Q3 2020 Earnings Call
Vision the conference call, we use non-GAAP financial measures explained in our press release and supplemental presentation, which are subject to the qualifications referenced in those documents.
Today's teleconference is available to the media and general public as well as to analyst and investors because the teleconference and its webcasts are open to all constituents in prior notification has been widely and Unselectively distributed all content of the call will be considered fully disclosed.
Our speakers today include Neil Schrimsher, Applieds, President and Chief Executive Officer, and Dave Wells, our chief.
The financial.
With that I'll turn it over to Neil Thank you Ryan and good morning, everyone. We appreciate you joining us and hope everyone is staying safe and healthy during this time.
With Cobot 19 top of everyone's mind I want to start with a summary of how applied is responding and what we're seeing across our business as a situation continues to evolve Dave will follow with a summary of our financials and some specifics on our third quarter and outlook and then I'll close with some final thoughts.
Yes.
First and foremost I want to think are more than 6000 associates as well as our customers suppliers and other business partners for their continued effort and support.
Our top priority. During this time is there well being and we have implemented various actions across our operating facilities reinforce our longstanding focus on the safety health and productivity of our organization.
We've taken steps to enhance sanitation and preventative maintenance protocols in our facilities and offices.
As well as promote social distancing restrict travel stagger work hours and institute remote working when possible.
We have a cross functional task force to ensure we make decisions using the most up to date information from the CDC and other authorities.
We're also leveraging our internal HR communication and I T systems, and finding new ways to collaborate and lead during these times.
I'd like to recognize all associates that have made a swift and effective adjustment their ongoing support and dedication is what our one applied culture is all about and is.
Allowing us to proactively and effectively respond across many essential industries, where we play a vital role and keeping the industrial supply chain running effectively and productively.
Were classified as critical infrastructure and our facilities remain open as they continue to support our customers, while adhering to health and safety guidelines.
We're also seeing sustained demand levels across various industry verticals, such as food and beverage agriculture pulp and paper infrastructure power generation life Sciences and technology.
With more than 50% of our service Center network demand tied to break fix requirements essential customers within these verticals are depending on us for critical parts services and solutions as they sustain operations and support vital areas of the economy.
For some customers the current slowdown is driving incremental maintenance on their direct production infrastructure and flow control systems given extended downtime.
And we remain a valued partner in supporting their engineering and maintenance teams in addressing any related needs.
We've also had minimal supply chain constraints to date with fulfillment at our distribution centers and local service centers remaining efficient, though we're keeping a close eye on it.
In instances, where customers are restricting facility access our sales teams are utilizing virtual selling and other communication platforms to understand our customer requirements and execute accordingly, as well as providing support through our applied dotcom channel.
This is also a time when we are reengaging with infrequent customers and identifying new opportunities as we've discussed in the past applieds value proposition has expanded in recent years, reflecting investments in our leading fluid power and flow control solutions as well as complementary.
Consumables and emerging automation platforms.
Our service capabilities and cross selling opportunity is the greatest in company history. Our tenured team has experienced passed down cycles and now focuses on establishing a stronger foundation for greater market share potential once a recovery unfolds.
It's also important to reflect on what applied has accomplished in recent years to optimize our operational.
In addition.
This includes investments and initiatives that enhance our systems talent processes analytics and leadership across the organization.
While we understand the challenges the current environment is presenting I believe applied has never been in a better position to manage through this.
And exit this pandemic driven downturn and an even stronger position as the overall macro economy eventually rebounds.
That said in the near term, there's considerable uncertainty as it relates to the scope and duration of the impact of Cobot 19.
We'll have we'll have on the industrial economy and our industry.
We are monitoring the situation closely as it evolves.
Prior to March our sales trends reflected an ongoing sluggish industrial environment as we had expected following a slower start to the year.
Demand weaken further however, during more arch as the cobot 19 impact became more prominent.
March organic sales declined in the mid teens percent year over year on a day's adjusted basis.
During April organic sales are trending down high teens percent year over year as we continue to see more customers announced temporary facility shutdowns idle equipment limit production and deferred projects.
This has been most notable in heavy industries and OEM end markets.
While we're hopeful April may will present trough periods for this downturn, our visibility remains limited and uncertainty exist around the trajectory of recovery in coming quarters as society adjusts to new realities.
As such we are proactively adjusting cost to manage to this new environment and prepare for potential ongoing headwinds in coming quarters.
Various cost measures have already been implemented.
In addition to the actions discussed earlier in our fiscal 2020.
These incremental actions are designed.
To further align expenses and support liquidity, while remaining agile to respond quickly once demand starts to recover.
Dave will provide more detail on the cost measures in a moment, but as our history in recent results have shown.
We understand our requirements and know how to manage through the cycle.
We also ended March and positive liquidity position with over 165 million of cash on hand, following our strongest third quarter of free cash generation today.
As well as approximately 250 million of Undrawn revolver capacity.
While our net debt is down over 20% from last year.
We're closely monitoring or working capital and are focused on driving additional cash generation in this our fourth quarter.
Overall, our cash centric and adaptable business model provides financial flexibility in the current economic environment.
Our capital of the Polymet priorities will remain prudent near term with a focus on supporting liquidity opportunistically, reducing debt and sustaining our dividend payment.
We continue to view acquisitions this quarter, our growth strategy overtime and remain active with our pipeline.
We understand these are times when valuable relationships are reinforced in may and we remain focused on the right opportunities to further scale our value proposition when the timing is most ideal.
At this time I'll turn the call over today for additional detail on our financial results and outlook.
Thanks, Neil Good morning, everyone before I begin a reminder, that a supplemental investor deck recapping key financial performance and Cobot 19 related talking points is available at our Investor site for your additional reference.
To provide more detail on our third quarter consolidated sales decreased 6.2% over the prior year quarter.
Acquisitions contributed 1.9% growth, while an extra selling day was a 1.6% positive impact.
This benefit was partially offset by an unfavorable foreign currency impact of 0.2%.
Netting these factors sales decreased 9.5% on an organic daily basis.
Looking at our results by segment as highlighted on slide seven and eight sales in our service Center segment declined 8.9% year over year or 10.9% on organic daily basis.
Lower industrial production activity and related MRO needs to continue to cross the majority of our service and our customer base into the quarter and this was subsequently compounded by idled production and customer facility closures during March as Cobot 19 precautions unfolded.
Within our fluid power and flow control segment sales increased 2.6% over the prior year quarter with our August 2019 acquisition of Olympus controls contributing five points of growth.
On an organic daily basis segment sales declined 6%, reflecting lower fluid power sales within industrial OEM and mobile off highway applications as well as weaker flow control sales from slower project activity.
As March played out against the emerging Cobot 19 crisis, we saw a customers reduce or hold production and trim capital spending.
This adverse impact was partially offset by fluid power sales growth within the technology and market during the quarter.
Moving to margin performance as highlighted on page nine of the deck adjusted gross margin of 29% was largely unchanged year over year.
Adjusted results exclude non routine expense of $3.9 billion related to business rationalization in our service Center segment.
Included in adjusted gross margin was approximately $2 million of noncash LIFO expense, which compared favorably to prior year LIFO expense of $3.6 million, resulting in an approximate 20 basis point positive impact year over year.
Excluding LIFO adjusted gross margin was down 15 basis points year over year and unchanged on a sequential basis.
Gross margin performance was in line with our expectations and reflects solid execution, considering greater topline headwinds ongoing inflation and slightly unfavorable mix.
Turning to our operating costs on an adjusted basis, selling distribution and administrative expenses declined 3.3% year over year, excluding $2.1 million of non routine cost in the quarter.
These cost includes severance and facility exit costs in our service Center segment, reflecting additional cost actions implemented in response to the weaker demand environment.
Adjusted EPS DNA expense declined 7.5% on an organic per day basis, when adjusting out operating cost associated with acquisitions.
Our team continues to display strong operational discipline in the current environment, including sustaining results from previously announced cost actions, while swiftly executing on additional measures in March as we begin to face weaker demand.
We remain highly focused on managing costs into our fourth quarter and beyond given the current environment.
Additional initiatives implemented in the quarter include restricting TNT overtime temporary labor and consulting spend.
In addition personnel spend is being rationalized with staffing alignment to near term demand, including reductions in force freezing of new hires implementation at furloughs and pay reductions and temporary suspension of the company's for a one k. match.
While material and difficult. These actions were taken across our organization and include a mix of both structural and near term actions, which can be quickly adjusted as we assessed the evolving demand environment in balance necessary cost alignment with execution on our strategic growth initiatives and requirements to re.
Ramp and effectively respond as a recovery eventually unfolds.
Adjusted EBITDA in the quarter was $75.9 billion compared to $84.6 million in the prior year quarter, while adjusted EBITDA margin was 9.1% or 9.4%, excluding noncash LIFO expense in the quarter.
On a GAAP basis, we reported an operating loss of $2 in 14 cents per share, which includes a noncash goodwill impairment charge of $131 million and $6 million previously referenced nonroutine cost on a pre tax basis as well as a $1 billion nonroutine tax.
Benefit related to the recently passed cares Act.
On a non-GAAP adjusted basis, excluding these items, we reported earnings per share of one dollar and two cents compared to one dollar and 16 cents in the prior year quarter.
The noncash goodwill impairment charge during the quarter is associated with our fiscal 2018 acquisition of FCX performance.
Given overall declines in the industrial economy, including ongoing softness across a number of our flow control end markets. We have lowered near term growth protections projections for this business unit, which drove the impairment.
Despite softer end market demand near term, we remain positive on our flow control platform and growth opportunities over the intermediate to long term.
Our strategic rationale for this acquisition remains firmly intact and we continue to execute on our five year synergy plan as we initially laid out.
This includes cost synergies already realized that have supported margin accretion in recent years as well as sale synergies tied to various cross selling opportunities expansion of service capabilities improve sales productivity and geographic expansion.
We are still in the early innings of the sales synergy potential across our flow control operations as we continue to execute on our five year plan.
I will move on now to an update on our cash flow performance and liquidity during the third quarter cash generated from operating activities was $64.7 million.
Free cash flow was $60.5 million or approximately 153% of adjusted net income.
Year to date free cash flow of $153 million represents 135% of adjusted net income and is up $65 million from the prior year comparable period.
Year to date cash generation highlights the continued contribution of our working capital initiatives and the counter cyclical cash flow profile of our business model.
Following our strong cash performance in the quarter, we ended March with over $165 million of cash on hand, with 80% of that unrestricted us held cash.
Our net debt is down 20% over the prior year with total debt outstanding down $120 million since early 2018.
Net leverage stood at 2.5 times adjusted EBITDA at quarter end similar to end of calendar 2019 levels and below the prior year period of 2.8 times.
We are in compliance across our financial covenants with cushion at the end of March given a maximum net leverage ratio covenant of 3.75 times EBITDA.
Combined with approximately $250 million of Undrawn revolver capacity, an additional $250 million accordion option and $100 million of incremental capacity on our uncommitted private shelf facility, we remain in a positive liquidity position.
Dialogue with our lending partners remains active and constructive highlighting available funding support and keen understanding of our industry position and flexible business model.
We have no material debt maturities until fiscal 2023, and make regular amortization payments on our term loan, which equates to approximately $10 million a quarter.
We also have a $40 million private shelf placement notes coming due in July, which we intend to refinance with our shelf capacity or extinguished with available cash depending on the market backdrop, and our working capital initiatives in coming months.
We have taken and we'll continue to take precautionary steps to maintain ample liquidity and drive additional cash generation into our fourth quarter, while opportunistically, reducing debt in the near term.
Actions include cash savings from the cost made essential capital expenditures leveraging our shared services model to optimize collections.
Inventory initiatives.
We're also conducting robust analysis and cadence to review our model across various sales margin and working capital scenarios.
This will support agility and timely response as the environment continues to evolve.
As it relates to collections performance has remained in line with our expectations April to date, and we will continue to manage appropriately.
Transitioning now to our outlook as noted in our press release, we have withdrawn our fiscal 2020 financial guidance due to the evolving and uncertain impac.
We will reevaluate guidance and our long term financial targets in coming months as we fully assessed the impact ahead and continue to respond and execute cost actions and liquidity initiatives necessary. We will provide additional color on sales and margin trends in the coming months in an effort to support transparent.
And your modeling assumptions.
To provide some more direction into the fourth quarter, assuming the level of April organic sales declines continue into May and June it decremental margins is an appropriate benchmark to use near term.
In addition, we remain constructive on our cash flow.
Just on our ongoing initiatives cost actions business model response and April trends.
Yes.
With that some final comments.
Thanks, Dave Okay.
Complicated at the moment and we face new challenges given the environment I firmly believe.
And our company's position and for as markets rebound.
Yes.
Accountability.
Continuous improvement.
Innovation and the way I'm proud of and grateful for how our team has.
Has responded and we remain committed to being the solution to our customers needs and challenges.
We have a remarkably strong business model that generates downturns history highlights this and recent operational initiatives reinforce it.
As the industrial economy begins to recover we will be ready to leverage our capabilities and support customers.
Early cycle growth requirements as industrial equipment and facility infrastructure ramps following an unprecedented.
And maintenance deferrals.
And across our network.
Yeah.
We will respond swiftly with local expertise and the most comprehensive suite of motion control.
Within our industry as well as it applies history believe behaviors reshaped by that pandemic will reinforce.
First secular growth opportunities tied to our technical service folio, which has become a greater portion of our business in recent years.
In particular, we believe customers will increasingly focused on addressing skilled labor constraints.
Plant.
Requirements.
While considerations around manufacturing reassuring and us industrial infrastructure have potential to gain momentum.
Ultimately this can accelerate customers outsource needs investments in automation and the consolidation of market share towards leading distribution platforms, giving increasing service operational and capital requirements.
We've made targeted investments in recent years to position the company as the leading distributor of technical solutions across the industrial supply chain.
This is differentiated our value proposition one in which we believe will be ever more relevant as the industrial economy starts its next phase of growth.
Once again, we thank you for your continued support and wish you all the best during this time stay well stay strong and with that we'll open up the lines for your questions.
Thank you we will now begin question answer session. If you would like to ask your question. Please pick up your handset Press Star then the number one on your telephone keypad.
If you would like to withdraw your question from Macquarie. Please press the pound Q.
We'll pause for a moment to compiled acuity roster.
Your first question comes from the line of David Manthey from Baird. Your line is open.
Good morning, Hope you guys are well.
Doing well doing well in the.
And the conference room here socially distant said.
12, three six or nine o'clock.
Good to hear.
So.
Mid teens decline in March that seemed a little outsized relative to both.
Other industrial distributors as well as the high teens declines you're seeing now in April I'm, just trying to understand if you started seeing the cobot impact earlier or more acutely and then secondarily if theres any implications for what we should expect during are coming out of the crisis.
So we think.
The impacts place started to show middle of Middle of March and for US more prominent in the heavy industries as they look to adjust and I think some made some adjustments to in that time period around covert 19 and also.
Make adjustments if their end markets, they were seeing slowing and adjust capacity to it. So I think that's where we've seen.
The most impact in our service center side of our segment and with that we're seeing a lot of activity and many of the essential industries that that we called out in the in the remarks.
So while while fluid at this time, we do think this pause. This idled production. These downtimes will create a lot of opportunity as we start to work out of it starting obviously with the early cycle industries in customers and then heading towards the mid cycle.
Okay. Thanks again.
I coming out of the the downturn I would assume service center revenues will rebound ones production starts backup treatment of break fix sales, but could we see timberland power and flow control staying lower for longer as.
Capacity utilization has freed up here with the with the economy, turning off and a lot of companies planning on cutting their capex at least for the remainder of this year what are your thoughts on that.
So at this stage.
I'm not convinced yet of a lower for longer around those customer segments.
They too are pretty well diversified and we think about some of those inside in segments like a technology and pharma and life science with those participations.
The flow control business was also heavily involved in.
Paper industries and such so.
There's a lot of good activity and if I think about flow control also.
We're probably at our highest level of shared pipeline of targets and quotes going on across the business right now.
Hey to be determined with customer.
Back in working and access to ship some of those units as they come back in and open back up. So we are finding ways to stay virtually connected worked with our customers physically when required and in their operations and then remotely as needed and the engineering exchanges.
So going on at a a good productive level with customers and so I've been impressed.
With our action, but also with our customers in the level of exchange in the project work that's going on people are wanting to find ways to stay active and productive.
Thanks Neil.
Thank you.
Your next question comes from Milan of Chris Dankert from Longbow Research. Your line is open.
Hi, good morning, everyone.
I guess, if we could dig in a little bit on some of the cost cuts. It sounds like the majority of that is kind of temporary reacting to the shock. We've seen here I guess just any quantification on.
How big those costs are what you see to kind of get into more structural costs. Just if we can kind of build that conversation out a bit.
Good morning, guys. This is Dave Thank you.
Going to quantify numerically the impact that we expect from those cost actions I would say that 75% to 80% of those are temporary in nature. So that we are able to flex and respond as we see the business come back and we'll continue to evaluate those actions temporary nature as we move through the quarter.
I would add that you given the the insight that we provided on the decremental margin expectations of high teens for the fourth quarter, you can somewhat size the cost actions accordingly, but we will continue to remain cost accountable managing the business.
To the near term as we call it.
And so I'd say Chris.
You know at this stage really.
Temporary by design and that we want to maintain the flexibility.
To be able to respond to customer needs quickly and so we have a geographic footprints that dispersed in close to these industries. So I'd say.
By design in that.
Obviously its tiered.
My participation.
Should be higher it is but I'm also pleased our our board of directors are participating in a reduction in their cash retainer in the quarter and and so those are a we think the appropriate temporary adjustments we need to make for where we're at in this environment and then we'll see what the type of recovery.
It looks like but we made appropriate adjustments as we started.
The fiscal year, two lighter volume reductions in activities, if I look back in our past we've done the same so we we will in this one I think the appropriate actions are the temporary ones, but as Dave.
Laid out the those do have some consequences to them to individuals and.
Appreciate that teams response across the business.
Yes that makes a lot of SaaS extra color guys.
I hate to focus so much on on the short term, but I guess is there any significant divergence in performance April 1st date fluid power and flow control versus the service Center business men are they both yes down in a similar amounts just any color there.
I would say the collective service center business and everything that's included would approach.
The down 20, and then the a fluid power and flow control in the mid teens high teens in that area, if I think about.
FCX in that may be running a little better maybe more mid teens right now and so.
That is encouraging also.
Got it thanks, much guys I'll hop back in Q.
As a reminder, in energy you ask your question. Please.
Pick up your handset press star one the number one on your telephone keypad. Your next question comes from the line of on them almost from Cleveland Research. Your line is open.
Oh.
Hi, guys. Good morning, hope everybody is saying healthy.
Dave I, just wonder if we could just expand the discussion that that more on your working capital aspirations I.
I guess just here in the near term, but maybe over the.
The next three to six months that understand everything's fluid with the the pace of revenues tough to determine but.
Any kind of rough ranges that you could provide us on on how you think you could manage inventories and.
In receivables and.
My second question then would be.
Related to that I know everybody is asking for an extended terms.
Are you seeing that with your customers and how are you addressing that thanks you bet. We're just you can't walk through those here again very pleased with the results in Q3, our strongest third quarter of cash generation in history I.
Thank you know we continued to show the benefit of our working capital initiatives, we've talked about those on prior calls in this area around the the shared services efforts on the collection side the business as well as the cross functional engagement on continuing to rightsize inventory levels. So that certainly was a benefit as we work.
Q3, if you look historically in this business.
We've we've had cash flow during downturns that you did pace, our our EBITDA so that would be our aspiration, assuming like we've said the continued down.
Hi teens.
We're seeing in April and with the benefit of the cost actions that we've rolled through and some further reduction in working capital as we move to Q4, we would expect our Q4 cash flow to outpace what we saw in Q3 and then Adam.
As it relates to the customer side I mean, obviously for US right. We know our sources of cash we know higher uses of cash we know what our customers want and it and expect really from us to be there for them.
With the right inventories the right service model in the in the break fix MRO and pay we perform a.
A critical function to them and so I will say that as a no discussion no no pressure as it goes through but we are essential to keep them up and running during this time I think that's that's recognized in that so a we will appropriately manage through it if I look back to other cycles, we have.
Strong history of doing that and I expect we will continue to do that in this environment.
Great. Thanks, guys.
Your next question comes from the line of Michael Mcgarry from Wells Fargo. Your line is open.
Good morning, everybody I was wondering if not.
I could just touch a little more on the margin framework with and.
Good.
Fluid power and service center.
There are large divergence and margins similar to that of what you're seeing on the topline the between the mid teens and then 20% in service on it.
No significant margin divergence.
You do so slightly better margins on the fluid power flow control and that's part of the accretive mix up benefit that we've talked about as we continue to grow in those expansionary areas, but yes, we've not seen any change in that trend as we move to the most recent quarter. It would not expect that trended changes we continue.
Into Q4 and beyond.
I'd say both segments I'd say, both segments and teams are doing.
The appropriate the right job of being focused on.
Point of sale, both groups have mix opportunities around service and repair, but but also the the customer and product mix that we have in the area. So all have a appropriate focus I think it's showing well in the quarter and really get those are kind of what we expect.
In this coming quarter.
As we said earlier.
Okay. Appreciate it and then obviously the games changed here you guys had some pretty big both organic and inorganic growth opportunities.
Opportunities.
Wondering what signpost will guide posts do you need to see to dip your toe back into the water for bolt on M&A is is that a market based a function or getting to a certain leverage target that maybe different than before can you just comment on that.
But I'd say, one I mean, we have a work in activity going on now with various shelters in place right creates distance. So it's a little harder to have some of those closer dialogue and diligence items that would be occurring in that time period. So we'll see when those when those.
Ease up.
A little bit in going forward, but.
Right now.
We're focused on running and operating the business very well.
It will generate a cash for us to to those priorities in time.
I would expect we will be active and.
In the game and as I think about our longer term objectives. We asked for 23, we still think we still believe those hold now we will get into determining what does it mean on on the timing and we'll work through the quarter and I expect that we will be providing input on those.
In the August time period, I think there absolutely the right objectives.
The company My view will accomplish those and that all year as we've discussed even likely higher levels in time.
So I will let this thing play out we will deal appropriately in the near term I think as we come into ending the fiscal year and and looking forward, we'll provide more commentary on what we expect.
Those to be over.
Over the three year horizon, and perhaps a little longer.
Okay.
Talking next weekend at our conference.
Very good.
Hey, thanks.
Your next question comes from the line of Joe Mondello from Sidoti and company. Your line is open.
Hi, everyone. Good morning.
Morning, Joe.
So I was wondering in terms of the reopen of their economy.
What you are seeing and what you have right at your what you can see at this point in time do you do you have any visibility to say the April is gonna be sort of the worst month.
I would say in that no not not perfect visibility.
Visibility to that and so we'll april or may be kind of that trough period, I, we already there, but it but it extends it extends on I mean, we know about a 75% of our customers are deemed more essential in that if we think about certain segments of the.
You know that we went through and in food and beverage in life Science and technology. The though there's a good segment of our business base, that's running highly productive and the news geographic variances that would go on on the various shelter in place and perhaps how certain companies.
Interpret those are where their AD in their own demand cycle I do suspect there will be some increased activities as states come back on and open up their economies. Some more from local accounts in doing it if I think about our national account type business I would say, we would have maybe 10 to fit.
18% of those that have either idled capacity, you're dealing with a temporary type shutdown in up how will that play out in may and beyond we'll see but that's kind of the level now and so I think.
April or may could look like a little bit of April today, we'll see.
And then I think we all will be rooting for improvements from the June period on but I think thats to be determined.
Okay and then in terms of your energy exposure could you talk about how you're looking at that end market, specifically compared to 2015 16, how that compares I mean, it feels a lot worse.
Not to think that we thought that it could have gone not worse, but it seems like it has but what is your what is your general feeling just given what your conversations are like with your customers. Yeah. So I'd say overall for US right is still now less than 7% of the overall business with our teams in locations.
We are having.
The right exchanges and dialogue with customers were making appropriate adjustments.
To the business model, we're positioned well we have made the determination to look at where we had some maybe additional locations in sites or coverage to combine some of those and so now that is in a in the quarter a little bit in results in activity.
He's so we'll continue to rightsize the business to the current environment and then stay prepared for when it when it starts to improve and so with the the position we think a between Permian and Anadarko.
We are positioned we have coverage we're in the in the right locations I don't think it stays at this level per watt for for a long along awhile, but for us the still less than 7% of the overall.
Okay, and then I wanted to ask a question on gross margins historically, even in downturns, you're able to I guess just your business model is able to performed quite well in terms of gross margins.
You know maintaining them your business has changed a lot over the years, specifically with fluid power and flow control. So could you number one described any risks at all that your always concerned of going into a downturn regarding your gross margins just in general and then more spin.
Typically how the gross margins change.
So I guess I know you don't define the gross margins on a segment segment level, but maybe you can just talk qualitatively on how fluid power flow control differs a little bit are there more fixed costs would it be a little more you do you see anymore operating leverage at the gross margin level at that segment.
Thanks.
Yes, so any historically to your point, we've done a very nice job protecting margins during downturns I think you quite frankly, given the the mix evolution you guys. The business continues to grow assemblies expansionary products, namely fluid power flow control as you point out.
I think that even in you better as our opportunity to be able to protect those gross margins.
During the downturn. So pleased that we saw here again flat sequential margin performance actually flat in terms of our gross margin year over year in the most recent quarter.
As we've talked as I mentioned to Chris a slight.
Slightly higher gross margin contribution out of those fluid power and flow control businesses in there you would see a little bit more.
As DNA support did just given the engineered.
Pointed to that business, which here again those are addressed with the the additional cost actions in terms of furloughs and some of the salary reductions to help manage overall operating margins so more than ever I like with the tools that we have our disposal with the systems investments we've made and.
The critical break fix nature of the the product in the business and the value add two we provide the customers our ability to actually protect margins again through this downturn.
Okay.
I'm sorry go ahead.
No I was just got it.
All right I summarize is going to add and I think we discussed it right as we think about.
You know margins in the current quarter, perhaps there at a level may be slightly slightly lower in it.
In the fourth quarter.
But we like the opportunities that we have and I think on the service center side.
This continued work around point of sale I think around the product mix. We are finding our way in this time right a little bit more consumables coming in and we know those have a.
Positive mix up.
As we go through as the various shelter in place goes on is open back up and more local customers open back up right that will get us back and running so to be determine how that mix plays out perfectly in this quarter and that's why we think maybe.
Theres a little bit of its at the same level or maybe just slightly down in that and then on the fluid power and flow control side. If you think about the margin opportunity for customers and in this environment theres going to be more service requirements theres going to be more people looking for repair opportunities in.
In that and so that will create work and mix opportunities.
For those that business segment in those businesses in it for us going forward.
Hey, Joe This is Ryan just wanted to add.
A little bit on that if you think about the LIFO as well has been a headwind for us still.
As it relates to our fiscal 2020, and so certainly we will depend on the direction of inflation, but that that could certainly start to ease even more so into our fiscal 21, and then if you go back and look historically the way the gross margins have performed during downturns, you're correct in saying some ism some nice resiliency there I think.
Part of that is a reflection of where we play within the supply chain as it relates to break fix products and solutions as well as technical solutions I think theres certainly a more critical aspect to what we're doing there that allows us to manage the inflationary.
And overall gross margin dynamic during downturns.
Okay, great. Thanks, I'll hop back in queue. Thanks.
Your next question comes from the line of Steve Burger from Keybanc capital markets. Your line is open.
Morning, guys.
And Steve warning.
Im curious how the competitive environment may have changed are you hearing about stress from smaller competitors are you seeing more inquiries as people think about going to channel partners with more scale are staying power.
Well I think our customers and even in the early to mid March and the various shelter in place. We they have key customers are put in the put in the calls and want to know what that meant for our business and a we were able to answer a across our operating platform.
Hey were deemed a critical infrastructure, we're here to serve essential businesses and we've operated continuously in that and if you're just in a certain market or geography, I could get it's a little bit more stressful I mean, we've talked about the times I mean working through cycles depend.
Moving on where you're at end stage of business can all be a challenge in doing it so.
Perhaps it's a little early for all of that but hey, no doubt Theres Theres stressors in the stressors in the economy, there stress stressors in the supply chain a little bit right now.
But a we've weathered through these before and we're operating effectively and efficiently right now.
Yep, just thinking about some of those stressors in the supply chain and you already addressed some of the split our people talking more about re shoring or localizing and are you seeing more inquiries or conversations about robotics or automation.
So.
Talk about the re shoring up on that one I'm going to say, yes, and so Jeff just in the short term right. As you think about in North America as countries make different interpretations on essential industries and timing and who's in who's out that's creating some movement of production and.
Capacity that goes on as you think about.
Asia markets or India, right as a shelter in place for a period of time I don't know that there's great finished products that come.
The U.S., but there would be components that would get worked or go into items now where we're at now and transit on water I think everyone's fine if that plays out longer that will get considerations do people make changes in their capacity models and and decide to do more in the geographic.
Markets are serving I U.S. and North America, and then as we think about robotics, yes, and so whether that be in a material in logistics and people wanting to stay running an operating and be able to have cobots to create a.
Some additional social distancing in space of that workforce and I think it's going to come in more and more to some of these other essential industries people are going to be more open to having that dialogue and we're working on those type projects.
We were in a reviews with the team on Monday, and I'm very impressed with the projects in the pipeline Thats going on the technology collaboration that's going on in those businesses and the types of projects, they're involved with and some of them are related to a co vid support industries.
And projects that are going to help in this recovery. So a all of those are encouraging.
You'd expect to start monetizing some of those opportunities as you go into Fourq you given that quickly.
To be determined on for Q I think as we think about that business.
They are probably essentially flat would be my started to say, how they're going to do up by challenging them to be a little better if they're on the line, but that's how I'd think about them in that because they've also got to work with customers on delivery of some of those projects and receipt. So they've had some of those customers put in.
More restrictive delivery requirements or perhaps they're down for a period of time and they're receiving areas. So is it as fast as Q4, maybe not I think clearly as we turned the corner and go into our new fiscal year, I think more and more of those play in.
Right and then last one from me, Dave your comment to managing the high Teen decremental and if you broke trends come in for the full quarter is that based on what you can see and and control in the model right now or based what you've seen from the business in past downturns.
That's a combination of looking back at what we've done historically and then looking very carefully what we're seeing now and projecting Steve for the balance of the quarter.
I think you hear again to the investments we've made we're better positioned to be able to demand each the to cost base appropriately.
Given the kind of the both the systems investments as well as the you the shared services model. We've deployed in many cases and elements of the business. Thank you all that just makes us better positioned to be able to react and MH those high teens decrementals.
And started I think David I'd say that I'd, just say the business and the team I think.
We're very responsive and proactive in okay, seeing what's coming and making the appropriate adjustments. So I think in the today's points a little bit of okay history, but we're not relying on history, it's really.
Actions that have been taken that to.
Build those comments.
Understood. Thank you.
Your next question comes from alone.
Garo Norian from Palisade capital management your line is okay.
And now I know that for several years, you are talking about increasing kind of safety products and building up that vertical and it was just curious how that has helped there yeah. What's done for your during this period.
Yeah. So as a goal we would see as a category for US overall is placed still a low single digits, but we would see growth in that and so as we provide a expanded consumables to to our current customers. We are rounding out that offering our vendor man.
Managed inventory specialists, depending on geography, or finding the ways to stay active some with the appropriate safety in precautions on site I think the teams also developed a some nice virtual tools that they can do that and have someone that's in the facility actually electronically do that have been Phil and it waves into.
Our system. So it has contributed and I think our teams across service center networks and other side of our businesses have been resourceful to help our customers deal with.
Jan San issues hand, Sanitizers in those so it has contributed and I would expect that it would but it's still in the overall for us in that low single digits type portion of the product mix.
Thanks, and then I don't recall off and what your guys exposure might be into the aerospace chain, but if you could talk about what it maybe now and then also strategically as that industry is likely to.
The challenge for let's say the near to intermediate term, but that still has a attractive arguably long term outlook.
Be curious about your thoughts of yeah potentially using this period, maybe expand more into that that end market.
Yes, So Garo force a overall now.
It's a small participation that we have as we go into the planning cycle and with our locations in their regional management will have some of those dialogues, but I expect over the mid term it it likely for us stays at that.
Perhaps a growth area could be if we find or believe we have some automation contributions to add in the into this space, perhaps that would be one but.
To date, it's not a very significant for us as a participating segment.
Great. Thanks very much.
And final question when it comes from the lowering of Joe Mondillo from Sidoti and company. Your line is open.
Hi, guys. Just two quick follow up calls and they're both accounting related questions on the tax benefit related to the cares Act I was just wondering what that is related to.
Yeah that was the ability to recognize a pre acquisition you carry forward losses related to the FCX business with the provisions, including the X. about a million dollar tax benefit for us in the quarter. If we did strip out and as a unusual item in the adjusted results.
Okay, and then also the impairment write down related to FCX not totally surprised that I I imagine other companies are going to start writing down goodwill in a similar fashion.
The bigger surprise to me, though was how early you're writing it down and then I always thought this was a sort of an end of year.
In addressing the end of year kind of thing so what what caused you to have to do that.
We have a January onest test date for goodwill impairment.
That said the business as we've talked in prior quarters has seen some softness creep in related to some of the the project spend as the overall industrial economy has slowed particularly with the exposure to metals and some of the other.
Industries that FCX plays in thank you know it is really matter. If you had taken a realistic look at the you know how quickly that recovers and certainly against you at least as you do these acquisitions of distribution businesses very asset light you're carrying a higher level of goodwill then you potentially a.
Manufacturing business, you know just thinking about the shape of that recovery and you know certainly exited in a in the script you very still optimistic in terms of the intermediate and longer term growth potential as we continue to work the that cross selling opportunities expand into service capabilities et cetera.
But being prudent in terms of that that likelihood and shape of that recovery how quickly that bounces back in the pressure that put on the model in the near term.
And just a follow up why wouldn't this happened in the prior quarter then if its January onest testing.
Yes, I guess I guess, it's following the prior quarter I go back yet is within our fiscal Q3 got it and gets finalized who would have ido, we would continue to evaluate even up to the you know the data publishing the financials and you could that that yes. The hindsight of here again some maybe.
You know more recent near term expectations for the business as we've continued to evolve that model looking at to the test date.
Got it alright, thanks, a lot guys good luck with everything.
Thank you.
Hi, This time I am showing we have no further questions I'll now turn the call over to Mr. schrimsher for any closing remarks.
Yeah, just want to thank everyone for taking the time to join US today for their interest in support we look forward to talking with you throughout the quarter.
That concludes today's conference ladies and gentlemen, thank you very much for joining you may now disconnect.
[music].