Welcome to the Fiscal 2021 Second Quarter Earnings Call for Applied Industrial Technologies. My name is Mariama, and I'll be your operator for today's call. Please note that this conference is being recorded. I will now turn the call over to Ryan Cieslak, Director of Investor Relations and Treasury. Ryan, you may begin..

Thanks, Mariama, and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing our second quarter results. Both of these documents are available in the Investor Relations' section of applied.com.

Before we begin, just a reminder, we'll discuss our business outlook and make forward-looking statements.

All forward-looking statements are based on current expectations, subject to certain risks, including the potential impact from the COVID-19 pandemic, as well as trends and sectors and geographies, the success of our business strategy and other risk factors. 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..

Thanks Ryan, and good morning, everyone. We appreciate you joining us and hope your new year is starting well. I'll begin today with some perspective on our second quarter results, current industry conditions and our position going forward.

Dave will follow with a summary of our financials and some specifics on our second quarter and outlook, and then I'll close with some final thoughts. We're pleased to report a solid and productive quarter for Applied, along with positive momentum building as we enter the second half of our fiscal year.

Our team executed extremely well during the second quarter and we saw a sustained sequential improvement in customer demand following the initial recovery highlighted last quarter. We are leveraging our industry position and generating incremental traction from our strategic growth initiatives.

These include addressing customer's early cycle, technical MRO needs, as well as playing a vital role in supporting efficiency and performance initiatives across their critical industrial infrastructure.

We believe these customer initiatives will be increasingly relevant giving a greater focus on operational risk management and supply chain considerations. We are capturing these initial tailwinds while remaining disciplined with controlling cost as sales continue to recover.

Cost accountability and execution have always been key to our culture and remain integral to our operational focus going forward. This is supplemented by operating efficiencies gained from optimizing processes, systems and talent across the organization in recent years.

While additional expense restoration will occur in the second half of our fiscal year, we expect these counter elements to provide further balance to our cost trajectory near-term and support our long-term EBITDA margin expansion potential as the demand recovery continues to unfold and we leverage our operational network.

I'm also encouraged by the strong cash generation we continue to see across the business. Year-to-date, free cash is up over 60% from prior-year levels and over 200% of adjusted net income. While influenced by the counter-cyclical nature of our model, cash flow is ahead of our expectations and up meaningfully from prior-year levels.

This highlights the progress we continue to make with regard to expanding our market position while optimizing our margin profile and working capital management..

Thanks Neil. Just another reminder before I begin, regarding the availability of the quarterly supplemental investor deck, recapping key performance and discussion points, which has been posted to our investors' site for your additional reference..

Thanks Dave. Approximately three quarters ago, during the initial weeks of the pandemic, I stated my belief that Applied has never been in a better position to manage through the current environment and exit the pandemic-driven downturn in an even stronger position.

Our performance since then provide strong confirmation of disposition, the tremendous team we have at Applied, and the earnings potential that lies ahead. This includes record cash generation and a 30% reduction in our net debt, our strong cost execution supporting relatively stable EBITDA margins despite the meaningful end market slowdown.

During this time, we also completed two acquisitions, supplementing our long-term growth profile, while advancing other key growth initiatives, including optimizing our cross-selling opportunity and strategic end-market positioning.

We are delivering on our requirements and commitments while moving the organization toward our longer-term next milestone financial objectives of $4.5 billion of revenue and 11% EBITDA margins.

We remain cognizant of ongoing end-market uncertainty, but we're eager to demonstrate what we're fully capable of in the years ahead as we continue to leverage our differentiated industry position as the leading technical distributor and solutions provider across critical industrial infrastructure. Once again, we thank you for your continued support.

And with that, we'll open up the lines for your questions..

Your first question comes from David Manthey with Baird. Your line is open..

So could you outline the automation outlook for - as we enter calendar 2021 here with Olympus, AVS and Gibson? And what I'm wondering is, can you now approach the market differently with the expanded geographic coverage that you have?.

So I believe we can approach the market fully, and so work that would go on now as we look across these businesses, we can share best practices that go on an approach in technology or sales engineers. We can look at support and perhaps development work from an applications engineering standpoint to start across the group.

And then as we have opportunities that can exist in some of the geographies, we can leverage some back-office infrastructure that would start. So it's early to be doing that.

And so each of the groups will be working with their current customer base, their current pipeline of opportunities, but we are broadening the effort to say where can we connect this automation to current, what would have been legacy service in our customers for additional growth opportunities..

Yes. That's helpful, Neil.

And on that last point, that was my second question is - have you begun the process of cross-selling and the legacy Applied salespeople have been trained to at least be knowledgeable in automation and robotics, so they can pull the experts in or how is that going and what - or if you can just give us a timeline as far as where we are and where we're going in that prospect?.

I would say, while early, we are raising that awareness of our account managers and selling teams of what is available, when they are inside of facilities where to look for the opportunities, how to start the dialog, and then providing support with automation capable individuals to help connect the dots.

And so we have projects, we have early results in the pipeline across that customer base and we have growing interest in that capability.

And so you can imagine more in the West, started in the Southeast and we're just getting started in that Northeast, Mid-Atlantic, but now with that growing footprint and capability, that can occur with customers that have sites and facilities across the geography..

Your next question comes from Adam Uhlman with Cleveland Research. Your line is open..

I wanted to start with a question around cash flow. I'm wondering what you're going to do with all this cash you're generating. I guess the inventory working capital, sounds like that's a source here over the next - a year or so over the next six months.

Could you maybe dimension how you're thinking about inventory additions as business levels start to pick up? And then related to that, steel prices have jumped quite a bit.

I'm sure the supplier price increases are starting to come through, any opportunity to buy ahead of that? Was that an opportunity here in the December quarter or maybe you could do a little of bit before than to mitigate the impact of higher material costs?.

Sure. I mean we're going to continue to evaluate, and I think we have a very good cross-functional process put into place to evaluate the trade-offs between the investment in inventory tie net working capital and leveraging those pre-buy opportunities.

So we'll see that continue into the back half of the year that's due to great result as you look at our cash flow year-to-date, with the working capital efficiency being the key driver of the - over drive that we have seen.

That said, I think we'll be mindful what we put back on the shelf going to peak the rate of demand and while protecting - the - making device to make, to protect our customer base against outages and where it makes sense despite the advance of potential increases.

But historically, we've done a very good job of matching and you've been able to manage that price cost inflation. We see that trend continues to move forward as we continue to leverage the inventory position and systems in place.

So back to the original question, we'll see some build in working capital as resolved this year, volume impact on AR even though we continue to make a nice job - and do a nice job of reducing our past due position, down another 5 points year-over-year across the business.

But then continue to leverage that cash flow, strategic M&A will continue to evaluate other growth opportunities to drive shareholder value..

And Adam, I would add. If we look back at our second quarter, I think price was kind of a modest contribution, I think it's very similar in the third quarter. And while the input cost of steel and other commodities start to go up, it is an input for many of our suppliers, they would still be processing them through.

We do see increased frequency of price increases coming, many of them may have announced periods to allow an orderly implementation to go on in that. So I think there will be greater activity there in the announcements before it's coming through in results, I'm not - for sure it's much of a change in the third quarter.

It may be an impact, a little more into the fourth and then obviously as we get into next fiscal year and then today's point, we've got a good track record and history of managing that price cost inflation as it goes forward, but I do think there will be a modest ramping as we think about it through the end of this fiscal year..

Thank you, that's very helpful. And my second question here is really on the oil and gas, it sounds like you did some more restructuring of your footprint there.

But I'm wondering if you're seeing any green shoots in that industry at all?.

We talked about in some of the heavy - heavier industries, perhaps having some of those oil and gas, I mean in it - I mean, we did the evaluation, as we look and also extend that outlook led us to making the adjustments, service centers that participate more in that oil and gas sector and reducing the number.

Obviously and unfortunately, right, that impacts individuals, but it does - we have opportunity to redeploy some of those resources to other growth initiatives. So I would say it's quite early to see many green shoots say in oil and gas.

We will have a presence, we're still good from a Permian standpoint, from an Anadarko standpoint, should participate in that, but from a percentage of our business, right, it's less than 5% today, and I expect that it stays at that level over a period of time..

Your next question comes from Chris Dankert with Longbow Research. Your line is open..

I guess just thinking about the opportunity for preventative maintenance and software revenue, any sense for kind of what inning we're in there with customers? I mean, is it still really early days? What's the additional opportunity with some of those preventative maintenance stuff? And ultimately do you think adding some of that software revenue can be margin-accretive for you guys? Just any thoughts there would be great..

So I would say it is still early. I mean, our approach on Applied, Internet of Things and how we connect, we are working very well with our leading manufacturers and we are targeting specific customers.

And I think most customer approaches are focused, they are focused on facility or areas of facility, prove out success, harness the data that is available off of equipment, and use that for predictive maintenance or perhaps for broader remote monitoring across multiple sites, especially, it with less travel, less physical presence that they're having in their own facility.

So I think that is early. We are having success. And as we do, we can replicate that with that customer in the facility and across their landscape. And as we do it within the industries, we can more but, for I think us, we think it is a great opportunity. It is very early innings. We are excited about it.

And so we're participating, but we think it's one that ramps over a period of time..

I guess just to kind of quick follow-up on that.

Is this an offering you guys are kind of leading with or is at the moment, preventative maintenance more of a customer pull thing where they're requesting it?.

We are leading with the enabling technologies that help in their discrete automation opportunities. So some of it may be predicted preventative maintenance, but in many places, it's using vision products to help with quality inspection or perhaps manage out some physical labor that was previously doing it.

The use of collaborative robots helps from a labor density standpoint in this time and provide some ongoing productivity in there. The data connection ones are now to say, we've had sensor-embedded products for a long period of time and that customers are wanting to connect those and understand that operation in going through.

So I think there's many elements into it and it's not just technology and monitoring for preventative maintenance..

Make sense, make sense. Thanks for that. And then I guess just the last one from me.

Talked a lot about automation, but we haven't heard a ton about linear motion, just any comments on how the growth's progressing there? Any additional focus on M&A or we still kind of - are we kind of shifting the M&A focus more to automation? Just any comment on linear would be great..

Well, I think for us overall in priorities and we're active across - Dave touched on them - some in automation rate, which has been the most recent couple in that.

We continue to be focused on and busy from a fluid power standpoint and we will look to how we selectively add to our capabilities and footprint, whether that be in flow control or the service center. So for us, linear motion, depending on the size can be across some of those segments in the industry.

So I would - it has the opportunity to contribute as we have going forward, but there is a big focus on fluid power, automation and flow control..

Your next question comes from Steve Barger with KeyBanc Capital Markets. Your line is open..

I'm just going to stick with the growth initiatives.

Now that you have the footprint on the West Coast and the Southeast, the Northeast, are you looking for further geographic coverage in the Midwest or can you do that here? And as you learn more, do you have the ability to organically create a business unit or do you need to do that by acquisition?.

I think we'll continue to look at companies and organizations that would provide additive benefit and capabilities, and so, even while we're in those geographies, perhaps, there is another way to further augment.

But as we grow in scale and start to leverage some of the back shared capabilities of the technology, of the application engineers, greater amount of sales engineers, even some of the virtual selling capabilities that exist today, we feel like we can grow in geographies also, leveraging footprint and capability that we have.

So it could be a mix as we go through and so we're going to continue to be active and busy as we evaluate that, but as we grow, we're opening up the ability to build on what we have and then leverage existing Applied resources that are in the service center selling side, but also in fluid power and flow control..

And as you think about the automation robotics, fluid power, flow control, I guess just bringing it back to automation and robotics specifically and maybe IoT implementations, can you tell us what percentage of revenue that is right now and what that growth rate is? Or what do you expect it to be relative to the rest of the business?.

I don't know if I have it top of mind or at hand on percent of revenue. I know we are having success in this environment and so while it's new to us, the things that are coming into the pipeline and as we move these projects along, they are working hard to commission and get implemented what they have in that side.

So, probably early to start comparing on the growth sides. As we march through less declines in sales and start to return to growth likely as we think about our fourth quarter and beyond in that, I expect this area to contribute at that rate and greater than that rate to be part of the pulling effort..

Yes Steve, this is Ryan.

Just as it relates to the size, do you think about the acquisitions that have been made specifically over the last 16 months to three of them, we talked about the size of Olympus Controls, we initially did it around your $45 million to $50 million of revenue, the last two that we did with ACS and Gibson, about half that size in terms of revenue, so that as you do get to an idea of - on an annual basis, what those three acquisitions represent today.

The other point though on top of that is, there is a number of offerings and capabilities that we have within our fluid power business and across our service center network where there is certainly automation tied to it.

So when you kind of mine that on top of that, that certainly would be incremental as well, but it is still be a - probably - certainly a lower percentage of the business today, but with the view that continues to ramp as we continue to build out the network, both organically and through acquisitions..

No, that's great detail. I guess what I was really trying to get at is, if you look at that, call it $90 million to $100 million in revenue, whether it's historically or on a go-forward basis, and I know it's tough to compare over the last year.

Is that part of the business, growing faster than the Fluid Power segment itself and how additive is that to the organization? And I guess is that also accretive that $100 million to the Fluid Power segment?.

So I think it can grow at that rate higher and we've talked from an accretive standpoint. Today I'm more at company average. I had - the potential is to be above that. And so that's our view and what we'll be working towards..

Got it. And then that just leads into my last question. Free cash flow has been outstanding as you noted, you talked about cash conversion moderating in to your return to growth, which is understandable.

But just as you think about mix and the growth initiatives, is that creating sustainable changes to the cash flow profile through cycles?.

Well, if you look back, right? We're at higher peaks, as we go through now and we think we have continued to improve and mix up our ability from a cash generation standpoint. And we do things internally with shared services and approach, how we leverage technology, and we think our effective use of inventory and management in that side.

So we do expect it to moderate, but we expect to be performing at a higher level than in time, right? We think working capital as a percent of sales can get to the 20%..

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..

I just simply want to thank everyone for joining us today and your ongoing support and we look forward to talking with many of you throughout the quarter. Thank you..

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