Applied Industrial Technologies Inc (AIT) 2017 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the fiscal 2017 first-quarter earnings call for Applied Industrial Technologies. (Operator Instructions). As a reminder, this conference is being recorded Wednesday, October 26, 2016.

I would now like to turn the conference over to Julie Kho. Please go ahead, ma'am.

Thank you, Kelly, and good morning everyone. Our earnings release was issued this morning before the market opened. If you haven't received it, you can retrieve it from our website at Applied.com. A replay of today's broadcast will be available for the next two weeks, as noted in the press release.

Before we begin, I would like to remind everyone that we'll discuss Applied's business outlook during the conference call and make statements that are considered forward-looking. All forward-looking statements, including those made during the question-and-answer portion, speak only as of the date hereof and are based on current expectations that are subject to certain risks, including trends in various industry sectors and geographies, the success of our various business strategies, and other risk factors identified in Applied's most recent periodic report and other filings made with the SEC, which are available at the Investor Relations section of our website at Applied.com. Accordingly, 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, whether due to new information or events or otherwise.

In compliance with SEC Regulation FD, this teleconference is being made available to the media and the general public as well as to analysts and investors. Because the teleconference and its webcast are open to all constituents, and prior notification has been widely and unselectively disseminated, all content of the call will be considered fully disclosed.

Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer, and Mark Eisele, our Chief Financial Officer. At this time, I would like to turn the call over to Neil.

Thank you, Julie, and good morning, everyone. We appreciate you joining us today.

I would be remiss if I didn't start my commentary by saying we are in exciting times in Cleveland. Early in the summer, the city successfully hosted the Republican National Convention, and now it's October, we are in the World Series competing for our second sports championship this year after quite a drought. Cleveland is experiencing some great momentum and proof of what hard work and teamwork can produce.

Now, turning to our results, we had a solid start to fiscal 2017 with positive impacts from operational improvements, restructuring activities, and our Working Together, Winning together Approach to business, serving our customers, enhancing our value-added capabilities and delivering on our commitment to generate benefits for all Applied stakeholders.

First-quarter fiscal 2017 net sales were $624.8 million compared to $641.9 million in the first quarter of 2016, a decrease of 2.7%. Despite the reduction in sales, net income of $27.4 million increased 12.7% from last year's $24.3 million as a result of our focus on cost controls and operational efficiencies.

EPS of $0.70 increased 14.8% from last year's $0.61 per share.

Before we get any further into the numbers, I'd like to spend a few minutes discussing some highlights of the quarter. We are in the early stages of our multiphased eCommerce plan that is focused on better serving current customers and reaching new end-users.

In late August, we celebrated the launch of our new Applied.com eCommerce site. The transformed site includes a modern and intuitive design, enhanced search and navigation capabilities, and improved order and account management. The initial response has been positive not only in terms of customer feedback but we're also seeing good results in site traffic, customer registration and order trends.

The reimagined Applied.com is one of our five channels to market, along with the 550-plus operating facilities that are close to and connected with local customers providing greater uptime and productivity. Our fluid power service and repair network, with over 65 locations, provides value-added services to mobile and industrial OEMs and expertise for MRO end users. We also reach and serve customers with a fully functional electronic and printed catalog while our maintenance supplies and solutions business has on-site vendor-managed inventory specialists to productively manage C class MRO supplies.

As customers continue to consolidate their industrial spend with fewer, better suppliers, we are confident more and more customers will do greater business with Applied across these multiple channels.

We are also pleased to announce that our Board of Directors recently authorized a new share repurchase plan for up to an additional 1.5 million shares of the Company's common stock. This additional authorization reflects confidence in our business strategy, our financial strength, and our ongoing commitment to optimize capital allocation and drive returns to shareholders through dividends, share repurchases and accretive acquisitions.

I'll now turn the call over to Mark for more detail on our financial results.

Thanks, Neil. Good morning, everyone. I'll provide some additional insight here regarding our first-quarter fiscal 2017 financial performance.

Our sales per day rate during the quarter was $9.76 million, 2.7% below the prior-year quarter and 1.4% below our rate in the June quarter. We had 64 selling days in both the September 2016 and September 2015 quarters. Acquisitions had a positive impact on sales of 2.4% during the quarter, and foreign currency impacts decreased sales by 0.3%. Excluding the effects of these items, core same-store operations experience a 4.8% decrease in sales compared to the prior year. This 4.8% decline consists of a 2% decrease attributable to traditional core operations with the remaining decrease related to sales from our operations serving the upstream oil and gas markets. We believe the impact of vendor price increases was minimal during the quarter.

Our product mix during the quarter was 27.5% fluid power products and 72.5% industrial products.

Fourth-quarter sales in our service center-based distribution segment decreased $12.9 million, or 2.4%. Acquisitions added $8.9 million, or 1.7%, and negative foreign currency impact reduced sales 0.3%.

Core same-store operations in the service center-base distribution segment experienced a 3.8% decrease. The majority of this decrease relates to our operations that sell to the upstream oil and gas industry, as our other traditional operations had a decrease of only 1.4%.

Taking a closer look at our operations that sell to upstream oil and gas customers, while we experienced a 35% decline in our sales from the September 2015 quarter, on a run rate perspective, we saw a 25% increase in sales compared to our June 2016 quarter. We expect our overall sales per day run rate to upstream oil and gas customers for the December quarter to be at or slightly better when compared to the September quarter.

Our fluid power businesses segment had broad-based sales decreases throughout Canada, Mexico and across the majority of our US operations, totaling $4.2 million, or 3.7%, year-over-year. Acquisitions within this segment increased sales $6.5 million, or 5.7%, while unfavorable foreign currency translation decreased sales by 0.4%. Excluding the acquisition and currency impacts, core fluid power operations saw a sales decrease of 9%.

From a geographic perspective, sales in the fourth quarter -- sales in the quarter for our US operations were down 2.4% compared to the prior-year quarter, and experienced a positive impact from acquisitions of $13.9 million, or 2.6%. Our Canadian operations experienced a sales decrease of $3.7 million, or 5.5%, while acquisitions added $1.5 million, or 2.3%, and favorable foreign currency translation increased Canadian sales by 0.2%.

Measured in local currency terms and excluding the impact of the acquired businesses, Canadian sales were down 8%. The local currency sales decline was entirely related to our Reliance operations serving upstream oil and gas customers as our other traditional broad-based Canadian operations had a local currency sales increase of 2.9%.

Consolidated sales from our other country operations, which include Mexico, Australia and New Zealand, had an overall decrease of $0.5 million, or 1.3%, year-over-year. This consisted of a sales increase in local currency of 4.9% and a negative foreign currency translation impact of 6.2% in the quarter. The local currency sales increase in the quarter relates to both our Mexican and Australian operations.

Our gross profit percentage for the quarter was 28.5%, 30 basis points higher than last year's first quarter and 40 basis points ahead of our fourth-quarter run rate. The improvement, compared to the prior-year first quarter, primarily relates to our continuous improvement efforts, our recent acquisitions and a small LIFO benefit.

Our selling, distribution and administrative expenses on an absolute basis decreased $4.9 million in the quarter, or 3.5%. SD&A related to acquisitions totaled $4 million, and the impact of currency translation decreased SD&A by $0.3 million. During the quarter, SD&A was also positively impacted by $1.1 million of gains on the sale of real estate at two of our former service center locations. Excluding these factors, core operations achieved a $7.5 million, or 5.4%, reduction in SD&A. In addition, overall SD&A was flat from the June 2016 quarter to the September 2016 quarter. Our results are fully capturing our annual estimated ongoing savings of $7.8 million from restructuring activities executed in fiscal 2016.

The effective income tax rate was 34.0% for the quarter. This is slightly lower than our estimates due to beneficial tax benefits recorded during the quarter. We believe our go-forward tax rate for fiscal 2017 remains in the range of 34.0% to 35.0%.

Our consolidated balance sheet remains strong with shareholders equity of $680.4 million and a conservative debt to total capitalization ratio of 31%. Our after-tax return on assets for the quarter was 8.4%. This improved from our fourth-quarter return on assets of 7.9%, primarily due to improved earnings.

Inventory at September 30 is $3.8 million above our June levels. This increase reflects normal variability during the quarter.

Cash generated from operating activities was $41.9 million for the quarter compared to $15.1 million in the prior-year quarter. The improvement relates to operational working capital improvements, primarily in accounts payable. We continue to expect cash provided from operating activities in fiscal 2017 to be in a similar range compared to what we accomplished in fiscal 2016.

As previously discussed in our earnings release, we affirmed our full-year earnings guidance of between $2.40 and $2.60 per share with a bias above the midpoint of our projected range. We do anticipate traditional seasonality coupled with fewer selling days in our second quarter. In addition, we will have planned investments in talent initiatives and technology over the remainder of fiscal 2017.

Now, I'll turn the call back to Neil for some final comments.

Thanks, Mark. We know there are many analogies between sports and business. Just as teamwork is taking center stage right now with our Cleveland sports teams, it's also clearly evident throughout Applied. In the current industrial economic environment, we know we must help ourselves through our business performance, expanding our product, service, and solutions offerings and creating opportunities with existing and new customers. We are in the early innings of our fiscal year, building on our strong foundation with opportunities for growth, both organically and through acquisitions. Our talent and technology investments will also positively impact our associates and in turn provide benefits for all Applied stakeholders.

At this time, we'll open up the lines for your questions.

Ladies and gentlemen, please stand by, the conference will resume shortly. Please remain on the line. Go ahead, sir, we can hear you. Please go ahead.

Matt Duncan, Stephens Inc.

Hey, good morning guys. This is Will on the call for Matt. Congrats on the quarter.

I wanted to start a little bit more with trends in the quarter. Can you talk about how they fluctuated month-to-month and more specifically from June to July? Did you see softness around the July 4th holiday and improvements from the middle of the month forward? And then lastly, on the trends, any color that you are seeing in October would be helpful too.

Sure. I would say, on our sales per day trends did include expected seasonal softness in July with improvements then in August, and even stronger in September. Order trends for October, as expected, developing a little softer than September. However, we still have a handful of days to go.

And I'd say, year-over-year, October just kind of down low single digits, which, again, is what we expected looking at the comparables. And again, that's got still a handful of days for us to positively impact it.

Okay. And on the oil and gas, it sounds like things really improved there quickly. Can you talk about where that ramp really started and are we sustaining that sequential benefit? You did say it's going to go into this quarter that we are in now. But was it a fast ramp that you saw in the middle of the quarter or has it been happening as oil prices have moved to the $50 range and we've seen more rigs come on through the quarter?

I would say it's been more steady, and so we would expect the next quarter to be similar, maybe slightly better. We'll see how it plays out. But if we look back at August and rig count and then kind of now to October, we would see improvements in the US still significantly off of what it was a year ago but we see that improvement. We see a little bit of improvement in that in Canada. So, I think, for us, it translates to sales. If we think about upstream oil and gas, new drilling can still have challenges, but some greater strength out of those operating wells on the upstream production side.

That's helpful. Can we move over to operating expenses for a moment? Can you talk more about what exactly you're doing there to get such a nice leverage that we saw in the quarter? And then this next quarter, we have the traditional seasonality, but can you quantify for us the restructuring actions, how much you expect to offset the seasonal slowdown that we're going to see with fewer selling days and how you expect that to flow through the remainder of the fiscal year?

So, I guess I can start. I would say as we look at the upcoming quarter, and with the seasonality, we would expect similar, maybe a little bit of a potential increase in SD&A as we move through it. With that said, we continue to work our restructuring initiatives and just continuous improvement.

But then as we think through or look forward to the second half, we just know we'll have some increased SD&A expenses coming at us. Some of those relate to talent initiatives that we have going on. We are working what we call our management development and planning process deep in our organization, so what we do to anticipate talent requirements, tracking the right candidates, recruiting, developing. So, in talent acquisition, we've established a talent network, new recruiting website, got a centralized recruiting team using HR analytics.

In our performance management, we've got a new system. We are expanding it globally so for our associates to establish clear goals, timely dialogue with them. And then on the talent development side, a new learning management system. And so we'll do the typical product and application training, but we're also doing more on skills and competencies for leadership.

And so as we think then about compensation and benefits, in our second half, we'll have normal merit increases linked to this performance dialogue.

And then in healthcare, I think, all in all, we've done a nice job. There continue -- can continue to be challenges in that environment. But we are going to make some moves, kind of some wellness initiatives. It will have biometrics screenings and some proactive management of expense in healthcare that, near-term, may have a little bit more cost. We think going forward for the business, very good for our associates and very good for the business from a competitive standpoint.

So, Q2 for us maybe a little bit of increase in SD&A and then more of these coming into the second half because we'll also have some planned expense around some IT projects as well.

Thank you guys.

(Operator Instructions). David Stratton, Great Lakes Review.

Congratulations on the quarter and thanks for taking the question. FX seems to be dwindling, and I know that we already were told to expect it to dwindle by the end of the year. Can you give us some more insight on that? Is that still the expectation going forward?

Yes, David, that's exactly the expectation. If you look at foreign exchange rates let's say for September, and if those would stay relatively stable through December, when we look at our overall sales, we would expect to have a 0% impact of currency translation in the December quarter.

Then if you keep going on through the rest of the fiscal year, you'd actually see a small positive impact probably in the March quarter and then more flattish in the June quarter. So, our view is, for the entire year, we may end up at virtually zero on FX. Obviously, it depends upon how the rates move from today forward, but that's our perspective. We are seeing some stability.

All right. And then the tax rate where you gave the full-year guidance, is that all increase due to the new accounting requirement? And what was the bottom line of that adjustment for the quarter?

Right. With the change in the accounting for share-based compensation, we did see that positively impact our tax rate during the September quarter by 40 basis points. And obviously, that is a discrete items and don't know what the impacts, if any, will be on the future quarters.

All right. And then just kind of a follow-up here. The 30 groups you usually track, what were your top performers and are you seeing any fundamental shifts taking place in those groups?

I'd say, overall, the results this past quarter were consistent with the prior I think 12 industries showing increases, perhaps comparables around some of the mining segments in metals and nonmetallic being a little better, but real positives around construction related industries, the aggregate cement, building materials, lumber wood products, and food stays consistent or positive as well.

All right, thank you.

Ryan Cieslak, KeyBanc Capital Markets.

Nice quarter following a nice win last night.

Yes (laughter).

Just, first, I wanted to go back to the SD&A cost comments. And I think, last quarter, you mentioned you were expecting that line item to be relatively flat for the full year on a year-over-year basis. I just wanted to get a sense of, it sounds like that's changed a little bit. What's the reasoning behind maybe making some of these decisions post how you guys were thinking at the end of your last fiscal year? And directionally, how do we think about that? Should we assume then those single digits type of increases for SD&A? Or just any color around that would be helpful.

Let me jump in and try to talk more specifically about that. When we looked at our second half of our fiscal year versus the first half of the fiscal year, Neil went through several bullet point items that are going to have an impact, that will have a change.

One other item just to mention that he didn't have on his list does include the normal restart of payroll taxes and unemployment taxes during the month of January. So, that does have an impact when you look at run rates of SD&A expense as you go throughout the year. And so that will be an uptick in January when you compare it to our Q3 and Q4. So, when you consider all of these items on an overall basis as compared to our SD&A run rate during the September quarter, we could see upwards of a 4% overall increase in SG&A during the second half of our fiscal year.

Obviously, there's many moving parts and we continue to actively manage all aspects of SD&A to maintain tight cost controls. But since we called this out in our press release and we talked about it here, we wanted to sort of give you a ballpark about what that might be.

Okay, that's helpful. Then just to clarify, the 4% increase would be relative to the first half or is that year-over-year you're talking?

Relative to the first half, to the SD&A rates that we saw in the September quarter. Like Neil mentioned, as we forecast the December quarter compared to September, we'll see some similarity. We do see some small upward pressures happening in the December quarter. But when you look at this compared to the second half, we could see upwards of a 4% increase compared to current run rates.

Okay, that's helpful, Mark. And then on the gross margin side, again, really nice trends we continue to see there from you guys. It sounded like there was a small LIFO benefit in the quarter. I just was wondering if you could quantify that. And then just how to think about some of the initiatives that you guys continue to work on there and how that might impact gross margin trends sequentially into the coming quarters?

I'll start out with that. On the LIFO side of things, we saw a little under 10 basis points, maybe 8 or 9 basis points, improvement from LIFO. And that's just from our normal quarterly double extension of our inventory products year-over-year and the impact that that has on LIFO. We did not see any LIFO layer liquidations during the quarter, and we don't have any layer liquidations forecast for the rest of the year either.

Then I'd say, on the go-forward, we just continually believe that we have opportunities for improvement. Our teams are focused on using the tools, using the data to make appropriate decisions, how we reduce variation across mix or groups of customers, how we reduce variation around some of the product categories. And then mix will be positive for us. As we do well in local accounts and smaller, medium users, that's a positive on the mix. And as we grow in expansionary type products and consumables, that's a positive mix for us as well.

And Neil, just to follow-up on that, you mentioned the local accounts. What is maybe driving that? Is there something new internally that you guys are focusing in on, the way your approaching those markets? Or maybe just some additional color on that?

I'd say, in each of our service center operations and teams, we go through very good account planning and we want to represent what is in the local and industrial economy plus serve larger national strategic accounts that we will have. And we are doing a good analysis to say where are we in that position? How far penetrated are we with some of those accounts with current customers, and what's our opportunity to grow? But we also look for new customers that we know there's available, we know we have capabilities, perhaps we've served recently or in the past, how we've picked some of those back up. And so good focus on not one or the other, large or small medium accounts, our belief is be focused on your total local market and we'll do very well.

Okay, great. And then the last one for me and then I'll pop back into the queue. I appreciate the color on the month-to-month sales trends. The October commentary you gave, any impact from -- that you could think of from Hurricane Matthew?

And then just secondly to that, any discussions around what you're hearing from your customers today if that's -- if their tone has changed any? I know, in the past, you've given some commentary on backlog, particularly on the fluid power side. Any update on that would be helpful as well.

Sure. I'd say, for the weather, I know there's impact, but I think it starts to smooth out as we go through the month from a macro standpoint in that. I think, on our fluid power business, we continue to perform well. Backlog is productive; it's showing some growth. To be determined on some of them when they fully release.

And I think I've shared before, you don't wish for slowdowns in segments, but boy, they do create opportunities to link with especially those OEMs on their products and how you may help them and grow your content in their solutions. And so just for their current business, you do better. And then as they ramp, we'll grow even more. So, our backlog reflects that as we start to combine technology into some of those solutions, add some controls to that. It's helping us in hydraulic and pneumatic applications. And then we are looking to leverage or use our fluid power capabilities in those companies with our MRO users as well.

And so when there's capital projects, when they need to do major investments or overhauls, we are very capable to participate in those. So, that starts to show up in our backlog and it will flush out as those products move forward.

Okay. Thanks guys. Best of luck.

We have no further phone questions at this time, sir. I'll turn it over to Mr. Schrimsher for any closing remarks.

All right. I just want to thank everyone for joining us today. We look forward to talking with you and seeing many of you throughout the quarter at upcoming events. Thank you very much.

Thank you. Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and we ask that you please disconnect your lines.