headwind in, whether it was December or just the broader quarter at all?

I think a short answer around our business is no.

And we talk about not a big stocking, destocking phenomenon in the business, especially, with break-fix MRO criticality of the products.

We think from a user standpoint on our side, our customers are not heavily stocking those products.

They're relying on us to be there and prepare to serve the random demand that can occur and of course, be there with technical solutions and services also.

Your next question comes from Adam Uhlman with Cleveland Research.

Can we circle back to the electronics business again?

Exactly, how big is that business for Applied as a percent of sales?

Yes so it's in our top 30 industries.

And it maps to our reported segment in our general industry so -- right, it's below any of the other call outs.

So it's low single digits in that.

And if I look back, right, it's kind of had steady progression and growth over prior periods.

And I think, just more recently, maybe a little bit in the past quarter, but definitely in this quarter, a little more of a step-down.

Now if I look forward, right, we like our participation around the segment.

And we expect a return to growth, but now the timing cannot call perfectly.

But if we think about artificial intelligence, big data, Internet of Things, if we think about machining making more decisions than humans and that growth trend, if we think about 4G to 5G products, those providers of those electronics and computer equipment will have growing demands.

And I just think we're working through a little bit of that cycle right now of those players that are supporting or feeding some of those end markets or those industries, but we expect that to be turning at some point as we go through calendar 2019.

Okay.

Got you.

And then back to Chris' question on the -- on price realization.

I guess, how much did that contribute to the 4% organic sales growth this past quarter?

Or was that like a point or 2?

Is it like bigger than that now?

And then, as I think about the gross margin rate for the second half of the year, what's like a reasonable estimate going forward?

Adam, we view the price realization -- here again, you were tracking that very discreetly for our same SKU sales year-over-year, particularly in our service center network.

Once again, that represents about 1/3 of the business and the service center has just given that randomness of demand, but we are seeing up 2% to 3% in terms of that price realization in that piece of the business.

We think that extrapolates really across the balance of the business just seeing, despite the lower volume, some improved step up in our fluid power margin.

So clearly offsetting the inflationary impact in those pieces of business where we don't have that unique same SKU tracking year-over-year.

I think if you think about the back half, certainly, we've talked about slow, steady inflation being good for industrial distributors.

When it comes a little bit lumpier, like it did this quarter, we don't always stick it perfectly in any given quarter.

So as Neil referenced, doing well with the smaller local accounts and the ability to pass that on.

We'll see some more price realization as we move through this quarter.

And that really is the key driver by -- behind that 15 to 30 basis point step up in our gross margin performance that we've assumed in our second half guidance.

Okay.

Got you.

That's helpful.

And then you had mentioned some SD&A countermeasures.

Some of that, obviously, is going to come through with commissions and everything else.

But I'm wondering if there is -- if you can talk about other areas where you're doing belt-tightening?

Is there facility rationalization that's come on to plan now, any more color?

Yes.

We'll continue to look at facilities.

And as we've expanded our footprint, we see opportunities to combine or collocate in some markets.

And so there's a little bit of that happened in Q2.

And we're confident we have more of those opportunities going forward, which will really help ability to serve and cost productivity.

We are also just continuing to get more efficient in the back office of our operations, and that's allowing us to have a differentiated staffing level there as we get retirements or transitions.

But our biases continue to have strong forward-facing resources, investments in those resources that touch customers and help the business to continue to grow.

So we have made technology investments, and we're reaping benefits from that.

And we will continue to drive continuous improvement initiatives across the business whether it be our DCs or in our shop operations or in our service centers or branches, that just helps that productivity.

I think Q2 does reflect nice leverage there.

As Neil indicated, continuing to exploit the investments that we've made in technology as well as the operational and excellence initiatives that we have ongoing, so I think while still funding some of our strategic priorities in the quarter.

So we made reference to it, up 2.7% higher for the quarter in terms of SD&A spend, with 1.2% of that driven by just higher self-insured medical costs, given some unusual claims that came through this quarter, and another 1.4% driven by our focal merits year-over-year.

So back half of the year, we would expect to continue that diligence while still funding those strategic initiatives.

We do have the addition of Fluid Power Sales that will reflect a bit of an increase in SD&A expense, plus our focal merits do take place January 1 or did take place January 1. So we'll see that impacting the back half of the year, but continue to offset that with the workaround, the leverage of technology and driving those operational initiatives as an offset.

(Operator Instructions) Your next question comes from Ryan Cieslak with Northcoast Research.

My first question, I just wanted to go back, Neil, and if you sort of strip out the weakness in late December, which seems like a lot of distributors experienced that, and maybe even the tech market you guys called out in fluid power, how would you maybe characterize the other end markets?

How they trended through the quarter and, certainly, here until early January?

Are they trending relatively in line or below what you would have expected at this point?

Yes.

So if I look back, October was really in the middle of the sales guidance range.

If I look at November, sequentially, improved a little.

Probably, the year-over-year comparable would have been slightly lower.

And then, as I shared, right, as we went through that December 21 time period, really that mid-single digits middle of that guidance range on that.

And so really the step down in that final week driven especially by a couple of those days.

If I look forward, right, it's still same.

Just I haven't seen today yet or yesterday, but 15 of 22 days were in that mid-single digit range in that.

So I think the things we've talked about on the 30 industries, those are probably likely continuing.

I don't know that we're getting a big spillover from shutdown and those concerns into this side.

As we look forward, I can get a little bit more optimistic.

They'll settle up and then look to do something more productive from a government standpoint, which could bode some positive for infrastructure projects, which would be good for us at some point as we work through.

That highway bill ends in 2020, so somebody's got to get in front of that.

And once they do, that's good for heavy industry, aggregate cement and earthmoving-type equipment.

So those are things that either in the back half of our fiscal year or as we look forward into the early part of fiscal '20, could also be a help for us.

Okay.

Just to be clear.

So I mean, what you're saying is, you're not really seeing a material change in the underlying momentum of your end markets right now that you would call out?

No.

Not from a -- not from big step down in the last week of December.

And right now, we're seeing it is more of the same.

Okay.

And then, can you just give some color around the oil and gas businesses, sorry if I missed, the growth you had there in the recent second quarter?

And then what is your guidance assuming the back half as it relates to year-over-year growth in those businesses?

Was there any revision to that as you think about the next couple of quarters?

From an oil and gas standpoint, we're really in the mid-teens performance in quarter.

And really, that's in our guidance outlook for the rest of the year.

We think perhaps there is a potential to be better.

Activity around the Permian continues where we have nice presence.

And if I look at drilled but uncompleted wells, the ratio to the drilling rigs is probably 8 to 10x, so our view is activity remains solid at the level that we're at, potentially with the ability to improve.

But guidance is really along that continuing in the mid-teens range.

On a year-over-year basis is what you're saying?

Yes.

Okay.

And then when you look at the implied organic growth or, I guess, the organic declines in Fluid Power Sales in the back half of the year, outside of what seems like as the tech market being one that declines, what other end markets or business segments within Fluid Power are you expecting sales to be down year-over-year?

I don't know that we've got steep declines in any other markets.

I mean, we're broad-based participants there in agriculture, in mining, in power generation.

There is some support around oil and gas, and so we think many of those mobile and industrial OEMs are continuing to have good outlook, good plans.

So right now it's around tech.

A couple or one of the other groups that has done well around utility projects is seeing a little softness as well, which we can understand a little bit with that segment also.

But clearly, looking at ways to diversify and fully participate in other end segments.

Okay.

And then my last question is, it seems like FCX in terms of the accretion there is running ahead of the original guidance that you laid out.

Dave, can you just reaffirm, I guess, the original guidance what I have was $0.15 to $0.20.

And have you updated that at this point?

What's sort of assumed in the accretion run rate in the back half guidance that you now have?

Yes.

So if you recall out of the gate, we did talk about up $0.10 to $0.20 in terms of fiscal '19 accretion.

As we saw the amortization expense [set away] and a bit favorable to what was assumed in that, we updated that to kind of, basically, that was a $0.04 benefit.

So you could take that range $0.14 to $0.24.

We've strung together a couple of quarters now of $0.06 in terms of the impact for the quarter.

So yes, certainly, trending to the higher end of that range, continuing to, like I said, on a 11-month basis of ownership now did exceed the top line and doing slightly ahead of plan on the synergy case.

So continuing to be pleased with the progress there.

And we would expect that to continue into the second half in our second half guidance.

Your next question comes from Steve Barger with KeyBanc Capital Markets.

Neil and Dave, this is Ryan Mills on for Steve.

There has been a lot of investor concern around the heavy equipment cycle, and I know you called out some OEM machinery softness.

So I guess, my question is, what's your view on that cycle?

And are you seeing machinery OEM customers get more cautious around order visibility and production?

I don't know that we'd see more cautious.

We talked earlier -- we think or we saw some of that as an end market segment, as it worked through December, now is at year-end calendar timing, is that their outlook, is that what they do in planned shutdowns or maintenance.

For many of the larger guys obviously, right, we're not on equipment.

We would be supporting their plants for midsize guys with our fluid power business.

We are part of the solution, we are in the equipment, including products plus electronics on those controls.

So I think it's a continue on to the start of the year.

I think there is still -- many are positive as they work through '19.

I think there is a fluid power association and some others that may show a weakening or softness of 1%, probably not 2%, but 1% or 2% around some hydraulics and pneumatics, which would feed into those solutions with a much more positive outlook in '20.

So if that comes to fruition, right, we will be working through it, grow our content in that period.

But is there a lull in some time in calendar '19, some are pointing to that.

As we start this year, this calendar year, 15-or-so days into it, don't know that we'd necessarily be seeing that.

Okay.

And then I have a couple of questions around free cash flow and the balance sheet.

Free cash flow realization was good in the quarter, and you have quite a bit of cash on the balance sheet.

I guess, my question is, if things do moderate from here, what is the capital allocation plan?

Do you start to reduce debt more?

Or are you still more deal-focused?

And how is the Board thinking about opportunistic share repurchases?

Sure.

We continue to evaluate that best allocation of the capital.

And to your point, we have given the stronger cash flow in the quarter, accumulated some cash in the quarter.

So we're going to maintain our discipline in terms of still a robust M&A funnel.

We think we can drive significant shareholder value just given kind of the accretive bolt-on opportunities in the space, as you think about particularly fluid power, flow control remaining true to our priorities there, while continuing to evaluate, obviously, the delevering that we had committed to, making nice progress there.

Then, opportunistically, potentially looking at share buyback depending on where stock price, ultimately, drives.

Okay.

And then free cash flow year-to-date is around $60 million.

Do you feel confident enough in the cash flow generation in the back half to achieve that implied guidance of $200 million to $220 million?

Yes, I sure do.

So I think -- think about the seasonality of the cash flow in this business, we're coming into the back half of the year, which is typically stronger.

I really like the momentum that we posted in the most recent quarter in terms of some of our collections' initiatives, some of the payables' initiatives.

So that's really helped to underscore and shore up confidence level in terms of delivery of that full year commitment that we've socialized.

So we'd reiterate that guidance on the free cash flow.

Okay.

And then just to wrap up, you sound more confident on the call today about ongoing conditions than the commentary in the press release, is that fair?

Did you just take a more conservative approach because of what happened in the back half of December?

I think we did try to paint the picture between really trying to call up the nuances of still a service center business that's doing very well that we're pleased with and nice growth and step up here, again in that back half, trying to draw up the nuances of some specific end market exposure in our fluid power business.

But given what we've seen in terms of those first few weeks of -- kind of that mid-single-digit growth, given the backlog portfolio that we do have in the fluid power and the flow control segment, that's helped to underscore that back half confidence.

And as I think, here, again, we do have some tough growth comps so that when you think about kind of the guidance assumes pretty much continuation of what we've seen in the last couple of quarters on the fluid power side of the business, but that yields some difficult comps.

So just trying to make sure we're presenting a balanced view there.

And from an internal standpoint, we're not letting go or we're not changing internal plans.

So we'll be working hard to secure profitable growth everywhere we can.

Good to know.

And then, just one last question, just to make sure I was thinking about it right.

I believe you said the tech exposure was low single digits.

Was that company-wide?

And if so could you give a little color on the exposure to your fluid power business?

It is across business segments that there would be participants, and hey, right, it's not just one company or just one end-user in that side.

So I don't know perfectly how it breaks out.

There may be a little bit more fluid power than there would be service center on that breakdown, but they both have participation.

Your next question comes from Jason Rodgers with Great Lakes Review.

So just to sum up the guidance, is it a fair statement to say that the reduction is due to the second quarter shortfall and the technology project delays in fluid power, purely those 2 items?

Or is there something that you see that makes you more cautious in the second half, other than those 2 items?

Those are, obviously, the key drivers, Jason.

As you think about kind of the Q2 impact, both in terms of some of the softer top line as well as the LIFO -- the noncash LIFO charge that we've recorded in the quarter.

So those would be the, certainly, the key drivers.

And looking out forward in terms of that continued trend in the fluid power kind of tech exposure just incorporating that into the guidance.

But here again, step up in the balance of the business, particularly in the service center segment.

So those were the key drivers.

And what's the possibility that these projects get to -- not get delayed, but get realized quicker than you expected?

There is that potential, tough to call.

We've taken, like I said, I think a realistic view based on discussions with the key customers and what they're seeing in terms of that project activity and secondary demand, but there is certainly that potential.

All right.

And just a few numbered questions, if I could.

Do you have the updated cash flow target for fiscal '19?

Free cash flow, once again, $205 million to $215 million.

All right.

And how many shares were repurchased in the quarter?

Looks like you'd bought like $23 million worth?

No shares were repurchased in those recent quarters.

We maintained focus on dividends and debt pay down and storing firepower for M&A activity.

Okay.

I was just looking at the cash flow statement and that's -- as far as the tax rate though, second half?

Yes, second half tax rate, we would guide 23% to 25%.

We saw some favorability, again this quarter.

Certainly, we had the discrete item in Q1 that we talked to, that was a $0.10 benefit.

That didn't repeat, obviously, in the most recent quarter.

Guiding the second half at 23% to 25% and seeing some ongoing favorability from being able to offset some of the global intangible tax with foreign tax credits is really the key driver, plus mix of earnings that we're seeing.

And finally, what is the target leverage ratio?

And by what time period?

Yes, so as we continue to generate cash in the back half of this year, we would see us kind of moving down to that 2.5x target.

And as we've talked, we're really wanting to maintain a balance between putting the balance sheet to work and doing that accretive M&A where we think we can drive significant shareholder value.

It's going to ebb and flow based on deal flow, but on an average kind of long-term, 2.5x would be our target leverage.

Your next question comes from Ryan Cieslak with Northcoast Research.

Just a quick follow-up.

Dave or Neil, can you just remind us again what -- as a percentage of your sales, what the oil and gas businesses represent today?

And then, just going back to my prior question, Neil, it sounded like you felt confident that the sales growth rate within those businesses can sustain mid-single-digit growth -- sorry, mid-teen growth into the back half of the year and that's sort of what's implied in your back half guidance.

Is there -- I just want to make sure I understand what you're seeing there.

Do you have visibility there that gives you confidence there?

Certainly, with oil lower, it would imply that you would see some softness or some deceleration at least.

I just want to make sure, I understand the type of visibility you guys have in those businesses over the next 2 quarters or so.

All right.

So I'll start, and maybe Dave will get to the percentage in the business.

So just a reminder, right, our participation is predominantly upstream.

And as we think about upstream in the segments of drilling, completion and ongoing production, it's really upstream and a lot of ongoing production.

And so if we look at rig count and activity that is going on in the Permian, and some of the other deposits are placed, but really the Permian, there's good activity.

And as wells go from free flow which we have participation to artificial lift and requiring parts and components or mechanical to do that, that's good for our business.

And really, through the activity and change in oil price from 60s to, I believe, it's around $52 now, a lot of those producers, I mean, they've worked well on their breakeven point.

So our view is that continues at its rate or activity in those geographies, and if we look ahead at what's been drilled and not completed, there's a lot that can or will come online at some point.

Now, hey, does global demand play into that?

Does the supply play into that?

But I think, supply is what, 8% above its 5-year average, doesn't seem to be having a slow down effect right now, especially in that geography given its take away to the refineries.

So that's what's driving our view.

Of course, there's discussions with customers and producers in that, but that's what's driving our view that the -- our second half is a lot like our first half, maybe perhaps with the potential to be a little bit better.

Yes.

Just to elaborate here, again, Neil referenced the high-teens growth that we've seen in that business, given that's still less than 10% of our overall sales in terms of our energy-related businesses.

And here, again, these customers have worked through the last downturn on those breakeven points.

So view is they can be productive at $35 a barrel, so we have not seen any adverse impact at all from these lower oil and gas prices.

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.

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

This concludes today's conference call.

You may now disconnect.