Welcome to the Fiscal 2021 First Quarter Earnings Call for Applied Industrial Technologies. My name is James, and I'll be your conference operator for today's call. Please note that this conference is being recorded. I'd now like to turn the call over to Ryan Cieslak, Director of Investor Relations and Treasury. Ryan, you may begin.

Thanks, James, and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing the first quarter results. Both of these documents are available in the Investor Relations section of applied.com. Before we begin, just a reminder, we'll discuss our business outlook and make forward-looking statements. All forward-looking statements are based on current expectations subject to certain risks, including the potential impact from COVID-19 as well as trends in sectors and geographies, the success of our business strategy and other risk factors. 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. In addition, the conference call will use non-GAAP financial measures, which are subject to the qualifications referenced in those documents. Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer; and Dave Wells, our Chief Financial Officer. With that, I'll turn it over to Neil.

Thanks, Ryan, and good morning, everyone. On behalf of our entire team at Applied, we hope you and your families are healthy, safe and managing well. I'll start today with a business update, including how we continue to respond to the pandemic as well as progress with various internal initiatives and color on the external environment. Dave will follow with a summary of our financials and some specifics on our first quarter and outlook, and then I'll close with some final thoughts. Into early fiscal 2021, we're seeing a modest recovery gain momentum and are executing well. I'm encouraged by the start to the year and believe we are in a solid position to build off this positive momentum as we move forward. Our operations are functioning productively. Our supply chain and inventory levels are in a good position and we are responding effectively to customers' increasing requirements as initial demand recovery appears to be underway. Throughout the past several quarters, we have quickly adapted to the evolving environment, including implementing new processes and ways to support our customer needs. A key part of our message to all our stakeholders during these evolving times is how Applied is stronger today than in prior cycles. This includes benefits from our expanded offerings, greater technical focus and a more diversified end market mix. We've also strengthened our marketing and sales efforts to showcase our comprehensive and leading technical offering and to further develop our cross-selling opportunities. We are increasingly critical to our customers as maintenance, production and efficiency requirements begin to ramp across their core operational infrastructure. These elements are providing near-term sales support and leave us increasingly constructive on our growth potential going forward. In addition, investments in systems, talent, analytics and operational processes in recent years are yielding additional benefits in the current environment. We quickly aligned our cost structure and once again are demonstrating our operational discipline and the resilience of our operating model. This is highlighted by better-than-expected decremental margins in the quarter as well as ongoing strengthening of our balance sheet following strong cash generation performance and a nearly 30% reduction in net debt levels over the prior year. Our capabilities and company-specific opportunities, combined with the improving outlook, position us to be a growth leader with increasing earnings power entering the next phase of recovery in the industrial economy. This is demonstrated by our recent tuck-in acquisition of Advanced Control Solutions earlier this month. ACS represents the next step in expanding our automation offering, which is further differentiating our value proposition, diversifying our end market mix and enhancing our growth profile to include next-generation industrial solutions. We welcome ACS to Applied and look forward to leveraging their innovative technology and capabilities as we continue to execute on this growth opportunity. As it relates to the broader demand environment, underlying trends remain below prior year levels during our first quarter as business activity continued to adjust to the ongoing pandemic. That said, customer order activity improved sequentially through the quarter, and we continue to gain traction with our internal growth initiatives. As a result, the year-over-year organic sales decline of 13.4% in the quarter improved notably from the 18.4% decline last quarter. Year-over-year organic sales declines improved each month and sequential trends in daily sales rates remain seasonally strong. We're starting to see greater maintenance activity and break/fix requirements with customers increasing access to their facilities and expanding equipment utilization as production gradually ramps back up, including at smaller local accounts. Feedback from our sales leaders suggests order sizes are increasing, customer inventory levels are being replenished and maintenance projects are getting authorized as businesses increase activity and new safety protocols support a productive path forward. In addition, we saw several industry verticals return to growth during the quarter with 10 of our top 30 verticals up year-over-year versus only 2 last quarter. Areas such as Food & Beverage, Aggregates, Technology, Chemicals and Transportation were all showing positive momentum. And while weakness remains greatest across heavy industries, such as Machinery, Metals and Oil & Gas, demand within these verticals appears to be stabilizing and improving slightly. We view these dynamics as a positive sign for the industrial economy and demand for our critical products and solutions. That said, the pace of end market improvement remains gradual and at times inconsistent. Organic sales through our first 18 business days of October are down by mid-teen percent over the prior year. We saw some easing in sales early in the month following a strong end to our fiscal first quarter. Sales trends have improved each week in October, with order momentum increasing sequentially across both our segments month-to-date. However, it's important to note that visibility remains limited ahead of the seasonally slower winter months as customers continue to manage through an uncertain macro and pandemic outlook near term. Additionally, customer purchasing discipline can be more restrained around any given election cycle. As we've shown in recent quarters, we know how to manage and execute in this still uncertain business environment and will remain prudent in our cost focus and capital deployment near term while focusing on our self-help growth opportunities. Overall, we're seeing signs that reinforce our view that the worst is behind us, and a recovery is starting to gain traction. This bodes well for when we enter the seasonally stronger second half of our fiscal year as comparisons become easier and we continue to execute on our internal growth initiatives. At this time, I'll turn the call over to Dave for additional detail on our financial results and outlook.

Thanks, Neil. Before I begin, I will remind everyone that a supplemental investor deck recapping key financial performance and discussion points is available on our investor site for your additional reference. To provide more detail on our first quarter, consolidated sales decreased 12.7% over the prior year quarter. Acquisitions contributed 1.1% growth, partially offset by an unfavorable foreign currency impact of 0.4%. Netting these factors, sales decreased 13.4% on an organic basis with a like number of selling days year-over-year. Turning to sales performance by segment, as highlighted on Slides 6 and 7. Sales in our Service Center segment declined 14.9% year-over-year or 14.4% on an organic basis. The decline reflects the ongoing impact from COVID-19, including reduced industrial production activity and customer facility restrictions which continue to impact MRO demand across our service center network. However, the 14% organic decline year-over-year represents an improvement from the 21% decline during last quarter. In addition, average daily sales rates were up more than 4% sequentially and above the normal seasonal progression. As Neil highlighted, we saw greater maintenance activity in break/fix demand. More customers are providing access into their facilities and releasing working capital spending following a slow pace during the summer months. Year-over-year declines remain greatest within Metals, Oil & Gas and Machinery end markets but were balanced by underlying improvement within Food & Beverage, Pulp & Paper, Aggregates, Forestry and Chemical Industries as well as ongoing growth in our Australian operations. Within our Fluid Power & Flow Control segment, sales decreased 7.4% over the prior year quarter with our August 2019 acquisition of Olympus Controls contributing 3.8 points of growth on roughly half a quarter of remaining inorganic contribution. On an organic basis, segment sales declined 11.2%, reflecting lower demand across Industrial, Off-Highway Mobile and process-related end markets. This was partially offset by sales growth within Technology, Life Sciences, Food & Beverage and Chemical end markets during the quarter as well as ongoing traction with our cross-selling initiatives and firm sales activity across our emerging automation platform. Moving to margin performance. As highlighted on Page 8 of the deck, gross margin of 28.9% declined approximately 50 basis points year-over-year or 40 basis points when excluding noncash LIFO expense of $1.1 million in the quarter and $0.4 million in the prior year quarter. Year-over-year declines primarily reflect unfavorable mix tied to sales declines across our local service center accounts, albeit more modest relative to last quarter as well as more subdued pricing opportunities given the softer demand environment. That said, on a sequential basis, gross margins improved 13 basis points or 17 basis points when excluding LIFO expense, and we're slightly ahead of our expectations. While we expect some of the volume-driven year-over-year headwinds to persist near term, we remain focused on driving annual gross margin expansion as demand levels normalize, reflecting benefits from our systems investments, the positive contribution of expansionary products, strategic growth driven by our technical service-oriented solutions and initiatives to expand business across our local customer base. In addition, we are starting to see a slightly greater level of supplier price increase announcements, which, combined with firming demand, could provide some positive momentum for pricing contribution and margin expansion into the second half of our fiscal year. Turning to our operating cost. Selling, distribution and administrative expenses declined 13.4% year-over-year or approximately 15% when excluding incremental operating costs associated with our Olympus Controls acquisition. Both of these figures exclude $1.5 million of nonroutine cost in the prior year quarter. The year-over-year decline reflects the ongoing benefit from various actions we've taken in recent quarters to align expenses with lower demand. This includes a mix of both structural and temporary cost actions as we continue to assess the environment. And while we have begun to roll back some of the temporary actions, our team continues to demonstrate great discipline in controlling costs and identifying internal opportunities. Combined with improving sales trends during the quarter, we reported a 9.5% decremental margin on operating income during our recent fiscal first quarter, which exceeded our expectations and highlights the adaptability and durability of our operating model. Going forward, we will remain prudent and disciplined in maintaining our cost structure as we continue to gradually roll off temporary cost actions to align with our recent performance, a more constructive outlook and our growth initiatives. EBITDA in the quarter was $67.6 million, down 13.6% compared to adjusted EBITDA of $78.2 million in the prior year quarter while EBITDA margin was 9%, down a modest 10 basis points over the prior year despite the double-digit sales decline. We reported net income of $34.8 million or $0.89 per share, down from adjusted net income of $39.9 million or $1.02 per share in the prior year quarter. Moving to our cash flow performance and liquidity. During the first quarter, cash generated from operating activities was $81.8 million while free cash flow was $78.2 million or approximately 225% of net income. This was up from $50 million and $45 million, respectively, as compared to the prior year quarter, and represents record first quarter cash generation. The strong cash performance during the quarter reflects ongoing contribution from our working capital initiatives as well as the countercyclical cash profile of our business model. Given the strong cash flow performance in the quarter, we ended September with over $271 million of cash on hand with approximately 75% of that unrestricted U.S. held cash. Of note, this is after utilizing $62 million of cash during the quarter to pay down debt. We have now paid down over $200 million of debt since early 2018, including over $80 million the past year. Our net debt is down nearly 30% over the prior year, and net leverage stood at 2.1x adjusted EBITDA at quarter end, below the prior year quarter level of 2.3x and the prior year level of 2.6x. Additionally, our revolver remained undrawn with approximately $250 million of capacity and an additional $250 million Accordion option. Combined with incremental capacity on our uncommitted private shelf facility, our liquidity is ample and our balance sheet is strong entering what appears to be an emerging recovery. This provides flexibility to fund incremental working capital requirements in coming quarters as customer demand continues to improve as well as opportunistically pursue strategic M&A aligned with our growth initiatives. Our M&A focus near-term remains on smaller bolt-on targets that align with our growth priorities, including additional automation and fluid power opportunities. Transitioning now to our outlook. As noted in our press release, we continue to refrain from providing formal full year fiscal 2021 financial guidance due to the uncertainty around the ongoing impact of the COVID-19 pandemic. Visibility remains limited on how customers will proceed with operations into the seasonally slower winter months. That said, to provide some directional views near term based on month-to-day trends in October and assuming normal sequential patterns in daily sales rates for the balance of the quarter, we would expect fiscal second quarter 2021 sales to decline 13% to 14% organically on a year-over-year basis. This includes an assumption of low-teen organic declines in both our Service Center segment and Fluid Power & Flow Control segment. Again, this direction is meant to provide a starting framework on how second quarter sales could shape up if trends follow normal seasonality over the next 2 months. If customers reduce underlying production activity, or extend these plant shutdowns, this could drive organic declines that are greater than the 13% to 14% assumption. On the other hand, if we see ongoing improvement in underlying industrial activity and further traction with our internal growth initiatives, organic declines could be better than the 13% to 14% assumption. In addition, we expect our recent acquisition of ACS to contribute approximately $6 million in sales during our fiscal second quarter. Based on the 13% to 14% organic sales decline, we believe a low double-digit to low-teen decremental margin is an appropriate benchmark to use for our second quarter. This assumes gross margin to be relatively stable sequentially to first quarter levels as well as the ongoing gradual rollback of temporary cost actions. As indicated, we will continue to take a mindful and balanced approach to our operating costs going forward, including ongoing focus on internal opportunities and margin initiatives, which we expect to provide balance into our cost trajectory moving forward. We also note an effective tax rate of 23% to 25% is still an appropriate assumption near term. Lastly, from a cash flow perspective, we would expect moderation from first quarter levels sequentially for the balance of the year, given potential greater working capital requirements as we look to support growth and the recovery as the year plays out. We remain confident in our cash generation potential over the cycle and reiterate our normalized annual free cash target of at least 100% of net income.

Thanks, Dave. Overall, I'm encouraged by how we started the year. Our entire team has shown tremendous resiliency over the past several quarters which is driving improved performance into early fiscal 2021 and positions us to respond and capitalize on the recovery as it continues to unfold. We have proven the durability of our business model, strengthened our balance sheet and optimized our cost structure. We are leveraging our unique and differentiated industry position to be an industrial growth leader into the emerging recovery and in years to come. All of this is reflected in our first quarter results and provides further evidence of the positive path we're on. From our industry-leading technical MRO capabilities to our Engineered Solutions focus, multichannel cross-selling opportunity and expanding automation platform, we have multiple catalysts to expand our market potential and accelerate share gains in coming years, all while driving additional margin expansion. This is integrated into our long-term targets of $4.5 billion in sales and 11% EBITDA margins, which are well within our capability and provide the framework for accelerating earnings power and stakeholder returns long term. Once again, we thank you for your continued support and look forward to demonstrating the strength of our value proposition going forward. And with that, we'll open up the lines for questions.

And our first question comes from Adam Uhlman with Cleveland Research.

Congrats on the strong quarter. Yes, I wanted to start the discussion about the pace of demand through the quarter. It sounds as if the year-over-year declines moderated and eased as you got through September. Maybe you could correct me if I'm wrong, but then it sounds like it took another step down at the beginning of October, I guess. And anything that you would point out as certain industries that might have been more acutely weighing on that gradual recovery or anything else that sticks out to the choppiness of sales?

Yes. Adam, I'd say at this point, I don't know that I would point to really any industries. I think those that were contributing and running positive somewhat continued. The heavy industries would continue to have some choppiness or some challenge to it. I think it could be a function of we ended the September period, the quarter well. And there was just some natural easing as we started those first few days into October. And as we look at it, then we are encouraged as we continue to see that progress as we work through October kind of week by week seeing some of that sequential improvement, which would really include our Service Center segment but also the Fluid Power & Flow Control.

Okay. Got you. And then secondly, on the gross margin, I think, Dave, you said that you expect it to be relatively flattish here into the December quarter. I think historically, it's expanded a little bit sequentially from the September quarter. And I think with the local customer demand maybe starting to pick up a little bit it would have been stronger. I would have thought it would have been a little bit stronger I guess. Is there anything weighing on the margin or is that just a conservative base case at this point?

I would describe the current situation as uncertain regarding the developments we've observed throughout the quarter. Generally, I don’t anticipate a significant sequential increase from Q1 to Q2. The uncertainty and fluctuations in activity, combined with some inflationary pressures we've begun to notice, have affected our LIFO calculations. From the perspective of providing guidance, I would say we expect results to be consistent with Q1. We appreciate the progress we made in Q1 with sequential improvement, and, as mentioned, we’re beginning to see some return of local account mixes. However, we are also actively pursuing self-help initiatives and enhancing our product mix. We hope that some of these positive trends will carry into Q2 to mitigate the potential additional LIFO challenges we might face.

Do you expect to see greater supplier incentives being offered in the December quarter for inventory purchases compared to a year ago, or is it still relatively normal?

Typically, you might see that. I think the overall sentiment has been in some of the discussions that there's not as much appetite or need to drive that incremental volume given a year that had such uncertainty and maybe lackluster performance. So we find that many of our suppliers are not as attuned or running to a plan or something that was set 12 months ago and maybe a little less motivated to drive any kind of special deals on that front is the kind of the overall sentiment, I believe, that we would see.

And our next question comes from the line of Chris Dankert with Longbow.

Dave, kind of wanted to go back to what you'd mentioned on SG&A, again, based on the decrementals, and I think just some of your comments. So we're looking at flattish sequentially to maybe up slightly into the second quarter. I just want to make sure I heard that correctly.

That's correct. Right. Just thinking about here again some of the investments still around growth, starting to see some of that further roll-off of the temporary cost actions as well as the impact of some of the medical and some of the things that provided favorability beyond discrete actions, travel, entertainment and things of that nature starting to read back through. So that would offset what really is a 2-day differential in terms of days. And which puts us at that flat to up slightly in terms of the SG&A progression as we move from Q1 to Q2.

Perfect. And I guess thinking bigger picture and longer term, you guys have done a lot in terms of investment in technology, but, I guess, are there any kind of blind spots or places that you do think you need to bolster or that could require some investment as we kind of come out of this downturn?

I think we've done a nice job of continuing to make those investments and being able to prioritize appropriately. We've got ongoing initiatives right now for warehouse management, software and automation that are continuing to be deployed. Work around further enhancements to .com, things of that nature that given that the big ERP investments are behind us, like where we've continued to prioritize those investments and thinking about Internet of Things and trying to get in front of some of that. So we've continued to fund those investments, striking a balance, obviously, with managing the near-term results that have not deprioritized some of those projects that we'll continue to set the business up for success as we come back out of this and continue to capitalize then on recovery going forward.

Got it. Got it. Glad to hear it. And just one last one, if I could. I guess thinking about ACS, how does that really kind of interplay with Olympus? Is there really a cross selling opportunity? Are they kind of in the same realm? Just any thoughts about how the portfolio is kind of coming together slowly here.

Yes. I think, Chris, the cross-sell opportunity really would be with the team and our legacy positions, industrials in our service center side of the network, obviously, right. We're all around that equipment and where discrete automation can be beneficial. We're seeing that with Olympus and the connection with Fluid Power customers or Service Center customers. We do think Olympus and ACS, there can be technology sharing as we work engineering projects can be cooperation and collaboration on that. And I think the companies bring a combination of expertise across some of the technology and applications, be it vision, be it robotics, mobile and collaborative, even communication products as customers look to expand their connectivity within their facility or connect to the Internet of Things across multiple sites. So we think the businesses do help one another. And we think there's a big additive help that can occur with our Service Center industrial customers.

Your next question comes from the line of Michael McGinn with Wells Fargo.

Neil, I was curious, has there been any early learnings from this downturn? And where you can structurally pull back, maybe not on labor, but certain processes that are not as important to driving profitable growth and share longer term?

I think we continue to look as we go through what's the balance of some of the temporary measures and actions that we take and when do those become a little bit more permanent or structural. And I would think it could be around geographies or access or points to certain market segments as we consider. I think there's been a kind of great learning as we've had in leveraging our technology investments that we've had, our go-to-market collaboration across our groups and how we are connecting with customers in newer ways with technology. And some of that as customers have become more open to that. But I think also, as we've gone through, it does reinforce the importance of being close to customers and having the ability to have a physical/virtual connection with them, to them as we go through. So I think that's going to stay important given the critical nature of the products. And then as customers have opened their facilities, I would say, we were one of the early ones in and given pretty bar out access. Obviously, our teams are following the safety guidelines, the protocols and procedures. But given the importance of our products and solutions that enable movement inside of these customers, it reinforces there. So I think in any time, when you go through something like this, there's learnings that we will translate and pull forward. And I think some of those play into as we grow into automation and how some of those technologies can help solve our customers' problems. And as customers have one more level of problems, that just further improves that return on investment around those technologies being adopted inside of their facilities. So there's a growing interest there.

I appreciate that. Now, moving on to the acquisition, I am interested in the level of cyclicality in ACS's business. How did it perform during the downturn in terms of revenue or margins compared to your core Applied brand? Additionally, you have a target to acquire $100 million per year. I'm curious if there are enough opportunities available to meet that goal.

I will begin with the latter. From a pipeline perspective, we remain focused on our priorities. In short, my answer would be yes. Given the current environment, we can't perfectly control timing, but we are actively engaged in priority areas such as Fluid Power, Automation, and Flow Control, along with discussions related to our traditional Service Center segment. Progress continues on those fronts. Regarding ACS performance, they have shown good growth historically, benefitting from a diverse range of end markets including Life Science and various technology sectors as we look ahead. There is already collaboration where we share common customers with our Service Center network, allowing one group to assist the other through introductions or shared opportunities. They've consistently shown strong growth. Historically, in terms of margins, their gross margin profile has been above the company's fleet average. Currently, from a profitability standpoint, they are at the company average, but there is potential for greater contributions and improvements moving forward.

And our next question comes from the line of Steve Barger with KeyBanc Capital Markets.

Can you talk about competitive dynamics versus smaller private players right now? Or just what are you hearing in the channel about their health? And does that create any opportunities?

I’m not hearing much about the overall health of the market. It’s undoubtedly a challenging environment, particularly when considering operational and working capital requirements. As a result, businesses are finding it difficult, and those in different stages of their cycle may need to re-evaluate. Overall, the industry remains productive, with good awareness of costs and service expenses. From our perspective, our enhanced capabilities are beneficial in connecting with customers during these times. We can address both opportunities and operational challenges related to Bearings and Power Transmission, Fluid Power, and Flow Control, while also engaging in more automation discussions. This is particularly helpful as customers gradually become more open to involving third parties in their facilities.

Has your team been successful in prospecting with the new set of capabilities? Are you observing any measurable progress in selling the portfolio?

We are seeing progress. And I mean, I think our potential is very notable. I'm encouraged, obviously, a bigger, stronger, more open macro helps all of that go faster. But I am encouraged. And it kind of success begets success. It opens eyes to the team and the momentum in the opportunity bill. So if I think about our sharing is higher, our quote activity is higher, the work along with that. And I think it shows more and more in the results as we go forward.

Any specifics about how you're using analytics to manage the business and to drive the sales force to make sure they're getting in front of the right customers?

The one we use it upfront as we think about attracting and recruiting use of analytics. We use analytics in development plans for associates as well. So those are kind of on the front end. And then we look at where we're at with customers and what's our position to the market potential and what's the position across categories. We're giving our selling teams greater tools from a sales portal standpoint that gives them kind of their own opportunity to drill down. We've had pretty good success and ability to provide that information on an ad hoc basis to push out. Now it's available for them to drill down real-time into the environment, and that's helped. We can also use that technology across the portal to load the leads in the cross-channel prospects that exist so that collaboration can go on pretty seamless across those groups right now. So that would be another area and we're going to continue to push ourselves. I think as we view the business and work our long-range strategy, we are consistent in saying, how do we help ourselves, what growth initiatives can we have and then build those into our plants. And so we don't have the big one-time investments to be making. Our view is we invest in ourselves as we go.

As you consider this, it might be difficult to determine because of the impact of the pandemic over the past few quarters. However, now that things are stabilizing, do you believe you are growing faster than the market, regardless of how you measure that?

I believe that if we examine other general industry surveys and economic indicators, we see positive signs. However, we are not completely satisfied and will continue to address certain issues. We recognize that in some aspects, we lack as much safety PPE as others in the industry, which may pose some challenges for us. I am optimistic about the performance and trajectory of the Service Centers. The Fluid Power business has shown strong performance from Q4 to Q1, and I am encouraged by the current backlog growth in both technology and the industrial Off-Highway Mobile segment. This suggests that we have potential for strong performance moving forward.

Got it, and for my last question, as I consider the model for the second quarter, should I expect that Fluid Power will decline at a slower rate than the Service Center distribution, similar to the trends we observed in the past couple of quarters?

We would expect both data points for Q2 to show a decline in the mid-teens to low-teens, particularly when considering the Service Center and the Fluid Power & Flow Control segment.

And Steve, just keep in mind that the Fluid Power & Flow Control segment will have a more difficult comp in the second quarter versus the first quarter.

More of a comp issue.

Right. Well, and I guess I will squeeze in one more. 3Q itself is a fairly easy comp before you get to the trough quarter last year. Any view on whether revenue could be positive year-over-year in both 3Q and 4Q?

No. I think if we continued on these trends and had the kind of typical seasonality play out with what we see now, that would be a more of a high single digits type decline and then the return to growth in the fourth quarter as we sit here today and following those historical trends.

We are pleased to report that the Fluid Power & Flow Control segment remains profitable. EBITDA has increased by 40 basis points year-over-year, despite a decrease in volume. This emphasizes the value and importance of the technology we provide.

And our next question comes from the line of David Manthey with Baird.

First question is on these temporary cost actions in SG&A. When you exit the December quarter, what percentage of those temporary cost actions will have been reinstated? I'm not talking about variable costs that flex with volume but those specific pandemic related temporary cost actions you took.

Yes. I'd say, Dave, on that one, it'd be a little bit to be determined, right? We started easing some of those now or we did in the first quarter. We'll see as we develop in the second quarter. I would suspect we will have some additional ones of those potentially ease. Are we all the way out of it by the time we exit December? I think that's to be determined.

Okay. Based on that answer, can we assume that the low-teens decrementals, which are between 13% to 14% organic declines, suggest that you haven't fully recuperated all those costs?

Well, as we work through the quarter, we would not be 100% back then how we exit and go into the third we'll be looking at it. And like I said, that's to be determined.

Okay. So it's less than 100%, but it's certainly greater than 50% will be rolled back at that point. And I'm talking about exiting the period too, just to get a sort of run rate as we enter the new calendar year.

I'll stay where I'm at right now. But I appreciate your diligence on it.

All right. And then so looking back at the mini Industrial recession that we saw back in '15 and '16, it took a little while for your sales to reaccelerate. But within about 24 months or so, you exceeded the prior peak operating margin levels nicely. And I'm just thinking, as you look at the cycle we're in, currently a deeper trough than that one, but how do you think this cycle will be different than that one in terms of just how you emerge from it?

I believe it’s still to be determined how the cycle will play out, but I see us as being stronger and better than before. Our Fluid Power business is on the right track, and we're actively involved in Flow Control and exploring new opportunities. We're also establishing ourselves as a provider of automation, which opens up many possibilities. The systems we have in place continue to enhance our performance and productivity, which has been beneficial. Our talent level has improved, aiding our execution. We've performed well, and I think that our business is now in an even stronger position to meet customer needs and perform better than the current environment might suggest. While it remains to be seen how the cycle will impact us, we believe that we will outperform the general market trends, and we possess significantly more capabilities than we have had in the past.

I'd add to that we continue to leverage that accretive margin mix as we see those sales redevelop and further strengthen and provide that opportunity to drive that operating margin and gross margin expansion.

Yes. Our perspective is that if you consider Applied, our incremental growth might be in the low teens. However, as we progress and reverse some of the temporary measures we've implemented, we anticipate moving into a mid- to upper teens incremental growth moving forward. This reflects our financial outlook and highlights the difference in the company's capabilities.

Our next question comes from the line of Michael McGinn with Wells Fargo.

I wanted to complete the conversation about freight. Some of your competitors have mentioned experiencing a surge in demand from e-commerce, and I’m curious about your positioning in this area and where you might see higher costs. Additionally, do you anticipate needing to source from multiple suppliers like some of your competitors?

We believe we are in a strong position regarding freight with our providers. Our products create an attractive freight business due to their high density and low seasonality, which contributes to predictability and adds value. When we consider our logistics to our distribution centers, including truckload and less than truckload shipping and our reliance on dedicated carriers, we find that any changes we've encountered have been manageable. We have a solid grasp of the situation, effective management in place, and we do not anticipate any significant negative impact.

I think earlier in the call, you mentioned working capital and the need to build inventory in the second half of this year to support your customers' growth needs. I'm curious about your current level of sales at approximately 17%, compared to the historical average of about 19%. How much of this difference is due to structural improvements from your investments in ERP and facility consolidations, versus the cyclical effects of lower sales?

The ERP investments, the use of the tools and the analytics there has certainly yielded the ability to better manage both the inventories that rationalize those during the most recent downturn. If you looked in the quarter, there has been a $24 million incremental reduction in operating inventories. So very pleased with that on a quarter where we started to see some of that volume come back, and we managed that with good contribution across both of the segments without adversely impacting service levels. So very pleased with analytics. So we use those same tools to be thoughtful and where we're adding back the inventory to respond to the ramping demand to better leverage that inventory investment as we move forward. Structurally though, I'd have to say, I like the work that we're doing, the continued benefit on the collections focus, particularly the shared services with the Service Center segment. Our administered kind of receivables there. We're at an all-time record, though, in terms of past due in the quarter across the aggregate business. It took over 90 days past due down another point sequentially. So we'll continue to work the structural actions as well on the collections to make sure that we're driving efficiencies there and once again, helping to mitigate what's going to naturally be an increase in new receivables as we start to see those volumes rebound. So to demonstrate on a $22 million sequential increase in sales in the quarter, we were flat in terms of receivables impact on working capital. So very pleased with the traction that we've also been able to demonstrate on that front. And here, again, that's a result of technology and that process focus that we put in place.

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

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

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation. You may now disconnect.