Welcome to the Fiscal 2021 Fourth Quarter Earnings Call for Applied Industrial Technologies. My name is Natalia and I will 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, Natalia and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing our fourth quarter results. Both of these documents are available in the Investor Relations section of applied.com. Before we begin, just a reminder, we will 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 in 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. In addition, the conference call will use non-GAAP financial measures, which are subject to the qualifications referenced in those documents. Our speakers today include Neil Schrimsher, Applied’s President and Chief Executive Officer; and Dave Wells, our Chief Financial Officer. With that, I’ll turn it over to Neil.

Thanks, Ryan and good morning everyone. We appreciate you joining us and hope you are doing well. I will start today with some perspective on our fourth quarter results, current industry conditions and company-specific opportunities. Dave will follow with more detail on the quarter’s performance and our forward outlook, including fiscal 2022 guidance and then I will close with some final thoughts. Overall, we ended our fiscal 2021 with strong fourth quarter performance that exceeded our expectations and highlights our favorable competitive position as the industrial recovery and internal initiatives continue to gain traction. Before I get to some specifics, I want to thank our Applied team for their commitment and strong execution throughout fiscal 2021, particularly considering the many challenges we faced as the result of the COVID-19 pandemic. Our associates’ teamwork, dedication and invaluable contributions turn these challenges into opportunities. This includes being a critical partner across essential industries and now supporting the growth requirements customer face as we enter what could be a prolonged period of favorable industrial demand. Combined with our strong cost discipline and the resilient nature of our model, we persevered and generated record earnings in fiscal 2021 while remaining fully invested in our long-term strategy. In a year unlike any other, we have held and often exceeded our commitments to customers, suppliers and all stakeholders. And we now look to build on this momentum going forward. As it relates to the quarter and our views going forward, I want to reemphasize several key points that continue to drive strong performance across our business. First, we are seeing sustained demand recovery. Second, our industry position and strategic initiatives are driving growth opportunities beyond the cycle recovery. Third, we are benefiting from a leaner cost structure and effective channel execution. And our final key point,…

Thanks, Neil. And just another reminder before I begin, consistent with prior quarters, we have posted a quarterly supplemental investor presentation to our investor site for your additional reference as we discuss our most recent quarter performance and outlook. Now, turning to our results for the quarter, consolidated sales increased 23.6% over the prior year quarter. Acquisitions contributed 2.1 percentage points of growth and foreign currency drove a favorable 1.7% increase. The number of selling days in the quarter were consistent year-over-year. Netting these factors, sales increased 19.8% on an organic basis. While partially benefiting from easier comparisons, driven by prior year pandemic-related headwinds, we note the 2-year stacked year-over-year organic change was positive in the quarter. In addition, average daily sales rates increased 6% sequentially on an organic basis in the third quarter, which was approximately 600 basis points above historical third quarter to fourth quarter sequential trends. As it relates to pricing, we estimate the overall contribution of product pricing on year-over-year sales growth was around 80 to 100 basis points in the quarter. Looking at sales performance across our segments, as highlighted on Slide 6 and 7 of the presentation, sales in our Service Center segment increased 19.8% year-over-year on an organic basis when excluding the impact from foreign currency. The segment’s average daily sales rates improved 4% sequentially from the prior quarter, which likewise was above normal seasonal patterns. Underlying demand improvement was broad-based during the quarter, though end markets such as lumber and forestry, food and beverage, chemicals, aggregates, pulp and paper and mining reflected the strongest growth on a 2-year stacked basis. In addition to strong sales performance across our U.S. service center operations, we saw favorable growth across our C-Class consumables and international operations, which contributed to our top line performance in the…

Thanks, Dave. Over the past several years, we’ve deployed strategic investments and initiatives that have positioned Applied for stronger growth relative to our legacy trends and improved returns on capital in the coming years. While near-term macro trends continue to face a number of variables as we transition away from an unprecedented downturn, I believe we remain early in a potentially prolonged industrial cycle, considering the breadth of tailwinds we see developing today. These include emerging CapEx spending following multiple years of underinvestment as well as greater industrial production across North America as customers reduce reliance on long-distance global supply chains. In addition, increasing signs of investment in U.S. infrastructure are promising, which could represent a notable tailwind, given our participation in industrial machinery, metals, aggregates, chemicals, mining and construction. We also enter fiscal 2022 with a record backlog and strong order growth across some of our longer-cycle businesses, which have expanded in recent years, including fluid power, flow control and now automation that focus on engineered solutions and tied to our customers’ core growth initiatives and capital investments. While supply chain tightness across the industry is partially influencing backlog right now, we see ongoing demand creation as Applied’s technical position is called upon to address customers’ greater operational and supply chain requirements. This includes improving demand across our higher-margin specialty flow control operations, which should benefit further into fiscal 2022 from pent-up maintenance and service activity as well as a greater focus on higher environmental and safety standards. We’re also expanding our flow control focus across attractive industry verticals such as life sciences and hygienics. Further, we will continue to expand into new and emerging areas of growth across the industrial supply chain. Of note, following the initial investment and build-out of our next-generation automation offering, we are now…

Thank you. Our first question is from the line of David Manthey with Baird.

Thank you. Good morning everyone.

Good morning.

I wanted to discuss the cost components here. I assume that the temporary cost actions you took a year ago have all normalized at this point. But what you’re talking about in the guidance is it’s just a negative year-to-year comparison because you took those actions a year ago. Could you remind us or tell us when those temporary cost actions were fully normalized? And will that negative comp stretch beyond just the first couple of quarters of the next fiscal year?

Yes, David, I would say fully normalized would have been in really the third quarter, our fiscal third quarter timing of that. And so they phased a little bit as we took some steps throughout that period but I’d say fully in our – into the third quarter.

Correct.

Okay. So we’ve got a couple of quarters of negative comps there and then you have the merit pay increases January 1. Okay, that’s helpful. Second, could you remind us your target net debt leverage ratio? And if there is no major deals that are in the pipeline as of today, could we see share repurchase be a bigger component in fiscal ‘22 and beyond?

I’d say we continue to believe our target net debt leverage would be 2.5x, given where we’re at today. And with the M&A pipeline, we could stay below that for a little bit of the near-term or foreseeable future and then that would open up additional capital allocation opportunities for us.

Okay. And then last question here. In terms of the organic growth, that 7% to 9% for fiscal ‘22, do you anticipate one segment will outgrow the other or should we – based on the comps, it looks like we could see relatively uniform growth like we did this quarter. Is that your expectation?

Well, I think a little bit in the assumptions. On the Service Center side, we’d probably be closer to high single digits. And then as we think about Fluid Power & Flow Control, high single digits, could reach low double digit in the guidance.

Okay. Thanks very much, Neil.

You bet.

Your next question is from the line of Chris Dankert with Loop Capital.

Hi, good morning guys. Thanks for taking my question. Touched on it a bit in the opening remarks. I guess, Fluid Power & Flow Control, are we seeing a real rebound in kind of that build-to-spec and OEM longer cycle side of that business yet or it’s still very early days in the recovery there?

I think we continue to see improvements across, one, with the technology solutions that we are offering in that. We alluded to it in the remarks. There is some queuing of some orders, right? People wanting to get in line, looking further ahead with some of the tightness in components or the longer lead times in doing it. But we’ve seen the order build and the productive backlog in prior. That’s coming through in the sales results. And as we look at backlog today, it stays at record levels in that. So I believe in those mid- and longer-cycle segments, we are in the early stages of what could be a continuing improved industrial cycle for a good period of time.

Got it. Understood. And then just the next one, I mean, looking at – you mentioned analytics and some of the technology investments that you’re undertaking right now. I guess, is that of a meaningful scale that’s part of the contribution to why incremental margins are a little bit lower than typical this year, kind of in addition to those other returning costs? And if you could, just where is the investment going? Is it more back end on the sourcing, improving rebates, that type of thing, or more on customer targeting, pricing initiatives? Any additional color on those investments would be really helpful.

Sure. And I would say, overall, our view is we will continue at maybe an $18 million to $20 million total capital investment side of that, so we don’t think any of those are outsized. But it’s really technology that can help our selling teams with mobility tools to help them drill down in the business. And so they are not high, high capital investments but greater point-of-use tools that they can have to go forward. So we don’t feel like there is a high capital side of that, but it is really helping us run the business, mine for the opportunities, manage sales funnels and pipelines and allowing our teams to focus and execute looking forward. And then we continue to have the right back-office investments that support shared services, warehouse management systems and those things that – where we can have greater productivity in the back of the house and more of our resources spending time forward-facing and productively engaging with customers.

Got it. That’s great color. Thanks so much, guys.

Your next question is from the line of Adam Uhlman with Cleveland Research.

Hi, guys. Good morning.

Good morning, Adam.

I guess maybe to start with some near-term questions. I guess July and August sound to be pretty good on a year-over-year basis. I guess could you help us understand what each of those months or, I guess, August to date have looked like relative to normal seasonality? Any trending better than expected or worse than what you would have expected on an organic basis?

Pretty consistent with normal seasonality. We did see a continued ramp, as we talked about, as we went across Q4 where we did buck that seasonality, where typically we would expect it to be flat, saw organic sales up 6%. So still as we look through August activity, talked about being up mid-teens organically, pretty consistent in terms of the seasonal trends we’d see moving from Q4 to Q1.

Okay, got it, thanks. And then can we go back to the price realization and the product cost discussion a bit more? I guess I’m surprised that pricing at least in the first half of the year, would it be more above the 1% that you’ve been seeing recently? Could you just remind us how product costs work flowing through your P&L? And I believe there is a disconnect based on the mix of what you’re selling in terms of what’s your realization is. And how should we think about that in the second half of the year as some of these bigger price increases start to come through and maybe lift the sales growth numbers, any thoughts on that?

I think, what you’re seeing, Adam, is here again, just the relative mix of this business where, on average, is less than third of our SKUs that do repeat year-over-year, when you think about the Fluid Power & Flow Control or project base where you’re selling a solution, you just don’t get the big price dynamic. So while we would – as you look at those being SKU, both cost increases and price increases we’d be able to enact, you’d see a much larger number, as you think about that relative mix of the business and those repeat SKUs where we use that as the gauge as we talk about price, that does water down the impact, and that yields that 80 to 100 basis points price realization in the most recent quarter.

Okay. Any thoughts about how that – do we get up to like 2% in the back half then with all the dilution that happened?

I just don’t see it, just given that relative mix. We continue to do a very good job of reacting and providing the teams, using kind of the pricing tools in place and the contractual work with our larger customers. But I wouldn’t want to venture a guess that it would get to maybe a 2% contribution, once again, just thinking about that relative mix and the random demand that we see in the business.

Okay. Great, thanks very much.

Thanks, Adam.

Your next question is from the line of Michael McGinn with Wells Fargo.

Thanks. You mentioned the guidance captures the seasonality of your business, and you’ve typically seen front and back-end loaded margin performance. Was wondering if there is a discernible pattern within orders regarding maybe size or scope that give you confidence to fill the middle part of your fiscal year or just any comment in general on the seasonality of your margins, how you expect that to play out for this year?

In terms of seasonality, certainly, as we see price increases coming fast and rapid, you do see some lumpiness, but I don’t see that bucking the typical trend significantly when you think about the margin profile and how that plays out seasonality, some of that driven by again, just the contractual pricing on some of the larger customers and the timing thereof. I think the thing we would expect to see is you think about the order book, and as Neil indicated, on Fluid Power & Flow Control, record levels in terms of backlog, which does provide some confidence in terms of seeing some slight outpace of the normal top line seasonality as we move through the next couple of quarters.

And Michael, I’d also say, too, right, as we think about that – the range and then the seasonality really at the low end of the range, we’re thinking it follows normal seasonal patterns. And at the high end of the range, it’s following those normal patterns, perhaps with 100 basis points above that. So that’s how we’ve framed it at this time.

Understood. So, moving to M&A, has there been a tweak to the process regarding screening or sourcing deals that usher in a different type of target? Maybe in the past, it was more legacy sellers that were coming to market via natural succession planning. Has that changed at all? And yes, I will just leave it at that.

I would say really no change, right. We work, we feel, we know our priorities. We are executing our strategy. We know those best organizations and companies and really look to have a long-term relationship. You never can perfectly control the timing that the fit when that’s going to occur or happen. So, we are staying around our priorities. We talk about them being automation and Fluid Power & Flow Control. In our Service Center side of our segment, there could be some geographical round-out or build-out in certain geographies. And that’s where we are active. That’s where we are active with our team in doing it. So, no discernible difference in that approach.

Got it. I appreciate the time. Thank you.

Your next question is from the line of Steve Barger with KeyBanc Capital Markets.

Hi, good morning guys. Neil, you said you expect maybe somewhat better organic growth on the fluid power side. Will that translate to higher incremental margin in that segment as well for the year or will the volume across Service Center drive more benefit in that segment?

So, as we think about in the segments, right, we had very good incrementals in the Fluid Power & Flow Control in this one. We will expect some of that to perhaps moderate back as we come in and some of those costs come back in and we go against – we see some normalization of healthcare and some of those other activities go in. But we are pleased with the performance. We think we have continued run rate to improve that business and have it contribute at good levels. And then I am pleased with our Service Center trajectory and performance as well, as they have had improvements, and they are doing a very good job of managing and pursuing opportunities with the right focus on the cost to serve. As I think back of actions that have been taken to really just optimize the footprint, optimize the structure, balance resources between forward-facing opportunities and leveraging technology for the back office, we feel like they are at a good position. So combined, they can both contribute. We just know in this somewhat transition year and as we go up against some of those temporary costs that are going to be coming back where we have to anniversary against, that’s what’s going to moderate. But we fully believe over the longer cycle, that mid to upper-teens incrementals, that’s our focus.

That might have been the – some of that stronger margin performance coming out of Fluid Power & Flow Control segment. The way the guidance lines out is going to offset, along with the volume benefit that we are seeing on the Service Center side of the equation, the assumption of some significant LIFO headwinds, given the material cost increases. So, about a 30 basis point adverse impact on the gross margin line that we are assuming in the guidance in terms of LIFO. So, a lot of that’s going to offset the LIFO headwinds to provide that neutral gross margin performance year-over-year.

Yes, okay. And the re-shoring and automation conversation was really strong when the pandemic first hit, then that seemed to cool off a bit. Now with supply chain and labor front of mind for a lot of companies again, are you sensing a greater sense of urgency from customers to pursue automation, robotics, analytics and just try and get ahead of supply chain constraints?

So, I think two things. I think re-shoring continues to look at the challenges that the long distance supply chain can present. And so with increased demands, pressure to reduce lead times, to increase flexibility, I think that has many customers and in fact some of our suppliers looking at how they enhance and be more regional in their approach to drive their performance. So, I think that continues and it will not be just around what was pandemic-related products, that it will include in technology and many of those other categories. And then I think automation continues to play across opportunities. And we look at many of our key industries, the penetration rates are kind of in the 30% to 40%. We know that’s going to increase, and we have greater activity and discussions going on with customers about what areas of their facility, what areas of their plants where they can help themselves with productivity. And those projects are moving forward. And so we had strong organic growth in that Automation segment in the quarter. We are encouraged about the amount of projects and engagement. And we feel like we are well, well positioned in the industrial MRO and all of those segments. I mean we are embedded into those facilities from a traditional standpoint in the bearings and power transmission and fluid power, that’s opening up more of those opportunities. So, I think our customers will look for that to help their ongoing performance going forward.

And as you pointed out, automation organic sales plus 30% in the fourth quarter, what do you expect for the year from that category for you and how positive is that for mix?

So we have got it – I would say, it’s captured in the total guide. So, I am not sure – they likely don’t continue at that level, although in our internal reviews, we will be talking about that as it goes through. They help from a gross margin side and they are running at really fleet average from a profitability side. But with that, we think we have got the opportunity to continue to improve that. And those are some of the efforts and actions that are underway now. So, we are encouraged by the performance in the quarter and the contributions that we can have in ‘22 and really beyond.

What are you seeing for lead times for robotic arms or other specialty equipment that you need to be able to sell those value-added services, is – are things available to you?

My short answer is going to say yes, that they are available. And I really say that across our other product categories as well. There can be components, there can be certain delays. We look to team with the manufacturers to know those and plan accordingly or look at what alternatives can be. So to-date, the impact across the business has been modest. We think we can operate and keep it that way. And then I think with many of the actions going on with manufacturers and suppliers, I think they are going to improve as we work through our fiscal 2022.

And last one for me. Can you just expand on the technology-end market a little bit? It seems like semiconductor manufacturers are going to be regionalizing production. There is going to be tens of billions of dollars, I guess, coming in terms of capacity build-out. How big of an opportunity is that for you?

It’s been a very good contributor for us going forward, and we will look to fully participate in that. And so semiconductor, but really the rest of the technology, we think about the infrastructure and look to build out more of the 5G infrastructure. I think that’s got a great driver for us. The amount of cloud and data storage requirements that are going on open up additional solutions and alternatives for us. So, as technology touches so much, we will fully participate. I think in our segments today, it’s probably above 5% in mix of the business, and I think it will continue to grow.

Thank you.

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

Thank you very much. I just want to thank everyone for joining us today, and we will look forward to talking with you throughout the quarter. Thanks again.

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.