Applied Industrial Technologies, Inc.

Fiscal 2025 Fourth Quarter Earnings Call for Applied Industrial Technologies. My name is Carly, and I will be your conference 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, press star followed by the number one 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 call you need to reach an operator, please press star zero. Please note that this conference is being recorded. I would now like to turn the call over to Ryan Cieslak, Director of Investor Relations and Treasury. Ryan, you may begin.

Okay. Thanks, Carly, 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 online. 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. Our forward-looking statements are based on current expectations subject to certain risks and uncertainties, including those 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 begin today with perspective and highlights on our results, including an update on industry conditions, and expectations going forward. Dave will follow with more financial detail on the quarter's performance and provide additional color on our fiscal 2026 guidance. I'll then close with some final thoughts. Before I discuss our fourth quarter results, I want to take a moment to acknowledge our applied team. I'm extremely proud of what we accomplished in fiscal 2025 within a muted demand backdrop. We achieved new records for sales EBITDA and EPS. Full year EPS growth of 4% exceeded the high end of our initial guidance. Growth margins expanded nearly 50 basis points and surpassed 30% for the first time in our history. We also delivered another record year of cash generation that enabled meaningful capital deployment. This included the strategic acquisition of Hydrodyne, our largest M&A transaction in six years. Overall, our performance in fiscal 2025 provides further evidence of our operating resiliency and value creation potential and builds on our compelling track record over the past five years. This includes compounded annual growth for EBITDA and EPS of 14% and 22% respectively, as well as gross margins and EBITDA margins expanding 130 and 330 basis points respectively. I'm honored to be a part of our incredible applied team and the financial performance we continue to deliver. Our progress in fiscal 2025 ended on an encouraging note with several positive trends developing. Fourth quarter sales and EPS exceeded our expectations. Our team once again executed well against an ongoing muted in-market backdrop. Sales exceeded the high end of our fourth quarter guidance by 2.5% and returned a modest positive organic growth. Underlying organic sales trends strengthened across both segments as the quarter progressed. Average daily sales increased 4% sequentially, which was ahead of normal seasonal patterns for the first time in 10 quarters. Upside compared to our expectations was primarily driven by stronger than expected engineered solutions segment sales. which grew organically year over year for the first time in seven quarters. The segment's 2% organic daily sales increase was a notable improvement from mid single-digit declines in recent quarters, with the underlying drivers encouraging on many fronts. Our ES teams capitalized on recent order strength, as well as improving demand and business development efforts across several key growth verticals. This includes double digit organic growth across our technology vertical and mid single digit organic growth across our automation platform during the quarter. Service center segment trends were also encouraging, including exceeding normal seasonal patterns for the second straight quarter and returning to positive organic growth during the month of June. M&A sales contribution was also encouraging, with progress continuing to develop at Hydrodyne, as well as initial contribution from our early May acquisition of Iris Factory Automation. Taken together, our fourth quarter sales performance highlights solid execution combined with emerging growth tailwinds tied our industry position and business pipeline. As it relates to underlying in-market demand, trends remained relatively mixed during the quarter, though with some positive signs developing. Year-over-year trends across our top 30 in-markets were relatively unchanged from last quarter, with 15 generating positive sales growth compared to 16 last quarter. Declines continued across several top markets, including machinery, primary metals, utility and energy, aggregates and chemicals. Consistent with prior quarters, declines were most pronounced across off-highway mobile OEM verticals within our fluid power operations. This was offset by solid demand across our technology vertical, which we estimate contributed approximately 100 basis points to our consolidated organic growth rate during the quarter. Sales were also positive across pulp and paper, fabricated metals, food and beverage, and oil and gas verticals. Further capital maintenance spending started to slowly pick up during the quarter within our service center network, while project activity across various process flow markets strengthens later in the quarter. In addition, orders in our engineered solution segment increased by a high single-digit percent year-over-year during the quarter, adding to the positive inflection we've seen in recent quarters. This includes positive growth in industrial and mobile OEM fluid power orders, an encouraging sign following notable headwinds in this area of our business over the past year. During fiscal 2025, reduced sales from industrial and mobile OEM fluid power customers negatively impacted our consolidated organic year-over-year sales growth rate by approximately 100 basis points, as well as the engineered solution segment organic growth rate by over 400 basis points. Overall, while in-market visibility remains limited and mixed, we believe the underlying backdrop improved modestly from last quarter. In addition, based on our core indicators, including order momentum, business funnels, and what we're hearing from our customers, we believe industrial activity and customer spending behavior are starting to pick up to some degree. It's also important to highlight the positive impact our own initiatives and ongoing evolution are having. While our overall organic sales trends in fiscal 2025 were muted, average daily sales finished the full year down a modest 2%. This was directionally in line with the midpoint of our initial guidance, despite a more challenging in-market backdrop that was highly influenced by persistent uncertainty tied to the US election, interest rates, and eventually shifts in trade policy. The negative impact to many of our legacy manufacturing in markets was evident, as reflected in the ISM hitting one of the longest contractionary stretches, as well as notable pressure we experienced in OEM and machinery related verticals. This also followed double digit organic compounded sales growth in the prior three-year period. Considering this context, we believe our fiscal 2025 performance showcases the more durable and differentiated growth profile we continue to shape across Applied. Of note, our service center segment benefited from ongoing Salesforce productivity initiatives, technology investments, and increased cross-selling momentum. which help balance softer MRO customer spending during the year. In addition, growth investments across our flow control and fluid power operations, as well as the ongoing expansion of our automation platform, have diversified our in-market exposure and supported our engineered solution segment. In particular, we benefited from encouraging growth tied to data centers, semiconductor manufacturing, new process infrastructure, advanced robotic solutions and calibration services as the year played out. This helped offset acute weakness in our legacy off-highway mobile markets and drove a return to positive segment organic growth during the fourth quarter. At the same time, we continued to expand gross margins while maintaining cost discipline in fiscal 2025. which helped drive modest EBITDA and EPS growth for the year. When excluding the impact from acquisitions, we achieved 10% decremental margins on low single-digit organic sales decline. This is inclusive of ongoing growth investment and inflationary pressures throughout the year. During the fourth quarter, gross margins increased sequentially and were in line with our guidance. As previously highlighted, year-over-year gross margin trends were impacted by a difficult prior year comparison, partially reflecting a LIFO layer liquidation benefit last fourth quarter. This fourth quarter also included higher than expected AR provisioning, which held back EBITDA margins to some degree, but is expected to normalize moving forward. Fiscal 2025 was also a year showcasing our cash generation and capital deployment capacity. We generated over $465 million of free cash, up 34%, to a new record on both an absolute basis and as a percent of sales. Over the past three years, our business has generated 40% compounded annual free cash growth which has culminated in meaningful capital deployment, including over 560 million deployed in fiscal 2025. We accelerated capital deployment on M&A, closing four transactions in fiscal 2025, including the strategic acquisition of Hydrodyne. Sales from acquisitions contributed over 400 basis points of inorganic growth in fiscal 2025, up 100 basis points from the prior year. At the same time, we were more active with share buybacks, repurchasing a total of 656,000 shares for $153 million, as well as increasing our quarterly dividend by 24%. We also continue to invest in technology platforms, distribution centers, and growth capacity. Overall, very compelling numbers that highlight the powerful flywheel effect of our operating model and strategy, including our consistency in generating elite levels of cash and shareholder returns long term. As it relates to the evolving tariff backdrop, we continue to work closely with our suppliers as they manage through the dynamic backdrop and the impact on supply chains. As expected, we received a greater level of price increase notifications from our suppliers during the fourth quarter. Our teams are proactively and effectively managing through this, and in short, we remain highly confident in our ability to execute as the tariff backdrop continues to evolve. As a reminder, we have limited direct exposure to procuring products outside the U.S. We also have a strong track record of effectively managing inflation given our technical industry position, while structural mixed tailwinds and various self-help gross margin initiatives provide strong countermeasures. The overall price impact to ourselves was limited in the fourth quarter, but we expected to slowly increase moving forward as supplier price increases take effect. Next, I'd like to take a moment to provide some initial thoughts on our outlook as we enter fiscal 2026. First, we're highly focused on accelerating growth. We remain mindful of ongoing trade and interest rate policy uncertainty, which continues to impact broader demand visibility and could remain a gating factor to growth near term. That said, when we consider the underlying fundamentals beneath this on both a secular and structural basis, we believe a productive demand environment should develop as policy clarity continues to emerge. Recent U.S. trade agreements with several primary trading partners are welcome development. In addition, the recent passage of tax reform legislation, including accelerated depreciation incentives and the potential for a more favorable U.S. interest rate policy could recatalyze U.S. business sentiment and capital investment. While it remains early, we're encouraged to see positive sales momentum continue into early fiscal 2026 with first quarter organic sales today up by an estimated 4% compared to prior year levels. Secular growth tailwinds also remain on firm footing. Our related exposure is high given our industry position supporting U.S. manufacturing and deep technical knowledge of our customers' facilities. As macro and trade policy dynamics stabilize, we believe our customers' capital investment decisions will be active given heightened considerations around reshoring. Technical service requirements will increase as break-fix MRO activity supports aged manufacturing equipment and as customers expand industrial production infrastructure across North America. Our service center segment is favorably positioned to benefit from these positive tailwinds. This could be particularly evident across heavy manufacturing, machinery, mining, metals, and aggregates given their break-fix-intensive nature, as well as potential incremental demand from U.S. trade and pro-growth policies. In addition, we expect additional benefits from technology investments, optimizing sales force productivity, and new business sourcing. We're also focused on increasing our growth with local customers through greater sales of ancillary products such as seals, material handling, fluid conveyance, chemicals, lubricants, and safety, as well as providing comprehensive service and repair solutions for their production assets. In addition, we're constructive on the growth opportunities developing across our engineered solution segment, considering ongoing positive order momentum and investments made in recent years. Underlying demand fundamentals are notable across key growth verticals, including technology and discrete automation, which combined represent more than 25% of segment sales today. The ongoing build out of data center and semiconductor infrastructure is expanding the addressable market for our fluid conveyance, flow control, and robotic solutions. We have a growing business pipeline tied to the emerging transition to electric-powered fluid power systems, where we expect to play a significant role giving our leading engineering capabilities and supplier relationships. Combined with required flow control infrastructure investments across the U.S., our engineered solution segment is in a strong position to drive above-market organic sales growth moving forward. We also expect acquisitions to remain an important element of our growth potential and we look to build on the M&A momentum we achieved in fiscal 2025. Our pipeline is developing nicely and we expect to be active in fiscal 2026 as we continue our strategic expansion. The value of our scale, broad technical solution portfolio, engineering capabilities, strategic supplier relationships, and balance sheet capacity has never been stronger in our marketplace. Lastly, we're in a strong position to further expand margins as these growth tailwinds play out. Of note, structural mixed tailwinds should strengthen as sales recover across our engineered solution segment and local customer accounts. We also have ongoing opportunities tied to pricing analytics, optimizing sales processes, utilizing AI, and expanding shared services, while synergy benefits from our Hydrodyne acquisition should ramp moving forward. Combined with leveraging recent growth investments and our scaling automation platform, we remain constructive on the EBITDA margin potential developing beyond our current intermediate target of 13%. At this time, I'll turn the call over to Dave for additional detail on our results and outlook.