Applied Industrial Technologies Inc (AIT) 2020 Q4 法說會逐字稿

Welcome to the Fiscal 2020 Fourth Quarter Earnings Call for Applied Industrial Technologies. My name is Michelle, and I will be your operator for today's call. (Operator Instructions) 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.

Thanks, Michelle, 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, including the potential impact from the COVID-19 pandemic as well as trends in 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, in the conference call we will use non-GAAP financial measures, which are subject to the qualifications referenced in those documents.

Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer; and Dave Wells, our Chief Financial Officer.

With that, I'll turn it over to Neil.

Thanks, Ryan, and good morning, everyone. On behalf of our entire team at Applied, we hope you and your families are healthy, safe and managing well.

I'll start today with a brief operational update, including our ongoing actions and response to the COVID-19 pandemic as well as what we're seeing across our business in this fluid environment. Dave will follow with a summary of our financials and some specifics on our fourth quarter and outlook, and then I'll close with some final thoughts.

I first want to take a moment to thank our entire Applied team for their strong effort and support throughout our fiscal 2020. I'm proud of what we've accomplished and how we've responded, particularly over the past several months as we face an unprecedented environment from the pandemic and managed to slower demand within our core end markets. It's inspiring to see how we've stepped up to the challenge collectively and remain focused on driving value across our customer and supplier base.

Our top priority remains the well-being of our associates, customers, suppliers and business partners as the COVID-19 pandemic continues to evolve. We've quickly adapted our operations and embedded various safety measures allowing us to swiftly adjust to our customers' requirements and solidify our supply chain. All our operations and facilities have remained open and fulfillment at our distribution centers and local service centers remains efficient. Our operating model and sales team has shown tremendous flexibility, effectively leveraging virtual communication platforms, system investments made in recent years and our multichannel capabilities. The resilient nature of our value proposition is apparent across many facets of our company, from the motion control products we provide for critical break/fix MRO applications throughout essential industries such as food and beverage, agriculture and pulp and paper, to leading fluid power solutions, including electronic control integration, driving greater safety and precision as well as pneumatic solutions supporting various areas of technology, life sciences and sustainability. Our position is further strengthened by our team at Olympus Controls, who are addressing greater safety and productivity requirements in the COVID-19 environment through leading next-generation automation solutions.

We're also gaining traction with our cross-selling opportunity focused on further penetrating our Fluid Power, Flow Control, automation and consumable solutions across our legacy service center customer base. Of note, we are experiencing greater quoting activity and sales of Flow Control products and solutions across our service center network over the past several quarters. We're also encouraged by initial progress in identifying and developing opportunities aimed at connecting Olympus Controls automation capabilities across traditional industries.

Our cross-functional teams are laying a foundation that is driving greater customer awareness at various strategic accounts, particularly as the environment cycles and customers look to consolidate spend with fewer, more capable providers that are already critical to their direct production infrastructure. We're still in the early innings of this cross-selling opportunity, which, we believe, is meaningful and should drive incremental growth into fiscal 2021 and beyond.

Importantly, through the evolving backdrop over the past several months, our business and entire Applied team has shown powerful durability. Our operating discipline and prompt cost actions have allowed us to quickly align expenses and manage working capital within this slower environment, driving mid-teen decremental margins, record cash generation and improved liquidity during our fiscal fourth quarter. We're encouraged by the execution across our team in recent months, which provides solid footing entering fiscal 2021. As expected, the broader demand environment remained challenging throughout our fourth quarter as customers implemented shelter in place orders, reduced production closed facilities and deferred project activity.

By month, organic daily sales declined by a high-teens percentage rate year-over-year during April and May, followed by a low 20% decline during June despite a slight sequential improvement in daily sales rates. Organic sales to date in our fiscal first quarter of 2021 are down by a mid-teens percentage year-over-year. When considering prior year comparisons by month and typical seasonal progression, we would characterize underlying sales as generally stable to slightly stronger since bottoming in May.

Weakness remains pronounced across many of our core manufacturing end markets. This includes heavy industries such as machinery, metals, oil and gas and transportation. While more customers are bringing facilities back online following shutdowns in recent months, the pace remains gradual and balanced by adjustments to production schedules and working capital discipline.

In addition, while we are selling greater amounts of safety and janitorial supplies to customers given COVID-19, this product category represents a small portion of our business and was less than 5% of our overall sales during fiscal 2020. There are, however, some positive signs in recent weeks worth noting. In particular, order rates have gradually improved across our Service Centers since early July. We're starting to see greater maintenance activity and break/fix demand from heavy industry customers as production gradually ramps and safety buffer stock is depleted, following what we believe was some unusual pandemic-driven pre-buying during April.

Combined with our increased orders across our consumables business and improving industrial sentiment such as indicators like PMI, which typically lead our core business, we believe industrial activity is firming and the worst is behind us. Ultimately, as industrial production regains momentum, we believe our customer requirements will be meaningful, following a prolonged period of idle production and maintenance deferrals on critical equipment and infrastructure.

That said, visibility remains limited and uncertainty still exists around the speed of recovery as customers continue to manage operations around a still-evolving pandemic and macro outlook. As such, we remain focused on managing expenses and are extending various cost actions we outlined last quarter into early fiscal 2021. These actions include temporary pay reductions and furloughs as we align to current business conditions while preserving jobs. We understand our requirements and will remain disciplined as the cycle continues to evolve.

That said, these actions are not easy, and we intend to proactively reverse them where appropriate as soon as possible, given the inherent value our associates bring to this organization, into our growth opportunity going forward.

With our business model showing durability in our fourth quarter, our balance sheet in a strong position and initial signs of a recovery ahead, we will take an offensive approach into fiscal 2021.

Now at this time, I'll turn the call over to Dave for additional detail on our financial results and outlook.

Thanks, Neil. Before I begin, I will remind everyone that a supplemental investor deck, which recaps key financial performance and discussion points, is available on our Investor site for your additional reference.

To provide more detail on our fourth quarter results, consolidated sales decreased 17.9% over the prior year quarter. Acquisitions contributed 1.5% growth, partially offset by an unfavorable foreign currency impact of approximately 1%. Netting these factors, sales decreased 18.4% on an organic basis with a light number of selling days year-over-year.

Turning to sales performance by segment. As highlighted on Slide 7 and 8 in the deck, sales in our Service Center segment declined 22.3% year-over-year or 21.1% on an organic basis. Lower industrial production activity and customer facility closures from COVID-19 precautions drove reduced MRO needs across the majority of our Service Center customer base during the quarter.

Weakness was particularly acute within metals, mining, oil and gas, machinery and transportation end markets, partially offset by more resilient demand within food and beverage, pulp and paper, forestry, electronics and chemical industries as well as growth in our Australian operations.

Within our Fluid Power & Flow Control segment, sales decreased 6.8% over the prior year quarter with our August 2019 acquisition of Olympus Controls contributing 5 points of growth. On an organic basis, segment sales declined 11.8%, reflecting lower Fluid Power sales with an industrial OEM and mobile off-highway applications as well as weaker Flow Control sales from slower project activity. This was partially offset by Fluid Power sales growth within the technology end market during the quarter.

Moving now to margin performance. As highlighted on Page 9 of the deck, gross margin of 28.7% declined approximately 40 basis points year-over-year or roughly 70 basis points when excluding noncash LIFO expense of $0.8 million in the quarter. This compared favorably to prior year LIFO expense of $3.4 million. Gross margin performance was largely in line with our expectations with year-over-year declines, primarily reflecting unfavorable mix tied to softer sales across our local Service Center accounts, coupled with a greater mix of lower-margin project business in our Canadian operations as well as lower levels of vendor support attributed to softer volumes. These headwinds were particularly -- were partially balanced by our margin expansion initiatives, stable price cost dynamics and positive Fluid Power & Flow Control segment performance.

While we expect some of these headwinds to persist near term, we remain focused on driving annual gross margin expansion as demand levels normalize, reflecting benefits from our systems investments, the positive contribution of expansionary products, strategic growth from our technical service-oriented solutions and initiatives to expand business across our local customer base.

Turning to our operating costs. On an adjusted basis, selling, distribution and administrative expenses declined 13.8% year-over-year, excluding $1.5 million of nonroutine costs in the quarter, $1 million of which was recorded in our Service Center segment and $0.5 million in our Fluid Power & Flow Control segment. These costs include severance and facility exit costs related to actions implemented in response to the weaker demand environment.

Adjusted SG&A expense declined nearly 16% over the prior year on an organic basis when excluding operating costs associated with our Olympus Controls acquisition. As highlighted last quarter, we implemented various actions to align expenses with lower demand. These include restricting T&E overtime, temporary labor and consulting spend as well as staffing alignments, implementation of furloughs and pay reductions and the temporary suspension of the company's 401(k) match.

While material and difficult, our team displayed great discipline and swiftly executed these requirements across the organization. As a reminder, this includes a mix of both structural and temporary cost actions as we continue to assess the environment.

With the demand outlook still soft and uncertain, we remained focused on managing costs near term and have extended the temporary cost actions into our current fiscal first quarter of 2021. That said, we will be balancing these cost alignments into our fiscal first half as we look to execute on our strategic growth initiatives and requirements to ramp and effectively respond as recovery continues to unfold.

Adjusted EBITDA in the quarter was $64.8 million, down roughly 26% compared to $87.6 million in the prior year quarter, while adjusted EBITDA margin was 8.9% or 9%, excluding noncash LIFO expense in the quarter.

On a GAAP basis, we reported net income of $30 million or $0.77 per share, which includes the $1.5 million of previously referenced nonroutine costs on a pretax basis.

On a non-GAAP adjusted basis, excluding these costs, we reported net income of $31.1 million or $0.80 per share, down $39.8 million or $1.02 per share, respectively, in the prior year quarter.

Moving to our cash flow performance and liquidity. During the fourth quarter, cash generated from operating activities was $127.1 million, while free cash flow was $123.2 million or nearly 4x adjusted net income.

For full year fiscal 2020, we generated record free cash flow of $277 million, representing 186% of adjusted net income and up over 70% from $162 million in the prior year. The strong cash performance during the quarter and the full year reflects ongoing contribution of our working capital initiatives as well as the countercyclical cash flow profile of our business model.

Given the strong cash flow performance in the quarter, we ended June with nearly $269 million of cash on hand, with over 80% of that unrestricted U.S.-held cash. Our net debt is down 22% over the prior year, and net leverage stood at 2.3x adjusted EBITDA at quarter end, below the prior quarter level of 2.5x and the prior year level of 2.6x.

We are in compliance across our financial covenants with cushion at the end of June, following the solid quarter of cash flow performance.

During July, we utilized excess cash to pay off a $40 million private placement note that came due. The paydown of the note, which had a 3.2% fixed rate, will drive additional cash interest savings into fiscal 2021. We have now paid down roughly $170 million of debt since early 2018, including $55 million within the past 7 months. In addition, our revolver remained undrawn with approximately $250 million of capacity and an additional $250 million accordion option. Combined with incremental capacity on our uncommitted private shelf facility, we remain in a positive liquidity position. Capital deployment near term, we'll continue to focus on preserving liquidity and opportunistically paying down debt, though our M&A initiatives and related pipeline remain active. Our focus remains on smaller bolt-on targets that align with our growth priorities, including Fluid Power, Flow Control and automation opportunities.

Transitioning now to our outlook. As noted in our press release, we are refraining from providing formal full year fiscal 2021 financial guidance at this point due to ongoing uncertainty around the impact of the COVID-19 pandemic. Visibility remains limited on how customers will proceed with operations, particularly if an additional wave of infections materializes into the fall and winter months. As such, we believe it more productive to be transparent on how our operations are trending to date and provide near-term directional guidance as appropriate, pending greater clarity on the macro trajectory, particularly when considering the unique nature of this downturn.

With that as a backdrop, assuming underlying demand remains consistent with July and early August trends for the remainder of the quarter, we expect fiscal first quarter 2021 sales to decline 17% to 18% organically year-over-year. This includes an assumption of high teens organic declines in our service center segment and mid-teen declines in our Fluid Power & Flow Control segment.

As a reminder, we will have roughly half a quarter of inorganic contribution from Olympus Controls, which was acquired in mid-August of 2019. At this sales level, we believe high-teen decremental margins is still an appropriate benchmark to use near term. This takes into consideration our cost actions and emerging growth and operational requirements as we position around the recovery.

In addition, to provide a frame of reference and some direction for your full year modeling, assuming sequential daily sales patterns are consistent with average historical trends, this would imply year-over-year sales declines do not materially improve until the second half of our fiscal year with a return to year-over-year organic growth in our fiscal fourth quarter. Again, this assumes sequential trends in the daily sales rates that are similar to historical seasonal patterns and can certainly vary depending on the direction of the industrial cycle, the broader economy and execution of our growth initiatives going forward.

Lastly, we believe an effective tax rate of 23% to 25% remains an appropriate assumption near term.

From a cash flow perspective, keep in mind, our free cash generation is typically softer in the first half of our fiscal year, reflecting modest seasonality. As such, we expect moderation from record fourth quarter levels sequentially near term. We also expect potentially greater working capital requirements in the fiscal 2021 as we look to support growth and the recovery -- as the recovery of the year plays out.

Our capital and CapEx requirements remain limited with fiscal 2021 targeted at $15 million to $20 million of capital spend.

Overall, we are encouraged by our fiscal 2020 cash performance, which provides further evidence of our strong cash flow profile, including benefits from working capital initiatives and improving margin profile in recent years. We remain confident in our cash generation potential going forward and reiterate our normalized annual free cash target of at least 100% of net income.

With that, I will now turn the call back over to Neil for some final comments.

Thanks, Dave. As we enter fiscal 2021, we see a significant opportunity ahead as we leverage our industry position as a leading technical distributor around new and emerging growth opportunities. While we're facing a challenge as the industrial economy transitions from a generational pandemic, we have a remarkably strong business model that generates cash and adapts well throughout the cycle as we demonstrated in our fourth quarter. This foundation will provide significant support to navigate through the near-term headwinds while staying focused on our strategic initiatives, aimed at positioning and adapting the company for stronger organic growth relative to our legacy trends, greater free cash generation and improved returns on capital in the coming years.

I strongly believe our greatest opportunity is now in front of us, considering our cross-selling potential, customers' increasing technical needs, potential greater U.S. industrial production requirements and likely ongoing, if not accelerated, industry consolidation in coming years. Our value proposition puts us in a unique position to emerge as a leading growth beneficiary from these tailwinds. We plan to leverage our comprehensive suite of technical products and solutions as we expand into emerging areas of growth from an ever more sophisticated, automated and connected industrial supply chain. These growth opportunities, combined with our operational excellence initiatives, expansion of our shared services model and leveraging our systems investments, will further solidify our ability to expand margins in coming years.

Long term, we remain committed to our financial targets of $4.5 billion in sales and 11% EBITDA margins. While the timing of these goals is dependent on the industrial cycle trajectory, I believe they are within Applied's reach and provide the framework for significant value creation as we execute our strategy going forward.

To our customers and suppliers, our message is clear: we are the leading stand-alone distributor of industrial motion, power and flow technologies, with growing capabilities across next-generation automation and Industry 4.0 solutions. We have the most comprehensive portfolio and technical service capabilities, premier engineered solution expertise and greatest track record of consistency and commitment to this vital space. We are investing for the future, developing best-in-class talent and focused on solidifying Applied as the imminent return-enhancing channel for your critical industrial supply chain products and solutions. We're here to serve and partner with you during these unique times and what will be fast-moving and dynamic environment going forward. Once again, we thank you for your continued support.

And with that, we'll open up the lines for questions.

(Operator Instructions) Your first question comes from Quinn Fredrickson from Baird.

So my first question is just on trends in the Service Center business. It seems like most of the recovery and momentum since April has been in the Fluid Power & Flow Control, whereas the Service Center business has stayed kind of steady. Is that just a function of more local customers in the service center than in the Fluid Power & Flow Control or a heavier mix of the heavy industries? Is there other reasons why the Service Center hasn't seen that same recovery?

I'll start. I would say one would be the participation and presence with the heavy industries. And so we think about metals, mining, oil and gas, machinery and transportation, that would be heavy participation there. Since the beginning of the fiscal year, we have seen some improvements in order rates and trends. But it has been a little modest and gradual as we've gone through. And then from the various shelter in place and customers coming back, the local customers perhaps have been a little slower to do that across some of the varieties. So you are correct in thinking that is an input on Service Centers.

Okay. And just secondly, on gross margin. Just any color you could provide on the near-term outlook? You've obviously got the continued point of sales and product mix tailwinds, plus maybe some further volume recovery in local customers. Would your expectation be that gross margin is slightly higher sequentially, but still down on a year-over-year basis in the first quarter?

Yes. I think, to start, as we move through play a good benchmark is, sequentially, I think, relatively unchanged. If we look, probably, a driver on gross margins was mix and local accounts. But we think coming through sequentially unchanged. And if I look at the comparison ahead year-over-year from last year, it will be a little more -- a little bit more challenging as we go through the first quarter. But I would think sequentially kind of unchanged as we start the fiscal year.

I'd just elaborate that Q1 is our toughest year-over-year comp. We were at 29.4% last year. But you're getting -- the fundamental's still there and expect to see that trend improve then as we start to see that local account mix come back.

And you next question will come from Michael McGinn from Wells Fargo.

I just want to walk through the margin incremental target. So you're taking additional temporary cost actions, but it seems like it's stagnant at that high-teens decremental. Can you just walk me through the math or the structure on why -- what could push you to maybe mid-teens or even below that?

We've talked to the high teens. We delivered a 15% decremental here in the most recent quarter. We do have some costs that come back in, in terms of bonus targets, things of that nature. But also we've left some room to, as we've talked in the script, to make some investments and position ourselves for growth. So we're not kind of top behind, if you will, in terms of as that recovery comes. So continuing to make some strategic investments in the business. You see that reading through, and that's why we're still talking in terms of a high teens versus potentially something that looks more like what we posted in Q4.

Yes. Michael, we will see some SG&A as travel starts to reoccur more than it did in the fourth quarter. And there will be some associated expense, I think, as general people find their way back to normal medical appointments and routines, there will be a little bit coming in that. But our real view is be connected to our customers. We're important to them. We're -- we think we're one of the few that get internal access into many of these facilities right now. And we plan on fully participating and helping them and not reacting or just responding to it later in the time period.

Okay. And just going back to the top line real quick, Fluid Power, I think the last quarter, you said it was trending down mid-teens, both your base business and FCX. Ties improved, but you mentioned you -- some of your customers restocked for some parts. Can you just frame the magnitude on how it affected the top line, maybe the margin as well? And then is that why we're seeing just kind of seeing a little dip back in here to the down mid-teens? Or any help there would be appreciated.

I don't think we saw -- especially on the Fluid Power, Flow Control side, a great deal of stocking or I'd say that phenomenons probably to this -- point where we picked up on it a bit more on the Service Center side of the business, really starting around April. We've talked previously, not a lot of stocking and destocking in this business just given the randomness of demand. But the other 50% that's not break/fix here, again, there are some repetitive items used and just protecting themselves from potential supply chain disruption that -- and the uncertainty of what was to come. We had some customers that may have ordered a bit heavier in April to protect themselves. So I think what we're seeing is very stable demand in Fluid Power, Flow Control, just given the to more project and technical-based nature of that business, less stocking, destocking that comes with that. And certainly, some easier comps as we go back to the comparisons between the growth of the Service Center side of the business is posting as opposed to Fluid Power & Flow Control, but both very stable and slightly improving demand trends as you look at the daily sales rates.

Yes, Mike, this is Ryan. Just to reinforce what Dave said on, and if you look at the Fluid Power & Flow Control segment performance and the Service Center segment, keep in mind, the comparisons are different there, right? As Dave mentioned, easier comps in our Fluid Power & Flow Control segment, which is helping the year-over-year trend there. But we'd also say that when you look at that business, as we talked about, this cycle, we do have a -- and we've seen expansion in growth within the technology and market, which is providing a nice balance to some of the legacy industrial Fluid Power business that we have. And we expect that to continue here going forward. But keep in mind, as we go into the first quarter and maybe even the second quarter and the comps within that segment, they do get more difficult. And that's why we said we would expect for the first quarter to be down mid-teens versus the down 12% organic they put up in the fourth quarter.

Okay. And then just last one on me. Free cash flow was really good. It's great. I think the working capital as a percent of sales, low as it's been since 2012. Can you just frame for me what a restocking looks like for you guys? Are we talking working capital a modest $20 million, $30 million used in mostly the back half? Or are we looking something more like we saw in 2012 time frame where that was a much larger $60 million use?

I mean we're going to do our best using the tools at our disposal. I think we're much better positioned this time. If you look at our -- kind of coming out of the last couple of cycles where you look back, we were, say, maybe a 60% to 70% of net income in terms of free cash as we did some restocking and built some of that working capital that comes with the volume. As we talked in the script, we're still targeting 100%. That's balancing and continuing to leverage the investments we've made in systems to bring back inventory thoughtfully and continuing initiatives around our collections to be able to fund some of the ARR growth that's going to come with the volume with further performance improvement in terms of past dues. So we see that being more balanced this quarter. There'll still be -- as we talked about, particularly the back half of a year, some demand and tug from the operating working capital that comes with the recovery. But we'll be much more, I think, disciplined and thoughtful and being able to manage through that coming out of this cycle.

(Operator Instructions) Your next question comes from Joe Mondillo from Sidoti & Company.

Just a follow-up on that last working capital question. Both inventory and payables, so inventory was down about 13% on the revenue being down 18%. How do you think you fared with your inventory management in the quarter? And do you foresee more opportunity to reduce inventory? And then on the payable side, your payables were up over 20%. Could you just help us understand what's going on there and what to expect going forward?

Sure. I think the inventory -- will address that first. Do you still see opportunities? As we work through, I like the results and kind of where we had traction in Q4 as we've continued to work to leverage the investment that we have in inventory and bring down some of that stocking level commensurate with the decline in sales we've seen. That was not fully balanced across the business. So we still have some opportunities that will provide some source of cash for us, particularly as we work through the first half of 2021. On the payable side, I really don't see anything unusual about the trends there in terms of -- so there was no change in discipline or approach in terms of payment terms. So I see that as a function of the kind of the inventory -- commensurate with the inventory purchases and that reading through. So we expect our payables trends to continue to look much like they have in prior quarters. Continued initiatives around, obviously, terms expansion, use of purchase card programs, et cetera, to help extend terms. But I think the real opportunity comes to us in terms of the continued management of inventories and working through here, getting some more opportunity there as well as like the traction we've made on the collection side of the equation. Actually, despite a tough environment, brought down overall past due about 3% sequentially in the quarter. So pleased with the performance of the team there, and we'll continue to work that one as well.

Okay. And then question on the Fluid Power & Flow Control segment. The margin was better than I was looking for, very good expansion there considering the challenges. How do we think about that margin that you put up in the fourth quarter? And how to think about sort of the year-over-year comparisons going forward?

Sure. Some of that margin, I mean, it's a combination of both very nice and improved gross margins in the business. That was one of the -- our synergy case opportunities at FCX that showed ongoing progress in terms of margin expansion there. Some of that -- just here, again, just the technical nature of the value that we bring there, helps us protect some of those margins on kind of both sides, Fluid Power & Flow Control.

The -- certainly, the overall operating margin benefit as well from the kind of the cost countermeasures reading through, we'll still expect gross margin expansion as we move forward. Some of that temporary benefit will roll off as we do see the recovery, but we'll replace with volume benefits. So still like our prospects for continuing to show improvement in operating margin across that business.

Okay. And I guess just lastly, that segment, I know, does have a little bit more of a backlog component to it. The particular parts of that segment that do have sort of backlog-driven as far as your visibility and what that backlog sort of looks like, did that come down throughout the quarter? And is that maybe why you're expecting the year-over-year declines to increase a little bit in the first quarter? Just talk about the visibility that you have in there.

Still pretty steady. And I think here, again, as Ryan indicated, we're seeing the benefit of tech market hang in very nicely. That's helped to provide some buffer. But really, we've seen pretty stable backlog position across the quarter, really does come down to more of that comp issue as we talked about in terms of the year-over-year comps now starting to get a bit tougher in that business.

Okay. And then I guess last thing for me. Regarding your debt and how you're thinking about managing that, should we expect you to continue to try to consistently ramp down the debt throughout the year? How are you thinking about debt paydown?

Sure. I mean, continued deleverage will be a priority just in this environment, still like our position and nearly $269 million of cash on the balance sheet as we ended the quarter. So we're -- as we talked on the call and the script, the priorities will still be deleveraging. Kind of the modest capital requirements is going to give us some flexibility to pursue some selective bolt-on M&A. We talked about the priorities there. In terms of the M&A and still a very active pipeline. So as we're able to start getting back out, perform diligence, et cetera. We expect some disciplined work around the M&A funnel as well. But deleveraging will still be a priority in this environment.

Your next question will come from Adam Uhlman from Cleveland Research.

Wanted to -- I might have missed it, but could you size the magnitude of the temporary cost savings here this past quarter? And then can you confirm your bets planning on being in place for the entirety of the first quarter?

Yes. I would say we don't really size them fully. But I would say 2/3 of the decline we had in the fourth quarter were more around specific actions. And really, those will continue for the duration of the first quarter that we're in. And so I think that will help.

Okay. Got you. And then, I guess, as society as a whole has shifted a lot of transactions to e-commerce, I would suspect that you've probably seen a lift in sales through that channel. I was wondering maybe you could speak to the activity levels that you're seeing there? And then maybe more so on any investment programs that you're -- you have in that channel to expand your scope and our breadth of offerings?

Yes. I think the good news on that side is the tools and the capabilities exist. I don't believe we have high or investment requirements in doing that, doing a little bit more in with engaging with customers and follow-up.

But from an electronic standpoint, I would say mid-20s, 25% or so of the business comes in that way. That includes applied.com. EDI, electronic data interchange, but also then procurement systems connections between ourselves and given customers. And so that could ramp a little bit. What we are seeing is also just more virtual connection with engineering teams and procurement teams and on-site teams. And so while we are physically present that time, so we're using some of that technology to generate demand and serve their requirements.

Okay. Got you. And the last thing for me. Do you have any additional restructuring costs planned for the current quarter or the first half?

I would say we'll continue to evaluate and look at and where we have requirements or opportunities that we'll act on. I wouldn't say at this stage that they are meaningful. Personally, I think we're in line on our cost, leadership team continues to have the right focus. In our sessions and reviews, now we're spending a lot more time on customers and our growth opportunities as we see those opportunities ahead of us rather on cost and cash. And we know how to operate in the cycle, demonstrated it in the fourth, will again in the first. That's where we're spending our time, effort and energy.

Your next question will come from Chris Dankert from Longbow Research.

I guess earlier we've been talking about seeing some increased brake/fix demand as some of this equipment that was kind of idled in an unplanned manner turns back on. I think you briefly mentioned something like that in the prepared remarks. But just, are we starting to see that break/fix demand come back in any meaningful way as things turn back on? Or is it a bit slower than you would have expected, I guess?

I think the ramp has been gradual. I think customers are still dealing with time out, whether -- as they adjust shifts or production schedules, some to their demand environment, some may be virus related. But as that equipment comes back up from being down or idled for a long period of time, we are starting to see a little bit more of that. And our view is that only increases as demand across these industries, including these heavy industries, starts to come through.

Got it, got it. Understood. And then my apologies if I missed it, but did you comment at all on the impact of pricing in the quarter? I assume it was nominal, but just to kind of dot the Is there, I guess.

It was nominal, offset -- inflationary impact, but negligible in terms of the impact on the overall growth.

Got it. Got it. And then to the extent you're kind of willing to comment here, I guess, trying to put all these pieces together, it seems to me like back of the envelope math assumes SG&A kind of comes up in something of a seasonal fashion for the first quarter off of a very impressive fourth quarter kind of controlled SG&A level. Is that the right way to think about it here?

Yes. We expect that here. Again, that's the difference between the mid-teens versus the high teens decremental we're talking about. Once again, that is some travel, et cetera, starting to ramp back up. So there's virtually none in Q4 as well as here, again, positioning around some investments as we work to make sure that we're ready to capture the opportunity on the upside. So not holding through to our strategic priorities and have not set off funding on some of the projects that we see will continue to drive growth for us in the future.

And your next question will come from Steve Barger from KeyBanc Capital Markets.

Back to your commentary around pace of service center improvement, are you confident you're retaining your typical share or are you seeing any kind of aggressive price competition from smaller competitors that you should be concerned about?

No, I think we're confident. We're confident in the broader capability in doing it. I still think the environment overall is productive, good recognition on cost to serve. I think for us, just the ability to be connected and then be connected with motion control bearings, power transmission products, but then also to be connected and have expertise around Fluid Power & Flow Control. And now even as we start a little bit more on automation and those solutions, I think that is helping us. So we feel very good about our position.

Great. And I want to make sure I understand the revenue dynamics. If 1Q revenue is down 17% to 18%, it looks like you'll have the normal sequential step down from 4Q. But do you expect 1Q is the trough quarter for revenue in dollars and then sequential improvement for the rest of the year?

I think as we think about it, assuming these kind of historical trends hold, that we would see year-over-year sales decline would not materially improve until the second half, and then we would return to growth in the fourth quarter.

And Steve, on Neil's point with that, the comment of not really seeing the year-over-year trends improve into the back half, that would be an assumption if we just assume normal sequential patterns from where we are today. And what that implies, ultimately then for the year-over-year trend -- because the comparisons really don't change much from the first to the second quarter, and then they change momentarily into the back half.

Yes. I mean, obviously, 2Q is normally down a little bit from 1Q. I was just wondering if that pattern changed this year because of the weakness that we've seen starting in April. But it sounds like you expect kind of stability in this level, plus or minus?

Yes. I think that is a fair assumption to start with, right? And certainly, depending on the cycle, coming off of what is very low levels, as you mentioned, in April, depending on our execution of growth strategies that we're deploying right now, that can vary that trend. But I think what we would say is just as a guiding post, if you assume normal sequential patterns on historical averages, that dynamic of no material improvement in the year-over-year trend into the back half is how I would think about it, again, as a starting point.

Got you. Switching gears, a big part of the strategy is helping customers to think about or integrate robotics, automation, Internet of Things. Can you talk about how those customer interactions or your commercial efforts have evolved over the past 5 or 6 months as you've had to step back from the physical?

Well, to your point, right, we're still making connections, sometimes physically on, sometimes they are virtual sessions. And when they're virtual sessions, you can really expand your participation and level of expertise. So as we think about Applied and our Internet of Things connect program with customers, we're working to deal with problems that they have or solutions that they're looking for and how can we solve them around discrete operations, discrete automation opportunities. And so I like what we're able to do and help them on communications connectivity-type devices as they look to connect IT with their operating technology, things around use of robotics that helps in their social distancing or material handling, even some of those that have some cleaning techniques around them, which has some encouraging potential for us to go through. Use of vision, which helps them on quality and inspection. And then connecting this data, which lets them do more remote management, remote monitoring. Whereas in the past, maybe they've relied on traveling people or experts to go around to some of their sites or facilities as they can connect them and review those similar things, they're just able to do it a little bit more productively, effectively, maybe safely in this environment.

And so those are the things that we're working on and connecting with our suppliers because there's more technology, more sensors, more capability coming into those products. So we think we're well positioned to connect those items from our suppliers to specific customer needs and then be part of reviewing and interpreting the performance data around them.

I think, yes. The team hasn't missed a beat in terms of the sales activity. One of our reviews here a month ago, when the sales who were engineers from Olympus indicated that there -- he's probably making 5x the sales pitches just because of being able to do it virtually, cast a wider net and be able to be more efficient in delivery. So I think, like I said, we've had some learnings come out of this, but the team has adapted well to the COVID environment and still driving growth.

Have you seen a commensurate increase in closings relative to that increase in pitches? In other words, are people just curious and trying to figure out what the capabilities are and then they're likely to revert if we get a vaccine or whatever? Or do you think this is driving a permanent change in how people are thinking about the importance of automation, robotics, vision, anything else?

I think it's driving more around the importance and the use and the adoption. So we don't feel like we're in perpetual presentation mode as we go through. Now we know we have some projects that got slowed as we would go on-site and help with commissioning and pull through. Now we think that's going to start to ease as we go into this quarter or perhaps future quarters because people are more comfortable with safety routines and having individuals through. But no, we think it's meaningful. We think it is here to stay and will be part of the ongoing value proposition.

And last one for me. You talked a little bit about this already, but any lessons learned that you're applying to your own business in terms of automating or digitizing? Just anything that's making you more productive based on how -- what you've learned from talking to customers about their requirements?

Yes. So as we do that, both with our supplier products and as we talk with customers and as we think about Internet of Things in technology, we're not missing the beat at using technology to improve or drive our own internal productivity. I think we always have a focus on that. But as we think about warehouse management opportunities and flow of material and put away, as we think about routines and practices that we can have in Service Centers and technology to help with shared services or pull out more what has been more manual or mundane task out of those operations and free up time for those individuals to spend more time connecting with customers and quotes and quote follow-ups, we'll continue to work those. I like some of the things we've done. I still feel like we have a nice runway to also help ourselves.

And your next question will come from Michael McGinn from Wells Fargo.

I just wanted to ask about the international business. Any color? One of your competitors, (inaudible), seeing some positive trends out of Australia. Can you just frame for us what a recovery looks like in the Service Center business and what the gap historically has been between your international and domestic? And what it currently is today?

I think we mentioned in the quarter, our team in Australia and New Zealand, they had growth and so continue to participate and have that now. So I think the team is faring very well. They, too, have dealt with some of the pandemic coming through. I think New Zealand has 100-plus days of stream going on. So operations continue there. But I think Australia has fared very well. So we continue to see that activity, and our local teams are fully participating in that. And they, too, right -- as we grow our offering and capability, including service and predictive preventative maintenance and remote monitoring, we're seeing those trends come through.

Okay. So the growth by F Q4 framework that you outlined, that's both a service center and FP comment? Or is it more weighted towards one or the other?

Mike, can you just repeat that question? I'm not sure we fully understood it.

So the peak to trough would, by growth, by the fiscal fourth quarter would apply a bigger move for Service Center. I'm just confirming that both Service Center and Fluid Power, you're assuming growth by the end of the year, if that's the case, is it more weighted one sector?

Yes. What we would say is it's -- we did not give a specific color around -- by segment as it relates to the fourth quarter, but we would expect a recovery in both of those segments starting to really materialize on a year-over-year trend basis. As we get into the fourth quarter.

At this time, I'm showing no further questions in queue. I will turn the call back over to Mr. Schrimsher for closing remarks.

I just simply want to thank everyone for taking the time joining us today, and we look forward to the continued interaction throughout the quarter.

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