Applied Industrial Technologies, Inc.AITNYSE
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Operator: Welcome to the Fiscal 2026 Second Quarter Earnings Call for Applied Industrial Technologies. My name is Mark, and I will be your operator for today's call. At this time, all participants are in listen-only mode. If you wish to ask a question at that time, please press star followed by the number one on 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 0. And please note that this conference is being recorded. I will now turn the call over to Ryan Cieslak, Director of Investor Relations and Treasury. Ryan, you may begin.
Ryan Cieslak: Okay. Thanks, Mark, and good morning to everyone. This morning, we issued our earnings release and supplemental investor deck detailing our second quarter results. Both of these documents are available in the Investor Relations section of applied.com. Before we begin, just a reminder, we'll discuss our business outlook and make forward-looking statements. All forward-looking statements are based on current expectations, subject to certain risks, and uncertainties, including those that are detailed in our SEC filings. 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's President and Chief Executive Officer, and David Wells, our Chief Financial Officer. With that, I'll turn it over to Neil.
Neil Schrimsher: Thanks, Ryan, and good morning, everyone. We appreciate you joining us. I'll begin today with perspective and highlights on our results, including an update on industry conditions and the expectations going forward. David will follow with more financial detail on the quarter's performance and provide additional color on our updated outlook. I'll then close with some final thoughts. Overall, we continue to effectively manage through a mixed yet evolving end-market backdrop during the second quarter. Sales and EBITDA margins were in line with guidance despite higher than expected LIFO expense and seasonally weak sales activity in December. Our team responded well with strong underlying margin performance and cost control while continuing to expand backlogs and business funnels supporting a stronger sales trajectory into calendar 2026. We also remain active with capital deployment across many fronts, supported by our free cash generation and balance sheet capacity. As it relates to sales trends in the quarter, reported year-over-year organic growth of 2.2% was modestly below last quarter of 3%. Underlying sales growth showed signs of strengthening as the quarter progressed, with November sales up by nearly mid-single-digit percent organically over the prior year following a low single-digit percent increase in October. However, growth moderated in December with average daily sales rates notably below normal seasonal patterns. While monthly sales trends have been choppy for most of the year, we do not view December's weakness as indicative of the underlying sales trend developing across the business. Of note, December is always a noisy month, given seasonal factors that can drive variability in how customers operate plants and phase shipments. This dynamic was further influenced this year by the midweek timing of the holidays. In addition, we're encouraged by early fiscal third-quarter trends with organic sales month-to-date in January trending up by mid-single-digit percent year-over-year. Booking rates are also continued to show positive momentum across both segments. In particular, orders in our engineered solutions segment increased over 10% year-over-year in the second quarter. This is the strongest quarterly order growth rate in the engineered solutions segment in over four years, with a two-year stack trend continuing to improve sequentially. These positive trends are more in line with various underlying demand signals that have developed over the last several quarters, including improved customer sentiment and ongoing growth across our business funnels. We're also seeing slightly more positive trends across several of our primary end markets. Year-over-year trends across our top 30 end markets were relatively unchanged sequentially with 15 generating positive sales growth compared to 16 last quarter. So this is up from 11 in the prior year second quarter. In addition, when looking at our top 10 verticals, we saw six positive year-over-year, compared to five last quarter and three in the 2025. Growth was strongest in metals, aggregates, utilities and energy, mining, machinery, transportation, and construction during the quarter. This was offset by declines primarily in lumber and wood, chemicals, oil and gas, rubber and plastics, and refining. From an operational and profitability standpoint, we delivered solid performance that helped balance softer sales activity in December, and greater than expected LIFO expense, as well as a difficult prior year margin comparison as we had previously highlighted. Of note, LIFO expense came in at roughly $7 million. This was above the $4 million to $5 million range we had assumed in guidance and compares to the less than $1 million in the prior year second quarter. As in prior periods of increasing LIFO expense, our teams responded with a focus on internal initiatives, effective management of product inflation, and strong channel execution. David will provide more details shortly, but when excluding the impact of LIFO, gross margins were up both year-over-year and sequentially and EBITDA margins held firm over the prior year against a difficult prior year comparison. This performance reinforces the durability of our operating model and various self-help opportunities across the business. We also continue to execute thoughtfully against our capital deployment priorities. Of note, this morning, announced an 11% increase in our quarterly dividend following a 24% increase last year. The increase is consistent with our expectation of ongoing dividend growth as we align annual increases with normalized earnings growth and our favorable cash generation profile. We also remain active with share buybacks deploying over $140 million on repurchases during the 2026. These actions reflect confidence in our cash flow generation, as well as the value we see across Applied from our strategy, and long-term earnings potential. Further, we continue to evaluate various M&A opportunities across both our segments that could drive a more active pace of acquisitions over the next twelve to eighteen months. Our acquisition priorities remain unchanged with an ongoing focus on expanding our technical engineered solutions position across automation, fluid power, and flow control. We also remain opportunistic with M&A opportunities across our service center network aimed at optimizing our local market coverage and service capabilities. Today's announced acquisition of Thompson Industrial Supply is a great example of this. With expected annual sales of $20 million, Thompson is a nice service center bolt-on acquisition that will enhance our footprint in Southern California. They bring strong technical knowledge, and align supplier relationships as well as in-house belting and fabrication capabilities that strengthen our value-added services and competitive position in the region. We're excited to welcome Thompson to the Applied team and look forward to their capabilities. As it relates to what we see ahead, I remain constructive on our growth potential entering the 2026 and beyond. While end markets remain mixed and choppy, several growth catalysts are becoming more evident. First, our service center segment is well-positioned to support our customers' heightened technical MRO needs as they catch up on required maintenance across an aged installed equipment base. We believe there's a clear underlying trend developing around this theme. Of note, our US service center sales were up over 4% year-over-year the second quarter inclusive of seasonally weak December activity. We saw growth across both strategic national accounts as well as our local accounts. Local account sales growth strengthened as the quarter progressed which is an encouraging signal for broader industrial activity. We also continue to see stronger activity across several of our heavy U.S. industrial verticals that are break-fix intensive. This includes primary metals and aggregate markets where related service center sales were up by a double-digit percent year-over-year in the quarter. Segment booking rates were positive in the quarter while month-to-date in January segment organic sales are trending up by a mid-single-digit percent year-over-year. Our scale local and consistent service capabilities and technical knowledge of motion control products and solutions are driving greater growth opportunities in both legacy and emerging end markets. We also continue to benefit from sales process initiatives ongoing pricing actions as well as increased traction from our cross-selling efforts. During November, our service center leadership teams gathered in Cleveland to collaborate on our strategic growth initiatives cross-selling opportunities, and operational requirements moving forward. There remains significant excitement and energy surrounding our core business today, and our teams are making notable progress deploying a number of strategic actions designed to further catalyze our growth long-term. Within our 2026, we're starting to see this play out. With segment organic sales trending up by a high single-digit percent year-over-year month-to-date in January. In addition, we expect increased customer activity across our technology vertical which represents about 15% of our engineered solutions segment. Of note, we continue to receive positive demand signals from our semiconductor customer base. This aligns with broader market indications suggesting a multiyear upcycle is emerging for semi wafer fab equipment. As a reminder, semiconductor space drives the bulk of our technology vertical participation where we provide various fluid conveyance, pneumatic, and automation solutions to wafer fab equipment manufacturers and other providers along the value chain. Many of our solutions are directly specified into wafer fab equipment across both new and established equipment platforms. I would also highlight recent investments we've made in engineering systems and production capacity that should provide support to fully leverage these demand tailwinds moving forward. Combined with new business tied to broader data center build-out, we believe our technology vertical could provide a nice tailwind to our organic growth in coming quarters. Our automation operations are also in solid position to drive stronger growth moving forward. Automation orders were up 20% year-over-year in the second quarter. We expect various secular tailwinds to continue to positively influence demand for our advanced automation solutions, including structural labor constraints, heightened focus on safety and quality, and North American reshoring activity. These dynamics are accelerating the adoption of collaborative and mobile robots, machine vision, and IoT solutions as well as require strong application and engineering support that aligns well with our market approach and value proposition. In addition, our flow control team is focused on capturing growth developing within life science, pharmaceutical, and power generation markets across the U.S. With established product portfolios and leading technical capabilities around calibration services, instrumentation, steam and process heating, and filtration we are favorably positioned to win in these markets. Year-to-date, flow control sales have been modestly lower year-over-year, partially reflecting muted activity across the chemicals end market as well as a slow pace to project shipment phasing in prior year comparisons. However, flow control orders were up by a high single-digit percent year-over-year in the second quarter. We expect more productive backlog conversion into the 2026 based on customer indications and firming end market trends as well as broadening maintenance and capital spending on process flow infrastructure across the U.S., in support of energy security, and power generation capacity. Lastly, we're encouraged by improving trends across our industrial and mobile OEM fluid power operations where organic sales were positive year-over-year for the first time in two years during the second quarter while orders were up by double-digit percent over the prior year. This positive development is notable considering the drag this area of our business has had on our growth the past several years. As a reminder, our Fluid Power customer base includes thousands of small and midsized specialty OEMs across a diversified industry base. Our leading innovative engineering capabilities access to premier supplier technologies, and customer reach are driving new business opportunities with these OEMs as they begin to integrate advanced power and control features into their next-generation equipment. Structurally higher, we believe demand for these features will be as OEMs begin to reaccelerate production giving an increased focus on power consumption machine performance, and automation. Combined with our enhanced footprint and capabilities following our Hydrodyne acquisition last year, our Fluid Power operations are in a strong position moving forward. As it relates to Hydrodyne, we marked the acquisition's one-year anniversary at the December. I want to take a moment to thank our team's combined efforts over the past year in making this acquisition a great early success. We've achieved notable growth operational momentum from this transaction, that stands to further augment our earnings potential as underlying end market demand begins to build. Of note, Hydrodyne generated over $30 million of EBITDA in the first twelve months of ownership, with contribution building year-to-date in fiscal 2026 as we continue to align teams, and realize synergies. During the second quarter, Hydrodyne's EBITDA margins exceeded 13% and were modestly accretive to our consolidated EBITDA margin performance. We've made tremendous progress in leveraging complementary solutions. Harmonizing technical capabilities and systems, and driving operational efficiencies across the combined operating platforms. We're connecting Hydrodyne with new growth opportunities by cross-selling their value-added fluid power repair solutions across our legacy US Southeastern customer base. We're also enhancing their capabilities. Serving the rapid pace of innovation, development, across Fluid Power mobile systems, as well as providing fluid conveyance solutions tied to data center thermal management needs. Moving forward, we expect Hydrodyne's contribution to be increasingly accretive to our underlying growth and margin performance as this positive momentum feathers into our organic results. At this time, I'll turn it over to David Wells for additional detail on our results and outlook.
David Wells: Thanks, Neil. Just as a reminder before I begin, as in prior quarters, we have posted a quarterly supplemental investor presentation to our investor site for additional reference as we recap our most recent quarter performance. Turning now to our financial performance in the quarter. Consolidated sales increased 8.4% over the prior year quarter. Acquisitions contributed six points of growth while the impact from foreign currency translation was a positive 20 basis point impact. The number of selling days in the quarter was consistent year-over-year. Many of these factors, sales increased 2.2% on an organic basis. It relates to pricing, estimate the contribution of product pricing on year-over-year sales growth approximately 250 basis points for the quarter. This is up from approximately 200 basis points in the first quarter and primarily reflects the effective pass-through of incrementals now supplier price increases in recent periods. Through the consolidated gross margin performance, as highlighted on page seven of the deck. Gross margin of 30.4% was down 19 basis points compared to the prior year level of 30.6%. During the quarter, we recognized LIFO expense of $6.9 million which was $2 million to $3 million above our expectations and up meaningfully from prior year second quarter LIFO expense of $700,000. On a net basis, this resulted in an unfavorable 54 basis point year-over-year impact on gross margins during the quarter. While the LIFO expense increased partially reflects broader cost inflation, and supplier price increases, we also prudently increased our level of inventory investment in the quarter based on our outlook and firming demand developing across the business. As a reminder, our use of LIFO accounting accelerates the recognition of price inflation on our results, which during periods of increasing inflation and inventory expansion reduces our tax burden and drives cash savings. Importantly, from a reported gross margin standpoint, the impact is more about timing of when we recognize product inflation and is not a change in the underlying economics of the business. As inflation levels out, and eventually normalizes, we would expect this impact to unwind accordingly as we saw in prior periods of greater inflation, and LIFO expense. That said, as Neil mentioned earlier, our team responded well to these inflationary headwinds through various countermeasures, including effectively managing supplier price increases channel execution, and margin initiatives. We also benefited from positive mix tighter Hydraland acquisition, as well as stronger growth across local accounts. Excluding record expense, gross margins of 31% up 34 basis points year-over-year against the strong prior year comparison. As it relates to our operating cost, selling, distribution, and administrative expenses increased 11.1% compared to prior year levels. On an organic constant currency basis, SD and A expense was up 1.4% year-over-year compared to a 2.2% increase in organic sales. During the quarter, ongoing inflationary headwinds and growth investments were balanced by solid cost control, and internal productivity initiatives. Overall, modest organic sales growth coupled with M&A contribution, favorable underlying gross margin performance, and cost control, resulted in reported EBITDA increasing 3.9% year-over-year inclusive of a 460 basis point year-over-year LIFO expense headwind. This resulted in EBITDA margins of 12.1% which was down 52 basis points from the prior year level up 12.6% inclusive of a 54 basis point year-over-year headwind from higher LIFO expense. The 12.1% reported EBITDA margin was within our second quarter guidance range of 12 to 12.3% despite greater than expected LIFO expense which was approximately 15 to 25 basis points unfavorable to our expectations. Reported earnings per share of $2.51 was up 4.6% from prior year EPS of $2.39. On a year-over-year basis, EPS benefit from a lower tax rate and reduced share count. Partially offset by increased interest, and other expense. On a net basis. Turning now to sales performance by segment, as highlighted on slides eight and nine of the presentation, sales in our service center segment increased 2.9% year-over-year on an organic basis when excluding a 30 basis point positive impact from foreign currency translation. The organic sales increase in the quarter was primarily driven by price contribution as volumes were relatively unchanged year-over-year reflecting seasonally slow sales activity December and lower international shipments. Across our US operations, sales increased more than 4% over the prior year, reflecting growth across both our national, and local account base. US service center sales benefited from firming demand across several core end markets as well as Salesforce investments and cross-selling actions that continue to read through within a mixed demand backdrop. Segment trends also continue to be supported by favorable growth across Fluid Power MRO sales. Segment EBITDA increased 2.2% over the prior year inclusive of a 340 basis point year-over-year LIFO headwind. While segment EBITDA margin of 13.3% declined 14 basis points inclusive of a 45 basis point year-over-year LIFO headwind. Excluding the impact of LIFO, the year-over-year improvement in segment EBITDA and EBITDA margin primarily reflects underlying operating leverage on stronger U.S. Sales, channel execution, and cost control. Within our engineered solutions segment, sales increased 19.1% over the prior year quarter with acquisitions contributing 18.6 points of growth. On organic basis, segment sales increased point 5% year-over-year. The increase was primarily driven by price contribution as well as modest volume growth across Fluid Power Mobile and industrial OEM customers partially offset by lower flow control sales. Sales across our automation business increased 3% on organic basis over the prior year. Representing the third great quarter of positive organic growth. Segment even increased 4.4% year-over-year over the prior year, inclusive of a 400 basis point year-over-year LIFO headwind primarily reflecting contribution from our Hydrodyne acquisition partially offset by lower organic EBITDA and muted sales trends in the quarter. Segment EBITDA margin of 14.3% was down roughly 200 basis points from prior year levels, inclusive of a 55 basis point year-over-year LIFO headwind. Excluding the LIFO impact, segment EBITDA margin declined was primarily driven by lower flow control sales, and unfavorable M&A mix as well as a difficult prior year comparison from record performance across our engineering solutions segment during the 2025 tied to favorable mix, as we had previously highlighted. Moving to our cash flow performance, cash generated from operating activities during the second quarter was $99.7 million while free cash flow totaled $93.4 million representing conversion of 98% relative to net income. Compared to the prior year, free cash was up slightly as greater working capital investment was balanced by ongoing progress within total initiatives. From a balance sheet perspective, we ended December with approximately $406 million of cash on hand and net leverage at point three times EBITDA. Our balance sheet is in a solid position support our capital deployment initiatives moving forward including accretive M&A, dividend growth, and opportunistic share buybacks. During the second quarter, we repurchased over 346,000 shares for $90 million bringing the year-to-date total to over 550,000 shares for $143 million. Turning now to our outlook. As indicated in today's press release, and detailed on Page 12 of our presentation, we are adjusting our full year fiscal 2026 EPS guidance following our first performance and updated outlook. We now project EPS within the range of $10.45 to $10.75 based on sales growth above 5.5 to up 7% and EBITDA margins of 12.2 to 12.4%. Previously, our guidance assumed EPS of $10.10 to $10.85 on sales growth of four to 7% and EBITDA margins of 12.2 to 12.5%. Our updated guidance now assumes LIFO expense of 24 to $26 million compared to prior guidance of $14 million to $18 million. In addition, we announced two hundred ten two hundred thirty basis points of year-over-year sales contribution from pricing up from prior guidance of 150 to 200 basis points. From an organic sales perspective, we are now assuming a 2.5% to 4% increase for the full year compared to our prior assumption of up one to 4%. This takes into account first half organic sales performance as well as early third quarter organic sales trends which as noted earlier, are trending up by mid-single-digit percent over the prior year in January. I would note prior year sales comparisons are slightly more difficult in February, March, compared to January. In addition, we continue to assume ongoing macro and policy uncertainty will influence customer spending behavior and shipment activity near term. We believe this could result in ongoing variability in monthly sales growth, any greater clarity on the macro backdrop, or incremental support lower interest rates, and fiscal policy. At the midpoint of our updated guidance, we assume organic sales increased by approximately 4% year-over-year in the 2026. With third quarter organic sales expected to increase by a low single-digit to mid-single-digit percent over the prior year. We also project inorganic M&A with sales and modest foreign currency tailwinds to contribute approximately 50 basis points of year-over-year growth in the second half of the year. The M&A contribution includes today's announced acquisition of Thompson Industrial Supply, as well as our May 2025 acquisition of Iris Factory Automation. Our guidance does not include contribution from future M&A or additional share repurchases in the second half of the year. From a margin perspective, we expect third quarter gross margins to decline sequentially to a low 30% range. This assumes a more normalized level of gross margin execution, relative to our strong underlying second quarter performance as well as slightly higher LIFO expense sequentially. Combined with modestly stronger operating leverage, and greater sales growth, as well as ongoing inflationary headwinds, anticipate growth investments and our annual merit increase effective January 1 we expect third quarter EBITDA margins to be within the range of 12.2 to 12.4%. Lastly, some housekeeping items. Our updated guidance does assume a slightly lower share count following second quarter share repurchases as well as a tax rate assumption of approximately 23% for the full year compared to our prior range of 23 to 24%. These slight EPS tailwinds are partially offset by an increase in net interest expense into the second half of our fiscal year following the net impact of our interest rate swap maturing at the January. With that, will now turn the call back over to Neil for some final comments.
Neil Schrimsher: So to wrap up, our team executed well through the 2026. We're delivering on our financial commitments and making strong progress on our strategic initiatives. As we enter the second half of the year, we do so from a position of strength, with signs of emerging growth catalyst developing across several areas of our business. Early fiscal third-quarter sales trends are encouraging and provide a nice jump-off point. Though we remain prudent with our guidance, as we look for greater consistency in sales trajectories as we move into more meaningful seasonal months while balancing the near-term timing impact of LIFO accounting. Importantly, sentiment from both our customers and our sales teams continue to be directionally positive. And our business funnels are expanding. Technical MRO requirements are heightened entering what should be a more productive operating environment. As we move through calendar 2026 when considering potential support from lower interest rates, a more favorable tax policy, and deregulation. In addition, our industry position places us in a unique and comprehensive position. To capture growth as capital spending broadens across many of our customer verticals. This includes pro-business policies supporting greater production and investments in core legacy verticals such as metals, mining, and machinery, as well as clear secular structural tailwinds supporting multiyear cycles across semiconductor, power generation, and energy end markets. We also expect to play a greater role across the data center space. Given our expertise and product offering in areas of thermal management, robotics, and fluid conveyance. With our deep technical industrial facility domain expertise, access to critical higher engineered industrial products, and balance sheet capacity we're well-positioned to capitalize on these growth opportunities. We also remain positive on our margin expansion potential as these tailwinds drive stronger top-line growth. We continue to see a clear path to achieve our mid to high teen incremental EBITDA margin target at mid-single-digit organic sales growth. This is supported by inherent operating leverage across our business model combined with mixed tailwinds tied to the ongoing expansion of engineered solutions segment and local account growth within our service center segment. Additional support should emerge as we continue to scale our automation platform following various growth investments in recent years. Overall, we look forward to fully capturing this growth potential through the remainder of fiscal 2026. And years to come, And as always, we thank you for your continued support. With that, we'll open up the lines for your questions.
Operator: 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 star followed by the number one on your telephone keypad. If you would like to withdraw your question from the queue, press star 1 again. As a reminder, if at any time you need to reach an operator, please press star 0. And our first question comes from the line of Christopher Glynn with Oppenheimer. Christopher, please go ahead.
Christopher Glynn: Thanks. Good morning, guys. Just wanted to dive into the engineered solutions orders in the quarter. Up over 10%. I assume that was an organic basis. Just want to clarify as well as you know, what degree of positive book to bill that might denote.
Neil Schrimsher: Yes. So that would be on an organic basis. And, you know, as we think about it, it broke out across the segments with automation as we talked about plus 20 fluid power, low teens, 13, and flow control, high single digit. 8%. Into this side. Book to bill was above one during the quarter, and, you know, now has been three of the last four quarters in that side.
Christopher Glynn: Great. Thanks. And, on the fluid power comparisons, you know, you've you've got the destock comparison. So curious if you could sort of dissect the kind of end demand trend versus you know, better kinda kinda sell through there in alignment?
Neil Schrimsher: Yeah. I think, really, the stock, destock given how that's elongated out, has really been worked through. So the performance that we saw in the mobile off highway part Fluid Power is encouraging. As well as the work that's going on with those mid-tier and smaller OEMs. We're also encouraged on the fluid power side of the amount of industrial activity I think that's similar to service centers on technical MRO requirements. That industrial customers are having to look at the aging of that installed base of it producing equipment and is giving us opportunities. And then, right, as we talked about in in the comments, we think the technology side of our fluid power is really set up well as we think about semi wafer fab equipment and also that growing participation in data center.
Christopher Glynn: Okay. And last one for me. Think in the January sales up mid-single digits, you mentioned Engineered Solutions was up high single digits. And you mentioned February and March, bit more difficult comps. So do just wanna make sure I have all that right. And, also, just on the thought that maybe January had a benefit from neutralizing the December pause?
Neil Schrimsher: Yeah. You you know, you think about it. There could be, right, from the December right, which we talked about or looked at from that side. From normal seasonal patterns there, right, running lower. So there could be But I think the height of some of that growth and increase we take as, we take as favorable that it it's more than just a little bit of, timing.
David Wells: Yeah. And, Chris, the the other know, thoughts on you know, the trends in engineered solutions being up high single digits in January is is is correct. And that maybe another part of your question that maybe we didn't answer, but let us know.
Christopher Glynn: Appreciate that. I think we got it.
Operator: And our next question comes from the line of David Manthey with Baird. David, please go ahead.
David Manthey: Good morning, guys. My first question is on SD and A. Organic constant currency SD and A growth was less than organic revenue growth again this quarter, which looks really good. I'm wondering as we lap Hydrodyne here, should overall fDNA come in closer to overall revenue growth next quarter. And then as we look forward, is there anything unusual in the '25 on SD and A? It looked like the sequential from the third quarter was up a greater than normal dollar amount there. And I'm just wondering if there was something unusual we should know about.
David Wells: Yeah. The you know, we'll start with the sequential increase in '25, you know, third to fourth quarter, David. The couple things came into play there. There was an increase in benefit cost. You know, there's there's variability obviously in our our self-insured medical expense. But also about a million 5, you know, that that swapped around with, you know, Rabbi Trust or deferred comp that, you know, gets offset in other income. So that did skew SDNA just a little bit. As you think about, you know, kind of now as we move into third quarter, we do have the focal mirror point coming in, you know, and and lapping hydrogen to your point. So we would still work to, you know, show an increase less than the rate of, you know, the sales increase. But I would expect it to, you know, given that they said the the late last quarter was about half the rate of the sales increase in terms of the SG and A increase. We'd expect that gap to close just a little bit just given those factors coming into play.
Neil Schrimsher: Hey, Dave. Just also on the prior year fourth quarter for fiscal twenty five, it was impacted if you recall by some AR provisioning that we had in the quarter. I think that was over over 2,000,000 or so year over year So that's part of the the year over year or the the the uptick in the fourth quarter trend you see there.
David Manthey: Yes. Thanks. And based on your guidance, it would appear that the fourth quarter of this year is more normal, kind of, I don't know, 10,000,000 quarter to quarter increase which which looks more normal. Okay. Thank you for that. And then on capital allocation, I'm not sure if it's in the deck here, but did you mention the shares left under your repurchase authorization? And I guess in the context of I think you have about a billion and a half dollars of borrowing capacity, including some accordion features, Does does share repurchase take priority over debt paydown in the near term given the your ample access to capital and and kind of the relative share price?
David Wells: You know, we we'll still be opportunistic when you look at the share repurchase. You know, we are contemplating some debt pay down you know, not the entirety of it, but given the you know, in January, the swap will roll off. So we'll work to neutralize a little bit of that, you know, added interest expense that would come with that. So you know, here again, take it in rank order priority. It's gonna be the organic growth investment. Followed by M&A, you know, followed by the dividend increase, you know, kind of 11%. You know, this quarter coming off to 24% last year. Increase. So continuing to move that in line with our, you know, increase in in earnings in the business. As well as then, you know, the opportunistic, you know, share repurchase. So we'll balance all those to your point. Plenty of, you know, you know, dry powder given the the billion 5 capacity and leverage of point three times. To really work all those angles.
Neil Schrimsher: Then, Dave, we have, I think, about about 700,000 shares left on the current authorization that we had, which we had you know, up updated, I think, last last August. Time frame. And so we'll we'll continue to look at that as we as we continue to buy back shares and and update it update that accordingly as as we progress through that the current program. And then lastly, Dave, I'd just say on the M and A side, as we touched in the remarks, we feel good about the pipeline, the work the activity, touch on the potential for greater activity as we look out over the twelve to eighteen months. Really around our stated priorities of continuing to build out engineered solutions with some more select opportunities for differentiation around the service center side. So we're low CapEx requirements. We'll continue to make those. They generate strong returns, but the M and A opportunity for us, we think, remains a a good priority for us as we operate through the rest of this fiscal year and look out beyond.
David Manthey: Thanks, guys. Appreciate it.
Operator: And your next question comes from the line of Brett Linzey with Mizuho. Brett? Please go ahead.
Brett Linzey: Hey. Good morning, Hey. Want to want to come back to the automation orders up up 20%. I I guess, how much of that do you think is related to pent up needs that were put on hold that are that are just starting to release verse new projects, capital formation that's being driven by incremental on your customers might be focused on?
Neil Schrimsher: Yeah. Brett, I I don't know if I got a perfect answer to that. Obviously, we've had growing funnel equity within our automation group. And also with our service center teams walking in here today A couple of releases are getting highlighted on projects that that were in flight. But there's also a a great amount of work if we consider what is coming to The US from a reshoring standpoint, we have more customers reaching out How can they drive their efficiencies and productivity on where collaborative or mobile robots will help If they're looking at quality control or quality and inspection where vision systems can help and even just connectivity products, right, to monitor KPI and performance where perhaps people did that manually in the past. At equipment to to way to have visual panels and boards on that. So I think both are gonna be continued drivers for us. As we look out over calendar 2026. Things that we worked on on ideas and solutions but also increase new opportunities as we think about the backdrop And then things like, tax policy and outlooks are probably gonna help further accelerate some of that look from customers.
Brett Linzey: Yeah. That that's great. And then just my follow ups on price. So the contribution was 250 bps in in the quarter. Curious what you're seeing here in calendar '20 from a vendor price standpoint. And how should we think about pricing contributions for the balance of this fiscal year in Q3 and Q4 as you got some wraparound and and maybe some incremental coming through?
Neil Schrimsher: Yeah. We think about activity from, our suppliers obviously, those that are more calendar year based and increases, we we see those in in place. We did see some that are later year perhaps midyear around their fiscal year events. Accelerate. So we think to a large part, there's more of that that is in now We would think the third quarter has the potential to be similar to the second quarter, so two fifty basis points in that And then with the fourth quarter, given perhaps that aging or overlapping of some prior increases, maybe that moderates to a couple 100 basis points impact in the fourth quarter. And so that that's what's encapsulated in our outlook. If we look beyond that, right, hey. We will see, there could be a path to higher upside in that as we think about the direction of of LIFO that we'll have into that side of it as well.
Brett Linzey: Alright. Got it. Thanks. Best of luck.
Operator: And our next question comes from the line of Sabrina Abrams with Bank of America. Sabrina, please go ahead.
Sabrina Abrams: Hey. Good morning, everyone.
Neil Schrimsher: Good morning.
Sabrina Abrams: Question. So, I know you guys did raise the pricing guide this quarter. And pricing, I guess, accelerated nicely quarter over quarter. But, you know, you did raise LIFO expense, and I would just like to ask why not assume price is going to accelerate into the second half because I would think price continues to accelerate from here. But just any color around that assumption.
Neil Schrimsher: Yeah. So so as we think about touched on just a little bit there. We're seeing the announced increases from our suppliers as we think about for much of '26 Kent, or perhaps likely in place now. And then if we think about the aging or the overlap of of prior increases, that's what we're saying perhaps the price moderates to that couple 100 basis points in the fourth quarter compared to this two fifty level that we have today. Obviously, they will be close to the inputs of looking at any other metals material increases that will be coming through with suppliers and work with them to orderly take them through to the markets. But hey, that that's our view now perhaps the tariff environment is gonna stay moderated at its current level right now as we look out over the rest of the fiscal year.
David Wells: I'd say too I'd add the, you know, obviously, you're seeing in the as you start looking at the comps in the back half of '25, some higher levels of pricing that that does skew year over year just a bit. Versus the first half. And then, you know, thinking about the LIFO doesn't necessarily travel in exact tandem with the dynamics that we see on the pricing despite price increases because that's also influenced by the mix of what we're purchasing. So we did have a heavier concentration this quarter of parts that we had not purchased for two, three years, which attracted a fair amount of you know, LIFO increase as we looked at the you know, the buy versus, you know, kind of the the two or three year ago price that we're carrying at. So, you know, that that is also a factor as you try to, you know, correlate those two.
Sabrina Abrams: And just on guidance, on my math, I think there's an extra versus a prior guide. I think there's an extra 18¢ from LIFO expense going up. Impacted embedded in the new EPS guide, and there's another couple cents of interest expense. And then on the other side, you have the benefit of maybe a lower share count and, like, very, very modest impact from the acquisition you did. And just, like, as I think about these moving pieces and the narrowed guidance, Maybe is the right way to think about it that the core guide has been raised? Because if I sort of back out all this other stuff, I'm getting to, like, core EBIT is higher versus the last versus last quarter, but I just wanna clarify with you guys whether that's the correct way to think about it and any, moving pieces I might be missing.
David Wells: Yeah. I think there's a modest increase there resulting from really the strong margin performance. You you get to strip out that life of 31% you know, gross margin performance against a very difficult comp, you know, like I said. Think about the year over year, you know, still being up. Partially driven by that high rise mix benefit. But nonetheless, you know, very pleased with the team's response to the in place in your environment. So you're seeing some of that read through. Still be cost conscious and, you know, kinda continuing to look at that. So I I you know, I'd say it's a modest increase there in the core. And then know, we think about the guide really tightening the guide at the upper end of the the previous guide.
Sabrina Abrams: And and just to clarify, oh, sorry.
Neil Schrimsher: No. This is Are you guys finished?
Sabrina Abrams: Yeah. No. That's that's fair. So I think, yeah, if you look at the midpoint of the guidance, you know, at, you know, the organic growth we're assuming in the back half of the year, is up slightly from what we were assuming in the prior guidance that we provided. Maybe even a more meaningful amount when we look at it, you know, at at the high end. And so not a huge change, but we are assuming a little bit greater growth, organic growth on sales, in the back half relative to what we were, you know, prior.
Sabrina Abrams: And just one last quick follow-up to that. Is that on the raised pricing assumption? Or is implicit ly did you raise your volume assumption?
Neil Schrimsher: Yeah. It's a it's primarily tied to the the break the raised pricing assumption, but still some volume volume assumptions as well in there as well.
Sabrina Abrams: Thank you. I'll pass it on.
Operator: Our next question comes from the line of Ken Newman with KeyBanc Capital Markets. Ken? Please go ahead.
Ken Newman: Hey. Good morning, guys. Thanks for squeezing me in. Wanted to first just touch on the margin guidance, if we could. You know, I guess there's a headwind due to LIFO here in the back half. I think the math is around, like, 30, 40 basis points. On EBITDA. But know, I would think that the high single digit the low double digit sales growth in engineered and then the automation orders being up 20% would be a decent mix offset. So maybe can you just help us think about, you know, bucketing the various moving pieces in the margin guide and what that assumes for mix versus price cost and LIFO headwinds?
Neil Schrimsher: Yeah. I can, I can start? So just as we think, right, and we talked about, hey. Perhaps we moderate below the 30.4 that we had in the second quarter that, tend to 30 basis points on gross margin on the guide. I think you're right. And potential for LIFO to be a 30 to 40 basis point headwind path to things that, could counteract Right? Right. One will be, hey. What is that true path of of LIFO in in the second half? To your point on on mixed dynamics, engineered solutions, local account growth, and service centers would both be the potential for benefit in that the the further path on on know, m and a performance, you know, Hydrodyne as it comes in. Would have the, perhaps continued improvement. And then, obviously, we'll be focused on our our our price actions and ongoing margin initiatives that we have across that benefited us in the second quarter. But, hey, as as we sit here today, right, we say there is that potential for that to show up, including that higher LIFO expense that we had in the second quarter somewhat to continue on at that $7 million to $8 million impact.
David Wells: Yeah. I think you strip that out Sorry. Yeah. You strip that out, Ken. I'd say, you know, the LIFO expense it it's a good story in terms of the incrementals. We're up over 20%, you know, that was implies in terms of guidance in the back half in terms of incrementals ex LIFO. So you are seeing all those things, you know, Neil indicated and highlighted there in terms of the you know, the mixed benefit, you know, flow control sales coming back the acquisition mix benefit, know, stronger, you know, engineered solution shipments, which help from a mix standpoint as well. So those things play in in addition to the the workaround pricing and and, you know, kind of the channel optimization.
Ken Newman: Okay. That's that's helpful. And then, you know, just for my follow-up, you know, it it was here it was nice to hear you guys reiterating the the mid teen incremental EBITDA margin target on mid single digit growth I think the midpoint of the of this quarter's guide is slightly below that But I I wanted to get your thoughts on, you know, one, do you think you could reach that target exiting this fiscal year? And if so, you know, do you need a specific number or a contribution of volume growth to kinda get there? Well, And maybe also, you know, if we get incremental pricing versus what you're already expecting in the guide today, would you expect that to be neutral to the operating leverage or accretive?
Neil Schrimsher: I can start. As we think about that leverage and then, hey, right, some of our targets that we have for the business, we think about them really from an annualized basis. But to your point, you know, we've demonstrated strong incrementals with with low single digit in volumes. As we move up Right? Those have the opportunities to to improve So as I think as we look out over calendar '26, we see that opportunity for that to play out and develop for us.
David Wells: Yeah. You know? And, again, I would say that, know, at the midpoint of the guidance, you know, we would assume that the fourth quarter gets to call it, a mid teen incremental margin on EBITDA, you know, at, you know, call it, you know, that, the 4% or so type of organic growth. That we have, you know, baked in into the guidance. You know, at this point. And that includes the LIFO increased LIFO year over year. As mentioned earlier, we will have a benefit year over year in the fourth quarter assuming normalized AR provisioning given that prior year, impact that we had. And so we're getting to that, you know, call it, mid teen to high teen range, you know, at slightly below mid single digit organic growth, but feel very good as we move into you know, more stabilized and firm mid single digit organic growth environment that those that that that incremental margin guide is is achievable. Then as it relates to pricing and anything incremental, a team that's doing a great job of of managing pricing, a number of other initiatives that we have on gross margin. Countermeasures to to manage through that. And, we'll see how it all plays out. But, obviously, inflationary environment, but the team's doing a good job executing through it.
Ken Newman: Very helpful. Thanks, guys.
Operator: And our next question comes from the line of Christopher Dankert with Loop Capital Markets. Chris?
Christopher Dankert: Hey. Morning. Thanks for, for fitting me in here. I guess just on third quarter guide, if I'm looking at what you guys have staked out from organic sales growth perspective, that seems to imply kind of a below typical seasonal growth level. I mean, I think, 5% sequentially is kind of what the midpoint implies. Longer term, you're typically up in the high single digit range. I guess, consider the December holiday timing impact, the the ES orders, snake metal pricing, Can you kind of help us square the below seasonal midpoint of that sales guidance for fiscal 3Q?
David Wells: Actually, Chris, if if you look at it, the you know, given the the low to mid single digit assumption for Q3, 4% here again organic for the the the total back half. That would assume for the first quarter in quite a while, been, you know, kind of, you know, last quarter was 200 basis points below the typical seasonality, but that that's really back in line with what we'd say is normal seasonality. As we transition from Q2 to Q3.
Christopher Dankert: Got it. Got it. Well, I guess in the interest of time, I'll I'll leave it there, but but thanks so much.
Operator: And our next question comes from the line again from Christopher Glynn. Oppenheimer. Christopher, please go ahead.
Christopher Glynn: Yeah. Thanks. Just one on the mechanics of LIFO. I you know, definitely don't claim a a deep appreciation of how it all works. But I'm wondering about the lead time dynamics, what they've been like for supplier price negotiations? Are they, you know, faster cycling than normal, or have the signals been too varied? Just wondering if there's perhaps an opportunity to standardize the the preplanning communications with suppliers a little bit more just given your long term, distinguished excellence in data and analytics? Throughout the organization on many dimensions.
Neil Schrimsher: Yeah. I can start. Chris, I think suppliers are being orderly in this and, you know, hey. That's that's our expectations. As they're working on them as they develop. Obviously, you need the data. You need the files to work through on that. To be able to effectively implement. So we're not changing our our expectations or views that that that has to be orderly. And so I think, suppliers are understand that, it's best for them as well. So they're they're working to do that. And so it kinda led, a little bit, I think, most of the annual increases are in, I think those that we're contemplating are more historically kinda mid or their more fiscal year side. Have accelerated. I think most of those are in. So from a price increase standpoint, I won't say that that they're they're finished at metals or something else moves. But then I think most of those are in place right now.
David Wells: Yeah. Christy, I think the other piece of LIFO, the the consider, as it relates to how it moves, quarter to quarter, obviously, is is what we decide to bring in bring in as relates to inventory Right? And so, if that remains, a fluid, you know, sort of dynamic and we feel good that what we're seeing in the back half is demand is starting to firm. That, you know, we're starting to bring more inventory on as we talked about a prudent way. And so that drove some of the think, increase in life or maybe relative to what we expected you know, last October when we talked about LIFO expense guidance. So that's that's probably a piece of it just to keep in mind, that that will continue to fluctuate depending on the demand backdrop.
Neil Schrimsher: Yeah. Put in context, operating invoice for us out of point and a half in terms of one half percent in terms of the yeah, sequential change in the quarter. As you see that, you know, demand firming. And we brought into the inventory to support that.
Operator: Thanks, everybody. At this time, I'm showing we have no further questions. I will now turn the call over to Neil Schrimsher for closing remarks.
Neil Schrimsher: Thank you. I just want to thank everyone for joining us today, and we look forward to talking with you throughout the quarter.
Operator: You, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.