Welcome to the Fiscal 2025 Third Quarter Earnings Call for Applied Industrial Technologies. My name is Celine, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] 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.

Okay. Thanks and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing our third 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 and uncertainties, including those detailed in our SEC filings. 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. As usual, I'll begin with perspective and highlights on our third quarter results including an update on industry conditions and expectations going forward. Dave will follow with more financial detail on the quarter's performance and provide additional color on our outlook and guidance. I'll then close with some final thoughts. Overall, our Applied team performed well in the third quarter against an ongoing muted and evolving end market backdrop. We focused on our internal growth and gross margin initiatives as well as cost controls and working capital management. As a result, gross margins, EBITDA margins, EBITDA and EPS exceeded our expectations and prior year levels. In addition, while market demand remained soft, there were signs of firming sales trends as the quarter developed. Of note, the 3% organic sales decline in the quarter was stable with last quarter and in line with our guidance, while sales trends improved across our Service Center segment as the quarter progressed. Sales declines in our Engineered Solutions segment persisted, reflecting softer OEM fluid power markets and more gradual backlog conversion. That said, this market appears to be bottoming and orders across the segment strengthened further during the quarter. As it relates to the quarter's margin performance, both gross margins and EBITDA margins exceeded our expectations, increasing 95 basis points and 59 basis points over the prior year, respectively. Our performance continues to benefit from solid channel execution and ongoing margin initiatives across various areas of our business as well as variable expense adjustments and cost management. Gross margins also benefited from our initial positive mix contribution from our recent Hydradyne acquisition. When looking at it over a longer period, gross margins have now expanded year-over-year in nine of the past 11 quarters, while…

Thanks, Neil. Just as a reminder before I begin. As in prior quarters, we have posted a quarterly supplemental investor presentation to our Investor site for additional reference as we recap our most recent quarter performance and updated guidance. Turning now to our financial performance in the quarter. Consolidated sales increased 1.8% over the prior year quarter. Acquisitions contributed 660 basis points of growth, which includes the first quarter of contribution from our recent acquisition of Hydradyne. This was partially offset by a negative 90 basis point impact from foreign currency translation and a negative 80 basis point impact from the difference in selling days year-over-year. Netting these factors, sales decreased 3.1% on an organic daily basis. As it relates to pricing, we estimate the contribution of product pricing on year-over-year sales growth was approximately 100 basis points in the quarter. Turning now to sales performance by segment. As highlighted on Slide 7 and 8 of the presentation. Sales in our Service Center segment declined 1.6% year-over-year on an organic daily basis. This excludes 20 basis points of contribution from acquisitions a negative 80 basis point impact from the difference in selling days and a negative 130 basis point impact from foreign currency translation. The organic sales decline was primarily driven by reduced MRO spending and lower capital maintenance projects compared to the prior year. On an encouraging note, the decline was a slight improvement from last quarter’s organic decline of 1.9%. This is despite a more difficult comparison, including seasonally strong brake fix and capital maintenance activity we saw in March of last year. The segment’s two-year stack organic year-over-year sales trend improved sequentially every month in the quarter, including posting positive 4% two-year stack growth in the month of March. In addition, segment EBITDA increased 6.4% over the…

As we prepare to close out fiscal 2025, I'm proud of the ongoing progress we are making to strengthen our industry position, customer experience and growth potential. Near term, we remain focused on executing and managing through a muted end market backdrop. We expect customers will continue to conservatively manage operational and capital spending amid ongoing business and economic uncertainty that has been intensified by the evolving tariff and trade backdrop. That said, we remain focused on internal growth and margin initiatives and believe our U.S.-centric technical industry position provides near-term resilience and strong growth catalyst long-term. Order and backlog trends across our higher-margin Engineered Solutions segment provide strong underlying growth momentum into fiscal 2026, and we are favorably positioned to manage potential greater inflation given our technical industry position minimal cross-border sourcing, structural mix tailwinds and various self-help countermeasures inherent to our strategy. Combined with our strong balance sheet, exposure to long-term secular tailwinds, including reshoring and easier comparisons moving forward. We remain constructive on our setup into fiscal 2026 and beyond. I want to recognize our entire Applied team to the foundation of our performance and evolution, their perseverance and operational focus provide a strong position to accelerate our potential moving forward. With that, we'll open up the lines for your questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. And your first question comes from the line of Christopher Glynn with Oppenheimer. Please go ahead.

Thanks. Good morning guys. So your analytics and everything, the insights into the margins in the markets are really impressive as always. I got a question, it might be a little tough. As you look across your broad customer base, how are you thinking about the mix of proportion of them that might be particularly levered to some China sourcing and possible major production slowdowns?

Chris, I don't know that I have all of that insight in going through. But I would say, I think the trends that we saw in the quarter and the improvement in the top 30 [ph] were positive to move from the 11% to 16%. So if I think across it, I think technology and the domestic work that I'll continue to do there, announced investments. I think those likely continue. I think, obviously, food and beverage should stay resilient. The amount of construction activity and that would be needed as industrial infrastructure builds out would be positive for the aggregates and others into that site. And I would expect – and we expect a pickup in machinery, utilities and metals as potentially more domestic work comes in, in that side. So that would be some of my inside or indications that I have right now.

Yes, appreciated. I know it’s an abstract topic.

In terms of improved daily sales rate as we moved across the quarter in the Service Centers segment. And of course, the positive impact and inflow flex, we saw on new order intake in the Engineered Solutions segment. So those are all encouraging signs.

Great. And then if we could look at some of the piece parts of Engineered Solutions, relative more specific growth for fluid power, flow control and automation? And do you think fluid power could pivot in the first half of fiscal 2026 or is that probably a little later?

I think there could be some trend there. So if I break it apart, automation on the order side was the strongest in the quarter, the 30% up year-over-year, and nice improvement sequentially. Fluid power on the technology side was double digit, plus 10% in that side, which was positive as well. And then the mobile and industrial positive year-over-year sequentially, up 6% into that side. I think we've talked about previously, I think the inventory has normalized in with some of those OEMs as well. And so in some of those sectors, as we work through 2026, we could start to see some of that pick up it could develop to your point, in the first half, but I think it continues to build throughout fiscal 2026.

Okay. And I missed your comment on fluid power, David, prior to Neil there.

I mean prior to I referenced broader Engineered Solutions segment order trends. As Neil indicated, broke that out in a little bit detail. We did see the tech up around 10% within fluid power encouraging year-over-year growth on the mobile off-highway piece, industrial as well fluid power and up 6% sequentially in terms of order intake. So all encouraging in terms of ultimate recovery in that mobile off-highway space within fluid power, where we've seen some of that lower demand and did experience some of that hangover coming off the – some of the supply chain disruption with some excess inventory in the channel. So all encouraging trends there for sure.

Thanks. Last one for me. I just want to check if that 30% automation orders growth is an organic number?

That is.

Great. Thank you.

Your next question comes from the line of David Manthey with Baird. Please go ahead.

Thanks. Good morning, guys. As it relates to the guidance, some companies are sort of assuming known and expected price increases and then layering that over their growth expectations. We just had a company that is not assuming price increases is kind of a hedge for demand destruction and others are in between that. Just wondering, as you think of your approach to setting guidance, how would you characterize it relative to factoring in any tariff-driven price increases and balancing that out with demand destruction?

So I think, David, as we go forward, we will be factoring in what we believe the price inflationary to look like. I think to date, and we've talked about it in the remarks. We probably had 100 basis points of impact in the third quarter or contribution to price. In our fourth quarter, we would expect similar amount. We are seeing increases from suppliers. I think many that have an annual increase at the beginning of the year have implemented that. There would be some inflationary expectation or input into that, so perhaps a slightly larger increase. There's another group of suppliers that would be more midyear that has looked to accelerate those. But if I look forward at our fourth quarter, I think many of those increases will start to layer in somewhat the middle part of the fourth quarter. And that's why we think price contribution is probably still similar in that 100 basis points category in the fourth quarter. And then as we look forward, I think it's still to be determined. We're working with suppliers, many are formulating strategies about what might be reciprocal tariffs and that impact I think it has the potential to be several hundred basis points potentially in that, but there's still things to work through in that time period. So we're going to work very hard to have the understanding and execute on what material? What price inflation will be and also what end market activities would be? And perhaps there will be some that get lessened through this area. But I also contend there are going to be some that are going to strengthen and go forward with investments and have more regionalized demand, be it in the U.S. or including in North America.

Okay. So it sounds like you're just taking a logical approach to the tariff-driven price increases you're seeing and layering that on to your demand forecast, and that's what's guiding you. Okay. That's helpful.

Yes, given – sorry given that we're guiding one quarter, David, it's a lot of what we're seeing in terms of price increases, as Neil indicated. It is more general inflation related as everyone seems to be taking a wait-and-see attitude in terms of that 90-day now 60-day window in terms of better clarity in terms of what tariffs do to us. So given that timing, very little impact for us in Q4, purely tariff-driven.

Yes. Great idea to be on a June fiscal year, this year, for sure.

Yes [ph].

Yes. So then I guess there's kind of the thesis out there that there's a differential in demand destruction or growth rates across whether it's MRO-related products, parts and components that are feeding production lines, and then third, sort of capital expenditure driven demand, it doesn't sound like you're seeing sort of an increasing level of demand destruction there, given your automation organic growth you just talked about. So can you just talk about those three things, MRO and then production sort of driven products versus capital expenditure driven sales? Is there a general trend in any of those? Or is it kind of dependent on the end market more?

Yes. I think for us, David, overall, we think about our service centers and given half their demand often will occur at a break fixed time, that's really resilient in that. We have seen in the broader MRO or some planned projects perhaps some deferrals or some kick out a little bit of that as customers work through or think through planning and look for a little bit more certainty in the backdrop. But MRO, we feel, given that, that's 70% of the overall company mix stays pretty resilient throughout. And then where we are involved in projects and capital projects to really not extremely large capital-intensive investments they're enabling customers to be more productive, more efficient into the site. They have good paybacks and returns. And so we have seen some deferral or some delays in that. Some of that's related to how they – the project – our part of the project interacts with the total part of the investment or the project. But we take encouraging signs. The Engineered Solutions order rate that we would have had in the quarter, the building backlog that we're seeing, including in flow control and automation in this side. And then the very early signs, even in off-highway mobile, perhaps it is bottoming and firming into the side while the technology that has been a headwind if we look back over perhaps 18 months to 24 months back is starting to be a contributor again.

That’s great color Neil. Thanks all.

And your next question comes from the line of Sabrina Abrams with Bank of America. Please go ahead.

Hey good morning, everyone.

Good morning.

Yes. I just wanted to talk, I guess, a little bit about the – what you're seeing in the macro. And I think generally, your trends seem positive like sequentially. Clearly, there's a great extent of uncertainty, but the Q4 guide suggests decelerating trends from Q3. And I guess I assume sort of May and June get worse. And I guess how much of that has to do with what you are currently seeing? Maybe if you could clarify whether April actually slowed from March, February or if there was something with Easter going on from a demand of paper has slowed. And I guess how much of things decelerating in the guide has to do with what you've already seen versus just assuming that things are going to get more negative from here? And then how do we sort of square the order trends in Engineered Solutions, which I think have been positive for two quarters now, with the implied deceleration quarter-over-quarter.

Yes. So I'll perhaps work backwards. I'll start with the Engineered Solutions orders. And so depending on the amount of engineering and the work to go into those projects, which can vary. The conversion time can be 120 days, maybe 180 days on some of those. So encouraging on the build that I think many of those start to contribute into our fiscal 2026 on that side. And then if I think about the overall guide, as we said, we want to be prudent in this environment. And as we work through these 90-day periods and what some of the tariffs and potential reciprocal tariffs may turn out to be into that site, which are still very focused on how we are executing the business and helping the customers in. So I think that guide has appropriately prudent in that area. To your point, April did have an influence of a Good Friday, Easter holiday timing into that. Perhaps that was 100 basis points into that side influence. And then as we think about March as it built up, probably on a two year stack basis would have been down 1%, March more 4% into that period. So as we think about April, given some of that order activity, we just want to be conscious of some of that either cross-current or uncertainties that could exist.

I'd add, as you move across the months, June is a little bit tougher comp for us. April did see that impact from what we call a half day in terms of Good Friday holiday. So we could factor accordingly for that. But I'd just add, really at the low end of the guidance, that assumes an average daily sales is roughly 500 basis points below the normal sequential trends in the quarter. At the high end, though, where we say, down low single digits. Assumes average daily sales roughly 100 basis points, the lower than normal step up we would see going into our Q4. So that compares that 100 basis points compares to a 230-basis point kind of below normal seasonality level we've been running year-to-date. So just given all the uncertainty, I thought it prudent to position it accordingly.

Got it. Thank you. That's helpful. And then just on the EBITDA margins because you had – you've had a good performance year-to-date. And I guess if you look at what's implied by the guide, you have maybe similar year-over-year sales growth and maybe slightly worse in Q4 to Q3 on a total basis. And then you have a much larger step up in SG&A year-over-year. So the implication is something like, I don't know, like 7% year-over-year increase in SG&A on 1% of sales growth. And just wanting to understand sort of what it's implied by the midpoint of your guide. I just sort of want to understand what will be driving so much deleveraging quarter-over-quarter. Does it have something to do with the acquisition, something with inflation. So any color there would be helpful.

Yes, very proud of the businesses, cost control and productivity in terms of SG&A spend in our most recent quarter. Hydradyne comes in at a favorable gross margin mix up benefit but still higher SG&A rates. So you're seeing that read through we're starting to get great traction on some of the synergy initiatives, but not a great deal of that reading through yet even in the fourth quarter. So that is an influence. And I'd say, thinking back to the gross margin performance, we said LIFO would be at a similar level sequentially what we saw in Q3. But just a reminder that in Q4 of last year as we comp this quarter, we did have a wear liquidation benefit in the prior year. So that alone drives about a 20 basis point adverse impact on both gross and EBITDA margins. So you're seeing all these combinations read through to show some deleveraging as a result of just looking at absolute numbers year-over-year.

I'll follow-up offline. Thank you.

You bet.

Your next question comes from the line of Ken Newman with KeyBanc Capital Markets. Please go ahead.

Hey, good morning guys.

Hi, Ken.

For the first question, I think longer term, I know you're not ready to talk about fiscal 2025 yet. But I think you typically think about incremental margin through the cycle of kind of being in that mid- to high teen range. If demand does start to normalize next year, whether it's in ES or in service center. Do you think that's the type of incremental that you could drive? Or does that become a little bit tougher depending on maybe some higher LIFO expense for potential price increases? Just how do you think about just maybe the moving pieces in operating leverage?

Yes, Ken. I would think into the year and longer term, we still believe in our ability to have incrementals in that mid- to high teens range into the side as we think about it, to your point, a little early on fiscal 2026 and a lot of moving – perhaps a lot of moving parts. But – and we'll be working through our planning. We're going through our long-range strategy sessions in game theory, had the service centers and game theory with the Board this past time, engineered solutions in coming up and we're working the planning cycles right now. But perhaps as a starter as we think about or look at 2026, perhaps it has the fourth quarter guidance that would end. And if you apply normal seasonality looking ahead, that results in something that's flat. Then if you think about there would be – will be price contribution in that. Perhaps that's several 100 basis points into it. perhaps with some of the uncertainty and environment that degrades that volume a little bit. But we also contend we can have engineered solutions with backlog conversion into that side, which could potentially contribute. So perhaps 2026 looks like a low single-digit environment overall. Perhaps it could be better as we work through. And then just as a reminder on LIFO, if there is more expense. I mean, obviously, I'd start with, it does provide our LIFO overall a significant cash benefit to us in inflationary times. And if they look back at 2017 through 2019 with LIFO, we did a very nice job managing through that, and we grew gross margins into that period, 60 basis points or so. So team has a good playbook. We have that muscle memory. We will be focused on really any operating environment that's ahead of how we execute and perform.

I'd just add, Ken, coming out of the inflationary kind of COVID, some of that demand rebound. The business did very nicely in terms of levering. When you think about at times incrementals in excess of 20% despite some of those continued LIFO headwinds, et cetera, that Neil indicated. So structure, I just think the business is even better positioned now when you think about the mix-up benefit that comes with higher engineered solutions contribution? And once again, just thinking about the way the business levers on some of that SG&A base once you get past that first 1% to 2% of growth would expect, like I said, those mid- to high teens incrementals for sure.

Yes. That's really helpful. Maybe for the second question here, just talk a little bit about capital deployment. Obviously, you've got the new bolt-on deal for Iris this morning. You also, I think, announced a new share repurchase program as well. Just how do you think about priorities between the two? Is this a good level or a good share price level as you think about enacting on that? That share repurchase program? And what's the capacity to act on M&A even here in the fourth quarter and into 2026.

Yes. So I can start. So can overall, our capital allocation, our priority is going to remain growth. We know that organic investments we make have high returns. And while we're not so capital intensive, we will be going through that planning and executing on those. We know also M&A can be a strong contributor to that. That will remain a priority. The pipeline is active. We're busy into that front. So that will contribute into the site. And then from a share repurchase standpoint, I'm pleased that the authorization was renewed in coming out. We will maintain a disciplined approach, a returns-driven approach at that, but I would expect that we will be active in the fourth quarter.

I'd just say it, yes. So coming off of Hydradyne and the incremental share repurchase activity in the most recent quarter, still at 0.4x leverage, plenty of dry powder to handle all those capital deployment opportunities.

Very helpful. Thanks.

And your last question comes from the line of Brett Linzey with Mizuho. Please go ahead.

Hey, good morning guys. This is Peter Cost [ph] on for Brett. Could you just add some color on what you're seeing from reshoring investments specifically? What's the pulse out there just as we weigh out this policy uncertainty? Anything you're hearing around customer tone would be helpful. Thanks.

So I think overall, the activity or discussions around reshoring continue. If I think about the investments in facilities, and we're seeing that from kind of the manufacturing non-resi construction rates being up I know there's been a positive impact for a number of years in manufacturing employment, whether that's 1.4%, 1.5% into the site. That continues many discussions with customers as they think about upcoming environments, what are they moving inside of their facilities or how they're looking to qualify other suppliers. And so many of those next tier, second and third-tier OEMs or customers of ours today. And so there will be capital and operating investments that could be continuing on that. And then we all see and read about large companies making extended investments. And so as those projects start, we've got great indirect participation with our service centers as we think about metals, mining, aggregate as things get built and formed. And then as the facilities run and operate, they give us a strong aftermarket MRO. And then for some of these, including in fluid power and technology products, depending on the industry, we're on that equipment going in, which can create some pull for us as well. So, I think reshoring continues to be an input and perhaps can be even a greater input as we look out at fiscal 2026 and beyond.

Thank you. And then maybe how do you think about the willingness of the channel to take on more price? Just any early pushback there as you kind of start to have the conversations with your suppliers and then with your channel? And then is there kind of just a willingness for the suppliers to work through on any contract timing as matches anything there?

Sorry, what was the last part of that question about suppliers?

Just any willingness on the supplier side to work through contract timing mismatches maybe with larger national accounts, anything like that?

Yes. So I would say, overall, right, I mean, there's clear awareness of tariffs, inflationary impacts and inputs throughout any environment. And we're firm believers that we, as consumers, we'll pay more for items going forward, and that's going to be the same in the industrial environment. And so many of our customers are looking at, right, how they have clarity of what those inputs are going to be and how they form those pricing inputs and policies as they take them forward and going out. As it relates to suppliers, they will be coming with the pace they'll provide the documentation that it will go through. And we work closely with them to have the right implementation schedule across the producing or customer landscape in that. And so if I look back, it's been productive in our operating history and cadence, and I expect the same as we go forward.

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 want to thank everyone for joining us today, and we look forward to talking with many of you throughout the quarter. Thank you.

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