Applied Industrial Technologies, Inc.

Welcome to the fiscal 2026 first quarter earnings call for Applied Industrial Technologies. My name is Eric, and I'll 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, please press star, followed by the number one on your telephone keypad. Prior to asking a question, 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 call 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, Eric, and good morning to everyone on the call. This morning we issued our earnings release and supplemental investor deck detailing our first 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 the business outlook and make forward-looking statements. All 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 outlook. I'll then close with some final thoughts. So overall, we had a nice start to fiscal 2026. We delivered strong earnings performance in the first quarter with EBITDA and EPS growing 13% and 11% respectively over the prior year, which exceeded our expectations. Sales growth was largely in line with our outlook and strengthened compared to last quarter against a still muted and choppy in-market backdrop. We converted stronger sales growth into even greater EBITDA growth through solid gross margin execution, cost control, and our internal initiatives. As a result, EBITDA margins expanded over the prior year and exceeded the high end of our first quarter guidance. In particular, our service center team delivered a strong quarter on both the top and bottom line. and I'm encouraged by the positive momentum building from our internal initiatives and industry position. Sales across our engineered solution segment were relatively flat versus the prior year, but orders remain positive. Hydrodyne contribution continues to increase, and the segment has solid growth potential moving forward. Overall, our execution and progress in the first quarter provides positive momentum to achieve our fiscal 2026 objectives and accelerate our value creation potential moving forward. Digging more into the sales trends, broader in-market demand remained mixed during the quarter as lingering trade policy uncertainty continued to impact customers' purchasing decisions. That said, we would describe the underlying demand backdrop as stable to slightly positive and overall moving in the right direction when looking at it over the past several quarters. Year-over-year trends across our top 30 end markets improved slightly with 16 generating positive sales growth compared to 15 last quarter. We saw stronger trends across several of our primary end markets with strongest growth in machinery, food and beverage, refining, pulp and paper, metals, oil and gas, and aggregates during the quarter. This was offset by declines in lumber and wood, transportation, chemicals, mining, and utilities and energy. Year-over-year organic sales trends were stronger in July and August relative to September, though partially reflecting more difficult comparisons later in the quarter. Combined with greater pricing contribution, reported organic sales growth of 3% was the strongest in two years, with the two-year stack trend improving sequentially for the third consecutive quarter. Organic sales growth in the quarter was led by our service center segment, with reported growth of 4.4%. accelerating nicely from the low single-digit declines we experienced in fiscal 2025. Growth was strongest across our national account base, while local account sales were up modestly year over year, which is an improvement from recent quarters. Strengthening service center sales growth is an encouraging sign for both the segment as well as our broader operations. As the shorter cycle nature of our service center operations is typically a good indicator of underlying industrial activity and potential demand for capital related spending moving forward. We believe modest firming and manufacturing production and capacity utilization combined with pent up demand from deferred maintenance activity is driving more technical MRO and break fix activity at the margin. We're seeing stronger activity across some of our heavy U.S. manufacturing verticals that are break-fix intensive. This includes primary metals market where related service center sales were up by a high single-digit percent year-over-year in the quarter. Our service center team also continues to benefit from ongoing sales initiatives, technology investments, and greater cross-selling opportunities, which is supplementing their performance beyond underlying market demand. It's also important to highlight the strong execution of our service center team in the quarter, where they levered 4% sales growth to 10% EBITDA growth. While particularly benefiting from more favorable AR provisioning over the prior year, the underlying earnings leverage was solid and highlights the team's operating discipline, ongoing cost control, and effective management of broader inflationary headwinds. Within our engineered solution segment, organic sales in the first quarter finished slightly lower compared to the prior year, but remain on a solid path to stronger growth. Of note, segment orders sustained positive momentum, increasing nearly 5% organically over the prior year during the quarter, with the two-year stack trend accelerating sequentially. Segment orders have now been positive year over year for three straight quarters, with book to bill above one during the quarter. Order growth strengthened across our industrial and mobile OEM fluid power operations during the quarter. This exceeded our expectations and leaves us incrementally constructive on related fluid power sales trends moving forward. Our fluid power team's leading engineering capabilities and customer reach are driving new business opportunities tied to mobile electrification, next generation fluid power systems, and fluid conveyance. We also believe a lower interest rate environment and tax incentives could be particularly positive for our fluid power customer base, which is primarily comprised of small to mid-sized domestic OEMs. In addition, new business development and customer indications signal a potentially active backdrop across our technology vertical and discrete automation operations entering the second half of fiscal 2026. This includes an expanding position supporting the data center market with our fluid power and flow control solutions tied to thermal management applications. and our automation teams providing robotic solutions supporting material handling applications. Our enhanced technical footprint in the southeast U.S. region following our Hydrodyne acquisition has further strengthened our data center position and related order momentum. Demand signals across our semiconductor customer base also remain encouraging and indicate a potential greater ramp in related orders and shipments during the second half of fiscal 2026 as the wafer fab equipment cycle gains momentum. I would also highlight recent investments we've made in engineering, systems, and production capacity over the past several years that provide significant support to fully leverage these demand tailwinds moving forward. As a reminder, the technology and discrete automation verticals combined represent more than 25% of our engineered solution segment sales and could be an increasing contributor to the segment's growth moving forward based on our initiatives, growing order book, and broader secular tailwinds. In addition, our flow control team is focused on capturing growth developing within life sciences, pharmaceutical, and power generation markets within the US. 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. On a side note, our flow control backlog ended the quarter at its highest first quarter level in over three years. with orders positive year over year. Combined with relatively easy comparisons, we remain optimistic on the setup of our engineered solution segment entering the second half of fiscal 2026 as recent order momentum converts and underlying end markets continue to firm. At the same time, we remain constructive on our ability to lever stronger sales and drive greater earnings growth and EBITDA margin expansion. Our first quarter performance is a good reflection on this. Of note, we achieved 17% incremental margins on EBITDA inclusive of ongoing inflationary pressures including LIFO and unfavorable M&A mix. We believe our underlying business model combined with ongoing operational initiatives and structural mixed tailwinds provide notable earnings growth levers to achieve our mid to high team incremental annual margin target and continue to expand EBITDA margins in a positive sales growth backdrop. In addition, sales growth and EBITDA margins should benefit from ongoing progress developing across Hydrodyne. As we approach our one year anniversary of the acquisition, we are very encouraged by the performance The broader team is delivering and the potential we see ahead. Hydrodyne earnings contribution continues to improve with EBITDA up over 20% sequentially in the first quarter and EBITDA margins improving nicely from the prior six-month trend. We are making strong progress with sales synergies and our teams collaborate and leverage innovative fluid power solutions. This includes connecting Hydrodyne's strong repair and field service support across our legacy MRO customer base, while enhancing their value proposition by providing access to our systems engineering team and complementary product lines. We're also tracking well to our operational synergy streams, including solid progress on harmonizing systems, processes, and operational efficiencies. Combined with a growing backlog and firming demand across their core end markets, we believe Hydrodyne could be nicely additive to our organic sales growth and EBITDA margin trend as we anniversary the transaction into the second half of fiscal 2026. Lastly, we remain on track to have another active year of capital deployment to further supplement our growth potential and shareholder returns. M&A remains a top capital allocation priority for fiscal 2026. Our pipeline is active with varying size targets across both segments. This includes several mid-size targets at various stages of due diligence that could enhance our technical differentiation and value-added service capabilities. In addition, we expect to remain active with share repurchases for the remainder of fiscal 2026 as we balance the cadence of potential acquisitions, our balance sheet capacity, and the value we see across applied from our strategy and long-term earnings potential. At this time, I'll turn it over to Dave for additional detail on our results and outlook. Thanks, Neal.

Just as a reminder before I begin, As in prior quarters, we have posted a quarterly supplemental investor presentation to our investor site for your additional reference as we recap our most recent quarter performance. Turning now to details of our financial performance in the quarter, consolidated sales increased 9.2% over the prior year quarter. Acquisitions contributed 6.3 points of growth, which was partially offset by a negative 10 basis point impact from foreign currency translation. The number of selling days in the quarter was consistent year-over-year. Netting these factors, sales increased 3% on an organic basis. As it relates to pricing, we estimate the contribution of product pricing on year-over-year sales growth was approximately 200 basis points for the quarter. This is up from approximately 100 basis points in the fourth quarter and primarily reflects the effect of pass-through of incremental announced supplier price increases in recent periods, as previously discussed. Moving to consolidated gross margin performance, as highlighted on page 7 of the deck, gross margin of 30.1% was up 55 basis points compared to the prior year level of 29.6%. During the quarter, we recognized LIFO expense of $2.6 million, which was up slightly from the prior year first quarter amount of $2 million. On an end basis, this resulted in an unfavorable five basis point year-over-year impact on gross margins during the quarter. The year-over-year improvement in gross margins primarily reflects positive mixed contribution from our Hydrodyne acquisition, Solitano execution, and benefits from our margin initiatives, as well as more muted gross margin performance in the prior year first quarter. This was partially offset by mixed headwinds from growth in strategic accounts, and lower flow control sales. Price-cost trends were relatively neutral in the quarter. As it relates to operating costs, selling, distribution, and administrative expenses increased 9.7% compared to prior levels. SD&A expense was 19.4% of sales during the quarter. Excluding depreciation and amortization expense, SD&A was 18% of sales during the quarter and down 10 basis points from the prior year. On an organic constant currency basis, SD&A expense was up a modest 0.7% year-over-year compared to the 3% increase in organic sales. During the quarter, ongoing inflationary headwinds and growth investments were balanced by solid cost control and internal productivity initiatives, as well as the benefit of more favorable AR provisioning resulting from our working capital initiatives and collections performance. Overall, stronger organic sales growth, coupled with M&A contribution, favorable gross margin performance, and solid cost control resulted in reported EBITDA increasing 13.4% year-over-year, including over 6% on an organic basis. This resulted in EBITDA margins of 12.2%, expanding 46 basis points from the prior year level of 11.7%, which was above the high end of our first quarter guidance of 11.9 to 12.1%. Reported earnings per share of $2.63 was up 11.4% from prior EPS of $2.36. On a year-over-year basis, EPS benefited from a reduced share count tied to our buyback activity, partially offset by a higher tax rate, as well as 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 4.4% year-over-year on an organic basis when excluding a 10 basis point positive impact from acquisitions and a 10 basis point negative impact from foreign currency translation. The organic sales increase in the quarter was primarily driven by ongoing internal initiatives, firming technical MRO demand, and incremental price contribution. Sales growth was strong across our national account base, reflecting benefits from sales force investments and cross-selling actions. Segment trends also continue to be supported by favorable growth across fluid power MRO sales. Segment EBITDA increased 10.1% over the prior year, while segment EBITDA margin of 13.9% expanded over 70 basis points. This year of year improvement primarily reflects solid operating leverage on stronger sales growth, channel execution, and cost control, as well as more favorable AR provisioning requirements. Within our engineered solution segment, sales increased 19.4% over the prior year quarter, with acquisitions contributing 19.8 points of growth. On an organic basis, segment sales decreased 0.4% year-over-year. The modest decline was primarily driven by muted sales trends during September across our flow control operations, reflecting softer project-related shipments. In addition, Sales growth across our technology vertical was softer than expected in September, primarily tied to more gradual order conversions across the semiconductor market. We view this as timing-related, considering backlog trends, customer indications, and broader sector tailwinds, as Neil highlighted earlier. Sales across industrial and mobile fluid power markets were also lower year-over-year, however, The decline was more modest and improved notably from fiscal 2025 trends, primarily reflecting easier comparisons and affirming OEM customer demand. Sales across our automation businesses increased organically for the second straight quarter, with organic growth of 4% year-over-year, driven by solid robotic solutions demand in the U.S. business. EBITDA increased 16% over the prior year, reflecting contribution from our Hydrodyne acquisition, as well as solid cost management, which was partially offset by modestly lower organic EBITDA on muted sales trends in the quarter. The segment EBITDA margin of 13.8% was down roughly 40 basis points from prior year levels, primarily reflecting unfavorable acquisition mix and lower flow control sales. That said, we expect segment EBITDA margin trends to improve as acquisition mix headwinds ease and segment sales improve. Of note, Hydrodyne's EBITDA contribution continues to increase as we progress along our integration and synergy initiatives with its financial performance tracking to our first year guidance of $260 million in sales and $30 million in EBITDA with growth and synergy momentum providing upside support into the second half of fiscal 2026. Moving to our cash flow performance, cash generated from operating activities during the first quarter was $119.3 million, while free cash flow totaled $112 million, representing conversion of 111% relative to net income. Compared to the prior year, free cash was down slightly, reflecting greater working capital investment balanced by ongoing progress with internal initiatives. From a balance sheet perspective, we ended up September with approximately $419 million of cash on hand and net leverage at 0.3 times EBITDA, which is above the prior year level of 0.1 times. Our balance sheet is in a solid position to support our capital deployment initiatives moving forward, including accretive M&A, dividend growth, and opportunistic share buybacks. During the first quarter, we repurchased approximately 204,000 shares for $53 million. Turning now to our outlook, as indicated in today's press release and detailed on page 12 of our presentation, we are modestly raising full-year fiscal 2026 EPS guidance to reflect first quarter performance and updated diluted share count assumptions following the first quarter buyback activity. We now project EPS in the range of $10.10 to $10.85 compared to prior guidance of $10 to $10.75. That said, we are maintaining our sales guidance of up four to 7%, including up one to 4% on organic basis, as well as EBITDA margins of 12.2 to 12.5%. Guidance continues to assume 150 to 200 basis points of year-over-year sales contributions from pricing. Our sales outlook remains largely unchanged from the views we provided in mid-August. We believe end-market trends are moving in the right direction, and we are encouraged by positive order and business funnel momentum. However, we continue to assume industrial activity remains mixed near-term and we expect ore conversion across our engineer solutions backlog to be more weighted toward the back half of our fiscal year. Combined with sales trends in October, we currently project fiscal second quarter organic sales to increase by a low single digit percent over the prior year quarter, with service center segment growth above the engineer solutions segment. This is consistent with the midpoint of our initial guidance provided in mid-August, It implies underlying sales trends remain relatively stable in the second half of our fiscal year at the midpoint. We also acknowledge the low end of our sales guidance would imply a softening market in the back half of the year. We view this as little probability based on our indicators and performance to date. However, consistent with our typical approach to guidance, we believe it remains prudent to maintain our full year range at this early point in the year pending greater clarity and less volatility across the macro and trade policy backdrop. Overall, we are running in line with our sales expectations year to date and remain constructive on our setup moving into the second half of the year. Lastly, from a margin standpoint, we are encouraged by our first quarter performance and reiterating the outlook provided in mid-August. We continue to assume ongoing inflationary pressures and growth investments as well as $14 to $18 million of LIFO expense. For the second quarter, we expect gross margins to increase slightly on a sequential basis and EBITDA margins of 12 to 12.3%. I would note that we face a difficult year-over-year gross margin and EBITDA margin comparison in the second quarter. Our prior year second quarter margin was favorably impacted by more modest LIFO expense of $0.7 million and non-routine supplier rebate benefits, as well as record performance across our engineered solution segment tied to favorable mix. We expect stronger relative year-to-year EBITDA margin trends in the second half of the year, reflecting greater expense leveraging and ongoing hydrodynamic synergy progress, as well as the potential for more favorable mix dynamics. With that, I will now turn the call back over to Neal for some final comments.

So to wrap up, we are encouraged by our first quarter performance, including stronger top line trends, sustained positive order momentum, and margin execution. We continue to have many self-help growth and margin opportunities that we expect to manifest in coming quarters and provide ongoing support levers. That said, we expect near-term sales to remain choppy as customers balance production schedules, project phasing, and capital investments into the seasonally slower fall and winter months, particularly as broader trade policy uncertainty continues to linger. Importantly, we believe the underlying fundamental backdrop within our core in markets is moving in the right direction. and has the potential to gain momentum as the year progresses. Feedback and sentiment from customers is gradually improving. Demand indications are more favorable across both traditional end markets, such as metals and machinery, as well as emerging verticals, including discrete automation, life sciences, and technology. We're seeing encouraging funnels across both our segments, that should translate into incremental order growth as additional trade policy clarity emerges, interest rates continue to moderate, and capital investment decisions are finalized. Certain U.S. industrial macro data points have trended more positive in recent months, including machinery and metals new orders, as well as mining production, which have traditionally correlated well with our underlying core business. While ISM readings remain in flux, we believe the elongated sub-50 trend is positioned to move higher when considering leaner inventories and potential benefits from pro-business policies. In addition, qualitative data points around planned investments in North American manufacturing infrastructure and onshoring continue to broaden while our customer service requirements are growing. as they face technical labor shortages and an aged equipment base. We are well positioned to capitalize on these trends given our domain knowledge and scale across industrial facilities core capital equipment. This includes our expertise around critical motion and powertrain products in demanding applications, access to premier supplier brands and nonstandard components, nationwide local service reliability. In addition, we have leading channel position in providing advanced robotics, machine vision, and high-tech fluid power systems. Combined with our network of service shops, technicians, and engineers, we're positioning our strategy and teams to play an increasingly critical role in linking legacy industrial production infrastructure and processes with new advanced applications and technologies, both now and into the future. Lastly, our balance sheet and liquidity provide strong support to opportunistically pursue ongoing organic investment and strategic M&A in the current environment, as well as other capital deployment that could augment returns for all stakeholders going forward. Once again, we thank you for your continued support. And with that, we'll open up the lines for 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, followed by the number 1 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. Your first question comes from the line of David Matty with Baird. Please go ahead.

Yeah, thank you. Good morning, guys. My first question, first a comment. I mean, the business seems to be tracking really well, and I appreciate the conservative guidance given the many headwinds. Along those lines, as we look forward here into the December quarter, Christmas is on a Thursday this year, which makes it kind of tough for that Friday, December 26th, between the holiday and the weekend. Just wondering if you've been hearing anything from your customers in terms of holiday shutdowns as they look forward to the end of the year.

I would say at this stage still a little early. We plan to be working. I'd say that for one. But I think a mini dialogue with our customers, they're starting to look at projects, plan maintenance, activity, out for and looking forward to what they think will be ongoing demand requirements for them. So we're aware of the midweek seasonal holiday dropping in that. a little early, but I'm expecting some customers are going to be leaning in and active as they look forward at demand requirements, and some others may take some time out, but that also opens up doors for additional planned project maintenance.

Hey, Dave, this is Ryan. I just would add to, you know, that dynamic is taken into account in terms of the second quarter guide that we provided as it relates to maybe some impact from the holiday timing. We do have an easier comparison in the month of December, which could balance some of that as well.

Great. I can't promise I'll be in the office on the 26th, but I'm glad to hear you guys will. Second question is, Neil, in the past, you've mentioned that inflation is manageable if your suppliers, A, increase the price as opposed to putting through a surcharge, and B, give you 45 days notice to push that through to the customer base. One of your distribution columns recently noted a compressed supplier notification periods, and I'm just wondering if you've noticed anything, any different behavior from your supplier base along those lines.

David, I'd say overall no real difference in behavior. I would say the orderly, the increases have been orderly notifications. Obviously, team is doing a very nice job in implementing across, you know, price cost and in the quarter equal into that side, we did see price contribution, you know, increased a couple hundred basis points in that. We're looking at perhaps there'll be the 232 on derivative products, but I think there are some manufacturers, a few moved, and I think some others are just contemplating looking at country of origin and what the impact will be and when that will come through as a price increase. And so some will organize that for the beginning of the calendar year with a typical notice period. I'd say overall it continues to be an orderly environment. Teams are focused. We know how to execute, and we'll continue to do so.

Sounds great. Thank you.

Your next question comes from the line of Brett Lindsey with Mizuho. Please go ahead.

Hey, good morning, guys. This is Peter Coston for Brett. But I think you had said previously that engineered solutions would outperform service center by about 100 basis points in fiscal 26. Is this still something that's possible with a stronger second half? Are you expecting a more balanced organic mix now?

Thanks. Yeah, I would say as we look at the second quarter, I could see service centers continuing to be ahead. And then as I look at the second half of the year, we could see engineered solutions with the order backlog project conversions to be greater than the service centers in the second half of fiscal 26.

Yeah, Peter, I'd say that assumption for the full year is still in line with our guidance as it relates to overall the engineered solution segment around 100 basis points.

Awesome, thank you. And then maybe just on consolidated incrementals, as you get, you know, engineered solutions comes back and hydrogen's less diluted, could you actually see upside to incrementals as we go into the second half?

Yeah, we think there could be the setup, also a broadening of local counts, you know, greater engineered solutions. So I think clearly that potential exists.

Awesome, thank you guys. Your next question comes from the line of Sabrina Abrams with Bank of America. Please go ahead.

Hey, good morning everyone. Morning. Can you help me understand, like the orders growth has been quite good for the past few quarters in both fluid power and I think on the flow control. And my understanding is, You know, the projects, the lead times are not particularly long, maybe 180 days or less. So just trying to understand the dynamic when these orders do turn positive and when you do convert out of backlog, are customers delaying? Because it seems like it's taken longer than usual. Thank you.

No, Sabrina, I would say there's just variance in projects on the time to convert. based on sometimes complexity of the project or the overall status of the project and the schedule and where we sequence into that. So I'm encouraged by the continuous orders expansion into that. Fluid power was up nicely, 9% in the quarter. Flow control, nice order growth in as well. I think there is some pivot in some of the projects where previously they would add projects around carbon capture and some other activity. There's a little more around power generation, life science, and pharmaceuticals, but we're encouraged that that work will continue to be in the U.S. markets. And then on the automation side, we had a tough comparable. plus 25% from an order standpoint last quarter, down slightly on order this side, but a two-year stack that's over 23%. We take that as very encouraging across our discrete automation opportunities in robotics and vision. So good coming input on projects. We expect the conversion will be occurring. Some of it may sequence more in with calendar year end into the second half of our fiscal 2026, but we've got a good pipeline to execute on.

Okay, great. Thank you. And just want to ask again about pricing. I think last quarter the thought was that pricing would ramp through the year with Q1, maybe not quite. It seems like pricing came in better than what we had spoken about. Have you changed how you are thinking about the cadence of pricing throughout the year? Because it seems to me not raising the pricing guide seems like you're being conservative here. Thank you.

Yeah, I think Sabrina were just early into it. You know, we did come in at the 200 basis points. We've guided to 150 to 200 basis points. Could it develop more as we look out? I think that'll be. a little bit contingent on market activity and the rate of additional supplier increases at that time. So, hey, we think coming off setting those expectations mid-August to looking at now, perhaps it's a little early to say it'll ramp beyond the 200 basis points that we had in the quarter.

Thank you. I'll pass it on.

The next question comes from the line of Ken Newman with KeyBank. Please go ahead.

Hey, good morning, guys.

Good morning.

Good morning. Maybe for my first one, Neil, on the engineer solution side, it's good to hear the orders there are improving. I'm just curious, you know, do you have any color on what you're seeing out of that segment through October? Any help on, you know, whether that's kind of improving from what you saw at the end of September with, you know, maybe a fall off in activity there and Just confidence on the timing of the conversion of that backlog.

Yeah, we continue to see good order activity. Teams are engaged in working on that order conversion and working on those projects. I would say also there is an MRO component in those businesses that we're working on. A little bit of the flow control group as they work through chemicals, perhaps there's a little bit of softness on the MRO side that played into the quarter. We expect that to continually improve, especially as we get into calendar 2026 with that interaction of customers. And then I just think that the setup and the dialogue, and we touched on it in the remarks, I think there's greater wafer fab equipment activity in calendar 2026. We know there's increased life sciences and pharmaceutical interest on that side. Our participation in data centers continues to grow and things that we're doing in thermal management liquid cooling but also our robotic solutions in that so I'm encouraged that our engineered solutions business has great breadth when an end market is shifting or changing the teams are very focused on being where growth is occurring and positioning ourselves very nicely. So as we work through the second quarter, we feel very good about the second half of fiscal 2026.

Got it. That's helpful. And then just thinking about capital allocation, it was good to hear that the pipeline is still pretty active for M&A. You did buy back some stock this past quarter. How do you think about the priorities or the opportunities to put capital to work here in the second quarter or into the back half, and with automation starting to pick up on demand, is that making it easier or harder to get deals done?

I would say a few things here. Priorities remain, right? We very much are going to be focused in funding our organic growth opportunities like we have to support automation, and our fluid power technology segment businesses in that. So we'll continue to have organic growth also in systems. M&A remains a priority. We are active, busy on multiple fronts. Pipeline continues to have bolt-on opportunities in both segments as well as some mid-size opportunities. So we'll continue to be busy on that front. then we'll have other ways to return capital to the shareholders, increasing dividend, as well as remaining active in share repurchase. So we think we're in a good position, continuing strong cash generation in that area. And I don't think the deal environment is, you know, more difficult in that front. We're going to continue to be a disciplined acquirer. We have clear priorities. We work to have ourselves in good positions when those opportunities arise. We say we can't perfectly control timing, but we feel good about our setup and opportunities for increased capital deployment in 2026.

Your next question comes from the line of Chris Danker with Loop Capital Markets. Please go ahead.

Hey, morning, guys, and congrats on a nice start to the year here. I guess, first off, I'm looking at the margin guidance, calling for gross margins up a little bit sequentially. Nice to see that. I guess I appreciate the year-over-year comp headwinds from rebates and mix and whatnot, but why wouldn't the EBITDA gross margin or excuse me, the EBITDA margin improve sequentially as well? What are some of the sequential offsets that we should be thinking about?

Yeah, I think as you get in, Dave touched on a little bit as we think about LIFO. LIFO expense in the second quarter last year, $700,000. As we think about LIFO this time, it could perhaps be $4 million or greater into the side. So I think that is one different point. Dave touched on the non-routine rebate. that would have occurred last time and then perhaps some of the mix headwinds. Still the M&A integration is lower as it would come in for now into that front and then I think on a little less engineered solutions in the quarter and perhaps Local accounts on the service center side ramping, but ramping less than some of the national accounts will all be influences on that side.

Beyond that, Chris, we did see some modest benefit in the first quarter. You recall we took some, you know, provisioning charges in our Q4 based on our formulaic approach with customers and a couple payment delays. You know, vast majority that came back to us in the quarter. So that was a. a modest, you know, benefit as well that would play through to EBITDA, you know, versus, you know, beyond the gross margin step-up that we talked about.

And then I think, Chris, right, if we look past the second quarter, we feel like we've got a nice opportunity for greater expense leveraging in the back half of our year, probably increased in ongoing contributions from hydrodine, and then potentially mixed benefits that we would get there of, greater engineered solutions as well as local accounts as we think about the back half of the year.

Got it. Thanks so much for the call there, guys. I guess just as a follow-up, you know, thinking about the hydrogen synergies, anything you can give us there in terms of is that still on track from both a cross-selling and a cross-reduction perspective? Any anecdotes in terms of cross-selling wind you highlight there?

Yeah, so I would say on track to deliver first year synergies. So we feel good about that. You know, growing opportunity on the cells and the repair. So they have very good capabilities there. And so we would see it on the on the maintenance side, cylinder repair and other opportunities just where we have capability and resource in an important geography. And then continued progress on the work streams on the cost side. You know, use of technology in that front, standardizing on some processes, supporting them with internal back office capabilities in that front, all of those developing nicely. And then as we think about ongoing growth, they're well positioned from a data center standpoint. We think there's more we can do there. and then how we support them from a central engineering standpoint, especially as fluid power technologies continue to increase around electrification and some of those electronics and controls can be positive as well on the growth side as we look forward.

Got it. Thanks so much.

We did highlight, too, in the comments, Chris, the EBITDA for the quarter did step up another 20% sequentially following the increase that we saw in Q4. So continue to be pleased with the progress the team's making there.

Agreed. Sounds good. Thank you.

Your next question comes from the line of Patrick Sechardt with Oppenheimer. Please go ahead.

Thanks, guys. I wanted to ask about automation growth in engineered solutions. Can you contrast how much of the positive sales growth is secular market pickup versus internal initiatives and or market share impact?

Well, hey, I think it's still early. We got a good run rate of the businesses, probably scaling nicely at $250 million or so. So we're doing a nice job in ramping I think we are opening and serving more industrial customers opportunities with these capabilities as well as participating in some nice projects around traditional industry segments. So we expect robotics as a general market to continue to grow and we're well positioned there, both collaborative and autonomous mobile robots into the side, but we're also doing a nice job in the vision offering and where customers can see the benefits of quality control and inspection and what those solutions provide in there. So I think it's a combination, Pat, that we're just a well-positioned, we're opening up more opportunities with existing customers as well as serving traditional verticals

with those companies that they had previously and growing them okay thanks uh and you talked about cross-selling as an organic driver um and you've mentioned in the past these initiatives were in the early innings of getting going so just looking for an update there what are you guys seeing in terms of revving that cross-selling tool overall yeah i'd still say uh we characterize it as early innings our funnels are growing project opportunities are expanding

Teams will be together in the coming weeks to further that planning and execution. Some key suppliers there as well. So pleased with the progress. We know we have even more impact that we can have with our customers. And as the customers deal with aging equipment, perhaps an aging technical workforce, They're looking for someone to help them on broader needs, broader solutions, and we're well positioned to continue to do that.

And if I could just squeeze one more in, you talked about some of the sequential margin dynamics in the guide, but I wanted to dig a little bit deeper on the top line. You mentioned demand is stable. The engineered business had positive book to build this quarter, but the guide implies the second quarter might be down slightly sequentially versus normal seasonality of low single digits. So just kind of curious if there's anything we should consider there.

Patrick, I would say nothing different than how we typically think about it. The guide for the second quarter top line is in line at the midpoint with what we guided in August. We continue to expect a choppy environment. as we talked about in the prepared remarks around the slower seasonality. Also, I was earlier talking about the timing of holidays, taking that into account as well. And then just the backlog conversion of the engineered solution segment, we expect that to be more of a back half weighted dynamic. And so taking that into account, but really is no change to how we viewed the year setting up in the original guidance that we established in August.

Okay, thanks, guys. I'll pass it on.

Your next question comes from the line of Sam Darkach with Raymond James.

Please go ahead. Good morning, Neil, Dave, Ryan. How are you?

Good morning. We're good.

Apologize if you mentioned this earlier and I missed it. I was kicked off the call midway through. First, your end market vertical commentary was fairly similar to your number one competitor with a couple of exceptions, which would be pulp and paper and oil and gas, which you called out as favorable and they called out as headwinds. What's specifically happening in those two particular verticals that's conceivably allowing you to pick up some incremental business?

Yeah, I don't know that I've got, you know, great comparison contrast in that. I think a broadly energy markets seem to be active in doing well. uh, into the, into the side and just paper, you know, we got a good position and we continue to look at how do we create a value add, uh, for those customers and perhaps expand our offering and capabilities with them. But in a comparison contrast, I don't know that I had anything else to point out.

Yeah. And my, my last question, um, and again, I'm sorry if you, if you've already mentioned this, um, the 2% pricing,

that you realized in the quarter how would that break out service center versus versus engineered yeah yeah uh sam i'd say relatively similar not a huge change or difference um in the advice segment if i had to push it one way maybe a little bit higher in the in the service center side of the business but pretty consistent are there particular product categories or verticals in which

pricing was more pronounced? I'm guessing product categories more so than verticals?

Yeah, nothing that we would call out as materially different. I mean, it's been generally a pretty broad-based impact across the product. And you're seeing inflation as well as just general price updates come through really across the board. So nothing that we would call out as materially different in one category versus the other.

So as an example, then, what I'm getting at, I guess, is bearings is not like, you know, something steel-related or something along those lines would not be a material outlier?

No. I mean, I think in the context of really our core products in general, a lot of steel content across all of them, you know, particularly on the service center side. So we would not call out bearings as an overweight in terms of what we're seeing from a pricing standpoint right now.

Okay. Thank you very much, guys.

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

I just want to thank everyone for joining us today, and we look forward to talking with you throughout the quarter. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.