Applied Industrial Technologies Inc (AIT) 2019 Q1 法說會逐字稿

Good morning, and welcome to the Fiscal 2019 First Quarter Earnings Call for Applied Industrial Technologies.

My name is Mariama, 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, and good morning, everyone.

This morning, we issued our earnings release and supplemental investor deck detailing latest quarter results.

These documents are available in the Investor Relations section of 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 the conference call and make statements that are considered forward-looking statements.

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 provided in our press release and 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 statements, whether due to new information or events or otherwise.

In addition, the conference call includes the use of non-GAAP financial measures.

These measures are explained in our press release and in the supplemental presentation material and are subject to the qualifications referenced in those documents.

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 know many of you have already seen our results, and Dave will provide more detail later in the call.

But I'd like to make a few comments on the key highlights.

On the heels of our fiscal 2018 record financial performance, we delivered a solid start to fiscal 2019 as we continue leveraging our expanded facilities and enhanced differentiation for growth and profitability.

Our net sales for the quarter grew 27% to $864.5 million from $680.7 million in the same quarter a year ago.

The overall sales increase for the quarter reflects 21.5% acquisitions-related growth and 6.9% organic growth, partially offset by the negative impact of foreign currency translation and adoption of ASC 606 revised revenue recognition standards.

Our sales growth was across all businesses and geographies, and while we reported more modest organic growth in fluid power due to the ASC 606 revenue recognition adoption, we're encouraged that 2/3 of the fluid power companies are exceeding plan and that backlog grew 6% sequentially and nearly 25% year-over-year.

Net income for the quarter increased 45.1% to $48.9 million from $33.7 million.

Earnings per share rose 44.2% to $1.24 per share compared with $0.86 per share in the first quarter of fiscal 2018, inclusive of benefits from the lower U.S. statutory tax rate and the impact of discrete tax items in the quarter.

EBITDA for the quarter of $82.5 million increased 32.4% versus the prior year quarter, reaching 9.5% of sales.

The EBITDA growth and percentage of sales demonstrate the value of and positive impact from our expanding value-add capabilities and accretive acquisitions.

We're very pleased with the continued integration progress and development of synergies with FCX Performance.

The FCX team members continue to provide great value-add to customers, strong growth with suppliers and are performing ahead of plan in sales and profitability for calendar of 2018.

As I've referenced throughout the anniversary year, our 95 years of leadership in industrial distribution is based on our guiding principle of taking care of the customer.

And while we're experiencing another active hurricane season at the start of this fiscal year, first with Florence, and most recently, Michael, our teams in the affected areas have worked diligently to overcome disruption and return to what we do best: taking care of the customer.

We sincerely appreciate the extra efforts of our associates in these affected areas.

At this time, I'll turn the call over to Dave for a closer look at our financial results.

Thanks, Neil, and good morning, everyone.

Before we move on to cover further details and our most recent quarter financial performance, a reminder that the supplemental investor deck issued this morning, which recaps key financial and performance talking points, is available for your reference on our Investors site.

As Neil noted, sales for the quarter ending September 2018 increased 27% over the prior quarter with acquisitions driving a 21.5% increase in sales.

Organically, sales grew 6.9% while the impact of foreign currency exchange decreased sales by 0.9%.

Additionally, the company's adoption of ASC 606 revised revenue recognition standards had a 50 basis point negative impact on sales.

First quarter sales in our Service Center Based Distribution segment increased by $35 million or 6.2% year-over-year.

Foreign currency fluctuations had a 1.1% unfavorable impact.

Excluding the adverse impact of currency translation, the organic sales increase was 7.3%.

Moving to our fluid power and flow control segment, first quarter sales increased $149 million or 133% as compared to the prior year.

Acquisitions within this segment, namely the addition of FCX Performance, generated 131% of the year-over-year segment growth.

Excluding the impact of acquisitions, the segment generated 5% organic sales growth for the quarter, down slightly from recent quarters, given the tougher year-over-year comps and timing of larger projects.

Adoption of the ASC 606 revenue recognition standard had a 3% dilutive impact on the quarter's sales growth.

Excluding FCX, the legacy fluid power organic backlog at quarter-end remained robust, increasing nearly 6% in the quarter and up 24.8% year-over-year.

From a geographic perspective, sales in the quarter for our U.S. operations were up $180 million or 31.7% year-over-year, with acquisitions driving an increase of 25.8%.

Excluding acquisition impact, organic sales growth from U.S. operations reflected a 6.5% increase, which was partially offset by the 0.6% dilutive impact of adoption of the new revenue recognition standards.

Sales from our businesses outside of the United States grew 9% organically with strong performance across all geographies.

Foreign currency impact, however, was a 5.5% headwind, resulting in a reported 3.5% sales increase in our foreign markets as compared to the prior year quarter.

Moving on to gross margins.

Our gross profit percentage for the quarter was 29.1%, up 86 basis points year-over-year.

The addition of the FCX flow control business drove 96 basis points of margin expansion year-over-year.

Excluding the accretive impact of the FCX acquisition, gross profit margin for the core business was 28.2%, just 10 basis points lower than prior year, despite the 18 basis point adverse impact of a LIFO inventory charge, driven primarily by our typical seasonal inventory build and higher project work-in-process inventory levels.

Our selling, distribution and administrative expenses on an absolute basis increased $44.9 million or 32% when compared to the same quarter in the prior year.

Acquired businesses accounted for $38 million or 27% of year-over-year SD&A growth, while fluctuations in foreign currency rates decreased SD&A for the quarter by 90 basis points compared to the prior year quarter.

Excluding the impact of acquisitions, the year-over-year increase in SD&A expenses was driven by the impact of annual merit increases, performance-based incentives resulting from improved business performance and timing of project spend.

The effective income tax rate was 12.8% for the quarter as a result of discrete tax adjustments.

First quarter results included a $4.1 million or $0.10 per share discrete tax benefit related to adjustments in the transition tax recorded as a result of enactment of the U.S. Tax Cuts and Jobs Act.

We now expect our effective tax rate to be in the range of 24% to 25% for the remainder of fiscal 2019 as compared to the previously communicated 24% to 26% range.

Resulting EPS for the quarter was $1.24 per share, up 44.2% year-over-year.

While this does include the benefit of the lower effective tax rate, it also includes a $0.02 per share adverse impact from adoption of the revised revenue recognition standards on reported quarter results.

Our consolidated balance sheet remains strong with shareholder's equity of $871 million.

Cash generated from operating activities was $11.8 million for the quarter, which represents a $2.4 million improvement from the prior year quarter.

Quarter results demonstrated continued traction generated by operating working capital management initiatives.

As we continue to distinguish the additional debt assumed to fund the FCX Performance acquisition, our near-term capital allocation priorities remain focused on delevering, with net leverage based on our existing credit facility covenants now under 2.9x EBITDA as of quarter-end.

During the most recent quarter, we fully extinguished the initial $112.5 million revolver draw taken in conjunction with the acquisition.

In addition to funding the $0.30 per share dividend just declared by our Board of Directors, we will also focus on preserving cash to continue to execute on accretive acquisitions to drive shareholder value.

As such, there was no share repurchase activity in the quarter.

To recap, our first quarter performance reflects the benefit of continued execution of our strategic priorities.

EBITDA for the quarter was $82.5 million or 9.5% of sales.

Our fluid power and flow control segment backlog position remains strong, and we continue to see broad-based contributions to growth from all businesses and geographies.

Additionally, we remain pleased with the contributions of the FCX Performance business as sales, profitability and synergy realization to date are all ahead of initial projections, with the acquisition contributing $0.06 per share to year-over-year growth in earnings per share in the quarter.

Transitioning now to our updated outlook for fiscal 2019.

As noted in our press release this morning, we continue to project a sales increase in the range of 16% to 18%, consistent with our original guidance.

Given our first quarter performance and benefit from the lower effective tax rate in the most recent quarter, we now expect earnings per share in the range of $4.65 to $4.85 per share.

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

Thanks, Dave.

Across the organization, we're excited about our growth prospects and remain focused on serving our customers, executing our business plans and delivering our commitments in fiscal 2019.

As we make our way into the final months of our year-long 95th anniversary celebration, we'd like to say thank you to all our stakeholders, including customers, associates, suppliers and shareholders, for the ongoing support and investment in Applied.

While we will enjoy the remaining months of the anniversary celebration, we will be even more focused on building upon our momentum to achieve our next level of performance.

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

(Operator Instructions) Your first question comes from Ryan Cieslak with Northcoast Research.

The first question, actually, I just wanted to get a sense ultimately of -- maybe how the quarter progressed, Neil, and maybe some updated thoughts of how October looks so far, now at this point, how the current quarter is shaping up.

And are you seeing any change in the end markets as it relates to maybe some impact from the tariffs, changes in the way people are buying, the way people are approaching project activity?

Any color around that would be helpful.

Okay, sure.

Our sales per day trends within the quarter, Q1, we saw improvements from July to August and then again in August to September.

We had the seasonality reduction from our Q4 to our Q1, but that has been less than other prior years, so that's encouraging.

And then, from an October standpoint, we've really seen it continue in the mid-single digits range.

So that's the view there.

On the project side, and I know I'm sure we'll get into price margin, I feel like we are doing a very effective job of dealing with 232 tariffs, understanding 301 and the varied lists from List 1, List 2 to List 3 and potentially List 4, in taking those increases on into point-of-sale prices.

As I talk with customers, they are still optimistic on really the finish of '18 and as they plan for and look out into '19.

Perhaps within subsegments, they may be thinking or timing of projects around their calendar year or perhaps fiscal year, but at this point more calendar year and flexing those dates a little bit, but not a great deal at this point.

Okay, great.

And then just maybe sticking on the tariff theme and as you mentioned, maybe just give us update and remind us again the exposure, the direct exposure you have in terms of your sourcing for your products from China directly or even indirectly, and I'm pretty sure it's a limited amount, but just give us an update there.

And then, as it relates to pricing in general, how do the price/cost dynamics look for you today?

Are they change any -- have they changed materially a couple of quarters?

And how do you think about them over the next couple of quarters?

Okay, sure.

So I would say we have relatively low direct impact or direct China imports coming in -- impact on our products.

So to our suppliers, perhaps a little bit -- a bit more either in a finished product or a component or assembly that they may put in into what becomes a finished product, but still for us, and the impact relatively low there.

I think about inflation and we've talked before, based on the repeatability of our sales, only 1/3 of our products repeat year-over-year in a quarter's time frame, and so 2/3 would be more unique based on the value-add, uniqueness of demand, being part of assembly.

So we don't get a perfect price match on those, but we can sense or we know when inflation is coming in on those products.

So I'd say from a pure price impact that we think would be coming through our sales, probably more in the 2% to 3% on the sales impact range I would say right now, I could see that increasing as we move on and into '19 into the 3% to 4% range and perhaps a little bit higher, depending on how some of these 301 tariffs continue to play out.

Okay, that's great color.

And then the last one for me, and I'll get back into queue.

A lot of headlines that are out there about the Permian and the bottlenecks issues there.

I know you guys had exposure as it relates to oil and gas businesses.

Can you just give an update on what you're seeing as it relates to your activity in those businesses?

And the order activity here in the past quarter, has it changed any, has it slowed down?

Do you expect to be impacted by that if not?

And then, well how do you -- how are you projecting that in your guidance?

What's sort of assumed in your guidance as it relates to the Permian and the oil and gas businesses?

Yes.

So I don't know that it's just the Permian, but it's a key part.

I'd say oil and gas, we look back and the quarter performed well, mid-teens.

Had, from a sales per day rate basis, nice progress throughout the quarter.

I think our companies that are performing upstream drilling or upstream on the production side continued to show improvements.

I think some of the projection still for the Permian would be to reach 3.5 million barrels a day output in the November time frame.

I know companies are working on expanding takeaway capacity, which in time, will give us good project opportunities.

But we were also seeing increased activity around Eagle Ford, Bakken and some of the other deposits and play.

So as we think about it going forward, we still -- we'd see oil and gas contributing into the mid-teens from a sales standpoint.

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

Wondered if you could clarify a point you made earlier.

The 2% to 3% impact, is that the impact of price on your sales growth in the quarter?

Yes.

And so we said, we don't have maybe a perfect visibility to that.

So given the randomness of demand, I mean, if you think about a pure price metric, 1/3 of our SKUs repeat quarter-over-quarter, so you could get a true price calculation on that.

2/3, either based on the randomness of the demand and the break picks and longer cycle use of some of these parts, components or solutions or being a subcomponent of a broader assembly, we don't get a perfect year-over-year price.

But our view is it's probably in the 2% to 3% range on of the sales and could be growing as we look forward perhaps into the 3% to 4% or a little more.

So hopefully clear.

Yes, I appreciate that.

And then, if you wouldn't mind running through the performance by industry for the quarter, strength and weakness.

So out of our 30, we would have 24 industries with increases higher than -- a little higher than recent quarters.

Continued positives around primary and fabricated metals, machinery OEMs, oil and gas, I think aggregate and chemicals and such.

So quite a few positives on that side.

I think segments, either close or demonstrating or being below, a little in durable goods and coal mining would have been off slightly.

And then as far as the ASC 606, what's the expectations for the second quarter, the impact on EPS and maybe the second half of fiscal '19?

It should have negligible impact as we move forward.

I'd view it really more as a onetime and then just very modest noise as we think about the out quarters.

And then finally, I mean, looks like FCX is performing ahead of your expectations.

Is $0.06 accretion the right way to look at the contribution from that acquisition going forward, $0.06 a quarter?

We guided initially a $0.10 to $0.20 range with the slightly lower amortization expense that did move up a little bit, but that would be at the high end of that range, but certainly how I would continue to think about the contributions of FCX as we move forward.

Your next question comes from Chris Dankert with Longbow Research.

I guess, looking at the fluid power backlog build, 24.8%, again, impressive, another really strong quarter here.

I guess, is there anything in particular driving that organic strength?

Or is it really truly broad-based at this point?

It's really broad based.

Our fluid power business is broad-based across in segments, in participation, and so we think or look at the company's groups, the geographies that they're in and the end markets, so we see quite a bit of positive developments.

I think we continue to bring technology in these mobile and industrial offerings with our customers, and that's part of building this backlog.

Now we won't perfectly control when it all releases, but those are good developments across those groups.

Got it, got it.

And kind of picking at that just a little bit further, there has been some concern about inventory prebuying, moving into destock in the latter half of the year.

I guess, can you just comment on how you guys view the supply chain at this point?

I know you're more MRO-centric, so it's not quite the same dynamic as some of your vendors would be, but just any commentary you can give on the state of the supply chain and inventory here.

We continue to work with our key suppliers as they work through either relocations or capacity and such and obviously plan well with our customers.

So our view is we're not a big stocker or destocker in some of those sides.

I mean, obviously, we plan the requirements around these projects and delivery time.

So we continue constructive dialogue with the key suppliers, and I think all in all, they're working well to stay up and serving the -- what is a good productive environment today.

Got it.

If I could just squeeze in one more.

Still early, but any chatter about extended downtime with customers into the holiday season here?

We're still kind of looking for preseasonal fiscal 2Q on the sales side for you guys.

I would say no, that I am picking up yet on extended downtime.

I think, obviously, some continue to run and so that's through the holiday period.

That's just normal business.

Some will take planned timeout, which can also create opportunity for us, right, because those will be planned project that they will implement and do while they are having downtime.

But at this stage, I'm not hearing a lot of customers thinking about taking out capacity or extended downtimes based on any market conditions.

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

So I want to talk about free cash flow, if we could.

Guidance, $200 million to $225 million, put up $9 million this quarter.

I know seasonally that's how it works sometimes.

But can you talk about working capital performance in the quarter and how you see that for the remainder of the year?

And just if you're still comfortable with the prior guide?

Still comfortable with the prior guidance, Steve.

Certainly some seasonality, obviously, is exceeding the business with the cash flow typically centered around some of the inventory build.

We did see that again this quarter.

The other factor that hurt us, we've made some very nice progress on our working capital initiatives, particularly our collections activity run through our shared services model, continued to drive reductions in past due.

Unfortunately, some of that was masked this quarter with the quarter ending on a Sunday, which hurt us to a degree in terms of those last couple of days of collections.

But we'd reaffirm the initial guidance provided there, certainly line of sight based on the projections for the business and the actions that we have working to deliver that.

And so the timing of the weekend, notwithstanding, you don't see any unusual or distressing performance in terms of payables from your customer base?

Not at all.

We made progress in terms of past due reduction.

So -- and I guess this -- that just leads me to another question.

I'm going to ask that's similar to other questions that have been asked.

But investors have gotten very nervous about the sustainability of OEM markets and the cycle in general, much of your served end markets.

I think Neil, you already alluded to the forward look.

But can you provide any more specifics around customer conversations and whether you currently see any cracks in the demand picture as you go into calendar '19?

So as we look at '19, dialogue with customers, I think, on suppliers as they build their plans, especially those that are calendar year, I think optimism continues, the investment discussions and how to participate in stronger markets for growth.

And so really don't have a lot talking about kind of the other side or worrying about it turning, especially at this point.

That's really good to hear.

We're seeing distributors track mid to high single-digit organic growth as they benefit from what's obviously a pretty solid cycle.

You're right there as well.

When you think about how to maximize margin in this environment, are there more opportunities internally in terms of efficiency and cost control?

Or do you see more opportunities to increase share of wallet with customers or maybe on the takeover business side?

Just how are you trying to play this to best effect?

So I guess, given those choices, I'll say both as we think about it.

I mean, we're working very hard at growing with current and gaining new customers and expanding our products and service offerings where we already do business.

Still big believer that customers are looking to consolidate their spend with fewer, more capable suppliers.

I think as customers also work through their labor and retirements of what has been some technical support staffs and teams, they're looking for qualified suppliers to support or take over some of that work, which plays to our value-add capabilities around our service centers but also fluid power and especially flow control.

And then, further on the margin side, we just know, with our data and some analytics, we can continue to improve in point-of-sale pricing and with customer mix, still serving strongly small, medium customers, and the product mix, as we move into expansionary products and those value-added services.

So I think we feel like we've got many levers, and while we've had tariffs and inflation coming at us, we feel like we're doing a very good job at understanding it, reflecting and acting with it and appropriately taking that to market.

Because I mean, fundamentally, I believe at the end, as an end consumer, those prices have to come through to me or others, but they also have to go through to end businesses and consumers.

They can't get stuck in the channel for a protracted period.

Sure.

So do you think customers understand that these price increases are coming and in general are not fighting this necessarily more than you would expect?

I think it's hard not to.

In their own businesses, they sell and -- it's hard not to understand 232 and the impact on materials and then the varied list that continue from 301.

And I think we do a good job to show where there's participation or perhaps where there's not.

But I think businesses and markets understand we're in an inflationary environment right now and part of that is driven by tariffs.

And so last question for me.

When you think about the negative impacts of tariffs and just general inflation versus the offsetting things from cost control or your moves into new products and services, would you expect that full year incremental contribution margin exceeds what you put up in 2018 about 11% on the EBIT line?

Is that a reasonable expectation?

Yes.

So our view is yes, and we continue to look at our overall performance and volume leverage.

And we'll look at the quarter and feel like the core businesses contributed well.

FCX did as well, right?

We haven't lapped all of those legacy fixed SD&A expenses yet, so we feel like together, as we do that, we will be in the high teens from a leverage standpoint.

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.

At this point, I just want to thank everyone for joining us today, and we will look forward to seeing many of you throughout the quarter.

Thank you.

Ladies and gentlemen, this concludes today's conference.

Thank you for participating.

You may now disconnect.