Q1 2020 Earnings Call
For applied industrial technologies, My name is Mariama and I'll be your operator for today's call.
This time all participants are in a listen only mode. Later, we will conduct a question and answer session. If you wish to ask a question at that time. Please press star one on your telephone keypad.
Prior to asking a question lift your handset to ensure the best audio quality. Please note that this conference is being recorded.
I will now turn the call over to try and see Soc director of Investor Relations and Treasury Ryan you may begin.
Thank you Mariama and good morning, everyone. This morning, we issued our earnings release and supplemental investor deck detailing or first quarter results.
Both of these documents are available in the Investor Relations section of our website at <unk> Dot Com a replay of todays broadcast will be available for the next two weeks before we begin just a reminder, that will discuss our business outlook and make statements that are considered forward looking.
Forward looking statements are based on current expectations, there are subject to certain risks, including trends in sectors and geographies. The success of our business strategy and other risk factors provided in our press release, our most recent periodic reports and other filings made with the FCC. These are available at the Investor Relations section of applied.
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 statements. In addition, the conference call. We use non-GAAP financial measures explained in our press release and supplemental presentation, which are subject to the qualifications reference in those documents.
Todays teleconference is available to the media in general public as well as to analysts and investors because of teleconference and its webcast are open to all constituents and prior notification has been widely and Unselectively distributed all content of the call will be considered fully disclosed.
Our speakers today include Neal Scripture applies president and Chief Executive Officer.
The wells, our Chief financial officer, with that I'll turn it over to Neil.
Thank you Ryan Good morning, everyone. We appreciate you joining us I'll begin with some brief solves than Dave will follow to review our financial results in more detail.
First I want to thank all our associates for their hard work to start our fiscal year the.
There are ongoing effort is apparent in several key areas that will enhance our industry position in future earnings potential.
Several companies specific trends during the quarter highlight this of note our gross margin expanded year over year.
While cash generation was seasonally strong with free cash up notably from a year ago.
In addition, consistent with our company's track record of operational discipline.
We are proactively adjusting to the slower demand environment.
We are seeing sustained benefits from ongoing productivity initiatives and effectively executed more direct cost actions during the quarter.
Benefits from our ongoing cost focus and Q1 actions will ramp into our second quarter results and support delivery of our fiscal 2020 guidance.
As discussed last quarter and consistent with macroeconomic industrial reports demand is subdued with a greater number of our end markets contracting year over year during the first quarter.
Declines were most notable within metals mining.
Oil and gas process and transportation related industries customers are producing and spending less given macro uncertainty around trade policy and a more modest pace the capital project activity.
That said well end market uncertainty remains our sales trends are running inline with our guidance assumptions provided in mid August and in several areas are showing signs of stabilization.
Year over year organic sales trends were consistent through the quarter and declines moderated into October and trend should also benefit from easier comparisons going forward.
Our focus is positioning the company for more robust growth as we believe our opportunity is meaningful.
Simply put we are integral to the motion power and control of industrial infrastructure and equipment.
Which today is increasingly complex requires comprehensive solutions and support.
And demands adapting to emerging technologies and labor shortages.
We believe our technical product portfolio service capabilities and engineered solutions are leading the industry.
And our strategy and investments are focused on embedding this value more deeply across our customers direct production and supply chain functions.
This includes investing into adjacent sees that further address our customers technical needs while building an additional moat around our value proposition.
Our 2018 acquisition of FCX, and they're leading flow control capabilities is an example of this which we expect to drive additional revenue synergy opportunities over the next several years.
Our recent acquisition of Olympus controls is another example, they're off to a solid start and showing promising growth potential tied to their premier automation solutions.
We expect greater contribution from these strategic growth areas over the intermediate to long term as we deploy return enhancing solutions across our extensive installed customer base.
This in turn gives us more technically tied to the customers direct operations and creates a significant incremental aftermarket opportunity supported by our extensive and localized MRO Service Center network.
So throughout applied we are excited about our potential.
And now at this time I'll turn the call over today for additional detail on our financial results.
Thanks, Neil Good morning, everyone before I begin another reminder, that a supplemental investor deck recapping key financial and performance talking points is available on our investor site.
To summarize the first quarter, while we face lower end market demand sales were in line with our expectations and we effectively manage through the softer demand environment.
We are sustaining gross margin enhancement generating significant free cash flow and initiated cost actions that will favorably impact earnings going forward.
Overall, we believe that we are well positioned to deliver on our fiscal 2020 and long term commitments.
To provide more detail consolidated sales decreased 2.9% over the prior year quarter.
Acquisitions contributed 2.8% growth with an extra selling day in the quarter generating a 1.6% positive impact.
This benefit was partially offset by unfavorable foreign currency impact of 0.1%.
Netting these factors sales decreased 5.2% on an organic daily basis, reflecting as previously highlighted slower demand across a number of key end markets.
In addition year over year trends continue to be impacted by the wind down of a large prior year flow control project with this quarter, representing our most difficult comparison.
Looking at the results by segment as highlighted on slide six and seven sales in our service Center segment were essentially flat year over year, but down 3.5% on an organic daily basis.
First quarter results reflected slower manufacturing activity and related MRO needs across our U.S. Service Center network as well as weaker demand across our Canadian operations and oil and gas end markets.
Comparisons also remain somewhat difficult with the prior year first quarter up over 7% on an organic daily basis.
On a two year stack basis segment sales were up 4% with a trend relatively stable through the quarter.
Within our fluid power and flow control segment sales decreased 2.8% over the prior year quarter.
Excluding the impact of acquisitions and selling days segment sales declined 9% on an organic daily basis.
First quarter results reflected slowing activity and cross our industrial OEM customer base as well as weaker flow control sales, which were primarily tied to the year over year drag from the large project previously referenced.
On a positive note overall segment sales were in line with two slightly above our expectations with year over year declines moderating as the quarter progressed.
This was partially driven by using technology market headwinds, where our backlog and order activity continues to improve.
Moving on now to margin performance as highlighted on page eight of the deck reported gross margin of 29.4% was up 23 basis points year over year in 21 basis points sequentially.
Results, including noncash LIFO charge during the quarter of just under $400000, which compared favorably to the prior year LIFO expense.
Excluding LIFO, our gross margins still increased eight basis points year over year, reflecting ongoing execution of our pricing and other margin expansion initiatives, coupled with the continued mix benefit from expansionary products and value added services.
Turning to our operating cost on a reported basis selling distribution and administrative expenses were up 2.6% year over year, but down 2.4% on an organic per day basis, when adjusting out the impact of acquisitions foreign currency and Nonroutine severance expenses in the quarter.
Our SDMA was elevated as a percent of sales during the quarter, which we had expected given an extra payroll day. Some integration focused investments made recently acquired businesses and the phasing of various cost actions in response to softer demand.
Benefits from these actions favorably impacted SDN, a leader in the quarter and will ramp to full run rate benefit in our second quarter.
As such we expect SDN 80, ease as a percent of sales for the balance of fiscal 2020.
Reported EPS for the quarter was one dollar per share inclusive of approximately two cents of Nonroutine severance expense, resulting from the previously mentioned cost actions. Excluding this incremental expense non-GAAP adjusted EPS was one dollar and two cents per share.
Cash generated from operating activities was $50 million, while free cash flow was $45.1 billion or approximately 113% of adjusted net income and over five times higher than prior year.
We had solid cash generation in the first quarter, which if you will recall is typically our weakest quarter for free cash generation.
We're continuing to make good progress in our working capital initiatives in a slower demand environment. This includes ongoing traction from our shared services and other collection initiatives and we expect additional tailwinds near term as we continue to optimize inventory levels.
We remain confident in our free cash flow potential for the full year, which will support our capital allocation strategy focused on reducing outstanding debt funding accretive tuck in M&A opportunities and opportunistically buying back shares.
We used cash on hand to fund our purchase of Olympus controls during the quarter and we also paid down $5 million of outstanding debt.
Our debt is down nearly $110 million since financing the acquisition of FCX with net leverage still at 2.6 times EBITDA at quarter end below the prior year period of 3.1 times.
Transitioning now to our outlook as noted in our press release, we are reaffirming our guidance for fiscal 2020, including a sales range of down 2% to up 2% or down 5% to down 1% on an organic per day basis as well as earnings per share in the range at $4.
20 cents to $4 than 50 cents per share.
We also reaffirm our free cash flow outlook of 200 million to $220 million, which represents a 30% increase over fiscal 2018 at the midpoint.
Our guidance continues to take into account the backdrop of uncertainty in near term industrial demand.
However, we are executing the plan year to date and remain focused on internal growth and margin initiatives as well as our long term strategy.
Combined with recent stabilization in sales trends and benefit of first quarter cost actions, we look to gain additional traction in the coming quarters.
With that I'll now turn the call back over to new for some final comments.
Thanks, Dave overall, while end market demand remains soft we know how to execute and navigate through it we're starting our second quarter with some positive momentum, which we will look to build on.
We delivered a track record of margin enhancement.
Quickly de Levered, our balance sheet post our FCX acquisition and our in position to generate record free cash flow. This year to drive further shareholder returns.
We believe our value proposition and growth opportunity ahead is strong and differentiated and puts us in position to adapt and capture emerging secular growth Tailwinds long term.
After starting out as a bearing distributor nearly 97 years ago, we're now designing engineering assembling and automating critical areas of the industrial supply chain and broader economy.
While providing unmatched technical aftermarket and MRO support through our localized service Center network and comprehensive product set.
I want to thank our customers associates and shareholders for their continued support.
We are confident in the value, we will unlock going forward.
With that we'll open up the lines for your questions.
Thank you we will now begin the question and answer session. If he would like to ask your question. Please pick up your handset and press Star and then the number one on your telephone keypad. If he would like to withdraw your question press the pound key we'll pause for just a moment to compiled acuity roster.
Your first question comes from Chris Dankert with Longbow Research. Your line is open.
Hi, Good morning, guys. Thanks for taking my question and congrats on a nice quarter here.
I guess starting off.
You heard the cost out actions taken in the quarter.
What is kind of the run rate there it sounds like it was more than just kind of pulling back on discretionary spending maybe just a little bit more elimination on the cost out actions.
So so I think go overall right there is plenty in the materials that could.
Guide your end towards what we view as a as DNA, but as we think about it will be lower in the second quarter sequentially as we think about it though year over year. It will be up acquisitions related so we won't go into every detail.
Well around it but perhaps to help.
The short cut productivity move for you.
We would think around.
21.5% for SDN, a in the second quarter.
Plus or minus 20 basis points around that with the actions down sequentially, Chris but here again had just a month and a half of Olympus in this quarter. So you'll see that run rate kick in here in Q2.
Got it got that that's really really helpful guys. Thank you.
And then just so I'm going through the deck, which by the way. Thank you for the update there.
You mentioned that electronics and try to food powers of seeing from improvement any directionality as far as you know bigger than a bread basket how much improvement we're seeing in electronics today.
I think overall, we can be pleased with some of the progress I mean, the overall market still has some slight declines in that we just think we're growing our content and involvement, especially with mid size Oems as we work with them on the equipment.
And the functionality functionality that they can increase in that so.
We feel like we're we're gaining in content and gaining in participation, but maybe we are participating in a.
Slower macro market overall.
Got it got it will drag in the quarter, but a positive in terms of backlog build in the quarter.
Got it maybe that's my final question before I hop back in queue, just any comment on food power backlog in totality.
I'd say no backlog overall, we're speaking specifically to electronics the components there pretty stable in terms of the.
Sequential look at backlog across the overall fluid power flow control business and we continue to obviously worked with customers on on the projects and and what's going to release and will any of it get extended out for a little bit in the period as well so.
We see some development in the backlog what will it.
Perfectly come out in the in the next quarter, the third quarter play not that full transparency.
Got it got thanks, so much guys.
Your next question comes from Adam Allman, with Cleveland Research. Your line is open.
Hi, guys. Good morning, congrats on the front quarter. Thanks.
Yes, I was wondering if you could expand a little bit more on outside of the electronics markets, where I think you mentioned that the orders or are picking up a bit.
What other end markets are you seeing kind of less worse trends that are helping moderate.
Sales declines here going into.
October or is that more like a comparison issue or maybe a stabilization of certain markets I'm just wondering if theres any green shoots out there that you're seeing yet.
I think thats more of a.
Stabilization in the so maybe a sequential.
We think about our 30 industries and.
This quarter, we would have had a positive so sequentially or down from.
The sequential standpoint, I think 18 in the last period I think those will you still see maybe a little stronger activity are continuing would be around aggregate.
Food, which is always has pretty good activity.
Maybe the rubber plastics area of that and then obviously the larger ones on the other side, we called those out earlier in metals mining oil and gas than some of the transportation process segments.
Okay Gotcha.
And then I was wondering if you could tell us what price realization was this quarter and how you're thinking about that through the rest of the year and then somewhat related to that how should we be thinking about the cadence of gross margin as we go through the year.
We think price contributed navy.
Less than a 100 basis points.
On the topline our view continues around margins that.
For the year, we'd have the the 10 to 20 basis points.
Opportunity for for improvement as we work our way through the through the year. So that's our view and expectations.
Great. Thank you very much.
Your next question comes from Joe Mondello with Sidoti and company. Your line is open.
Hi, good morning, guys.
Good morning.
Just wondering what the sort of trajectory of your business that you sort of viewing things.
We've seen a lot of the macro data as well as micro data just looking at all these companies in the industrial sector.
Growth slowing over the last several quarters.
It seems like the data or the earnings for a lot industrial companies have a mix so far but it seems like there is a continuing slowing I'm just wondering sort of.
Seems like maybe there's some stabilization within your business, especially a fluid power.
But I'm just wondering how you are sort of viewing things.
And.
In terms of interest overall environment.
I think.
Some macro things too.
Considered still will be.
The production index, we think in fluid power durable goods, which I believe is running down mid single digit so perhaps in the kind of the core segment of fluid power, we might be slightly better than that.
Right now, but we think those trends continue we.
Recognize them when we established initial guidance in the mid August timeframe, and those still shape our views today and there could be a case for the low end.
There might be some improvements in the back half for the.
For the higher end, but our real believe sitting here today still is anchored around the the midpoint of the ranges.
Okay and then.
It sounds like the backlog.
Fluid power flow control it seems like you're sort of describing as stabilizing.
Just curious on fluid power side of things.
Our.
Things sort of continuing to weekend.
They're just.
Based on sort of some of the.
Markets and customers that you deal with Yeah, I think it's I think it's very dry and you'll see the larger producers with their numbers and in trends in it obviously theyre. They're also have an aftermarket, but some large OE participation.
That's not our petition participation and b.
More than midsize and smaller always in the industrial aftermarket.
In that and so.
I think for US we feel like we're in a similar environment. Obviously, we're continuing to work hard and engage where we can be involved in projects in engineering and design.
Accretes us opportunities for aftermarket service and repair.
What we don't know perfectly is when every one of those opportunities will release as they go into the to the demand environment and so that's where we say with the the backlog and some of the other ones.
We feel like we still just got to work our way to work our way through it as we get through this quarter and probably turn into the new calendar year.
Okay and then last question for me I'm not sure if I missed this on your prepared commentary but.
What are sort of some of the stronger.
Market for businesses that you're seeing within the overall company.
I think those that where we continue to see activity.
Around the aggregate segment.
Food and.
And probably.
Rubber and plastics would be the ones that would be showing.
Kind of continued.
Positives in that side.
Okay perfect. Thank thought.
As a reminder, if he would like to ask a question. Please pick up your handset and press Star and then the number one on your telephone keypad.
Next question comes from Steve Barker with Keybanc capital Your line is open.
Hey, Good morning, guys. This is Ken Newman on for Steve. Thanks for taking my question.
And we're getting.
Morning.
The free cash flow. This quarter was was very was very good, especially on a conversion basis relative to that net income just curious.
Talked about traction in the working capital initiatives amid the slower environment can you just talked about.
How much of that was from an internal initiative versus just inventory is kind of clearing off for the balance sheet and any commentary and you have on what you foresee for from a destocking perspective in customers inventories at this point of the cycle.
It here again, we're not suspect to a great deal of stocking de stocking nor do we see a lot of that and business our business in terms of.
Inventory that we would hold figure we did talk as we ended last year about focusing on a modest excess inventory position that we continue to work down some of that effort was actually offset listen project and the impact us and push out is fluid power flow control.
Segment. So we did see even with the stronger cash flow performance a slight build obviously on the inventory side. So the real benefit was driven by the continued work that we see around collections. So we certainly you got some leverage from lower volumes, but but outpaced that in terms of performance like the traction that we continued to show there.
So we'll continue to work those initiatives as we move forward as well as you continue to work on some of that inventory build burning through that there will be bit about modest tailwind for us as we think about.
The out quarters so.
Helps to firm up here again, given the seasonally stronger start.
And the kind of the guidance of 200 220 million that we put out there on free cash for the year.
Right makes sense okay.
And my follow up question here is just on the M&A pipeline, obviously I think in your your deck you mentioned that it's still remains a high priority for you going forward just trying to get a better sense of how does the pipeline look if you want to provide any detail at this point.
And how do you think about an ideal candidate in terms of deal size or or product offering.
Especially in a challenging demand environment like the one that we're seeing today.
I'd say, our M&A priorities remain consistent.
Across our product segments, so that would be bearings and power transmission.
Be fluid power would be flow control.
Now we add into that look at automation in time as we go through and then perhaps some other general consumable. So our priority stay the same we work hard to know best prospects and targets and maintain a relationship as we go.
You never can perfectly control the timing in any part of the economic cycle or environment, and and Theres kind of all sizes of candidates that would be in their fuel. If you look back on a revenue basis, maybe the the average is been around.
Less than $30 million.
Which would to be some addition, bolt ons tuck ins around some.
But obviously if you look back in history, there has been larger ones as well so it'd be hard to perfectly characterize the everything in the pipeline.
That's helpful. Thank you guys.
Okay.
Your next question comes from Michael Mcginn with Wells Fargo Securities. Your line is open.
Hi, good morning, everybody.
I was wondering if I could sneak one in on gross margin going back to that just you mentioned OEM a little weaker.
I was wondering to get a little sense of.
How much of the gross margin improvement was kind of the aftermarket fluidics that benefiting it versus your own structural actions, what kind of mixes embedded within the.
Current quarter and I'm going forward.
Yeah, We think just on margin we continue to work our view of all aspects of of margin and own obviously.
Stay balanced.
In customer mix.
Both with the local accounts and larger accounts.
We do get benefit as we expand our products and service offering.
In the product mix contribution side of those so.
That can and our expectation will continue to contribute to the to the business going forward. So I think a thing that has helped us not only this quarter, but by than in past quarters is that we have a broad approach to working those initiatives and efforts and that builds our confidence we.
Can continue to do that as we look going out.
Great and then if I could just.
I'd get a finer point on the S. Una commentary historically in a year, where you havent done where you haven't been as acquisition have a year Sina has ramped on an absolute dollar perspective throughout the year. It sounds like maybe your that cadence is change this year.
It is my assumption right there.
It is an M&A destroyed driven by the here again, you'll see an offset to the full quarter Olympus really driven by the impact of the cost actions that we rolled out that that provided very very modest benefit in Q1 s. The ROI see the at that ramp as we discussed into Q2 and could you to read through this benefit.
For the balance of the year.
Okay.
And then just lastly, if I could touch base on the M&A side, you guys moved discipline MMS down in the DAC on slide 11, but it's still sounds like it's a focus for you in the past.
Next increase your Tam in certain markets I think chemicals won there.
An area that you'd like to highlight that you know you're past initiatives you're building skit you think you're building scale or current verticals, where you think you still have some work to do.
Well, we like that are.
Targeted addressable market continues to to expand and grow.
It's probably getting closer to 70 billion as we do some things and think about the business expansion geographically within our served served markets. We could build a path that it could easily get to 80 billion in that side and we continue to think market back to industrial customers.
How do we broaden our capabilities to their requirements and I still believe there's fundamental drivers that customers are looking to consolidate their spend with fewer more capable suppliers and they're also getting challenged as they deal with the kind of a technical labor expertise gap.
And they are needing some qualified providers to do that and so that's what really drives.
Our focus our efforts in.
Not only bearings and power transmission, but fluid power and flow control and automation because we think all of those are linked.
Two industrial production in the broader industrial supply chain.
All right appreciate the color great quarter.
Thanks, Mike.
At this time I am showing we have no further questions I will now turn the call over to Mr. schrimsher for any closing remark I.
Just simply want to thank everyone for joining us on the call and we look forward to seeing many of you.
Throughout this quarter. Thank you.
Thank you ladies and gentlemen. This concludes today's conference. Thank you for participating you may now disconnect.