Q1 2022 Applied Industrial Technologies Inc Earnings Call
Welcome to the fiscal 2022 first quarter earnings call for applied industrial technologies.
My name is Shelby and I'll be your operator for today's call.
At this time all participants are in a listen only mode. Later, we will conduct a question and answer session.
If you wish to ask a question at that time. Please press star one on your telephone keypad.
Prior to asking a question that's 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 Slack director of Investor Relations and Treasury Ryan you may begin.
Thank you Shelby and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing our first quarter results.
These documents are available in the Investor Relations section of applied dotcom.
Before we begin just a reminder, will 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 the COVID-19, pandemic 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 President and Chief Executive Officer, and Dave Wells, Our Chief Financial Officer.
I'll turn it over to Neil.
Thanks, Ryan and good morning, everyone. We appreciate you joining us and hope you're doing well.
I'll start today with some perspective on our first quarter results current industry conditions and company specific opportunities David will follow with more specific detail on the quarter's performance and provide some additional color on our outlook and guidance and then I'll close with some final thoughts.
In the early fiscal 2022, we are executing well and making progress on our strategic initiatives.
We reported.
Record first quarter sales EBITDA and earnings per share.
As well as another strong quarter of cash generation, despite greater working capital investments year to date.
As widely evident across the industrial sector.
And any pressures and supply chain constraints are presenting challenges as industrial production and broader economic activity continues to recover.
Nonetheless, we are in a strong position to handle these conditions and believe the current backdrop is reinforcing our value proposition and long term growth opportunity.
As it relates to the quarter and our views going forward I want to emphasize a few key points that continue to drive our performance.
First underlying demand remains positive.
Second our industry position operational capabilities and internal growth initiatives are supporting results.
And third we continue to benefit from efficiency gains and effective channel execution.
In terms of underlying demand trends remain favorable across both our segments during the quarter.
Industrial supply chain constraints are having some impact on the timing of demand flowing through to sales.
So solid execution and our favorable industry position still drove an over 16% organic increase in sales versus prior year levels.
And stronger growth on a two year stacked basis relative to recent quarters.
This positive momentum has continued into our fiscal second quarter with organic sales month to date in October up by a mid teens percent over the prior year.
As it relates to customer end markets trends during the quarter were strongest across technology chemicals lumber and wood pulp and paper and aggregate verticals. In addition, we continued to see stronger order and sales momentum across heavy industries, including industrial machine.
Murray metals and mining.
Providing incremental support to our sales growth into early fiscal 2022.
Forward demand indicators also remain largely positive.
King activity across our service Center network is holding up well despite sector wide supply chain pressures. We believe this partially reflects the diversity of our customer mix as well as sustained MRO demand as customers catch up on required maintenance activity provide.
Greater facility access and continue to gradually release capital spending.
Our ability to provide strong technical and local support.
Inventory availability and supply chain solutions Places our service Center network in a solid position to address our customers' evolving needs near term, while helping them prepare and execute growing production requirements over the intermediate to long term.
In our fluid power and flow control segment, we continued to see strong demand from the technology sector. This includes areas tied to five G infrastructure and cloud computing as well as direct solutions, we're providing to semiconductor manufacturing.
Customer indications and related outlooks across the technology end market remained robust, reflecting various secular tailwind and production expectations.
Continue with an ongoing recovery in longer and later cycle markets, such as industrial OE and process flow, we believe the underlying demand backdrop across our fluid power and flow control operations remains favorable.
In addition, we're seeing strong growth indications across our expanding automation platform.
Tight labor market combined with evolving production considerations post the pandemic is driving greater customer interactions and related order momentum for our automation solutions.
We remain focused on expanding our automation reach and capabilities, both organically and through additional M&A.
During the quarter, we announced the tuck in acquisition of our our fluid a company a regional provider of advanced automation solutions in the U S. Midwest.
The transaction further optimizes, our footprint and strategy across next generation technologies, including machine vision and robotics.
We welcome our our fluid eat two applied and look forward to leveraging their capabilities going forward.
Overall, the demand environment remains positive and were seeing ongoing contribution from our internal growth initiatives.
That said, we expect supply chain constraints to persist across the industrial sector near term.
Lead times remain extended across certain product categories, driving component delays and an increase in fulfillment timing we.
We saw greater evidence of this across both our segments during the quarter.
Our teams are effectively managing through these issues to date as reflected by our first quarter results as well as our ability to increase operational inventory levels in the U S by 6% during the quarter.
Our products are primarily sourced across North America, limiting our direct exposure to international freight and supply chain dynamics.
Technical scale local presence and supplier relationships are key competitive advantages in the current backdrop, providing a strong.
Platform to gain share as the cycle continues to unfold.
The broader supply chain backdrop is also increasing inflationary pressures across our business both through the products, we sell and the expense we incurred to support our competitive position and growth initiatives. We saw ongoing supplier price increases developed during the quarter with indications of additional increases.
Coming quarters, our price actions strong channel execution and benefits from productivity gains are helping offset current inflationary headwinds as reflected by solid EBITDA growth and EBITDA margin expansion during our first quarter.
We continue to take appropriate actions to offset these headwinds.
Overall, we are encouraged by our ongoing execution.
First quarter results highlight the strength of our position and company specific earnings potential despite broader challenges industry wide.
And reinforced our ability to progress towards both near term and long term objectives in any operational environment.
Combined with our strong balance sheet, increasing order momentum exiting the quarter and greater signs of secular growth tailwind across our business, we remain positive on our potential going forward.
Now at this time I'll turn the call over to Dave for additional detail on our financial results and outlook.
Thanks, Neil just a reminder, before I begin consistent with prior quarters, we have posted a quarterly supplemental investor presentation to our Investor site. This will serve as an additional reference for you as we discuss our most recent quarter performance and outlook.
Turning down to our results for the quarter consolidated sales increased 19, 2% over the prior year quarter.
Positions contributed 2.1 percentage points of growth and foreign currency drove a favorable 80 basis point increase.
The number of selling days in the quarter was consistent year over years.
Many of these factors sales increased 16, 3% on an organic basis.
On a two year stack basis, Jordan change was positive in the quarter and strengthened from fiscal 'twenty, one fourth quarter trends.
As it relates to pricing, we estimate the contribution of product pricing on a year over year sales growth was around 140 to 180 basis points in the quarter.
As a reminder, this is something only reflects measurable topline contribution from price increases on Skus sold in both periods year over year.
Looking at sales performance across our segments as highlighted on slides six and seven of the presentation sales in our service Center segment increased 15, 9% year over year on an organic basis, when excluding the impact from foreign currency.
On a two year stack basis segment organic sales were up nearly 2% an improvement from fiscal 'twenty, one fourth quarter trends.
End markets, such as lumber and fourth street pulp and paper chemicals aggregates and food and beverage had the strongest growth on a two year stack basis during the quarter, while primary metals machinery and mine are showing greater improvement both year over year and sequentially.
In addition to solid sales performance in our U S Service Center operations, we saw favorable growth across our international operations, which contributed to the segment's top line performance in the quarter.
Within our fluid power and flow control segment sales.
<unk> increased 24% over the prior year quarter with acquisitions contributing six six points of growth.
On an organic basis segment sales increased 17, 4% year over year and 6% on a two year stack basis.
Segment sales continued to benefit from strong demand within technology end markets as well as across life Sciences, chemical and agricultural end markets.
Sales trends within primary metals and refinery end markets also improved nicely during the quarter, partially offset by moderating trends across certain transportation vertical.
By business unit segment growth was strongest across fluid power and automation.
In addition demand across our it later and longer cycle fluid control operations continues to improve with customer quote activity and order momentum building through the quarter.
Extend their supplier lead times and inbound component delays had some effect on segment sales growth during the quarter, though the overall impact remains limited and manageable to date.
Moving to gross margin performance as highlighted on page eight of the deck.
Margin of 28, 6% declined 22 basis points year over year.
During the quarter, we recognized LIFO expense of $3 $6 million compared to $1 $1 million of expense in the prior year quarter, and a $3 $7 million LIFO benefit in our fiscal 'twenty, one and fourth quarter.
The net LIFO headwind had an unfavorable 25 basis point year over year impact on gross margins during the quarter.
LIFO expense was higher than expected during the quarter, reflecting supply of product inflation and a greater level of strategic inventory expansion year to date.
Excluding the impact of LIFO gross margins were relatively unchanged year over year and up sequentially, reflecting strong channel execution pricing actions and ongoing progress with internal margin initiatives.
Turning to our operating cost selling distribution and administrative expenses increased 10, 6% year over year or approximately 7% on an organic constant currency basis.
SG&A expense was 23% of sales during the quarter down from 21, 9% in the prior year quarter.
Had another solid quarter of SG&A expense control, reflecting our leaner cost structure following business rationalization taken in recent years as well as benefits from our operational excellence initiatives shared services model and technology investments.
These dynamics are helping mitigate the impact from inflationary pressures higher employee related expenses lapping prior year temporary cost actions and normalizing medical expense.
Combined with improving sales and effective price cost management EBITDA grew 31% year over year, while EBITDA margin of nine 9% was up 89 basis points over the prior year.
Including reduced interest expense and a slightly lower tax rate reported earnings per share of $1.36 was up 52% from the prior year.
Moving to our cash flow performance and liquidity.
Cash generated from operating activities during the first quarter was $48 $6 million, while free cash flow totaled $45 million or 85% of net income.
We had a strong quarter of cash generation, considering grading greater working capital investment year to date.
Including a strategic inventory build during the quarter to support growth.
Dress supply chain constraints.
We continued to benefit from our working capital initiatives and solid execution across our business.
Our cash performance and outlook continues to support capital deployment opportunities.
During the quarter, we deployed a total of $36 million on share buybacks debt reduction dividends and acquisitions.
With regards to share buybacks, we repurchased nearly 77000 shares for approximately $6 $5 million.
We ended September with just over $247 million of cash on hand, and net leverage at one seven times adjusted EBITDA, which is below the prior year level of two one times and in fiscal 'twenty, one fourth quarter level up one eight times.
Our revolver remains undrawn with approximately $250 million of capacity and an additional $250 million accordion option.
Combined with incremental capacity on our securitization facility and uncommitted private shelf facility, our liquidity remains strong.
Turning now to our outlook as indicated in today's press release and detailed on page 10 of our presentation. We are maintaining our full year fiscal 2022 guidance established in mid August.
Includes EPS in the range of $5 to $5 40 per share based on sales growth of 8% to 10%, including a 7% to 9% organic growth assumption as well as EBITDA margins of 9.7 to nine 9%.
We are encouraged by our year to date operational performance and remain focused on our growth margin and working capital initiatives.
Combined with our favorable industry position ongoing order momentum and forward demand indications, our fundamental outlook and underlying earnings potential remains firmly intact.
That said as previously highlighted LIFO expense year to date is running higher than our initial expectations.
Assuming fiscal Q1, LIFO expense levels of $3 six $3 $6 million sustained for the balance of year. This would result in LIFO expense, representing an approximate 40 basis point year over year headwind on EBITDA margins compared to our initial expectation of 20 to 30 basis points.
Combined with ongoing uncertainty from industrial supply team and inflationary pressures. We currently view the midpoint of EPS guidance as most reasonable from a directional standpoint pending additional insight into how the year progresses.
In addition, based on month to date sales trends in October and considering slightly more difficult comparisons in coming months. We currently project physical a second core organic sales to grow by a low double digit to low teen percentage over the prior year quarter.
We expect gross margins will be down slightly on a sequential basis during the second quarter, assuming a similar level of legal expenses the first quarter.
This would be directionally in line with normal seasonal trends.
We expect SG&A expense will be flat to up slightly on a sequential basis compared to first quarter levels of approximately $181 million.
Lastly from a cash flow perspective, we continue to expect free cash flow to be lower year over year in fiscal 2022 compared to fiscal 2021 has a R levels continued to cyclically build and we replenish inventory.
That said, we are encouraged by our first quarter cash flow performance and continue to drive working capital initiatives I think partial offset across our business.
With that I'll now turn the call back over to Neil for some final comments.
Thanks, Dave.
Overall, we are encouraged by how we started the year and what we see entering our physical second quarter.
Order momentum remained firm across our businesses our fluid power backlog is at record levels and.
And we are effectively building inventory to support our growth opportunities.
Our increased exposure to technology and markets is driving greater participation and secular growth tailwind, while our later cycle flow control business is seeing increased activity across key market verticals, where I was.
Making great progress in building, our automation platform, including organically as customer and supplier relationships continue to develop and broaden across new industry verticals and within our legacy end markets.
Customer outlooks on underlying demand and capital spending remain largely favorable over the intermediate term and we're on track to achieve our initial guidance provided in mid August.
As is common across the industry right now, we're dealing with inflationary pressures supply chain constraints and lingering COVID-19 related impacts.
As our historical track record and first quarter results show, we know how to execute in any environment. In addition, I believe our strategy on our ongoing initiatives will prove out further in this environment as the industrial economy continues to evolve both cyclically and struck.
Truly.
The breadth and availability of our products combined with our leading technical solutions and localized support is a significant competitive advantage right now.
We look to leverage these capabilities across our expanded addressable market.
During these dynamic times and in years to come.
At the same time, our balance sheet and liquidity provides strong support to pursue strategic M&A opportunities.
We maintain a disciplined approach to M&A and are actively evaluating opportunities primarily across key priority areas of fluid power flow control and automation.
There remains significant potential to further scale, our leading technical industry position across these areas.
We're eager to demonstrate what we're fully capable of in the years ahead as we continue to leverage our position as the leading technical distributor and solutions provider across critical industrial infrastructure. Once again, we thank you for your continued support and with that we'll open up the lines for questions.
Thank you we will now begin the question and answer session.
If you'd like to ask a question. Please pick up your handset press Star then the number one on your telephone keypad.
If you would like to withdraw your question from the queue press the pound key.
Well pause for just a moment to compile the Q&A roster.
Your first question is from David Manthey of Baird.
Thank you and good morning, everybody.
First off could you tell us how many of your 30 industries would be up on a two year stack basis.
So we talked on right.
Year to date in the quarter 25 up on a two year stacked basis.
We would have 17 up which I think is relatively similar to last quarter.
If we think about strongest growth compared to 2019, those would include chemicals lumber and wood.
Technology aggregates, and then paper and allied products with really all of those being a 20% up compared to 2019 levels.
Okay.
And then R. R.
Ludy, what approximately revenues and EBITDA there Neil.
So we'd say similar size.
Of recent acquisitions on the run rate and so collectively for the total business now right in the quarter organically, we were up 20% and then as we think about with flu the run rate of the business now 120 million in total on the automation side. So a very good addition for us there.
In the Midwest.
Okay. It seems to be coming together and then finally on the second quarter S. DNA outlook for flat to up slightly normal seasonal wood would be more like flat to down could you just talk about the factors that are driving that opex outlook.
Yeah, a couple of things come into play there David you do have the full full quarter fluid a reading through millions of millions five is going to be an impact also you know even though we've got three less selling days sequentially in the last selling day year over year. We had the number of same number of payroll days, both year over year and sequentially. So that that does play in.
Yeah, not quite the typical seasonal trend you would see there so combination of the additional M&A related S. D N a as well as just the like payroll days, where the factor that comes into play there.
Perfect. Thanks, a lot guys.
You bet.
Your next question is from Adam Uhlman of Cleveland Research.
Hey, guys good morning.
One of them.
Wanted to start on it looks like you had some strategic inventory buys this quarter and that's that's really helping us.
A liver some some good results, but I'm wondering if you would expect any more in to year end and then you know Dave you had mentioned some thoughts on on working capital.
I'm being somewhat of a headwind this year.
And any thoughts on just how you would think about inventories.
And as we think about the trends into June.
So Adam I'll start we will continue our interaction with our leading suppliers across the product categories.
<unk> managed through the supply chain headwinds and have wide inventories for our customers both higher velocity types, but also doing the advanced planning of some of those that are gonna have extended lead times and how we stay in front of those are two really insulate protect our customers and continue to serve.
So in addition to that Adam I think the the thing you'll see is some additional increase in the inventory level. It's just thinking about the the strongest backlog position, we've seen across the project oriented nature of our business fluid power flow control automation now so you'll see some temporary increases as well just related to the project's flushing.
Through so would anticipate working capital continue to be a headwind for that as indicated in the script will continue to mitigate that with some of the work that's ongoing and philosophy on inventory planning into cross functional Act.
Activities, we have going on there that have yielded results for us and would still indicate to you know kind of in line with our initial expectations, you know, 80% to 85% of free cash flow. So it's a slightly lower in terms of are you.
Free cash as presented income as a result of that working capital investment, but making the right tradeoffs to protect service levels. There and you know some of that just coming with the sheer growth that we're seeing in the business moving forward.
Okay, and then with the fluid power backlog at record highs I guess do you have any concern about that.
Muscles that you have in that backlog relative to product cost moving up quite a bit or is that not a not a concern do you think you can price for it was higher.
Yeah, I would say I would say not not a big concern I mean, some of that is on order and so we will expect the deliveries of that and for extended items in the in the backlog because they are the requirement to look at the pricing that that will go out and so it has not been.
And in that are an issue for us as we look back and we don't expect that to be an issue going forward.
Okay Gotcha.
To me I might have missed it but could you share what you're seeing across your oil and gas operations and how you expect demand from that market to unfold over the next call it like six to nine months.
So we are seeing improved activity in that segment for us overall, it's still today around 3% of ourself, but we we are seeing increased activity and the team's done a nice job of.
Positioning to the.
Positioning to the market and the demand in that and and so we're operating in and serving well.
Great. Thanks.
Your next question is from Chris Dankert of loop capital.
Hey morning, guys. Thanks for taking my question here.
I guess looking at the you know the sales guide for the year not taken that up at this point just given what we've seen first quarter, what you're seeing into October and kind of your expectations. There. It seemed like you know kind of calling for a below seasonal growth in the back half is that just taking a conservative cut out of given the volatility out there right.
Now or is there any reason to believe things are going to slow in the back half here.
Well you know I just think on the start really after a couple of months, where we established our guidance and it was early to your point, there's a few moving pieces and some uncertainty around supply chain and inflation and clearly a LIFO it is running higher.
Higher than we expected right when we established guidance Oh that was inclusive of maybe 20 to 30.
And it's running a little bit more than that right. Now. So I think that goes in if we think about the range of our assumptions really kind of the low end of the guidance assumes a sequential pattern that's slightly below a normal and then the high end of the guidance assumes a sequential patterns that are really relatively.
<unk> in line and so eight today, we think it's appropriate to.
To maintain guidance you know to Dave's comments, we'd talk about.
Maybe the orientation towards the midpoint of that but as the year unfolds. So you know, we still see a path for something that.
That can be greater than that midpoint, but its still early at this stage.
Got it no that makes complete sense. Thanks for the color there and I guess given the impact of LIFO here, it's still reasonable to assume we can hit kind of a flattish gross margin for the year or is kind of the expectation now it'll be a little bit of a softening just given that that headwind.
I think operationally, excluding LIFO certainly you'll see some modest improvement that was.
Well its really embedded in the underlying assumptions, which did include a 20 to 30 basis point headwind from LIFO you again here with what we saw this stronger LIFO expense in Q1, if we see that continue it is 40 to 45 basis point.
Headwind that we'll be working to offset there. So good underlying traction from the initiatives pricing you know other offsets in terms of margin initiatives.
But that could put pressure just to paint on the sustained impact of that life of expense, but underneath that you'll continue to see I think you know positive trends in terms of our gross margin performed well.
So as we think about it for the quarter just looking ahead, maybe a little sequential decline.
In that side in the in the quarter and then pay the back half to be determined but as we work to go forward, then with our pricing actions and our own internal margin initiatives. You know, we'll be talking more about that as we get.
Through second quarter and talk about the back half of the upcoming fiscal year.
Got it got it.
And then if I could sneak one more in here quick I know, we're building off a small base, but just can you share what the organic growth wasn't that automation business this quarter.
So in the in the quarter the organic growth of automation was 20% in the quarter. So Oh, it will we'll work and keep growing the base with the with new customers served and and bringing those solutions and technology to our legacy customer base.
Got it thanks, so much guys and best of luck.
Yeah.
As a reminder, if you'd like to ask a question. Please press star one.
Your next question is from Michael Mcginn of Wells Fargo.
Hey morning, everyone.
Can you comment on some of them can.
Can you comment on some of the mitigating supply chain actions and levers you have to pull if things get worse from here.
There'd be port's freight types stocking methodologies and does second sourcing have any impact on supplier rebates are you having the second source right now.
Well I'd say for that last point I mean, we continue to work with leading suppliers and best brands as we go forward in that so no no real impact work or effort going on there.
Our products are predominantly north American produced they could have some long distance components that would go into that but we continue to work with suppliers of having that awareness and visibility. So are we.
We do not anticipate any pivot are different and the strategy, we look to to stay engage be nimble.
We're working with those suppliers, we productively built inventory in that and we look to stay connected with our customers and working with our suppliers to do that in this coming quarter and you know is it likely continues on into the start of calendar 2022 will do.
The same but it's not a big differentiation or deviation.
Our strategy in our work.
Okay.
Got it and sorry, if I missed this last quarter I think price contributed contributed 80 to 100 bps. A is there an update to that number on what it at what was the benefit in Q1.
If you would talk to that would be 940 to 180 basis point benefit here again, that's where he got the same SKU match year over year, which I'll just remind you is less than a third of the business you think about the variability of the demand that we see.
Got it I appreciate the time.
Your final question is from Steve Barger of Keybanc capital markets.
Hey, Thanks, good morning, guys.
Just starting with the <unk> Guide I know you have one less selling day this quarter, but with negative 10% comps for both segments from last year do you expect double digit organic growth in each segment for <unk>.
We would we would see you know kind of expect both contribution and contribution of both segments. Steve. So we'd expect to see that here again really both segments you know the.
The low double digit to essentially low teens.
And and Neil a couple of times, you've mentioned inflation and supply chain challenges in general do you see those issues as a risk to your business outlook or an opportunity given your inventory position and your vendor relationships.
Well you know, we just feel I mean, we know our responsibilities and requirements. So we feel confident that we can execute through it I believe good steady inflation. It can be a positive for the environment and the distribution now the size of some of these are rather large and so.
We will continue to manage appropriately so it it is the environment and we're committed to executing in it and representing our suppliers well and serving our customers.
And I think you mentioned this but just to confirm you're not seeing signs of demand destruction from price or parts.
Parts availability or anything else so far.
No we're not.
Point to the quarter end and the results that we have the growing orders in the backlog and I think also the positive signs up underneath us as mid to later cycle segments continue to grow as that progresses, and what I view and second quarter back half that will be very positive.
<unk> for us.
Got it.
And with basically every company complaining about labor shortages. It seems like the best environment, maybe ever to sell automated solutions. So I guess first we've heard the lead times are expanding for some automation products are you getting all the parts and products you need to be able to sell those solutions.
So my short answer is going to be yes, it's the same approach and techniques as we had the the orders coming in to plan out the bill of materials and the requirements. You know lead times may extend a little bit and you know we saw early on access into some of the facilities at times could have slowed.
That's really open back up and so based solutions around machine tending a vision systems robotics, we continue to see that and and we liked across there are other parts of the business will be engage with our suppliers to deliver those solutions.
Yeah.
Are you worried about an increasingly competitive environment for that part of the portfolio just given the secular trends and do you have the footprint in Salesforce you need to make sure you're.
Winning more than your fair share of new business.
We really like our our footprint and we're gonna be focused on continuing to grow it.
Organically and and perhaps Inorganically, you know, where we're active in that but I like our lineup and it is still a fragmented space and so really our our competition that at the customer level. We're engaged with the customers. We have a long standing embedded knowhow at these customers across.
Many many of these segments and now we're just expanding what we can bring to them to help them solve problems around discrete automation, but I.
I think it sets up very well for us.
Understood. Thanks.
I'm showing we have no further questions I will now turn the call back to Mr. Schrimsher for any closing remarks.
Yeah.
I just want to thank everyone for joining us today, and we look forward to talking with many of you throughout the quarter. Thanks a lot.
Thank you ladies and gentlemen. This concludes today's conference. Thank you for participating you may now disconnect.
Uh huh.
[music].
Yes.
[music].
Yes.
Yes.
Okay.
Yes.