Applied Industrial Technologies, Inc. Stock

Welcome to the fiscal 2026 Fourth Quarter Earnings Call for Applied Industrial Technologies. My name is Trevor, and I'll be your moderator for today's call. [Operator Instructions]. Please note that this conference is being recorded. I will now turn the call over to Ryan Cieslak, Vice President of Investor Relations and Treasury. Ryan, you may begin.

Okay. Thanks, Trevor, and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing our fourth quarter results. Both of these documents are available in the Investor Relations section of applied.com. Before we begin, just a reminder, we'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, we will use non-GAAP financial measures during the conference call, which are subject to the qualifications referenced in our SEC filings. Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer; and Dave Wells, our Chief Financial Officer.

With that, I'll turn it over to Neil.

Thanks, Ryan, and good morning, everyone. We appreciate you joining us. I'll begin today with perspective and highlights on our results, including an update on industry conditions and expectations going forward as well as provide an overview of our new intermediate financial targets. Dave will follow with more financial detail on the quarter's performance and provide additional color on our fiscal 2027 guidance. I'll then close with some final thoughts.

So overall, we reported a solid finish to fiscal 2026 with record fourth quarter sales and earnings that exceeded our expectations. The quarter was underscored by organic sales growth of 10%, which was the strongest in more than 3 years and a notable improvement from the 6% growth we reported last quarter. We levered the stronger growth very well, expanding EBITDA margins by more than 60 basis points to over 13%, growing EBITDA by 16% and EPS by 13% compared to the prior year, which is inclusive of ongoing LIFO expense headwinds.

In total, these are strong results to end the year that was both defining and pivotal on many fronts, including showing strong evidence of our operating durability as well as early signs of the significant growth potential taking shape across our business. I want to thank our Applied team for their ongoing execution. The focus drove another year of exceeding our commitments and creating meaningful value for our customers, suppliers and all stakeholders, further validating the power of our collective efforts and differentiated industry position.

So several key points to highlight in more detail. First, underlying demand improved across both segments during the quarter. Trends strengthened through the end of the quarter with organic sales increasing over 10% year-over-year in June despite more difficult comparisons. The stronger sales growth was volume-driven, reflecting greater technical MRO and capital spending activity. combined with ongoing benefits from our internal sales initiatives and industry position.

The strengthening underlying demand was apparent in year-over-year trends across our top 30 end markets, where 20 generated positive sales growth compared to 17% last quarter and 15% in the prior year quarter. Growth was strongest across metals, technology, utilities and energy, machinery, rubber and plastics and pulp and paper. This was partially offset by declines primarily in chemicals, lumber and wood and transportation. Sales growth during the quarter was led by our Engineered Solutions segment, which delivered 13% organic sales growth year-over-year, up from 9% last quarter.

During the quarter, we saw stronger demand across legacy and emerging customer verticals as well as solid backlog conversion. Segment order trends also remained positive during the quarter, increasing by a double-digit percent year-over-year for the third straight quarter. Sales growth in the quarter was strongest in automation, where organic sales increased over 20% year-over-year. This was strongest organic growth in over 4 years, underscoring the solid demand developing for our automation solutions as the adoption of robotics machine vision and digital technologies ramps higher with more productive capital spending environment.

Growth also strengthened across our industrial and mobile fluid power operations, where sales increased by a high single-digit percent over the prior year. Demand is improving across many of our legacy fluid power markets, including construction, metals and machinery. In addition, our engineering project funnel is expanding as OEM customers increasingly focus on upgrading fluid power systems and integrate new advanced features into their mobile equipment.

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

As a reminder, our technology vertical represents over 15% of our Engineered Solutions segment today with related participation across all 3 areas of the segment, including automation, fluid power and flow control. Our Service Center segment also had a solid quarter. Organic sales growth of 8% accelerated from 4% last quarter with average daily sales up approximately 5% sequentially and ahead of normal seasonality for the second straight quarter. Greater brake fix and technical MRO activity continued to broaden throughout the quarter.

Of note, 27 of our top 30 industry verticals were up year-over-year in our U.S. service center network during the fourth quarter with notable strength across metals, pulp and paper, rubber and plastics and utilities and energy. Growth was strongest across national strategic accounts where sales continue to benefit from our internal initiatives and 1 Applied value proposition.

We also saw demand strengthen across small and midsized local accounts where sales increased by a high single-digit percent year-over-year during the quarter, providing further evidence of the recovery taking shape across the industrial sector. It's also worth noting the Service Centers segment's performance throughout fiscal 2026. Despite more mixed end market demand to start the year, segment sales grew organically year-over-year every quarter in fiscal 2026. Total sales finished up nearly 6% while EBITDA grew 8%, inclusive of greater LIFO expense.

Looking at the segment's performance over the past 5 years, organic sales growth has averaged 8% while EBITDA growth has averaged 13%. Overall, this is a notable performance that highlights a stronger and more doable growth profile that exists across our Service Center segment today, reflecting benefits from internal initiatives as well as secular and structural tailwinds positively impacting our core market position.

So overall, a solid quarter, highlighting continued positive top line momentum building across Applied. At the same time, our team remains focused on driving stronger returns as this more favorable growth backdrop continues to develop. We saw solid evidence of this during the quarter where we levered 10% sales growth into 16% EBITDA growth, representing incremental margins of over 19% or more than 22% when excluding LIFO expense. We also had a strong quarter of free cash generation, which increased 16% over the prior year.

Free cash totaled $461 million in fiscal 2026, which was down modestly over the prior year despite greater working capital requirements to support growth in the back half of the year. Ongoing initiatives and system investments continue to optimize our working capital KPIs, including areas of accounts receivable and inventory management with net working capital as a percent of sales ending fiscal 2026 at a 6-year low.

Moving forward, we remain well positioned to drive stronger earnings growth and solid cash generation with ongoing support from our internal initiatives and mix tailwinds. From a capital deployment standpoint, we had another year -- another productive year in fiscal 2026, deploying approximately $425 million on share buybacks, dividends, CapEx and M&A. Over the past 2 years, related capital deployment totaled just under $1 billion. In fiscal 2026, we were more active with share buybacks, repurchasing a total of 1.2 million shares for $37 million.

We also increased our quarterly dividend by 11% and continued to invest in our technology platforms, distribution centers and growth capacity during the year. We expect to remain active with capital deployment in fiscal 2027 with nearly $2 billion of balance sheet capacity. As always, we will remain disciplined with a focus on deploying capital that enhances our scale, growth profile and competitive position going forward. M&A remains a top priority, and we continue to actively evaluate various targets across both our segments.

Lastly, I'd like to take a moment to provide some initial thoughts on our fiscal 2027 outlook as well as our intermediate financial objectives, which we increased this morning. Dave will provide greater detail on our guidance assumptions. But overall, we enter fiscal 2027 with solid growth potential and operational momentum developing across both our segments. Positive sales momentum has continued into the first quarter with organic sales to date of approximately 7% compared to prior year levels. End market demand in aggregate, appears to be on solid footing with limited pockets of weakness or signs of slowing near term.

Broader macro indicators, including ISM, industrial production and durable goods orders continue to trend favorably. In addition, following a more muted growth backdrop in fiscal 2026, we expect potentially greater contribution from higher-margin flow control sales in fiscal 2027 as MRO and project activity across process end markets improve following a greater level of deferred spending this past year, particularly in chemicals and refining verticals. We remain mindful of the evolving geopolitical backdrop and trade policy uncertainty, both of which could impact the cadence and trajectory of end market growth, depending on how things develop.

We will also face more difficult comparisons, most notably in the second half of the year following our recent strong performance. These considerations are contemplated in our initial fiscal 2027 guidance. Beyond critical and core end market dynamics, we expect ongoing positive contribution from our internal sales initiatives, including greater cross-selling momentum and benefits from sales productivity investments. We also expect structural and secular tailwinds to remain positive and potentially more impactful factors to our demand moving forward.

Of note, our ongoing evolution has positioned Applied at the intersection of exciting and powerful growth trends tied to rising technical support at customer plants, industrial system upgrades, automation adoption, including physical AI integration, and the build-out of critical infrastructure across both legacy and emerging customer verticals. Our related exposure to these trends is high, given our industry position supporting U.S. manufacturing and deep technical knowledge of our customers' facilities as well as greater scale we have today in areas of advanced automation and fluid power.

Further, our balance sheet and cash generation provide meaningful capacity to further compound our growth through ongoing M&A. As I mentioned earlier, our pipeline remains active, and we believe M&A contribution could be more meaningful to our sales growth through fiscal 2027 and beyond as we further execute our strategy. The M&A backdrop is increasingly productive as targets face heightened competition, required operational investments and extended ownership life cycles.

Our acquisition track record, including more than 18 transactions since 2018, combined with our leading technical solutions platform makes us a compelling home for the companies we are currently evaluating. So we see many catalysts and tailwinds supporting our ongoing growth across Applied as we enter the next phase of our evolution. At the same time, we have great potential to further expand our EBITDA margin profile moving forward. Our business model provides inherent operating leverage, and we continue to target mid to high-teen incremental EBITDA margins at mid-single-digit organic sales growth.

The ongoing expansion of our Engineered Solutions segment and local account growth across our service centers provide durable and structural mix tailwinds that should intensify in a more favorable demand environment. We also see opportunities to further optimize our productivity and operating leverage through ongoing technology investments, expanding our shared services model and leveraging AI. While ongoing synergy progress across recent acquisitions, including Hydradyne provide further margin support.

The opportunity ahead is exciting and one that has been built through compounding years of executing our strategy, committing to continuous improvement, leveraging our differentiated industry position and adhering to a disciplined approach to capital investment. From various organic investments and positioning made across our core service center segment to strategic moves into flow control and automation, our strategy has driven intentional transformation across our business to serve customers more completely, expand our market potential and strengthen our overall value proposition.

Our historical performance provides strong evidence of the power of our strategy and potential. In the past 5 years, we've grown sales by 9%, EBITDA by 14%, EPS by 18% and free cash flow by 15% on a compounded annual basis. Over the same period, gross margins have expanded 120 basis points and EBITDA margins have expanded by over 260 basis points, while our return on capital metrics have improved notably. Considering these dynamics, we believe now is the opportune time to update our intermediate financial targets, including increasing our sales objective to $7 billion from $5.5 billion prior and increasing our EBITDA margin objective to 14% from 13% prior.

We believe these objectives are well within the company's capability and can be achieved over the next 5 years depending on broader macro conditions, the cadence and scope of M&A and other factors. Overall, our team is now engaged and ready to execute on these next milestones, which we believe provides the framework for significant value creation for all stakeholders moving forward.

At this time, I'll turn it over to Dave for additional detail on our results and outlook.

Thanks, Neil, and good morning to everyone joining today. Just another reminder before I begin. As in prior quarters, we have posted a supplemental investor presentation to our investor site for your additional reference. We hope that you will find this to be a useful resource as we recap our most recent quarter performance and initial fiscal 2027 guidance.

Turning now to our financial performance in the quarter. Consolidated sales increased 10.4% over the prior year quarter. Acquisitions and foreign currency were a modest tailwind in the period, adding 30 and 40 basis points, respectively, of growth. The number of selling days in the quarter was consistent year-over-year. Netting these factors, sales increased 9.7% on an organic basis. As it relates to pricing, we estimate the contribution of product pricing to year-over-year sales growth was approximately 250 basis points in the quarter, which was above our guidance of 200 basis points.

Netting this impact, we estimate volumes grew approximately 7% over the prior year, a nice acceleration from the March quarter volume growth of 3.5%. Moving to consolidated gross margin performance. As highlighted on Page 8 of the deck, gross margins of 30.4% was down 20 basis points compared to the prior year level. During the quarter, we recognized LIFO expense of $6.4 million compared to $2.9 million in the prior year quarter and $5.6 million last quarter.

On a net basis, this resulted in an unfavorable 26 basis point year-over-year impact on gross margins. Excluding LIFO expense, gross margins were up modestly year-over-year, reflecting ongoing progress with our internal margin initiatives as well as price and channel execution. As it relates to our operating costs, selling, distribution and administrative expenses increased 5.1% compared to prior year levels. On an organic constant currency basis, SG&A expense was up 4.3% year-over-year. As a percentage of sales, SG&A expense improved 94 basis points year-over-year to 18.6%, highlighting strong operating leverage in the quarter and a solid improvement from trends last quarter.

Our teams continue to remain disciplined on spend, while also focusing on various efficiency initiatives tied to technology investments, shared services and sales productivity tools. This helped offset continuing inflationary headwinds, higher incentives and ongoing growth investment in the business during the quarter. Overall, stronger organic sales growth, combined with steady gross margin performance and solid cost leverage resulted in reported EBITDA increasing 16.1% over the prior year. This is inclusive of greater LIFO expense year-over-year, which negatively impacted EBITDA growth by 2.3 percentage points compared to the prior year quarter.

Reported EBITDA margin of 13.1% was up 64 basis points from the prior year level with year-over-year LIFO headwinds negatively impacting EBITDA margin by 26 basis points. EBITDA margins exceeded our fourth quarter guidance range of 12.6% to 12.8%, primarily reflecting more favorable cost leverage on stronger sales growth in the quarter. Reported earnings per share of $3.17 increased 13.2% from prior year EPS of $2.80. On a year-over-year basis, EPS was impacted by a higher tax rate and net interest expense, partially offset by a lower diluted share count.

Turning now to our performance by business segment. As highlighted on Slides 9 and 10 of the presentation, sales in our Service Center segment increased 7.9% year-over-year on an organic basis. This excludes 50 basis points of contribution from acquisitions and a positive 60 basis point impact from foreign currency translation. Improved organic sales growth was primarily driven by stronger volume growth across our U.S. Service Center operations, reflecting more favorable end market demand and benefits from our internal sales initiatives and, to a lesser extent, improved volume growth across our international operations.

Segment EBITDA increased 16.3% over the prior year while segment EBITDA margin of 14.5% expanded 91 basis points. This year improvement primarily reflects favorable operating leverage on stronger sales growth combined with solid channel execution and cost control, which more than offset ongoing inflationary headwinds, including greater LIFO expense compared to the prior year level.

Within our Engineered Solutions segment, sales increased 12.9% over the prior year quarter on an organic basis. The year-over-year increase was primarily driven by double-digit growth across our automation and fluid power operations, reflecting solid backlog conversion, improving end market demand and positive technology vertical contribution. This was partially offset by muted sales growth across our flow control operations, primarily reflecting a more difficult prior year comparison, coupled with softer MRO activity across various process end markets during the quarter.

Segment EBITDA increased 15.8% over the prior year or approximately 19% when excluding LIFO expense. In addition, segment EBITDA margin of 15.1% expanded 38 basis points from prior year levels, inclusive of a 44 basis point year-over-year LIFO headwind. The strong EBITDA growth and EBITDA margin performance in the quarter primarily reflects solid underlying incremental margins on more robust sales growth, combined with ongoing cost accountability, partially offset by muted flow control sales growth in the quarter.

Moving to our cash flow performance. Cash generated from operating activities during the fourth quarter was $165 million, while free cash flow totaled $159.7 million representing conversion of approximately 135% relative to net income. Compared to the prior year fourth quarter, free cash was up nearly 16%, reflecting stronger earnings and ongoing benefits from our working capital initiatives. From a balance sheet perspective, we ended June with approximately $127 million of cash on hand and net leverage at 0.2x EBITDA.

Our current revolving credit agreement has approximately $826 million of available capacity and an additional $800 million accordion option, combined with incremental capacity under our AR securitization facility, we have significant financial capacity to support our capital deployment initiatives moving forward, including accretive M&A, dividend growth and share buyback. During the fourth quarter, we repurchased over 265,000 shares for $81 million.

Turning now to our outlook, which is detailed on Page 13 of the presentation, we are establishing full year fiscal 2027 guidance, including EPS in the range of $11.65 to $12.15 based on sales growth of 4% to 6.5% and EBITDA margins of 12.5% to 12.8%. Our outlook takes into consideration ongoing economic uncertainty tied to current geopolitical and trade policy dynamics as well as lingering inflationary pressures. At the midpoint of guidance, we assume stronger organic sales growth in the first half of the year based on current underlying market conditions followed by more modest growth rates in the back half of the year, reflecting more difficult comparisons as well as more muted market growth assumptions, pending greater clarity on how macro and trade policy dynamics developed later in the year.

While we are positive on current demand conditions and our market position entering fiscal 2027, we believe a prudent approach to our market growth rate assumptions remains warranted at this time considering the inherent risk and dynamic nature of current geopolitical and trade policy dynamics, which in totality represent a still somewhat unprecedented operating backdrop. Guidance also assumes 150 to 200 basis points of year-over-year sales contribution from pricing. Guidance does not assume contribution from future acquisitions or share buybacks.

In addition, based on quarter-to-date sales trends through mid-August and our near-term outlook, we currently project fiscal first quarter organic sales to increase by 6% to 8% versus the prior year quarter. Our guidance also assumes fiscal first quarter EBITDA margins within the range of 12.3% to 12.4%. From a margin and cost perspective, guidance assumes ongoing inflationary pressures and growth investments as well as higher LIFO expense in fiscal 2027 versus 2026. That said, we expect the year-over-year increase in LIFO expense to be more modest in fiscal 2027 following the notable increase we saw in fiscal 2026 combined with more balanced supplier price increases relative to last year.

In addition, the midpoint of our full year guidance assumes incremental EBITDA margins that are within our targeted range of mid- to high teens. Lastly, we expect free cash generation to remain strong in fiscal 2027, but to potentially trend lower year-over-year, reflecting greater working capital investment to support our growth opportunities. In addition, we expect ongoing organic investments supporting our strategy and technology investments with capital expenditures targeted in the $35 to $40 million range for fiscal 2027.

With that, I will now turn the call back over to Neil for some final comments.

So as we begin fiscal 2027, we are encouraged by the ongoing positive sales momentum. The recovery taking shape across the industrial sector appears doable near term, with customers operating at higher production levels and increasing capital spending in support of a growing manufacturing backdrop across North America, including clear secular tailwinds, gaining traction. Our initial guidance for fiscal 2027 incorporates a steady and favorable growth backdrop in the first half of the year and a more prudent assumptions in the back half as we take into consideration the short-cycle nature of our business, more difficult comparisons and limited visibility in how current trade policy and geopolitical dynamics might develop as the year progresses.

That said, current market conditions and sustained order momentum leave us positively biased, and we continue to have many self-help opportunities to positively influence our performance above and beyond underlying market growth. In addition, as highlighted by the increase to our intermediate financial objectives, we enter fiscal 2027 with the strongest market position in Applied's history and with strategic initiatives that present a path to deliver meaningful earnings growth over the next 5 years.

Overall, our track record highlights the power of our strategy and value creation potential, and we're extremely motivated and engaged based on what we believe lies ahead. With that, we'll open up the lines for your questions.

[Operator Instructions]

Our first question comes from the line of Christopher Glynn with Oppenheimer.

Just kind of curiosity question first. The CapEx is almost 50% higher than the average in the past several years. Just curious if anything particularly causing that or just keeping up with growth?

Yes. We're coming off a year. It's not a capital-intensive business, as you know, Chris, but see some opportunities that are in flight, both in terms of some organic investment to further our footprint across some of the automation business, for example, some technology, further technology investments. No big heavy single hitters there, but just some organic investment, continue to focus on both efficiencies and organic growth opportunities in the business. So stepping up as part of our capital deployment, that CapEx a bit to see some of those opportunities that we see in front of us.

Great. Makes sense. And -- so it's nice to see the environment more enabling to show up the virility of the business model. And in that vein, you talked about some initiatives taking hold. Curious, in automation, are those key applications? I know they have plenty of runway, but anything really standing out among the vision digitization, robotics? Are there any new categories you want to feature there that might roll into the full near term? And also in the initiatives bucket, you talked about increasing cross-selling momentum. So maybe go into that of debt?

Sure. I can start, Chris. So I think, first, across automation, they are active and continue to participate in technology. So if you think about semi wafer fab equipment and data center, that's good. But also food and beverage, we're doing more with productized solutions that can help in robotics and autonomous mobile robots through facilities as well as vision systems in and around consumer packaging and goods. And we're also helping with some solutions around strategic inventory management where vigilant systems can play into there.

So we think this setup and the industry outlooks around robotics and collaborative robots is strong for years ahead. I think we're finding really good applications and developing those on the vision side. We'll continue to look at what else is important in rounding out. I mean we've got good digital solutions, user interface. We're helping customers as they think about AI, putting things in place in their facilities that help that with robotics and vision and get returns for them in that front. So we think we have a good mix. We'll continue to evaluate on that front.

And then, hey, just broader initiatives, I think, across the group on cross-selling. I'm still encouraged with the team's engagement on that. Good pipeline of opportunities. We're seeing increased number of customers looking to us as we know their operating facilities so well that we can help them with advancements in fluid power systems, robotics and vision, and we're even seeing more opportunity around services and repair and pumps and valves with our flow control business.

Great. And if I could sneak in a final one. I understand the mid to high teens incremental margin, long-term framework. You did put up a 22% underlying in the quarter. You had maybe 3 years of kind of flattish end market environments. You're clearly out of that right now. But is there an opportunity where that could stay in the 20% range like you had underlying in the fourth quarter?

Well, you've seen that potential, obviously, as you know, the guidance does assume some slightly higher LIFO expense on a year-over-year basis. We finished '26 at $21.5 million guidance assumes $24 million to $28 million. So I said the biggest wildcard, to your point, Chris, would be LIFO expense and what that does in terms of the P&L. If you strip that away, nice performance, we've shown the ability to other things being equal, deliver 20-plus percent EBITDA incrementals. But that potential is there. I think that's the biggest wildcard in my mind because the team has done a nice job, as you saw in the most recent quarter, continuing to grow that underlying gross margin profile and control SG&A.

Our next question comes from the line of David Manthey with Baird.

Our next question comes from the line of Ken Newman with KeyBanc Capital Markets.

Nice quarter. Maybe for my first question here, it was nice to see a pretty solid order growth of, I think, you said 20% year-over-year in your automation business this quarter. Neil, curious if you expect any kind of impact from this recent FCC ban on foreign robotics imports. I'm assuming it's pretty low, but maybe can you remind us how much of the automation business is exposed to products impacted by the ban and curious if that provides either a catalyst for pricing or share gains just relative to the new automation project integration.

Yes. I'd say to date, the assessment is, it is pretty low into that front. Business, to your point, continues to operate very well. Incoming orders are strong, our work on applications in those targeted verticals as well as some cross-selling opportunity remains good. So at this point, I think it's smaller.

Okay. That's helpful. Also was a year towards your comment, Neil, on M&A potentially driving some stronger contributions to revenue growth this year. I know it's not included in your guidance. But maybe any color just on what you're seeing in the change in activity and in the M&A pipeline? I'm curious if there's a way to kind of frame up what some of these targets could look like from a revenue or a margin perspective, if that's something you can talk to.

Yes, it'd be harder to put it to specific revenues in that. We continue to be active. And if you think about things like Hydradyne and midsized potential in naturally across both segments of the business, there can be some smaller bolt-ons. And then there are perhaps a few larger properties that I think will either evaluate or look at coming to market over a period. Do those impact into '27 or not? Really to be determined. But I think it is a good a good environment from an M&A standpoint.

We continue to operate with clear priorities and evaluate things that can be additive to our Engineered Solutions across fluid power, flow control and automation as well as augment our Service Center presence and performance into that. So a good activity in front. We're a believer in helping ourselves as we go through that. So we know what priorities matter. We know good prospects, good targets. And so those dialogues and exchanges continue.

Our next question comes from the line of Andrew Obin with Bank of America.

Can you hear me?

Yes. Yes.

Yes. Just maybe a question. Can you just talk about the daily activity, average daily sales throughout the quarter? And what are you seeing in August?

Kind of trending across the quarter in terms of organic growth. We had April at 10%, May pull back just a bit to 8%, June finished up 10% again organically. So a 2-year stack at a very nice level as we closed out the quarter. Quarter-to-date, we have seen -- we talked about 6% to 8% expectation in terms of organic sales growth. Quarter-to-date, we're trending at about 7%, so right in line with expectations, Andrew.

Yes, I was just going to add, we think about July, we saw good continued positive order momentum in July. So that's encouraging. The Engineered Solutions segment really up mid-20s into that. So automation continuing saw some good order input on process flow control, FCX. So that's encouraging, right? We talked about a little bit in the remarks, expecting more to come from customers inside and fluid power continuing at a good rate into the 20s as well. So backlog up year-over-year sequentially improved when it's usually flat from a seasonality standpoint and book-to-bill encouraging as well. So good intake from a July standpoint.

And just maybe a follow-up on the same thing. As things continue to improve, how are you thinking about restocking maybe in fluid power maybe valves and controls? Like how do you think about -- given the demand is coming out or of process automation, fluid power, how do you think about potentially restocking into this growing demand?

Yes. So I think overall, we do a very good job. Obviously, we're connected with the suppliers in that given our mobile OEM presence into that and connect to it and also some industrial and service and repair and then on the technology space. I think predominantly, we're in line, and we say often, we do not have great stocking nor destocking in that as we relate to customers, probably the differing point being on some of these mobile OEM side of it. So I think that strong kind of high single-digit growth, the continued positive look at orders on that can potentially turn into greater demand for us greater stocking levels than for our key suppliers as well.

Our next question comes from the line of Chris Dankert with D.A. Davidson.

I guess to kind of pull the thread on the ES order growth, I mean, up 20% or mid-20 is pretty impressive. Normally, that stuff book and turn fairly quickly. So maybe can you kind of help put that order growth in the context of the guide? I mean, what are we expecting for ES growth in the first quarter? I assume still double digits, but maybe just kind of put ES growth in context for the first quarter and the full year.

Yes, I can start on the order side, Chris, I don't know that all of those turn so quickly, right? They can be related to projects even in inflow control that can have a sequence in that. If we think about the guide in the quarter, I would expect Engineered Solutions to perhaps be higher. And then the Service Centers perhaps moderate a little bit as we work through. Obviously, it will play out into the quarter. But I think that informs the guide that we have for the first quarter in that. But those Engineered Solutions orders, some of those fit into other customer requirements or timing, which dictates that. And so are they a quarter out? Or are they 2 quarters out or perhaps a little longer, right, we will see.

Got it. That's incredibly helpful. And I guess more of a high-level question. I mean you guys have been kind of working some of these internal cost optimization workflows for over a decade now, lot of opportunity. I guess, where are you focused today? And kind of how long is that runway? Is it evergreen? Just kind of update us on what we're actually executing on in terms of cost optimization internally?

Yes. I think there's an evergreen opportunity around continuous improvement. And we've got a good history of cost accountability. So as we look and think about use of technology in our business, I think that helps us in back-office efficiencies, and we're going to have more resources forward-facing and engaging with customers. I think the shared services opportunity is still in front of us with opportunities, especially across our Engineered Solutions businesses in that, which can be just plus other good ongoing continuous improvement on the site.

I'm encouraged by some of the things that we're looking at that can take out slowing cues with the use of technology and AI as we think about data, as we think about customer portals, and I think in time, some of those even further can support growth efficiencies as well. So we continue to have a good history and a good pipeline of projects about how to continue to be cost effective because I think as we scale and grow, there's an opportunity for us to do that with similar resources and perhaps more forward-facing and engaging with customers in those market opportunities.

That really makes sense in the context of the medium-term update. So best of luck into the new year, guys.

Our next question comes from the line of David Manthey with Baird.

So the -- I don't want to split atoms here, but when I look at the declining segments, refining came out, it doesn't mean it's not still flat or negative. But -- and chemicals remains the first industry that's named there. I'm wondering if you could talk about trends you're seeing in process industries and maybe the day-to-day maintenance business and the outlook for turnarounds over the next several months?

Yes. So if I think about chemicals, and you're right. We think about it in process flow control, down low single digit into that stable to the last quarter. We touched on July orders. I think about turnarounds and service work, especially in chemicals and refining have the potential to improve and contribute as we go through the fiscal year, including in the first half, but it has been a bit of a headwind in those sides, but we think that service and that repair, those turnarounds are work that's going to have to be done as some of that was deferred out from a year ago.

Yes, Dave, I just would add, I think encouraging both sales growth as well as order growth that we saw out of our flow control business in the month of July, which again is sort of a good indication that some of those process end markets starting to recover here into early fiscal '27 following would have been a little bit of a softer backdrop that we saw throughout '26.

Yes, that's good to hear. And then, Dave, on the guidance, $12 million to $13 million for interest expense seems a little high based on sort of where we are. I just wonder if you could walk through the rationale behind that level of guidance.

A couple of things that play into that, Dave. There's -- the interest rate swap we had place has rolled off, which gives us more flexibility in deploying capital to pay down further debt if we so desire. Part of it is the function of some of the assumptions around increased rates yet and lower cash balances, where we are kind of offsetting and earning interest income and that gives that interest expense as we continue to deploy capital for both M&A, share buyback and other capital allocation priorities. So really, all 3 of those factors play into that that scenario that drive up the interest expense on a year-over-year basis. That hedge rolled off really around Q3 of last year. So you're seeing away half year where we had some of that benefit of the interest rate swap hedge in the '26 results.

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

I just want to thank everyone for taking the time to join us today, and we look forward to talking with you throughout the quarter. Thank you.

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

Welcome to the fiscal 2026 Third Quarter Earnings Call for Applied Industrial Technologies. My name is Alexandra, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ryan Cieslak, Director of Investor Relations and Treasury. Ryan, you may now begin.

Okay. Thanks, Alexandra, 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 and including those detailed in our SEC filings. Actual results may differ materially from those expressed in the forward-looking statements. The company undertakes no obligation to update publicly or revise any forward-looking statement. In addition, the conference call will use non-GAAP financial measures, which are subject to the qualifications referenced in those documents. Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer; and Dave Wells, our Chief Financial Officer.

With that, I'll turn it over to Neil.

Thanks, Ryan, and good morning, everyone. We appreciate you joining us. I'll begin today with perspective and highlights on our 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 updated outlook. I'll then close with some final thoughts. So overall, we reported a solid third quarter underpinned by stronger organic sales growth across the business. .

Specifically, sales increased 6% organically over the prior year, which was the strongest growth in over 2 years. This was up notably from 2% last quarter. and at the high end of our third quarter guidance. In addition, orders, backlog and business funnel activity continue to build positive momentum. We also delivered another quarter of steady underlying margin performance with gross margins holding firm year-over-year, inclusive of ongoing LIFO headwinds. These positive dynamics drove record quarterly EBITDA that was at the high end of our expectations as well as 6% above the prior year or 8% when excluding the impact of LIFO.

At the same time, we continue to invest internally to support our growth potential and strategy. So taken together, a very productive quarter with many encouraging signals for the business moving forward. I want to thank our Applied team for another solid quarter of execution. So a few key points to emphasize. First, stronger sales growth in the quarter was broad-based with several encouraging underlying trends. Of note, average organic daily sales increased $0.05 sequentially, which was above normal seasonal patterns. Trends strengthened as the quarter progressed with organic sales in March, up 10% over the prior year period.

The stronger growth was volume driven with customer spending behavior increasingly positive and showing signs of broadening. More positive underlying demand was apparent in year-over-year trends across our top 30 end markets where 17 generated positive sales growth compared to 15 last quarter. In addition, 2-year stack trends across our top 30 markets improved notably on a sequential basis. Growth was strongest across metals, technology, machinery, aggregates, utilities and energy, mining and construction. This was offset by declines primarily in chemicals, lumber and wood, transportation, rubber and plastics and refining.

Stronger sales activity was evident across both segments in the quarter with particular strength in our Engineered Solutions segment, which delivered over 9% organic growth year-over-year. Growth was strongest across automation and fluid power, both increasing by a double-digit percent year-over-year in the quarter. Organic sales growth across our flow control operations also improved and was a contributor. In addition, segment orders were up by a double-digit percent over the prior year for the second straight quarter with backlog and book-to-bill, both increasing sequentially during the quarter. Overall, this performance is an encouraging sign for our engineered solutions segments expanding and differentiated growth potential as several favorable dynamics are converging.

Of note, sales cycles for our advanced automation solutions are turning faster, as customers put money to work in brownfield applications to drive production agility within existing capacity and address labor constraints. Our engineering depth tailored solutions and comprehensive application and support are helping customers navigate automation deployments in both high-tech industries as well as across our legacy industrial verticals. In addition, project activity and investment in process infrastructure across the U.S. is gradually increasing.

We're also seeing recovery continuing to take shape in our legacy industrial and mobile OEM fluid power in markets, following a prolonged multiyear downturn. Alongside structural and secular growth in newer verticals where our exposure has increased in recent years following the ongoing expansion of the segment. On this last point, we're seeing solid demand build across our technology vertical, which today represents over 15% of the Engineered Solutions segment and contributed over 300 basis points to the segment's organic sales growth rate in the quarter. Our exposure to the technology vertical includes an established an ongoing position across the semiconductor space as well as emerging growth opportunities developing within the data center market.

On Slide 8 of our earnings presentation, we've added an overview of our position and the solutions we provide within these verticals, which spans across all 3 areas of the segment, including fluid power, automation and flow control. In semiconductor, we provide various fluid conveyance, pneumatic, robotic and mechatronic solutions that are primarily tied to wafer fab equipment manufacturing as well as flow control solutions used in material processing. In data center, our deep expertise of fluid management and handling combined with established supplier relationships, are presenting growing opportunities supporting various thermal management applications through engineered assemblies. In addition, our automation team provides robotic and machine vision solutions that automate and trace material handling within a data center facility. Our data center service capabilities and coverage were also enhanced through our Hydradine acquisition, where they are providing various fluid conveyance solutions and assemblies specified in liquid cooling systems.

So overall, a very diverse and embedded position within these key growth verticals that highlights our ongoing evolution and technical capabilities as we continue to expand our Engineered Solutions segment. I'm also encouraged by the growth potential developing across our core service center segment. organic sales growth of 4% in the third quarter strengthened from last quarter, with average daily sales up approximately 5% sequentially on an organic basis and ahead of normal seasonality. We Trends were strongest during March, where organic sales increased over 6% compared to the prior year, including nearly 8% within the U.S.

Customer spending behavior continues to strengthen as greater capacity utilization drives more brake fix activity and required maintenance on critical and age production equipment. This drove stronger growth across strategic national accounts as well as our local accounts during the quarter. In addition, 13 of our top 15 industry verticals were up year-over-year in our U.S. service center network during the third quarter. This compares to 10 last quarter and 6 in the prior year quarter. Benefits from our sales initiative and 1 applied value proposition are reading through as we support our customers' heightened technical MRO requirements within an increasingly positive U.S. industrial backdrop.

This includes our deep knowledge and supplier relationships tied to critical motion control equipment and infrastructure, supported by our local service capabilities. I would also note, over the past several years, our service center team has been executing on a comprehensive strategic plan, focusing on deepening our customer relationships, modernizing our sales processes and tools and enhancing our speed to market through investments in talent, systems and analytics. In addition, our service center team's value proposition has strengthened through the expansion of our Engineered Solutions segment, giving them access to engineering, design, assembly, repair and integration support to address our customers' legacy industrial system needs as well as emerging required investments in automation.

This is driving new business wins as well as greater cross-selling activity. We estimate cross-selling contributed over 100 basis points to the segment's organic growth in the quarter, which is up from the first half fiscal 2026 levels and an encouraging sign. Overall, these initiatives remain ongoing and provide solid company-specific growth drivers for our Service Center segment moving forward. as end-market demand cycles higher and as customers look to leverage the many secular and structural tailwinds developing across the North American manufacturing sector. So overall, a solid quarter highlighting building top line momentum across Applied and our differentiated industry position.

Positive sales trends have continued in the early part of our fourth quarter with organic sales trending up by a high single-digit percent year-over-year month-to-date in April. We're also well positioned to drive further EBITDA margin expansion and stronger earnings growth, assuming the improved top line trends sustained moving forward. During the third quarter, EBITDA margins were in line with our expectations while our year-over-year trends improved as the quarter progressed and sales growth strengthened. As a reminder, on an annualized basis, we target mid- to high-teen incremental EBITDA margins at mid-single-digit organic sales growth with strong support from our ongoing internal margin initiatives, continuous improvement culture and structural mix tailwinds.

With that being said, we remain mindful that we continue to operate in a dynamic environment where customers purchasing decisions remain sensitive to broader macro uncertainty that is persisting. This includes an ongoing dynamic trade policy and tariff backdrop. To date, we have not seen a significant impact from recent tariff and trade policy modifications. Price increase announcements from our suppliers remain steady and over the last several quarters have normalized to a more regular cadence following an active pace this time last year. However, the inflationary environment and suppliers' approach to pricing remains highly fluid at this point. We continue to work closely with our suppliers as they assess the evolving backdrop as well as other inflationary pressures on their supply chains.

As evidenced by our performance over the past year, our teams continue to effectively manage broader inflationary pressures. And overall, we remain well positioned. We operate from an agile business model in well-structured markets tied to critical and technical processes with strategic supplier relationships. Combined with structural mix tailwinds and various self-help gross margin countermeasures inherent to our strategy, we are highly confident in our ability to continue to adapt and execute as the tariff and broader inflationary backdrop continues to evolve.

And lastly, before I turn it over to Dave, just a few thoughts as it relates to capital deployment and ongoing opportunities moving forward. Year-to-date, we've remained active, deploying over $300 million on share repurchases, M&A and growing our dividend. With regard to M&A, which remains a top priority and key element of our growth strategy, we are actively evaluating various targets across both our segments with our focus primarily on midsize and smaller tuck-in companies. While timing of M&A can vary quarter-to-quarter, I continue to believe the next 12 to 18 months will be more active period for Applied, given the work being done and as we continue to execute on our strategy. In that, I think it's important to reflect on the potential.

Since 2018, we've closed 18 acquisitions, representing over $1 billion in acquired sales. This included key strategic acquisitions that expanded our engineered solutions capabilities into areas of flow control and automation as well as strengthened legacy positions in Fluid Power and within our service center network. Over that same period, we've grown EPS by 16% and free cash flow by 18% and on a compounded annual basis. I believe that flywheel position and approach to M&A is even stronger today, given the investments we've made in our team, processes and systems as well as the compelling value proposition we offer to many companies looking to join our leading technical industry position within a still fragmented industry. In addition to ongoing M&A activity, we remain proactive with share buybacks.

Long term, we see significant value creation potential across supply, considering our strategic initiatives, industry position, exposure to secular growth tailwinds and margin expansion potential. When appropriate, 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 authorization to repurchase up to 3 million shares.

At this time, I'll turn it over to Dave for additional detail on our results and outlook.

Thanks, Neil, and good morning to everyone joining today. Just another reminder, our quarterly earnings presentation is available on our Investors site. We hope that you will find this a useful reference as we recap our most recent quarter performance and updated guidance. Turning now to our financial performance of the quarter consolidated sales increased 7.3% over the prior year quarter. Acquisitions and foreign currency were a modest tailwind in the period, adding 50 and 80 basis points of growth, respectively. The number of selling days in the quarter was consistent year-over-year.

Metis factors, sales increased 6% on an organic basis. As it relates to pricing, we estimate the contribution of product pricing on year-over-year sales growth was approximately 250 basis points in the quarter, which was in line with our guidance and last quarter's trend. Netting this impact, we estimate volumes grew 3.5% over the prior year, a nice acceleration from the prior quarter.

Moving to consolidated gross margin performance. As highlighted on Page 9 of the deck, gross margin of 30.4% and was relatively unchanged compared to the prior year level. During the quarter, we recognized LIFO expense of $5.6 million compared to $2.2 million in the prior year quarter. On a net basis, this resulted in an unfavorable 27 basis point year-over-year impact on gross margins. Excluding the LIFO headwind, gross margins improved year-over-year reflecting ongoing progress with our internal margin initiatives, price of T&O execution and more favorable mix. As it relates to our operating costs, selling, distribution and administrative expenses increased 7.5% compared to prior year levels.

On an organic constant currency basis, SG&A expense was up 6% year-over-year. Our teams continue to drive strong cost discipline while also focusing on various efficiency initiatives tied to technology investments, shared services and sales tools. This helped offset ongoing inflationary headwinds and annual merit increases, higher incentives and ongoing growth investment into the business during the quarter. SG&A expense as a percentage of sales was at 19.4% and which was relatively unchanged from the prior year, but improved approximately 40 basis points sequentially.

We saw cost leverage improve nicely through the quarter as sales growth strengthened. Overall, stronger organic sales growth, modest M&A contribution and favorable underlying gross margin performance resulted in reported EBITDA increasing 6.2% over the prior year. This is inclusive of greater LIFO expense year-over-year, which negatively impacted EBITDA growth by 2.3 percentage points compared to the prior year quarter. Reported EBITDA margin of 12.3% was down 13 basis points from the prior year level with year-over-year LIFO headwinds negatively impacting EBITDA margin by 27 basis points. EBITDA margins were in line with our third quarter guidance range of 12.2% to 12.4%.

In addition, year-over-year EBITDA growth and EBITDA margin trends strengthened as the quarter progressed. Reported earnings per share of $2.65 in the third quarter increased 3.1% from prior year EPS of $2.57. On a year-over-year basis, was impacted by a higher tax rate and net interest expense, partially offset by a lower diluted share count. Results this quarter included $1.7 million or approximately $0.05 per share of nonroutine discrete tax expense related to prior year tax provision adjustments. We expect our tax rate in the fourth quarter to be within a range of $24.4 million to 24.6%.

Turning now to sales performance by segment. As highlighted on Slides 10 and 11 of the presentation. Sales in our Service Center segment increased 4.2% year-over-year on an organic daily basis. This excludes 20 basis points of contribution from acquisitions and a positive 130 basis point impact from foreign currency translation. Organic sales growth was driven by stable price contribution and stronger volume growth across our U.S. service center operations, partially offset by softer international sales. Segment EBITDA increased 2.7% over the prior year, while segment EBITDA margin of 14.2% decreased 42 basis points. Year-over-year segment EBITDA and EBITDA margin trends were impacted by LIFO headwinds and higher employee-related costs, including incentives as well as a difficult prior year comparison.

On a year-to-date basis, segment EBITDA growth of approximately 5% is slightly ahead of reported sales growth, while segment EBITDA margins are relatively unchanged year-over-year. Within our Engineered Solutions segment, sales increased 10.2% over the prior year quarter, with acquisitions contributing 90 basis points of growth. On an organic basis, segment sales increased 9.3% year-over-year, primarily reflecting strong volume growth across our fluid power and automation operations as well as improved growth across our flow control operations.

Segment EBITDA increased 11.9% over the prior year or approximately 14% when excluding the impact of LIFO expense. In addition, segment EBITDA margin of 14% and was up 21 basis points from prior year levels, inclusive of a 50 basis point year-over-year LIFO headwind. The strong EBITDA growth and EBITDA margin performance in the quarter primarily reflect solid underlying incremental margins on stronger sales growth, firm gross margin performance and ongoing cost accountability. Moving to our cash flow performance. Cash generated from operating activities during the third quarter was $100.1 million, while free cash flow totaled $95.4 million, representing conversion of approximately 96% relative to net income.

Compared to the prior year, free cash was down 8%, reflecting greater working capital investment in relation to stronger sales growth partially balanced by ongoing progress with internal initiatives. From a balance sheet perspective, we ended March with approximately $172 million of cash on hand and net leverage at 0.3x EBITDA. Our balance sheet remains in a solid position to support our capital deployment initiatives moving forward, including accretive M&A, dividend growth and share buybacks, during the third quarter, we repurchased over 346,000 shares for $93 million, bringing the year-to-date total to over 897,000 shares for $236 million.

Turning now to our outlook. As indicated in today's press release and detailed on Page 14 of our presentation, we are tightening our full year fiscal 2026 guidance toward the high end of our prior range following our third quarter performance. We now project EPS within the range of $10.60 to $10.75 based on sales growth of 7.2% to 7.7%, including a 3.8% to 4.2% organic sales growth assumption as well as EBITDA margins of 12.3% to 12.4%. Previously, our guidance assumed EPS of $10.45 to $10.75 and on sales growth of 5.5% to 7%, including 2.5% to 4% on an organic basis and EBITDA margins of 12.2% to 12.4%, our updated guidance assumes a fiscal fourth quarter EPS range of $2.85 to $2.96 on organic sales growth of 4% to 5.5% year-over-year. as well as EBITDA margins in the range of 12.6% to 12.8%.

We expect inorganic M&A sales contribution to be slightly lower sequentially in the fourth quarter as we anniversary our Iris factory automation acquisition at the beginning of May, combined with ongoing initial contribution from our Thomson Industrial Supply acquisition, which we announced last quarter. Our fourth quarter organic sales growth assumption takes into account more difficult prior year comparisons in May and June. In addition, while we are encouraged by the positive sales momentum developing we remain mindful of ongoing geopolitical developments and trade policy uncertainty, which may continue to influence customer spending behavior. As a result, we continue to assume a degree of variability persists across our end markets near term. Lastly, from a margin perspective, we expect fourth quarter gross margins to be relatively stable sequentially. This assumes slightly higher LIFO expense compared to the third quarter.

With that, I will now turn the call back over to Neil for some final comments.

So as we prepare to close out fiscal 2026, we do so from a position of strength with several growth catalysts beginning to emerge across our business. As Dave highlighted, we remain prudent with our near-term assumptions and outlook as we are still navigating an evolving and dynamic market backdrop influenced by geopolitical and trade-related uncertainty. As we've seen over the past year, this could still present a choppy and uneven end market demand as customers continue to balance this complex landscape.

That said, the trajectory of our sales and broader industrial macro indicators year-to-date in calendar 2026 are currently more indicative of an early end market recovery beginning to take shape, followed by a prolonged stagnant period of deferred maintenance and capital spending throughout the last 2 years. Business funnel and order momentum is sustaining positive trajectory, while technical MRO spending requirements are high, given aged manufacturing equipment across North America. As these trends progress, we expect customers to partner with larger, more capable providers like Applied, given our comprehensive solutions and technical service capabilities.

At the same time, applied automation, growth is accelerating as adoption of cobots, mobile robots, machine vision and IoT solutions are increasingly viewed as need to have. We are also favorably positioned to benefit from multiyear growth tailwinds continuing to develop across our technology vertical, while our cross-selling initiative is gaining traction. So overall, the momentum is building in the right direction. Our teams are executing well. The industry and competitive position we've assembled is strong. We are excited about the opportunities in front of us and remain highly focused on translating our growing momentum into superior long-term shareholder value creation.

With that, we'll open up the lines for your questions.

[Operator Instructions] Your first question comes from the line of Christopher Glynn with Omnicom.

I was curious if you may have mentioned a little bit, but wanted to at any rate, go a little deeper into the trends you're seeing with locals versus nationals. I'm guessing some of the sequential acceleration may have been led by the local accounts picking up some momentum, but I speculate.

Okay. So I can start so Chris, I'd say we saw good growth with both. So local accounts year-over-year were up 5% and versus 3.5% in Q2. But we also saw good growth in progress with national accounts, up 7% year-over-year. And versus the 4% that we saw in the second quarter.

Great. And then I also wanted to you got some really exciting things going on with automation and in the fluid power comparisons were so down. Flow Control has been kind of more of a narrower sign way trajectory, but clearly some broadening out there. Wondering if you could also kind of go down a layer or 2 into the flow control of the process arena.

Sure. So if you think about Flow Control, they benefited from the tech vertical segment. really 300 basis points to flow control in the side. In the quarter, they had 6%. So high single digit I mean, mid-single strong mid-single-digit growth. We also saw benefit in primary metals, general industry and energy and the utilities on the side. Chemicals would be the 1 that would be still down year-over-year, but the trend is improving on that front. So we're encouraged as we close the year and then move into the next fiscal year.

Okay. And just an interesting comment you made about, I think it was the automation side where kind of sales lead times and conversions were shortening up a bit. Are you seeing that as a trend on the process side as well?

Yes. That reference was really around customers moving from their projects moving faster. So when we're part of a larger project, we're seeing good speed there. And when we're providing productized solutions, it just seems more customers are interested in accelerating automation projects for what they can do for their productivity or ongoing quality assurance in their offering. So that is encouraging as well as the order rates and the backlog that we've been building. .

Your next question comes from the line of Ken Newman with KeyBanc Capital Market.

Maybe for the first question on Engineered Solutions, the operating leverage there seemed a little bit lighter than I would have expected, just given the 9% organic growth there. I know you guys are still kind of talking to mid-single-digit growth with mid- to high teens incremental margins on the EBITDA side. Maybe can you just talk about what we saw in the margins? How much of that was maybe driven by LIFO headwinds or mix? And then Dave Neil, if you want to talk about what you think about normalized operating leverage in just the ES segment alone as we go into fourth quarter and beyond.

So I think incrementals in the quarter for ES were 16% and ex LIFO more than 19% on that front. So we feel good about that performance in the side. Within that, within Flow Control, they had some projects that came in lower. But depending on the mix, that can be typical in the front. And then Ken, you'll recall, right, Hydradine to date really at fleet average for the company so under the Engineered Solutions average, but with continued focus and continued improvement. So we're well pleased on that front. So I think that's what we would see from the performance side Kenan, I just would add, I think through the quarter, we saw incremental margins and EBITDA margins in the segment on a year-over-year basis, strengthen as the top line strengthen as well.

So overall, I'd say the results from the incremental margin and operating leverage standpoint were in line with our expectations and nice improvement as the quarter played out.

Got it. Okay. And then for the follow-up, it was really nice to hear about the orders within engineers being up double digits for the second straight quarter here. How should we think about the timing of those orders flowing through the P&L into fiscal '27? And I'm just curious how much conservatism might be built into this fourth quarter guide as it relates to what you're seeing from the order front?

So I think, one, we want to be prudent as we talked about, with a little bit of either trade policy moderations that could go on or some of the geopolitical. We are encouraged by the orders. We've talked about timing of the order conversion can vary. One is going to be around the complexity of the order and our engineering time. But also some of these projects are tied to overall customers' projects. So we're in a sequence of an overall project gain chart. So there are some that will go in a 60- to 90-day time period. There will be others that can extend out.

Okay if I could just squeeze 1 more in. Could you just remind us how big the step-up is in the May and June comps versus last year?

Yes. So compared to the May compared to April will be 200 basis points higher. And then the May time period or the June time period will be another step-up of 200. .

[Operator Instructions] Your next question comes from the line of Andrew Obin with Bank of America. Please go ahead.

Good morning. on, Andrew. Just maybe dig in on M&A environment because especially a big driver for value creation. Just maybe a little bit more color. Your M&A has been sort of slower post-COVID what are you seeing that encourages you because I think you've been constructive for a while, but we haven't seen a huge acceleration in the M&A activity. So what do you think is changing? Or what's remaining stable? And what would it take to sort of unlock the M&A potential.

Well, I think as we talked, I mean, we've got clear priorities that we're working in Engineered Solutions prospects or targets around fluid power, around flow control and automation good bolt-on opportunities as well as midsized companies and opportunities like Hydradine presented. And then we'll also have in the pipeline adjacency work that we could have or geographic around the service center side of the front. So we are active and engaged at various stages of the M&A process.

So I think that's what builds. I think an improving environment may cause some of these companies to look at the opportunity as well. So I just gauge it by we've got clear priorities. I know where we're engaged, the level of the team's work in that I expect M&A to be a stronger contributor over the next 12 to 18 months.

And maybe a couple of markets that you highlighted as headwinds. And I think 1 of them was refining and chemicals, and I think you address chemicals and the other one, transportation. We've heard on sort of refining and chemicals that I think, generally do what's happening in Iran, people, global companies have sort of paused some of the spending, but the view is that it is going to come back in the second half of calendar particularly given what high prices are doing to profitability of North American assets. So that's question number one. And question number two, on transportation, are you guys going to be impacted positively if or when trucks come back?

Yes. So if I think about refining and chemicals, I could agree with the logic on second half improvement and activity there. I would also say, given our North American footprint and focus with the geopolitical in the Middle East, we are likely to see more activity occur in U.S., North America on those fronts. And I'd say, broadly across transportation, not our largest segment, but we will participate. So an improving environment would be good for us.

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

Hi. Good morning. This is narcan hopping on for Dave this morning. Apologies if I missed this in the opening remarks. But for my first question, I know pricing can be imperfect to measure since you don't sell every SKU every year, but that caveat, can you give us your best framing of how the 6% organic growth this quarter is split between price and volume? And if price realization is tracking ahead of the 1% to 2% range.

We said pricing in the quarter was about 250 basis points we estimate based on the analysis where we do have like SKUs and extrapolating that that would indicate obviously about 350 basis point benefit from volume. That 250 basis points was consistent sequentially and in line with expectations in terms of pricing we expect kind of a Q4 guide assumes that to moderate just a bit, really a function of some of the year-over-year kind of tariff and other binary impact driven price increases that we saw in our Q4 prior year. So a nice contributor, but also a nice volume rebound as well in the quarter. .

Super helpful. And if you could provide an early April read on volume specifically through the first few weeks, that would be great too. You're seeing customers prebuy or pause given the dynamic policy environment. And Lastly, can you remind us and define what Applied specifically means to you today and how you're measuring progress internally?

Sure. We start with the what we're seeing in terms of volume month-to-date at high single digits. We're up did remind everybody that the comp does kind of the comparative steps up in May and June, about 200 basis points each month. So a little bit tougher comps as we move across the quarter. but encouraged by the start that we see kind of month to date. I'm sorry, the other part of the question?

I can take it. It was on 1 applied. And if you think about it from an end customer standpoint, there's really nothing moving inside of their facilities that our products, our services, our solutions are not a part of. So our service center teams have a great operating know-how of the customers moving equipment and that functionality and how the customers make money with uptime and production. And then from a 1 applied standpoint, we're supporting those plant operations with greater engineered solutions expertise, whether that be in fluid power systems, process flow control and now more on the discrete automation side as many look to utilize collaborative robots or mobile robots in their facility, vision systems for quality control and inspection and really more IoT or connectivity to pull performance data off that operating equipment within a facility or across multiple facilities.

And so we see a growing capability or growing need of customers for that full utilization. And our teams are comfortable in doing this. We have a growing pipeline of projects and that we've touched on in the comments, really contributing over 100 basis points to the service center this quarter, and we expect that to continue to grow.

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

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

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

Welcome to the Fiscal 2026 Second Quarter Earnings Call for Applied Industrial Technologies. My name is Mark, and I will be your operator for today's call. [Operator Instructions] And please note that this conference is being recorded. I will now turn the call over to Ryan Cieslak, Director of Investor Relations and Treasury. Ryan, you may begin.

Okay. Thanks, Mark, and good morning to everyone. This morning, we issued our earnings release and supplemental investor deck detailing our second quarter results. Both of these documents are available in the Investor Relations section of applied.com.

Before we begin, just a reminder, we'll discuss our business outlook and make forward-looking statements. All forward-looking statements are based on current expectations subject to certain risks and uncertainties, including those that are detailed in our SEC filings. Actual results may differ materially from those expressed in the forward-looking statements. The company undertakes no obligation to update publicly or revise any forward-looking statement. In addition, the conference call will use non-GAAP financial measures, which are subject to the qualifications referenced in those documents. Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer; and David 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. I'll begin today with perspective and highlights on our results, including an update on industry conditions and the expectations going forward. Dave will follow with more financial detail on the quarter's performance and provide additional color on our updated outlook. I'll then close with some final thoughts.

Overall, we continue to effectively manage through a mixed yet evolving end market backdrop during the second quarter. Sales and EBITDA margins were in line with guidance despite higher-than-expected LIFO expense and seasonally weak sales activity in December. Our team responded well with strong underlying margin performance and cost control while continuing to expand backlogs and business funnels, supporting a stronger sales trajectory into calendar 2026. We also remain active with capital deployment across many fronts, supported by our free cash generation and balance sheet capacity. As it relates to sales trends in the quarter, reported year-over-year organic growth of 2.2% was modestly below last quarter of 3%. Underlying sales growth showed signs of strengthening as the quarter progressed with November sales up by a nearly mid-single-digit percent organically over the prior year, following a low single-digit percent increase in October. However, growth moderated in December with average daily sales rates notably below normal seasonal patterns. While monthly sales trends have been choppy for most of the year, we do not view December's weakness as indicative of the underlying sales trend developing across the business. Of note, December is always a noisy month given seasonal factors that can drive variability in how customers operate plants and phase shipments. This dynamic was further influenced this year by the midweek timing of the holidays.

In addition, we're encouraged by early fiscal third quarter trends with organic sales month-to-date in January trending up by a mid-single-digit percent year-over-year. Booking rates are also continued to show positive momentum across both segments. In particular, orders in our Engineered Solutions segment increased over 10% year-over-year in the second quarter. This is the strongest quarterly order growth rate in the Engineered Solutions segment in over 4 years, with a 2-year stack trend continuing to improve sequentially. These positive trends are more in line with various underlying demand signals that have developed over the last several quarters, including improved customer sentiment and ongoing growth across our business funnels. We're also seeing slightly more positive trends across several of our primary end markets. Year-over-year trends across our top 30 end markets were relatively unchanged sequentially with 15 generating positive sales growth compared to 16 last quarter, though this is up from 11 in the prior year second quarter.

In addition, when looking at our top 10 verticals, we saw 6 positive year-over-year compared to 5 last quarter and 3 in the second quarter of fiscal 2025. Growth was strongest in metals, aggregates, utilities and energy, mining, machinery, transportation and construction during the quarter. This was offset by declines primarily in lumber and wood, chemicals, oil and gas, rubber and plastics and refining.

From an operational and profitability standpoint, we delivered solid performance that helped balance softer sales activity in December and greater-than-expected LIFO expense as well as a difficult prior year margin comparison as we had previously highlighted. Of note, LIFO expense came in at roughly $7 million. This was above the $4 million to $5 million range we had assumed in guidance and compares to the less than $1 million in the prior year second quarter. As in prior periods of increasing LIFO expense, our teams responded with a focus on internal initiatives, effective management of product inflation and strong channel execution. Dave will provide more details shortly, but -- when excluding the impact of LIFO, gross margins were up both year-over-year and sequentially, and EBITDA margins held firm over the prior year against a difficult prior year comparison. This performance reinforces the durability of our operating model and various self-help opportunities across the business.

We also continue to execute thoughtfully against our capital deployment priorities. Of note this morning, we announced an 11% increase in our quarterly dividend, following a 24% increase last year. The increase is consistent with our expectation of ongoing dividend growth as we align annual increases with normalized earnings growth and our favorable cash generation profile. We also remain active with share buybacks, deploying over $140 million on repurchases during the first half of fiscal 2026. These actions reflect confidence in our cash flow generation as well as the value we see across Applied from our strategy and long-term earnings potential. Further, we continue to evaluate various M&A opportunities across both our segments that could drive a more active pace of acquisitions over the next 12 to 18 months. Our acquisition priorities remain unchanged with an ongoing focus on expanding our technical engineered solutions position across automation, fluid power and flow control.

We also remain opportunistic with M&A opportunities across our Service Center network aimed at optimizing our local market coverage and service capabilities. Today's announced acquisition of Thompson Industrial Supply is a great example of this. With expected annual sales of $20 million, Thompson is a nice Service Center bolt-on acquisition that will enhance our footprint in Southern California. They bring strong technical knowledge and aligned supplier relationships as well as in-house belting and fabrication capabilities that strengthen our value-added services and competitive position in the region. We're excited to welcome Thompson to the Applied team and look forward to leveraging their capabilities. As it relates to what we see ahead, I remain constructive on our growth potential entering the second half of fiscal 2026 and beyond. While end markets remain mixed and choppy, several growth catalysts are becoming more evident. First, our Service Center segment is well positioned to support our customers' heightened technical MRO needs as they catch up on required maintenance across an aged installed equipment base. We believe there's a clear underlying trend developing around this theme. Of note, our U.S. Service Center sales were up over 4% year-over-year in the second quarter, inclusive of seasonally weak December activity. We saw growth across both strategic national accounts as well as our local accounts. Local account sales growth strengthened as the quarter progressed, which is an encouraging signal for broader industrial activity. We also continue to see stronger activity across several of our heavy U.S. industrial verticals that are break-fix intensive. This includes primary metals and aggregate markets, where related Service Center sales were up by a double-digit percent year-over-year in the quarter.

Segment booking rates were positive in the quarter, while month-to-date in January, segment organic sales are trending up by a mid-single-digit percent year-over-year. Our scale, local and consistent service capabilities and technical knowledge of motion control products and solutions are driving greater growth opportunities in both legacy and emerging end markets. We also continue to benefit from sales process initiatives and ongoing pricing actions as well as increased traction from our cross-selling efforts. During November, our Service Center leadership teams gathered in Cleveland to collaborate on our strategic growth initiatives, cross-selling opportunities and operational requirements moving forward. There remains significant excitement and energy surrounding our core business today, and our teams are making notable progress deploying a number of strategic actions designed to further catalyze our growth long term.

Within our Engineered Solutions segment, we expect positive order momentum over the past several quarters to translate into more meaningful sales growth beginning in the second half of fiscal 2026. We're starting to see this play out with segment organic sales trending up by a high single-digit percent year-over-year, month-to-date in January. In addition, we expect increased customer activity across our technology vertical, which represents about 15% of our Engineered Solutions segment. Of note, we continue to receive positive demand signals from our semiconductor customer base. This aligns with broader market indications suggesting a multiyear up cycle is emerging for semi wafer fab equipment. As a reminder, semiconductor space drives the bulk of our technology vertical participation where we provide various fluid conveyance, pneumatic and automation solutions to wafer fab equipment manufacturers and other providers along the value chain. Many of our solutions are directly specified into wafer fab equipment across both new and established equipment platforms. I would also highlight recent investments we've made in engineering, systems and production capacity that should provide support to fully leverage these demand tailwinds moving forward. Combined with new business tied to broader data center build-out, we believe our technology vertical could provide a nice tailwind to our organic growth in coming quarters.

Our automation operations are also in solid position to drive stronger growth moving forward. Automation orders were up 20% year-over-year in the second quarter. We expect various secular tailwinds to continue to positively influence demand for our advanced automation solutions, including structural labor constraints, heightened focus on safety and quality and North American reshoring activity. These dynamics are accelerating the adoption of collaborative and mobile robots, machine vision and IoT solutions as well as require strong application and engineering support that aligns well with our market approach and value proposition.

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

Lastly, we're encouraged by improving trends across our industrial and mobile OEM fluid power operations, where organic sales were positive year-over-year for the first time in 2 years during the second quarter, while orders were up by a double-digit percent over the prior year. This positive development is notable considering the drag this area of our business has had on our growth the past several years. As a reminder, our fluid power customer base includes thousands of small and midsized specialty OEMs across a diversified industry base. Our leading innovative engineering capabilities, access to premier supplier technologies and customer reach are driving new business opportunities with these OEMs as they begin to integrate advanced power and control features into their next-generation equipment. We believe demand for these features will be structurally higher as OEMs begin to reaccelerate production, giving an increased focus on power consumption, machine performance and automation. Combined with our enhanced footprint and capabilities following our Hydradyne acquisition last year, our fluid power operations are in a strong position moving forward. As it relates to Hydradyne, we marked the acquisition's 1-year anniversary at the end of December. I want to take a moment to thank our team's combined efforts over the past year in making this acquisition a great early success. We've achieved notable growth and operational momentum from this transaction that stands to further augment our earnings potential as underlying end market demand begins to build. Of note, Hydradyne generated over $30 million of EBITDA in the first 12 months of ownership with contribution building year-to-date in fiscal 2026 as we continue to align teams and realize synergies.

During the second quarter, Hydradyne's EBITDA margins exceeded 13% and were modestly accretive to our consolidated EBITDA margin performance. We've made tremendous progress in leveraging complementary solutions, harmonizing technical capabilities and systems and driving operational efficiencies across the combined operating platforms. We're connecting Hydradyne with new growth opportunities by cross-selling their value-added fluid power repair solutions across our legacy U.S. Southeastern customer base. We're also enhancing their capabilities, serving the rapid pace of innovation developing across fluid power and mobile systems as well as providing fluid conveyance solutions tied to data center thermal management needs.

Moving forward, we expect Hydradyne's contribution to be increasingly accretive to our underlying growth and margin performance as this positive momentum feathers into our organic results.

At this time, I'll turn it over to Dave for additional detail on our results and outlook.

Thanks, Neil. Just a reminder before I begin, as in prior quarters, we have posted a quarterly supplemental investor presentation to our Investor site for additional reference as we recap our most recent quarter performance.

Turning now to our financial performance in the quarter. Consolidated sales increased 8.4% over the prior year quarter. Acquisitions contributed 6 points of growth, while the impact from foreign currency translation was a positive 20 basis point impact. The number of selling days in the quarter was consistent year-to-year. Netting these factors, sales increased 2.2% on an organic basis. As it relates to pricing, we estimate the contribution of product pricing on year-over-year sales growth was approximately 250 basis points for the quarter. This is up from approximately 200 basis points in the first quarter and primarily reflects the effective pass-through of incrementals announced supplier price increases in recent periods. Moving to consolidated gross margin performance as highlighted on Page 7 of the deck, gross margin of 30.4% was down 19 basis points compared to the prior year level of 30.6%.

During the quarter, we recognized LIFO expense of $6.9 million, which was $2 million to $3 million above our expectations and up meaningfully from prior year second quarter LIFO expense of $0.7 million. On a net basis, this resulted in an unfavorable 54 basis point year-over-year impact on gross margins during the quarter. While the LIFO expense increase partially reflects broader product inflation and supplier price increases, we also prudently increased our level of inventory investment in the quarter based on our outlook and firming demand developing across the business. As a reminder, our use of LIFO accounting accelerates the recognition of product inflation on our results, which during periods of increasing inflation and inventory expansion reduces our tax burden and drives cash savings. Importantly, from a gross margin standpoint, the impact is more about timing of when we recognize product inflation and is not a change in the underlying economics of the business. As inflation levels out and eventually normalizes, we would expect this impact to unwind accordingly as we saw in prior periods of greater inflation and LIFO expense. That said, as Neil mentioned earlier, our team responded well to these inflationary headwinds through various countermeasures, including effectively managing supplier price increases channel execution and margin initiatives. We also benefited from positive mix tied to our Hydradyne acquisition as well as longer growth across local accounts.

Excluding LIFO expense, gross margins of 31% were up 34 basis points year-over-year against a strong prior year comparison. As it relates to our operating cost, selling, distribution and administrative expenses increased 11.1% compared to prior year levels. On an organic constant currency basis, SG&A expense was up 1.4% year-over-year compared to a 2.2% increase in organic sales.

During the quarter, ongoing inflationary headwinds and growth investments were balanced by solid cost control and internal productivity initiatives. Overall, modest organic sales growth, coupled with M&A contribution, favorable underlying gross margin performance and cost control resulted in reported EBITDA, increasing 3.9% year-over-year, inclusive of a 460 basis point year-over-year LIFO expense headwind. This resulted in EBITDA margins of 12.1%, which was down 52 basis points from the prior year level, up 12.6%, inclusive of a 54 basis point year-over-year headwind from higher LIFO expense. The 12.1% reported EBITDA margin was within our second quarter guidance range of 12% to 12.3% despite greater-than-expected LIFO expense which was approximately 15 to 25 basis points unfavorable to our expectations.

Reported earnings per share of $2.51 was up 4.6% from prior year EPS of $2.39. On a year-over-year basis, EPS benefited from a lower tax rate and reduced share count, partially offset by increased interest and other expense on a net basis.

Turning now to sales performance by segment. As highlighted on Slides 8 and 9 of the presentation, sales in our Service Center segment increased 2.9% year-over-year on an organic basis when excluding a 30 basis point positive impact from foreign currency translation. The organic sales increase in the quarter was primarily driven by price contribution as volumes were relatively unchanged year-over-year, reflecting seasonally slow sales activity in December and lower international shipments. Across our U.S. operations, sales increased more than 4% over the prior year, reflecting growth across both our national and local account base. U.S. Service Center sales benefited from firming demand across several core end markets as well as sales force investments and cross-selling actions that continue to read through within a mixed demand backdrop.

Segment trends also continue to be supported by favorable growth across fluid power MRO sales. Segment EBITDA increased 2.2% over the prior year, inclusive of a 340 basis point year-over-year LIFO headwind, while segment EBITDA margin of 13.3% declined 14 basis points, inclusive of a 45 basis point year-over-year LIFO headwind. Excluding the impact of LIFO, the year-over-year improvement in segment EBITDA and EBITDA margin primarily reflects underlying operating leverage on stronger U.S. sales, channel execution and cost control.

Within our Engineered Solutions segment, sales increased 19.1% over the prior year quarter with acquisitions contributing 18.6 points of growth. On an organic basis, segment sales increased 0.5% year-over-year. The increase was primarily driven by price contribution as well as modest volume growth across fluid power mobile and industrial OEM customers, partially offset by lower flow control sales.

Sales across our automation business increased 3% on an organic basis over the prior year, representing the third straight quarter of positive organic growth. Segment EBITDA increased 4.4% year-over-year over the prior year, inclusive of a 400 basis point year-over-year LIFO headwind, primarily reflecting contribution from our Hydradyne acquisition, partially offset by lower organic EBITDA and muted sales trends in the quarter.

Segment EBITDA margin of 14.3% was down roughly 200 basis points from prior year levels, inclusive of a 55 basis point year-over-year LIFO headwind. Excluding the LIFO impact, the segment EBITDA margin decline was primarily driven by lower flow control sales and unfavorable M&A mix as well as a difficult prior year comparison from record performance across our Engineered Solutions segment during the second quarter of fiscal 2025 tied to favorable mix as we had previously highlighted.

Moving to our cash flow performance. Cash generated from operating activities during the second quarter was $99.7 million, while free cash flow totaled $93.4 million, representing conversion of 98% relative to net income. Compared to the prior year, free cash was up slightly as greater working capital investment was balanced by ongoing progress with internal initiatives. From a balance sheet perspective, we ended December with approximately $406 million of cash on hand and net leverage at 0.3x EBITDA. Our balance sheet is in a solid position to support our capital deployment initiatives moving forward, including accretive M&A, dividend growth and opportunistic share buybacks. During the second quarter, we repurchased over 346,000 shares for $90 million, bringing the year-to-date total to over 550,000 shares for $143 million.

Turning now to our outlook. As indicated in today's press release and detailed on Page 12 of our presentation, we are adjusting our full year fiscal 2026 EPS guidance following our first half performance and updated outlook. We now project EPS range of $10.45 to $10.75 based on sales growth of up 5.5% to up 7% and EBITDA margins of 12.2% to 12.4%. Previously, our guidance assumed EPS of $10.10 to $10.85 on sales growth of 4% to 7% and EBITDA margins of 12.2% to 12.5%. Our updated guidance now assumes LIFO expense of $24 million to $26 million compared to prior guidance of $14 million to $18 million. In addition, we now assume 210 to 230 basis points of year-over-year sales contribution from pricing up from prior guidance of 150 to 200 basis points. From an organic sales perspective, we are now assuming a 2.5% to 4% increase for the full year compared to our prior assumption of up 1% to 4%. This takes into account first half organic sales performance as well as early third quarter organic sales trends which, as noted earlier, are trending up by a mid-single-digit percent over the prior year in January. I would note prior year sales comparisons are slightly more difficult in February and March compared to January. In addition, we continue to assume ongoing macro and policy uncertainty will influence customer spending behavior and shipment activity near term. We believe this could result in ongoing variability in monthly sales growth, pending greater clarity on the macro backdrop or incremental support from lower interest rates and fiscal policy.

At the midpoint of our updated guidance, we assume organic sales increased by approximately 4% year-over-year in the second half of fiscal 2026, with third quarter organic sales expected to increase by a low single-digit to mid-single-digit percent over the prior year. We also project inorganic M&A-related sales and modest foreign currency tailwinds to contribute approximately 50 basis points of year-over-year growth in the second half of the year. The M&A contribution includes today's announced acquisition of Thompson Industrial Supply as well as our May 2025 acquisition of IRIS Factory Automation. Our guidance does not include contribution from future M&A or additional share repurchases in the second half of the year.

From a margin perspective, we expect third quarter gross margins to decline sequentially to a low 30% range. This assumes a more normalized level of gross margin execution relative to our strong underlying second quarter performance as well as slightly higher LIFO expense sequentially. Combined with modestly stronger operating leverage on greater sales growth as well as ongoing inflationary headwinds, anticipate growth investments in our annual merit increase effective January 1, we expect third quarter EBITDA margins to be within a range of 12.2% to 12.4%.

Lastly, some housekeeping items. Our updated guidance does assume a slightly lower share count following second quarter share repurchases as well as a tax rate assumption of approximately 23% for the full year compared to our prior range of 23% to 24%. These slight EPS tailwinds are partially offset by an increase in net interest expense into the second half of our fiscal year following the net impact of our interest rate swap maturing at the end of January.

With that, I will now turn the call back over to Neil for some final comments.

So to wrap up, our team executed well through the first half of fiscal 2026. We're delivering on our financial commitments and making strong progress on our strategic initiatives. As we enter the second half of the year, we do so from a position of strength with signs of emerging growth catalyst developing across several areas of our business. Early fiscal third quarter sales trends are encouraging and provide a nice jump-off point. So we remain prudent with our guidance as we look for greater consistency in sales trajectories as we move into more meaningful seasonal months while balancing the near-term timing impact of LIFO accounting.

Importantly, sentiment from both our customers and our sales teams continue to be directionally positive, and our business funnels are expanding. Technical MRO requirements are heightened entering what should be a more productive operating environment as we move through calendar 2026 when considering potential support from lower interest rates, a more favorable tax policy and deregulation. In addition, our industry position places us in a unique and comprehensive position to capture growth as capital spending broadens across many of our customer verticals. This includes pro-business policies supporting greater production and investments in core legacy verticals such as metals, mining and machinery as well as clear secular and structural tailwinds supporting multiyear cycles across semiconductor, power generation and energy end markets. We also expect to play a greater role across the data center space, given our expertise and product offering in areas of thermal management, robotics and fluid conveyance. With our deep technical industrial facility domain expertise, access to critical higher engineered industrial products and balance sheet capacity, we're well positioned to capitalize on these growth opportunities. We also remain positive on our margin expansion potential as these tailwinds drive stronger top line growth. We continue to see a clear path to achieve our mid- to high-teen incremental EBITDA margin target at mid-single-digit organic sales growth. This is supported by inherent operating leverage across our business model, combined with mix tailwinds tied to the ongoing expansion of Engineered Solutions segment and local account growth within our Service Center segment. Additional support should emerge as we continue to scale our automation platform following various growth investments in recent years.

Overall, we look forward to fully capturing this growth potential through the remainder of fiscal 2026 and years to come. And as always, we thank you for your continued support.

With that, we'll open up the lines for your questions.

[Operator Instructions] and our first question comes from the line of Christopher Glynn with Oppenheimer.

Just wanted to dive into the Engineered Solutions orders in the quarter, up over 10%. I assume that was on organic basis. I just want to clarify as well as what degree of positive book-to-bill that might denote?

Yes. So that would be on an organic basis. And as we think about it, it broke out across the segments with automation, as we talked about, plus 20%, fluid power, low teens, 13% and flow Control, high single digit, 8% into the side. Book-to-bill was above 1 during the quarter and now has been 3 of the last 4 quarters in that side.

Great. And on the fluid power comparisons, you've got the destock comparison. So curious, if you could sort of dissect the kind of end demand trend versus better kind of sell-through there in alignment.

Yes. I think really the stock, destock, given how that's elongated out has really been worked through. So the performance that we saw in the mobile off-highway part of fluid power is encouraging as well as the work that's going on with those mid-tier and smaller OEMs. We're also encouraged on the fluid power side of the amount of industrial activity. I think that's similar to Service Center's on technical MRO requirements that industrial customers are having to look at the aging of that installed base of producing equipment and is giving us opportunities. And then, right, as we talked about in the comments, we think the technology side of our fluid power is really set up well as we think about semi wafer fab equipment and also that growing participation in data center.

Okay. And last one for me. I think in the January sales up mid-single digits. You mentioned Engineered Solutions was up high single digits. And you mentioned February and March, a bit more difficult comp. So I just want to make sure I have all that right. And also just on the thought that maybe January had a benefit from neutralizing the December pause?

Yes. You think about it, there could be, right, from the December, right, which we talked about or looked at from that side from normal seasonal patterns there, right, running lower. So there could be. But I think the height of some of that growth and increase, we take as favorable that it's more than just a little bit of timing.

Yes. And Chris, the other thoughts on the trends in Engineered Solutions being up high single digits in January is correct. And there was -- maybe another part of your question that maybe we didn't answer, but let us know.

Appreciate that. I think we got it.

And our next question comes from the line of David Manthey with Baird.

My first question is on SD&A. Organic constant currency SD&A growth was less than organic revenue growth again this quarter, which looks really good. I'm wondering, as we lap Hydradyne here, should overall SD&A coming closer to overall revenue growth next quarter? And then as we look forward, is there anything unusual in the fourth quarter of fiscal '25 on SD&A? It looked like the sequential from the third quarter was up, a greater than normal dollar amount there. And I'm just wondering if there was something unusual we should know about.

Yes. The -- we'll start with the sequential increase in '25, third to fourth quarter, David. The -- a couple of things came into play there. There was an increase in benefit costs. There's variability, obviously, in our self-insured medical expense, but also about $1.5 million that swapped around with rabbi trust or deferred comp that gets offset in other income. So that did skew SD&A just a little bit. As you think about kind of now as we move into the third quarter, we do have the focal merit point coming in and lapping Hydradyne, to your point. So we would still work to show an increase less than the rate of the sales increase. But I would expect that given that the [indiscernible] the late last quarter was about half the rate of the sales increase in terms of the SD&A increase. We'd expect that gap to close just a little bit just given those factors coming into play.

Dave, just also on the prior year fourth quarter for fiscal '25, it was impacted, if you recall, by some AR provisioning that we had in the quarter. I think that was over $2 million or so year-over-year. So that's part of the year-over-year or the uptick in the fourth quarter trend you see there.

Yes. And based on your guidance, it would appear that the fourth quarter of this year is a more normal kind of, I don't know, $10 million quarter-to-quarter increase, which looks more normal. Okay. Thank you for that.

And then on capital allocation, I'm not sure if it's in the deck here, but did you mention the shares left under your repurchase authorization? And I guess in the context of I think you have about $1.5 billion of borrowing capacity, including some accordion features. Does share repurchase take priority over debt paydown in the near term given the -- your ample access to capital and kind of the relative share price?

We'll still be opportunistic when you look at the share repurchase, we are contemplating some debt paydown, not the entirety of it, but given the -- in January, the swap will roll off. So we'll work to neutralize a little bit of that added interest expense that would come with that. So here again, taking it in rank order priority, it's going to be the organic growth investment, followed by M&A, followed by the dividend increase of 11% this quarter coming off the 24% last year increase. So continue to move that in line with our increase in earnings in the business as well as then the opportunistic share repurchase. So we'll balance all those, to your point, plenty of dry powder given the $1.5 billion capacity and leverage of 0.3x to really work all those angles.

And then, Dave, we have, I think, about 700,000 shares left on the current authorization that we had, which we had updated, I think, last August. time frame. And so we'll continue to look at that as we continue to buy back shares and update that accordingly as we progress through that, the current program.

And then lastly, David, I'd just say on the M&A side, as we touched in the remarks, we feel good about the pipeline, the work, the activity, touch on the potential for greater activity as we look out over the 12 to 18 months, really around our stated priorities of continuing to build out Engineered Solutions with some more select opportunities for differentiation around the Service Center side. So we're low CapEx requirements. We'll continue to make those. They generate strong returns, but the M&A opportunity for us, we think, remains a good priority for us as we operate through the rest of this fiscal year and look out beyond.

And your next question comes from the line of Brett Linzey with Mizuho.

I want to come back to the automation orders up 20%, I guess. How much of that do you think is related to pent-up needs that were put on hold that are just starting to release versus new projects, capital formation that's being driven by incremental onshoring your customers might be focused on?

Yes. Brett, I don't know if I got a perfect answer to that. Obviously, we've had growing funnel of -- activity within our automation group and also with our Service Center teams walking in here today, a couple of releases are getting highlighted on projects that were in flight. But there's also a great amount of work. If we consider what is coming to the U.S. from a reshoring standpoint, we have more customers reaching out, how can they drive their efficiencies and productivity on where collaborative or mobile robots will help. If they're looking at quality control or quality and inspection where vision systems can help and even just connectivity products, right, to monitor KPI and performance where perhaps people did that manually in the past at equipment [ to ] way to have visual panels and boards on that. So I think both are going to be continued drivers for us as we look out over calendar 2026. things that we worked on, on ideas and solutions, but also increased new opportunities as we think about the backdrop. And then things like tax policy and outlook are probably going to help further accelerate some of that look from customers.

Yes, that's great. And then just my follow-up is on price. So the contribution was 250 bps in the quarter. Curious what you're seeing here in calendar '26 from a vendor price standpoint? And how should we think about pricing contributions for the balance of this fiscal year in Q3 and Q4 as you got some wraparound and maybe some incremental coming through?

Yes. We think about activity from our suppliers. Obviously, those that are more calendar year based in increases, we see those in place. We did see some that are later year, perhaps midyear around their fiscal year events, accelerate. So we think to a large part, there's more of that, that is in now. We would think the third quarter has the potential to be similar to the second quarter, so 250 basis points in that. And then with the fourth quarter, given perhaps that aging or overlapping of some prior increases, maybe that moderates to a couple of hundred basis points impact in the fourth quarter. And so that's what's encapsulated in our outlook. If we look beyond that, right, hey, we will see. There could be a path to higher upside in that as we think about the direction of LIFO that we'll have into that side of it as well.

And our next question comes from the line of Sabrina Abrams with Bank of America.

Question. So I know you guys did raise the pricing guide this quarter and pricing, I guess, accelerated nicely quarter-over-quarter. But you did raise LIFO expense, and I would just like to ask why not assume price is going to accelerate into the second half because I would think price continues to accelerate from here, but just any color around that assumption?

Yes. So as we think about -- we touched on just a little bit there. We're seeing the announced increases from our suppliers as we think about for much of '26 are perhaps likely in place now. And then if we think about the aging or the overlap of prior increases, that's what we're saying perhaps the price moderates to that couple of hundred basis points in the fourth quarter compared to this 250 level that we have today. Obviously, we'll be close to the inputs of looking at any other metals material increases that will be coming through with suppliers and work with them to orderly take them through to the markets. But that's our view now. And perhaps the tariff environment is going to stay moderated at its current level right now as we look out over the rest of the fiscal year.

I'd say, too, I'd add the -- obviously, you're seeing in the -- as you start looking at the comps in the back half of '25, some higher levels of pricing that does skew year-over-year just a bit versus the first half. And then thinking about the LIFO doesn't necessarily travel in exact tandem with the dynamics that we see on the pricing and supply price increases because that's also influenced by the mix of what we're purchasing. So we did have a heavier concentration this quarter of parts that we had not purchased for 2, 3 years, which attracted a fair amount of LIFO increase as we looked at the buy versus kind of the 2- or 3-year ago price that we were carrying at. So that is also a factor as you try to correlate those 2.

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

Yes, I think there's a modest increase there resulting from really the strong margin performance. And again, if you strip out that LIFO, 31% gross margin performance. Again it's a very difficult comp like I said, if you think about the year-over-year still being up partially driven by that Hydradyne mix benefit. But nonetheless, very pleased with the team's response to the inflationary environment. So you're seeing some of that read through. We'll still be cost conscious and kind of continuing to look at that. So I'd say it's a modest increase there in the quarter. And then when we think about the guide really kind of tightening the guide at the upper end of the previous guidance.

And just to clarify -- I'm sorry. Are you guys finished?

Yes. No, that's fair. So I think if you look at the midpoint of the guidance, the organic growth, we're assuming in the back half of the year, is up slightly from what we were assuming in the prior guidance that we provided and maybe even a more meaningful amount, we look at it in the -- at the high end. And so not a huge change, but we are assuming a little bit greater growth, organic growth on sales in the back half relative to what we were prior.

And just one last quick follow-up to that. Is that on the raised pricing assumption? Or is implicitly, did you raise your volume assumption?

Yes. It's primarily tied to the raised pricing assumption, but still some volume assumptions as well in there as well.

And our next question comes from the line of Ken Newman with KeyBanc Capital Markets.

I wanted to first just touch on the margin guidance, if we could. I guess if there's a headwind due to LIFO here in the back half. I think the math is around like 30, 40 basis points on EBITDA. But I would think that the high single-digit to low double-digit sales growth in engineered and then the automation orders being up 20% would be a decent mix offset. So maybe can you just help us think about bucketing the various moving pieces in the margin guide and what that assumes for mix versus price costs and LIFO headwinds.

Yes, I can start. So just as we think, right, and we talked about, hey, perhaps we moderate below the 30.4% that we had in the second quarter that1 10 to 30 basis points on gross margin on the guide. I think you're right and potential for LIFO to be a 30 to 40 basis point headwind path to things that could counteract, right? One will be, what is that true path of LIFO in the second half. To your point on mix dynamics, Engineered Solutions, local account growth and Service Centers would both be the potential for benefit in that. The further path on M&A performance, Hydradyne as it comes in, would have the perhaps continued improvement. And then obviously, we'll be focused on our price actions and ongoing margin initiatives that we have across that benefited us in the second quarter. But hey, as we sit here today, right, we see there is that potential for that to show up, including that higher LIFO expense that we had in the second quarter somewhat to continue on at that $7 million to $8 million impact.

Yes. I think you stripped that out -- sorry, you stripped that out, Ken, I'd say the LIFO expense, it's a good story in terms of incrementals. We're up over 20%, what that implies in terms of guidance in the back half, in terms of incrementals ex LIFO. So you're seeing all those things Neil indicated and highlighted there in terms of the mix benefit, flow control sales coming back, the acquisition mix benefit stronger Engineered Solutions shipments, which helps from a mix standpoint as well. So all those things play in, in addition to the work around pricing and kind of the channel optimization.

Okay. That's helpful. And then just for my follow-up, it was hear -- nice to hear you guys reiterating the mid-teen incremental EBITDA margin target on mid-single-digit growth. I think the midpoint of this quarter's guide is slightly below that. But I wanted to get your thoughts on, one, do you think you could reach that target exiting this fiscal year? And if so, do you need a specific number or contribution of volume growth to kind of get there? And maybe also, if we get incremental pricing versus what you're already expecting in the guide today? Would you expect that to be neutral to the operating leverage or accretive?

Yes. I can start. As we think about that leverage and then, right, some of our targets that we have for the business, we think about them really from an annualized basis. But to your point, we've demonstrated strong incrementals with low single digit in volumes as we move up, right? Those have the opportunities to improve. So I think as we look out over calendar '26, we see that opportunity for that to play out and develop for us.

Yes. And Ken, I would say that at the midpoint of the guidance, we would assume that the fourth quarter gets to, call it, a mid-teen incremental margin on EBITDA at, call it, that 4% or so type of organic growth that we have baked into the guidance at this point that includes the LIFO -- increased LIFO year-over-year. As mentioned earlier, we will have a benefit year-over-year in the fourth quarter, assuming normalized AR provisioning, given that prior year impact that we had. And so we're getting to that, call it, mid-teen to high-teen range at slightly below mid-single-digit organic growth, but feel very good as we move into a more stabilized and firm mid-single-digit organic growth environment that those -- that incremental margin guide is achievable. And then as it relates to pricing and needing incremental, a team that is doing a great job of managing pricing, a number of other initiatives that we have on gross margin and countermeasures to manage through that. And we'll see how it all plays out, but obviously, inflationary environment, but the team is doing a good job executing through it.

And our next question comes from the line of Chris Dankert with Loop Capital Markets.

I guess just on the third quarter guide, if I'm looking at what you guys have staked out from an organic sales growth perspective, that seems to imply kind of a below typical seasonal growth level. I mean, I think, plus 5% to quarter kind of what the midpoint implies. Longer term, you're typically up in the high single-digit range. I guess when we consider the December holiday timing impact, the ES orders, and incremental pricing, can you kind of help us square the below seasonal midpoint of that sales guidance for fiscal 3Q?

Actually, Chris, if you look at the -- given the low- to mid-single-digit assumption for Q3, 4% here again organic for the total back half, that would assume for the first quarter in quite a while. We've been kind of -- last quarter, it was 200 basis points below the typical seasonality, but that's really back in line with what we'd say is normal seasonality as we transition from Q2 to Q3.

And our next question comes from the line again from Christopher Glynn with Oppenheimer.

Just one on the mechanics of LIFO. I definitely don't claim a deep appreciation of how it all works. But I'm wondering about the lead time dynamics, what they've been like for supplier price negotiations? Are they faster cycling than normal? Or have the signals been too varied? I'm just wondering if there's perhaps an opportunity to standardize the preplanning communications with suppliers a little bit more, just given your long-term distinguished excellence in data and analytics throughout the organization on many dimensions.

Yes. I can start. Chris, I think suppliers are being orderly in this. And hey, that's our expectations as they're working on them as they develop. Obviously, you need the data, you need the files to work through on that to be able to effectively implement. So we're not changing our expectations or views that, that has to be orderly. And so I think suppliers are -- understand that, it's best for them as well, so they're working to do that. And so it kind of led a little bit. I think most of the annual increases are in. I think those that we're contemplating are more historically kind of mid or their more fiscal year side have accelerated. I think most of those are in. So from a price increase standpoint, I won't say that they're finished if metals or something else moves. But I think most of those are in place right now.

Yes, Chris, I think the other piece of LIFO to consider as it relates to how it moves quarter-to-quarter, obviously, is what we decide to bring in as it relates to the inventory investment, right? And so that remains a fluid sort of dynamic, and we feel good that what we're seeing in the back half as demand is starting to firm. We're starting to bring more inventory on as we talked about in a prudent way. And so that drove some of the, I think, increase in LIFO maybe relative to what we expected last October when we talked about LIFO expense guidance. So that's probably a piece of it just to keep in mind that, that will continue to fluctuate depending on the demand backdrop.

[ Put ] in context, operating [ entries ] were up about 1.5% in terms of 1.5%, in terms of the sequential change in the quarter as you see that demand firming and we brought in some of the inventory to support that.

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

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

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

Welcome to the fiscal 2026 First Quarter Earnings Call for Applied Industrial Technologies. My name is Eric, and I'll be your conference operator for today's call. [Operator Instructions] Please note that this conference call is being recorded.

I will now turn the call over to Ryan Cieslak, Director of Investor Relations and Treasury. Ryan, you may begin.

Okay. Thanks, Eric, 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 the business outlook and make forward-looking statements. All forward-looking statements are based on current expectations subject to certain risks and uncertainties, including those detailed in our SEC filings. Actual results may differ materially from those expressed in the forward-looking statements. The company undertakes no obligation to update publicly or revise any forward-looking statement. In addition, the conference call will use non-GAAP financial measures, which are subject to the qualifications referenced in those documents.

Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer; and Dave Wells, our Chief Financial Officer.

With that, I'll turn it over to Neil.

Thanks, Ryan, and good morning, everyone. We appreciate you joining us. I'll begin today with perspective and highlights on our 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. I'll then close with some final thoughts.

So overall, we had a nice start to fiscal 2026. We delivered strong earnings performance in the first quarter with EBITDA and EPS growing 13% and 11%, respectively, over the prior year, which exceeded our expectations. Sales growth was largely in line with our outlook and strengthened compared to last quarter against a still muted and choppy end market backdrop. We converted stronger sales growth into even greater EBITDA growth through solid gross margin execution, cost control and our internal initiatives.

As a result, EBITDA margins expanded over the prior year and exceeded the high end of our first quarter guidance. In particular, our service center team delivered a strong quarter on both the top and bottom line, and I'm encouraged by the positive momentum building from our internal initiatives and industry position.

Sales across our Engineered Solutions segment were relatively flat versus the prior year, but orders remain positive. Hydradyne contribution continues to increase and the segment has solid growth potential moving forward. Overall, our execution and progress in the first quarter provides positive momentum to achieve our fiscal 2026 objectives and accelerate our value creation potential moving forward.

Digging more into the sales trends, broader end market demand remained mixed during the quarter as lingering trade policy uncertainty continued to impact customers' purchasing decisions. That said, we would describe the underlying demand backdrop as stable to slightly positive. And overall, moving in the right direction when looking at it over the past several quarters.

Year-over-year trends across our top 30 end markets improved slightly with 16 generating positive sales growth compared to 15 last quarter. We saw stronger trends across several of our primary end markets with strongest growth in machinery, food and beverage, refining, pulp and paper, metals, oil and gas and aggregates during the quarter. This was offset by declines in lumber and wood, transportation, chemicals, mining and utilities and energy.

Year-over-year organic sales trends were stronger in July and August relative to September, though partially reflecting more difficult comparisons later in the quarter. Combined with greater pricing contribution, reported organic sales growth of 3% was the strongest in 2 years with a 2-year stack trend improving sequentially for the third consecutive quarter.

Organic sales growth in the quarter was led by our Service Center segment with reported growth of 4.4%, accelerating nicely from the low single-digit declines we experienced in fiscal 2025. Growth was strongest across our national account base, while local account sales were up modestly year-over-year. which is an improvement from recent quarters.

Strengthening service center sales growth is an encouraging sign for both the segment as well as our broader operations, as the shorter cycle nature of our service center operations is typically a good indicator of underlying industrial activity and potential demand for capital-related spending moving forward. We believe modest firming in manufacturing production and capacity utilization, combined with pent-up demand from deferred maintenance activity is driving more technical MRO and break-fix activity at the margin.

We're seeing stronger activity across some of our heavy U.S. manufacturing verticals that are break-fix intensive. This includes primary metals market, where related service center sales were up by a high single-digit percent year-over-year in the quarter.

Our service center team also continues to benefit from ongoing sales initiatives technology investments and greater cross-selling opportunities, which is supplementing their performance beyond underlying market demand. It's also important to highlight the strong execution of our service center team in the quarter where they levered 4% sales growth to 10% EBITDA growth, while particularly benefiting from more favorable AR provisioning over the prior year, the underlying earnings leverage was solid and highlights the team's operating discipline, ongoing cost control and effective management of broader inflationary headwinds.

Within our Engineered Solutions segment, organic sales in the first quarter finished slightly lower compared to the prior year but remain on a solid path to stronger growth. Of note, segment orders sustained positive momentum, increasing nearly 5% organically over the prior year during the quarter, with a 2-year stack trend accelerating sequentially. Segment orders have now been positive year-over-year for 3 straight quarters with book-to-bill above 1 during the quarter.

Order growth strengthened across our industrial and mobile OEM fluid power operations during the quarter. This exceeded our expectations and leaves us incrementally constructive on related fluid power sales trends moving forward.

Our fluid power team for leading engineering capabilities and customer reach are driving new business opportunities tied to mobile electrification, next-generation fluid power systems and fluid conveyance. We also believe a lower interest rate environment and tax incentives could be particularly positive for our fluid power customer base, which is primarily comprised of small to midsized domestic OEMs.

In addition, new business development and customer indications signal a potentially active backdrop across our technology vertical and discrete automation operations entering the second half of fiscal 2026. This includes an expanding position supporting the data center market with our fluid power and flow control solutions tied to thermal management applications and our automation teams providing robotic solutions supporting material handling applications.

Our enhanced technical footprint in the Southeast U.S. region, following our Hydradyne acquisition, has further strengthened our data center position and related order momentum. Demand signals across our semiconductor customer base also remain encouraging and indicate a potential greater ramp in related orders and shipments during the second half of fiscal 2026, as the wafer fab equipment cycle gains momentum.

I would also highlight recent investments we've made in engineering, systems and production capacity over the past several years that provide significant support to fully leverage these demand tailwinds moving forward. As a reminder, the technology and discrete automation verticals combined represent more than 25% and of our Engineered Solutions segment sales and could be an increasing contributor to the segment's growth moving forward based on our initiatives, growing order book and broader secular tailwinds.

In addition, our flow control team is focused on capturing growth developing within life sciences, pharmaceutical and power generation markets within the U.S. With established product portfolios and leading technical capabilities around calibration services, instrumentation, steam and process heating and filtration we are favorably positioned to win in these markets.

On a side note, our flow control backlog ended the quarter at its highest first quarter level in over 3 years, with orders positive year-over-year. Combined with relatively easy comparisons, we remain optimistic on the setup of our Engineered Solutions segment entering the second half of fiscal 2026 as recent order momentum converts and underlying end markets continue to firm.

At the same time, we remain constructive on our ability to lever stronger sales and drive greater earnings growth and EBITDA margin expansion. Our first quarter performance is a good reflection on this. Of note, we achieved 17% incremental margins on EBITDA, inclusive of ongoing inflationary pressures, including LIFO and unfavorable M&A mix.

We believe our underlying business model, combined with ongoing operational initiatives and structural mix tailwinds provide notable earnings growth levers to achieve our mid- to high-teen incremental annual margin target and continue to expand EBITDA margins in a positive sales growth backdrop. In addition, sales growth and EBITDA margin should benefit from ongoing progress developing across Hydradyne.

As we approach our 1-year anniversary of the acquisition, we are very encouraged by the performance the broader team is delivering and the potential we see ahead. Hydradyne earnings contribution continues to improve, with EBITDA up over 20% sequentially in the first quarter and EBITDA margins improving nicely from the prior 6-month trend. We are making strong progress with sales synergies and our teams collaborate and leverage innovative fluid power solutions. This includes connecting Hydradyne strong repair and field service support across our legacy MRO customer base while enhancing their value proposition by providing access to our systems engineering team and complementary product lines.

We're also tracking well to our operational synergy streams, including solid progress on harmonizing systems processes and operational efficiencies. Combined with the growing backlog and firming demand across their core end markets, we believe Hydradyne could be nicely additive to our organic sales growth and EBITDA margin trend as we anniversary the transaction into the second half of fiscal 2026.

Lastly, we remain on track to have another active year of capital deployment to further supplement our growth potential and shareholder returns. M&A remains a top capital allocation priority for fiscal 2026. Our pipeline is active with varying sized targets across both segments. This includes several midsized targets at various stages of due diligence that could enhance our technical differentiation and value-added service capabilities. In addition, we expect to remain active with share repurchases for the remainder of fiscal 2026 as we balance the cadence of potential acquisitions, our balance sheet capacity and the value we see across applied from our strategy and long-term earnings potential.

At this time, I'll turn it over to Dave for additional detail on our results and outlook.

Thanks, Neil. Just as a reminder before I begin, as in prior quarters, we have posted a quarterly supplemental investor presentation to our investor site for 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 9.2% over the prior year quarter. Acquisitions contributed 6.3 points of growth which was partially offset by a negative 10 basis point impact from foreign currency translation. The number of selling days in the quarter was consistent year-over-year. Netting these factors, sales increased 3% on an organic basis. As it relates to pricing, we estimate the contribution of product pricing on year-over-year sales growth was approximately 200 basis points for the quarter.

This is up from approximately 100 basis points in the fourth quarter and primarily reflects the effective pass-through of incremental announced supplier price increases in recent periods as previously discussed.

Moving to consolidated gross margin performance as highlighted on Page 7 of the deck, gross margin of 30.1% was up 55 basis points compared to the prior year level of 29.6%. During the quarter, we recognized LIFO expense of $2.6 million which was up slightly from the prior year first quarter amount of $2 million. On a net basis, this resulted in an unfavorable 5 basis point year-over-year impact on gross margins during the quarter.

The year-over-year improvement in gross margins primarily reflects positive mix contribution from our Hydradyne acquisition, solid channel execution and benefits from our margin initiatives as well as more muted gross margin performance in the prior year first quarter. This was partially offset by mix headwinds from growth in strategic accounts and lower flow control sales. Price cost trends were relatively neutral in the quarter.

As it relates to operating costs, selling, distribution and administrative expenses increased 9.7% compared to prior year levels. SG&A expense was 19.4% of sales during the quarter. Excluding depreciation and amortization expense, SG&A was 18% of sales during the quarter and down 10 basis points from the prior year. On an organic constant currency basis, SG&A expense was up a modest 0.7% year-over-year compared to the 3% increase in organic sales.

During the quarter, ongoing inflationary headwinds and growth investments were balanced by solid cost control and internal productivity initiatives as well as the benefit of more favorable AR provisioning resulting from our working capital initiatives and collections performance. Overall, stronger organic sales growth, coupled with M&A contribution, favorable gross margin performance and solid cost control resulted in reported EBITDA increasing 13.4% year-over-year, including over 6% on an organic basis.

This resulted in EBITDA margins of 12.2%, expanding 46 basis points from the prior year level of 11.7%, which was above the high end of our first quarter guidance of 11.9% to 12.1%. Reported earnings per share of $2.63 was up 11.4% from prior year EPS of $2.36. On a year-over-year basis, EPS benefited from a reduced share count tied to our buyback activity, partially offset by a higher tax rate as well as increased interest and other expense on a net basis.

Turning now to sales performance by segment. As highlighted on Slides 8 and 9 of the presentation. Sales in our Service Center segment increased 4.4% year-over-year on an organic basis when excluding a 10 basis point positive impact from acquisitions and a 10 basis point negative impact from foreign currency translation. So organic sales increase in the quarter was primarily driven by ongoing internal initiatives firming technical MRO demand and incremental price contribution.

Sales growth was strong across our national account base, reflecting benefits from sales force investments and cross-selling actions. Segment trends also continue to be supported by favorable growth across Fluid Power MRO sales. Segment EBITDA increased 10.1% over the prior year while segment EBITDA margin of 13.9% expanded over 70 basis points. This year-over-year improvement primarily reflects solid operating leverage and stronger sales growth, channel execution and cost control as well as more favorable AR provisioning requirements.

Within our Engineered Solutions segment, sales increased 19.4% over the prior year quarter with acquisitions contributing 19.8 points of growth. On an organic basis, segment sales decreased 0.4% year-over-year. The modest decline was primarily driven by muted sales trends during September across our flow control operations, reflecting softer project-related shipments. In addition, sales growth across our technology vertical was softer than expected in September, primarily tied to more gradual or conversions across the semiconductor market.

We view this as timing related, considering backlog trends customer indications and broader sector tailwinds, as Neil highlighted earlier. Sales across industrial and mobile fluid power markets were also lower year-over-year. However, the decline was more modest and improved notably from fiscal 2025 trends, primarily reflecting easier comparisons and firming OEM customer demand.

Sales across our automation businesses increased organically for the second straight quarter with organic growth of 4% year-over-year, driven by solid robotic solutions demand in the U.S. business. EBITDA increased 16% over the prior year, reflecting contributions from our Hydradyne acquisition as well as solid cost management, which was partially offset by modestly lower organic EBITDA on muted sales trends in the quarter.

Segment EBITDA margin of 13.8% was down roughly 40 basis points from prior year levels, primarily reflecting unfavorable acquisition mix and lower fluid control sales. That said, we expect segment EBITDA margin trends to improve as acquisition mix headwinds ease and segment sales improve. Of note, Hydradyne's EBITDA contribution continues to increase as we progress along our integration and synergy initiatives with its financial performance tracking to our first year guidance of $260 million in sales and $30 million in EBITDA with growth and synergy momentum, providing upside support into the second half of fiscal 2026.

Moving to our cash flow performance. Cash generated from operating activities during the first quarter was $119.3 million, while free cash flow totaled $112 million, representing conversion of 111% relative to net income. Compared to the prior year, free cash was down slightly, reflecting greater working capital investment balanced by ongoing progress with internal initiatives.

From a balance sheet perspective, we ended up September with approximately -- excuse me, $419 million of cash on hand and net leverage at 0.3x EBITDA, which is above the prior year level of 0.1x. Our balance sheet is in a solid position to support our capital deployment initiatives moving forward. including accretive M&A, dividend growth and opportunistic share buybacks. During the first quarter, we repurchased approximately 204,000 shares for $53 million.

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 2026 EPS guidance to reflect first quarter performance and updated diluted share count assumptions following the first quarter buyback activity. We now project EPS in the range of $10.10 to $10.85 compared to prior guidance of $10 to $10.75. That said, we are maintaining our sales guidance of about 4% to 7%, including up 1% to 4% and on an organic basis as well as EBITDA margins of 12.2% to 12.5%. Guidance continues to assume 150 to 200 basis points of year-over-year sales contributions from pricing.

Our sales outlook remains largely unchanged from the views we provided in mid-August. We believe end market trends are moving in the right direction, and we are encouraged by positive order and business funnel momentum. However, we continue to assume industrial activity remains mixed near term, and we expect our conversion across our Engineered Solutions backlog to be more weighted toward the back half of our fiscal year.

Combined with sales trends in October, we currently project fiscal second quarter organic sales to increase by a low single-digit percent over the prior year quarter with Service Center segment growth above the Engineered Solutions segment. This is consistent with the midpoint of our initial guidance provided in mid-August and implies underlying sales trends remain relatively stable in the second half of our fiscal year at midpoint.

We also acknowledge the low end of our sales guidance would imply a softening market in the back half of the year. We view this as little probability based on our indicators and performance to date. However, consistent with our typical approach to guidance, we believe it remains prudent to maintain our full year range at this early point in the year, pending greater clarity and less volatility across the macro and trade policy backdrop. Overall, we are running in line with our sales expectations year-to-date and remain constructive on our setup moving to the second half of the year.

Lastly, from a margin standpoint, we are encouraged by our first quarter performance and reiterating the outlook provided in mid-August. We continue to assume ongoing inflationary pressures and growth investments as well as $14 million to $18 million of LIFO expense. For the second quarter, we expect gross margins to increase slightly on a sequential basis and EBITDA margins of 12% to 12.3%.

I would note that we faced a difficult year-over-year gross margin and EBITDA margin comparison in the second quarter. Our prior year second quarter margin was favorably impacted by more modest LIFO expense of $0.7 million and nonroutine supplier rebate benefits as well as record performance across our Engineered Solutions segment tied to favorable mix. We expect stronger relative year-over-year EBITDA margin trends in the second half of the year reflecting greater expense leveraging and ongoing Hydradyne synergy progress as well as the potential for more favorable mix dynamics.

With that, I will now turn the call back over to Neil for some final comments.

So to wrap up, we are encouraged by our first quarter performance, including stronger top line trends, sustained positive order momentum and margin execution. We continue to have many self-help growth and margin opportunities that we expect to manifest in coming quarters and provide ongoing support levers. That said, we expect near-term sales to remain choppy, as customers balance production schedules, project phasing and capital investments into the seasonally slower fall and winter months particularly as broader trade policy uncertainty continues to linger.

Importantly, we believe the underlying fundamental backdrop within our core end markets is moving in the right direction and has the potential to gain momentum as the year progresses. Feedback and sentiment from customers is gradually improving. Demand indications are more favorable across both traditional end markets, such as metals and machinery as well as emerging verticals, including discrete automation, life sciences and technology.

We're seeing encouraging funnels across both our segments that should translate into incremental order growth as additional trade policy clarity emerges, interest rates continue to moderate and capital investment decisions are finalized. Certain U.S. industrial macro data points have trended more positive in recent months, including machinery and metals new orders as well as mining production, which have traditionally correlated well with our underlying core business. While ISM readings remain in flux, we believe the elongated sub-50 trend is positioned to move higher when considering leaner inventories and potential benefits from pro-business policies.

In addition, qualitative data points around planned investments in North American manufacturing infrastructure, and onshoring continue to broaden, while our customer service requirements are growing as they face technical labor shortages and an aged equipment base. We are well positioned to capitalize on these trends given our domain knowledge and scale across industrial facilities core capital equipment. This includes our expertise around critical motion and powertrain products in demanding applications, access to premier supplier brands and nonstandard components, nationwide local service reliability.

In addition, we have 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 are positioning our strategy and teams to play an increasingly critical role in linking legacy industrial production infrastructure and processes with new advanced applications and technologies, both now and into the future.

Lastly, our balance sheet and liquidity provide strong support to opportunistically pursue ongoing organic investment and strategic M&A in the current environment as well as other capital deployment that could augment returns for all stakeholders going forward. Once again, we thank you for your continued support. And with that, we'll open up the lines for questions.

[Operator Instructions] Your first question comes from the line of David Manthey with Baird.

My first question -- first a comment, I mean, the business seems to be tracking really well, and I appreciate the conservative guidance given the many headwinds. And along those lines, as we look forward here into the December quarter, Christmas is on a Thursday this year, which makes it kind of tough for that Friday, December 26 between the holiday and the weekend. Just wondering if you've been hearing anything from your customers in terms of holiday shutdowns as they look forward to the end of the year.

I would say at this stage, still a little early. We plan to be working. I'd say that for one. But I think many dialogue with our customers, they're starting to look at projects, planned maintenance activity out for and looking forward to the -- what they think will be ongoing demand requirements for them. So -- and we're aware of the mid-week seasonal holiday dropping in that, a little early, but I'm expecting some customers are going to be leaning in and active as they look forward at demand requirements and some others may take some time out, but that also opens up doors for additional planned project maintenance.

Dave, this is Ryan. I just would add to that dynamic is taken into account in terms of the second quarter guide that we provided as it relates to maybe some impact from the holiday timing. We do have an easier comparison in the month of December, which could balance some of that as well.

Great. I can't promise I'll be in the office on the 26th, but I'm glad to hear you guys will. Second question is, Neil, in the past, you've mentioned that inflation is manageable if your suppliers, a, increase the price as opposed to putting through a surcharge and b, give you 45 days' notice to push that through to the customer base. One of your distribution comps recently noted a compressed supplier notification periods. And I'm just wondering if you've noticed anything, any different behavior from your supplier base along those lines?

David, I'd say overall, no real difference in behavior. I would say the orderly the increases have been orderly notifications. Obviously, the team is doing a very nice job in implementing across price/cost in the quarter, equal into that side, we did see price contribution increased a couple of hundred basis points in that. We're looking at perhaps there'll be the 232 on derivative products. But I think there, some manufacturers, a few moved, and I think some others are just contemplating looking at country of origin and when that -- what the impact will be and when that will come through as a price increase. And so some will organize that for the beginning of the calendar year with the typical notice period. So I'd say overall, it continues to be an orderly environment. Teams are focused. We know how to execute, and we'll continue to do so.

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

This is Peter Costa on for Brett. So I think you had said previously that Engineered Solutions would outperform Service Center by about 100 basis points in fiscal '26, is this still something that's possible with a stronger second half? Or are you expecting a more balanced organic mix now?

Yes. I would say as we look at the second quarter, I could see service centers continuing to be ahead. And then as I look at the second half of the year, we could see Engineered Solutions with the order backlog, project conversions to be greater than the Service Centers in the second half of fiscal '26.

Yes, Peter, I'd say that, that assumption for the full year is still in line with our guidance as it relates to overall the Engineered Solutions segment around 100 basis points.

Awesome. And then maybe just on consolidated incrementals as you get Engineered Solutions comes back and Hydradyne's less dilutive. Could you actually see upside to incrementals as we go into the second half?

Yes, we think there could be the setup also a broadening of local accounts, greater engineered solutions. So I think clearly, that potential exists.

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

Can you help me understand like the orders growth has been quite good for the past few quarters in both fluid power and I think on the flow control. And my understanding is the projects, the lead times are not particularly long, maybe 180 days or less. So just trying to understand the dynamic. When these orders do turn positive and when you do convert out of backlog, are customers delaying? Because it seems like it's taken longer than usual.

No, Sabrina, I would say there's just variance in projects on the time to convert based on sometimes complexity of the project or the overall status of the project and the schedule and where we sequenced into that. So I'm encouraged by the continuous orders expansion into that. Fluid power was up nicely, 9% in the quarter. Flow control, nice order growth in as well. I think there, there is some pivot in some of the projects where previously they would add projects around carbon capture and some other activity. There's a little more around power generation, life science and pharmaceuticals, but we're encouraged that, that work will continue to be in the U.S. markets.

And then on the automation side, we had a tough comparable, plus 25% from an order standpoint last quarter, down slightly on order this side, but a 2-year stack that's over 23%. We take that as very encouraging across our discrete automation opportunities in robotics and vision. So good coming input on projects. We expect the conversion will be occurring. Some of it may sequence more in with calendar year-end into the second half of our fiscal 2026, but we've got a good pipeline to execute on.

Okay. Great. And just want to ask again about pricing. I think last quarter, the thought was that pricing would ramp through the year with Q1 maybe not quite -- like it seems like pricing came in better than what we had spoken about. Have you changed how you are thinking about the cadence of pricing throughout the year? Because it seems to me not raising the pricing guide. It seems like you're being conservative here.

I think, Sabrina, we're just early into it. We did come in at that 200 basis points. We've guided to 150 to 200 basis points. Could it develop more as we look out, I think that will be a little bit contingent on market activity and the rate of additional supplier increases at that time. So we think coming offsetting those expectations mid-August to looking at now, perhaps it's a little early to say it will ramp beyond the 200 basis points that we had in the quarter.

Your next question comes from the line of Ken Newman with KeyBanc.

Maybe for my first one. Neil, on the Engineered Solutions side, it's good to hear that the orders they are improving. I'm just curious, do you have any color on what you're seeing out of that segment through October? Any help on whether that's kind of improving from what you saw at the end of September with maybe the fall off in activity there and just confidence on the timing of the conversion of that backlog.

Yes. We continue to see good order activity. Teams are engaged and working on that order conversion and working on those projects. I would say also there is an MRO component in those businesses that we're working on. A little bit of the flow control group as they work through chemicals, perhaps there's a little bit of softness on the MRO side that played into the quarter. We expect that to continually improve, especially as we get into calendar 2026, with that interaction of customers.

And then I just think that the setup and the dialogue, and we touched on it in the remarks. I think there's greater wafer fab equipment activity in calendar 2026. We know there's increased life sciences and pharmaceutical interest on that side. Our participation in data centers continues to grow and things that we're doing in thermal management, liquid cooling, but also our robotic solutions in that.

So I'm encouraged that our Engineered Solutions business has great breadth. When an end market is shifting or changing, the teams are very focused on being where growth is occurring and positioning ourselves very nicely. So as we work through the second quarter, we feel very good about the second half of fiscal 2026.

Got it. That's helpful. And then just thinking about capital allocation, it was good to hear that the pipeline is still pretty active for M&A you did buy back some stock this past quarter. How do you think about the priority or the opportunities to put capital to work here in the second quarter or into the back half? And with automation starting to pick up on demand, is that making it easier or harder to get deals done?

I would say a few things there. Priorities remain, right? We very much are going to be focused in funding our organic growth opportunities like we have to support automation and our fluid power technology segment businesses in that. So we'll continue to have organic growth also in systems remains a priority. We are active, busy on multiple fronts. Pipeline continues to have bolt-on opportunities in both segments as well as some midsized opportunities. So we'll continue to be busy on that front.

And then we'll have other ways to return capital to the shareholders, increasing dividend as well as remaining active in share repurchase. So we think we're in a good position, continuing strong cash generation in that area. And I don't think the deal environment is more difficult in that front. We're going to continue to be a disciplined acquirer. We have clear priorities. We work to have ourselves in good positions when those opportunities arise. We say we can't perfectly control timing, but we feel good about our setup and opportunities for increased capital deployment in 2026.

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

Congrats on a nice start to the year here. I guess, first off, I'm looking at the margin guidance, calling for gross margins up a little bit sequentially, nice to see that. I guess I appreciate the year-over-year comp headwinds from rebates and mix and whatnot. But why wouldn't the EBITDA gross margin -- or excuse me, the EBITDA margin improved sequentially as well? And what are some of the maybe the sequential offsets that we should be thinking about?

Yes. I think as you get in, Dave touched on it a little bit as we think about LIFO, the LIFO expense in the second quarter last year, $700,000. As we think about LIFO this time, it could perhaps be $4 million or greater into the site. So I think that is one different point Dave touched on the nonroutine rebate that would have occurred last time. And then perhaps some of the mix headwinds, still the M&A integration is lower as it would come in for now into that front. And then I think on a little less engineered solutions in the quarter and perhaps local accounts on the service center side ramping, but ramping less than some of the national accounts will all be influences on that side.

Yes, on that, Chris, we did see some modest benefit in the first quarter. You recall we took some provisioning charges in our Q4 based on our formulaic approach with customers and a couple of payment delays, vast majority of that came back to us in the quarter. So that was a modest benefit as well that would play through to EBITDA versus beyond the gross margin step-up that we talked about.

And then I think, Chris, right, if we look past the second quarter, we feel like we've got a nice opportunity for greater expense leveraging in the back half of our year, probably increased in ongoing contributions from Hydradyne and then potentially mix benefits that we would get there of greater engineered solutions as well as local accounts as we think about the back half of the year.

Got it. I guess as a follow-up, thinking about the Hydradyne synergies, anything you can give us there in terms of is that still on track from both a cross-selling and a cost reduction perspective? Any anecdotes in terms of cross-selling wins you highlight there?

Yes. So I would say on track to deliver first year synergies. So we feel good about that, growing opportunity on the sales and the repair. So they have very good capabilities there. And so we would see it on the maintenance side, cylinder repair and other opportunities, just where we have capability and resource in an important geography and then continued progress on the work streams on the cost side, use of technology in that front, standardizing on some processes, supporting them for the internal back-office capabilities in that front, all of those developing nicely.

And then as we think about ongoing growth, they're well positioned from a data center standpoint. We think there's more we can do there and then how we support them from a central engineering standpoint, especially as fluid power technologies continue to increase around electrification in some of those electronics and controls can be positive as well on the growth side as we look forward.

We did highlight too in the comments, Chris, the EBITDA for the quarter did step up another 20% sequentially following the increase that we saw in Q4. So we continue to be pleased with the progress the team is making there.

Your next question comes from the line of Patrick Schuchard with Oppenheimer.

I wanted to ask about automation growth in Engineered Solutions. Can you contrast how much of the positive sales growth is secular market pickup versus internal initiatives and/or market share impact?

Well, I think it's still early. We got a good run rate of the businesses probably scaling nicely at $250 million or so. So we're doing a nice job in ramping. I think we are opening and serving more industrial customers opportunities with these capabilities as well as participating in some nice projects around traditional industry segments. So we expect robotics as a general market to continue to grow, and we're well positioned there, both collaborative and autonomous mobile robots into the site.

But we're also doing a nice job in the vision offering and where customers can see the benefits of quality control and inspection and what those solutions provide in there. So I think it's a combination, Pat, that we're just well positioned. We're opening up more opportunities with existing customers as well as serving traditional verticals with those companies that they had previously and growing them.

Okay. And you talked about cross-selling as an organic driver. And you've mentioned in the past these initiatives were in the early innings of getting going. So just looking for an update there, what are you guys seeing in terms of revenue at cross-selling tool overall?

Yes. I'd still say we'd characterize it as early innings. Our funnels are growing, project opportunities are expanding. Teams will be together in the coming weeks to further that planning and execution, some key suppliers there as well. So pleased with the progress. We know we have even more impact that we can have with our customers. And as the customers deal with aging equipment, perhaps an aging technical workforce, they're looking for someone to help them on broader needs, broader solutions, and we're well positioned to continue to do that.

And if I could just squeeze one more in. You talked about some of the sequential margin dynamics in the guide, but I wanted to dig a little bit deeper on the top line. You mentioned demand is stable. The engineered business had positive book-to-bill this quarter, but the guide implies the second quarter might be down slightly sequentially versus normal seasonality, up low single digits. So just kind of curious if there's anything we should consider there.

Patrick, I would say nothing different than how we typically think about it. The guide for the second quarter top line is in line at the midpoint with what we guided in August. We continue to expect a choppy environment near term, as we talked about in the prepared remarks around the slower seasonality, also earlier talking about the timing of holidays, taking that into account as well. And then just the backlog conversion of the Engineered Solutions segment, we expect that to be more of a back-half weighted dynamic. And so taking, taking that into account, but really is no change to how we view the year setting up in the original guidance that we established in August.

Your next question comes from the line of Sam Darkatsh with Raymond James.

Apologize if you mentioned this earlier and I missed it, I was kicked off the call middle of the way through. First, your end market vertical commentary was fairly similar to your #1 competitor with a couple of exceptions, which would be pulp and paper and oil and gas, which you called out as favorable and they called out as headwinds. What specifically happening in those 2 particular verticals that's conceivably allowing you to pick up some incremental business?

Yes, I don't know that I've got a great comparison contrast in that. I think a broadly energy markets seem to be active and doing well into the side. And just paper, we've got a good position, and we continue to look at how do we create value add for those customers and perhaps expand our offering and capabilities with them. But in a comparison contrast, I don't know if they had anything else to point out.

Got it. And my last question. And again, I'm sorry if you've already mentioned this. The 2% pricing that you realized in the quarter, how would that break out service center versus engineered?

Yes. Yes. Sam, I'd say relatively similar. Not a huge change or difference in the -- by segment if I had to push it one way, maybe a little bit higher in the service center side of the business, but pretty consistent.

Are there particular product categories or verticals in which pricing was more pronounced, I'm guessing product categories more so than verticals?

Yes, nothing that we would call out as materially different. I mean, it's been generally a pretty broad-based impact across the product and you're seeing inflation as well as just general price updates come through really across the board. So nothing that we would call out as materially different in one category versus the other.

So as an example, then what I'm getting at, I guess, is bearings is not like something steel related or something along those lines would not be a material outlier?

No. I mean, I think in the context of really our core products in general, a lot of steel content across all of them, particularly on the service center side. So we would not call out bearings as an overweight in terms of what we're seeing from a pricing standpoint right now.

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

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

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