Applied Industrial Technologies Inc (AIT) Q3 2025 Earnings Call Transcript

Welcome to the Fiscal 2025 Third Quarter Earnings Call for Applied Industrial Technologies. My name is Celine and I'll 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. If you wish to ask a question at that time, press star 1 followed by the number 1 on your telephone keypad. Prior to asking a question, 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 zero. Please note that this conference is being recorded. I will now turn the call over to Ryan Cislak, 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 Scrimcher, 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 in-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 HydroDyne 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 EBITDA margins are up 320 basis points over the past five years. This performance has helped drive 12% compounded annual growth for both EBITDA and free cash flow over the past five years. Very compelling trends when considering various market headwinds over the past several years, including higher inflation, supply chain disruptions, and more recently, softer demand trends. Overall, our margin expansion highlights the benefits of our strategy and strong market position. This includes structural mixed tailwinds as we continue to expand our engineered solution segment both organically and through M&A, combined with focused initiatives tied to pricing analytics and processes, supplier relationships, local account growth, and supply chain optimization. In addition, we're on track to achieve another record year of cash generation with free cash flow up 50% year-over-year in the third quarter and 39% year-to-date. Our cash generation and strong balance sheet provide financial strength and flexibility in the current macro landscape, allowing us to proactively enhance our growth position and shareholder returns through greater capital allocation year-to-date. Of note, we've deployed over $440 million in capital through the end of March. This partially reflects greater M&A activity, including our recent acquisition of Hydrodyne. We're extremely excited about the growth and operational momentum we expect to build with HydroDyne. Initial integration is going well with strong collaboration and strategic positioning across operating teams. We expect financial contribution to increase into the fourth quarter and fiscal 2026 as initial synergies are achieved and demand strengthens across core and emerging fluid power markets. In addition, our M&A pipeline remains active and provides ongoing momentum moving forward, as reflected by today's announced definitive agreement to acquire IRIS factory automation. IRIS is a nice bolt-on acquisition for our automation team that we believe will be incremental to our growth potential and value proposition long-term, given their focused capabilities. Of note, Iris provides proprietary turnkey productized solutions that can be easily deployed in a customer's facility to address common automation needs. Their solutions utilize advanced vision and robotics and support processes such as palletizing, case backing, and quality inspection. Expanding our portfolio of productized automation solutions is a key focus area that should accelerate our cross-selling potential and addressable market long-term. IRIS will add over 30 new associates and is expected to generate annual sales of around 10 million in the first year of ownership, though we believe this acquisition can drive stronger growth synergy long-term as we leverage our core suppliers' leading automation technologies and Applied's access to legacy manufacturing verticals. Overall, we look forward to welcoming IRIS to Applied and leveraging their capabilities going forward. In addition to ongoing M&A activity, we remain proactive with share buybacks, including repurchasing over 330,000 shares for approximately 80 million year-to-date in fiscal 2025. Our approach to share buybacks remains consistent with our capital allocation strategy of returning excess cash to opportunistic share buybacks utilizing a disciplined valuation and returns-focused framework. Long term, we see significant intrinsic value creation potential across applied considering our strategic initiatives, industry position, exposure to secular growth tailwinds, and margin expansion potential. We will continue to utilize share buybacks to enhance shareholder returns, and as indicated in our press release today, I'm pleased to announce our board has approved a new 1.5 million share repurchase authorization. As it relates to the underlying demand environment, overall dynamics remain mixed during the third quarter as the evolving tariff and trade policy backdrop combined with higher interest rates continue to weigh on broader industrial activity. As expected, similar to last quarter, customers maintained a gradual approach to production and continue to conservatively manage MRO and capital spending, including delaying new system installs and extending the phasing of capital projects. That said, we did see several encouraging trends in the quarter. First, demand across our service center segment gradually improved following a slow start in January, with average daily sales increasing nearly 4% sequentially versus the second quarter, which was slightly ahead of normal seasonal patterns. Trends across our top 30 in markets improved from last quarter, with 16 generating positive sales growth year over year compared to 11 last quarter. While sales declines continue across several top markets, including machinery, metals, and utilities, we saw a number of markets turn slightly positive in the quarter, including rubber and plastics and oil and gas, as well as several lower tier verticals. Growth was strongest in technology, food and beverage, pulp and paper, aggregates, and transportation markets. Further, while mid-single digit organic sales declines persisted across our engineered solution segment, segment orders increased three percent year over year and eight percent sequentially on an organic basis during the quarter. This drove the segments booked a bill above one for the first time in nearly three years. Stronger order trends were primarily driven in automation where orders grew by over 30 percent year over year and 20 percent sequentially in the third quarter. While some of these orders are longer cycle in nature and likely won't contribute to sales growth until fiscal 2026, it's a positive trend nonetheless that provides strong support to this scaling area of our business. We also saw orders across industrial and mobile OEM fluid power markets turned slightly positive year over year in the quarter. This is an encouraging sign following notable sales headwinds in this area of our business over the past year. During the third quarter, reduced sales from industrial and mobile OEM fluid power customers negatively impacted our consolidated organic year-over-year of sales growth rate by approximately 100 basis points, as well as the engineered solution segment organic growth rate by over 300 basis. Mobilizing orders combined with more normalized OEM inventory levels emerging hydradyne synergies, and much easier comparisons provide a solid path to see this area of our business potentially reemerge as a growth tailwind into fiscal 2026 and beyond. For all, a number of positive takeaways from our third quarter performance that highlight the strength of our industry position and operational caliber, as well as underlying growth setup we have developing. That said, needless to say, we are now operating in an environment that is more volatile given the dynamic global trading and tariff backdrop. The related macro uncertainty that has ensued represents a distinct challenge for our customers, near-term operational, and capital management planning processes. Dave will provide more color and views on our outlook and guidance shortly but we believe the current backdrop could continue to weigh on industrial production and capital spending into the spring and summer months this was partially evident during april where we estimate average organic daily sales declined by an approximate three percent over the prior that said similar to the sequential improvement we saw during the third quarter, we expect break-fix and maintenance activity to potentially pick up as the quarter progresses, considering deferred technical MRO spending over the past year. As a reminder, over 70% of our total sales come from technical MRO and aftermarket support on direct production equipment and systems, with roughly half our service center sales from break-fix applications. We also remain intensely focused on our internal and self-help growth initiatives tied to expanding cross-selling opportunities, sales force investments, and product category penetration. In addition, our U.S.-centric customer base and manufacturing domain expertise, combined with our scaling automation platform and diverse supplier base, puts us in a strong and opportunistic position to play offense as trade policies and supply chains potentially structurally shift. This includes playing a critical role in providing technical maintenance, engineering and assembly, and process enhancements to U.S. manufacturing systems and industrial equipment. In the near to mid-term, this position could benefit if utilization of existing U.S. production capacity structurally increases including potential demand shifts, third-tier domestic producing OEMs, which are key customers to many of our business units. In addition, our strategic relationships with a diverse U.S. supplier base combined with our technical repair, rebuild, and shop capabilities provide customers component optionality and alternatives as they manage through potential supply chain inflation and disruptions. Then on a longer-term basis, the potential for greater reshoring activity and new manufacturing investments could represent a meaningful tailwind across many of our essential customer industries from legacy metals and machinery verticals to advanced technology and life sciences. I'd also like to take a moment to discuss potential tariffs and the impact can have on cost structure and operations. Our U.S. operations direct exposure to procuring products outside the U.S. is very limited representing less than two percent of total COGS, including an immaterial amount directly from China. As a result, we do not have or expect to have any significant exposure to direct tariff costs. From an indirect standpoint, we're working closely with our suppliers as they continue to assess the impacts of tariffs and other inflationary pressures on their supply chains. We've received varying levels of price increase announcements from many suppliers over the past several months. Our teams are proactively and effectively managing through this evolving backdrop, and overall we believe we are comparatively well positioned. Our track record during the inflationary period of 2021 to 2023 provides strong evidence of our ability to manage and pass along inflation. We have a proven execution playbook that has been enhanced by system investments and analytical tools in recent years. We operate from an agile business model in well-structured markets tied to critical and technical processes with strategic supplier relationships. Combined with structural mixed tailwinds and various self-help gross margin countermeasures inherent to our strategy, we are highly confident in our ability to adapt and execute as the tariff and broader inflationary backdrop continues to evolve. At this time, I'll turn the call over to Dave for additional detail on our financial results and outlook. Thanks, Neil.

Just another reminder before I begin. As in prior quarters, we have posted a quarterly sub-level 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 HydroDyne. 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 a 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 break-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 prior year, despite a 3.5% decrease in total sales, while segment EBITDA margin of 14.7% expanded 140 basis points. The year-over-year improvement was driven by strong cost management, gross margin initiatives, reduced LIFO expense, as well as favorable accounts receivable provisioning as a result of our internal working capital management initiatives. These results demonstrate solid performance and additional evidence of our ability to adjust and execute operationally in any demand environment. Within our engineered solution segment, sales increased 13.5% over the prior year quarter, with acquisitions contributing 20.8% growth, including our recent acquisition of HydroDyne. On an organic daily basis, segment sales decreased 6.5% year-over-year, which was relatively similar to last quarter. The segment's organic sales decline continues to primarily reflect ongoing demand weakness across fluid power OEM customers tied to reduced activity across the mobile fluid power market. In addition, backlog conversion on engineered systems and equipment remains low as customers continue to take a measured approach to capital deployment and project phasing across our flow control and automation operations. This was partially balanced by growth across the technology vertical. Segment EBITDA increased 10.2% over the prior year, reflecting contribution from HydroDyne, as well as gross margin initiatives, cost management, and ongoing operational enhancements as we continue to execute our engineered solutions strategy. Segment EBITDA margin of 13.8% was below the prior level of 14.3% and last quarter of 16.3%, though largely in line with our expectations, considering the initial mixed impact from HydroDyne, as well as more normalized organic gross margins trends following the last quarter. As a reminder, we see strong upside potential in HydroDyne's EBITDA margins as we complete integration and execute our synergy plan, particularly considering the business's higher gross margin profile. Moving to consolidated gross margin performance, as highlighted on page 9 of the deck, gross margin of 30.5% increased 95 basis points compared to the prior year level of 29.5%. During the quarter, we recognized LIFO expense of $2.2 million compared to $4.8 million in the prior year quarter. This net BIFO tailwind had a favorable 22 basis point year-by-year impact on gross margins. Gross margins also benefited from initial positive mixed contribution from our recent HydroDyne acquisition. However, when excluding these positive impacts, we still generate solid gross margin expansion in the quarter, reflecting strong channel execution and the benefits of ongoing gross margin initiatives. Trends were relatively neutral in the quarter. In addition, while gross margin mix benefited from recent M&A, the business continues to face mixed headwinds from lower sales across local accounts and the engineer solution segment. As it relates to our operating costs, selling, distribution, and administrative expenses increased 4.1% compared to prior year levels. SD&A expense was 19.4% of sales during the quarter reflecting an increase of 43 basis points from the prior year quarter excluding depreciation and amortization expense sdna was 17.9 percent of sales during the quarter an increase of only 10 basis points from the prior year on an organic constant currency basis sdna expense was down 6.3 percent year-over-year during the quarter we've benefited from ongoing efficiency gains and reduced variable expense on lower sales, as well as other cost measures, as our team continues to effectively navigate through this subdued demand environment. We also experienced lower medical expense, as well as favorable AR provisioning tied to our working capital initiatives with particularly strong collections performance. Overall, positive gross margin performance, coupled with the benefit of spend initiatives and M&A contribution, resulted in reported EBITDA increasing 6.8% year-over-year, including an approximate 2% organic improvement, while EBITDA margin of 12.4% expanded 59 basis points from the prior level of 11.8%. In addition, reported earnings per share of $2.57 was up 3.7% from prior year EPS of $2.48. This includes an unfavorable impact year-over-year from interest and other income and a slightly higher tax rate, partially offset by a lower share count. Moving to our cash flow performance, cash generated from operating activities during the third quarter was $122.5 million, while free cash flow totaled $114.9 million, representing conversion of 115% relative to net income, and a 50% increase from the prior year level. Year-to-date, we have generated approximately $327 million of free cash flow, which is up 39% every year. Our cash flow growth so far this year primarily reflects more modest working capital investment compared to the prior year, as well as ongoing progress with internal initiatives and our enhanced margin profile. From a balance sheet perspective, we ended March with approximately $353 million of cash on hand and net leverage at 0.4 times EBITDA, which is above the prior level of 0.3 times, but below last quarter's level of 0.5 times. Our balance sheet is in a solid position to support our capital deployment initiatives moving forward, as well as enhanced returns for all stakeholders. During the third quarter, we repurchased approximately 205,000 shares for $50 million, bringing the year-to-date total on share repurchases to 332,000 shares for $80 million. Turning now to our outlook, as indicated in today's Crest release and detailed on page 12 of our presentation, we are adjusting full-year fiscal 2025 guidance to reflect our third quarter performance and updated fourth quarter expectations. Specifically, we now project EPS in the range of $9.85 to $10, based on sales growth of flat to up 1%, including a down 4% to down 3% organic growth assumption, as well as EBITDA margins of 12.3 to 12.4%. Previously, our guidance assumed EPS of $9.65 to $10.05, sales growth of 1 to 3%, including organic sales of down 3% to 1% and EBITDA margins of 12.2% to 12.4%. Our updated guidance implies a fiscal fourth quarter EPS range of $2.52 to $2.67 on a total sales year-over-year range of down 1% to up 3% and EBITDA margins of 12.6% to 12.8%. The quarter sales guidance assumes average daily sales decline organically by a mid-to-low single-digit percent over the prior year. The updated outlook considers average daily sales in April declining by an estimated 3% organically year-over-year, as well as near-term demand implications from greater economic uncertainty around recent tariff actions and an evolving global trade landscape. We believe this backdrop could weigh on seasonal industrial production trends into the summer as customers conservatively manage cost and capital spending, spending greater clarity on trade and tariff policy. From a margin perspective, we expect fourth quarter gross margins to be relatively stable sequentially. The outlook assumes limited impact from tariffs on pricing and cost inflation in the fourth quarter, given the timing of announced supplier price increases, our product procurement exposure, and an evolving tariff and trade policy backdrop. In addition, we expect LIFO expenses to be relatively unchanged sequentially and slightly above $2 million, pending any significant changes in our inventory levels near term. However, this would represent a headwind year-over-year in the fourth quarter of about 20 basis points on margins, reflecting LIFO favorability in the prior year fourth quarter, which we previously highlighted partially benefited from a layer of liquidation benefit. We remain constructive on our setup moving forward, considering our industry position, easing prior year comparisons, sustained benefits from our internal initiatives, and engineer solutions segment order trends. Greater financial contribution from our recent HydroDyn acquisition, including initial synergy benefits, provides additional support. That said, we believe it prudent and remains prudent to take a balanced approach to our near-term outlook in the current uncertain operating environment pending more definitive and broader signs of a positive inflection in macro and industry conditions as trade and tariff policies are formalized. With that, I'll now turn the call back over to Neil for some final comments.

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 in-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're favorably positioned to manage potential greater inflation given our technical industry position, minimal cross-border sourcing, structural mixed 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. They're 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. If you would like to ask a question please pick up your handset press star one 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 a moment just to confide the q a roster and your first question comes from the line of christopher Glenn with Oppenheimer. Please go ahead.

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

You know, Chris, I don't know that I have, you know, all of that insight in going through, but I would say I think that trends that we saw in the quarter and the improvement in the top 30 were positive that moved from the 11 to 16. So if I think across it, I think technology and the domestic work that will 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 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 insider indications that I have right now.

Yeah, I appreciate it.

I know it's an abstract topic.

In terms of improved daily sales rate as we moved across the core and the service center segment, segments and of course the you know the positive impact and then flow flux we saw on new order intake and the engineered solution segment so those were all encouraging signs.

Great and then if we could look at some of the the piece parts of engineered solutions you know relative or specific growth for fluid power flow control and automation and do you think fluid power could pivot in the first half of fiscal 26 or is that probably a little later?

I think there could be some trends 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, you know, 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 26, we can 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 in fiscal 26.

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

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

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

That is.

Great. Thank you.

Thank you.

Your next question comes from the line of David Manty with Perry. Please go ahead.

Yeah, 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 as kind of a hedge for demand destruction and others are in between that. I was 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 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 mid-year 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 placed 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 in-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 onto your demand forecast, and that's what's guiding you. Okay, that's helpful.

Yeah, given they were guiding one quarter, David, it's, you know, So a lot of what we're seeing in terms of those price increases, as Neal indicated, is more general inflation-related, as it 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.

Yeah, great idea to be on a June fiscal year this year for sure. Yeah. So then I guess there's kind of this 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. And 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 could 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?

Yeah, I think for us, David, overall, we think about our service centers and given half their demand often will occur at a break-fix time. You know, 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, you know, stays pretty resilient throughout. And then where we are involved in projects and capital projects, They're really not extremely large capital-intensive investments. They're enabling customers to be more productive, more efficient into the side. 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 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 to 24 months back, is starting to be a contributor again.

That's great call, O'Neal. Thanks, all.

And your next question comes from the line of Sabrina Ibrams with Bank of America.

Please go ahead. hey good morning everyone good morning um yeah i just wanted to talk i guess a little bit about the um what you're seeing in the macro and uh i think generally uh your trends seem positive um like sequentially clearly there's a great extent of uncertainty um but the q4 guide suggests decelerating trends from Q3 and you know I guess it assumes sort of May and June get worse and I guess how much of that has to do with what you are currently seeing uh maybe if you could clarify whether April actually slowed from March February or if there was something with Easter going on but from a demand if April has slowed and I guess how much of uh things accelerating 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 engineer solutions which i think have been positive for two quarters now um with the implied deceleration uh quarter over quarter yeah okay 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 26 on 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. We're still very focused on how we are executing the business and helping the customers in. So I think that guide has, you know, appropriately prudent in that area. To your point, April did have an influence of a good Friday, Easter holiday timing into that. You know, perhaps that was 100 basis points into that side influence. And then as we think about, you know, 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.

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

Got it. No, thank you. That's helpful. And then just on the EBITDA margins, because 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 want to understand – this is sort of what it's implied by the midpoint of your guide, and I just sort of want to understand what would be driving so much the leveraging quarter-over-quarter. Does it have something to do with the acquisitions? Does it have something to do with inflation? So any clue there would be helpful.

Yeah, you bet. Yeah, very proud of the businesses' cost controls and productivity in terms of SG&A spend in our most recent quarter. Hydrodyne, you know, comes in as a favorable gross margin mix-up benefit, but still, you know, higher SDNA 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, you know, thinking back to the gross margin performance, we said LIPO 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 layer of liquidation benefit in the prior year. So that alone drives about a 20 basis point adverse impact on both gross and even a margin. So you're seeing all those 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.

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

Hey, good morning, guys. You know, for the first question, I think longer term, I know you're not ready to talk about fiscal 25 yet, but, you know, 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, you know, maybe some higher LIFO expense for potential price increases? Just how do you think about maybe the moving pieces and operating leverage?

Yeah, Ken, I would think end of 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. You know, to your point, a little early on fiscal 26 and a lot of moving parts, but, and we'll be working through our planning. We're going through our long range strategy sessions and game theory had to serve in game theory with the board this past time engineered solutions in in coming up and we're working uh the planning cycles right now but as a start out or look at 26 that would end and if you apply normal seasonality looking ahead uh that results in something that's uh flat uh then if you think about there would be will be price contribution in that perhaps that's uh several hundred 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 26 looks like a low single-digit environment overall. 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, or LIFO overall, a significant cash benefit to us in inflationary times. And if they look back at 17 through 19 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, you know, Ken, coming out of the inflationary, kind of the COVID, and some of that demand rebound, you know, the business did very nicely in terms of levering. When you think about, at times, you know, incremental is in excess of 20%, despite some of those continued LIFO headwinds, et cetera, that Neil indicated. So structurally, I just think the business is in an even better position now when you think about the mix-up benefit that comes with, you know, higher engineered solutions, contribution. And once again, just thinking about the way the business levers on, you know, some of that SDNA base that, you know, once you get past that first one to 2% of growth would expect, you know, like I said, those mid to high teens incrementals for sure.

Yep, that's really helpful. Maybe for the second question here, 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. How do you think about the priorities between the two? Is this a good level or a good share price level as you think about enacting on that share repurchase program? And what's the capacity to act on M&A even here in the fourth quarter and into 26?

Yeah, so I can start. So, you know, Ken, 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's active. We're busy into that front, so that will contribute into the side. 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 just say it. Yeah, so coming off of Hydrodine and the incremental share repurchase activity in the most recent quarter, still at 0.4 times leverage, plenty of dry powder to, you know, handle all those capital deployment opportunities.

Very helpful. Thanks.

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

Hey, good morning, guys. This is Peter Kasson from Brett.

Could you just add some color on what you're seeing from, you know, reshoring investments specifically? you know what's the pulse out there just as we wait 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 percent into the side, 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, third-tier OEMs are 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 in, 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 26 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 mismatches, 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?

Yeah, so I would say overall, right? I mean, there's clear awareness of inflationary impacts and inputs in the environment, and we're firm believers that we as consumers will 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 in going out. As it relates to suppliers, they will be coming with the phases. They'll provide the documentation that it will go through. And, you know, 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. Scrimshaw 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.