Earnings Call Transcript - AIT Q1 2025

Operator, Operator

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

Okay. Thanks, Angela, and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing our first quarter results. Both of these documents are available in the Investor Relations section of applied.com. Before we begin, just a reminder, we'll discuss our business outlook and make forward-looking statements. All forward-looking statements are based on current expectations subject to certain risks and uncertainties, including those detailed in our SEC filings. Actual results may differ materially from those expressed in the forward-looking statements. The company undertakes no obligation to update publicly or revise any forward-looking statement. In addition, the conference call will use non-GAAP financial measures which are subject to the qualifications referenced in those documents. Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer; and Dave Wells, our Chief Financial Officer. With that, I'll turn it over to Neil.

Neil Schrimsher, President and CEO

Thanks, Ryan, and good morning, everyone. We appreciate you being here. I’ll begin by discussing our first quarter results, the current state of the industry, and what we anticipate moving forward. Dave will provide more detailed financial information as well as our updated outlook, and I’ll conclude with some final comments. To start, our Applied team made notable progress on our strategic initiatives this quarter, positioning the company for growth beyond market averages and margin expansion in the future. Organic daily sales fell 3% compared to the previous year but were better than we anticipated, supported by positive trends in September. We also achieved a record in free cash generation, nearly doubling last year's figures. As expected, margin trends were affected by earlier sales declines and other factors, though we anticipate improved margins for the rest of the year. EBITDA met our expectations for the quarter, and EPS benefited from lower tax rates and fewer shares due to recent buybacks. This sets up a solid foundation for the year ahead. Looking at sales trends more closely, demand across various markets was mixed, aligning with recent industrial macro data, which resulted in lower customer activity at the beginning of the quarter. However, we ended the quarter on a positive note with several encouraging trends. In particular, organic average daily sales in September showed seasonal strength and remained stable year-over-year, largely driven by improved shipment and order trends in our Engineered Solutions segment. Additionally, our U.S. Service Center operations saw improved sales in September, thanks to increased brake-fix activity and benefits from our sales strategies. This was slightly offset by ongoing weakness in machinery markets, particularly within our fluid power mobile OEM customers. Among our top 30 end markets, 13 showed positive growth compared to last year, down from 14 last quarter. The strongest growth was seen in food and beverage, primary metals, transportation, aggregates, and technology. In contrast, we saw declines in machinery, oil & gas, lumber, fabricated metals, pulp & paper, rubber & plastics, and utilities. Although there are early signs of recovery, the demand landscape remains uneven. This is evident in the early sales trends of the second fiscal quarter, where organic sales have dipped slightly compared to last year. We believe some of this decline may be linked to hurricanes affecting the Southeast. We also note that the timing of shipments in our Engineered Solutions segment varies monthly. With U.S. elections on the horizon, we are cautious about drawing conclusions from early October trends but remain aware of the ongoing market dynamics. Delving into each segment: Average daily sales in our Service Center segment experienced a 1.4% organic decline compared to last year, following strong growth in the past two years. Similar to the previous quarter, spending on MRO and maintenance projects has been cautious as customers manage expenses tightly. Nevertheless, sales trends in our core U.S. Service Center network remained relatively strong, with September showing seasonal strength in brake-fix and general MRO activities. We are also benefiting from our service capabilities, local inventory investments, ongoing sales initiatives, and increased cross-selling opportunities. Over the last five years, sales per U.S. service center associate have increased over 7% annually, and our local market position has been bolstered by acquisitions made last year, expanding growth in new and less penetrated verticals. Overall, we believe our Service Center team is well-positioned for the future, especially as end market demand is expected to pick up in the short cycle and brake-fix areas. There likely exists some pent-up MRO demand across markets following a period of subdued activity and deferred maintenance, which could become apparent after the U.S. elections if interest rates ease. Our technical expertise combined with a locally focused distribution network presents a strong value proposition as trends around reshoring, infrastructure, labor shortages, and energy efficiency gain traction. In our Engineered Solutions segment, organic sales declined 6% from the prior year, aligning with both last quarter and our expectations, as ongoing destocking and softer demand among fluid power mobile OEM customers persist. However, sales and orders strengthened later in the quarter, benefiting from seasonal trends in component and system sales in September. Orders in the first quarter indeed increased by mid-single-digits year-over-year, with positive momentum observed in automation and technology-focused fluid power customers, which constitute over 20% of our segment sales. We are encouraged by increasingly positive sales funnel activity and feedback from our channels, particularly in these higher growth areas. Flow control orders also grew year-over-year as we continue to see robust project demand linked to decarbonization and data center investments. While we are cautious, as one quarter alone does not establish a trend, these dynamics are promising for the higher-margin Engineered Solutions segment. We anticipate momentum could build in the latter half of fiscal 2025 as customer capital spending resumes, interest rates potentially decrease further, and we effectively implement our growth investments. We remain committed to investing and equipping our teams to support our customers and suppliers as we enter the next phase of growth. This includes ongoing investments in engineering talent, digital sales tools, and e-commerce capabilities. Additionally, we've expanded our facilities and upgraded tooling and machining capabilities in our Engineered Solutions segment, modernized technology systems in our distribution centers, and improved logistics equipment. Our automation platform and footprint have also significantly expanded compared to prior cycles, positioning us well in high-growth areas as demand for advanced automation technologies increases. Furthermore, we have made investments in fluid power engineering and system capabilities to address rising demand related to modernization efforts across industrial and mobile equipment. We are also starting to utilize AI in our sales processes, accounts receivable, accounts payable automation, and recruitment efforts. Collectively, these investments are designed to enhance our growth capacity, market responsiveness, and operating leverage. Lastly, with nearly $2 billion in balance sheet capacity and over $500 million in cash on hand, we are well-positioned for accelerating growth and improving margins. This includes capabilities for both organic investments and acquisitions that enhance our technical service offerings and reinforce our competitive position. Our recent portfolio evolution through strategic investments and acquisitions has been intentional and plays a critical role in facilitating faster growth and higher margins while improving returns on capital. We remain dedicated to this focused, returns-driven approach, which centers on comprehensively serving our customers' essential industrial assets and processes. Our M&A pipeline is active, primarily targeting bolt-on and midsized opportunities to generate long-term shareholder value. We also have the flexibility to return capital through various means, including share buybacks in light of our strong long-term outlook and the intrinsic value we see in our company, as well as a commitment to growing our dividend. Overall, we aim for greater capital deployment in fiscal 2025 in line with our return objectives and strategic goals. Now, I’ll pass it over to Dave for more details on our financial results and outlook.

David Wells, Chief Financial Officer

Thanks, Neil. Just as a reminder, again and in prior quarters, we have posted a quarterly supplemental investor presentation to our investor site. This is for your additional reference as we recap our most recent quarter performance. Turning now to details of our financial performance in the quarter. Consolidated sales increased 0.3% over the prior year quarter. Acquisitions contributed 200 basis points while the one extra selling day year-over-year in the quarter had a positive 160 basis point impact. This was partially offset by a negative 30 basis point impact from foreign currency translation. Netting these factors, sales decreased 3% 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 for the quarter and in line with our expectations. Turning now to sales performance by segment. As highlighted on Slide 7 and 8 of the presentation, sales in our Service Center segment declined 1.4% year-over-year on an organic daily basis, when excluding a 0.7% positive impact from acquisitions, the positive 1.6% impact from the difference in selling days, and a negative 50 basis point impact from foreign currency translation. The organic sales decline in the quarter was primarily driven by softer MRO spending and the deferral of capital maintenance projects early in the quarter, which was concentrated across local accounts. Sales outside the U.S. were also weaker over the prior year, though partially offset by continued growth across national accounts and fluid power MRO sales in the U.S. From a vertical market standpoint, softer demand was most notable across machinery, pulp and paper, and oil and gas markets, partially offset by ongoing growth within food and beverage, primary metals, utilities, and transportation. Segment EBITDA decreased 2% over the prior year, our segment EBITDA margin of 13.2% declined 36 basis points over the prior year. Within our Engineered Solutions segment, sales increased 0.2% over the prior year quarter, with acquisitions contributing 4.7 points of growth. On an organic daily basis, accounting for the difference in selling days, segment sales decreased 6.1% year-over-year. Consistent with last quarter, the year-over-year decline was primarily driven by a high-single-digit percent decline in fluid power sales, and to a lesser extent, softer automation and flow control sales. As mentioned earlier, fluid power sales continue to be adversely impacted by lower demand across off-highway mobile OEM customers, partially balanced by stable trends across industrial in-plant applications and solutions as well as improving demand in technology-related end markets. In addition, while lower year-over-year for the full quarter, both automation and flow control sales returned to positive organic growth during September. Segment EBITDA decreased approximately 2% over the prior year while segment EBITDA margin of 14.2% was 37 points below prior year levels, largely reflecting expense deleveraging on sales declines and ongoing growth positioning in the quarter. Moving to gross margin performance. As highlighted on Page 9 of the deck, gross margin of 29.6% decreased 10 basis points compared to the prior year level of 29.7%. During the quarter, we recognized LIFO expense of $2 million compared to $4.6 million in the prior year quarter. This net LIFO tailwind had a favorable 24 basis point year-over-year impact on gross margins. Overall, the underlying trend in the quarter was largely in line with our expectation for some near-term gross margin easing into early fiscal 2025. This partially reflects tougher comparisons, including prior year first quarter rebates favorability in our Service Center segment as well as LIFO expense favorability during the fourth quarter of last year. In addition, mix was unfavorable, both year-over-year and sequentially, primarily reflecting outpaced national account growth and lower Engineered Solutions sales. Scrapping freight costs were also slightly higher in the quarter but are expected to normalize going forward. We estimate price cost was relatively neutral to the quarter's performance. As it relates to operating costs, selling, distribution, and administrative expenses increased 3.7% compared to prior year levels. SG&A expense was 19.3% of sales during the quarter, up from 18.7% during the prior year quarter. On an organic constant currency basis, SG&A expense was up 80 basis points over the prior year period. This includes an unfavorable 150 basis point impact from higher deferred compensation costs and one extra payroll day compared to the prior year. As a reminder, fluctuations of deferred compensation costs in SG&A are primarily driven by market values of investments tied to our nonqualified deferred compensation plan, there's a corresponding offset to these fluctuations in other income and expense, which we report below net interest expense and income. In addition, we had some expense deleveraging as expected given the sales decline in the quarter. On an organic basis, adjusting for the M&A impact, currency fluctuations, the extra payroll day and deferred comp accounting impact, SG&A expense was down slightly year-over-year. We remain prudent with cost measures and have continued to fund in-process strategic growth-oriented investments in light of firming demand the past couple of months. Overall, the organic sales decline in the quarter, combined with the aforementioned gross margin and SG&A dynamics resulted in reported EBITDA declining 3.3% year-over-year, while EBITDA margin of 11.7% decreased 44 basis points though EBITDA was partially balanced by greater interest income on higher cash balances as well as a lower tax rate relative to prior year levels and foreign currency gains. Netting of these factors, we reported earnings per share of $2.36, which was down a modest 1% from prior year levels. Moving to our cash flow performance. Cash generated from operating activities during the first quarter was $127.7 million, while free cash flow totaled $122.2 million representing conversion of 133% relative to net income. Compared to the prior year, free cash nearly doubled and hit a record first quarter level. Our cash flow growth primarily reflects more modest working capital investment compared to the prior year as well as ongoing progress with the internal initiatives and our enhanced margin profile. Turning now to our outlook. As indicated in today's press release and detailed on Page 12 of our presentation, we are modestly raising full year fiscal 2025 EPS guidance to reflect updated assumptions for interest and other income following first quarter results. We now project EPS in the range of $9.25 to $10 compared to prior guidance of $9.20 to $9.95. That said, we are maintaining our sales guidance of down 2.5% to up 2.5%, including down 4% to up 1% on an organic daily basis as well as EBITDA margins of 12.1% to 12.3%. Our sales outlook takes into consideration October-to-date sales trends and ongoing near-term economic uncertainty. We're assuming potentially subdued customer activity through the balance of the calendar year, reflecting general malaise around the upcoming U.S. election and into the seasonally slower fall and winter months. Taken together, we currently project fiscal second quarter organic daily sales to decline by a low to mid-single digit percent over the prior year quarter. We assume end market demand stabilizes into the back half of the year with potential for some modest improvement later in the year. Combined with easing comparisons, the midpoint of guidance assumes average organic daily sales are relatively unchanged year-over-year in the second half of our fiscal year, including a return to modest growth in the fourth quarter. Overall, this underlying quarterly sales trend assumption is directionally consistent with our initial outlook provided in August. And while our first quarter sales exceeded our expectations, we believe it remains prudent to maintain our initial assumptions at this early point in our fiscal year. Lastly, we expect second quarter gross margins to increase slightly on a sequential basis, and EBITDA margins of 11.7% to 11.9%. This includes assumptions of potential expense deleveraging on organic sales declines as well as the impact of our growth investments offset by lower LIFO expense compared to the prior year. With that, I'll now turn the call back over to Neil for some final comments.

Neil Schrimsher, President and CEO

Thanks, Dave. So to wrap up and summarize, we feel good about the positive demand signals that we're starting to see develop, including rising order trends across our higher-margin Engineered Solutions segment. We also had many self-help growth and margin opportunities that we expect to manifest in coming quarters. That said, we expect near-term sales to remain choppy as customers slowly reengage production and capital investments ahead of the upcoming U.S. election and seasonally slower fall and winter months. We also remain cognizant of lingering macro cross currents, including geopolitical unrest and some uncertainty around the cadence and extent of interest rate cuts near term. As such, we believe maintaining our fiscal 2025 sales and EBITDA margin outlook remains prudent at this juncture, pending greater clarity on the demand and macro backdrop in coming months. Importantly, we remain constructive on the underlying fundamental outlook within our core end markets and industry focus. We're favorably positioned to drive above-market growth and margin expansion as demand reaccelerates, reflecting our industry position and internal initiatives. From critical break-fix MRO support at a local level to an expanding portfolio of emerging technologies and specialized engineering solutions, we believe our capabilities and strategy are significant to our customers and as customers reconfigure and reinforce supply chains in support of their own growth strategies long term. Demand tailwinds around reshoring and infrastructure investment in the U.S. are just beginning to manifest and could accelerate over the next three to five years. At the same time, U.S. manufacturing infrastructure is aged and as our customers' technical service and support requirements have increased as they manage their own labor constraints. We believe this backdrop could present an extended period of structurally higher break-fix MRO activity as well as ongoing investment into refreshing and expanding industrial production infrastructure and capacity across North America. This will require strong channel partners with leading technical capabilities, next-generation solutions, and strategic supplier relationships. Our strategy and growth initiatives are strongly aligned with these trends and requirements. We believe this creates a compelling growth opportunity into calendar 2025 and longer term, and we're positioning our teams and investments accordingly. And then lastly, we're well positioned to capitalize on the next iteration of the industrial economy given our domain knowledge and scale across industrial facilities core capital equipment. This includes our expertise around critical motion and power, trained products in demanding applications, access to premier supplier brands and nonstandard components, and nationwide local service reliability. In addition, we have a leading channel position in providing advanced robotics, machine vision, and high-tech fluid power systems. Combined with our network of service shops, technicians, and engineers, we're playing a critical role in linking legacy industrial production infrastructure and processes with new advanced applications and technologies, both now and into the future. Overall, I remain excited about our potential, and we look forward to showcasing our capabilities in the quarters and years to come. Once again, we thank you for your continued support. And with that, we'll open up the lines for your questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Your first question comes from the line of David Manthey with Baird. Please go ahead.

David Manthey, Analyst

Thank you. Good morning, guys. My first question is more out of curiosity. When you talk about orders in the ES segment, do you have a rough approximation of what percentage of ES sales are coming via customer capital spending budgets versus expense items? And then related to that, you talked about that orders were better in September and then you talked about, I guess, delivery sales trends in October being a bit softer, but did orders remain strong in the midst of October as well?

Neil Schrimsher, President and CEO

Yes. I'll begin by saying that with our Engineered Solutions, many sales to customers can be capitalized by them. However, these are not major capital investments and they offer a good returns profile. Essentially, these are more like operating expenses that enhance performance and productivity, which customers will capitalize. They are not heavily capital-intensive systems. We were pleased with the order trends discussed in the first quarter, including a positive double-digit growth in technology, which is encouraging, along with progress in automation. Although there may be some fluctuations from month to month, we are optimistic about the ongoing activity, particularly regarding automation and our collaborative efforts with Service Center teams to assist customers in addressing challenges related to labor constraints and exploring automation and technology to boost productivity. While it's still early to predict consistent growth, we remain hopeful.

David Manthey, Analyst

It's great to hear that. Thanks, Neil. Next question is somewhat directed at Dave, as things seem to be quiet on the acquisition front. Your net debt is decreasing, so I'm curious about the pipeline. Are seller expectations too elevated? Are you having trouble finding targets that align with your strategy? Also, when I look at Slide 11 and consider share repurchase in relation to other capital allocation priorities, it seems like if M&A deals remain elusive, share repurchase could move up to the second position on that list. Neil, you mentioned allocating more capital in the coming years, so could you elaborate on these two points as we approach the next calendar year?

David Wells, Chief Financial Officer

Absolutely. In response to your point, Dave, we are committed to maintaining discipline regarding our targets. However, we are encouraged by our pipeline and our current position, especially with both traditional bolt-on acquisitions and some midsized deals. We are very focused on our priorities, which include the continued development of Engineered Solutions, particularly in expanding our automation capabilities both organically and through acquisitions. We're also focused on enhancing our flow control and fluid power segments. I appreciate the positive outlook of our pipeline and our recent activity in share buybacks, though we remain disciplined in that area as well. We anticipate that this trend will continue in the upcoming quarters, especially considering our cash position and leverage. I am optimistic about our prospects moving forward, but I understand that I can't always dictate the timing of pending acquisitions.

Neil Schrimsher, President and CEO

Yeah. And I'd say, Dave, you mentioned Slide 11. We think the $1 billion number of capital returned over the four years is good. Last year at a little over $250 million, and we would expect this year to be higher. And so we know and we'll continue to vet where there are good organic opportunities for us to invest that have a strong return profile in doing it. With that said, we're not so capital intensive to do that. M&A will remain a strong priority. But we're committed. We will not just stack cash. We think in the setup in this environment, we're going to have multiple opportunities to further build out our differentiation, our technical differentiation and what that will mean to customers and really all our stakeholders.

David Wells, Chief Financial Officer

And I do like the fact that we continue to protect some of the SG&A spend that’s very much focused on organic growth with several key projects ongoing there in light of what we see is pending recovery and the importance of that investment as well for organic growth. So we continue to work some of the temporary cost actions in addition to just the natural shock absorbers in the business to protect the bottom line profitability but continue to still fund some of that SG&A spend that’s focused on some very critical organic growth projects.

David Manthey, Analyst

Yeah. That all sounds really good. Thanks a lot, guys.

Operator, Operator

Your next question comes from the line of Christopher Glynn with Oppenheimer. Please go ahead.

Christopher Glynn, Analyst

Good morning. I wanted to discuss some areas of improvement, particularly in automation and technology, as the commentary seems to have changed from recent quarters. Can you provide some insight on how stable you believe these developments are? Additionally, what can you tell us about the technology front? Are you observing an increase in production from device makers and similar customers?

Neil Schrimsher, President and CEO

Yeah. So if I start on technology, it's good to see the increased order rate and activity that was a sales contributor to our Engineered Solutions segment in the quarter kind of relatively flat for the past seven quarters or so, good to see that. I think most indicators are an activity that we would see, increased activity around the chip manufacturers. And then, I think the forecast that many have for '25 on wafer fab equipment being at high percentage numbers, perhaps over 20% for '26, perhaps still being double-digit on top of that, I think we'd start to see some early indications. Obviously, we're involved with customers and have those exchanges into that. So perhaps still early. But I think as we move into and through calendar '25, that's going to be favorable for us on the technology front. And then on the automation side, continue to be high interest and activity on the robotics side, the autonomous mobile robots, AMRs, the collaborative side as customers look to enhance or deal with their own labor challenges, and doing it has been encouraging. So pipeline and activity, the amount of application engineering work that we have going on is good. But also on the vision side, as we think about product and process inspection, what that can mean for quality control and enhancements on that side, we've got good activity on that front. And so like we say, not always even when the projects get implemented. And oftentimes, there's other parts that have to sequence into that but we are encouraged by the general activity. And so directly to your question, I think there's stickiness there.

Christopher Glynn, Analyst

Great. And then just a little more on the capital. That's the other area on the pipeline where it sounds like the commentary has inflected to more bullish. And I don't recall the midsized reference, standard press release, but what has really transpired in that pipeline? Are you seeing looser postures by sellers that you've been tracking for a long time?

Neil Schrimsher, President and CEO

You need time to understand the environment or cycles as companies become available. We know which prospects align with our timing. Our main focus remains on bolt-on acquisitions in the right areas, as well as midsized opportunities. There may not be too much to interpret from the remarks. I believe it's evident in our communication and focus that we're making progress. We see many good opportunities, though operating those businesses comes with challenges due to the cyclical nature. Having scale can certainly help. Customers are looking for more from us, and there are areas where we can provide assistance. With the frequency of our acquisitions, we have established a strong track record in integration and operation, which is appealing to potential sellers.

Christopher Glynn, Analyst

Thanks, Neil.

Operator, Operator

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

Ken Newman, Analyst

Hey. Good morning, guys.

Neil Schrimsher, President and CEO

Good morning, Ken.

Ken Newman, Analyst

Good morning. So first question here on the October trends. Sorry if I missed this, but is there a way to quantify what you think the hurricane impacts are so far into the month? And then just any color on the monthly comps for November and December, and what those look like as we progress through the record? I'm just trying to frame the new 2Q AIT guide relative to the October trends.

Neil Schrimsher, President and CEO

Yeah, I can start. I think on the hurricane, I don't know that I've got a great quantification to it. We can look at associates that are still displaced in a few of the areas. We're up and running and operating. We do look at customers in some of the most impacted areas. And I'd say, they fall in buckets of maybe easily think about it, a third running very well, a third running maybe at some reduced but likely to ramp, and then some others that perhaps will be down for a little bit more extended period. But it is one great tragedy and we're looking to support all of them. I think in its total, from an economic standpoint, it's one, hey, we just work through like other weather events in the side. And then as I just think about the October side rate, it's still early on the month-to-date trends. We do have six to seven days to go, and there can be natural pickup in those final days. There's usually that type of activity. And so we could expect some of that to occur as well in October.

Ryan Cieslak, Director of Investor Relations and Treasury

Ken, I just would say, as it relates to the year-over-year comps by month, I'd say, November is somewhat similar to October in the prior year. And then we do have an easier comparison coming about in December relative to both October and November.

Ken Newman, Analyst

Got it. That's very helpful. And then a follow-up here, I was pleasantly surprised by just how good the quarter ended. I'm curious if you could just talk a little bit about whether you think you're gaining incremental share in this weaker demand environment? I think one of your largest competitors saw some weaker demand in their industrial business this past quarter versus their expectations. And so it does seem like you outperformed here, but I'm just curious if you think you are potentially winning customers from your bigger competitors or if this is more so just a mix dynamic depending on the niches of the end markets that you play in?

Neil Schrimsher, President and CEO

I think we’re getting benefits on our focus areas in that as it executes and we talked about a little bit of the Engineered Solutions. I mean, obviously, the space is large, and there’s a lot of solutions and product sets that go out, and we compete against many in that highly fragmented space, I think what you are seeing and will continue. Customers just look to consolidate spend. They’re going to look to do business with fewer, more capable suppliers into that side. And we’re just intent on being one of those that can do that. But we’ve got a clear focus, we’ve got a clear strategy on our customers and how we can expand our offering within them, and that’s going to continue to be a focus area. And then we think cross-sell, while still early innings, we’ll continue to gain traction, and that’s valuable to the customers and our teams continue to do a good job at it.

Ken Newman, Analyst

Very good. Thanks for the color.

Operator, Operator

Your next question comes from the line of Brett Linzey with Mizuho. Please go ahead.

Brett Linzey, Analyst

All right. Good morning, all.

Neil Schrimsher, President and CEO

Good morning.

Brett Linzey, Analyst

Hey. My first question is just on the automation engineered platform. And thinking in terms of staffing and overhead, is it fair to say that the AIT retained a lot of the personnel and the integrator capacity even when volumes were weak? And as we see this recovery, you should get fairly good utilization and leverage there or are the resources that need to come back as you satisfy some of the return of the order growth here?

Neil Schrimsher, President and CEO

No, Brett, we worked hard to stay at staffing levels we talked about in those periods. We were active, we were busy in the amount of customer engagement, the application engineering on the projects. The pace of those going through, maybe in some of those earlier times, slower times, there's a few more, there's an extra step in the approval process in doing it. But no, we've maintained consciously to have capability to have focus for what we see now and for what we believe for the period ahead, especially around robotics and vision. We think there'll be two highly attractive areas. Especially when we consider our core customer segments, their percentage of automation adoption remains still relatively low. So interest is increasing. The need is there, and we think we can help fulfill a lot of that demand.

Brett Linzey, Analyst

That's great. Thanks for that. And then just a follow-up on the reassuring dynamic. So AIT has doubled the addressable markets over the last several years. You've expanded the solutions. As you think about some of these critical industries that are getting reshored into the U.S., how is AIT's content per project or the wallet share of that commensurately improved or increased in line with the TAM? Should we think about kind of doubling of that as well? Any thoughts there on your content?

Neil Schrimsher, President and CEO

Yes, we are indeed benefitting from the reshoring trend and the overall activity in industrial construction projects. We are directly involved in many of these projects, but we also see indirect benefits for supporting industries like metals, aggregates, and cement, where we have significant participation. We expect this trend to continue as industries seek to reduce risks in their supply chains and increase local availability. The outcome of the election cycle may influence tariff dynamics, but it appears that tariffs will likely persist, potentially at heightened levels. Therefore, we anticipate that reshoring will remain strong. We are actively engaging with our customers to assist them in bringing work back to their facilities. This might involve running their existing equipment more efficiently or qualifying new suppliers to enhance capacity. Overall, our positioning is strong, not only in the U.S. but also in Mexico and Canada, which are also experiencing benefits from these developments.

Brett Linzey, Analyst

Great. Thanks for the insight.

Operator, Operator

Your next question comes from the line of Chris Dankert with Loop Capital Markets. Please go ahead.

Christopher Dankert, Analyst

Hey. Good morning. Thanks for taking the questions. I guess to circle back to the organic investment opportunities you were kind of touching on earlier, I guess, maybe any update on the Pacific Northwest capacity investments? And update on some of the technology proliferation opportunities, anything worth kind of calling out in terms of things that start to kind of ramp into the back half of fiscal '25?

Neil Schrimsher, President and CEO

Yeah. So what I would say, in the Northwest complete operational team fully in, in doing it, same with the fluid power technology investment in new facility running and operating there as well. So well positioned, and we think both capacity moves, timing and investment for what it could be, will be an inflection of greater demand and both of those will serve us very well.

David Wells, Chief Financial Officer

To make investments as well and times to move our automation businesses together with Engineering Solutions, things like that. So they can collaborate and cross-sell even amongst where they have areas of specialties and continue to expand that footprint organically as well. So that's another area of focus, as well as driving some additional efficiencies and back office, some additional technology investment there really across the business, Chris. So it's on many fronts.

Christopher Dankert, Analyst

Got it. Thanks for the color there. And I guess maybe one more conceptual question. It seems like there's a lot of appetite at the customer level for distributors that are able to play a more system integrator type approach in automation specifically. AIT seems to be kind of in a sweet spot there, I guess. Do you think that's a correct assessment? And then, is there any kind of friction between some of the maybe integrated customers you serve and kind of where you play? Just maybe some thoughts on that market, particularly as it pertains to automation and the growth you're seeing there?

Neil Schrimsher, President and CEO

Sure. So Chris, I'd say I don't view that there's friction and often in channels and markets and especially when they're going to be accelerated growth, products and solutions flow to multiple paths and customers often dictate that. And so if they have some internal capability or it's a lighter project in that, they may be more active themselves. If the project is more complex, there's going to be integrators involved in that. And the way we work is that we're happy when our solutions flow in either of those ways in doing it. We are also working and have more productized solutions as we think about in vision, in robotics, both collaborative and palletizing type applications and others that are more turnkey for customers as it goes in. And so that are lighter, they're not high investments, but they yield good benefit and that they can be replicated across. So we'll look at those ways how we participate more in that. But no, hey, we're agnostic. Our focus is how we help customers with their problems with our solutions and integrators are a part of that going to market.

Christopher Dankert, Analyst

Got it. If I could just kind of follow up on that really briefly, the productized solutions are a really compelling opportunity. I guess, in the past, I think palletizing was more mature. And I think there were some new markets you guys were kind of exploring or moving further into, machine operation and CMC operation being one. Just any update in terms of the number of markets you're serving with the productized solutions today?

Neil Schrimsher, President and CEO

Yeah, I don't know if I have a number of end markets. We think about those applications, whether they can be CMC, machine tending, warehousing and logistics, which also exist in all of our customers, right? Because as they move product out of the production environments and doing it in consumer packaging and quality control and inspection, there's more and more of those applications. So in some of those, if we can make it easier, less integration requirements, less upfront engineering requirements in that, it just accelerates adoption. And then for us, we think it opens up even more opportunities around things that may be a little bit more technically challenging to do but still we’ll have very significant benefits for the customer. So we like the productized solutions as an entry point. It’s likely not taking or solving all the customer requirements in their facilities or addressing all the opportunities they can, but it is opening more and more doors for us.

Operator, Operator

Your next question comes from the line of Aaron Reed with Northcoast Research. Please go ahead.

Aaron Reed, Analyst

Hey. Good morning, gentlemen.

Neil Schrimsher, President and CEO

Good morning.

Aaron Reed, Analyst

I was wondering if you could talk a little bit more about any remaining pressure coming from inflation or are there any remaining pockets that you're seeing that could be issues in the near future or is most of that behind you guys?

David Wells, Chief Financial Officer

We still see general steady inflation, which, once again, for distributors is good. We said price cost relatively neutral in the quarter, price at about 100 basis points. So I think what we're seeing is that slow, steady inflationary impact largely coming from labor and other overhead spend from our manufacturers. Once again, we do partner well with our key suppliers to take those price increases and pass them on in orderly fashion. But you can see it in the easing LIFO trends, and it's more normalized and steady state now. So no pockets I look at as areas of concern. And like I said, this good, steady, slight inflationary impact is good for distribution because we know how to take it, package it, pass it on in orderly fashion and drop some incremental to the bottom line during the process.

Aaron Reed, Analyst

Okay, great. The other part is that we are hearing a lot about pent-up demand from people who are waiting for after the election. I'm curious if when you hear this, you think people are genuinely planning to wait until after the election, or if they are using it as an excuse, suggesting there might be other factors influencing their decision. I understand it's tough to quantify this, but could you elaborate on the potential timing? If there is indeed pent-up demand, how soon do you think we would start to see revenue generated from that?

Ryan Cieslak, Director of Investor Relations and Treasury

Yeah. So one, I think the election, I don’t know that it’s a real driver, but clearly, it has top of mind conversations for many of that. I think we have seen general belt tightening and deferral. And if that’s the entry point, there will be more of that release in post-November time frame into December and then going into early 2025 on that front. So we think that has occurred, and so there can be some positives or some pickup for us as we go through then into what would be our Q3 and the start of the new calendar year.

Operator, Operator

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

Sabrina Abrams, Analyst

Hey. Good morning, everyone.

David Wells, Chief Financial Officer

Good morning.

Sabrina Abrams, Analyst

I just want to ask a little bit about destock from both your end and the customer standpoint. So I guess, a, how are you thinking about your own inventories from here? And it sounds like maybe getting a little more constructive on things bottoming. So maybe not destocking from here, but I just want to ask about how do think your own inventories? And then, b, are any of your customers still destocking?

Neil Schrimsher, President and CEO

Yeah. So I can start with our own. And hey, we're working with our core suppliers very closely and where to make the appropriate inventory investments. We want to know what's going on in their business and where they may be at any various projects and production into the side, but we have not been reducing or pulling back on inventories. We want the right preparation. Obviously, we talk to them on high-velocity types that they make regular restock, but we're not looking to overstock in those. Things that are slower moving, harder to make, longer lead times are probably the ones that we're going to look to have the appropriate investments in. And that helps customers stay up and running. And for our suppliers, it makes sure that they continue to fully participate in what is an attractive MRO aftermarket of them. So that's our approach. For the most part, I'd say, around our technical nature of the products, we do not get the benefit of stocking, therefore, the penalty of destocking in any economic cycles. I think the area that we did see some of that, and it still would go on a little bit would be in the off-highway mobile portion of our business in fluid power. And I think that was driven by when lead times extended out to over two years, 16 months on some of the side, those smaller OEMs had to make bets or placements on needs and requirements. And then as that product comes in, and the demand environment softens a little bit, they could have what their needs or requirements from a near-term production standpoint would be. I think that will improve. It will improve as we go through this quarter, perhaps into the early part of '25. If I look at the demand cycles for off-highway mobile, I do think there's a pickup in calendar '25, which will be positive. And I know we're taking this time to also work with them on an engineering front as more technology comes in, whether that be in electronic controls, into automation, perhaps even in start of some autonomy-type projects with them. So we'll work that. But hopefully, that's the right color for inventory stocking, destocking.

Sabrina Abrams, Analyst

Thank you. That's super helpful. And then I just wanted to ask about the EBITDA margins in the quarter. I think they came in a little below what you guys had guided and obviously maintained the full year guide, but I just want to understand what trended differently from your expectations?

Neil Schrimsher, President and CEO

I would say that, as we reflect on our progress, it's generally in line with our expectations, although not always in a straightforward manner from the beginning of the year to the end. The sales development we discussed for the first quarter did happen somewhat later than anticipated, but we remained focused on making the right investments into growth areas that we anticipate will benefit us moving forward. Regarding gross margin, our analysis indicated that there were timing issues with the comparisons at the start, particularly since we were coming off higher LIFO costs, including some layer liquidation in the fourth quarter. We expected some sequential changes as a result. However, when we look at the year-over-year comparisons, there were some favorable factors that emerged in the first quarter of the previous year. Overall, we believe we are in a strong position and are not altering our outlook or plans. I believe we still have significant opportunities to enhance our margins using the strategies available to us.

David Wells, Chief Financial Officer

Yeah. I think if you look back typically in this business, Q1 is our softest gross margin performance quarter. We bucked that trend last year with some anomalies on some vendor rebates and we’re 29.7% even with some higher LIFO expense reading through versus what we saw this year. So a tough comparison there. And I said, we really felt good about the sales development, slightly outpacing our expectations. The gross margins, like I said, do see a path and continue to see those improve as we move across the quarters, and a lot of what you’re seeing on a year-over-year basis is that tough comp that we saw last year.

Sabrina Abrams, Analyst

Thank you so much.

Operator, Operator

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

Neil Schrimsher, President and CEO

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

Operator, Operator

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