Applied Industrial Technologies, Inc.

Welcome to the fiscal 2023 fourth quarter earnings call for Applied Industrial Technologies. My name is Frank, 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 the 1 followed by the 4 on your telephone keypad. Prior to asking a question, please lift your handset to ensure the best audio quality. If at any time during the conference you need to reach an operator, please press star zero. Please note that this conference is being recorded. I will now turn the call over to Ryan Cieslak, Director of Investor Relations and Treasury. Ryan, you may begin.

Okay, thanks, Frank, and good morning to everyone on the call. This morning we issued our earnings release and supplemental investor deck detailing our fourth 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 Neal Scrimshaw, 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. I'll start today with some perspective on our fourth quarter results, current industry conditions, and our expectations going forward. Dave will follow with more specific detail on the quarter's performance and our forward outlook, including fiscal 2024 guidance. I'll then close with some final thoughts. So first, I'd like to start by acknowledging and thanking our applied team for their hard work in delivering a record and pivotal year. We continue to exemplify best execution and commitment to consistently serving our customers, with industry-leading technical expertise. From our core legacy operations to our expanding engineered solutions, our customer focus and operational execution are evident as the evolution that applied continues to unfold. This is apparent when considering the strong finish to fiscal 2023 with fourth quarter sales, EBITDA, EPS, and cash flow growing nicely and exceeding our expectations. EBITDA grew 17% on 9% sales growth, driving full-year fiscal 2023 EBITDA growth to 28% on 16% sales growth. This is on top of significant growth achieved last year and against normalizing in-market demand during the quarter, so really solid performance that is top tier within our core markets. We're achieving this growth while continuing to expand gross margin and EBITDA margins with both reaching new record highs in fiscal 2023, despite meaningful LIFO headwinds. Another point to highlight is the strong cash generation in the fourth quarter, bringing our full year fiscal 2023 free cash to a record level of approximately $320 million. This is nearly twofold increase over the prior year and inclusive of working capital investment and higher capex. Very encouraging progress and a strong indication of the enhanced cash flow power of applied as we scale and optimize our operations and margins as well as drive various internal initiatives. Furthermore, our competitive position and operational rigor had never been stronger. This is evident by the significant improvement in our return on capital metrics throughout the year, which are the highest in over 10 years. Overall, in a year that faced ongoing headwinds from supply chain constraints and persistent inflation to a mixed macro and demand backdrop, we exceeded our commitments and created meaningful value for our customers, suppliers, and all stakeholders. Once again, thanks to the entire applied team for driving this performance. So several key points to highlight in more detail. First, in terms of underlying demand, we saw generally firm trends through the quarter, including a solid finish during June. Average daily sales increased 3% sequentially, largely in line with normal seasonal trends. while organic growth was strong on a two-year and three-year stacked basis at 27% and 47% respectively, which compares favorably relative to prior quarters. Growth was strongest in many of our top industry verticals and across our larger national account base. We saw particular strength across food and beverage, pulp and paper, energy, utilities, lumber and wood, and mining verticals during the quarter. Ongoing backlog conversion across our engineered solution segment provided further support. In addition, we believe we're capturing incremental growth opportunities from our industry position and service capabilities, as well as building momentum from our cross-selling initiatives. Of note, growth contribution from cross-selling actions continue to build during fiscal 2023 with related sales growth accelerating at a notable level compared to the prior year. While still in the early innings, we see solid potential from cross-selling going forward with business unit alignment and sales effectiveness gaining traction across our legacy service center customer base. From fluid power and process systems to advanced automation solutions and indirect consumable support, The breadth of our solutions and application expertise provides our customers coverage across all areas of their operations, a compelling value proposition that is driving a strong funnel of new business opportunities entering fiscal 2024. It's great to see the sustained growth momentum within our business, particularly when considering broader macro market activity. continued to normalize as we expected. Of note, we saw some incremental softening within metals, technology, and chemical end markets during the quarter, as well as delayed capital spending across certain pockets of our customer base. In the early fiscal 2024, organic sales are up by a low single-digit percent. While early trends in the quarter are always difficult to gauge given typical seasonality in the summer and some normalization following our year-end close, we remain mindful of ongoing macro headwinds and easing customer production activity that is presenting a more modest near-term in-market backdrop. That said, we have yet to see any meaningful signs of a broad material slowing to date and customer feedback remains generally optimistic. Additionally, we believe emerging reshoring activity and investments in U.S. industrial infrastructure are creating incremental demand layers for our technical MRO and engineered solutions both directly and indirectly. All these considerations suggest to us that current market easing is more reflective of a modest cooling in customer activity rather than a retrenchment or contraction in our core end markets. But we're keeping a close eye on the environment and will adjust if required. Digging a little more into each of our segments, sales growth within our service center network remains encouraging. With service center segment sales up over 9% organically, over prior year levels during the fourth quarter, and on top of 21% growth last year. In the early fiscal 2024, we're seeing relatively firm sales trends across our U.S. Service Center network, which is an encouraging sign for general demand, as well as the ongoing outgrowth we see in this core area of applied. In particular, growth remained solid during the fourth quarter across larger national accounts and fluid power aftermarket sales. Transactions through our digital channels, including EDI and applied.com, are also growing nicely, with related sales up over 30% during fiscal 2023. Our digital channels are benefiting from systems and process tool investments in recent years, which are helping drive new customer growth. In addition, we see greater Salesforce effectiveness as we continue to deploy and utilize prescriptive analytics to drive more robust benchmarking, wallet share gains, product penetration, and geographic coverage. Combined with ongoing talent initiatives and our local service capabilities, we're capturing new growth opportunities across both legacy and emerging end markets. Within our engineered solution segment, which includes fluid power, flow control, and automation offerings, we saw underlying growth moderate slightly from prior quarters, though sales were still up by a high single digit percent over the prior year. Component delays and supply bottlenecks remain hurdles within this system build and assembly focused area of our business. albeit at a lesser degree compared to prior quarters. Within fluid power, we saw strong backlog conversion as the quarter progressed and solid growth within our core off-highway mobile and industrial verticals, where sales were up in the low teens year over year and orders continued to grow during the quarter. This helped offset softer demand we continue to see across technology-related end markets. Our fluid power backlog exited fiscal 2023 still well above normalized levels, and we expect a reacceleration in orders across the technology-related vertical as fiscal 2024 plays out. Given structural growth tailwinds underpending this market, and our channel position. In addition, our design, engineering, and software coding expertise are in greater demand as customers focus on reducing power consumption and CO2 emissions, navigate a tight labor market, and integrate more autonomous features into their equipment. Demand also remains positive for our higher margin process flow control products and solutions. During the quarter, MRO activity and capital spending on process infrastructure remained solid in core end markets such as chemicals, food and beverage, utilities, energy, and pulp and paper. As noted in prior quarters, our flow control solutions are increasingly used in applications tied to our customer decarbonization efforts and other required infrastructure investments as end markets transition around new energy requirements. This includes providing technical support for the configuration, assembly, and testing of process systems. We see further momentum building into fiscal 2024 as we execute on this meaningful opportunity. As it relates to our expanding automation platform focused on next generation robotics, machine vision, and digital solutions, we continue to see positive demand backdrop. Year-over-year organic sales growth improved to 9% in the quarter against ongoing supply chain constraints and slightly longer sales cycles across certain verticals. Demand remains strong across biotech, life sciences, data centers, and consumer packaging, partially offset by slower trends across semiconductor and electronic markets. Importantly, customer interest in new business opportunities remain elevated, with our sales funnel and pre-sales engineering activity at record highs. We also have more than 100 open projects tied to our joint cross-selling efforts, which is up meaningfully from prior year and represents a notable sales contribution opportunity heading into fiscal 2024. Overall, underlying growth momentum remains resilient and promising as we continue to navigate an uncertain macro environment. Lastly, we ended fiscal 2023 with a healthy balance sheet and over $300 million cash on hand, net leverage below one time, and over $1.5 billion in balance sheet capacity. We deployed over 180 million in fiscal 2023 on capital allocation actions, including two automation acquisitions, a greater level of CapEx investment supporting organic growth initiatives, ongoing debt reduction, and growth in our dividend. Looking ahead, we expect favorable cash generation to sustain as our working capital requirements moderate following heavy investment in recent years. This provides significant firepower to drive ongoing organic investment as well as potentially accelerate M&A. On top, our top M&A priorities remain focused on automation, fluid power, and flow control markets. We also continue to evaluate select M&A opportunities across our service center network aimed at optimizing our market coverage, talent, and service capabilities as we look to fully leverage and capture the significant growth potential continuing to develop in our core service center business. This includes tailwinds tied to reshoring, customer CapEx investments, and technical supply chain requirements. In addition, we remain flexible to return capital through other avenues if necessary, including a potentially more active approach to share buybacks given our long-term earnings potential, and the intrinsic value we see across the company. At this time, I'll turn the call over to Dave for additional detail on our financial results and outlook. Thanks, Neal.