Q2 2025 Applied Industrial Technologies Inc Earnings Call
Welcome to the Fiscal 2025 Second Quarter Earnings Call for Applied Industrial Technologies.
Our speakers today include Neil Schrimsher applied President and Chief Executive Officer, and Dave Wells, Our Chief Financial Officer with that I'll turn it over to Neil.
Thanks, Ryan and good morning, everyone. We appreciate you joining us I'll begin today with perspective on our second quarter results and current industry conditions.
Followed by some thoughts on recent on the recent acquisition of Hydra, Dyne and expectations going forward.
Dave Wells: Dave will then provide additional financial detail on the quarter's performance and updated outlook in.
Dave Wells: And I'll, then close with some final thoughts.
Dave Wells: Overall, we had a productive second quarter that highlight the operational resiliency and self help opportunities of our differentiated industry position and strategy.
Dave Wells: We grew earnings and expanded margins over the prior year.
Dave Wells: And in an environment, where demand remains soft and sales declined slightly.
Dave Wells: <unk> also made progress in positioning the company for stronger growth moving forward. This includes ongoing investment in our sales tools and operational systems and technical talent.
Dave Wells: Building, a business funnels, which is driving stronger orders as well as announcing and closing of our strategic acquisition of Hydra, Dyne, which I'll discuss in more detail in a moment.
Dave Wells: As it relates to the quarter's results, both EBITDA and EPS exceeded our expectations, increasing approximately 3% and 7% over the prior year respectively.
Dave Wells: We benefited from strong gross margin performance and cost controls, while lower LIFO expense contributed to margin performance in the quarter, both gross margins and EBITDA margins still expanded nicely over the prior year when excluding the change in LIFO expense.
Dave Wells: The positive performance was primarily driven by channel execution and ongoing margin initiatives across various areas of our business as well as variable expense adjustments and cost control inherent to our model and operational discipline.
Dave Wells: Margin improvement was led by our engineered solutions segment, where EBITDA margins expanded 115 basis points over the prior year end.
Dave Wells: And exceeded 16% for the first time.
Engineered solutions segment EBITDA margin has expanded over 450 basis points the past five years.
Dave Wells: We're making solid progress with our internal initiatives and operational enhancements as we continue to scale this strategic area of our business.
Dave Wells: The segments margin expansion highlights the strong market position and value proposition, we have across our portfolio, our fluid power flow control and automation solutions and should enhance our mix tailwind and overall margin expansion potential moving forward.
Dave Wells: At segment sales began to Reaccelerate.
Dave Wells: As it relates to topline trends average daily sales declined three 4% over the prior year, which was in line with the guidance. We provided in October are down mid single to low single digits.
Dave Wells: We continue to operate within a muted end market backdrop with customers conservative conservatively, managing MRO spending and delaying capital investments.
Dave Wells: Underlying demand improved slightly following the slow start to October, but moderated and was below normal seasonal patterns during December.
Dave Wells: Most of December weakness was concentrated later in the month and in our view was primarily tied to the timing of holidays. This year with Christmas and new year's falling midweek.
Dave Wells: As well as extended customer plant idling and deferred maintenance activity within our service Center segment.
Dave Wells: We estimate softer sales during the last two weeks of December negatively impacted the quarter's overall organic sales growth by approximately 100 basis points.
Dave Wells: When looking at our top 30 in markets 11 were positive year over year in the second quarter.
Dave Wells: Which is below the 13 reported last quarter.
Dave Wells: In markets that were up year over year included chemicals, food and beverage pulp and paper and technology.
Dave Wells: This was offset by declines primarily in machinery transportation aggregates fabricated metals oil and gas and mining end markets.
Dave Wells: Mixed end market demand has continued into the early part of our fiscal third quarter as customers are settling into the new year and continue to operate at a gradual pace of note January sales are currently trending down a mid single digit percent year over year on an organic basis.
Dave Wells: We believe ongoing macro policy and interest rate uncertainty remain headwinds.
Dave Wells: Weather has played a role across the southern U S regions, all over the past month as well.
Dave Wells: That said, we do not view January sales is indicative of how the third quarter and the balance of the year could play out based on several directionally positive trends taking shape.
Dave Wells: Of note various industrial macro data points are showing some signs of improvement.
Dave Wells: The new orders component of the ISI Am index was in expansionary territory in November and December.
Dave Wells: Bookings across our service Center network are improving following a slow into December.
Dave Wells: Feedback and sentiment among customers are more positive post the election.
Dave Wells: Our service Center segment is well positioned as end market demand reaccelerate with.
Dave Wells: With approximately 50% of our service center business tied to technical break fix situations across critical industrial processes systems and infrastructure we.
Dave Wells: We believe demand for our service center products and technical support could ramp quickly and broadly over the next year as customers Reengage production and catch up on required technical MRO activity.
Dave Wells: This will be particularly evident across heavy manufacturing machinery mining metals and aggregate markets.
Dave Wells: Given their break fix intensive nature and deferred maintenance in recent periods.
Dave Wells: In addition, a lighter regulatory agenda with a new U S administration represents a potential incremental new tailwind in many of our legacy end markets across our service center operations as well as within our flow control network.
Dave Wells: Combined we estimate these break fix intensive and more regulated markets represent about 40% to 50% of our total sales today.
Dave Wells: In addition order momentum in business funnels are building across the technology vertical which represents approximately 15% of our engineered solutions segment and 5% of our overall sales.
Dave Wells: We are beginning to see stronger demand across the semiconductor sector and related spending on wafer fab equipment. Following the demand headwind we experienced in this sector over the past several years.
Dave Wells: <unk> customer activity across the technology vertical is encouraging and a potentially strong growth tailwind moving forward.
Dave Wells: We also continue to see positive momentum developing across our automation business with orders strengthening year to date as various secular tailwind continue to positively influence demand.
Dave Wells: These dynamics are driving ongoing adoption of collaborative and mobile robots.
Dave Wells: <unk> vision and Iot solutions are.
Dave Wells: Our strong application and engineering capabilities, along with an expanded footprint and facility capacity will further supplement our potential in this high growth area of our business as discrete automation investments reaccelerate in coming quarters and demand for aftermarket.
Dave Wells: And service support starts to emerge.
Dave Wells: On another encouraging note order trends are beginning to stabilize and improve slightly across fluid power industrial and mobile OEM customers.
Dave Wells: You recall this has been a primary area of sales weakness for us over the past year.
Dave Wells: During the second quarter reduced sales from industrial and mobile OEM fluid power customers negatively impacted our consolidated organic year over year sales growth rate by approximately 150 basis points.
Dave Wells: However related orders.
Dave Wells: From these customers were up 9% sequentially from the first quarter and relatively unchanged year over year during December.
Dave Wells: Combined with more normalized OEM inventory levels. Following recent destocking and much easier comparisons we expect the year over year sales trend and related impact in this area of our business to improve moving forward.
Dave Wells: This includes potentially re emerging as a growth tailwind in coming quarters, considering secular demand and required investments.
Dave Wells: Developing across fluid power systems as well as ongoing strategic investments, we are making into this more specialized and highly technical area of industrial distribution.
Dave Wells: Of note we are extremely excited about the growth and operational momentum we expect to build following the completion of our hydro dine acquisition at the end of December.
Dave Wells: Based in Dallas, Texas, Hydra Dyne as one of the largest U S district distributors focused on fluid power and motion control systems.
Dave Wells: With advanced service capabilities and product offerings in hydraulics, pneumatics, electromechanical instrumentation filtration and fluid conveyance.
The addition of Hydra dyne aligns extremely well with our strategy with.
Dave Wells: With anticipated sales of $260 million and EBITDA of $30 million in the first year of ownership.
Dave Wells: <unk> strengthens our number one fluid power position by extending our footprint across the southern U S where they operate with a team of nearly 500 associates out of 33 locations.
Dave Wells: Hydro down also brings strong technical capabilities that complement our current fluid power service and solutions portfolio with approximately 30% of sales tied to repair engineering and design system fabrication pose assemblies and other value added solutions.
Dave Wells: <unk>.
Dave Wells: Our combined technical capabilities and access to premier fluid power motion flow control and automation technologies presented powerful value proposition for our customers that will accelerate cross selling and market penetration.
Dave Wells: This includes enhancing our collective efforts to serve the rapid pace of innovation developing across fluid power systems.
Dave Wells: Our strategy and teams are aligned to support thousands of.
Dave Wells: Specialized Oems and industrial manufacturers.
Dave Wells: Near design and integrate these advanced features into their mobile and industrial equipment with World class technologies from top fluid power suppliers.
Dave Wells: The strength of our combined technical teams and footprint will also allow us to more effectively and broadly capture growth opportunities developing across emerging and markets and commercial applications.
Dave Wells: We provide more detail around Hydra dyne acquisition in slides five and six of our second quarter earnings presentation, and Dave will cover off on some of the key financial considerations, including our initial accretion expectations.
Dave Wells: In summary, we're very excited to welcome hydro dine in their capabilities to the applied platform.
Dave Wells: Overall I'm encouraged by the progress, we're making with our strategy, including the ongoing build out of our engineered solutions segment.
Dave Wells: Following the Hydra Dyne acquisition. This segment is now approaching 40% of overall sales compared to 15% 10 years ago.
Dave Wells: Strategic expansion of this segment has further differentiated our industry position and strengthened our competitive mode.
Dave Wells: We've established and fortified our leading market positions building in serving critical motion power and control systems across nearly every industrial vertical.
Dave Wells: <unk> has created a unique and potentially significant cross selling opportunity throughout our legacy embedded customer base.
Dave Wells: While increasing exposure to faster growing end markets and secular tailwind.
It's also expanding our addressable market and allowing us to evolve and enhance our competitive position as the industrial sector and related systems advance with new age processes and technologies.
Dave Wells: Combined with a positive margin profile and ongoing operational enhancements, we expect our engineered solutions segment to be a strong and differentiated driver.
Dave Wells: Of earnings growth and returns going forward.
Dave Wells: Yeah.
Dave Wells: Lastly, I'm encouraged by the ongoing capital deployment opportunities with our industry position balance sheet and cash flow generation continue to support.
Dave Wells: Year to date, we've deployed over $380 million in capital focused on enhancing our growth position and shareholder returns.
Dave Wells: This compares to $251 million of capital deployed for all of fiscal 2024.
Dave Wells: While partially reflecting our recent Hydra Dyne acquisition. We also continued to return capital through share buybacks, including deploying 30 million on share repurchases year to date.
Dave Wells: In addition, we announced this morning, a 24% increase in our quarterly dividend.
Dave Wells: The increase is in line with our expectation for greater dividend growth as we align annual increases with normalized earnings growth, including the strong earnings and cash generation achieved in recent years.
Dave Wells: Our capital allocation priorities remain unchanged and highly focused on organic investments and M&A.
Dave Wells: However, our broader capital deployment trends year to date showcased multiple opportunities and ways, we can deploy capital to optimize shareholder returns as we continue to scale, our business and achieve our strategic goals.
Dave Wells: Moving forward, our balance sheet and financial capacity remain extremely well positioned.
Dave Wells: To continue to support M&A and other capital deployment opportunities.
Dave Wells: We have ongoing scope for additional buybacks for the remainder of fiscal 2025 based on our current financial capacity and the intrinsic value, we see across our company long term.
Dave Wells: In addition, our M&A pipeline and related due diligence remains active across both segments with a primary focus on bolt on and midsize targets, where we can create significant shareholder value.
Dave Wells: At this time I'll turn the call over to Dave for additional detail on our financial results and outlook.
Dave Wells: Thanks, Neil just as a reminder, before I begin as in prior quarters, we have posted a supplemental investor presentation to our investor site for additional reference.
Dave Wells: This quarterly presentation provides a more detailed recap of our second quarter results updated guidance and details on our recent acquisition of Hydra Dyne.
Dave Wells: Turning now to our financial performance in the quarter Consol.
Dave Wells: Consolidated sales decreased <unk>, 4% over the prior year quarter.
Dave Wells: Acquisitions contributed 190 basis points, while the difference in selling days had a positive 160 basis point impact.
Dave Wells: This was partially offset by a negative 50 basis point impact from foreign currency translation.
Dave Wells: Netting these factors sales decreased three 4% on an organic daily basis.
Dave Wells: As it relates to pricing, we estimate the contribution of product pricing on year over year sales growth was slightly less than 100 basis points for the quarter and largely in line with our expectations.
Dave Wells: Turning now to sales performance by segment as highlighted on slides nine and tenant the presentation sales in our service Center segment declined one 9% year over year on an organic daily basis.
Dave Wells: This excludes a positive 30 basis point impact from acquisitions, a positive 160 basis point impact from the difference in selling days and a negative 70 basis point impact from foreign currency translation.
Dave Wells: The organic sales decline was primarily driven by reduced MRO spending lower capital maintenance project activity extended customer plant idling and the timing of holidays in the month of December.
Dave Wells: The impact from weaker sales in late December was most pronounced across our service center operations. This followed more stable trends in October November where segment sales were relatively unchanged year over year.
Dave Wells: Growth in National accounts during the quarter was more than offset by weaker sales from local accounts.
Dave Wells: Segment, EBITDA increased one 4% over the prior year.
Dave Wells: Segment EBITDA margin of 13, 4% improved nearly 30 basis points year over year.
Within our engineered solutions segment sales increased 4% over the prior year quarter with acquisitions contributing five one percentage points of growth and the impact from one extra selling day provided an additional 160 basis points of growth.
Dave Wells: On an organic daily basis segment sales decreased six 3% year over year.
Dave Wells: The decline was primarily driven by ongoing sales weakness across fluid power OEM customers.
Dave Wells: Lastly, reflecting reduced demand across mobile fluid power markets.
Dave Wells: This was partially balanced by more stable trends across industrial implant applications as well as improving demand and technology related fluid power end markets.
Dave Wells: Meanwhile, sales within our automation operations declined by a high single digit percentage year over year on an organic daily basis.
Dave Wells: This is consistent with last quarter, and primarily reflects or headwinds from customers continuing to delay spending in response to macro uncertainty.
Dave Wells: Dr fluid power and automation sales were partially offset by ongoing growth across our flow control operations.
Dave Wells: Average daily sales increased 2% year over year and over 4% sequentially.
Dave Wells: Collecting firm project activity on process infrastructure.
Dave Wells: In addition, despite the sales decline in the quarter segment EBITDA increased 8% over the prior year, while segment EBITDA margin of 16, 3% expanded 115 basis points from prior year levels.
Dave Wells: The performance primarily reflects strong gross margin expansion tied to our internal initiatives and value proposition more favorable mix and to a lesser extent lower LIFO expense as well as contributions from ongoing operational enhancements as we continue to execute our engineered solution strategy.
Dave Wells: Moving to consolidated gross margin performance as highlighted on page 11 of the deck gross margin of 36% increased 114 basis points compared to the prior year level of 29, 4%.
Dave Wells: During the quarter, we recognized LIFO expense of <unk> $7 million compared to $3 4 million in the prior year quarter.
Dave Wells: This net LIFO tailwind had a favorable 25 basis point year over year impact on gross margins.
Dave Wells: Excluding this impact we still generated solid gross margin expansion in the quarter, despite ongoing mix headwinds tied to lower sales across our engineered solutions segment and local accounts.
Dave Wells: <unk> performance reflects the strong channel execution, our engineered solutions segment performance and the benefits of ongoing margin initiatives.
Dave Wells: As it relates to our operating cost selling distribution and administrative expenses increased two 3% compared to the prior year levels.
Dave Wells: SG&A expense was 19, 3% of sales during the quarter reflected an increase of 51 basis points from the prior year quarter.
Dave Wells: On an organic constant currency basis, SG&A expense was up 3% over the prior year period, but down over 1% when adjusting for the extra payroll day in the quarter.
Our team did a nice job controlling costs in the quarter against the muted demand backdrop, while managing inflationary pressures in order to continue to balance and sustained critical investments for growth.
Dave Wells: We also benefited from ongoing efficiency gains and reduced variable expense on lower sales, which helped balance higher administrative and occupancy cost.
Dave Wells: In particular, the quarter included approximately $1 $5 million of due diligence and transaction related expenses related to the Hydra Dyne acquisition.
Dave Wells: Overall positive gross margin performance, coupled with the benefit of spend initiatives resulted in reported EBITDA, increasing three 3% year over year, while EBITDA margin of 12, 6% expanded 45 basis points from the prior level of 12, 1%.
Dave Wells: Combined with greater interest income on higher average cash balances and is slightly reduced share count we reported earnings per share of $2 39.
Dave Wells: Which was up six 7% from prior year adjusted EPS levels of $2 24.
Dave Wells: Of note prior year, adjusted EPS excludes a pre tax $3 million or <unk> <unk> per share deferred tax valuation allowance benefit.
Dave Wells: Moving now to our cash flow performance cash generated from operating activities. During the second quarter was $95 1 million, while free cash flow totaled $89 $9 million.
Dave Wells: Representing conversion of 96% relative to net income.
Dave Wells: Year to date, we have generated approximately $212 million of free cash flow, which is up 34% year over year and represents conversion of 114% relative to net income.
Dave Wells: Our cash flow growth. So far this year, primarily reflects more modest working capital investment compared to prior year as well as ongoing progress with internal initiatives and our enhanced margin profile.
Dave Wells: Turning now to our acquisition of Hydro Dine as Neil mentioned, we're extremely excited about this transaction.
Dave Wells: It represents another notable milestone for applied and our overall value proposition to customers suppliers and to all stakeholders.
Dave Wells: Not only does the acquisition fit extremely well with our M&A priorities and return based capital deployment strategy Hydro <unk> local customer centric culture and operational caliber aligns well with our operating framework, which will provide a strong foundation on which to build positive momentum early on.
Dave Wells: As it relates to some of the financial considerations of the deal the purchase price of $276 million was funded with cash on hand, representing a trans matched transaction multiple of nine one times enterprise value to forward EBITDA before anticipated synergies.
Dave Wells: We expect the transaction to generate approximately $260 million in sales and $30 million in EBITDA as well as be accretive to EPS by approximately <unk> 15.
Dave Wells: Within the first 12 months of ownership.
Dave Wells: The EPS accretion estimate is net of projected acquisition intangible amortization expense of over $11 million in the first year or 22 per share as well as reduced interest income on lower cash balances after funding the transaction.
Dave Wells: In addition, these assumptions are before anticipated synergies tied to cross selling leveraging complimentary solutions harmonising technical capabilities and systems and driving operational efficiencies across the combined operating platforms.
We expect synergies to begin to develop in fiscal 2025, but be more meaningful in fiscal 2026 and 2027.
Dave Wells: Hi.
Dave Wells: Based on our initial projections, we are targeting net synergies of 5 million to $10 million within the first three years of ownership.
Dave Wells: Of additional note following the transaction our balance sheet remains strong with pro forma net leverage increasing to a modest <unk> five times and approximately $1 $5 billion of balance sheet capacity remaining.
Dave Wells: Okay.
Dave Wells: Turning now to our outlook as indicated in today's press release and detailed on page 14 of our presentation. We are raising full year fiscal 2025 guidance to reflect our stronger second quarter earnings performance and estimated initial contribution from our acquisition of Hydra Dyne.
Dave Wells: We now project EPS in the range of $9 65 to $10 five.
Dave Wells: Based on sales growth of 1% to 3% and EBIT margins of 12, two to 12, 4%.
Dave Wells: Previously our guidance assumed EPS of $9 25 to $10 sales growth of down two 5% to up two 5% and EBIT margins of 12, 1% to 12, 3%.
Dave Wells: Yes.
Dave Wells: Our updated guidance assumes full year fiscal 2025 sales declined organically by 3% to 1% on an average daily basis.
Dave Wells: Third to our prior assumption of down four to up 1%.
Dave Wells: We are now assuming year over year organic sales trends improve more gradually in the second half of fiscal 2025.
Dave Wells: We believe this is reasonable given the ongoing uncertainty tied to macro policy and interest rates, which could continue to restrain customer capital spending and production growth near term.
Dave Wells: We're also taking into account the slower start to early third quarter organic sales trends, which has noted earlier are trending down by a mid single digit percentage over the prior year in January.
Dave Wells: The midpoint of guidance now assumes average organic sales decline by slowly slow single digit percent year over year in the second half of fiscal 2025, including mid single to low single digit declines in the third quarter, followed by a return to modest growth in the fourth quarter.
Dave Wells: We are projecting M&A generated sales, including Hydra dyne to contribute 600 to 700 basis points of year over year sales growth in the second half of the year.
Dave Wells: Partially offset by ongoing foreign currency transaction and translation headwinds.
Dave Wells: Overall, we remain constructive on our setup moving forward considering easier prior year comparisons improving demand indicators and sustained benefits from our internal initiatives.
Dave Wells: Leave a balanced approach to our near term outlook remains appropriate setting more definitive signs of a positive inflection in the underlying industrial activity.
Dave Wells: Lastly from a margin perspective, we expect third quarter gross margins to decline sequentially to around 30%.
Dave Wells: This assumes a more normalized level of gross margin execution relative to our strong second quarter performance as well as slightly higher LIFO expense.
Dave Wells: Combined with ongoing inflationary headwinds anticipated growth investments, our annual Merit increase which was effective January one and initial integration cost mix considerations from our hydro Dine acquisition, we expect third quarter EBIT margins to moderate sequentially to 12 to 12, 2%.
Dave Wells: So still expand year over year.
Dave Wells: Lastly, our updated guidance assumes initial EPS accretion from hydro <unk> is modest in the third quarter as we begin integration and align initiatives within the muted end market backdrop.
Dave Wells: We expect accretion to begin to ramp in the fourth quarter and into fiscal 2026 as initial synergies are achieved and end markets begin to recover.
Neil Schrimsher: With that I will now turn the call back over to Neil for some final comments.
Neil Schrimsher: So to wrap up I'm proud of the applied team and our performance through the first half of fiscal 2025.
Neil Schrimsher: We're delivering on our commitments and making strong progress toward our interim financial objectives of $5 5 billion of revenue and 13% EBITDA margins.
Neil Schrimsher: Near term, we believe the underlying demand environment could remain muted and somewhat choppy pending.
Neil Schrimsher: Pending a more defined direction on macro policies post the election.
Neil Schrimsher: As our second quarter results show, we have the ongoing self help opportunities to manage and perform well if demand remains sluggish near term.
Neil Schrimsher: That said as we look forward and consider our industry position. We continue to believe we are close to entering a very favorable growth period at applied we.
Neil Schrimsher: We feel good about the positive demand signals developing including stronger order trends across our higher margin engineered solutions segment.
Neil Schrimsher: Investments over the past several years should optimize our organic growth potential is in markets begin to recover.
Neil Schrimsher: This includes recent facility expansion to optimize our service capabilities across the technology vertical and our automation operations.
Neil Schrimsher: Our recent board meeting was held at one of these facilities, where we saw firsthand the growth potential of our expanded capacity and technical market position as well as some of the building customer activity beginning to develop.
Neil Schrimsher: We also believe break fix activity should accelerate across our service center network into the spring and summer as production schedules ramp back up.
Neil Schrimsher: This could drive more heightened technical MRO and capital spending as customers reengage initiatives to modernize equipment and expand production facilities now with the election behind us and as additional transparency develops on U S trade policies and interest rates.
Neil Schrimsher: Our technical domain expertise and access to core industrial equipment puts us in a leading position to help customers manage through these operational requirements.
Neil Schrimsher: Lastly, we are in a strong position to benefit from ongoing industry consolidation over the next several years, considering the high fragmentation and technical requirements associated with our industry segment.
Neil Schrimsher: We believe the drivers of consolidation or higher today.
Neil Schrimsher: Customers supply chain focus has intensified.
Neil Schrimsher: They are potentially facing one of the more favorable U S manufacturing backdrops in decades, while also managing through limited technical labor availability and greater mandates to eliminate operational risk.
Neil Schrimsher: Accelerating innovation and significance of motion power and control systems.
Neil Schrimsher: And our increasing service requirements, including access to new production solutions and system the repairs.
Neil Schrimsher: Combined with structurally higher inflation, we believe these considerations could accelerate consolidation across sector, both organically and through M&A as customers and suppliers increased business with larger more capable distributors.
Neil Schrimsher: The value of our scale technical service engineering capabilities strategic supplier relationships and available balance sheet capacity has never been stronger and our marketplace.
Neil Schrimsher: Overall, we look forward to fully capturing this growth potential through the remainder of fiscal 2025 and years to come.
Neil Schrimsher: As always we thank you for your continued support.
Neil Schrimsher: With that we'll open up the lines for your questions.
Neil Schrimsher: Thank you we will now begin the question and answer session.
Speaker Change: I'd like to ask a question please pickup your handset.
Speaker Change: Hello, Ladies and number one on your telephone keypad, if you will.
Speaker Change: I'd like to withdraw your question from the queue Press Star one again.
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Speaker Change: Zero.
Speaker Change: Just a moment to compile the Q&A roster.
Speaker Change: Yes.
Speaker Change: And your first question comes from the line of David Manthey.
Speaker Change: Please go ahead.
Speaker Change: Yes.
Speaker Change: Thank you and good morning, everyone.
Speaker Change: Good morning.
Speaker Change: The first question is in the second quarter, excluding rebates and and the LIFO tailwind you improved core gross margin by about 80 basis points year over year.
Speaker Change: And one of the slides you mentioned execution Es segment and initiatives I'm wondering if you can further refine the sources and the sustainability of that improvement.
Speaker Change: Yes, so I can start David that I would say in the energy segment. Good performance, we got benefit from mix.
Speaker Change: Scale is coming through for us into that side and so we think just overall good execution as the team looks to appropriately price to the value of the systems and solutions that we have so positive and point of sale there, but also benefit in the technical nature of the products and solutions mix as.
Speaker Change: As well as some of the customer side and that I think as Dave pointed out we did get some supplier benefits into the side I would say roughly 10 to 20 basis points of that.
Speaker Change: That could have been or that was tied to achieving a higher tier in to that side. So it came through into this quarter, we would not look for that two to.
Speaker Change: To replicate necessarily in the third quarter and that really points of students, saying gross margins are more low thirties.
Speaker Change: <unk> in the third quarter and the rest of the back half, but we did get another.
Speaker Change: 10 to 15 basis points of just good continued execution across the business as well.
Dave Wells: When you get to your point, Dave stripping out that unusual support vendor support in the LIFO, which combined.
Dave Wells: 10 to 20 basis points on the vendor support and 25 basis points in the LIFO solid underlying performance about 50 basis points of that did come out of the engineered solutions segment.
Dave Wells: Nation as Neil indicated mix I mean, big piece of that reading through us. So we said we were up 2%.
Dave Wells: Year over year in terms of our flow control shipments up 4% sequentially that is one of our richer gross margin performing businesses as well as just you because you're getting pricing for the value and some.
Dave Wells: And the variability that we're seeing coming out of that segment, but beyond that the proud to see that 5% to 50 basis points improvement in the service center side of the business. So really hitting on all cylinders there with the continued work around operational efficiencies pricing in both pieces of the equation and USAID.
Dave Wells: Maximizing the channel benefit.
Dave Wells: The market position that we do hold.
Dave Wells: Okay. Thanks for the detail there and second.
Neil Schrimsher: Dave maybe you could talk about dipped.
Speaker Change: Depreciation and amortization.
Neil Schrimsher: Due to the.
Neil Schrimsher: Acquisition of Hydra Dyne separately, just what is the step up there and then also related to hydro Diane you mentioned today $5 million to $10 million of synergies over the first.
Neil Schrimsher: Three years.
Neil Schrimsher: I'm wondering number one is that a run rate by the time, you're at the end of three years and then second is that cost synergies sales synergies or both.
Neil Schrimsher: Yes.
Neil Schrimsher: Majority of it's about let me see 70 30 mix in terms of.
Neil Schrimsher: Sales synergies cost synergies, we'll get those by virtue of benefits harmonization Leverages some of our licensee for you. Both both businesses are legacy fluid power business in hydro dine on and at the core product.
Neil Schrimsher: We do have some very favorable licensing costs for <unk> do anticipate as I said.
Neil Schrimsher: Obviously, the sales synergies coming through as we continue to leverage and particularly given the underserved nature of that southeast region that we've been looking to enhance our position in for so long as we targeted this acquisition.
Neil Schrimsher: <unk> seen some of that come through so combination of both the <unk> impact in terms of depreciation and amortization expense as we talked about.
Neil Schrimsher: Stripping out specifically Hydra dyne, yes.
Neil Schrimsher: Yes.
Neil Schrimsher: Maybe I'll take that one just as it relates to depreciate and Dave and amortization into the back half, we will step up to in total closer to $17 million per quarter and sold Hydra dyne, including the intangible amortization as well as your depreciation about $3 million of incremental DNA or depreciation and amortization per quarter in the <unk>.
Neil Schrimsher: Back half of the year.
Neil Schrimsher: Yes, Dave I'd say, then as we think about the synergies as we break them out.
Neil Schrimsher: We think the cost margin side is in that more 70 to 80.
Neil Schrimsher: Into that.
Neil Schrimsher: Obviously scale helps us some in that we think on the on the purchasing side some of the indirect support.
Neil Schrimsher: But with that said, we're excited about the additional cells synergy opportunities, perhaps in that 20% to 30% range that that opens up to leverage the capabilities strong service and repair and solutions in the geographies that can link with the service centers in and then.
Neil Schrimsher: The acceleration that we think across those end market segments and electronic controls, perhaps electrification in time, we will open up some of the sales synergies as well so overall very.
Neil Schrimsher: Excited about this strategic addition to us.
Neil Schrimsher: And a core focus area of our fluid power and in them and an important geography.
Neil Schrimsher: I appreciate the detail. Thank you.
Speaker Change: And your next question comes from the line of Ken Keenan.
Speaker Change: From Keybanc capital markets. Please go ahead.
Ken Keenan: Hey, good morning, guys.
Speaker Change: Good morning.
Speaker Change: First I just wanted to clarify Neal on the January trends.
Speaker Change: Running down mid single digits.
Speaker Change: I think it makes sense that it is being impacted by some of the holiday timing that you saw in December.
Speaker Change: And I am curious if you have any color on what the weekly trends through the monitor how the avs trends kind of shifted from the beginning of the month towards the end and whether or not we are back to pre shutdown levels or when you expect us to get there.
Speaker Change: Sure. So I would say Ken most of the drag in January which was early in the month and I'd say, probably the first couple of weeks down double digit.
Speaker Change: I would really say.
Speaker Change: The last couple of weeks.
Speaker Change: Up low single digits.
Speaker Change: A few days to go here as we move through so that would be the break and so that builds part of our view that.
Speaker Change: It's hard to extrapolate.
Speaker Change: Holidays in November December and the early start of January as the fault indicators. So so we're encouraged by the.
Speaker Change: The pickup over the last couple of weeks.
Speaker Change: Right.
Speaker Change: That's very helpful.
Speaker Change: And then Neal.
Neal: You're essentially at your 40 60 segment mix between the engineered solutions and service center businesses.
Neal: Do you or the board have a sense of where you want that makes the ultimately go from here and how do you envision the pace of that mix shift change.
Neal: From the growth that you've seen in the last five years.
Neal: So I think we got still great potential on both segments.
Neal: We talked about it time to get to the.
Neal: Perhaps 60 service center 40 approaching that.
Neal: With that said.
Neal: Opportunities on both segments to organically grow our cross sell opportunities that help both as well as future M&A.
Could I anticipate engineered solutions growing past, 40% and timed to 45 or 50, a good healthy balance across the business absolutely.
Neal: But that will play out and there will be continued opportunities for for bolt ons on the service center side, but if it.
Neal: Stabilizes out and at a future date at a good healthy 50, 50 with both profitably growing that'll be a good spot for the company.
Neal: Yes.
As helpful. Maybe if I could just squeeze one more in here.
Speaker Change: You talked about.
Speaker Change: Year to date engineered orders being up year over year, it's driven by automation intact.
Speaker Change: Just to clarify are you is the expectation that the revenue growth in those subsectors flipped positive here in the second half.
Speaker Change: And maybe just some color on where the automation business is run rating from a revenue perspective today.
Speaker Change: Yes, so I'll start.
Speaker Change: Work backwards, I'd say run rate of the automation businesses, probably in that $2 40 type range or.
Speaker Change: Around that on the side.
Speaker Change: We did touch on order rates encouraging by automation.
Speaker Change: In the high single digit Tac.
Speaker Change: Double digit in that front, but collectively good activity in broadly in engineered solutions may be more low single digit with.
Speaker Change: The broader impact that we've had in fluid power and then the off highway mobile segment.
Speaker Change: But as we've talked in the remarks, a little bit of an improvement there that we think could be encouraging.
Speaker Change: As it as it goes across as far as the conversion timing it really depends some of them are very.
Speaker Change: Quickly and conversion other that have a more technical nature of complexity in the build out could be a 120.
Ken Keenan: Perhaps more days into the side in that technical conversion on the site. So it really depends on the application of that conversion or where it fits in with the customer and their overall project, which that can also cause some slotting are timing impacts as well and then Ken as you think about the guidance by segment.
Ken Keenan: The top line perspective, I think there as it relates to the down mid single to low single digits organically in the third quarter, we think the segments could probably trend around that in somewhat similar way this quarter and then as we get into the fourth quarter. There is a path clearly given the order trends that we've seen in the engineered solutions segment.
Ken Keenan: To start to see the segment.
Ken Keenan: ROE a little bit above where we see the service center segment from that standpoint.
Speaker Change: Very helpful. I appreciate the color guys.
Speaker Change: Your next question comes from the line of Chris. Thank you.
Mike: Mike. Please go ahead.
Speaker Change: Hey, good morning, guys. Thanks for taking the questions.
Speaker Change: I guess congrats on the quarter, we're looking at gross margin here.
Speaker Change: The delineation that was very helpful. I guess anything to call out on the freight side that was a tailwind in the quarter. How do we think about maybe freight going into the back half of fiscal 'twenty five here.
Speaker Change: Yes.
Chris: Chris ill start I'd say nothing significant to call out.
Chris: <unk> continued to have good have a good focus and execution on on freight.
Chris: And we will continue that emphasis we know the importance of it so I don't think our material input in the quarter, nor a big change in expectation for the for the back half correct.
Chris: Got it got rates have gone up significantly we do have some nice contractual pricing in the team is very focused on freight recovery.
Chris: Kind of matching that so really not a mover for us either direction as we've seen sort of the ebb and flow of this freight costs.
Chris: Helpful. Thank you so much there.
Chris: And then maybe zoom out to 30000 feet per second lot of talk around changes to the U S. MCA I know, we've been hearing some better investment conversation from.
Chris: Metals customers anything else that you are hearing or trying to keep in mind around trade talks and kind of how customers are positioning themselves here.
Chris: Yes, so if we think about that.
Chris: We have a very good business and operations in Canada in Mexico.
Chris: Large portion of that.
Chris: Is that they are they are highly contained in serving customers and segments and in Mexico, not only the service centers in fluid power. Recent strong addition in automation with co par in that front. So.
Chris: To date, we think thats potentially lower impact to be determined the views on the views on tariffs and what that impacts can be in that front.
Or is it to get improvements on immigration and perhaps drugs and some other policies in that but.
Chris: To date.
Chris: Our view is it will not have a significant impact in U S and in those countries. It can be adjustments as I look back at.
Chris: Trump policies, one point, though.
Chris: Very effective at managing.
Chris: The tariffs and the impacts in the $2 32 in the various 301 list.
Chris: And of that we still have that in our playbook if our win.
Chris: Those tariffs.
Chris: We'll know how to execute.
Chris: Understood. Thanks, so much guys.
Speaker Change: Your next question comes from the line of Sabrina If Jim Smith Bank of America.
Chris: Please go ahead.
Chris: Hey, good morning, guys.
Chris: Good morning.
Speaker Change: You talked about I guess pricing coming in a little under a 100 Bips. This quarter just wanted to ask about the behavior, you're seeing from suppliers on pricing.
Speaker Change: Do you feel you are caught up on price cost has pricing sort of normalized.
Speaker Change: And just any signs of disinflation.
Speaker Change: Maybe color by product line would be helpful as well.
Speaker Change: Yes, so I can start I would say really no signs of this inflation I would say the.
Speaker Change: The amount of increase the frequency and the rate are similar supplier probably organize around a couple of buckets. Some will be now at calendar year end and start and some others will operate more perhaps off their fiscal calendar and there'll be a grouping of suppliers there.
Speaker Change: Think about overall dynamics are there still would be inflationary inputs around labor for many of our suppliers are as inflationary inputs.
Speaker Change: General and administrative expenses medical healthcare into those sides and perhaps.
Speaker Change: Metals inputs can can vary into the front, but what we are seeing is that the rate of increases have more normalized as we look back I think back all the way to the pandemic of being more once per year.
Speaker Change: And the size of the increases are more normalized and of course, that's all dependent on our pre any tariff impact and I think their suppliers are clearly aligned if tariffs developed on some of those items they will come through as increase.
Speaker Change: As to the product prices not any just auxiliary cost and so it would result in inflation, but all of that said right now to your point in the remarks less than a 100 basis points impact if we that would be our current expectation for the back half.
Half of the fiscal year.
Speaker Change: <unk>.
Speaker Change: Aside of any other significant policy change.
Speaker Change: Yes.
Speaker Change: Reiterate call it normalized in terms of the pricing that we do continue to see.
Speaker Change: Really you.
Speaker Change: Might jump to conclusion that the lower LIFO expense was a result of lower price inputs really more of a function. In this case of the reduction in operating inventories. We've continued to achieve operating inventories you sequentially continue to normalize in the quarter down about two 5% sequentially or $18 million. So it took some of the pressure off the.
Speaker Change: The LIFO calc and lowered some of that expense in the quarter, but.
Speaker Change: Here again, let's call it more normalized in that good steady inflation that distributors like because we know how to take that recover that and pass it on.
Speaker Change: Thank you.
Speaker Change: And then we talked about this a little but can you give us color on why gross margins moderate Q over Q I guess Theres 10 to 20 bps from the supplier rebates that I think you said it doesn't repeat.
Speaker Change: But theres ever banning 40, 50 that sort of a sequential moderation in just like wondering if it's mix.
Speaker Change: Sourcing is a price cost how should I think about that moderation.
Speaker Change: It would be a combination of mix and then yeah. We did say we do assume.
Speaker Change: Slightly step up from what we saw in the most recent quarter in terms of LIFO just deal not expected to reduce inventory levels further to that order of magnitude.
Speaker Change: So we'd see LIFO expense expense step back up we've got in you know kind of around another million or so each quarter.
Speaker Change: That's where the biggest drivers and to seeing some of that mix impact our normalized would be the other factor as I look at the equation and the expectation for some of that normalized in terms of the gross margin performance.
Speaker Change: Thank you.
Speaker Change: Your next question comes from the line of Brett Linzey. Mr. Mizuno. Please go ahead.
Brett Linzey: Hey, good morning, Thanks for the questions.
Brett Linzey: Good morning, first one just on the tariff situation. So obviously, it's still a bit unclear on where those might land, but you did note additional policy transparency would certainly be good for demand.
Speaker Change: Just curious what you're hearing from customers in terms of.
Potential pre buy activity ahead of any tariff related pricing and how that might work in the channels.
Bret: Yes, so let's say Bret.
For us given the supply base in that.
Bret: Many of the products can either be <unk>.
Bret: Domestically or North America produced in that area right where low.
Bret: Direct import some of our suppliers may have componentry to adjust in the time I do not see heightened pre buy activity on products. I think most are taking the stance if or when they occur there'll be some notice period to do that perhaps there'll be some existing inventory in that.
Channel and end customers are prepared to take.
Bret: Take it forward to the marketplace as well and so if there are tariffs right. It can have an inflationary impact on that will need to pass all the way through the businesses all the way through the channels into the to the end users the end consumers in that and so I do not see.
A big move to get in front, because there is not really the understanding of the clarity of what went on last time does that repeat or is it going to be different.
Speaker Change: I'd add to that we can think about 50% of our service center business being break fix and you're not really being able to anticipate what they do need that shneur to damage dynamic that.
Bret: Yes.
Bret: We didn't see as much stocking destocking in this business as a result.
Bret: It makes sense and then just just a follow up on M&A. So you noted a number of bolt on in mid sized deals in the pipeline, maybe just talk about the near term action ability of the pipeline for Hydra Dyne size.
Bret: And then if there's any constraints on.
Bret: Management integration resources or anything to do a couple more of these chunkier mid size deals and maybe what's behind that thanks a lot.
Bret: So I'd say that the business the teams a clearly we have the operating capacity and the capability to do these across.
Bret: Our businesses, whether it would be fluid power flow control and automation as you can imagine the teams start to turn in the operating teams slightly different in those as well as the service centers.
Bret: I'd said.
Bret: Perfectly control the timing on these as well.
Bret: We did touch on Knight.
Bret: Business the expectations the requirements of customers in to that side.
Bret: I think it will cause more businesses to look and consider and so we just plan on like we are really in all periods stay active to our priorities.
Bret: With those companies with those prospects and what those targets.
Bret: Okay, Great best of luck. Thank.
Bret: Thank you.
Bret: Your question comes from the line of Patrick.
Bret: Please go ahead.
Speaker Change: Hey, guys wondering if you could give us some background on the history, you've had with Hydra dyne, leading up to the deal.
Speaker Change: What attracted you to it any incremental learnings and cross selling potential or the technical capabilities. You listed that you may have had in your first month of ownership as you get a better look under the Hood.
Speaker Change: Yes, so Patrick I'd say one.
Speaker Change: Very good business that we've known for an extended period of time from a geographic standpoint. It was not an area that we had from our fluid power company standpoint, really the reach and the participation. So helps us very much there I would say very similar.
A value added solutions approach into that both in industrial end market applications as well as mobile on and off highway in the front a lot of good service and repair capabilities. So we think given our service center participation across businesses that can.
Speaker Change: Fulfill some of the service and repair needs of those customers effectively in those in those served geographies. So it's early but a very good team very good approach in doing it.
Speaker Change: We'll be smart about the business operation and the integration and how we go forward. We think we have good line of sight to margins that combined with the businesses around scale and cost and on the margin side as well as it will open up more synergy opportunities on the selling side.
Speaker Change: For us over that time period, so again, a very good strategic fit and the geography, a lot of capabilities fitting our engineered solutions build out priority, especially around the fluid power side.
Speaker Change: Okay. Thanks for that.
Speaker Change: You guys mentioned ample capacity for more M&A in <unk>.
Speaker Change: <unk> asked about the size, but I'm curious what the pipeline looks like now regarding strategic focus areas you guys prioritizing additional targets in fluid power or would you view other product areas as more likely one excessive.
Speaker Change: So we would continue to have good prospects and targets in fluid power as well as flow control and automation, so little more select opportunities on build out on the on the service Center side.
Speaker Change: The effective leverage at five times now post acquisition. So we still have a ready capacity and capability to continue to be acquisitive. In this I mean, we've said the business can clearly operate with.
Speaker Change: Two turns two times leverage.
Speaker Change: In an environment and so obviously to talk about two you got to get to one first in that front. So there's very good opportunities for us in that business has strong capacity and it will be part of our continued build out as we get to the next level targets of the $5 billion in revenue.
Speaker Change: And 13% EBITDA margins, we will continue to grow organically as well as right acquisitions.
Speaker Change: Okay. Thanks, I'll pass it on.
Speaker Change: Yeah.
Neil Schrimsher: At this time Im showing we have no further questions I will now turn the call over to Mr. Schrimsher for any closing remarks.
Neil Schrimsher: Alright, simply I want to thank everyone for joining us today, and we look forward to talking with many of you throughout the quarter. Thank you.
Neil Schrimsher: Thank you ladies and gentlemen. This concludes today's conference. Thank you for participating you may now disconnect.
Neil Schrimsher: Yeah.
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