APPLIED INDUSTRIAL TECHNOLOGIES INC Q2 FY2025 earnings call

• Second quarter results showed operational resiliency with earnings growth and margin expansion despite soft demand and slight sales decline. - Benefited from strong gross margin performance and cost controls, with Engineered Solutions segment EBITDA margins expanding 115 basis points. - Muted end market backdrop with customers conservatively managing MRO spending and delaying capital investments, but underlying demand improved slightly after slow start. - Service Center segment well-positioned as end market demand reaccelerates, with ~50% of business tied to break-fix situations. - Technology vertical has building order momentum, with stronger demand in semiconductor sector. - Automation business has positive momentum with orders strengthening. - Completed acquisition of Hydradyne, which aligns with strategy, strengthens fluid power position, and brings technical capabilities.

Service Center segment: Organic daily sales declined 1.9% year-over-year. Segment EBITDA increased 1.4% over the prior year while segment EBITDA margin of 13.4% improved nearly 30 basis points year-over-year. Engineered Solutions segment: Sales increased 0.4% over the prior year quarter. On an organic daily basis, segment sales decreased 6.3% year-over-year. Segment EBITDA increased 8% over the prior year while segment EBITDA margin of 16.3% expanded 115 basis points from prior year levels. The Engineered Solutions segment now approaches 40% of overall sales compared to 15% 10 years ago.

• Raised full year fiscal 2025 guidance: EPS in range of $9.65 to $10.05, sales growth 1% to 3%, EBITDA margins 12.2% to 12.4%. - Organic sales trends expected to improve gradually in second half, with M&A including Hydradyne contributing 600-700 basis points to sales growth. - Third quarter gross margins expected to decline to around 30%, EBITDA margins to moderate sequentially to 12%-12.2% but expand year-over-year. - Initial EPS accretion from Hydradyne modest in third quarter, expected to ramp in fourth quarter and 2026 as synergies are achieved.

• Macro policy and interest rate uncertainty remain headwinds. - Weather has played a role in the southern U.S. - Uncertainty around trade policies like tariffs and their potential impact on business.

Q: In the second quarter, excluding rebates and the LIFO tailwind, how to further refine the sources and sustainability of the core gross margin improvement?

A: Neil Schrimsher said it came from mix, scale, and execution, with ~10-20 basis points from vendor support, 25 basis points from LIFO, and ~50 basis points from Engineered Solutions segment mix. Dave Wells added it included 5-15 basis points improvement in Service Center side.

Q: Talk about depreciation and amortization due to Hydradyne acquisition separately, and the $5 million to $10 million of synergies over first three years. Is it a run rate by end of three years? And cost or sales synergies?

A: Dave Wells said majority is 70:30 mix of sales and cost synergies. Neil Schrimsher said depreciation and amortization will step up to ~$17 million per quarter in back half, with Hydradyne contributing ~$3 million incremental D&A per quarter.

Q: On January trends, where do ADS trends shift and when to get back to pre-shutdown levels?

A: Neil Schrimsher said most drag in January was early in the month down double-digit, last couple of weeks up low-single-digit, with pickup in last couple of weeks.

Q: Behavior of suppliers on pricing, signs of disinflation?

A: Neil Schrimsher said no signs of disinflation, amount, frequency, and rate of increase similar. Dave Wells added it's more normalized and distributors can recover and pass on inflation.

Q: Why gross margins moderate Q-over-Q?

A: Dave Wells said it's combination of mix and slightly higher LIFO expense as inventory levels won't reduce further to that extent.

Q: Behavior of customers on pre-buy activity ahead of tariff-related pricing?

A: Neil Schrimsher said no heightened pre-buy activity as there's no clarity on tariffs repeating. Dave Wells added Service Center business is break-fix and not seeing much stocking/destocking.

Q: Pipeline of M&A, strategic focus areas?

A: Neil Schrimsher said continue to have good prospects in fluid power, flow control, automation, and Service Center side, with good capacity for M&A.