Applied Industrial Technologies, Inc.

Welcome to the Fiscal 2022 Third Quarter Earnings Call for the Applied Industrial Technologies. My name is Anne and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. If you wish to ask a question at that time, please press star 1 on your telephone keypad. Prior to asking a question, lift your handset to ensure the best audio quality. Please note that this conference is being recorded. I will now turn the call over to Ryan Sisnek, Director of Investor Relations and Treasury. Ryan, you may begin.

Thanks, Anne, and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing our third quarter results. Both of these documents are available in the Investor Relations section of apply.com. Just before we begin, 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, including the potential impact from the COVID-19 pandemic, as well as trends and sectors and geographies, the success of our business strategy, and other risk factors. Actual results may differ materially from those expressed in the forward-looking statements. The company undertakes no obligation to update publicly or revise any forward-looking statement. In addition, the conference call will use non-GAAP financial measures, which are subject to the qualifications referenced in those documents. Our speakers today include Neal Scrimcher, Applied's President and Chief Executive Officer, and Dave Wells, our Chief Financial Officer. With that, I'll turn it over to Neal.

Thanks, Ryan, and good morning, everyone. We appreciate you joining us and hope everyone is doing well. I'll begin today with some perspective on our third quarter results, current industry conditions, and our expectations going forward. Dave will follow with more specific detail on the quarter's performance and provide some additional color on our outlook and guidance, which we raised this morning. I'll then close with some final thoughts. Overall, we had a very good quarter, further demonstrating the positive momentum sustaining across our business. We grew EBITDA and EPS 25% and 27% respectively on approximately 17% sales growth. Expanded EBITDA margins above 11% and generated solid cash flow while continuing to invest across our business for future growth. We did this against the backdrop of persistent and notable inflationary and supply chain headwinds that continue across our industry. My thanks to our applied team for delivering another solid quarter and demonstrating ongoing commitment to our strategic goals. So a couple of key points to highlight. First, underlying demand remains broadly positive and strengthened further from first half levels during the third quarter. Trends were strongest across metals, technology, mining, utilities, chemicals, building materials, machinery, and freight transportation markets. We're also seeing incremental demand across natural resource and refinery in markets. In addition to solid underlying market demand, we're capturing incremental growth opportunities from the strength of our industry position and internal initiatives. Combined with greater price contribution, reflective of the broader inflationary environment, Organic daily sales increased 15% compared to prior year levels and on a two-year stack basis. Last quarter, our growth on a two-year stack basis was 6%, so nice acceleration once again in the underlying trend. Similar to the last couple of quarters, our service center network is benefiting from greater break-fix demand and required maintenance activity across our customer base. Recent industry data indicates U.S. manufacturing capacity utilization is at its highest level in 15 years. We believe this is increasing the frequency of maintenance and repair activity and spurring new capital spending and maintenance projects on production infrastructure. These are meaningful trends for our service center network given our core focus on more highly engineered motion control products and solutions across the North American industrial supply chain. In addition, service center customer orders and new business opportunities remain encouraging as we enter the final quarter of our fiscal year. Favorable underlying demand is persisting across fluid power and flow control segment as well. In particular, we're seeing strong order trends sustaining within all three of our core application verticals. including industrial, off-highway mobile, and technology. OE fluid power demand is picking up within later cycle segments, such as heavy equipment, metals, mining, and construction. Our expertise and solutions tied to semiconductor manufacturing, data center cooling, and 5G build-out also remain key contributors. where secular tailwinds continue to increase related backlogs. In addition, orders remain strong for engineered solutions that optimize the productivity, safety, and efficiency of our customers' production infrastructure and off-highway mobile equipment. These solutions, including our design, engineering, and software coding capabilities, are in greater demand as customers focus on reducing power consumption, and CO2 emissions, navigate a tight labor market, and integrate more predictive maintenance into their equipment. We're also positioning our fluid power business for greater growth opportunities around IoT, telematics, and electrification for fluid power systems. Demand for these technology advancements is picking up across our fluid power operations, and over the long term, present a significant additive growth opportunity for Applied, giving our leading engineered solutions capabilities. We're also seeing accelerating demand for later cycle flow control products and solutions. Of note, MRO activity and capital spending on process infrastructure is ramping up in core end markets, such as chemicals, refining, petrochemical, utilities, and metals. In addition, we continue to see strong growth within hygienic and high purity applications where we have strategic growth initiatives. During March, we saw our highest quoting and order activity for flow control products in over three years, with positive momentum continuing into April. Relaxed COVID restrictions, greater customer facility access, and cross-selling opportunities are increasing sales momentum across our higher margin, low control business. This is great to see and we expect additional positive trends going forward. As it relates to our expanding automation platform, we continue to have strong growth in orders and backlog. Related sales during the quarter were up by a double-digit percent over the prior year and over 20% on a two-year stack basis. This business, which includes our four automation acquisitions over the past three years, is now annualizing around $150 million in sales and is positioned to grow significantly in coming years through both M&A and organic expansion initiatives. As highlighted last quarter, we are organically entering new markets across the U.S. As we look further to penetrate this expanding market opportunity. Our engineered solutions focus on next generation robotics, machine vision, and industrial networking combined with our historical competencies around motion control technologies is becoming increasingly recognized across the industry. Going forward, we believe we can leverage our existing service center and operational network to support this growth in coming years. Overall, we believe our differentiated industry position, addressable market, and secular tailwinds are driving stronger and sustainable organic growth across our business. At the same time, we continue to manage through supply chain constraints and inflationary pressures. Indications suggest these pressures will likely persist in coming quarters as supplier price increases and labor bottlenecks have shown little sign of easing. Given our LIFO inventory accounting method, we are recognizing these inflationary pressures in relatively real time, as evident by the nearly $16 million of LIFO expense reported year to date. This compares to roughly $3 million of LIFO expense recognized over the same period last year. Despite this headwind, we have held gross margins year-to-date relatively flat with prior year levels, and as our price actions and strong channel execution are providing support. In addition, we're seeing solid cost leverage as our growth potential plays out, reflecting enhanced internal processes and operational efficiencies from system investments and our shared services model. This is positively influencing our incremental margins year to date, which are trending toward the high end of our interim target range despite greater LIFO expense and other inflationary headwinds. And so with that, our EBITDA margins continue to expand and we're making solid progress towards achieving our interim annual EBITDA margin target of 11%, which also driving strong support in our returns on capital. We think we're in a great spot to build on this momentum into fiscal 2023 as our growth and margin initiatives gain additional traction. And lastly, our balance sheet is in a very solid position, following strong cash generation over the past several years, as well as EBITDA growth year to date. Stronger EBITDA margins and ongoing working capital initiatives are supporting solid cash conversion, even with ongoing working capital investment to support growth. Our M&A pipeline remains active and a primary focus area of capital deployment as we look to further expand our automation, fluid power, and flow control offerings. As indicated in recent quarters, we're maintaining a disciplined approach as we focus on assets that drive strong double-digit returns on capital and enhance our competitive position while increasing our differentiation and growth potential long term. While the cadence of M&A activity can vary period to period, we believe we're in a strong position to accelerate this growth component of our strategy moving forward and into fiscal 2023. At this time, I'll turn the call over to Dave for additional detail on our financial results and outlook.

Thanks, Neal. And just another reminder before I begin. Consistent with prior quarters, we have posted a quarterly supplemental investor presentation to our investor site. This is made available for your additional reference as we discuss our most recent quarter performance and updated outlook. Turning now to our results for the quarter, consolidated sales increased 16.6% over the prior year quarter. Acquisitions contributed 0.4 percentage points of growth and one extra selling day, drove a favorable 160 basis point increase. This was partially offset by a 10 basis point headwind from foreign currency translation. Metting these factors, sales increased 14.7% on an organic daily basis. Average daily sales rates increased nearly 7% sequentially versus the prior quarter and were above normal seasonal patterns. As it relates to pricing, we estimate the contribution of product pricing on year-over-year sales growth with approximately 400 basis points in the quarter. As a reminder, this assumption only includes and reflects measurable top line contribution from price increases on SKUs sold in both year-over-year periods. Looking at sales performance across our segment, as highlighted on slide six and seven of the presentation, sales in our service center segment increased 13.6% year-over-year on an organic daily basis when excluding the impact from foreign currency and one extra selling day in the quarter. In markets such as lumber and forestry, mining, aggregates, pulp and paper, building materials, and machinery had the strongest growth on a two-year stacked basis during the quarter. Demand improvement continues across heavier industries as well, including primary metals, natural resources, and heavy manufacturing, where we are seeing strong acceleration in two-year stacked growth trends. Within our fluid power and flow control segment, sales increased 20% over the prior year quarter, with acquisitions contributing 1.3 points of growth. On an organic daily basis, segment sales increased 17.1% year-over-year, with a similar increase on a two-year stack basis. Segment sales continue to benefit from strong demand within technology and markets, as well as across life sciences, chemical, utilities, metals, and machinery and markets. Underlying growth on a two-year stack basis remains strongest across fluid power and automation, partially reflecting solid demand for our engineered solutions and system build capabilities. In addition, growth continued to accelerate nicely across our later and longer cycle flow control operations during the quarter, after lagging the segment average over the past year. Moving to gross margin performance, as highlighted on page eight of the deck, gross margin of 29.3% declined 10 basis points compared to the prior year level of 29.4%. During the quarter, we recognized LIFO expense of $7.4 million compared to only $0.8 million of expense in the prior year quarter. The net LIFO headwind had an unfavorable 67 basis point year-over-year impact on gross margins during the quarter and reflects supplier product inflation and ongoing inventory expansion year-to-date. Overall, our team is responding well to broader inflationary dynamics, as evidenced by gross margins holding relatively firm both sequentially and year-over-year, despite the incremental LIFO expense headwind in the quarter. Our performance reflects broad-based channel execution, pricing actions, and ongoing margin countermeasures, as well as solid freight expense management. Our business mix was also margin accretive, as we saw a benefit from growth across local accounts and our fluid power and flow control segment, as well as from favorable customer mix within our international operations. Turning to our operating cost, selling, distribution, and administrative expenses increased 9.2% compared to prior year adjusted levels, which compares favorably relative to the nearly 17% increase in sales during the quarter. At CNA, expense was 19.5% of sales during the quarter, down from 20.9% on an adjusted basis during the prior year quarter. While we are facing inflationary pressures across our operating cost stack this year, including higher employee-related expenses, we continue to benefit from a leaner cost structure following business rationalization initiatives undertaken in recent years, as well as benefits from our operational excellence initiatives shared services model, and technology investments. Overall, our solid sales growth, gross margin execution, and cost control drove a 25.1% increase in EBITDA over prior year adjusted levels, while EBITDA margin of 11.1% was up 75 basis points over the prior year. Including reduced interest expense reported earnings per share of $1.75, was up over 27% from prior year adjusted earnings per share levels. As a reminder, our adjusted tax rate during the prior year quarter benefited from several discrete items. Excluding these favorable items and using the normalized tax rate in the prior year period, our year-over-year growth in earnings per share would have been closer to 35% in the third quarter. Moving to our cash flow performance, Cash generated from operating activities during the third quarter was $52.6 million, while free cash flow totaled $48.4 million. Our third quarter free cash was up over the prior year and sequentially. Year to date, our free cash generation of $122 million represents approximately 68.5% of net income. We continue to see solid cash generation across our business considering greater working capital investment, including the ongoing growth-driven inventory build. Our operational inventory levels are up 15% year-to-date on an organic basis, and we expect additional inventory investments during our fiscal fourth quarter. As it relates to other areas of capital deployment, we repurchased 35,000 shares for approximately $3.5 million during the quarter, bringing the year-to-date amount of share repurchases to approximately 147,000 shares, or $13.6 million. We ended March with approximately $188 million of cash on hand and net leverage at 1.4 times adjusted EBITDA, which is below the prior level of 1.9 times and the fiscal 21 fourth quarter level of 1.8 times. Our revolver, as of the end of March, had approximately $460 million of available capacity with an additional $500 million accordion option. Combined with incremental capacity on our AR securitization facility and uncommitted private shelf facility, our liquidity is strong. Turning now to our outlook, as indicated in today's press release and detailed on page 10 of our presentation, We are raising full-year fiscal 2022 guidance for the second time this year to reflect our third quarter performance and constructive near-term outlook. We now project full-year fiscal 2022 EPS in the range of $6.15 to $6.25 per share based on sales growth of 14.8% to 15.3%, including a 13.6% to 14.1% organic growth assumption as well as EBITDA margins of 10.5 to 10.6 percent. Previously, our guidance assumed EPS of $5.70 to $5.90 per share. Bill is growth of 11.5 to 12.5 percent, including a 10.5 to 11.5 percent organic growth assumption and EBITDA margins of 10.1 to 10.3 percent. Our updated guidance applies a fiscal fourth quarter EPS range of $1.59 to $1.69 on high single digit sales growth and a 10.6% EBITDA margin at the midpoint. We expect gross margins during our fourth quarter to be slightly below our third quarter level of 29.3%. In addition, please keep in mind our prior year fourth quarter benefited from a net $3.7 million of LIFO income related to inventory layer liquidations. This compares to roughly $8 to $9 million of LIFO expense we were assuming in our fiscal fourth quarter guidance, which will result in greater year-over-year LIFO headwind on our gross margins and incremental margins during the fourth quarter compared to year-to-date trends. With that, I will now turn the call back over to Neal for some final comments. Thanks, Dave.

As we close out fiscal 2022 in the month ahead, I remain constructive on the outlook for our company and the potential for sustained above-market earnings growth going forward. While we are cognizant of various cross-currents, including ongoing inflationary, supply chain, and macro uncertainties, we are uniquely positioned to drive the favorable performance we've seen year-to-date into fiscal 2023 and beyond. Of note, we believe we remain in the early innings of a potentially meaningful growth opportunity as capital investment accelerates across the North American industrial manufacturing complex. From our legacy service center network supporting critical break-fix applications to our leading engineered fluid power and flow control solutions, and a scaling presence across advanced automation solutions, we will be an increasingly critical partner for our customers' most valuable assets and supply chain investments in coming years. The potential for greater manufacturing reshoring to North America, U.S. infrastructure spending, and a more meaningful recovery across the automotive industry provides additional in-market growth support going forward. Further, we will continue to expand into new and emerging areas of growth across the industrial supply chain. Following our initial automation build out in recent years, we are now a leading distributor and solutions provider across advanced machine vision and collaborative and mobile robotic technologies. We're also investing in digital capabilities that complement our local presence. and continue to evaluate and develop new commercial solutions that fully leverage our technical capabilities and applications expertise as legacy industrial infrastructure converges with new emerging technologies. We expect the mix of these newer areas of growth to increase and be additive to our growth in coming years. Lastly, we see ongoing margin expansion over the long term reflecting a diverse set of self-help opportunities tied to mixed tailwinds and system investments, plus a competitive moat from the critical nature of our core product set, applications expertise, and customized solutions. Our legacy footprint and embedded customer base combined with our historical cost discipline provides a strong platform to continue to leverage our cost base as we capture new growth opportunities. Overall, we remain poised to create significant value for our customers, associates, and all stakeholders within any operational environment, as our historical track record and year-to-date results show. Once again, we thank you for your continued support, and with that, we'll open up the lines for your questions.

Thank you. We will now begin the question and answer session. If you would like to ask a question, please pick up your handset, press star, then the number one on your telephone keypad. If you would like to withdraw your question from the queue, press the pound key. We'll pause for just a moment to compile the Q&A roster. Our first question comes from the line of Chris Dankert from Loop Capital. Your line is now open.

Hey, morning, guys. Thanks for taking my question here. I guess first off, and I know it's early, but as we're kind of looking out to fiscal 23, is it fair to assume we kind of get back into the 2030 basis point gross margin improvement for the year, assuming we do see some modest tapering in kind of inflation and pricing or maybe roughly flattish if these LIPO headwinds continue? Would that be what you'd expect kind of in those scenarios here?

Obviously, we see opportunities both from our accretive mix and the pricing and other gross margin countermeasures to continue to expand margins. We would expect that. I think one thing we do have to be cautious of, Chris, is that the LIFO tail, depending on when we see some of that inflation subside, we'll have a longer tail. Think about the random demand we see in this business, and we'll have parts that will continue to hit the radar and be replenished. that have not been replenished since this inflation really started to ramp. So there will be some pressure we see continuing in the next year, our fiscal 23, in terms of LIFO, but clearly the accretive mix impact, the outpaced growth on the fluid power flow control, which comes with the higher margins and automation, of course, as well as the blocking and tackling around the service center side of the equation. Certainly, we would look to continue to improve the margin trend as we move forward.

Got it. That's helpful. Thank you. Again, you highlighted the pricing and the price-cost piece of a very impressive gross margin number here. Any other comments? Can you walk us through the impact of mix and freight? I see there's a lot of other moving parts there. Any other comments on what contributed to that really nice gross margin number if we pull LIFO out of it?

If you pull out the LIFO, please, the business, keeping everybody focused on you know, what's right in front of us as opposed to, you know, what's ultimately coming through the P&L as a moving average cost. So nice work there. Looted in the script that, you know, our mix was accretive, both the outpaced growth of some of the local accounts. Obviously, as we grow quicker in fluid power, flow control, and automation, those do come at, you know, richer margins. You know, that does provide a mix-up benefit that we've talked about before. As well as our international operations, we saw some... Nice performance there and some favorable customer mix with the near national operations as well. So some of that here again, we've talked about in terms of the opportunities in front of us to continue to drive that margin expansion, but really proud of the team in terms of the execution, staying on top of it and really working all the levers. Think about what goes into that gross margin improvement in these inflationary times.

Chris, I'd just add that as we think about it, we look at a quarter and perhaps to the year ahead, and we're in our planning cycle now. But the real view is the inflationary environment is persisting. Supply chain headwinds are not really easing. They persist. Labor tightness and bottlenecks persist in that. we've got ourselves organized teams focused on how we continue to execute in that environment in closing this fiscal year and as we move into fiscal 2023. Got it.

Well, thanks so much for the call, gentlemen. And, again, congrats to the whole team. Just a really nice quarter here.

Thanks, Chris. Thank you. Our next question comes from the line of Michael McGinn from Wells Fargo. Your line is open.

Hey, good morning, everybody. Congratulations on the results. I wanted to dig into the different growth drivers, obviously solid organic growth. Um, but if, if we look at within service center and then maybe switching the fluid power service center, can you just kind of any commentary on how implant solutions are stacking them up against the legacy service center? And then maybe fluid power sounded like. Flow control was really the incremental growth driver to that upside. I just wanted to put a finer point on those, those items.

So I'll start on the service center. I think we continue to see just heightened activity. If you look at manufacturing capacity utilization, our customers are operating equipment longer and harder as they look to serve that demand. That creates a greater break-fix into that. And then as we work with them on planned maintenance projects and solutions into that, all of those continue to contribute to the service center side of the results and the team's performance. I would say our fluid power business continues to perform very well across industrial, off-highway, mobile, and technology. The order rates and the backlogs continue to expand, so they clearly contributed to the results. As we point out with the flow control position and some of those later cycle segments now starting to see quotes and orders. So flow control has contributed this quarter, but I wouldn't characterize that it's all flow control in those results. And then the automation side of the business. We talk about those results. on the orders, the sales, the two-year stack at over 20% year-to-date, high teams growth on that side. So, we're encouraged there as well.

Okay. And I guess on the service center side, a couple of your peers have noted, you know, during the pandemic, implants and the consumable fees kind of pulled back, you know, due to obviously, COVID concerns. And that is a product category that I believe skews higher margin Class C consumables for you guys. So just trying to gauge the level of upside as those start to pick up into your next fiscal year.

Yeah, I would say we'll participate. I think in general consumables around 5% of our sales in that side. So we will participate. But I think the bigger drivers have been around the mechanical power transmission and those solutions that we're offering and helping customers maintain high uptime, avoiding downtime in those areas. That's been the driver of our results.

Okay. I guess this might be my second or third question, depending on how you count it. I'm going to go with analyst numbering right here, so sneak one more in. You know, I guess on the, you mentioned upside to the 11% interim target, or I guess meeting that target, you know, what is the level of competence here in terms of gross margin, SG&A, you know, reaching all-time lows of percentage sales? Just walk us through what feels cyclical and secular in this environment.

So we're going, you know, we'll be going through the planning cycle. But if I look forward at the demand environment right now, we feel very good. about what is driving demand and what is likely coming. And if we look at the trends, and I think it's reflected in the capacity utilization of increased reshoring and activity going on, as customers look to de-risk long-distance supply chains to bring some of that activity in-house, or they're localizing with suppliers more closer to their operations, we see that infrastructure spend really hasn't started into this and so that will be a driver on the heavy industries. If we think about from an industrial production standpoint, we've seen 13 months of expansion and most cycles are 60 to 70 months in that site so we feel encouraged about that. So we think there's many fundamental secular backdrops that are going to be beneficial plus we have a strong focus to help ourselves with our technical differentiation and how we bring those solutions forward to our customers to help them run and operate. And as they deal with challenges of an aging technical workforce, their own labor constraints and challenges, we can fill those gaps and voids for them and help them keep running productively. And what we see is a strong industrial manufacturing backdrop.

Got it. Appreciate the time. Thank you. Thank you.

Thank you. Our next question comes from the line of David Manthe from Bird. Your line is now open.

Yeah. Hey, guys. Good morning. Good morning. Not to keep hitting on the economic question, but you guys have such a great window into industrial America. Neil, in your comments, you mentioned the early innings of opportunity in certain areas. You talked about these mid and late cycle industries picking up. If we had to pin you down, how do you think about it? I mean, two years out of recession, but rates going up now. Where are we in the U.S. economic cycle, do you think?

Well, you know, not an economist, but, you know, I'd say from my perspective, I still think we're, I mean, as we look forward, I mean, what we had really two plus years of low CapEx. And we see it with customers' dialogue and planning. I think we see it in releases from various companies. Many are planning CapEx expenditure increases. And so I know as a percent of GDP, it's normally around 9%. I think we're a lot closer to 8% right now. That's going to play out and contribute on the side. To the earlier comments, I think reshoring continues into it. I think it's reflected in the manufacturing capacity utilization for us. That'll be very positive, especially if some of those local accounts will continue to invest and grow. I know there's concerns or everyone would want to look, is it peaking here or is there concerns there? Our view is it is a constructive, productive environment, and that's what we're planning and executing for. If the environment changes, hey, obviously we know how to execute, right, as we did before in cycles, as we did through the pandemic. But it is not what we anticipate right now.

okay yeah thanks for that insight i appreciate it and then um second on um as we think about just the model going forward and continued inflationary trends feeding into opex next year um you know your model is to increase gross margin 20 to 30 basis points annually it sounds like you're outperforming that right now And then you get OPEX leverage, your contribution margins should be kind of mid-teens over the cycle. As you look to next year with the trends you're seeing, is that still how you should think about it? Are there areas that should be a little bit better or a little bit more challenging for you relative to that secular model?

Yeah, so we'll be going through the planning cycle now. We're closing out in some areas of the business and taking our board through long-range strategic looks at the business and what we want to be doing, accomplishing, and investing around. And then we're working the annual planning cycle right now. So we'll provide clearly more color as we get to August. But I think one view is over the up cycle, our view of the algorithm is, is that, hey, over an upcycle, we'll grow mid-single digits organically in sales, and we'll have incrementals that'll be mid to high teams in that side. We're talking about in the fourth quarter, if we set aside LIFO, we'll be strong in that side from an incremental standpoint. So that's probably where I'll leave it for now, but we're working it, and we'll try it a lot more as we get to August and we guide for 23.

Yeah, great. Sounds good, Neil. Thank you.

Thank you.

Thank you. Again, if you would like to ask a question, please pick up your handset, press star, and then the number one on your telephone keypad. Our next question comes from the line of Ken Newman from KeyBank Capital Markets. Your line is open.

Hey, good morning, guys. Good morning, Ken. You know, I think service center margins were a record this quarter, and I just wanted to ask about how you think that, you know, what was the primary driver for that relative to the price increases or the customer mix, and just how we should think about the sustainability of those margins going forward.

Go ahead. I mean, there was a terrible mix that came into play. So, you know, it'd be about obviously just talking about the service centers. You know, some of that international customer mix, the The growth in the local accounts certainly does benefit from the mixed standpoint. You're clearly seeing the overall volume leverage as you think about our SDNA being roughly 30% variable. Obviously, to get that incremental volume, it does lever nicely. From the SDNA standpoint, we did have a little bit lighter than we would have expected. We've seen in recent quarters medical expense. can't count on that repeating, but like the work that the service center teams are doing around, you know, staying in front of the inflationary impact, you know, kind of counter even that LIFO headwind that we're seeing, you know, so as we continue to drive volume there, we'll stay cost accountable, continue to work the gross margin levers, and, you know, like I said, that business does lever nicely on incremental volumes.

Got it. And then for my follow-up, you know, I just wanted to To dig into the automation comments made earlier, I'm curious if you're just seeing any outsized acceleration for specific processes, whether it be for vision systems or palletizing robotic systems. Obviously, the growth has been pretty strong, which makes sense given the tight labor markets, but is there any way that you can help us maybe think about what's been limited from a supply chain perspective or how high would orders have been if you could actually get the parts you needed.

I don't know that I've got any specific comments. Obviously, there can be tightness in. It can vary based on supplier or some of the product groups. I think the teams are doing a very nice job at understanding, and like the rest of the business, how we engage with these core suppliers to work through the resolution. So clearly, we're doing well. in Envision and those systems. I think more and more customers are seeing opportunities to put them in in quality inspection. They can use them to reduce labor in some areas. We're seeing in robotics machine tending and pallet loading and all of those type applications for collaborative robots. Also, from a mobile standpoint, how you can move materials through and what that can mean for productivity and also reduce some labor requirements in the side. And it's really broad-based across many vertical segments. And so a good performance in the quarter encouraged by the continued order trends and growing backlog. I think it's fundamentally set up that it's a double-digit contributor as we look out over the horizon.

Yep. I'll sneak one more in if you don't mind. Maybe you just talk a little bit about fuel or transportation costs. What was the drag for that on gross margins this quarter and how should we think about the impact that's embedded in the guide at this point?

I'd say, hey, it's in the numbers. As a team, we recognize freight and cost are part of the contributing factors and just like any headwinds that you get, you take it on and you find your countermeasures and and offset. So across the board, the team has done a very nice job thinking about point of sale and inflation mix and how we sell richer products and solutions. And to Dave's point earlier, customer mix with local accounts. And we're doing a very nice job in the freight arena in managing input cost and taking them forward. So part of business. Very good. Thanks.

Thank you. Our next question comes from the line of Barry Haynes from Sage Asset Management. Your line is open.

Thanks so much for taking my questions. First, a question on automation. Could you size it as a percent of revenue just to get a feel for its size currently? And related to that, you talked a lot about reshoring. And, you know, some of that comes back to the U.S., but I would think a fair amount of that might go to Mexico, and I'm wondering if Mexico is part of the plan. And I have one other one, but we'll start with there.

Okay. So automation in sizing, and we talked about it a little bit, our annualized run rate of the businesses today would be $150 million, and so those would include our Our recent acquisitions over the last three years with the focus around vision and robotics, motion control products, but also data connectivity. I'll point out, I mean, we've got technology and degrees of automation weaving throughout our businesses in fluid power and flow control and even in our service center side of that. But from an automation side, that's what we have. From a reshoring standpoint, I agree. I think many of our customers are looking at their U.S. or their North America footprint as they look to develop these solutions and solve long-distance supply chains of whether they would come from Asia, Europe, or other aspects. So we would see U.S. fully or contributing, fully participating, but it will be positive also for Mexico going forward. and I believe you got a third.

Yeah, just one other one. I wonder if you could just talk a little bit about the M&A pipeline and pricing, kind of what you're seeing there. Obviously, the financial markets have been in a fair amount of turmoil, and just wondering how that may or may not be affecting the M&A market that you're seeing. Thank you.

So I can just speak for us. One, we're busy, we're active. I think we've got a a full, robust pipeline. We are focused on our priorities that we think fit our business and that are most attractive going forward. And so we've touched on those around automation, fluid power, and flow control. It's probably a little early for me to comment, you know, what's it mean with rising rates on some of the impacts of that. I'd say to date, not as much. I think as those activities or as rates rise, it may prompt more properties, more businesses to look, to transact in the coming time horizon. So it may actually stimulate some activity.

Great. Thanks so much. Thanks for the great quarter. Thank you.

Thank you. Next question comes from the line of Michael McGinn from Wells Fargo. Your line is open.

Hey, thanks for the follow-up. I just wanted to piggyback on that last line of questioning. So you've added five nice adjacent bolt-ons within your automation space, I can believe since fiscal 19. This is a platform you kind of built from the ground up and it's growing double digits. You got the balance sheet to execute on a lot of things. Just thinking high level, as you add these next round of opportunities, Is there still regional gaps or are these something that are going to be melded into the portfolio and maybe become less disruptive from having to build it from the ground up initially?

So, you know, we have clear platforms, channels to market. Those are our focus areas. As part of our long-range strategy, I mean, we'll continue to evaluate segments and potential and what's next. I mean, so it's just like we went into with flow control and into automation in that side. But what I would say is we have opportunities in the business from an acquisition standpoint, but also organically. And so as we grow the infrastructure, the support, we can go into adjacent markets where we operate. So I think in the go forward, it can be a combination, an expansion combination of acquisitions and also organically.

Thanks. I'll pass along.

Okay.

Thank you. At this time, I'm showing we have no further questions. I will now turn the call over to Mr. Scrimshaw for any closing remarks.

Thank you very much. I just want to thank everyone for joining us today, and we look forward to talking to and seeing many of you in the quarter ahead. Thanks again.