Applied Industrial Technologies Signals Resilient Earnings Momentum

Applied Industrial Technologies, Inc. ((AIT)) has held its Q2 earnings call. Read on for the main highlights of the call.

Applied Industrial Technologies’ earnings call struck an overall constructive tone, with management emphasizing broad-based operational strength, robust cash generation, and healthy demand indicators despite some accounting-related margin pressure and pockets of end-market softness. Executives framed the quarter as a continuation of solid execution — particularly in automation, engineered solutions orders, and service centers — and expressed confidence that margin headwinds, largely driven by higher LIFO expense and mix, are transient rather than structural.

Consolidated Sales Growth

Applied delivered 8.4% year-over-year consolidated sales growth for the quarter, underscoring resilient demand across its portfolio. Acquisitions contributed roughly six percentage points to the top line, while currency provided a small 0.2-point tailwind. The figures show the company is still expanding at a healthy clip even as industrial demand moderates in certain pockets.

Building Organic Sales Momentum

Organic sales grew 2.2% in the quarter, but the more important story was the improving momentum through the period. November organic growth approached mid-single digits, and early fiscal third-quarter (January month-to-date) organic sales rose in the mid-single digits year over year. Management highlighted this trajectory as evidence that underlying activity is strengthening after a choppy December.

Engineered Solutions Order Strength

Orders in the engineered solutions segment climbed more than 10% year over year, marking the strongest quarterly order performance in over four years. The book-to-bill ratio remained above 1, signaling that new business is outpacing shipments and building a solid backlog. Management pointed to this as a key proof point for sustained demand in higher-value engineered offerings.

Automation Outperformance

Automation continued to stand out as a growth engine. Automation orders surged 20% year over year, while organic automation sales were up about 3%. The company underscored that customers are still investing in automation projects to boost productivity and offset labor challenges, suggesting this category should remain a structural growth driver for Applied.

Hydrodyne Acquisition Success

The Hydrodyne acquisition is proving highly accretive. In its first 12 months under Applied’s ownership, Hydrodyne generated more than $30 million of EBITDA and delivered EBITDA margins above 13% in the quarter. The business was modestly accretive to consolidated EBITDA, reinforcing management’s strategy of using targeted M&A to deepen capabilities and enhance margins.

Service Center Resilience

Applied’s service center segment showed solid resilience, with organic sales up 2.9% year over year and U.S. service centers growing more than 4%. The company saw double-digit growth in primary metals and aggregates within the service-center channel and reported mid-single-digit organic momentum in January. These trends point to steady industrial activity and demonstrate the value of Applied’s broad distribution footprint.

Margin Performance Excluding LIFO

Underneath the reported numbers, the core margin picture looked healthier than headline figures suggested. Excluding LIFO, consolidated gross margin reached 31.0%, up roughly 34 basis points from a year earlier. Cost discipline and mix supported EBITDA growth of 3.9% year over year, with reported EBITDA margin at 12.1%, still within guidance despite the LIFO drag. Management reiterated confidence in achieving mid- to high-teen incremental EBITDA at mid-single-digit organic growth.

Strong Cash Generation and Capital Deployment

Cash generation remained a standout. Operating cash flow came in at $99.7 million and free cash flow at $93.4 million, representing about 98% conversion of net income. Applied ended the quarter with approximately $406 million in cash and net leverage of just 0.3x, giving it ample balance sheet flexibility. The company has repurchased more than $143 million of shares year to date and announced an 11% increase to its quarterly dividend, signaling confidence in long-term cash flow and earnings power.

Strategic M&A and Regional Bolt-On Expansion

Beyond Hydrodyne, Applied is continuing to execute on a disciplined acquisition strategy. It announced the purchase of Thompson Industrial Supply, a roughly $20 million revenue business that expands its service center footprint in Southern California. Management indicated that additional targeted deals are likely over the next 12–18 months, particularly in engineered solutions and service-center optimization, reinforcing inorganic growth as a core pillar of the company’s strategy.

Higher-Than-Expected LIFO Expense

A key headwind in the quarter was higher-than-anticipated LIFO expense. LIFO totaled about $6.9 million versus the $4–5 million assumed in prior guidance and less than $1 million in the year-ago period. This created roughly a 54-basis-point hit to gross margin and about a 52-basis-point drag on EBITDA margin year over year. Management stressed that this impact is accounting- and timing-related, tied to inventory and inflation dynamics, rather than an indicator of underlying margin weakness.

Guidance Revision Reflecting Greater LIFO Pressure

In response to the higher LIFO burden, Applied lifted its full-year LIFO expense outlook to $24–26 million from $14–18 million and narrowed its EPS range to $10.45–$10.75 from $10.10–$10.85. The revision acknowledges the margin headwind from inventory accounting but reflects confidence in offsetting operational performance.

Seasonally Weak December Sales

December proved seasonally weak and choppy, with average daily sales falling below typical patterns. This softness weighed on quarterly volume even as trends improved into November and January. Management characterized December’s performance as timing-related “noise” rather than a structural slowdown, pointing to the subsequent pickup in early third-quarter activity as evidence.

Segment Mix and Engineered Solutions Organic Softness

While engineered solutions revenue jumped 19.1% overall, organic growth in the segment was just 0.5%, with acquisitions contributing roughly 18.6 percentage points. The engineered solutions EBITDA margin declined about 200 basis points year over year, including roughly 55 basis points of LIFO pressure. The combination of mix, project timing, and the LIFO burden weighed on reported profitability, even as orders strengthened sharply.

Divergent End-Market Trends

Applied saw a mixed picture across end markets. Several key verticals declined year over year, including lumber and wood, chemicals, oil and gas, rubber and plastics, and refining. These areas offset strength in metals, aggregates, utilities and energy, mining, machinery, transportation, and construction. The broad spread underscores the importance of Applied’s diversified exposure, which helped stabilize overall growth despite pockets of weakness.

Flow Control and Product-Specific Weakness

Flow control was one of the softer product categories, with sales modestly lower year over year, even as orders rose at a high-single-digit rate. Segment margins in flow control were pressured by lower volumes and project phasing. Management indicated that the order strength suggests a better outlook ahead as projects convert to revenue, although near-term profitability remains constrained.

Operating Expense Growth and Investments

Selling, distribution and administrative costs increased 11.1% on a reported basis. On an organic constant-currency basis, SD&A grew 1.4% versus 2.2% organic sales growth, reflecting both inflation and ongoing growth investments. The company cited cost-control initiatives that partially offset these pressures, but investors will be watching how effectively Applied balances spending to support growth with maintaining margin discipline.

Interest Expense and Swap Maturity

Management noted that interest expense will rise in the second half of the year following the maturity of an interest rate swap in January. This headwind will partly offset EPS benefits from a slightly lower share count and a reduced tax-rate assumption. While the impact is manageable given the company’s low leverage, it is another factor weighing modestly on earnings growth.

Forward-Looking Guidance and Outlook

Looking ahead, Applied updated its fiscal 2026 outlook to reflect stronger top-line expectations and higher LIFO expense. The company now projects sales growth of more than 5.5% up to 7%, improved from its prior 4–7% range, and expects full-year organic sales growth of 2.5%–4%, with the midpoint around 4%. Pricing is now expected to contribute roughly 210–230 basis points to year-over-year sales. EBITDA margin is guided to 12.2%–12.4%, essentially unchanged at the midpoint despite the larger $24–26 million LIFO headwind. For the third quarter, management anticipates low- to mid-single-digit organic sales growth, gross margin in the low-30% range, and EBITDA margin of 12.2%–12.4%. Inorganic M&A and FX are expected to add about 50 basis points to growth in the back half, and the outlook assumes a tax rate near 23% and excludes potential future deals or additional buybacks.

In sum, Applied Industrial Technologies’ earnings call painted a picture of a company executing well in a mixed macro environment, with strong orders, solid organic momentum, successful acquisitions, and robust cash generation underpinning a constructive outlook. While elevated LIFO expense, uneven end markets, and higher interest costs are tempering near-term margins and EPS, management’s confidence in margin recovery, disciplined capital deployment, and continued M&A suggests that the long-term growth and profitability story remains firmly intact for investors watching the name.