Q2 2020 Earnings Call
My name is one thing and I'll be your operator for today's call.
This time, all participants are not 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.
Higher to asking a question lift your handset to ensure the best audio quality.
Please note that this conference is being recorded.
I'll now turn the call over to Brian see signs director of Investor Relations and Treasury.
Brian you may begin.
Thank you Lindsay and good morning, everyone. This morning, we issued our earnings release and supplemental investor deck detailing our second quarter results.
These documents are available in the Investor Relations section or web site at applied Dot Com a replay of today's 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 that are subject to certain breast, including trends sectors and geographies. The success separate business strategy and other risk factors provided in our press release, our most recent periodic reports and other filings made with the FCC.
There are available at the Investor Relations section of applied Dot com.
Actual results may differ materially from those expressed in forward looking statements. The company undertakes no obligation to update publicly or revise any forward looking statement. In addition, the conference call. We use non-GAAP financial measure explained in our press release and supplemental presentation, which are subject to the qualifications referenced in those.
Documents.
Today's teleconference is available to the media and general public as well as to analyst and investors.
Because the teleconference and webcast are open to all constituents in prior notification has been widely and on selectively distributed.
All constant public call will be considered fully disclosed our speakers today include Neal Scripture applies president and Chief Executive Officer, and D Wells, our Chief financial Officer with that I'll turn it over to Neil.
Thank you Ryan and good morning, everyone. We appreciate you joining us I'll begin with some brief thoughts and then Dave will follow to review our financial results in more detail.
Our second quarter was characterized by cost discipline margin control and solid cash generation within a persistent soft end market backdrop.
Execution in these areas is providing a path to deliver earnings and cash commitments for the year and should support accretive growth once demand rebalance as well as capital deployment opportunities going forward.
We also remain highly focused on accelerating our company specific outgrowth potential regardless of the industrial cycle.
As highlighted in recent quarters are leading technical position and service capabilities across motion control fluid power.
Flow control and now automation puts us in a unique position to capture greater share organically as our customers outsource their technical and MRO and production infrastructure needs.
As well as to M&A as smaller players look to partner with a leading technical platform, given increasing service operational and capital requirements.
Trend should supplement a strong cross selling opportunity here at applied that remains in the early innings and is focused on expanding the reach of our fluid power flow control consumables and automation solutions across our embedded service Center network customer base.
We also into our second half of fiscal 2020 with a strong balance sheet.
Having reduced outstanding debt by 115 million over two years post our acquisition of FCX with net leverage down to our stated target of 2.5 times.
Combined with our cash generation trajectory, we have notable flexibility for additional de leveraging acquisitions and pursuing other opportunities to enhance shareholder returns in the back half of our fiscal year.
As it relates to the broader end market backdrop as discussed in recent quarters and consistent with macroeconomic industrial reports.
Demand remains weak across our top industry verticals.
After seeing some stabilization during October and November customer activity was unusually weak during December and remain subdued with organic sales trending down in the mid single digits year over year, So far in January .
While softness remains broad based declines are most notable within metals mining oil and gas machinery and process related industries.
We also saw greater weakness across our international operations during the quarter within Canada and Mexico.
Some of the recent softness likely reflects demand abnormalities that occurred this time of year, given seasonality plant shutdowns and customer budget resets in turn making it difficult to fully gauge the underlying direction of current demand.
We were also cognisant of potential positive momentum that could arise if a trade resolution can stay on track, which has the potential to positively influence trends for the balance of our fiscal 2020 and into fiscal 2021.
That said uncertainty remains and we believe it sensible approach to our outlook remains prudent at this time.
Regardless of the direction of the cycle near term, we know how to operate to it.
As our industry and recent results highlight at the same time Theres, a great understanding and commitment on the opportunity applied has long term as the leading technical MRO distribution and solutions provider.
Our strategy is deeply focused on this opportunity and moving the company toward its long term financial goals, providing the framework for Signet significant earnings growth.
And value creation in the coming years.
At this time I will turn the call over today for additional detail on our financial results.
Thanks, and 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 we are managing effectively in a slow in uncertain end market environment with timely execution of our recent cost initiatives continued solid gross margin performance and another positive quarter of cash generation.
We expect cash generation momentum to continue into the second half of fiscal 2020, providing ample flexibility to pursue capital deployment opportunities.
Overall, we believe we are well positioned in the current environment.
How about your results for the quarter consolidated sales decreased 0.8% over the prior year quarter.
Excluding 3.2% growth contribution from acquisitions sales declined 4% on an organic basis.
Both selling days and foreign currency had a neutral impact this quarter.
As previously highlighted sustained weak demand across a number of key end markets remains the primary drag on sales.
Looking at our results by segment as highlighted on slide six and seven sales in our service Center segment declined 2.3% year over year or 3.5%, excluding a 1.2% incremental impact from acquisitions.
Results reflect continued weak manufacturing activity and related amro needs across our service Center network as well a softer demand within our international operations in Canada and Mexico.
Segment sales were unusually weak during the month of December .
As mentioned earlier, we believe part of this reflects seasonal variations that occur around the holidays as customers take time off and adjust project and production schedules.
Within our fluid power and flow control segment sales increased 2.7% over the prior year quarter with acquisitions, adding 7.6% growth.
This includes a full quarter contribution from our August 2019 acquisition of them with this controls.
And one remaining the month of contribution from our November 2018 acquisition of fluid power sales.
On an organic basis segment sales declined 4.9%, reflecting weaker flow control sales and slower activity across our industrial OEM customer base as well as the remaining year over year drag from the large project referenced in prior quarters.
Excluding the project related drag segment sales declined approximately 3% on organic basis over the prior year.
We know declines in this segment moderated in the daily sales rate was up modestly on a sequential basis, partially reflecting improving technology end market demand during the quarter.
Moving on to margin performance as highlighted on page eight of the deck reported gross margin of 28.9% was up four basis points year over year.
Results, including noncash LIFO charge during the quarter of approximately $1.9 million, which compared favorably to prior year life. The expense of $2.7 billion, resulting in a roughly 9.8 basis point positive impact year over year.
Excluding LIFO, our gross margin was down a modest five basis points year over year.
Margins were slightly pressured by an unfavorable mix impact, resulting from slower growth within local accounts as compared to large national accounts in our U.S. Service Center operations.
This modest headwind was partially balanced by ongoing execution on pricing and other margin expansion initiatives.
Overtime, we continue to expect mixed benefit margins, reflecting the positive contribution of expansionary products growth among our technical service oriented solutions.
Ongoing actions to expand business across our local customer base.
Turning to operating cost on a reported basis selling distribution and administrative expenses were up <unk>, 0.3% year over year, but down 3.4% on an organic basis, when adjusting out the impact of acquisitions and foreign currency translation.
As DNA was 21.9% of sales during the quarter down 15 basis points sequentially on adjusted basis.
Our teams are doing a commendable job managing expenses in a slower environment, including their time the execution of previously announced cost actions.
While we remain highly focused on managing cost into the second half of our fiscal 2020, given the current environment.
As a reminder, Rs DNA expense will increase on an absolute basis sequentially into our third quarter, reflecting seasonality as well as the impact of annual merit increases in two extra selling days versus the second quarter.
That said, we still expect SDN Ada declined as a percentage of sales into our second half relative to first half levels.
EBITDA in the quarter was $74.5 million compared to $76 million in the prior year quarter, while EBITDA margin was 8.9% or 9.2%, excluding noncash LIFO expense in the quarter.
Resorted reported EPS for the quarter was 97 cents per share compared to 99 cents per share in the prior year.
Cash generated from operating activities was $54.9 million, while free cash flow was $47.9 million or approximately 126% of net income.
Year to date free cash flow of $93 million represents 118% of adjusted net income and is up nearly 60% from the prior year.
We're continuing to make good progress on our working capital initiatives in a slower demand environment.
This includes ongoing traction from our shared services and other collection initiatives.
We expect additional tailwinds and to the second half of fiscal 2020 as inventory levels decline from the second quarter ending position.
We remain confident in our free cash flow potential for the full year, which will support our capital allocation strategy focused on reducing now see any debt.
Indeed, M&A opportunities in Opportunistically buying back shares.
We paid down $5 million about sandy debt during the quarter.
Our debt is down nearly $115 million since findings in the acquisition of FCX.
Net leverage at 2.5 times EBITDA at quarter end below the prior year period of 2.8 times.
As noted in our press release today, we announced that our board of directors approved an increase in a quarterly cash dividend to 32 cents per common share.
This represents the 11 dividend increase since 2010, and underscores our strong cash generation and commitment to delivering shareholder value.
Transitioning now to our outlook as noted in our press release, we're updating our guidance for fiscal 2020 in light of year to date performance and ongoing end market uncertainty.
We are narrowing our previous guidance ranges and now expect sales of down 2% to flat year over year were down 5% to down 3% on an organic the per day basis as well as earnings per share in the range afford hours and 20 cents to $4 in 40 cents per share.
Previously our guidance assumes sales down 5% to down 1% organically.
Yes afford hours and 20 cents to Ford hours in 50 cents per share.
Our updated guidance assumes end market weakness seen during December and January continues in coming months with seasonal Q3 sales step up at the lower end of historical trends.
At the midpoint. This implies mid single digit organic sales declines will persist in the third quarter with declines easy to the low single digits in the fourth quarter on easier comparisons.
By segment, our guidance assumes mid to low single digit organic declines year over year in our service Center segment during the second half and low single digit organic declines in our fluid power and flow control segment.
Our guidance also assumes gross margins are flat to up 10 10 basis points for the full year slightly below our prior guidance of up 10 to 20 basis points.
We continue to view 10 to 20 basis points of gross margin expansion as the appropriate annual target overtime, given our internal initiatives.
Lastly, we reaffirm our free cash flow outlook of 200 million to $220 million, which represents a 30% increase over fiscal 2019 at the midpoint.
With that I'll now turn the call back over to New York for some final comments.
Thanks, Dave.
Overall, why we're executing largely the planned year to date, we remain prudent with our outlook given the backdrop of uncertainty in near term industrial demand.
We remain highly focused on our internal growth and margin initiatives, which in addition to potential benefits from trade resolution and ongoing cost opportunities. We see several levers that should support our earnings momentum in coming quarters. If the current environment does not weaken further.
Bind with our cash generation potential we believe our position is strong and we are eagerly moving forward to realize our full potential.
With that we'll open up the lines for your questions.
Thank you we will now begin the question and answer session. If you would like to ask a question. Please pick up your Hanson Press Star and then the number one on your telephone keypad.
If you would like to withdraw your question from the Q press the pound.
We'll pause for just a moment to come out of the culinary roster.
My first question comes from Chris Dankert with Longbow Research. Your line is open.
Hi, Good morning, guys. Thanks for taking my questions.
I guess first off we did talk about electronics briefly inside of fluid power I'm still a slight drag on the quarter, but going forward just any comments on what backlog in that business looks like movies backlog for total fluid power just any thoughts there would be really helpful.
So Chris I'll start I think in the quarter.
We did see some a positive contribution I think it's still could be early to fully call. It how it's going to be in the second half but did provide.
Some balance to fluid power and fluid power and flow control, but we still see some pressure in the general.
Industry segments, and some of the mobile segments to date, so that leads to our view of combined it would be down low single digits in the second half.
Okay got it very helpful. Thanks, guys.
And then just get your initial thoughts on sale Eaton's Hydrox visit the Dan Foss.
I mean, I assume it's probably a generally pop in development, but just would love to hear how you're thinking about that change.
Let's start with our view right I don't think it's a real surprise you know as Eaton has continued to work their business portfolio.
I think the deal takes so we'll take some time I think they're talking about towards the towards the end of the year.
But I see positives in the business, especially as we think about it going forward I think Dan Focess described it as a once in a lifetime opportunity with complimentary product portfolios and the geographic footprint. So I think for them right. The industrial presence the north American market is additive.
Fluid conveyance is additive in and I think there's opportunities then around.
Mobile presence and the potential technical add value capabilities that really exist in both businesses around electronics.
Got it.
Sneak one more and quick and I'll turn it over.
Is the expectation for the year still for about a seven 8 million dollar LIFO headwind I know most of that was supposed to be in the first half little bit light here, just any thoughts on life of for the year.
Yeah, I mean, given the kind of continued trend there were still coin at six to seven but that is down slightly from our seven $8 million previous guidance on LIFO.
Perfect. Thanks, so much guys I'll hop back in queue you bet.
Our next question comes from David Manthey with Baird. Your line is now open.
Thank you good morning, guys.
Not to get too granular, but relative to the weakness you saw in January I assume that you saw an incremental weakness around the mid week, New year's day holiday similar to the the Christmas mid week holiday.
Have you seen any improvement relative to historical trends over the past couple of weeks or was the.
As the weakness been more broad based and continuing beyond just at first week of January .
So David I'll start and say I think it's.
Beyond just the early part if I go back to December we're probably until.
The 20-F December Twentyth running mid single digits decline and then greater over the from the 20 Threerd on right and pulled that probably to a high single digits decline and so coming in to January we havent seen the full snapped back bounced back so thats where.
To date through these kind of 15 or so days still mid single digits will now with that said hey, the remaining seven days, we can see some movement in January and we think.
Thats going to be more indicative, then obviously to the third and perhaps to the back half of our of our fiscal years, but.
That's what leads us to kind of our overall view around this uncertainty in our our guidance right now.
Okay. Thank you and.
Relative to the 20 of your 30 end markets.
Your industry verticals being down.
Do you have any insight in terms of how many of those are in selecting one way or another meeting relative to the rate of change.
Do you do track the number that are improving versus worsening in terms of the second derivative of growth.
Well there can be.
No.
A little noise in the numbers, we will look and then obviously look for.
Materiality in the change so.
I think in the last period.
We would have had.
Eight positive or thus 22 down so a little bit of of change in the overall segment.
Some of those segments that would show positive trends still around food, we think about aggregate rubber plastics and paper and then I'll pay top of mind I don't get at this level a lot of.
Takeaways from from Big inflection changes that would lead it towards being one being more positive or one being more negative.
Okay, Great and then final question on SDN a.
Clearly you're focused on day to day expense discipline has there been any additional cost actions taken since Q1.
That would provide any step function benefits and I believe you said that the Q1 cost actions would would be fully in the run rate in Q2, just checking on that as well.
Largely in the look in the Q2 run rate, but there is some slight incremental benefit which you took what on an absolute basis, we're going to see a step up just because of merit and the number of days in the back half but.
We'll go to offset on a percentage of sales bases.
That that back half step up so some modest incremental benefit and continue evaluate across various businesses just given the economic conditions, where it may warrant additional actions and we have taken those and we'll continue to take those as appropriate.
David I'd say to write a we remain focused on an intune with the environment.
No out to operate in that as I think about SDMA going forward in the third quarter on an absolute basis, we'll have cost actions read through but you will be it will be higher.
We do our focal point Merritt planning to start the year.
In January so there will be some coming in there there's extra selling days in.
As we look forward and obviously M&A yet adds to that so if we're at the midpoint our view from an EPS DNA standpoint were flat.
From a year over year standpoint in the in the third quarter.
Sounds good thanks, very much guys okay.
Our next question comes from Goldman with Cleveland Research. Your line is now open.
Hi, good morning, everyone.
If we start with the.
Comments about the local business being down a bit more than the national account.
I guess is that just.
A cyclical thing that you're seeing there or could you maybe just expand your thoughts on what you're seeing with.
Yes.
Average customer accounts or average order size and.
Maybe just.
Expand a bit more on that and then any kind of efforts that you have for.
Getting that business to pick up in the second half of the year, what kind of initiatives are underway.
Adam My view of a lot of that local account was December and maybe start till January but especially December late December into that and I think that as kind of a carryover influence of.
Gross margins being flattish in that period, and we think about.
Less activity going on in December and especially over those last couple of weeks and so we continue to have very good activities across our business and participate in the local economy.
And we have cross sell opportunities with though so we like our position we like our our focus in that segment and on that business and so we think it's more timing of year in some of those customers choosing to take that time out.
Okay.
And then.
It could you.
Talk a little bit more about the free cash flow outlook for the year.
Usually the fourth quarters that big source of.
Pickup in cash do you expect not.
Happen again this year and then remind me how much inventory you expect to pick out in the second half sure.
I think I am pleased with the sustained contraction across the year in terms of the cash generation much more level loaded this year, but absolutely to your point the back half a does tend to be much seasonally stronger in terms of our cash flow generation profile. So we've made and I think very pleased with the progress we continue to make.
On reduction in past due in your receivables and collection. So if you look at the the overall reduction and they are year over year versus the decline in sales certainly you can see that progress reading through.
On the inventory side, we still got work to doing that as I point out will be a tailwind in the back half of the year.
Im not going to hang a number on it at this point, but certainly we've continued to make good progress when you look across the service Center network in terms of sizing inventories commensurate with the some of the the demand profile that we'd seen but have seen a bit of a build that causes inventory still to be higher year over year and particularly.
Fluid power flow control business, just given some project timing project delays and still some supplier constraints the impeded some shipments so.
Some opportunity through and both sides equation, but.
Certainly will continue to move the needle there will be a tailwind and that will help that that stronger second half cash profile.
Okay. Thanks.
Yeah.
Your next question comes from Joe Mondillo with Sidoti and company. Your line is now open.
Hi, everyone. Good morning.
Just wanted to clarify a regarding the cost initiatives. David did you say that most of the cost initiatives were in place in the first quarter. So the run rate that we saw in the second quarter should be sort of similar in the back half unless you know the environment changes at all.
Marginal incremental benefit from.
A handful of those initiatives that we did not see the full benefit in the most recent quarter and as I indicated to you we could today give or take actions and some of the more challenge businesses to size the cost appropriately so.
Some modest incremental benefit as you think about that back half and that's part of that offset once again to the focal point merits and the incremental selling days in the quarter.
All right great. Thanks, and then also I'm just looking at the fluid power flow control segment.
Could you just give us sort of the puts and takes what's going on there outside of the electronics business, which is really small piece of the business.
Just given sort of the OEM exposure that you have at fluid power and then.
Capacity utilization I think of some some of your customers probably coming down at flow control just curious what the puts and takes our going over the next where the trends are going because I know, it's sort of there was a comp sort of tough comp that you've been going up against last couple of quarters.
But now we have some I think some organic.
Negative trends that are going on in some of your end markets. There. So I'm just curious.
How you're thinking about back going forward.
So we.
Maybe a ticket from a few angles the.
On the flow control side right. We've had a large project that we comped against that will.
For the most part now be behind us in that area.
There are some general headwinds around process related to industries.
But the team looking back and somewhat expectations looking forward in this macro while we have opportunities that could result in kind of a low single digit and then we think about fluid power, we talk about some of the electronics and technical being able to.
Contribute we'll see in the kind of coming months in quarters, two the level, but to your point there are industrials and some of those mobile OE fees that are seeing slowness now with that creates some opportunities for us to be with them working their products working the design.
How we can grow our content.
But that will contribute to us in future periods not necessarily in in the quarter that were in or in the back half. So.
That kind of leads us to we think at our midpoint.
There's a low single digit headwind in the segment.
Okay, great. Thanks, and then just the.
Touch on your guidance.
Just wondering what part of the business or what line item or.
You know margin revenue segment wise, what was really the biggest.
Caused that sort of took off the high end of the guidance off off the table.
Yes, ROI to sum it up it was just the softer daily sales rates that we saw as indicated both in December but then continue into the of the month to date January that.
Gave as pause it just given that uncertainty the broad based kind of market headwinds that we've seen.
Got it appropriate too.
Tug on that upper end, just in terms of relative to expectations.
Okay.
And then just lastly, the tax rate was slower than I anticipated that I didn't hear.
You mentioned anything in the per weren't prepared remarks, but I'm just wondering.
What you expect I guess for maybe the yeah for the whole year, you bet as opposed to 25% to 26%. We previously guided we did see some discretes that benefit US again in Q2, so as we look at the back half we will see some upward pressure on the the back half rate, but I would as result of the Q2 perform.
Permits and favorability would now call it 24% to 25% in terms of the overall for your effective tax rate.
Okay. Thanks appreciate taking my questions.
Our next question comes from Steve.
Keybanc capital markets your.
Your line is now.
Morning, guys.
Right.
I wanted to go back to the broader environment I think theres a lot of expectation that there'll be a recovery in calendar two half 20. So when you say subdued demand pursue will persist do you have any additional thoughts about duration and what you're thinking about for catalyst to restart growth.
So I mean, obviously, we think that.
Continues for the half and so for the start of what will be our new fiscal year I don't know that we're not fully into from a planning standpoint.
Those trade resolution.
Obviously has the opportunity to help and contribute to that potentially as we think about it going forward also if theres a broader infrastructure effort.
But that's probably not ahead of an election cycle, but perhaps occurs after an election cycle.
So you think the phase one deal and maybe getting you SMC a sign will provide enough clarity to give business is looking to grow again or do you need something or will they need something more specific.
I think it can start to help from a sentiment standpoint, but.
That's not all into our guidance right now yeah.
Are you given the environment are you seeing any change in multiple in the private market or do you expect that'll happen as trailing 12 month EBITDA numbers start to come down.
I think for us.
Hopefully early but from an M&A exit standpoint, we're active we're busy but on those read throughs, it's probably hard to say when they when they perfectly come through.
Yes, and just I guess philosophically in recent quarters, we've seen private equity takeout command distribution.
Another were made of strong run an anixter and the electrical distribution space, given where public market market multiples are do you think there'll be more PE interest in public markets.
Hey, again, theres, probably better experts and I clearly money's available there's interest in some of the.
Spaces.
Multiples on and some of the segments, we think about eating those can be attractive.
In the side.
We have a disciplined approach as we think about it going forward and working our targets going through so I don't know that it creates a undue pressure for us in M&A environment.
Alright. Thanks.
And again, if you would like to ask a question. Please press star one on your telephone keypad.
Our next question comes from Michael Mcgarry with Wells Fargo.
And is now open.
Thanks sticking with the M&A theme can you give us an update on the underlying fundamentals of the robotics and automation market specifically the growth rate, you're seeing within Olympus relative to your base business.
Well I think you can see in the quarter that Olympus performed well continues to be right as they terminate right where innovation meets automation. So it. We're we're excited about the product offerings that are available our work on key projects that exist today.
Broader engineered solutions, and then that opportunity for us to expand that.
Into some other markets are into or with some other customers in that side. So.
The growth or the interest in and the growth in the adoption.
Continues to be at a good rate. So we're pleased with the performance and.
In the quarter and and we think it can be a nice contributor for us in the business going forward.
Is it fair to say that back growth rate that nice growth rate is better than the service center and where fluid power is operating right now.
I'd say today in the cycle, yes, we would say that.
Okay, and then switching gears the gross margin flat to up 10, Bips still sounds relatively positive and you've never been the primary indicator for the trade War given your limited direct exposure to China, but can you comment and how sticky. This current run rate is if we see a broader tail peripheral back and subsequent.
In conversations with customers on pricing.
For us we think.
It continues to stick and stay if I if I look at.
Suppliers today, they're still.
Incoming price increases they moderated from from the past, but there will still be some of those coming through and and we will be taking them to the marketplace and then for US on margins right. We'll continue to work on point of sale really just reducing variation around customer groups and product groups.
And we think mix helps us.
Going forward and those as well as we provide more value content more value added solutions and projects to that helps us on the margin side.
Over time, we think for a longer period, we still believe theres, the 10 to 20 basis point improvement.
Okay.
And then if I can sneak one more in on the international side of your business, you called out, Canada, and Mexico, but left out Australia.
Was the Canada and East Coast comment more tied to general industrial or West coast common tied to natural resources.
And then if you could you size, Australia sales as a percent of total that'd be helpful. Sure. So I'd say.
Canada could be a really across right.
Some challenges in the western provinces, and Thats predominantly resource and resource connected.
But also in some of those eastern provinces around the general industry activity and so their participation in either metals mining.
Machinery.
Process related industries, there's some commonality in there maybe some uniqueness, but there is some commonality across and then from an Australian standpoint.
Less than 2% of the overall.
All right. Thanks, a lot I'll pass along.
At this time I am showing we have no further questions ill now turn the call Mr. scrum sure for any closing remarks. Thank you very much and I just want to thank everyone for taking their time and joining us today and we look forward to talking to many of you throughout the quarter.
Thank you ladies and gentlemen. This concludes today's conference. Thank you for participating you may now disconnect.