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Applied Industrial Technologies Inc (NYSE:AIT)
Q3 2020 Earnings Call
Apr 30, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the Fiscal 2020 Third Quarter Earnings Call for Applied Industrial Technologies. My name is Jason, and I will be your operator for today's call. [Operator Instructions]

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

Ryan Dale Cieslak -- Investor Relations & Treasury

Thank you, Jason, and good morning, everyone. 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 our website at applied.com. A replay of today's broadcast will be available for the next two weeks. Before we begin, just a reminder that we'll discuss our business outlook and make statements that are considered forward-looking. All forward-looking statements are based on current expectations that are subject to certain risks, including our comments on the potential impact from the COVID-19 pandemic, as well as trends in sectors and geographies, the success of our business strategy and other risk factors provided in our press release, our most recent periodic report and other filings made with the SEC. These are available at the Investor Relations section of applied.com. 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 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 analysts and investors. Because the teleconference and its webcast are open to all constituents and prior notification has been widely and unselectively distributed, all content of the call will be considered fully disclosed. Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer; and Dave Wells, our Chief Financial Officer. With that, I'll turn it over to Neil.

Neil A. Schrimsher -- Chief Executive Officer

Thank you, Ryan, and good morning, everyone. We appreciate you joining us, and hope everyone is staying safe and healthy during this time. With COVID-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 the 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. First and foremost, I want to thank our more than 6,000 associates as well as our customers, suppliers and other business partners for their continued effort and support. Our top priority during this time is their well-being, and we have implemented various actions across our operating facilities to reinforce our long-standing 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 IT 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 to the 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 fixed 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.com channel. This is also a time when we are reengaging with infrequent customers and identifying new opportunities. As we've discussed in the past, Applied's 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 past 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 position. 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 in 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 COVID-19 will 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 weakened further, however, during March, as the COVID-19 impact became more prominent, March organic sales declined in the midteens percent year-over-year on a days-adjusted basis. During April, organic sales are trending down high teens percent year-over-year as we continue to see more customers announce temporary facility shutdowns, idle equipment, limit production and defer projects. This has been most notable in heavy industries and OEM end markets. While we're hopeful April or May will present trough periods for this downturn, our visibility remains limited and uncertainty exists around the trajectory of recovery in coming quarters as society adjusts to new realities. As such, we are proactively adjusting costs 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 and 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 to date as well as approximately $250 million of undrawn revolver capacity, while our net debt is down over 20% from last year. We are closely monitoring our 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 deployment 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 as core to our growth strategy over time and remain active with our pipeline. We understand these are times when valuable relationships are reinforced and made, 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 to Dave for additional detail on our financial results and outlook.

David K. Wells -- Vice President,Chief Financial Officer Treasurer

Thanks, Neil, and good morning, everyone. Before I begin, a reminder that a supplemental investor deck recapping key financial performance and COVID-19 related talking points is available on 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, a sales in our service center segment declined 8.9% year-over-year or 10.9% on an organic daily basis. Lower industrial production activity and related MRO needs continued across the majority of our service center customer base into the quarter, and this was subsequently compounded by idle production and customer facility closures during March as COVID-19 precautions unfolded. Within our Fluid Power and Flow Control segment, sales increased 0.6% 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 COVID-19 crisis, we saw customers reduce or halt production and trim capital spending. This adverse impact was partially offset by fluid power sales growth within the technology end 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 nonroutine expense of $3.9 million 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 top line 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 nonroutine costs in the quarter. These costs include severance and facility exit costs in our service center segment, reflecting additional cost actions implemented in response to the weaker demand environment. Adjusted SD&A expense declined 7.5% on an organic per day basis when adjusting our operating costs 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 T&E over time, 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 of furloughs and pay reductions and temporary suspension of the company's 401(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 assess the evolving demand environment and balance necessary cost alignment with execution on our strategic growth initiatives and requirements to ramp and effectively respond as a recovery eventually unfolds. Adjusted EBITDA in the quarter was $75.9 million 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 $2.14 per share, which includes a noncash goodwill impairment charge of $131 million and $6 million of previously referenced nonroutine costs on a pre-tax basis as well as a $1 million 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 $1.02 compared to $1.16 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 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 sales synergies tied to various cross-selling opportunities, expansion of service capabilities, improved 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 while 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 countercyclical 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 U.S.-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 equate to approximately $10 million a quarter. We also have a $40 million private shelf placement note coming due in July, which we intend to refinance with our shelf capacity or extinguish available cash depending on the market backdrop and our working capital initiatives in coming months. We have taken and will 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 measures deployed, deferring nonessential capital expenditures, leveraging our shared services model to optimize collections and deploying additional cross-functional inventory initiatives. We are also conducting robust analysis and cadence reviews to identify sensitivities to 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 impact of the COVID-19 pandemic. We will reevaluate guidance and our long-term financial targets in coming months as we fully assess the impact ahead of our fiscal 2021 outlook and continue to respond and execute cost actions and liquidity initiatives. If appropriate and necessary, we will provide additional color on sales and margin trends in the coming months in an effort to support transparency 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, we believe high teens decremental margins is an appropriate benchmark to use near term. In addition, we remain constructive on our cash flow potential for the fourth quarter based on our ongoing initiatives, cost actions, business model response and April trends. With that, I will now turn the call back over to Neil for some final comments.

Neil A. Schrimsher -- Chief Executive Officer

Thanks, Dave. Overall, while life can seem complicated at the moment, and we face new challenges given the environment. I firmly believe in our company's position and ability to emerge stronger than ever as markets rebound. Our core values of customer focus, accountability, continuous improvement, innovation and teamwork will continue to lead the way. I'm proud of and grateful for how our team 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 cash and adapts well during 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. We believe this will be meaningful as industrial equipment and facility infrastructure ramps, following an unprecedented period of idle production and maintenance deferrals. This will drive critical brake fix demand across our network. We will respond swiftly with local expertise and the most comprehensive suite of motion control technologies and services within our industry, as well as in Applied's history.

In addition, we believe behaviors reshaped by the pandemic will reinforce secular growth opportunities tied to our technical service and engineered solutions portfolio, which has become a greater portion of our business in recent years. In particular, we believe customers will increasingly focus on addressing skilled labor constraints, plant efficiency and regulatory requirements, while considerations around manufacturing, reshoring and U.S. industrial infrastructure have potential to gain momentum. Ultimately, this can accelerate customers' outsourcing of technical MRO and service needs investments in automation and the consolidation of market share toward 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 has 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.

Questions and Answers:

Operator

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

David Manthey -- Baird -- Analyst

Good morning. Hope you guys are well doing well, doing well in the in the conference room here socially distance that 3-6 and 9 o'clock good to hear. So mid-teens declines in March, that seems a little outsized relative to both other industrial distributors as well as the high teens declines you're seeing now in April. Just trying to understand. If you started seeing the COVID impact earlier or more acutely and then, secondarily, if there's any implications for what we should expect during or coming out of the crisis.

Neil A. Schrimsher -- Chief Executive Officer

So we think the impact play started to show 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 the time period around COVID-19 and also make adjustments if they're in 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 just seeing a lot of activity in many of the essential industries that we've called out in the remarks. And so while fluid at this time, we do think this pause, this idle production, these downtimes will create a lot of opportunity as we start to work out of it starting, obviously, with the early cycle industries and customers and then heading toward the mid cycle.

David Manthey -- Baird -- Analyst

Okay. And coming out of the downturn, I would assume service center revenues will rebound once production starts back up, some of the brake fix sales. But could we see fluid power and flow control stay lower for longer as capacity utilization is freed up here 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?

Neil A. Schrimsher -- Chief Executive Officer

So at this stage, I'm not convinced yet of lower for longer around those customer segments. They, too, are pretty well diversified, and we think about some of those end segments like technology and pharma and life science with those participations. The flow control business is also heavily involved in paper industries, and 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 and working in 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, work with our customers, physically when required and in their operations and then remotely as needed. And the engineering exchange is still going on at a good productive level with customers. And so I've been impressed with our actions but also with our customers and the level of exchange and the project work that's going on. People are wanting to find ways to stay active and productive.

David Manthey -- Baird -- Analyst

Thanks, Neil.

Operator

Your next question comes from the line of Chris Dankert from Longbow Research. Your line is open.

Chris Dankert -- Longbow Research -- Analyst

Hey, 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, any quantification on how big those cuts are, what you'd have to see to kind of get into more structural cuts. Just if we can kind of build that conversation out a bit.

David K. Wells -- Vice President,Chief Financial Officer Treasurer

Good morning, Chris. This is Dave. We're not 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 of temporary nature as we move through the quarter. I would add that given the insight that we provided on the decremental margin expectations of high teens for the fourth quarter, you could 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.

Neil A. Schrimsher -- Chief Executive Officer

And so I'd think, Chris, 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 geographic footprints that dispersed and close to these industries. So I'd say by design in that. Obviously, it's tiered. My participation should be higher. It is, but I'm also pleased our Board of Directors are participating in a reduction in their cash retainer in the quarter. And so those are, 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 looks like. But we made appropriate adjustments as we started the fiscal year to lighter volume reductions and activities. If I look back in our past, we've done the same. So we will in this one. I think the appropriate actions are the temporary ones. But as Dave laid out, those do have some consequences to them, to individuals, and I appreciate the team's response across the business.

Chris Dankert -- Longbow Research -- Analyst

Yes. That makes a lot of sense. And I hate to focus so much on the short term, but I guess, is there any significant divergence in that performance, April to date, Fluid Power and Flow Control versus the service center business? I mean, are they both down in a similar amount? Just any color there?

Neil A. Schrimsher -- Chief Executive Officer

Yes. I would say the collective service center business and everything that's included would approach the down $20 million. And then the Fluid Power and Flow Control in the mid-teens, high teens in that area. If I think about FCX in that, maybe running a little better, maybe more mid-teens right now, and so that is encouraging also.

Chris Dankert -- Longbow Research -- Analyst

Thanks so much guys.

Operator

[Operator Instructions] Your next question comes from the line of Adam Uhlman from Cleveland Research. Your line is open.

Adam Uhlman -- Cleveland Research -- Analyst

Yeah, hi guys, good morning. For everybody saying healthy. Dave, I was wondering if you could just expand the discussion a bit more on your working capital aspirations, I guess just here in the near term, Maybe over the next three to six months understand that everything is fluid with the pace of revenue, tough to determine. But any kind of rough ranges that you can provide us on how you think you could manage inventories and receivables? And my second question then would be related to that. I know everybody is asking for extended terms. Are you seeing that with your customers? And how are you addressing that?

David K. Wells -- Vice President,Chief Financial Officer Treasurer

You bet. We just kind of walk through those. Here, again, are very pleased with the results in Q3, our strongest third quarter of cash generation in history. I think we've continued to show the benefit of our working capital initiatives. We've talked about those on prior calls, necessarily around the shared services efforts on the collection side of the business as well as the cross-functional engagement on continuing to rightsize inventory levels. So that certainly was a benefit as we work through Q3. If you look historically in this business, we've had cash flow during downturns that did pace our EBITDA. So that would be our aspiration. Assuming, like we've said, the continued down tight teens that 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 through Q4, we would expect our Q4 cash flow to outpace what we saw in Q3.

Neil A. Schrimsher -- Chief Executive Officer

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 expect really from us to be there for them with the right inventories, the right service model in the break fix MRO, and we perform a critical function to them. And so I want to say that there's no discussion, no pressure as it goes through. But we are essential to keep them up and running during this time. I think that's recognized in that. So we will appropriately manage through it. If I look back to other cycles, we have a strong history of doing that, and I expect we will continue to do that in this environment.

Chris Dankert -- Longbow Research -- Analyst

Great, thanks guys.

Operator

Your next question comes from the line of Michael McGinn from Wells Fargo. Your line is open.

Michael McGinn -- Wells Fargo -- Analyst

Morning everybody. was wondering if I could just touch a little more on the margin framework within fluid power and service center. Is there a large divergence in margins similar to that of what you're seeing on the top line between the midteens and then the 20% in service center?

David K. Wells -- Vice President,Chief Financial Officer Treasurer

No significant margin divergence. We do serve slightly better margins on the fluid power, flow control, and that's part of the accretive mix benefit that we've talked about as we continue to grow in those expansionary areas. But we've not seen any change in that trend as we've moved through the most recent quarter. I would not expect that trend to change as we continue into Q4 and beyond.

Neil A. Schrimsher -- Chief Executive Officer

I'd say both segments and teams are doing the appropriate the right job of being focused on point of sale. Both groups have mixed opportunities around service and repair but also the customer and product mix that we have in the area. So all have appropriate focus. I think it's showing well in the quarter. And really, those are kind of what we expect in this coming quarter, as we said earlier.

Michael McGinn -- Wells Fargo -- Analyst

Okay. Appreciate it. And then obviously, the game's changed here. You guys had some pretty big, both organic and inorganic, growth opportunities. I'm just wondering what signpost, what guidepost do you need to see to dip your toe back into the water for bolt-on M&A. Is it a market-based function or getting to a certain leverage target that may be different than before? Can you just comment on that?

Neil A. Schrimsher -- Chief Executive Officer

I'd say, one, I mean, we have work and 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 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 cash for us to those priorities in time. I would expect we will be active in the game. And as I think about our longer-term objectives, we 23. We still think we still believe those hold. Now we will get into determining what does it mean 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 they're absolutely the right objective. The company, in my view, will accomplish those and that probably, as we've discussed, even likely higher levels in time. So we'll let this thing play out. We will deal appropriately in the near term. I think if we come into ending the fiscal year and looking forward, we'll provide more commentary on what we expect those to be over the three year horizon and perhaps a little longer.

Michael McGinn -- Wells Fargo -- Analyst

Talk to you next week. Then at our conference. Very good.

Operator

Your next question comes from the line of Joe Mondillo from Sidoti & Company. Your line is open.

Joe Mondillo -- Sidoti & Company -- Analyst

Hi, everyone. Good morning.

Neil A. Schrimsher -- Chief Executive Officer

Morning, Joe.

Joe Mondillo -- Sidoti & Company -- Analyst

So I was wondering, in terms of the reopening of the economy, what you are seeing and what you have at your what you can see at this point in time, do you have any visibility to say that April is going to be sort of the worst month?

Neil A. Schrimsher -- Chief Executive Officer

I would say in that no, not perfect visibility to that. And so will April or May be kind of that trough period? We're already there, but it extends on. I mean, we know about 75% of our customers are deemed more essential in that. If we think about certain segments of them that we went through in food and beverage and life science and technology, that's a good segment of our business base that's running highly productive. And then there's geographic variances that would go on, on the various shelter in place and perhaps how certain companies interpret those or where they're at in their own demand cycle. I do suspect there will be some increased activities as states come back on and open up their economy some more from local accounts and doing it. If I think about our national account type business, I would say we would have maybe 10% to 15% of those that have either idled capacity or dealing with a temporary type shutdown. 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 that's to be determined.

Joe Mondillo -- Sidoti & Company -- Analyst

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, 2016, how that compares? I mean it feels a lot worse, not to think that we thought that it could have gotten that worse, but it seems like it has. But what is your general feeling, just given what your conversations are like with your customers?

Neil A. Schrimsher -- Chief Executive Officer

Yes. So I'd say, overall for us, right, it's still now less than 7% of the overall business with our teams and locations. We're having the right exchanges and dialogue with customers. We're 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 that is, in the quarter, a little bit in results and activities. So we'll continue to rightsize the business to the current environment and then stay prepared for when it starts to improve. And so the position, we think, between Permian and Anadarko, we're positioned. We have coverage. We're in the right locations. I don't think it stays at this level for a long, long while. But for us, still less than 7% of the overall.

Joe Mondillo -- Sidoti & Company -- Analyst

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 perform quite well in terms of gross margins, maintaining them. Your business has changed a lot over the years, specifically with Fluid Power and Flow Control. So could you, number one, describe any risks at all that you're always concerned of going into a downturn regarding your gross margins, just in general and then, more specifically, how the gross margins change? I guess, I know you don't define the gross margins on the 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? Do you see any more operating leverage at the gross margin level at that segment?

Neil A. Schrimsher -- Chief Executive Officer

Yes. So historically, to your point, we've done a very nice job of protecting margins during downturns. I think, quite frankly, given the mix evolution as the business continues to grow into some of these expansionary products, namely fluid power, flow control. As you point out, I think that even betters our opportunity to be able to protect those gross margins during the downturn. So pleased that we saw here, again, flat sequential margin performance, essentially 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. And there, you would see a little bit more SD&A support just given the engineered component to that business, which here again, those are addressed with 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 at our disposal with the systems investments we've made and the critical break fix nature of the product and the business and the value-add that we provide to customers, our ability to actually protect margins again through this downturn.

David Manthey -- Baird -- Analyst

Okay, Joe I'm sorry, go ahead.

Neil A. Schrimsher -- Chief Executive Officer

I was just going to all right. I was just going to add, I think we discussed it, right? As we think about margins in the current quarter, perhaps they're at a level maybe slightly lower in it in the fourth quarter. But we like the opportunities that we have, and I think on the service center side, there's 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. We know those have a positive mix up as we go through. As the various shelter in place goes on, as those open back up and more local customers open back up, right, that will get us back and running. So to be determined how that mix plays out perfectly in this quarter, and that's why we think maybe there's a little bit of it's 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, there's going to be more service requirements. There's going to be more people looking for repair opportunities in that, and so that will create work and mix opportunities for those that business segment and those businesses in it for us going forward.

Ryan Dale Cieslak -- Investor Relations & Treasury

Joe, this is Ryan. I 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, it will depend on the direction of inflation, but that could certainly start to ease even more so into our fiscal 2021. And then if you go back and you look historically, the way the gross margins have performed during downturns, you're correct in saying 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 there's 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.

Operator

Our next question comes from the line of Steve Barger from KeyBanc Capital Markets. Your line is open.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Good morning, guys.

Neil A. Schrimsher -- Chief Executive Officer

Steve. Good morning.

Steve Barger -- KeyBanc Capital Markets -- Analyst

I'm 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 or staying power?

Neil A. Schrimsher -- Chief Executive Officer

Well, I think our customers, and even in early to mid-March and the various shelter in place, we have key customers putting the calls and want to know what that meant for our business. And we were able to answer across our operating platform. We're deemed 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 we're working through cycles, depending on where you're at in stage of business can all be a challenge in doing it. So perhaps it's a little early for all of that. But, no doubt. There's stressors in the economy. There's stressors in the supply chain a little bit right now. But we've weathered through these before, and we're operating effectively and efficiently right now.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Yes. Just thinking about some of those stresses in the supply chain, and you already addressed some of this, but are people talking more about reshoring or localizing? And are you seeing more inquiries or conversations about robotics or automation?

Neil A. Schrimsher -- Chief Executive Officer

So let's talk about the reshoring. On that one, I'm going to say, yes. And so 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 they shelter in place for a period of time, I don't know that there's great finished products that come to 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 we'll get considerations, do people make changes in their capacity models and decide to do more in the geographic markets they're serving, i.e., U.S. in North America.

And then as we think about robotics, yes. And so whether that be in material and logistics and people wanting to stay running and operating and be able to have cobots to create some additional social distancing and 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 reviews with the team on Monday, and I'm very impressed with the projects in the pipeline that's 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 COVID support industries and projects that are going to help in this recovery. So all of those are encouraging.

Steve Barger -- KeyBanc Capital Markets -- Analyst

You'd expect to start monetizing some of those opportunities as you go into 4Q even?

Neil A. Schrimsher -- Chief Executive Officer

That to be determined on 4Q. I think as we think about that business to be flat. It would be my start as they tend to be a little better if they're on the line. But that's how I think about them in that because they've also got to work with customers on delivery of some of those projects and receipts. So they've had some of those customers put in requirements or perhaps they're down for a period of time in their reeving areas. So is it as fast? As we turn the corner and go into our new fiscal year, I think more and more of those play in.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Right. And then last one for me. Dave, your comment on managing the high teen decremental and if April trends come in for the full quarter, is that big in control in the model right now or based on what you've seen from the business in past downturns?

David Manthey -- Baird -- Analyst

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 here again, the investments we've made were better, Steve, the cost base appropriately given the kind of the both the systems investments as well as the shared services model we've deployed, in many cases, and elements of the business, I think all that just makes us better positioned to those high teens decrementals.

Neil A. Schrimsher -- Chief Executive Officer

I'd say I'd just say the business and the team, I think, proactive and, OK, seeing the appropriate adjustments. So I think to Dave's point, it's a little bit of OK, history, but we're not really provide expanded consumables to our current customers. We are rounding out a managed inventory specialist, depending on geography or finding the ways to safety and precautions on site. I think the team has also developed some nice virtual tools that they can do that and have someone that's in the facility, actually electronically do the infill and it waves into our system. So it has contributed. And I think our teams across service center networks and other side of our business customers deal with hand sanitizers and those. So it has contributed, and I would expect that it would bode well for us in the low single digits.

Steve Barger -- KeyBanc Capital Markets -- Analyst

And then I don't recall off hand what your guys' exposure might be changed. But if you could talk about what it may be now and then also, strategically, as that industry is likely to be challenge for, let's say, the near to intermediate term, but it still has an attractive, arguably, long-term outlook, be curious about your thoughts of potentially using this period to maybe expand more into that end market.

Neil A. Schrimsher -- Chief Executive Officer

Yes. So Steve, for us, overall now participation that we have as we go into the planning cycle and with our locations and their regional management. We'll have some of those dialogues. But I expect over the midterm, 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 into the space. Perhaps that would be one. But to date, it's not very significant for us as a participating segment.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Thanks very much.

Operator

And for our final question. It comes from the line of Joe Mondillo from Sidoti & Company. Your line is open.

Joe Mondillo -- Sidoti & Company -- Analyst

Hi guys, Just two and they're both accounting-related questions. The tax benefit related to the Cares Act, I was just wondering what that is related to.

Neil A. Schrimsher -- Chief Executive Officer

The ability to recognize forward losses related to the FCX business were the provisions included in the act. About $1 million tax benefit for us in the quarter that we did strip out is an unusual item in the adjusted results.

Joe Mondillo -- Sidoti & Company -- Analyst

Okay. And then also related to FCX. I imagine other companies are going to start writing down goodwill. And a bigger surprise to me, though, was how early you're writing it down. And then I always thought this was sort of an end of year and addressing that end-of-year kind of a thing. So what caused you to have to do that?

Neil A. Schrimsher -- Chief Executive Officer

We have a January one test date for goodwill impairment. That said, the quarters have seen some softness in 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. I think it was really a matter of taking a realistic look at the how quickly that recovers. And certainly against distribution businesses, very asset-light, potentially a manufacturing business. Just thinking about the shape of that recovery. And certainly, I said in the script, we're very still optimistic in terms of the intermediate longer-term growth on the cross-selling opportunities expanding the service capabilities, etc. but being prudent in terms of that likelihood in shape of that recovery, how quickly that bounces back and the pressure that put on the model.

Michael McGinn -- Wells Fargo -- Analyst

And just a follow-up, why wouldn't this happen in the prior quarter if it's January one test date? I guess it's following the prior quarter?

Neil A. Schrimsher -- Chief Executive Officer

Yes. It is within our fiscal Q3 and gets evaluated even up to the data publishing the financials. And that the hindsight of here again, so maybe more recent near-term expectations for the business as we continue the test date.

Joe Mondillo -- Sidoti & Company -- Analyst

All right, thanks a lot guys. Good luck with everything. Thank you.

Operator

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

Neil A. Schrimsher -- Chief Executive Officer

Hey, I just want to thank everyone for taking the time to join us today for their interest in throughout the quarter.

Operator

[Operator Closing Remarks].

Duration: 62 minutes

Call participants:

Ryan Dale Cieslak -- Investor Relations & Treasury

Neil A. Schrimsher -- Chief Executive Officer

David K. Wells -- Vice President,Chief Financial Officer Treasurer

David Manthey -- Baird -- Analyst

Chris Dankert -- Longbow Research -- Analyst

Adam Uhlman -- Cleveland Research -- Analyst

Michael McGinn -- Wells Fargo -- Analyst

Joe Mondillo -- Sidoti & Company -- Analyst

Steve Barger -- KeyBanc Capital Markets -- Analyst

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