Q1 2023 Applied Industrial Technologies Inc Earnings Call
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Welcome to the fiscal 2023 first quarter earnings call for applied Industrial technologies. My name is Bridget and I will 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 one followed by four on your telephone keypad.
Prior to asking a question lift your handset to ensure the best audio quality if at any time during the conference call you need to reach an operator. Please press star Zero. Please note that this conference is being recorded I will now turn the call over to Mr. Ryan see slack director of.
Of Investor Relations and Treasury, Ryan you may begin.
Okay. Thanks, Bridget and good morning to everyone on the call.
We issued our earnings release and Investor presentation detailing our first quarter results both of these documents.
Occupants are available in the Investor Relations section of apply dotcom.
Before we begin just a reminder, will discuss our business outlook and make forward looking statements.
Just on current expectations subject to certain risks and uncertainties, including those detailed in our SEC filings.
Actual results may differ materially from these expectations.
The company undertakes no obligation to update publicly or revise any forward looking statement.
In addition, the conference call, we use certain non-GAAP financial measures, which are subject to qualifications referenced in those documents.
Our speakers today include Neil Scriptures applies president and Chief Executive Officer, and Dave Welch, Our Chief Financial Officer with that I'll turn it over to Neil.
Thanks, Ryan and good morning, everyone. We appreciate you joining us I'll start today with some perspective on our first quarter results, including an update on current industry conditions, and our performance as well as our expectations going forward there.
Dave will follow with more specific detail on the quarter's financials and provide additional color on our outlook and guidance, which we raised this morning.
And I'll, then close with some final thoughts.
So overall, we had a solid start to fiscal 2023.
<unk> EBITDA and EPS, all hit record first quarter levels with respect to growth of 19%, 34% and 45% over prior year levels.
Demand remained strong during the quarter, we continued to benefit from our industry position and internal growth initiatives. This is driving new growth opportunities across both our segments.
We're also doing an excellent job of managing inflation and controlling costs.
This consistent performance is supporting robust operating leverage helping further expand our margin profile and resulting in meaningful earnings growth. Despite more difficult comparisons I want to thank our entire team for their ongoing effort and focus on optimizing and positioning of <unk>.
Lied to achieve these results.
So several key points to highlight in more detail first as it relates to underlying demand customer order and spending activity remained healthy through the quarter and exceeded our initial expectations.
Saw some normalization in sequential trends following robust levels in recent quarters.
However, bookings in order trends remain firm and highlight a productive and steady demand environment.
As customers work through record backlogs reinforced supply chains and equipment across their production base and make required maintenance and growth investments.
Our diversified end market basis, providing further support.
Positive underlying demand and sales growth has continued into the early part of our physical second quarter with organic sales month to date in October .
Similarly, 20% over the prior year.
Within our service Center segment organic sales growth was above 20% for the second straight quarter. This is on top of 16% in the prior year period, so very positive trends.
Segment orders in booking rates remain firm through the quarter and we continue to see encouraging order patterns into October .
Break fix MRO activity remains steady at healthy levels with within most of our core end markets. In addition, we believe the level of growth sustaining across our service Center network, partially reflects various secular growth tailwind and supply chain requirements facing the U S.
Manufacturing sector today.
Our scale local and consistent service capabilities and technical knowledge emotion and control products and solutions are driving greater growth opportunities across both legacy and emerging in markets as these tailwind persist.
We also continue to benefit from sales process initiatives and ongoing pricing actions as well as increased traction from our cross selling efforts.
Earlier this month, our broader U S Service Center leadership team gathered in Cleveland for the first time in three years, the excitement and energy surrounding our core business today is meaningful and our teams are making significant progress deploying a number of strategic actions designed to further catalyze our growth.
And margin profile long term.
Sales growth also remained solid and our engineered solutions segment, which as indicated in our press release. This morning is the new name of our former fluid power and flow control segment.
As we continue to strategically expand this segment, including the scope and capabilities of our fluid power flow control and automation businesses. We believe the new name aligns better with our core value proposition and leading technical capabilities across these higher.
Engineered products and solutions.
These specific elements are integral to the solid growth were seeing across the segment.
Of note engineered solutions segment organic sales growth of 18% accelerated from 14% last quarter.
Growth in this segment continues to benefit from firm demand across longer cycle industrial OE.
All Taiwan mobile and process flow verticals.
Our fluid power team continues to see healthy demand across many of our leading engineered solutions from customized manifolds and industrial power units.
Pneumatic automation systems, and advanced solutions tied to Iot telematics and the electrification of fluid power systems.
In addition, MRO activity and capital spending on process infrastructure remains positive and our core flow control in markets with incremental support from new business tied to our customers' de carbonization efforts.
We also continue to see healthy order growth and backlog across our automation platform.
Our automation growth strategy and value proposition is gaining further traction across the market.
As customers managed through structural labor constraints and evolving production considerations in the post pandemic industrial economy.
We remain very excited about the potential of our automation platform, including an active pipeline of strategic M&A opportunities that we expect to further scale and optimize our competitive position going forward.
Overall, the momentum sustaining across engineered solutions segment is encouraging, particularly when considering ongoing supply chain constraints and component delays, which are impacting the timing of system builds and shipments are.
Our industry position and supplier relationships provide the ability to manage through these ongoing constraints near term.
And we continue to work with our suppliers to optimize component availability going forward.
In addition to sustained top line momentum, we had another strong quarter, managing inflationary pressures through channel execution and additional countermeasures.
Combined with our cost discipline and efficiency gains we grew EBITDA nearly twice the rate of sales growth and expanded EBITDA margins year over year for the eighth straight quarter while.
EPS grew nearly two and a half times the rate of sales during the quarter.
So really solid flow through once again with strong contribution from both segments.
At this time I'll turn the call over to Dave for additional detail on our financial results and the outlook.
Thanks, Neil first just another reminder, at our quarterly supplemental Investor presentation is available on our Investor site for your additional reference I.
I will start by reiterating neil's comments on a solid quarter and ongoing execution by our team it's great to see the momentum.
So now for a few more details on the quarter consolidated sales increased 19, 1% over the prior year quarter.
Acquisitions contributed 20 basis points of growth, which was offset by a 50 basis point headwind from foreign currency translation.
The number of selling days in the quarter was consistent year over year.
Netting these factors sales increased 19, 4% on an organic basis.
As it relates to pricing, we estimate the contribution of product pricing on a year over year sales growth was approximately 500 basis points in the quarter consistent with last quarter.
As a reminder, this assumption reflects miserable topline contribution from price increases on Skus sold in both year over year periods.
Turning now to our sales performance by segment as highlighted on slide six and seven of the presentation.
Sales in our service Center segment increased 23% year over year on organic basis, when excluding the impact of foreign currency.
Growth remains broad based across our core end markets, but was strongest was in food and beverage mining metals pulp and paper energy aggregates and lumber and wood.
Within our engineered solutions segment sales increased 18, 4% over the prior year quarter with acquisitions contributing 60 basis points of growth.
On an organic basis segment sales increased 17, 8% year over year and over 35% on a two year stack basis.
Segment sales growth is being supported by strong order rates and backlog across our fluid power division sustained customer MRO, and capex spending and process flow infrastructure and ongoing healthy demand for our next generation automation solutions.
By end market segment demand during the quarter was strongest within metals mining agriculture chemicals technology, guten beverage and machinery.
Extended supplier lead times and inbound component delays continued to weigh on segment sales growth during the quarter, but the overall impact remains limited to date.
Moving to our gross margin performance as highlighted on page eight of the deck gross margin at 28, 9% increased 24 basis points compared to the prior year level of 28, 6%.
During the quarter, we recognized LIFO expense of $9 $1 million compared to $3 6 million in the prior year quarter.
The net LIFO headwind had an unfavorable 52 basis point year over year impact on gross margins during the quarter and reflects supply of product inflation and ongoing inventory expansion year to date.
Overall underlying gross margin trends were in line with our expectations during the quarter.
Our team continues to respond well to macro inflationary dynamics with broad based you know execution pricing actions and ongoing margin countermeasures.
As it relates to our operating cost selling distribution and administrative expenses increased 11% on an organic constant currency basis compared to prior year levels.
SG&A expense was 18, 8% of sales during the quarter down from 23% during the prior year quarter.
Despite ongoing inflationary headwinds, including higher employee related expenses. Our teams are doing a great job of controlling costs in the current environment as we leverage our operational excellence initiatives shared services model and technology investments.
Overall, our solid sales growth gross margin management and cost leverage drove a 34, 2% increase in EBITDA over prior year levels.
In addition, EBITDA margin of 11, 2% increased 125 basis points compared to prior year levels. This includes an unfavorable 32 basis point year over year impact due to LIFO.
Lastly reported earnings per share of $1 97 was up 45% from prior year earnings per share levels.
Moving to our cash flow performance cash generated from operating activities. During the first quarter was $25 $9 million, while free cash flow totaled $24 million.
As a reminder, the first quarter is typically our lowest cash generation quarter from a seasonal perspective.
Ongoing demand momentum and sales mix, where other influencing factors on working capital during the quarter.
Looking ahead, we expect easing working capital trends as the year progresses, including some benefit from the conversion of working process tied to our engineered solutions segment as well as continued benefits from our working capital initiatives.
From a balance sheet perspective, we ended September with approximately $148 million of cash on hand, and net leverage at one one times EBITDA, which is below the prior year level of one seven times adjusted EBITDA.
Revolver currently has approximately $490 million and available capacity.
An additional $500 million accordion option.
We also have incremental capacity on our AR securitization facility and uncommitted private shelf facilities.
Turning now to our outlook as indicated in today's press release and detailed on page 10 of our presentation. We are raising full year fiscal 2023 guidance to reflect the strong first quarter performance and increase the assumptions for the first half of the year.
We now project EPS in the range of $6.90.
$1 55 per share based on sales growth of 5% to 9%, including a 6% to 10% organic growth assumption as well as EBIT margins up 10, nine to 11, 2%.
Previously our guidance assumes EPS of $6 65 to.
Two $7 30 per share sales growth of 3% to 7% and EBITDA margins of 10 eight to 11, 1%.
Our sales outlook continues to take into consideration broader economic uncertainty as well as ongoing inflationary and supply chain pressures. We're also mindful of the potential of some moderation in normalization of order rates driven by the slower industrial activity and growth as the year continues to play out.
We have incorporated these assumptions into our updated guidance, particularly within the second half of our fiscal year.
In addition, based on month to date sales trends in October and our near term outlook. We currently project physical second quarter organic sales to grow by a low to mid teen percentage over the prior year quarter.
Please note that sales comparisons are more difficult as the second quarter progresses, especially as we comp against the strong sales growth we saw last December .
In addition, we expect potentially more subdued scheduled maintenance activity into the seasonally slower late fall and winter months of this year as customers manage calendar yearend budget spending in an uncertain environment.
Lastly, based on our low to mid teen organic sales growth assumption, we expect second quarter gross margins to be relatively unchanged compared to first quarter levels and SG&A expense down slightly on a sequential basis.
With that I will now turn the call back over to Neil for some final comments.
Thanks, Dave so to wrap up and summarize we feel good about the sustained momentum we are seeing in the early part of our fiscal 2023 year.
The performance is providing strong evidence of the favorable position, we have is structural and secular tailwind persist across the industrial sector.
From critical break fix MRO support at a local level to an expanding portfolio of emerging technologies and specialized engineering solutions, we believe our capabilities and strategy are significant as customers reconfigure and reinforce supply chains and supported their own growth.
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The underlying fundamental backdrop is further supported by increasing evidence of re shoring and localizing production back to North America. This is evident when considering the U S manufacturing capacity utilization was at a 22 year high in September .
At the same time U S manufacturing infrastructure is aged and our customers technical service and support requirements are increasing.
We believe this backdrop could present, an extended period of structurally higher break fix MRO activity as well as ongoing investment into refreshing and expanding industrial production infrastructure and capacity across North America.
This will require strong channel partners with leading technical capabilities next generation solutions strategic supplier relationships and industry leading talent.
Our strategy and growth initiatives are strongly aligned with these trends and requirements.
As Dave mentioned, we remain cognizant of the uncertain economic backdrop near term, including the potential impact of higher interest rates on business investment globally.
Bob potentially slowing demand industry wide in coming quarters, we believe our industry position diversified end market mix and notable self help opportunities can't continue to drive above market growth going forward.
In addition, as we've shown in the past our business model and operating discipline provides the playbook and flexibility to easily adjust if need be while simultaneously generating significant cash flow.
And lastly, our balance sheet and liquidity provides strong support for ongoing organic investment and pursuit of strategic M&A opportunities in the current environment.
So overall, it's great to see how the year started and we remain very focused on what's ahead as we progress towards our next milestone of 5 billion in revenue and 12% EBITDA margins. Once again, we thank you for your continued support and 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 handset press one followed by four on your telephone keypad. If you would like to withdraw your registration from the queue.
<unk> press the one followed by the Street as a reminder, if at any time you need to reach an operator. Please press star zero, we'll pause for just a moment to compile the Q&A roster.
Yeah.
And our first question comes from the line of Chris Dankert of Loop capital. Please proceed with your question.
Hey, good morning, everyone. I guess first off just a very genuine congratulations to you and the whole team over there applied should be very proud of this result here so kudos.
I guess first question thinking about the guide I mean incredible <unk>, if I'm reading the tea leaves you gave on two Q correctly are we assuming kind of yeah.
Midpoint of the guide organic growth drops to flat in the back half of the year am I reading that correctly and just how do we think about how your the shape of the year I guess baked into guidance today.
Yeah. The guide at the midpoint would imply you know flat to up modestly second half organic growth just based on that uncertainty out there. So you know it.
Clear vision, obviously with the backlog position through the second quarter.
So just be prudent in terms of that uncertainty that's still out there as we think about the macro and you know kind of that that outlook for the back half of the year at this point.
Got it understood and then just to kind of move down the line a bit to SG&A and EBITDA margin.
For us of execution in the first quarter here, but.
Typically or at least in the in the past in the recent several years. Your first quarter EBITDA margin has been kind of the lowest of the year.
Is it fair to say that again baked in guidance, where we're thinking kind of an inverse shape. Just again kind of once you have the high watermark given the level of growth we've seen here.
We did suggest here again second quarter consistent with the first quarter.
The Big factor is the you know the LIFO headwinds continuing to weigh on as you think about once again that the Rand with demand in this business as some of those parts hit the radar in terms of Remeasurement. So we're going to see a longer tail on that those some of those economic increases come through so you know just being cognizant of that continued LIFO headwind as we think about the guide here.
And how that plays out we would expect that he's obviously as we move across the year. So could could point to a little bit about you know upside then as you think about from the current rates, but Q2 consistent with Q1 as we had to take right now.
And just a follow up on that I guess forgive me if I've missed it but is it current LIFO expected to be like.
20 million drag on the year right now.
No. It's a it could be upwards of $30 million right now because it's the way we're calling it.
Got it got it thanks, so much for the color and again congrats on the quarter guys.
Thanks, Chris.
And our next question comes from the line of David Manthey of Baird. Please proceed with your question.
Okay.
Thank you and good morning, everyone.
For renaming the engineered solutions segment that'll save us all a lot of trouble going forward.
Dave on your second quarter comments regarding gross margin being unchanged I didn't catch it were you referring to a year over year or sequentially.
Basically from Q1.
Got it.
Okay.
And then I hate to get too granular here you beat the street by what it looks like 36 says I don't know exactly what your outlook was the raise the guide at the midpoint by 25 says I assume we shouldn't read anything into that given the October strength.
Or if you could just talk about are there any leading indicators that are more troublesome today than what you saw a 75% or 80 days ago or I might just reading too much into that.
Yeah, I would say David not not anymore. We're just trying to be mindful of the various crosscurrents and things we read.
That our customers read as well.
But our dialogue with our with our teams with our customers continues to remain constructive.
We're pleased with the solid start thus far in the quarter, we know that the comparables get a little stronger as we go through and especially if we think back to the last December .
And then after that you know we've got it potentially being relatively flat as we think about broader market is it going to slow a little bit I think we can build a case that the general market could.
But we are definitely working on how we perform above market and take advantage of our own growth initiatives plus our position for what we feel are very unique and very strong secular trends that I don't think.
Our business has senior experienced a quite some time or it forever.
Yeah, Okay. Thanks that we do appreciate that conservatism.
Oh here just a couple more lagging sliding here. So first on the strength at off highway mobile you've been seeing that for some time now is there an infrastructure demand pull there and are you seeing any other kind of these.
Pro growth.
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Pull forward of demand in any of your business segments, and then and then second Neal just.
I will hop off.
Automation could you talk about what industries, you're having the most success in it.
Automation or applications. Thank you.
Sure. So if I think about the fluid power and off highway mobile I don't think there's anything unique and driving it from general market conditions. I think we are growing in this segment as we expand our solutions and capabilities as we bring our electronic controls in as we expand.
The offering and capabilities that many of these mid sized Oems are introducing new features on their equipment and participating in it and a good marketplace to pull those two so we feel like we are growing and broadening our solution set with them.
And collectively we're both doing well in the market and then on the automation side.
It's really the the full range, if I think about the cross sell potential given our embedded position and very important capital equipment with the service centers across those segments from whether they'd be food and beverage machinery paper.
More automation solutions are coming in we think about robotics and machine tending and how that's helped or material movement with mobile robots inside of plants and facilities, that's helping with labor bottlenecks that can exist for our customers and envision systems are really increased.
The output and the quality control around our consumer goods and packaging and other industries. So we feel like many of these indoor.
Industrial segments are about 30%, 35% penetrated with automation solutions.
No we're not naive it doesn't go to 100, but we feel like it materially steps up from here and we plan to fully participate.
Sounds great. Thanks, a lot guys congrats.
Thank you.
And again as a reminder to register questions. Please press the one followed by the four on your telephone.
Our next question comes from the line of Ken Newman of Keybanc Capital markets. Please proceed with your question.
Hey, good morning, guys congrats on the quarter.
Got it.
It.
Could you just expand a little bit on what you're expecting in terms of industry consolidation in the back half I'm curious how much do you think are your assuming youre going to outperform the industry.
Yeah. So as we would look probably for the first half. We think you know market conditions industrial production could be up mid single digits.
And then as we think about the back half there could be a potential that there was a decline of mid single digit in that side. So.
That's forming some of our views on the general market conditions, and the guide, but with that we feel like we're well positioned.
Our locations our service capabilities, our broadening expanding engineered solutions to perform very very well.
Understood.
For my follow up you know there was a there was a large acquisition announced this morning between two of your largest suppliers.
Not sure if you've gotten to take a look at that but I'm curious if you have any initial color on just how much product overlap there is between altra and real rexnord and whether we should think about this as a net positive impact for you going forward.
You know I did get to see it come across and Oh exchange. Some congratulatory notes I mean, we we obviously know both both suppliers and the businesses I assume it'll take a little bit of time for the regulatory review and approve.
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We see it as positive.
Again strong position with with both as it goes through and.
I think as they take out those.
Extended solutions, we would view that as as additive so Oh no no no adverse opinion on it from our side.
Okay.
One more if I could squeeze it in.
I'm sorry, if I missed this but did you quantify how much the automation business was up organically in the quarter and curious if you could just give us an update on where our run rate annualized sales are.
Sure So I'd say the growth.
Growth rate was somewhat similar to what we saw last quarter kind of that mid single digit up organically with that order rates and backlog did grow so.
You mentioned in the comments.
The segment has experienced some backlog or delays of certain components that have held up systems and going out we continue to see that our September number was very strong and doing it. So our expectations are that the segment will continue to perform and perhaps outperform what will be the overall.
Blended conditions for the business as we think about it going forward. So encouraged continued to work and it is one.
That we will look at making the appropriate organic and inorganic investments to grow.
Even with that still up north of $150 million in terms of annualized run rate at this point again.
Understood and then is there.
Sorry, maybe just the M&A pipeline within that business I know you talked positively about it being active any color there and how do you think about capital deployment.
Higher macro uncertainty.
Yeah. So so overall I mean, obviously are we continuing to do a nice job with our financial position and our priorities remain.
Where we can make our organic investments in the business, we will and do the.
The M&A acquisitions or opportunities that we have and in these times, where we're busy to our priorities that are that we've talked about in the past. So those would remain are big ones and then obviously you hey, we're still always be committed to the dividend and then share repurchase.
Be a view more opportunistically look.
Understood. Thanks for the time.
Thank you.
Okay.
And we do have a follow up question from the line of David Manthey of Baird. Please proceed with your question.
Yeah, a quick follow up here.
Could you remind us the differences of the company in terms of mix.
And business in general relative to 2015 and 2016, we saw a retrench in IP of about <unk> <unk>.
Mid single digit amount back then and of course that was accompanied by oil rolling over hard in 14, and 15, but could you just remind us the key differences in the business make up today versus that.
Yeah. So I don't have it all to compare to that but against that time, you know David we've clearly grown fluid power.
Flow control and now automation on the side. So it was engineered solutions. You know approaches are male 30, 33% of the business. We expect in time, we look down the road the company mix could be would be 60 to 40 and perhaps even further out 50 50.
With a strong focus on growing both I've been very impressed with the service Center performance.
In the time.
And many of those secular trends benefiting so.
In that time period, we think we managed Decrementals well, then and we're continuing to demonstrate that capability. If we have that type of pullback that we can manage decrementals just like we've expanded our incrementals going forward.
And certainly a much less oil and gas exposure double digit at that time, David you know kind of less than 4% now at this point.
Dave This is Brian and I, just I just would add to the exposure that we have around areas like food and beverage aggregates.
Greater exposure there today as well as you know there is a category that we talk about around general industry. I think as you know that captures anything that's 4% or less of the business in a much larger percentage of the business today.
And then in prior cycles as well so the diversification of the end markets. It is a notable element of apply today certainly relative to prior cycles.
Got it thanks for the time guys.
Thank you.
Thank you at this time I'm showing we have no further questions I will now turn the call over to Mr. Scream share for any closing remarks.
I simply want to thank everyone for joining us today, and we look forward to seeing many of you throughout the quarter.
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Thank you ladies and gentlemen that concludes today's conference. Thank you for participating you may now disconnect.
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