Applied Industrial Technologies, Inc. 2026 Q4 Earnings Call

Thanks, Trevor, 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 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, we will use non-GAAP financial measures during the conference call, which are subject to the qualifications referenced in our SEC filings. Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer, and Dave Wells, our Chief Financial Officer.

With that, I will turn it over to Neil.

Thanks, Ryan, and good morning, everyone. We appreciate you joining us. I will begin today with perspective and highlights on our results, including an update on industry conditions and expectations going forward, as well as provide an overview of our new intermediate financial targets. Dave will follow with more financial detail on the quarter's performance and provide additional color on our fiscal 2027 guidance. I will then close with some final thoughts. Overall, we reported a solid finish to fiscal 2026, with record fourth quarter sales and earnings that exceeded our expectations. The quarter was underscored by organic sales growth of 10%, which was the strongest in more than 3 years, and a notable improvement from the 6% growth we reported last quarter.

We levered the stronger growth very well, expanding EBITDA margins by more than 60 basis points to over 13%, growing EBITDA by 16% and EPS by 13% compared to the prior year, which is inclusive of ongoing LIFO expense headwinds. In total, these were strong results to end a year that was both defining and pivotal on many fronts, including showing strong evidence of our operating durability, as well as early signs of the significant growth potential taking shape across our business. I want to thank our Applied team for their ongoing execution. The focus drove another year of exceeding our commitments and creating meaningful value for our customers, suppliers, and all stakeholders, further validating the power of our collective efforts and differentiated industry position. Several key points to highlight in more detail. First, underlying demand improved across both segments during the quarter.

Trends strengthened through the end of the quarter, with organic sales increasing over 10% year-over-year in June, despite more difficult comparisons. The stronger sales growth was volume driven, reflecting greater technical MRO and capital spending activity, combined with ongoing benefits from our internal sales initiatives and industry position. Strengthening underlying demand was apparent in year-over-year trends across our top 30 end markets, where 20 generated positive sales growth compared to 17 last quarter and 15 in the prior year quarter. Growth was strongest across metals, technology, utilities and energy, machinery, rubber and plastics, and pulp and paper. This was partially offset by declines primarily in chemicals, lumber and wood, and transportation. Sales growth during the quarter was led by our Engineered Solutions segment, which delivered 13% organic sales growth year-over-year, up from 9% last quarter.

During the quarter, we saw stronger demand across legacy and emerging customer verticals, as well as solid backlog conversion. Segment order trends also remained positive during the quarter, increasing by a double-digit percent year-over-year for the third straight quarter. Sales growth in the quarter was strongest in automation, where organic sales increased over 20% year-over-year. This was the strongest organic growth in over four years, underscoring the solid demand developing for our automation solutions as the adoption of robotics, machine vision, and digital technologies ramps higher with more productive capital spending environment. Growth also strengthened across our industrial and mobile fluid power operations, where sales increased by a high single-digit percent over the prior year. Demand is improving across many of our legacy Fluid Power markets, including construction, metals, and machinery.

In addition, our engineering project funnel is expanding as OEM customers increasingly focus on upgrading fluid power systems and integrate new advanced features into their mobile equipment. Our fluid power performance is also benefiting from Hydradyne, which, as you recall, we acquired 18 months ago. We have made tremendous progress across our synergy work streams, and contribution from Hydradyne improved throughout fiscal 2026. Of note, the second half of fiscal 2026, Hydradyne sales increased by a double-digit percent year-over-year, while their EBITDA margins improved over 200 basis points. In addition, segment performance during the quarter benefited from strong technology vertical contribution, including favorable growth across the semiconductor space, as well as new business continuing to develop around data centers.

As a reminder, our technology vertical represents over 15% of our Engineered Solutions segment today, with related participation across all three areas of the segment, including automation, fluid power, and flow control. Our service center segment also had a solid quarter. Organic sales growth of 8% accelerated from 4% last quarter, with average daily sales up approximately 5% sequentially and ahead of normal seasonality for the second straight quarter. Greater break fix and technical MRO activity continued to broaden throughout the quarter. Of note, 27 of our top 30 industry verticals were up year-over-year in our U.S. service center network during the fourth quarter, with notable strength across metals, pulp and paper, rubber and plastics, and utilities and energy. Growth was strongest across national strategic accounts, where sales continued to benefit from our internal initiatives and one Applied value proposition.

We also saw demand strengthen across small and mid-size local accounts, where sales increased by a high single-digit percent year-over-year during the quarter, providing further evidence of the recovery taking shape across the industrial sector. It is also worth noting the service center segment's performance throughout fiscal 2026. Despite more mixed end-market demand to start the year, segment sales grew organically year-over-year, every quarter in fiscal 2026. Total sales finished up nearly 6%, while EBITDA grew 8%, inclusive of greater LIFO expense. Looking at the segment's performance over the past five years, organic sales growth has averaged 8%, while EBITDA growth has averaged 13%. Overall, this is notable performance that highlights a stronger and more durable growth profile that exists across our service center segment today, reflecting benefits from internal initiatives as well as secular and structural tailwinds positively impacting our core market position.

Overall, a solid quarter highlighting continued positive top-line momentum building across Applied. At the same time, our team remains focused on driving stronger returns as this more favorable growth backdrop continues to develop. We saw solid evidence of this during the quarter, where we levered 10% sales growth into 16% EBITDA growth, representing incremental margins of over 19%, or more than 22% when excluding LIFO expense. We also had a strong quarter of free cash generation, which increased 16% over the prior year. Free cash totaled $461 million in fiscal 2026, which was down modestly over the prior year, despite greater working capital requirements to support growth in the back half of the year.

Ongoing initiatives and system investments continue to optimize our working capital KPIs, including areas of accounts receivable and inventory management, with net working capital as a percent of sales ending fiscal 2026 at a six-year low. Moving forward, we remain well positioned to drive stronger earnings growth and solid cash generation with ongoing support from our internal initiatives and mixed tailwinds. From a capital deployment standpoint, we had another productive year in fiscal 2026, deploying approximately $425 million on share buybacks, dividends, CapEx, and M&A. Over the past two years, related capital deployment totaled just under $1 billion. In fiscal 2026, we were more active with share buybacks, repurchasing a total of 1.2 million shares for $317 million. We also increased our quarterly dividend by 11% and continued to invest in our technology platforms, distribution centers, and growth capacity during the year.

We expect to remain active with capital deployment in fiscal 2027 with nearly $2 billion of balance sheet capacity. As always, we will remain disciplined with a focus on deploying capital that enhances our scale, growth profile, and competitive position going forward. M&A remains a top priority, and we continue to actively evaluate various targets across both our segments. Lastly, I'd like to take a moment to provide some initial thoughts on our fiscal 2027 outlook, as well as our intermediate financial objectives, which we increased this morning. Dave Wells will provide greater detail on our guidance assumptions, but overall, we enter fiscal 2027 with solid growth potential and operational momentum developing across both our segments. Positive sales momentum has continued into the first quarter, with organic sales to date up approximately 7% compared to prior year levels.

End market demand in aggregate appears to be on solid footing, with limited pockets of weakness or signs of slowing near term. Broader macro indicators, including ISM, industrial production, and durable goods orders, continue to trend favorably. In addition, following a more muted growth backdrop in fiscal 2026, we expect potentially greater contribution from higher margin flow control sales in fiscal 2027 as MRO and project activity across process end markets improve following a greater level of deferred spending this past year, particularly in chemicals and refining verticals. We remain mindful of the evolving geopolitical backdrop and trade policy uncertainty, both of which could impact the cadence and trajectory of end market growth, depending on how things develop. We will also face more difficult comparisons, most notably in the second half of the year, following our recent strong performance. These considerations are contemplated in our initial fiscal 2027 guidance.