Applied Industrial Technologies Inc (AIT) 2018 Q1 法說會逐字稿

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Earnings Call for Applied Industrial Technologies.

My name is Sherin, and I'll 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 Julie Kho.

Julie, you may begin.

Thank you, Sherin, and good morning, everyone.

Our earnings release was issued this morning before the market opened.

If you hadn'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 2 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 this 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 public -- to update publicly or revise any forward-looking statements, 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 Dave Wells, 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.

I'll begin with a brief overview of our results.

Our sales for the first quarter of fiscal year 2018 grew 8.9% to $680.7 million from $624.8 million in the same period a year ago.

Net income for the quarter increased 23.2% to $33.7 million from $27.4 million.

And earnings per share rose 22.9% to $0.86 per share compared with $0.70 per share in the first quarter of fiscal 2017.

Building on our recent momentum, we're off to a solid start to the fiscal year.

Our first quarter results reflect ongoing progress in executing our strategic plan with emphasis on serving our customers, enhancing our capabilities and driving continuous improvements for growth and profitability.

Helping to fuel our efforts with the productive takeaways from our August leadership meeting and key supplier sessions throughout the quarter, each outlining the importance of teamwork, shared vision, clear expectations and accountability for actions and results.

These sessions provide an excellent opportunity to revisit our strategic initiatives, review best practices, recognize achievements and cascade goals for the new fiscal year.

Distribution is a people-driven business and engaging our associates and suppliers drives benefits for our customers and our shareholders.

We know this outstanding potential for Applied, and we're working to realize that potential every day.

Now with a closer look at our financial performance for the quarter, here's Dave.

Thanks, Neil, and good morning, everyone.

Moving on to further details on the most recent quarter results.

Our daily sales rate during the quarter was $10.8 million, up 10.7% compared to the prior year quarter and up nearly 100 basis points sequentially from the June quarter.

Acquisitions drove 80 basis points of the 10.7% year-over-year growth and daily sales rates.

And foreign currency translation increased sales by 70 basis points.

Underlying organic growth in daily sales was 9.2%.

The impact of 1 less selling day in the quarter generated a 1.8 percentage point negative offset, resulting in reported sales, which were 8.9% higher year-over-year.

Breaking down the 9.2% organic daily sales growth for the quarter, 8 points of this growth was generated from our service center distribution operations.

Our operations serving the upstream oil and gas markets contributed 2.7 points, while our core service center business generated 5.3 points of Applied's Q1 organic growth.

The remaining 1.2 points was attributed to the continued momentum in our fluid power operations, where the organic daily sales rate increased 14.7% year-over-year.

The impact of vendor price increases and resulting price pass-through remained nominal during the quarter.

Our product mix during the quarter was 73.7% industrial products and 26.3% fluid power products.

First quarter sales in our Service Center Based Distribution segment increased $39.7 million or 7.5%.

Acquisitions added $0.8 million or 10 basis points, and favorable foreign currency impact increased sales by $4.5 million or 90 basis points.

Excluding a 1.7% headwind from 1 less sales day in the quarter as well as acquisition and foreign currency impact, daily sales increased 8.2% year-over-year.

Operations that sell to the upstream oil and gas industry generated 3.2 points of this increase, with the balance attributed to traditional core industrial distribution operations.

Complementing the traction demonstrated in our Service Center Based Distribution operations, our fluid power business segment increased $16.2 million or 16.9% year-over-year sales.

Acquisitions within this segment increased sales by $3.9 million or 4.1%.

Excluding acquisition impact, sales increased 12.8%, driven by a 14.7% organic increase in daily sales, which was partially offset by a 1.9% decrease attributed to the 1 less selling day in the first quarter of fiscal 2018.

Moving on now to the geographic cut of the business.

Sales in the first quarter from our U.S. operations increased $44.2 million or 8.4% compared to the prior year quarter with $3.9 million or 80 basis points of this growth attributed to acquisitions.

Of the 7.6% organic sales increase for the quarter, 6.6 percentage points is derived from our traditional core distribution operations with another 2.8 point contribution from our upstream oil and gas focused operations.

This favorable performance was partially offset by a 1.8 percentage points decrease attributed to the difference in sales days year-over-year.

Sales from our Canadian operations increased $4.2 million or 6.8%, which includes a $2.6 million or 4.1% benefit from favorable foreign currency translation.

Excluding the impact of foreign currency, Canadian sales increased $1.6 million or 2.7%.

Consolidated sales from our other country operations, which include Mexico, Australia, New Zealand and Singapore, reflected an overall increase of $7.5 million or an 18.1% from prior year.

This consisted of a sales increase in local currencies of $4.8 million or 12.1% prior to acquisition benefit of $0.8 million, representing a 2% increase and favorable foreign currency translation impact of $1.9 million or a 5% in the quarter.

The local currency sales increase in the quarter was a result of positive growth trends across all operations.

Our gross profit percentage for the quarter was 28.3%, 20 basis points lower than last year's first quarter, but flat to the prior quarter when adjusted for the 50 basis point net benefit of LIFO income recognized in our fourth quarter fiscal 2017 results.

The year-over-year decline was primarily attributed to nonrepeat LIFO income recognized in the prior year quarter, which masked underlining year-over-year improvement in operating gross margins across the business.

Selling, distribution and administrative expenses decreased $7.3 million or 4.9% sequentially and as a percentage of sales improved 100 basis points sequentially.

Year-over-year, first quarter SD&A increased $5.7 million or 4.2%.

Foreign currency translation drove $1 million or 70 basis point increase as compared to the prior year quarter, while SD&A from businesses acquired accounted for $0.9 million or 60 basis points of the increase.

Net of acquisitions and foreign currency translation impact, SD&A increased by $3.8 million or 2.9% year-over-year.

Our selling, distribution and administrative expenses returned to normalized levels coming off the impact of performance-based incentive and bonus recognition, which adversely impacted the second half of fiscal 2 years -- 2017 and reflected the benefits of our ongoing operational and excellence initiatives and volume leverage.

The effective income tax rate was 31 -- excuse me, 33.1% for the quarter.

This was slightly lower than our estimates due to a discrete state tax adjustment, which positively impacted the quarter rate.

As such, we still project our go-forward tax rate for the balance of fiscal year to be in the 34% to 35% range.

Our consolidated balance sheet remains strong with shareholders' equity of $773.7 million and a conservative debt-to-total capitalization ratio of 27%.

Our after-tax return on assets for the quarter was 10%, improved from 9.2% in the June quarter and from 8.4% in the prior year quarter.

Volume driven increases in inventory and receivables coupled with normal variability coming off our June fiscal year-end, resulted in cash generated from operating activities of $9.4 million as compared to $41.9 million in the prior year quarter.

While operating assets and liabilities, net of acquisitions increased $35 million on higher business volumes, operating working capital turns were flat to prior quarter and improved slightly year-over-year.

We continue to expect cash provided from operating activities in fiscal 2018 to be comparable to fiscal 2017 as we leverage systems, investments and fully implement initiatives designed to deliver sustained improvements in both operating and financial performance.

During the quarter, we completed the acquisition of DICOFASA, a single location distributor of accessories and components for hydraulic and lubrication systems, headquartered in Puebla, Mexico.

During the quarter, we also purchased 247,500 shares of treasury stock on the open market at an average cost of $55.60 per share for a total of $13.8 million.

We will continue to evaluate future capital allocation decisions with the focus on maximizing shareholder value.

Regarding our full year outlook, as referenced in today's earnings release, we tightened the range on our initial fiscal year earnings guidance between $3 and $3.20 per share to a range of $3.10 and $3.20 per share.

Corresponding top line guidance of 3% to 5% sales growth was tightened accordingly to a range of 4% to 5% growth.

While we expect the typical second quarter seasonality and the impact of fewer sales days to be reflected in sequential sales, we remain optimistic but at a prudent level, given the positive start to the year and recent traction generated from execution of our strategic priorities.

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

Thanks, Dave.

I'd like to take this opportunity to recognize those impacted by the recent intense hurricanes, specifically Harvey, Irma and Maria.

The storms touched many of our associates and so many others, resulting in significant hardship and personal loss.

I'd be remiss in not calling out the tremendous efforts and commitment displayed by our associates in the affected areas.

Despite challenging logistics, our teams worked to sustain our high standards of service, helping our customers and these communities to resume operating productively.

The Applied organization has always rallied around our own associates and the communities we serve.

And we witnessed that again following these powerful hurricanes.

It's important to recognize and thank our associates for their resiliency, generosity and care from supporting our customers to helping our fellow associates, we're committed to Applied's core values, which includes teamwork at all times.

Likewise, we're committed to the actions that will drive growth and increase profitability across our organization.

We're well positioned in our markets and on track to deliver our fiscal year commitments with opportunities for continued improvement in sales, operating performance and earnings.

With that, we'll open the lines for your questions.

(Operator Instructions) Your first question comes from Adam Uhlman from Cleveland Research.

I was wondering if we could start with a discussion of what you're seeing in your major end markets, you know by the -- SIC codes that you track and maybe if you could kind of touch through how the pace of business unfolded through the quarter?

And then early look at October trends?

Okay.

Sure.

So in the 30 industries, our sales performance had 18 industries showing increases, that's really similar with the recent quarters, positives that you'd expect around oil and gas, primary metals, machinery OEMs and food with some declines around chemical and refining.

To me, that's more timing related around the hurricane impact, which was I view more of a business interruption and a change in timing than a long-term systemic impact.

If they look back at the quarter, our sales per day trends improved overall from Q4 to Q1.

We saw improvements from July to August and even stronger improvements from August to September.

Our month-to-date, October started well.

Year-over-year, it's high single digits.

But it is off from the September with a few more days to go.

So that's what it's looking like -- what it looked like through quarter 1 and the start of this one.

Your next question comes from Ryan Cieslak from North Coast Research.

Neil, I think maybe first off -- this would maybe appreciate -- maybe some color on, when you think about the sales growth you're seeing right now, how much do you think this is really driven by this end market strengthening versus some of the strategic initiatives you have on place?

And then with regard to those strategic initiatives, maybe just characterize to us where we are with those?

And what's really driving that?

It seems like fluid power you guys have had a lot of nice traction there in the last couple of quarters and it continues to accelerate.

Are we still in the early innings with regard to some of the things you're doing there?

Or is that something we should expect to flatten out as we go into later part of this year?

So I'll start with where you ended around fluid power.

The businesses are performing well.

Nice quarter, 13% plus type growth.

If I look across the group, I would say, 80% of that group in number are demonstrating or showing sales growth.

The other companies are close in doing it.

And it's some really nice initiatives with mobile and industrials connecting technology.

More electronics into those hydraulic design and solutions.

We're involved in projects from the design stage to the build stage to the delivery stage, provide the nice then either stickiness to us for ongoing customers or enriching the product mix features for those OEMs.

So we still feel that is in early innings as we think about taking that technology into all the applications that it can go.

If I think about the other groups in our business, our U.S. service centers performed well, continuing to work on growth initiatives with current customers and growing and delivering value and expanding our products, but also pursuing new customers.

Our Maintenance Supplies & Solutions group working hard to the same type growth.

If I think about our global guys, they performed well in country and in growing in local markets as well.

So -- undoubtedly year-over-year, the economy has improved, and we're participating.

But we're also working at how we can even be better than what market level's going to be.

And we feel like we had some of that in the quarter.

And then our focus is just to continue to do that going forward.

We feel like we can operate in any environment, and in a better environment, we want to be stronger than just what the market's going to give us.

Okay, great.

That's really nice color.

I appreciate it.

And just for my follow-up and I'll get back into the queue.

Dave, when thinking about the operating costs here in the quarter coming down sequentially, some of the incentive comp and merit increases normalized, I'm assuming that it should, maybe, obviously be depending on how the results look will ramp back up in the back half of the fiscal year.

Just directionally, how do we think about that step-up from the first half to the second half as it relates to maybe some of the cadence with the current guidance you guys have out there

Sure.

You bet, Ryan.

So I think we see -- had the quarter characterized that as normalized spend, we will see some modest step-up even as we work in the Q2 with some investments that we're making both continued investments in technology as well as in capacity expansion.

And then, I'll remind everybody, we are in a focused January first merit.

So we would see the back half of the year kind of stepped up with the result of merit, infringe, impact, et cetera, and some of those investments kind of in the high mid-single-digit range.

But I would say, here again, seeing the leverage from the -- certainly the -- on the sales and some of the impact and benefit from the initiatives we've been working and the restructuring completed in prior year in the business.

Your next question comes from Jason Rodgers from Great Lakes Review.

Yes, just a question about the hurricanes.

I know it's difficult to try to quantify, but what do you estimate to be the potential benefit you could see as the rebuilding effort commences?

I think that's really to be determined.

We know it disrupted days, to us that's more timing.

And then, the benefit as -- many of those customers are back online, operating and running.

We think about our business in Puerto Rico right now.

A month-to-date, we could see now sales variances versus the prior month sales decline.

I think in the end, it normalizes out over the mid to long term.

So significant personal impact to individuals.

I think from a business perspective over the mid to long term, it normalizes out.

And just looking at your guidance, you had an especially strong quarter, this quarter.

And you brought your guidance up somewhat, but did not raise the top end.

And that's kind of implying that the first quarter as far as the year-over-year growth will be the strongest or close to the strongest for the year.

Just wanted to get your thoughts on that?

And if there was anything particularly onetime in nature for this quarter that may not carry through for the rest of the year?

Right.

I'll start it.

I don't know that there's anything onetime in it, but we feel like a solid start.

We know Q2 has fewer absolute days so that translates into a lower sales level.

So the 4% to 5% sales range really has Q2 likely in the higher single digits against a weaker comparable.

And then, the second half of fiscal '18 at kind of similar sales per day rates.

And so would translate into more moderate growth.

And they're viewing a brake-fix MRO.

We don't have perfect visibility.

They don't carry a big backlog.

We do in some of our segments like fluid power, but for a large portion of our business that we don't.

And so that plays into the sales side of the guidance as we look out for the year and the second half.

And then, I think from a earnings per share standpoint, I would suspect right.

Q2 EPS, it will print nicely against a weaker comparable, probably more the teens.

And then, the second half of EPS could moderate.

They touched on earlier some of the second half SD&A and focal point merit and benefits.

We're doing some things around wellness initiatives for our associates.

We think that's good for them, and we think it's also good mid and long term in continuing to positively impact health care cost.

And then a little bit of technology investment.

And for us, those are really around IT projects.

And so some of that will come in to the second half of the year.

So that's our view.

We're going to be working it hard every day through this quarter.

And then, obviously, we'll be back together again in January providing some further thought.

That's helpful.

Just one final question.

Are you seeing any material business shift online either your own business or perhaps losing some small amount to online competitors?

Yes.

So for us and our channels to market, when we talk about 5 channels to market, so we love our local presence.

And with our 430-plus service centers, our fluid power business in the 70 locations with service and repair capability, touching mobile and industrial OEMs and also supporting some of the industrial fluid power MRO efforts as well.

We've got a productive printed and electronic catalog, a strong technical resource for our customers.

We have our Maintenance Supplies & Solutions, vendor managed inventory specialists.

And then, applied.com.

And if I look at the statistics, the trends there, I'm pleased with the trajectory and the absolute percents.

I believe more and more customers will do business with us across multiple of those channels.

So I view our products, the technical nature of them, the service requirements often required, the time element, speed required around brake-fix MRO and get back up and running.

I like our position.

I like our added electronic capabilities.

I believe that's good for our business.

So we think we'll see continued development across really all 5 of those channels.

And we're not seeing erosion from elsewhere.

(Operator Instructions) Your next question comes from Steve Barger from KeyBanc Capital Markets.

My first question is on pricing.

Just thinking about some of the volume trends we're seeing from OEMs on the order rates or other distributors, we're starting to hear a little more about price pressure in the channel.

Can you talk about what you're seeing from suppliers?

So we think about pricing, we would see some more suppliers, some of the increased activity of supplier increases coming into the quarter, and we expect that can likely continue as we go into calendar 2018.

We had a little LIFO expense impact from kind one of those modest supplier increases in the past quarters.

So we expect.

But to this point, not unexpected to the level or the pace.

And I think we will see some of that as we work more through 2018.

And your expectation is you will be able to pass along the price increases that do come to you?

It is.

And that now as we think about kind of a modest, steady inflation environment we have in the past, and it'd be our expectation to continue to do so going forward.

And then, it will continue also to work the rest of our margin initiatives.

And using kind of the systems and analytics to reduce pricing variation around customer groups or product types.

And then we know we have opportunity with mix, both customer mix doing well on the local economy as well as with larger accounts, but also in product mix around our core products.

But growth in expansionary products and consumables help us on the margin side as well.

For the price increases that you have seen or the conversations you're having with suppliers, how would you characterize the rate of increase that you're seeing?

I don't know if I have all that in front, but it's still in the, I'd say, low to mid-single digits, some will be more selective on, maybe, odd or obsoleting-type products with higher price expectations on those and sometimes more tonnage or flow types perhaps little less, but that's what I would say at this point.

And then, if some have a high raw material input that is increasing, maybe a little higher.

And then so we're seeing some of that in perhaps some of the resin-based type products could be a little higher.

Okay.

Free cash flow, little lower than my expectation in the quarter.

I know -- I see what happened with working cap there as a function of volume increasing.

But how should we think about the free cash flow walk through the rest of the year?

Sure.

And we have a number of initiatives working in terms of both the collections, where we did lose just a little bit of traction.

We did see a mix impact.

Our best possible DSO increased about 1.2 days in the quarter.

But we did lose some traction on the, particularly, the service center-based collections where we've got initiatives working in terms of centralization, using some enhanced tools and process, where, I think, we'll recover that nicely in the next couple of quarters.

So we'll still expect to see as we committed improving free cash flow or cash for operating activities over the kind of the context of the year and something back closer to what we saw in fiscal 2017 as a result of working both the collection side of the equation as well as driving the inventory velocity as we continue to leverage some of the SAP tools and investments that we've made and some of the operation and excellence initiatives we have work in.

In a growing volume environment, would you expect free cash flow conversion exceeds net income?

Or is that a high hurdle in a -- when volume's rising the way it is?

It'll present its challenges, but we've got line of sight, I think, in terms of the initiatives that we're working to bring that to parity and that's our target still as we work across the year.

(Operator Instructions) Your next question comes from Ryan Cieslak from North Coast Research.

Just a really quick, just to dovetail on that question from Steve.

On the inventories, it did obviously come up sequentially on an absolute basis.

I think last quarter, you were talking more about flat inventory trends for the year.

Is the assumption that sort of trickles back down going forward?

How do we think about sort of inventories for the balance of the year?

I think we expected a bit of a ramp coming off our fiscal year-end, not atypical in this business.

So certainly, that factored into our equation as we thought about the full year profile in terms of inventories.

So you're getting to see impact of the greater volume, work-in-process inventories on the fluid power side of the business especially did increase.

But turns improved and here again we've got a lot working in terms of better visibility, making sure we've got inventory in the right spots as we think about servicing our customers.

So once again, I think, that was contemplated, that build was contemplated in our full year profile.

And we'll continue to work those initiatives to try to drive that back down as we work throughout the course of the year.

Okay, great.

And then just lastly, sorry if I missed this, but I think in the past, you've guys have talked about your view that you guys can expand gross margins roughly 20 to 30 basis points annually.

Is that still the assumption, you know, following the first quarter or so?

And then just remind me, is that inclusive of some modest price improvement?

Or is that really just what you guys have in your control at this point with regard to mix in some of the initiatives?

Ryan, this is Neil.

It still would be our objective, our initiatives around 20 to 30 basis points improvement.

And we feel we get that with point-of-sale improvement, touched on a little bit earlier, right?

Better management, reduction of variability either cross product ranges or groups around customer types.

We just know we have opportunity.

And then on the mix side with customers' growth with local accounts as well as balanced with larger accounts, we can improve from customer mix.

And then, product mix with that growth into consumables, expanded products, applied.com further accelerates or helps us there as well.

We can improve our margins plus perhaps a couple other initiatives that we'll be working.

So if we look at the past quarter, right, we know the drivers sequentially with the LIFO benefit that we had in Q4 year-over-year the comparison.

I mean, we know that down 20 basis points there with -- we got a little LIFO help in that prior quarter, and we took a little bit of LIFO expense this one.

There's also probably a little change or foreign currency impact on that on some dollar denominated sales going outside of the U.S. But operationally, we showed improvement.

And so we're encouraged by that.

And our view is we're going to continue to work those improvement levers in quarter 2 and the second half of our year, and our belief is that'll yield results.

At this time, I'm showing we have no further questions.

So I will now turn the call over to Mr. Schrimsher for any closing remarks.

I will simply close with thanking everyone for joining us, and we look forward to seeing or talking with many of you throughout the quarter.

Thanks.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.