Applied Industrial Technologies Inc (AIT) 2017 Q2 法說會逐字稿

Welcome to the FY17 second-quarter earnings call for Applied Industrial Technologies. My name is Tara, 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 conference over to Julie Kho. Julie, you may begin.

Thank you, Tara, and good morning, everyone. Our earnings release was issued this morning before the market opened. If you haven't received it, you could 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 will 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. I will now turn the call over to Neil.

Thank you, Julie, and good morning, everyone. We appreciate you joining us today. Let me begin with a recap of our news release this morning. Our sales for the second quarter of FY17 were $608.1 million, a decrease of 0.4%, compared with $610.3 million in the same period a year ago. Net income for the quarter was $24.1 million, or $0.61 per share, compared with $23.9 million, or $0.61 per share in the second quarter of FY16.

At the mid-point of our fiscal year, we are encouraged by the improving sales per day developments, and remain focused on expanding our capabilities with new and existing customers. Furthermore, we are pleased with the continued operational enhancements and efficiencies throughout our organization, as these actions strengthen our market position.

Based on our current results and our expectations for the remainder of the year, we are narrowing our full-year earnings per share guidance to between $2.50 and $2.60 per share, and our full-year sales guidance to between down 2% to up 1%.

Also today, we announced that our Board of Directors increased the quarterly cash dividend to $0.29 per common share. This represents the eighth dividend increase since 2010, and a cumulative increase of more than 70% in the quarterly dividend over this period.

We are committed to driving the growth and continued success of Applied, generating shareholder value through our business performance, strategic acquisitions, and returning cash via share buy-backs and dividends. At this time I'll turn the call over to Mark for more detail on our financial results.

Thanks, Neil. Good morning, everyone. I'll provide some additional insight regarding our second-quarter FY17 financial performance. Our sales per day rate during the quarter was $9.97 million, 1.3% ahead of the prior-year quarter, and 2.1% greater than our rate in the September quarter. We had 61 selling days in the December 2016 quarter, compared to 62 days in the December 2015 quarter. This resulted in a 1.6% headwind when comparing sales in the current quarter versus the prior-year quarter.

Acquisitions had a positive impact on sales of 1.3% during the quarter, and foreign currency impacts decreased sales by 0.5%. Excluding the effects of these items, our organic operations experienced a 0.4% sales increase in sales per day compared to the prior year. In addition, we believe the impact of vendor price increases was minimal during the quarter.

Our product mix during the quarter was 26.9% fluid power products, and 73.1% industrial products. Second-quarter sales in our service-center-based distribution segment decreased $5.9 million, or 1.2%. Acquisitions added $7.8 million, or 1.5%, and foreign currency fluctuations reduced sales 0.5%.

After factoring in the decrease in sales days, acquisitions, and currency translation, organic operations in the service-center-based distribution segment experienced a 0.6% decrease in sales per day. The majority of this decrease relates to our operations that sell to the upstream oil and gas industry.

Taking a closer look at our operations that sell to the upstream oil and gas customers, while these specific operations experienced a 7% decline in sales from the December 2015 quarter, on a run-rate perspective we saw a 20% increase in sales compared to our September 2016 quarter. We expect our overall sales per day run rate to upstream oil and gas customers for the March 2017 quarter to improve when compared to the December 2016 quarter.

Our fluid power businesses segment experienced a sales increase of $3.7 million, or 3.6% year over year. There was no acquisition impact within this segment during the quarter, and unfavorable foreign currency translation decreased sales by 0.6%. Excluding the impact of one fewer sales day and currency translation, the fluid power business segment operations saw a sales increase of 5.8%.

From a geographic perspective, sales in the quarter for our overall US operations were up 0.3% compared to the prior-year quarter, including a positive impact from acquisitions of $6.5 million, or 1.3%. US organic operations experienced a 0.6% improvement in sales per day, offset by the negative 1.6% impact from having one fewer selling day.

Our Canadian operations experienced a sales decrease of $5.4 million, or 8%, with a positive impact from acquisitions of $1.3 million, or 1.9%. There is no foreign currency translation impact during the quarter. Canadian organic operations experienced an 8.3% reduction in sales per day, as well as the negative 1.6% impact from having one less selling day in the quarter.

Consolidated sales from our other country operations, which include Mexico, Australia, and New Zealand, increased $1.5 million, or 4.6% year over year. This consisted of a sales increase in local currency of 14.6%, and a negative foreign currency translation impact of 10% 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 28.4%, consistent with the same quarter in the prior year. We expect our gross profit percentage to continue around this level for the remainder of FY17. Our selling, distribution, and administrative expenses on an absolute basis were flat when compared to the same quarter in the prior year, and includes $2.2 million related to acquisitions.

In addition, overall SD&A has been flat to slightly down each quarter since the June 2016 quarter. Our results are fully capturing our annual estimated ongoing savings of $7.8 million from restructuring activities executed in FY16. During the remainder of FY17, there are planned SD&A investments in talent initiatives and technology when compared to the first half of our fiscal year.

The effective income tax rate was 32.7% for the quarter. This is slightly lower than our previous estimate, due to tax benefits from discrete items recorded during the quarter. Year to date, our effective tax rate is 33.4%. Our view for the second half of FY17 is for an effective tax rate in the range of 33.5% to 34.5%.

Our consolidated balance sheet remains strong, with shareholders' equity of $681.4 million, and a conservative debt to total capitalization ratio of 32%. Our after-tax return on assets for the quarter was 7.5%.

Inventory at December 2016 increased sequentially by $7 million. This increase reflects calendar year-end buying opportunities with certain strategic suppliers. As we look forward to our June fiscal year end, we expect operational inventory levels to increase by $15 million to $20 million.

Cash generated from operating activities was $3.8 million for the quarter, and $45.7 million year to date. This compares to $33.8 million year to date in the year-ago period. Improved results pertained to operational working capital improvements, primarily in accounts payable.

We continue to expect cash provided from operating activities in FY17 to be in a similar range compared to what we accomplished in FY16. Now I'll turn the call back to Neil for some final comments.

Thanks, Mark. In summary, I'd like to reinforce a couple of points. First, our disciplined approach to driving operational enhancements and efficiencies are providing meaningful benefits across the business today, and position us for ongoing value creation as markets improve.

Second, we're committed to helping ourselves, pursuing strategic opportunities that extend our business reach, expanding our product service and solution offering, and creating opportunities with existing and new customers. Our foundation of quality brands, innovative solutions, and dedicated customer service afford us great potential and room to grow. With that, we'll open up the lines for your questions.

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Matt Duncan, Stephens.

Good morning, guys, nice job this quarter.

Good morning, Matt.

First question, obviously we've seen some improvement in December from some of your peers. I was curious if you could talk a little bit about the month-to-month sales trend that you're seeing in the business, both through the quarter and then here into January.

Sure. I would say for us, as we move through the last quarter, the sales per day trends improved from October to November, and really for us through a large part or mid-part of December. I think as expected, we had some seasonal softness in comparisons around the holidays, but we finished fine. Then overall in January, I'd say the quarter trends are continuing. We're showing modest improvements, I'd say, around year over year 1%, with a few days to go.

Okay, that's helpful. Then as you look at the business and talk to customers, are there particular customer end markets or geographies, maybe, that you would call out as you're more optimistic on than others? Are there places where you're seeing a little bit more strength than others? Just curious if you could break the business down for us, that would be great?

Yes, if we think about our top industries, I think this past quarter we had a few more positives. I think 14 out of the 30 still positives around those construction-related industries. I think as expected, lumber, wood products, building materials. I think also in cement and aggregate. As you talk with customers, there's probably some optimism around infrastructure-type projects. They don't see all of those today, but there's a belief that there will be investments, and those will be going forward.

Food has been steady and a good comparable. Then also in oil and gas and refining and some of those related industries, just a little step-up or pick-up in activity, and probably a little bit of optimism.

It's still early. We touched on year over year we still had a decline sequentially as we moved through the quarter in those businesses. We had improvements. We think as we go through the back half of our fiscal year and into 2017, we would expect some continued improvements in those markets.

Okay, that's great, Neil. Specifically, the last thing for me in that oil and gas business, are there certain energy plays where you're seeing more strength than others. My recollection is that you guys are fairly strong in the Permian, and that seems to be an area where rig count's really ramping back up here. Is that really where you're seeing that business pick up?

That would be the highest amount of activity. Obviously, rig count has started up in Canada. Cold weather will cooperate. I think that's to be determined. But out of the plays, the Permian would be the strongest.

All right, appreciate it. Thanks for all the insight, guys.

Okay.

Jason Rodgers, Great Lakes Review.

Good morning.

Good morning.

Looking at your guidance, if we take the top end of that, it's showing basically minimal earnings growth in the second half versus a year ago. I was wondering why that is the case, given that the core operations are now showing some growth. Oil-related head winds are lessening, and the environment seems to be a little bit better. Is that due to just the SD&A increase? As a follow-up, where do you expect the SD&A to be as a percentage of sales in the second half?

Let me start with that question. I think when you look at our second half of the year, let's talk about the top-line expectations. Obviously, we narrowed our guidance for the full year. But if you say the minus 2% to plus 1% from a sales guidance perspective, if you just take the mid-point of that, you're like a 0.5%, or a negative 0.5%.

To end up at a negative 0.5% for the year, we would basically have relatively flat sales per day in the second half compared to where we experienced in the December quarter. We're about a -- just doing the math, it's a 0.2% increase in sales per day for that.

To get to the top end of our sales guidance, which would end up at a plus 1%, that would be about a 3% improvement in our December quarter sales per day through the remainder of the year. From an overall perspective and view, we have -- you look at those numbers, and compare that to what we had in sales a year ago, and they're very comparable. The top line is very similar with those.

Our expectation on gross profit percent like we mentioned in the call is hey, we expect to be consistent with the 28.4%-ish numbers that we had in the first half and the second quarter. We have those numbers for that.

We've talked about the small step-up in SD&A that's expected in the second half of the year versus the first half of the year. I don't actually have the SD&A as a percentage of sales for that. We look at it from gross dollar perspectives, is how it's going to flow through.

Within our second half of the year, we do have some additional IT project investments that are more weighted to our second half versus our first half of the year. Obviously when you reset a calendar year, you do have impacts on payroll taxes for FICA and unemployment taxes; then obviously with the annual merit increases for associates effective at the beginning of the calendar year, too.

Just a follow-up on the energy markets. You mentioned you are expecting a sequential increase in the current quarter. Would you expect the magnitude of that increase sequentially on a year-over-year basis to be similar as what you saw here in the first quarter -- or sorry, the second quarter?

Right. Yes, that's a hard one to call. What I will say is in our September quarter, we had a 25% run rate improvement from the June quarter, and we had another 20% improvement from September to December. We just believe those improvements will continue. To the magnitude of the percentages, that remains to be seen.

Thank you.

Adam Uhlman, Cleveland Research.

Hi, good morning.

Good morning, Adam.

Congrats on getting back to growth. Nice to see. The one area that seems to be pretty strong still is on fluid power. I was wondering if you could talk through maybe what you're seeing there, the pipeline of the project wins, in a sense helping the Company for a little bit of time, here. Could you maybe flesh it out a little bit?

Sure. I'd say, Adam, we're pleased with the business and the performance, and encouraged about our prospects looking forward. I think in each of those businesses, they're doing very well in translating their value-added capabilities to our customers. We're doing that with mobile and industrial OEMs, but also with large industrials combining with our service center network.

With those solutions, we're adding more technology to traditional solutions, so it's helping our customers lower their owning and operating cost, and enhancing performance. Our pipeline around those type projects is larger. Our overall backlog is larger. Across those segments, those fluid power companies are performing well.

Now we have a mix. We have a mix of those up, and those aspiring to be up as we work through that. Then the service center network is leveraging more and more that capability with the key customers. That's helping us, also.

Okay, got you, thanks. Then could you talk through -- you had mentioned earlier about looking to grow with existing and also new customers. Can you talk about what you're seeing with your active account base? Is it growing year over year yet?

We would see positives around active accounts, and we would be working with our teams, not only just in pure count, but also the depth with the accounts, in the number of product categories. While still early -- I mean, the other avenue that will help us with this is Applied.com. A mid to late August launch, we're encouraged by the site feedback, the customer experience. We updated for mobile applications recently in that November time frame. We're encouraged with those.

Our view is that's just one additional channel that customers are going to interact with us. It supports us in service centers in that connection, and along with our other channels coming across. Our selling teams are focused on winning with their current customers. We think we've got a lot of capability and room to go, but also adding new customers to the mix.

Great. Any idea of how large that channel could be for Applied within the next year or two?

You're saying specifically in Applied.com?

Yes.

I'd say for us early or maybe to be determined. We've said before, percentage of our sales coming through electronic -- which can be a lot different means -- has been high teens. We expect it to grow, but it will be supportive of the other channels.

We are working on additional customer experience. We are working with customers that use our systems for punch-outs with theirs. That's a case-by-case basis to get them up and running through that. We will have some other search engine optimization and some things planned yet in the second half of our fiscal year, and as we go throughout 2017. We're probably not ready to quite make a call on how big it gets. I think it just continues to develop every quarter as we go forward.

Great, thank you.

Thank you.

(Operator Instructions)

Ryan Cieslak, KeyBanc Capital Markets.

Good morning, Neil and Mark.

Good morning, Ryan.

My first question is on pricing. I think Neil you said it was minimal in the quarter, but I would be curious to hear maybe what you're seeing here into the early part of the year, or hearing from some of your suppliers with regard to potential price increases this year, and how that compares to what we've seen in the last couple years?

I would say the comparison to past years or the start of a calendar year, I would say it's very similar. You will have suppliers that will come in with annual-type increases, more modest amounts. We haven't seen really a greater number or a swell of those. I think it has been steady, as it has been in past periods at this time of year.

Okay. Then on the gross margins in the quarter, I know they were stable year over year, but they were a little bit below where I was looking for, and maybe even just sequentially relative to what you typically see. Was there anything, Mark, in the quarter with regard to how the gross margin came out relative to your expectations? I know you gave guidance for the back of the year, but just again, anything unusual in the gross margins this quarter?

Obviously, when we look at the gross profit percent, we will have variations from quarter to quarter, especially when you compare this year to prior year and things of that nature. What we try to look at, and what we've talked about in our guidance is that our expectations is that we as an organization should be able to deliver about a 30-basis-point improvement in gross profit percent year over year.

For FY16, we ended up at 28.1%. Our Q1 of this year was 28.5%, then we had 28.4% this quarter. We expect that to continue for the remaining half of the year, so that for the full year we are targeting to still hit our 30-basis-point improvement.

Obviously, we have opportunities to do better in the second half, and we're going to work hard to try to make those things happen. But there's always pluses and minuses as you go through the year.

Okay, fair enough. My last question is just going back to the fluid power business. Really nice improvement there here in the quarter, and I know the comp was easy. I would be curious, Neil. You mentioned the backlog and some other things going on within that business. Is that type of run rate with regard to the year-over-year improvement, is that you think is sustainable in the back half? How should we be thinking about fluid power directionally over the next couple quarters?

Let me jump in here before Neil talks, talk a little bit about the math. We believe our sales per day rates that the fluid power businesses segment is accomplishing in the December quarter can continue in the second half of the year. I haven't done the math as to what's that percentage change for Q3 and then Q4 for things. I don't have that answer, if that's going to really be a big positive or a big negative.

I know from an operating standpoint and review with the teams, there's some variation in the groups on performance, many doing well, others with strong activities to go on to get themselves into the positive column. As a total mix, I expect us to continue to improve as we go through the second half. We've got a lot of capability. We're delivering it to our customers very well. It's creating a nice backlog of projects. We don't perfectly control those timing of the releases, but they are encouraging, I think as we go throughout the year 2017.

Okay, thanks guys. I appreciate it.

Chris Dankert, Longbow Research.

Hi, good morning, guys. Thanks for taking my question.

Sure, good morning.

I guess first off, you've done a great job as far as managing SG&A through the down-turn here. I was wondering, you're also going to streamline the business; but is there anything in particular you would be looking to call out as far as further cost cuts, back-end spending consolidation, anything -- any initiatives there you would be looking to point out?

I don't know that we've got things to call out. Fundamentally, we view continuous improvement and restructuring as a part of business. A few quarters ago we grouped a bunch of those. We continue to look at our site locations and say, are we in the right locations. We have multiple locations in some markets, so we've done some combination. The outcome of that is we're in bigger facilities with more scale, more capability, and we think that helps us. We shed a little redundancy cost from being in multiple properties.

I think across our distribution centers, our service centers, and our shops, we will work on lean projects, identifying waste, and how we reduce or eliminate that waste. Those start to come through our results.

Then we say from a central functions and support standpoint, how do we have our workflow more productively? How do we use some of our technology and tools? That's going to allow us to have a same amount of back-office people for more and more volume. Investments then, as we make them go forward, are going to be more forward-facing resources that touch customers and help us grow.

It's not one project that we are banking all improvements on. I think our teams across, our leaders across, are looking at how we stay cost-accountable, and how we can generate productivity every week, every month, every quarter.

Got you, thank you. Thinking about it looks like we're starting to see some light as far as end demand goes. Has there been any discussion about adding head count to help drive more share gains in this environment, or is it a bit too early to be thinking about that?

I think we consistently or regularly look at where we have opportunities to make investments in resources. The other that we're doing, as we work through to reduce hours on back-office activity, that's giving us forward-facing capacity in people to do more things that impact and touch customers, whether they be with orders or with quotes or with follow-ups or technical service. Those are helping us, and don't necessarily require a resource add.

The other that we're doing in some of our talent initiatives on training and development. It's helping our resources be productive, but also impactful with our customers. We talk with our customers every day about how we generate value-add with them, and how we can get documented hard-cost savings, and lower their owning and operating costs of their business.

Got you, and one more quick question, if I could sneak it in here. The top issue here lately has been the whole cross-border tax discussion. Any estimate or breakdown of what your COGS percentage would be from imports?

Let me chat a little bit about that. For the most part, we buy product in country for the countries we operate in. In the US, we by product from US organizations that are providing it to us. In Canada, we buy it from their Canadian organizations. We as a Company record generally don't do importing. That's really done by our suppliers, if they do it. That would just be an impact for them.

Got you. Thanks so much, guys.

Sure.

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

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

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may disconnect.