Applied Industrial Technologies Q2 Fiscal 2026 Earnings Call - LIFO Headwind Masks Improving Organic Demand and Strong Cash Generation

Mark, Conference Call Operator: Welcome to the fiscal 2026 second quarter earnings call for Applied Industrial Technologies. My name is Mark, and I will be your operator for today’s call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. If you wish to ask a question at that time, please press star followed by the number 1 on your telephone keypad. Prior to asking a question, please leave your handset to ensure the best audio quality. If at any time during the conference call you need to reach an operator, please press star 0. 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.

Ryan Cieslak, Director of Investor Relations and Treasury, Applied Industrial Technologies: Okay, thanks, Mark, and good morning to everyone. 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 and uncertainties, including those that are 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.

Neil Schrimsher, President and Chief Executive Officer, Applied Industrial Technologies: Thanks, Ryan, and good morning, everyone. We appreciate you joining us. I’ll begin today with perspective and highlights on our results, including an update on industry conditions and the expectations going forward. Dave will follow with more financial detail on the quarter’s performance and provide additional color on our updated outlook. I’ll then close with some final thoughts. Overall, we continued to effectively manage through a mixed yet evolving in-market backdrop during the second quarter. Sales and EBITDA margins were in line with guidance despite higher-than-expected LIFO expense and seasonally weak sales activity in December. Our team responded well with strong underlying margin performance and cost control while continuing to expand backlogs and business funnels, supporting a stronger sales trajectory into calendar 2026. We also remained active with capital deployment across many fronts, supported by our free cash generation and balance sheet capacity.

As it relates to sales trends in the quarter, reported year-over-year organic growth of 2.2% was modestly below last quarter of 3%. Underlying sales growth showed signs of strengthening as the quarter progressed, with November sales up by a nearly mid-single-digit percent organically over the prior year, following a low single-digit percent increase in October. However, growth moderated in December, with average daily sales rates notably below normal seasonal patterns. While monthly sales trends have been choppy for most of the year, we do not view December’s weakness as indicative of the underlying sales trend developing across the business. Of note, December is always a noisy month, given seasonal factors that can drive variability in how customers operate plants and phase shipments. This dynamic was further influenced this year by the midweek timing of the holidays.

In addition, we’re encouraged by early fiscal third quarter trends, with organic sales month-to-date in January trending up by a mid-single-digit % year-over-year. Booking rates are also continuing to show positive momentum across both segments. In particular, orders in our Engineered Solutions segment increased over 10% year-over-year in the second quarter. This is the strongest quarterly order growth rate in the Engineered Solutions segment in over four years, with the two-year stack trend continuing to improve sequentially. These positive trends are more in line with various underlying demand signals that have developed over the last several quarters, including improved customer sentiment and ongoing growth across our business funnels. We’re also seeing slightly more positive trends across several of our primary end markets.

Year-over-year trends across our top 30 end markets were relatively unchanged sequentially, with 15 generating positive sales growth compared to 16 last quarter, though this is up from 11 in the prior year second quarter. In addition, when looking at our top 10 verticals, we saw six positive year-over-year compared to five last quarter and three in the second quarter of fiscal 2025. Growth was strongest in metals, aggregates, utilities and energy, mining, machinery, transportation, and construction during the quarter. This was offset by declines primarily in lumber and wood, chemicals, oil and gas, rubber and plastics, and refining. From an operational and profitability standpoint, we delivered solid performance that helped balance softer sales activity in December and greater-than-expected LIFO expense, as well as a difficult prior year margin comparison, as we had previously highlighted. Of note, LIFO expense came in at roughly $7 million.

This was above the $4-$5 million range we had assumed in guidance and compares to the less than $1 million in the prior year second quarter. As in prior periods of increasing LIFO expense, our teams responded with a focus on internal initiatives, effective management of product inflation, and strong channel execution. Dave will provide more details shortly, but when excluding the impact of LIFO, gross margins were up both year-over-year and sequentially, and EBITDA margins held firm over the prior year against a difficult prior year comparison. This performance reinforces the durability of our operating model and various self-help opportunities across the business. We also continue to execute thoughtfully against our capital deployment priorities. Of note, this morning, we announced an 11% increase in our quarterly dividend, following a 24% increase last year.

The increase is consistent with our expectation of ongoing dividend growth as we align annual increases with normalized earnings growth and our favorable cash generation profile. We also remain active with share buybacks, deploying over $140 million on repurchases during the first half of fiscal 2026. These actions reflect confidence in our cash flow generation as well as the value we see across Applied from our strategy and long-term earnings potential. Further, we continue to evaluate various M&A opportunities across both our segments that could drive a more active pace of acquisitions over the next 12-18 months. Our acquisition priorities remain unchanged, with an ongoing focus on expanding our technical engineered solutions position across automation, fluid power, and flow control. We also remain opportunistic with M&A opportunities across our service center network aimed at optimizing our local market coverage and service capabilities.

Today’s announced acquisition of Thompson Industrial Supply is a great example of this. With expected annual sales of $20 million, Thompson is a nice Service Center segment bolt-on acquisition that will enhance our footprint in Southern California. They bring strong technical knowledge and aligned supplier relationships, as well as in-house belting and fabrication capabilities that strengthen our value-added services and competitive position in the region. We’re excited to welcome Thompson to the Applied team and look forward to leveraging their capabilities. As it relates to what we see ahead, I remain constructive on our growth potential entering the second half of fiscal 2026 and beyond. While in-markets remain mixed and choppy, several growth catalysts are becoming more evident. First, our Service Center segment is well-positioned to support our customers’ heightened technical MRO needs as they catch up on required maintenance across an aged installed equipment base.

We believe there’s a clear underlying trend developing around this theme. Of note, our U.S. service center sales were up over 4% year-over-year in the second quarter, inclusive of seasonally weak December activity. We saw growth across both strategic national accounts as well as our local accounts. Local account sales growth strengthened as the quarter progressed, which is an encouraging signal for broader industrial activity. We also continue to see stronger activity across several of our heavy U.S. industrial verticals that are break-fix intensive. This includes primary metals and aggregate markets, where related service center sales were up by a double-digit % year-over-year in the quarter. Segment booking rates were positive in the quarter, while month-to-date in January, segment organic sales are trending up by a mid-single-digit % year-over-year.

Our scale, local and consistent service capabilities, and technical knowledge of motion-controlled products and solutions are driving greater growth opportunities in both legacy and emerging in-markets. We also continue to benefit from sales process initiatives and ongoing pricing actions, as well as increased traction from our cross-selling efforts. During November, our service center leadership teams gathered in Cleveland to collaborate on our strategic growth initiatives, cross-selling opportunities, and operational requirements moving forward. There remains significant excitement and energy surrounding our core business today, and our teams are making notable progress deploying a number of strategic actions designed to further catalyze our growth long-term. Within our Engineered Solutions segment, we expect positive order momentum over the past several quarters to translate into more meaningful sales growth beginning in the second half of fiscal 2026.

We’re starting to see this play out, with segment organic sales trending up by a high single-digit % year-over-year, month-to-date in January. In addition, we expect increased customer activity across our technology vertical, which represents about 15% of our Engineered Solutions segment. Of note, we continue to receive positive demand signals from our semiconductor customer base. This aligns with broader market indications suggesting a multi-year upcycle is emerging for semi-wafer fab equipment. As a reminder, semiconductor space drives the bulk of our technology vertical participation, where we provide various fluid conveyance, pneumatic, and automation solutions to wafer fab equipment manufacturers and other providers along the value chain. Many of our solutions are directly specified into wafer fab equipment across both new and established equipment platforms.

I would also highlight recent investments we’ve made in engineering, systems, and production capacity that should provide support to fully leverage these demand tailwinds moving forward. Combined with new business tied to broader data center build-out, we believe our technology vertical could provide a nice tailwind to our organic growth in coming quarters. Our automation operations are also in solid position to drive stronger growth moving forward. Automation orders were up 20% year-over-year in the second quarter. We expect various secular tailwinds to continue to positively influence demand for our advanced automation solutions, including structural labor constraints, heightened focus on safety and quality, and North American reshoring activity. These dynamics are accelerating the adoption of collaborative and mobile robots, machine vision, and IoT solutions, as well as require strong application and engineering support that aligns well with our market approach and value proposition.

In addition, our flow control team is focused on capturing growth developing within life science, pharmaceutical, and power generation markets across the U.S. With established product portfolios and leading technical capabilities around calibration services, instrumentation, steam and process heating, and filtration, we are favorably positioned to win in these markets. Year-to-date, flow control sales have been modestly lower year-over-year, partially reflecting muted activity across the chemicals in-market, as well as a slow pace to project shipment phasing in prior year comparisons. However, flow control orders were up by a high single-digit % year-over-year in the second quarter, and we expect more productive backlog conversion into the second half of fiscal 2026 based on customer indications and firming in-market trends, as well as broadening maintenance and capital spending on process flow infrastructure across the U.S. in support of energy security and power generation capacity.

Lastly, we’re encouraged by improving trends across our industrial and mobile OEM fluid power operations, where organic sales were positive year-over-year for the first time in two years during the second quarter, while orders were up by a double-digit % over the prior year. This positive development is notable considering the drag this area of our business has had on our growth the past several years. As a reminder, our fluid power customer base includes thousands of small and mid-sized specialty OEMs across a diversified industry base. Our leading innovative engineering capabilities, access to premier supplier technologies, and customer reach are driving new business opportunities with these OEMs as they begin to integrate advanced power and control features into their next-generation equipment. We believe demand for these features will be structurally higher as OEMs begin to re-accelerate production, giving an increased focus on power consumption, machine performance, and automation.

Combined with our enhanced footprint and capabilities following our Hydradyne acquisition last year, our fluid power operations are in a strong position moving forward. As it relates to Hydradyne, we mark the acquisition’s one-year anniversary at the end of December. I want to take a moment to thank our team’s combined efforts over the past year in making this acquisition a great early success. We’ve achieved notable growth and operational momentum from this transaction that stands to further augment our earnings potential as underlying in-market demand begins to build. Of note, Hydradyne generated over $30 million of EBITDA in the first 12 months of ownership, with contribution building year-to-date in fiscal 2026 as we continue to align teams and realize synergies. During the second quarter, Hydradyne’s EBITDA margins exceeded 13% and were modestly accretive to our consolidated EBITDA margin performance.

We’ve made tremendous progress in leveraging complementary solutions, harmonizing technical capabilities and systems, and driving operational efficiencies across the combined operating platforms. We’re connecting Hydradyne with new growth opportunities by cross-selling their value-added fluid power repair solutions across our legacy U.S. southeastern customer base. We’re also enhancing their capabilities, serving the rapid pace of innovation developing across fluid power mobile systems, as well as providing fluid conveyance solutions tied to data center thermal management needs. Moving forward, we expect Hydradyne’s contribution to be increasingly accretive to our underlying growth and margin performance as this positive momentum feathers into our organic results. At this time, I’ll turn it over to Dave for additional detail on our results and outlook. 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. Turning now to our financial performance in the quarter, consolidated sales increased 8.4% over the prior year quarter. Acquisitions contributed 6 points of growth, while the impact from foreign currency translation was a positive 20 basis point impact. The number of selling days in the quarter was consistent year-to-year. Many of these factors, sales increased 2.2% on an organic basis. As it relates to pricing, we estimate the contribution of product pricing on year-to-year sales growth was approximately 250 basis points for the quarter. This is up from approximately 200 basis points in the first quarter and primarily reflects the effective pass-through of incremental supplier price increases in recent periods.

Moving to consolidated gross margin performance, as highlighted on page seven of the deck, gross margin of 30.4% was down 19 basis points compared to the prior year level of 30.6%. During the quarter, we recognized LIFO expense of $6.9 million, which was $2-$3 million above our expectations and up meaningfully from prior year’s second quarter LIFO expense of $0.7 million. On a net basis, this resulted in an unfavorable 54 basis point year-to-year impact on gross margins during the quarter. While the LIFO expense increase partially reflects broader product inflation and supplier price increases, we also prudently increased our level of inventory investment in the quarter based on our outlook and firming demand developing across the business.

As a reminder, our use of LIFO accounting accelerates the recognition of product inflation on our results, which during periods of increasing inflation and inventory expansion reduces our tax burden and drives cash savings. Importantly, from a reported gross margin standpoint, the impact is more about timing of when we recognize product inflation and is not a change in the underlying economics of the business. As inflation levels out and eventually normalizes, we would expect this impact to unwind accordingly, as we saw in prior periods of greater inflation and LIFO expense. That said, as Neil mentioned earlier, our team responded well to these inflationary headwinds through various countermeasures, including effectively managing supplier price increases, channel execution, and margin initiatives. We also benefited from positive mix tied to our Hydradyne acquisition, as well as stronger growth across local accounts.

Excluding LIFO expense, gross margins of 31% were up 34 basis points year-to-year against a strong prior year comparison. As it relates to our operating costs, selling, distribution, and administrative expenses increased 11.1% compared to prior year levels. On an organic constant currency basis, SD&A expense was up 1.4% year-to-year compared to a 2.2% increase in organic sales. During the quarter, ongoing inflationary headwinds and growth investments were balanced by solid cost control and internal productivity initiatives. Overall, modest organic sales growth coupled with M&A contribution, favorable underlying gross margin performance, and cost control resulted in reported EBITDA increasing 3.9% year-to-year, inclusive of a 460 basis point year-to-year LIFO expense headwind. This resulted in EBITDA margins of 12.1%, which was down 52 basis points from the prior year level of 12.6%, inclusive of a 54 basis point year-to-year headwind from higher LIFO expense.

The 12.1% reported EBITDA margin was within our second quarter guidance range of 12%-12.3%, despite greater than expected LIFO expense, which was approximately 15 to 25 basis points unfavorable to our expectations. Reported earnings per share of $2.51 was up 4.6% from prior year EPS of $2.39. On a year-to-year basis, EPS benefited from a lower tax rate and reduced share count, partially offset by increased interest and other expense on a net basis. Turning now to sales performance by segment, as highlighted on slides 8 and 9 of the presentation, sales in our Service Center segment increased 2.9% year-to-year on an organic basis when excluding a 30 basis point positive impact from foreign currency translation. The organic sales increase in the quarter was primarily driven by price contribution as volumes were relatively unchanged year-to-year, reflecting seasonally slow sales activity in December and lower international shipments.

Across our U.S. operations, sales increased more than 4% over the prior year, reflecting growth across both our national and local account base. U.S. service center sales benefited from firming demand across several core end markets, as well as sales force investments and cross-selling actions that continue to read through within a mixed demand backdrop. Segment trends also continue to be supported by favorable growth across fluid power MRO sales. Segment EBITDA increased 2.2% over the prior year, inclusive of a 340 basis point year-to-year LIFO headwind, while segment EBITDA margin of 13.3% declined 14 basis points, inclusive of a 45 basis point year-to-year LIFO headwind. Excluding the impact of LIFO, the year-to-year improvement in segment EBITDA and EBITDA margin primarily reflects underlying operating leverage on stronger U.S. sales, channel execution, and cost control.

Within our Engineered Solutions segment, sales increased 19.1% over the prior year quarter, with acquisitions contributing 18.6 points of growth. On an organic basis, segment sales increased 0.5% year-to-year. The increase was primarily driven by price contribution, as well as modest volume growth across fluid power mobile and industrial OEM customers, partially offset by lower flow control sales. Sales across our automation business increased 3% on an organic basis over the prior year, representing a third straight quarter of positive organic growth. Segment EBITDA increased 4.4% year-to-year over the prior year, inclusive of a 400 basis point year-to-year LIFO headwind, primarily reflecting contribution from our Hydradyne acquisition, partially offset by lower organic EBITDA on muted sales trends in the quarter. Segment EBITDA margin of 14.3% was down roughly 200 basis points from prior year levels, inclusive of a 55 basis point year-to-year LIFO headwind.

Excluding the LIFO impact, the segment EBITDA margin decline was primarily driven by lower flow control sales and unfavorable M&A mix, as well as a difficult prior year comparison from record performance across our Engineered Solutions segment during the second quarter of fiscal 2025 tied to favorable mix, as we had previously highlighted. Moving to our cash flow performance, cash generated from operating activities during the second quarter was $99.7 million, while free cash flow totaled $93.4 million, representing conversion of 98% relative to net income. Compared to the prior year, free cash was up slightly as greater working capital investment was balanced by ongoing progress with internal initiatives. From a balance sheet perspective, we ended December with approximately $406 million of cash on hand and net leverage at 0.3 times EBITDA.

Our balance sheet is in a solid position to support our capital deployment initiatives moving forward, including accretive M&A, dividend growth, and opportunistic share buybacks. During the second quarter, we repurchased over 346,000 shares for $90 million, bringing the year-to-date total to over 550,000 shares for $143 million. Turning now to our outlook, as indicated in today’s press release and detailed on page 12 of our presentation, we are adjusting our full year fiscal 2026 EPS guidance following our first performance and updated outlook. We now project EPS within a range of $10.45-$10.75 based on sales growth of up 5.5%-7% and EBITDA margins of 12.2%-12.4%. Previously, our guidance assumed EPS at $10.10-$10.85 on sales growth of 4%-7% and EBITDA margins of 12.2%-12.5%.

Our updated guidance now assumes LIFO expense of $24-$26 million compared to prior guidance of $14-$18 million. In addition, we now assume 210-230 basis points of year-to-year sales contribution from pricing, up from prior guidance of 150-200 basis points. From an organic sales perspective, we are now assuming a 2.5%-4% increase for the full year compared to our prior assumption of up 1%-4%. This takes into account first-half organic sales performance as well as early third quarter organic sales trends, which, as noted earlier, are trending up by a mid-single-digit % over the prior year in January. I would note prior year sales comparisons are slightly more difficult in February and March compared to January.

In addition, we continue to assume ongoing macro and policy uncertainty will influence customer spending behavior and shipment activity near the term. We believe this could result in ongoing variability in monthly sales growth, pending greater clarity on the macro backdrop or incremental support from lower interest rates and fiscal policy. At the midpoint of our updated guidance, we assume organic sales increase by approximately 4% year-to-year in the second half of fiscal 2026, with third quarter organic sales expected to increase by a low single-digit to mid-single-digit % over the prior year. We also project inorganic M&A-related sales and modest foreign currency tailwinds to contribute approximately 50 basis points of year-to-year growth in the second half of the year. The M&A contribution includes today’s announced acquisition of Thompson Industrial Supply, as well as our May 2025 acquisition of IRIS Factory Automation.

Our guidance does not include contribution from future M&A or additional share purchases in the second half of the year. From a margin perspective, we expect third quarter gross margins to decline sequentially to a low 30% range. This assumes a more normalized level of gross margin execution relative to our strong underlying second quarter performance, as well as slightly higher LIFO expense sequentially. Combined with modestly stronger operating leverage on greater sales growth, as well as ongoing inflationary headwinds, anticipate growth investments in our annual merit increase effective January 1st. We expect third quarter EBITDA margins to be within a range of 12.2%-12.4%. Lastly, some housekeeping items. Our updated guidance does assume a slightly lower share count following second quarter share repurchases, as well as a tax rate assumption of approximately 23% for the full year compared to our prior range of 23%-24%.

These slight EPS tailwinds are partially offset by an increase in net interest expense into the second half of our fiscal year following the net impact of our interest rate swap maturing at the end of January. With that, I will now turn the call back over to Neil for some final comments. So to wrap up, our team executed well through the first half of fiscal 2026. We’re delivering on our financial commitments and making strong progress on our strategic initiatives. As we enter the second half of the year, we do so from a position of strength with signs of emerging growth catalysts developing across several areas of our business. Early fiscal third quarter sales trends are encouraging and provide a nice jump-off point.

We remain prudent with our guidance as we look for greater consistency in sales trajectories as we move into more meaningful seasonal months while balancing the near-term timing impact of LIFO accounting. Importantly, sentiment from both our customers and our sales teams continues to be directionally positive, and our business funnels are expanding. Technical MRO requirements are heightened, entering what should be a more productive operating environment as we move through calendar 2026 when considering potential support from lower interest rates, a more favorable tax policy, and deregulation. In addition, our industry position places us in a unique and comprehensive position to capture growth as capital spending broadens across many of our customer verticals.

This includes pro-business policies supporting greater production and investments in core legacy verticals such as metals, mining, and machinery, as well as clear secular and structural tailwinds supporting multi-year cycles across semiconductor, power generation, and energy in markets. We also expect to play a greater role across the data center space, given our expertise and product offering in areas of thermal management, robotics, and fluid conveyance. With our deep technical industrial facility domain expertise, access to critical higher-engineered industrial products, and balance sheet capacity, we’re well positioned to capitalize on these growth opportunities. We also remain positive on our margin expansion potential as these tailwinds drive stronger top-line growth. We continue to see a clear path to achieve our mid-to-high-teens incremental EBITDA margin target at mid-single-digit organic sales growth.

This is supported by inherent operating leverage across our business model, combined with mixed tailwinds tied to the ongoing expansion of Engineered Solutions segment and local account growth within our Service Center segment. Additional support should emerge as we continue to scale our automation platform following various growth investments in recent years. Overall, we look forward to fully capturing this growth potential through the remainder of fiscal 2026 and years to come. And as always, we thank you for your continued support. With that, we’ll open up the lines for your questions. Thank you. We will now begin the question and answer session. If you would like to ask a question, please pick up your handset, press star, followed by the number one on your telephone keypad. If you would like to withdraw your question from the queue, press star one again.

As a reminder, if at any time you need to reach an operator, please press star zero. We’ll pause for just a moment to compile the Q&A roster. Our first question comes from the line of Christopher Glynn with Oppenheimer. Christopher, please go ahead. Thanks. Good morning, guys. Just wanted to dive into the Engineered Solutions orders in the quarter, up over 10%. I assume that was an organic basis. Just want to clarify, as well as what degree of positive book-to-bill that might denote. Yes. So that would be on an organic basis. And as we think about it, it broke out across the segments with automation, as we talked about, +20% fluid power, low teens, 13%, and flow control, high single digit, 8% into the side.

Book-to-bill was above 1 during the quarter and now has been 3 of the last 4 quarters in that side. Great. Thanks. And on the fluid power comparisons, you’ve got the destocking comparison. So curious if you could sort of dissect the kind of end demand trend versus better kind of sell-through there and alignment. Yeah. I think really the stock, destocking, given how that’s elongated out, has really been worked through. So the performance that we saw in the mobile off-highway part of fluid power is encouraging, as well as the work that’s going on with those mid-tier and smaller OEMs. We’re also encouraged on the fluid power side of the amount of industrial activity.

I think that’s similar to service centers on technical MRO requirements, that industrial customers are having to look at the aging of that installed base of producing equipment and is giving us opportunities. And then, right as we talked about in the comments, we think the technology side of our fluid power is really set up well as we think about semi-wafer fab equipment and also that growing participation in data center. Okay. And last one for me. I think of the January sales at mid-single digits. You mentioned Engineered Solutions was up high single digits. And you mentioned February, March, a bit more difficult comps. So just want to make sure I have all that right. And also just on the thought that maybe January had a benefit from neutralizing the December pause. Yeah. You think about it.

There could be, right, from the December, right, which we talked about or looked at from that side, from normal seasonal patterns there, right, running lower. So there could be. But I think the height of some of that growth and increase we take as favorable that it’s more than just a little bit of timing. Yeah. And Chris, the other thoughts on the trends in engineered solutions being up high single digits in January is correct. And there was maybe another part of your question that maybe we didn’t answer, but let us know. Appreciate that. I think we got it. Okay. Thanks. And our next question comes from the line of David Manthey with Baird. David, please go ahead. Morning, guys. My first question is on SD&A. Organic constant currency SD&A growth was less than organic revenue growth again this quarter, which looks really good.

I’m wondering, as we lap Hydradyne here, should overall SD&A come in closer to overall revenue growth next quarter? And then as we look forward, is there anything unusual in the fourth quarter of fiscal 2025 on SD&A? It looked like the sequential from the third quarter was up a greater than normal dollar amount there. And I’m just wondering if there was something unusual we should know about. Yeah. We’ll start with the sequential increase in 2025, third to fourth quarter, David. A couple of things came into play there. There was an increase in benefit cost. There’s variability, obviously, in our self-insured medical expense, but also about $1.5 million that swapped around with Rabbi Trust or deferred comp that gets offset in other income. So that did skew SD&A just a little bit.

As you think about kind of now as we move into third quarter, we do have the focal merit point coming in and lapping Hydradyne, to your point. So we would still work to show an increase less than the rate of the sales increase. But I would expect it, given that, like I said, the last quarter was about half the rate of the sales increase in terms of the SD&A increase. We’d expect that gap to close just a little bit, just given those factors coming into play. Hey, Dave, just also on the prior year fourth quarter for fiscal 2025, it was impacted, if you recall, by some AR provisioning that we had in the quarter. I think that was over $2 million or so year-over-year. So that’s part of the year-over-year or the uptick in the fourth quarter trend you see there.

Yeah. Thanks. And based on your guidance, it would appear that the fourth quarter of this year is a more normal kind of, I don’t know, $10 million quarter-to-quarter increase, which looks more normal. Okay. Thank you for that. And then on capital allocation, I’m not sure if it’s in the deck here, but did you mention the shares left under your repurchase authorization? And I guess in the context of, I think you have about $1.5 billion of borrowing capacity, including some accordion features. Does share repurchase take priority over debt paydown in the near term, given your ample access to capital and kind of the relative share price? We’re still be optimistic when you look at the share repurchase. We are contemplating some debt paydown, not the entirety of it, but given the in January, the swap will roll off.

So we’ll work to neutralize a little bit of that added interest expense that would come with that. So here again, taking it in rank order priority, it’s going to be the organic growth investment, followed by M&A, followed by the dividend increase, kind of 11% this quarter coming off the 24% last year increase. So continuing to move that in line with our increase in earnings in the business, as well as then the opportunistic share repurchase. So we’ll balance all those, to your point, plenty of dry powder, given the $1.5 billion capacity and leverage at 0.3x to really work all those angles. And then, Dave, we have, I think, about 700,000 shares left on the current authorization that we had, which we had updated, I think, last August timeframe.

And so we’ll continue to look at that as we continue to buy back shares and update that accordingly as we progress through the current program. And then lastly, Dave, I’d just say on the M&A side, as we touched in the remarks, we feel good about the pipeline, the work, the activity, touch on the potential for greater activity as we look out over the 12-18 months, really around our stated priorities of continuing to build out engineered solutions with some more select opportunities for differentiation around the service center side. So we’re low CapEx requirements. We’ll continue to make those. They generate strong returns, but the M&A opportunity for us, we think, remains a good priority for us as we operate through the rest of this fiscal year and look out beyond. Thanks, guys. Appreciate it.

Your next question comes from the line of Brett Linzey with Mizuho. Brett, please go ahead. Hey, good morning, all. Hey, I wanted to come back to the automation orders up 20%. I guess how much of that do you think is related to pent-up needs that were put on hold that are just starting to release versus new projects, capital formation that’s being driven by incremental onshoring your customers might be focused on? Yeah. Brett, I don’t know if I got a perfect answer to that. Obviously, we’ve had growing funnel within our automation group and also with our service center teams walking in here today. A couple of releases are getting highlighted on projects that were in flight. But there’s also a great amount of work. If we consider what is coming to the U.S. from a reshoring standpoint, we have more customers reaching out.

How can they drive their efficiencies and productivity where collaborative or mobile robots will help? They’re looking at quality control or quality and inspection where vision systems can help, and even just connectivity products, right, to monitor KPI and performance where perhaps people did that manually in the past at equipment to a way to have visual panels and boards on that. So I think both are going to be continued drivers for us as we look out over calendar 2026. Things that we’ve worked on, on ideas and solutions, but also increased new opportunities as we think about the backdrop. And then things like tax policy and outlooks are probably going to help further accelerate some of that look from customers. Yeah. That’s great. And then just my follow-ups on price. So the contribution was 250 basis points in the quarter.

Curious what you’re seeing here in calendar 2026 from a vendor price standpoint, and how should we think about pricing contributions for the balance of this fiscal year in Q3 and Q4 as you got some wrap-around and maybe some incremental coming through? Yeah. We think about activity from our suppliers. Obviously, those that are more calendar year-based and increases, we see those in place. We did see some that are later year, perhaps mid-year around their fiscal year events, accelerate. So we think to a large part, there’s more of that that is in now. We would think the third quarter has the potential to be similar to the second quarter, so 250 basis points in that. And then with the fourth quarter, given perhaps that aging or overlapping of some prior increases, maybe that moderates to a couple hundred basis points impact in the fourth quarter.

And so that’s what’s encapsulated in our outlook. If we look beyond that, right, hey, we will see. There could be a path to higher upside in that as we think about the direction of LIFO that we’ll have into that side of it as well. All right. Got it. Thanks. Best of luck. And our next question comes from the line of Sabrina Abrams with Bank of America. Sabrina, please go ahead. Hey, good morning, everyone. Good morning. Question. So I know you guys did raise the pricing guide this quarter, and pricing, I guess, accelerated nicely quarter-over-quarter. But you did raise LIFO expense, and we’d just like to ask why not assume prices going to accelerate into the second half? Because I would think price continues to accelerate from here, but just any color around that assumption. Yeah.

So as we think about, we touched on just a little bit there. We’re seeing the announced increases from our suppliers as we think about for much of 2026 are perhaps likely in place now. And then if we think about the aging or the overlap of prior increases, that’s what we’re saying perhaps the price moderates to that 200 basis points in the fourth quarter compared to this 250 level that we have today. Obviously, we’ll be close to the inputs of looking at any other metals, material increases that will be coming through with suppliers and work with them to orderly take them through to the markets. But hey, that’s our view now. And perhaps the tariff environment is going to stay moderated at its current level right now as we look out over the rest of the fiscal year.

I’d say too, I’d add the, obviously, you’re seeing in the, as you start looking at the comps in the back half of 2025, some higher levels of pricing that does skew year-over-year just a bit versus the first half. And then thinking about the LIFO, doesn’t necessarily travel in exact tandem with the dynamics that we see on the pricing and supplier price increases because that’s also influenced by the mix of what we’re purchasing. So we did have a heavier concentration this quarter of parts that we had not purchased for 2 to 3 years, which attracted a fair amount of LIFO increase as we looked at the buy versus kind of the 2 or 3-year-ago price that we were carrying at. So that is also a factor as you try to correlate those two. Thank you.

And just on guidance, on my math, I think there’s an extra versus the prior guide, I think there’s an extra $0.18 from LIFO expense going up, embedded in the new EPS guide, and there’s another couple cents of interest expense. And then on the other side, you have the benefit of maybe a lower share count and very, very modest impact from the acquisition you did. And just as I think about these moving pieces and the narrowed guidance, maybe is the right way to think about it that the core guide has been raised? Because if I sort of back out all this other stuff, I’m getting to core EBIT is higher versus last quarter, but I just want to clarify with you guys whether that’s the correct way to think about it and any moving pieces I might be missing. Yeah.

I think there’s a modest increase there resulting from really the strong margin performance. You’re going to see stripped out that LIFO of 31% gross margin performance against a very difficult comp. Like I said, you think about the year-over-year still being up, partially driven by that Hydradyne mix benefit, but nonetheless, very pleased with the team’s response to the pricing environment. So you’re seeing some of that read through. We’ll still be cost-conscious and kind of continuing to look at that. So I’d say it’s a modest increase there in the core. And then we think about the guide, really kind of tightening the guide at the upper end of the previous guides. And just to clarify. Oh, sorry. Sorry, you guys finished. Yeah. No, that’s fair.

So, I think, yeah, if you look at the midpoint of the guidance, the organic growth we’re assuming in the back half of the year is up slightly from what we were assuming in the prior guidance that we provided, and maybe even a more meaningful amount when we look at it at the high end. And so, not a huge change, but we are assuming a little bit greater organic growth on sales in the back half relative to what we were prior. Thank you. And just one last quick follow-up to that. Is that on the raised pricing assumption, or did you raise your volume assumption? Yeah. I’d say it’s primarily tied to the raised pricing assumption, but still some volume assumptions as well in there as well. Thank you. I’ll pass it on.

And our next question comes from the line of Ken Newman with KeyBanc Capital Markets. Ken, please go ahead. Hey. Good morning, guys. Thanks for squeezing me in. Wanted to first just touch on the margin guidance if we could. I guess there’s a headwind due to LIFO here in the back half. I think the math is around 30-40 basis points on EBITDA. But I would think that the high single-digit, the low double-digit sales growth in engineered, and then the automation orders being up 20% would be a decent mix offset. So maybe can you just help us think about bucketing the various moving pieces in the margin guide and what that assumes for mix versus price cost and LIFO headwinds? Yeah. I can start.

So just as we think, right, and we talked about, hey, perhaps we moderate below the 30.4 that we had in the second quarter, that 10-30 basis points on gross margin on the guide. I think you’re right on potential for LIFO to be a 30-40 basis point headwind, path to things that could counteract, right? One will be, hey, what is that true path of LIFO in the second half? To your point on mixed dynamics, engineered solutions, local account growth, and service centers would both be the potential for benefit in that. The further path on M&A performance, Hydradyne as it comes in would have the perhaps continued improvement. And then, obviously, we’ll be focused on our price actions and ongoing margin initiatives that we have across that benefited us in the second quarter.

But hey, as we sit here today, right, we see there is that potential for that to show up, including that higher LIFO expense that we had in the second quarter, somewhat to continue on at that $7 million-$8 million impact. Yeah. I think you stripped that out. Sorry. Yeah. You stripped that out, Ken. I’d say the LIFO expense, it’s a good story in terms of incrementals. We’re up over 20%, what that implies in terms of the guidance in the back half in terms of incrementals ex LIFO. So you are seeing all those things you indicated and highlighted there in terms of the mixed benefit, flow control sales coming back, the acquisition mix benefit, stronger engineered solution shipments, which helps from a mixed standpoint as well. So all those things play in in addition to the workaround pricing and kind of the channel optimization. Okay.

That’s helpful. And then just for my follow-up, it was nice to hear you guys reiterating the mid-teen incremental EBITDA margin target on mid-single-digit growth. I think the midpoint of this quarter’s guide is slightly below that, but I wanted to get your thoughts on, one, do you think you could reach that target exiting this fiscal year? And if so, do you need a specific number or a contribution of volume growth to kind of get there? And maybe also, if we get incremental pricing versus what you’re already expecting in the guide today, would you expect that to be neutral to the operating leverage or creative? Yeah. I can start. As we think about that leverage and then, hey, right, some of our targets that we have for the business, we think about them really from an annualized basis.

But to your point, we’ve demonstrated strong incrementals with low single-digit in volumes. As we move up, right, those have the opportunities to improve. So I think as we look out over calendar 2026, we see that opportunity for that to play out and develop for us. Yeah. And again, I would say that at the midpoint of the guidance, we would assume that the fourth quarter gets to, you’ll call it a mid-teen incremental margin on EBITDA at, you’ll call it that 4% or so type of organic growth that we have baked into the guidance at this point. And that includes the LIFO, increased LIFO year-over-year. As mentioned earlier, we will have a benefit year-over-year in the fourth quarter, assuming normalized AR provisioning given that prior year impact that we had.

And so we’re getting to that, call it mid-teen to high-teen range at slightly below mid-single-digit organic growth, but feel very good as we move into a more stabilized and firm mid-single-digit organic growth environment that that incremental margin guide is achievable. And then as it relates to pricing and anything incremental, the team is doing a great job of managing pricing, a number of other initiatives that we have on gross margin and countermeasures to manage through that. And we’ll see how it all plays out, but obviously, inflationary environment, but the team’s doing a good job executing through it. Very helpful. Thanks, guys. And now our next question comes from the line of Chris Dankert with Loop Capital Markets. Chris, please go ahead. Hey, morning. Thanks for fitting me in here.

I guess just on the third quarter guide, if I’m looking at what you guys have staked out from an organic sales growth perspective, that seems to imply kind of a below typical seasonal growth level. I mean, I think +5% sequence is kind of what the midpoint implies. Longer term, you’re typically up in the high single-digit range. I guess when we consider the December holiday timing impact, the ES orders, incremental pricing, can you kind of help us square the below seasonal midpoint of that sales guidance for fiscal 3Q? Actually, Chris, if you look at it, given the low- to mid-single-digit assumption for Q3, 4% year again, organic for the total back half, that would assume for the first quarter in quite a while.

We’ve been kind of last quarter was 200 basis points below the typical seasonality, but that’s really back in line with what we’d say is normal seasonality as we transition from Q2 to Q3. Got it. Got it. Well, I guess in the interest of time, I’ll leave it there, but thanks so much. And our next question comes from the line again from Christopher Glynn with Oppenheimer. Christopher, please go ahead. Yes, thanks. Just on the mechanics of LIFO, I definitely don’t claim a deep appreciation of how it all works, but I’m wondering about the lead time dynamics, what they’ve been like for supplier price negotiations. Are they faster cycling than normal, or have the signals been too varied?

I’m just wondering if there’s perhaps an opportunity to standardize the pre-planning communications with suppliers a little bit more, just given your long-term distinguished excellence in data and analytics throughout the organization on many dimensions. Yeah. I can start. Chris, I think suppliers are being orderly in this and, hey, that’s our expectations. As they’re working on them as they develop, obviously, you need the data, you need the files to work through on that to be able to effectively implement. So we’re not changing our expectations or views that that has to be orderly. And so I think suppliers understand that it’s best for them as well. So they’re working to do that. And so it kind of led a little bit. I think most of the annual increases are in.

I think those that we’re contemplating are more historically kind of mid or they’re more fiscal year side have accelerated. I think most of those are in. So from a price increase standpoint, I won’t say that they’re finished if metals or something else moves, but then I think most of those are in place right now. Yeah. Chris, I think the other piece of LIFO to consider as it relates to how it moves quarter to quarter, obviously, is what we decide to bring in as it relates to inventory investment, right? And so that remains a fluid, sort of dynamic, and we feel good that what we’re seeing in the back half is demand is starting to firm. We’re starting to bring more inventory on, as we talked about, in a prudent way.

And so that drove some of the, I think, increase in LIFO maybe relative to what we expected last October when we talked about LIFO expense guidance. So that’s probably a piece of it just to keep in mind that will continue to fluctuate depending on the demand backdrop. Yeah. For the context, operating inventory roughly about a point and a half in terms of 0.5% in terms of the sequential change in the quarter, as you see that demand firming, and we brought in some of the inventory to support that. Thanks, everybody. At this time, I’m showing we have no further questions. I will now turn the call over to Mr. Schrimsher for closing remarks. Thank you. I just want to thank everyone for joining us today, and we look forward to talking with you throughout the quarter. Thank you, ladies and gentlemen.

This concludes today’s conference call. Thank you for participating. You may now disconnect.