Enerpac Tool Group Corp.

Greetings, and welcome to the InterPAC Tool Group first quarter 2021 earnings conference call. At this time, all participants are in listen-only mode. If anyone should require operator assistance, please press star zero on your telephone keypad. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Bobby Belsner. Please go ahead.

Thank you, operator. Good morning, and thank you for joining us for Interpac Tool Group's first quarter fiscal 21 earnings conference call. On the call today to present the company's results are Randy Baker, President and Chief Executive Officer, Rick Dillon, Chief Financial Officer, and Jeff Schmeling, Chief Operating Officer. Also with us are Barb Bolins, Chief Strategy Officer, Fabrizetti, General Counsel, and Brian Johnson, Chief Accounting Officer. Our earnings release and slide presentation for today's call are available on our website at enterpactoolgroup.com in the investor section. We are also recording this call and will archive it on our website. During today's call, we will reference non-GAAP measures such as adjusted profit margins and adjusted earnings. You can find a reconciliation of non-GAAP to GAAP measures in the schedules to this morning's release. We also would like to remind you that we will be making statements in today's call and presentation that are not historical facts and are considered forward-looking statements. We are making those statements pursuant to the safe harbor provisions of federal securities law. Please see our SEC filings for the risks and other factors that may cause actual results to differ materially from forecasts, anticipated results, or other forward-looking statements. Consistent with how we've conducted prior calls, we ask that you follow our one question, one follow-up practice in order to keep today's call to an hour and also allow us to address questions from as many participants as possible. Thank you in advance for your cooperation. Now I will turn the call over to Randy.

Thanks, Bobbie, and good morning, everybody. I hope everybody's safe and healthy and getting ready for a great holiday week here. And we're going to start today on slide three, but before we review the details in the quarter, I'd like to go over the status of InterPAC and how the state of the world is affecting us. Starting with health and safety, InterPAC continues to operate under essential worker status. We have approximately 40% of our employees working from home offices while only mandatory personnel are on sites. The increased infection rates has caused concerns in North America and other countries, which facilitated our heightened safety measures. Our objective remains keeping all of our employees safe and providing the best possible work environment. During the quarter, we experienced two quarantine events requiring partial production stoppage at two locations affecting both Interpac and Cortland. Our screening processes coupled with contact tracing were successful in avoiding a full site quarantine and lowered the impact to both production and sales. Additionally, our sales and marketing teams around the world are continuing our cautious approach to customer visits while actively promoting Interpac tools. Moving on to a more positive side, Interpac tool group improved sequentially versus our fourth quarter of fiscal 2020. All aspects, including sales, profit, incremental margins, and cash improved and further supports the quality of Interpac's earnings potential. Our swift actions to control cost and drive decremental margins beat our expectations. Secondly, our focus on working capital has delivered positive cash flow, which is typically not the case in our first quarter. We remain very focused on executing our strategy and protecting the key elements of our organic growth to ensure our company is healthy post-pandemic. It's critical to our management team that we continue to deliver great new products and provide the best sales support to our dealer network. We launched three new product families and maintained our 10% new product objectives in the quarter. Lastly, supporting our local community where Interpac resides and work is very important to us, and that's why we've launched a new program to provide educational resources and scholarships. We firmly believe that Interpac must be a leader in our community and be an employer where all employees feel welcome and proud to be part of the team. Moving over to slide four, The sequential order rates improved in our quarter, with some wider deviations due to large orders in the prior year. In comparison to fiscal 2020, we are now down in the low teens, which continue to improve in December. Our prediction of a gradual return to a normal business environment has progressed, and we expect this to continue absent a major resurgence in the virus. Consistent with prior quarters, several of our 13 vertical markets experienced sales growth, particularly in military aerospace and alternative energy. Conversely, many markets are still impacted by the pandemic and the resulting sales demand. Moving over to slide five, as I mentioned earlier, our first quarter met our expectation in many of the key financial metrics. Sales grew sequentially versus our fourth quarter. However, core sales declined by 18% versus our fiscal 2020, comprised of 16% down in products and 24% down in service. Despite the lower sales, we were able to control our costs and deliver an even margin at near parity with 2020 fiscal results. Our decremental margins in the quarter were 18%, which is sequentially better than our fourth quarter and well below our stated range of 35% to 45%. This resulted in an EPS of $0.09 per share, which is also a marked improvement over the fourth quarter. From a cash flow perspective, we were able to generate positive cash versus usage in the first quarter of fiscal 2020. This was a direct result of our focus on inventory and receivables to ensure the best possible working capital results. At the end of the quarter, our net leverage remained positive at 1.9 times, which is a great indication of the health of InterPAC. Originally, our core sales results varied based on the impact of the pandemic and the strength of the underlying vertical markets. European operations was our best performing region, which grew moderately in the quarter versus fiscal 2020. Our European team performed very well in focusing on driving sales while maintaining a safe work environment. The Americas continued to slowly return to normal and were down in the high teens. This improved sequentially during the quarter, and we believe this trend will continue. Asia-Pacific declined in the low 20% range, which was affected by increased pandemic shutdowns in Southeast Asia and helped by the Chinese market, which has largely returned to normal. And lastly, Mideast operations were down in the mid-30% range, which continues to be impacted by oil prices and the effect of the pandemic. Now, in summary, we are pleased with the sequential improvement of our company. as we navigate the impact of the pandemic. Our focus on cost and key areas we can control has supported our improved earnings and laid the groundwork for a top-performing company. I'm going to turn the call over to Jeff and Rick now to review the details in the quarter, then I'll come back with the market projections and some closing comments.

Jeff, over to you. Okay, thanks, Randy. I'd like to add some color on what we saw in the quarter in our various regions, trends in some of our key verticals, as well as what we're hearing from our distribution. I'll also touch a little bit on order rates as well as a few notes on our operations. As we go through the region results, you're going to hear varying degrees of recovery by region. I want you to think as you think about the speed of the recovery, please keep in mind that a significant portion of our business comes from the heavy industrial laneway. While we are seeing improvement in that sector, It's clear that these markets and end users have been slower to recover than the consumer and commercial markets that many of our tool peers play in much more heavily. Starting on slide six, we're happy to see continued stabilization in both product and service sales in Q1 compared to the previous two quarters. Despite still being down year over year, we're really pleased to see continued momentum as the quarter progressed, which culminated in a very strong November in both sales and orders. From a regional perspective, Europe was our first region to return to positive growth year over year, which was led by strong sales in our heavy lift business and a recovery in orders from our general distribution network. Continued investment in wind energy is helping us drive sales in both our torque and tension business as well as some of the heavy lift products that should carry some repeat potential as some of our solutions become more widely adopted. Despite some recent announcement about additional COVID actions in Germany, the UK, and the Netherlands, and the continued overall cautious approach by most other countries in Europe, our distributors and our own team are finding ways to stay safely engaged with our customers. We're seeing continued improvement in the Americas, albeit at a slower rate, and we can point to a few key indicators that are giving us some encouragement about the continued improvement. While certainly not back to normal rates, we did see some of our larger distributors increase their stocking orders in the quarter, and we also saw a slight downtick in our dropship requests compared to the previous few quarters. Our national accounts team was successful in securing several blanket orders from some of our OEM customers that serve various industries like vehicle repair and rail, which we also take as a sign of returning confidence in these markets. Switching over to Latin America, we also had a strong quarter driven in large part to the continued strength in copper and iron ore pricing, which has led to maintenance spend at many of our mining customers and the distributors that service them. Within Asia Pacific, the state of recovery varied by country, leading to sales being off the prior year in the low 20% range compared to the approximate 30% down in the fourth quarter. Australia and China continue to improve after fending off the second wave of the pandemic. and we're continuing to see relaxation of restrictions and improved sales activities within those regions. Conversely, Southeast Asia continues to be an area of concern as both Indonesia and Malaysia remain in partial lockdowns. As in Latin America, Australian mining is showing some strength, as well as in power generation, specifically wind. Shipbuilding and auto continue to be stressed, but we do expect that these verticals will begin to recover as the global economy picks up. Turning to new product development, as Randy mentioned, we continue to deliver on our goal of 10% NPVI here again in our first quarter. Q1 marks the start of our new NPD launch strategy, where we have moved now to a single quarterly NPD launch program that wraps all of our new product releases, product training, retail and wholesale programming, and all the related marketing communications we do into a single quarterly event aimed at increasing customer excitement, and hopefully distributor participation. Our Q1 event resulted in meaningful pre-orders for several new products and improved training delivery both internally and externally. We're really excited about this approach and have several more products set to launch during our January event, and we're well underway planning for our Q3 and Q4 launches as well. Moving on to slide seven and turning now to service, I'm really encouraged by the sequential improvement in service sales, which were down 24% year over year versus being down almost 45% in both the third and the fourth quarter of fiscal 20. This improvement was largely driven by the service delivery in our MNAC region, where as anticipated, we saw several routine maintenance projects come back online, along with some major projects that were halted due to COVID start to begin to restart. Despite the improvement, our MNAC region was hardest hit in Q1 as we're still facing challenges with lockdowns and curfews. The region is starting to see a change in spending habits, however, as new budgets are released with more maintenance work being signed off to start in the coming months. This creates more visibility than we have had in the past nine months, and that's encouraging as we expect this may result in a nice improvement in sequential trends coming out of our Q2. In Europe, service activity was strong, particularly in Germany, but this was offset by lower levels in the Americas where service revenue was off was still off prior to the prior year early in the quarter. Starting in the middle of the quarter, however, we did start to see a nice uptick of emergent work popping up in both the U.S. and the Middle East that we were able to capture as companies are looking to spend budgets before the end of the calendar year. Just as a reminder, our service business is primarily tied to a customer's maintenance requirements and not to CapEx, so these projects are generally less susceptible to outright cancellation. as they have to get done to ensure the viability of the oil and gas assets around the world. Operationally, the entire team across all our sites continues to successfully navigate the complexities that COVID brings, yet deliver against our commitments to safety, quality, and on-time delivery. We have seen no significant drop-off in our ability to meet our customers' demands, and with an uptick in volumes, we're focused on improving utilization and efficiencies at all of our plants. We're closely monitoring air freight and commodity costs given rising rates on both. Should there be a need to adjust pricing, we will, but it is our hope we can get back into our normal price adjustment cadence later this fiscal year. As I did last quarter, just a few comments on inventory and supply chain. We continue to thread the needle as far as matching our inbound orders to retail demand to both control inventories yet still have the stock we need to take advantage of unexpected orders during the recovery. As the recovery continues, our commercial supply chain and operations teams are working really hard to predict the unpredictable and keep our key suppliers and operations one step ahead of the curve to not miss sales and disappoint our customers. I'm really pleased with our team's performance thus far. While we don't normally comment on our backlog, our solid order rates in November and now into the first part of December here have led to an uptick in backlog, which gives us some confidence for the rest of the quarter. And now on for a few comments on Cortland. The Cortland business experienced sequential improvement in the quarter with the combined business down 35% year-over-year compared to the 39% we saw last quarter. The industrial ropes portion of the business was impacted due to increased lead times driven by a tight labor market and further exacerbated by COVID-related quarantines. On the medical side, low hospital bed availability due to COVID continues to limit non-COVID related procedures and drove our customers to keep their inventories low. If you recall, we have a purpose-built medical facility that we are in the final stages of relocation, which has also delayed order releases as validation activities were completed there. We expect continued improvement for Q2 in the industrial ropes business as we have now addressed our labor and we have deployed rapid testing to limit the impact of COVID-related quarantines going forward. The medical business will likely continue to see the impacts of COVID through Q2 as improvements in hospital bed availability will take time to affect the supply chain. We do expect, however, that the completion of the relocation activities and customers sitting at or below target inventory levels will drive sequential improvement in Q2. And that's all for me. I'll turn the call over to Rick for some financials.

Thanks, Jeff. So you just heard Randy and Jeff discuss most of this, but I'll give a quick update here on slide eight. Fiscal 2021 first quarter sales increased by 7% when compared to the fourth quarter of fiscal 2020, and we're down 19% from the prior year. Core tools product sales were down 14%. an improvement from down 20% in the fourth quarter. Service was down 24% compared to down 45% in the fourth quarter. And Courtland sales were down 35% or $4 million versus down 39% in the fourth quarter. We had a $2 million positive impact from our HTL acquisition consistent with the fourth quarter. The adjusted EBITDA margin for the quarter was 12%, and that's up 300 basis points from the fourth quarter and down slightly from the 13% reported in the prior year. The adjusted tax rate for the quarter was 31%, which is up significantly from the prior year of 12%, and it was impacted by a $3 million tax benefit from new regulations during the prior year quarter. As a reminder, we have included in the appendix some baseline fiscal 21 modeling assumptions on the tax rate, cash taxes, depreciation, and amortization, and interest expense and CapEx based on what we know today. And there you'll see that the adjusted tax rate assumption for the year is still 25%. So let's turn to slide nine. The sales waterfall illustrates the components of the sales decline. Jeff already covered what we're seeing by region, but I'll just make a few comments here. I'll remind everyone that the first and second quarter are seasonally our lowest two quarters, with the second quarter being the lowest. As we look at the recovery, sequential improvement from our fourth quarter results in these two quarters are clear indicators that we are continuing to move in the right direction towards normal quarterly rates. So fiscal 2020 results showed the typical sequential decline with Q1 2020 down 5% from Q4 2019 and Q2 2020 down 5% from Q1 of 2020. So counter to that, this year our first quarter of 2021 results are up 7% from the fourth quarter. Also want to point out here that this is the last quarter we will need to report strategic exits. in our year-over-year comparison as we anniversary the product line and service exits completed in the first quarter of last year. So, moving on to the adjusted EBITDA waterfall on slide 10. As we've noted, our decremental margin for the quarter was 18% and reflects the improved leverage that our lower cost structure provides as sequential volume increases. As we have seen through the pandemic, our lower sales continue to weigh heavily on the adjusted EBITDA Manufacturing variances of 6 million reflect the negative impact of volume on absorption at our manufacturing facilities and utilization of our service labor. The absorption variance was about $3 million, consistent with the fourth quarter, as we held production levels steady through a few COVID disruptions while managing global inventory levels. The impact of the COVID disruption is estimated at less than $500,000 from a cost perspective. Service utilization improved to down $2 million versus down $4 million in the fourth quarter, and this is consistent with the increase in activity and labor mobility we discussed at the beginning of the quarter. As expected, our temporary COVID-19 cost actions generated $6 million in savings for the quarter. Over half of this benefit is from lower travel expenses, with incremental benefits in the quarter from employee furloughs and the 401 suspension In addition, we received less than $500,000 of government stimulus funds from our international locations. While we do expect to see some continued financial benefits from reduced travel expenses and maybe potential international stimulus funds, we did reinstate our employee bonus plan this quarter and will reinstate our 401 match in January 2021. With commercial activity continuing to increase, We expect travel expense will return to normal levels as we progress through the year. In addition to our temporary COVID-19 actions, we saw SAU spending favorability of approximately $3 million. Our previously announced restructuring actions resulted in approximately $4 million in savings for the first quarter, and we still estimate incremental year-over-year restructuring savings for the fiscal year of $8 million. that essentially gets us to a full year run rate on the balance of the actions announced in the back half of last year. So between permanent structural cost actions, variable spend management and temporary cost reductions, we recognize the combined 13 million in year over year savings during the quarter. Since the third quarter, we have seen the impact of our temporary COVID actions decrease from $12 million to $6 million while EBITDA increased by $10 million over the same period. The temporary actions were taken to offset the impact of lost sales volume, and as the volume is returning, the benefits we are seeing from top-line growth clearly outweighs the impact of the temporary actions expiring. So let me provide an update on where we are with commodity costs and air freight. Commodity prices dropped significantly as COVID shut down markets in the March-April timeframe. The commodities we watch closely are steel and aluminum. We spend about $20 million on steel and $2 million on aluminum each year. We saw steel prices decline about 12% year over year in April. And during this time, we were able to move ahead with our annual supply contracts, locking in some of the favorability. However, as markets have reopened, the prices have begun to rebound. So just a little bit more color. Over the last six to eight weeks, we've seen acceleration in prices for both steel and aluminum. At these accelerated rates, we saw steel prices could be up as high as 5% to 8% per year and aluminum up 25% to 30% year over year. So what would that mean for us on a normal spend level? Raw steel would translate to a 1% to 2% increase in the cost of machine parts or $100,000 to $200,000 on an annual basis. and aluminum would translate into a 7% to 9% increase, or $140,000 to $180,000 on an annual basis. To date, we have not had suppliers attempt to pass through the impact of rising commodity costs, as all are looking to capture early demand in the recovery. As demand inches closer to normalized level, we anticipate that we will see a greater push to recover lost margins from commodities. However, we don't believe the commodity cost impact will be material to our results this year. Air freight also remains a hot topic. We typically spend about 3 to 4 million on air freight per year. As we noted in our third quarter report, through the trough, we were seeing air freight rates two to six times higher than normal rates. Rates gradually declined as markets reopened, and at the beginning of the first quarter, we were at near parity with pre-COVID levels. Since September, rates have gradually increased back to two times normal rates. Our first quarter air freight spend was about 800,000, representing an approximately a 10% increase over last year's spend despite lower volumes. The COVID vaccine distribution is expected to put an additional strain on global freight capacity and make rates volatile for a prolonged period of time. Based on current information, we will need to allow for as many as seven to 10 additional days of transit for air freight in our planning systems. We see this as a long-term planning constraint and we are adjusting accordingly. Due to capacity constraints, we are hearing that rates will fluctuate between two and four times normal rates depending on demand. Our focus on improving sales and operation planning will reduce the need for air freight going forward. And as Jeff noted, we'll continue to monitor this along with all other moving pieces and take the appropriate actions needed. So turning now to liquidity on slide 11, We generated approximately $7 million in free cash flow during the quarter. We saw a $6 million increase in accounts receivable, driven primarily by timing of sales towards the end of the quarter. We remained diligent in our receivable collection activity with no meaningful bad debts or deterioration in our aging as a result of the COVID environment. Our inventories increased by just $1 million, and this really is a reflection of our backlog and timing of shipments. We ended the quarter with $159 million in cash on hand, and this is up $7 million from the end of the fourth quarter. Our leverage is at 1.9 times trailing 12 EBITDA, up from 0.8 times at the end of the first quarter of last year. We are pleased with where we sit from a cash and liquidity perspective, and we remain diligent in proactively managing our balance sheet going forward. Randy, I will turn the call back to you.

Thanks a lot, Rick. Let's turn over to slide 12. Timing of the pandemic recovery is the most critical question we have to contend with today. Have you seen today? Interpac sequential order rates have improved, but we are still navigating a highly unpredictable market. The advent of the coming vaccine has helped the sense of optimism throughout the distribution channel, but we are all driven by actual results. Consistent with prior quarters, we are continuing the suspension of our guidance pending a clear view of the market stability. Our objectives remain focused on, number one, cost management and driving the highest possible margins. Secondly, the commitment to organic initiatives will continue to be a central part of our investment criteria. And finally, maintaining the strongest possible balance sheet is critical. Our second quarter is typically the weakest, but given the sequential improvement, we believe this pattern will not occur in fiscal 2021. Now, flipping over to the last slide, as we assess and recalibrate InterPAC Tool Group's long-term objectives post-pandemic, we are still very committed to our strategy. We have been very consistent in terms of our capital allocation priorities and the view of the critical elements of our strategy. We have positioned Interpac Tool Group with the ability to grow organically above the market conditions. Our investments in R&D and commercial process continue to deliver results. Our drive towards efficiency and profitability have not changed, and we have taken all the necessary structural cost actions to achieve our long-term margin objectives as the volumes return to normal. And as you've seen in the quarter, we are very focused on the elements of the balance sheet, which has allowed us to deliver cash flow conversions consistently above 100%. And lastly, we believe Interpac Tool Group will deliver best-in-class ROIC returns, particularly under normal market conditions. On behalf of the entire management team, we'd like to wish our employees and investors a happy and safe holiday season. Operator, that concludes today's prepared remarks. Let's open it up for questions.

Thank you, and I'll be conducting a question and answer session. If you'd like to be placed in the question queue, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing star 1. One moment, please, while we poll for questions. Our first question today is coming from Jeff Hammond from KeyBank Capital Markets. Your line is now live.

Hey, good morning, everyone.

Hey, Jeff.

Hey, Kevin. So just want to dig in on this. You know, you get the dynamic of distributors kind of starting to order again and you guys trying to keep inventories lean. Just, you know, if you could just comment on your readiness, you know, as we start to see kind of orders inflect more positive and distributors kind of wanting to restock and certainly some inflation, just kind of your readiness to kind of handle all that understanding, you know, things are still kind of choppy.

Let me start off, and then, Jeff, why don't you bring in some comments as well. I think that we've done a good job of looking at our sales and operations planning process in a way that allows us to predict some influx of new orders. One of the key metrics that we watch very closely, obviously, is our OTD rate, and we've been able to maintain a very positive one. Now, as we get more orders flowing in, that certainly is going to be a metrics that we keep a very close eye on. Because at this point in time, Jeff, we do not want to miss a single order. Jeff, why don't you jump in and maybe you can give some more guidance there.

Yeah, good morning, Jeff. You know, we think about our orders kind of in two buckets. We have our top products, which are, you know, the fast movers. That's usually the distributor stocking type product. And as Randy mentioned, our S&OP process, we're really trying to trying to look hard at those and making sure that we're delivering those same day, next day type of thing. And those are really the ones that drive a big part of the revenue as well as our OTD performance. So in terms of our ability to respond, I think we feel pretty good about those, and those are really the types of products that we're engaged with our sub-suppliers with almost on a daily basis. And some of the longer lead, more project-type stuff, we plan as best we can, but some of those will be a surprise. But I think the long-range supply chain is in pretty good shape right now.

Thank you. Our next question is coming from Dean Dre from RBC Capital Markets. Your line is now live.

Thanks. Good morning, everyone.

Good morning.

Hey, I want to follow up with Rick on the cash flow because that was one of the bright spots this quarter. And, you know, that's not your usual first quarter because you're usually a use of cash. But you called out inventory and the timing of shipments. Do you expect this to reverse in the second quarter? Just maybe any other color there would be helpful. Thanks.

No, we're not anticipating a reversal in the second quarter. As you pointed out, our first quarter is typically our highest use of cash, and the delta this year is significant. Also, recognizing that last year, Q1, we still had ECS, which was a big part of that use. As the year progresses, we usually see our cash flow generation increase. improve sequentially, and we're anticipating that along with sequential improvements, if we stay the course, we should follow that same pattern. And as usual, the majority of our cash flow would be generated in the back half of the year. I think what you saw from an inventory perspective, that was a negligible increase. You saw the large decreases the last two quarters. I think to the earlier question, I think we're monitoring things closely. And, you know, should we need to increase our inventory levels, we will. We saw the response here to, as Jeff mentioned, a strong backlog. We anticipate that our inventories will not need to spike, but we'll watch them closely. I think what we're seeing from an air freight perspective, leading that seven to ten days, of lead time that may result, depending on demand, in some inventory, but we're not expecting that to be significant.

Got it. Just on and follow up, some additional color on air freight. And first, I appreciate all the detail you provided here. I mean, the range of two to six times, that's really kind of eye-popping. And then appreciate the color on the commodity costs. But just how dependent are you on air freight? I mean, if you look at all of your freight total, what percent is air? Because I would think that would be more on an exception basis, or maybe I'm thinking about it wrong.

No, it is on an exception basis. And we continue to monitor that. I'm just flipping here to the percent of air freight. But it's definitely on an exception basis. As Jeff mentioned earlier, occasionally, We do find ourselves in a situation where we need to air freight, and we respond accordingly. If we do the S&OP planning work that we've been working on, we minimize that activity. But, you know, it isn't the primary source of transportation. I will, as the call progresses, I'll get that number and I'll I'll put it out there.

That'd be real helpful. You know, just, you know, you highlighted the exception basis being up so much as want to know, you know, how the ground transportation looks. Sure. But I appreciate all the color on the call and also the specifics you provide in the appendix. So thanks. That's it for me.

Thank you. Our next question is coming from Michael McGinn from Wells Fargo. Your line is now live.

Thanks, everybody. I just wanted to touch on something you mentioned earlier in the call that this quarter sales beat your internal projections. You alluded to some additional employee costs in the back half of this year. Have you changed your accrual comp expectations for the year, up or down, either way? When you say bonus?

Yeah. So if I'm understanding the question.

Yeah, that and broader SG&A accruals for compensation.

Sure. I guess a couple of things. Last year, we took the bonus out. And as I mentioned, we reinstated the bonus. So you will see bonus flowing through on a quarterly basis. And so that is a change year over year. And compensation, there's nothing unusual that you'll see there. You know, you'll see the traditional equity or non-cash compensation, long-term compensation, and you'll see a bonus much more in line with normal activity but also aligned to results. So, you know, that's when I talked about the temporary actions. You won't see us talking about a benefit from a bonus like we did in Q3 and Q4 of last year.

Got it, that makes sense.

And just to add there, I did mention furloughs on the call. If you recall in Q3 and Q4, we announced, Q3 we announced a two-week furlough. The last of those came through here in the first quarter, and right now we don't have any furloughs planned for the remainder of the year.

Okay, appreciate it. And then moving on to the gross profit, we've talked a lot about freight. Just wondering if you're able to size or if you still have manufacturing inefficiencies as your plant, you mentioned a couple COVID incidents. What would the dollar or percentage offset to freight be from more normalized operations going forward?

When you say percentage offset, what do you mean?

As a percent of gross margin basis points or from a dollar's perspective, just looking for any incremental color on what kind of the manufacturing inefficiencies, if any, are still weighing on the gross profit line.

So the two parts to that answer. The first part is the manufacturing variances from volume. We saw about 3 million of those during the quarter. And those are truly more operating at a lower volume with some inefficiencies given that volume and the protections we're taking from a COVID perspective. We saw those hold flat from Q4, and that's just at a steady production level. As volume increases, we anticipate those variances go away. In my prepared comments, I gave you kind of an indicator of the impact on margins that you may see from a pure play. These are independent of each other, but just from a pure play impact of steel, impact of aluminum, and those can vary, but steel anywhere from 100 to 200 if we do our normalized volume, and it translates into a 1% to 2% increase, and aluminum, 140 to 180. Those are cost numbers on an annual basis, and that's assuming a 5% to 8% increase in aluminum, and then a fluctuating, I'm sorry, 25% to 30% increase in aluminum, 5% to 8% increase in steel. And so that's how you can sensitize what those commodity elements might be, and true manufacturing variances will really be a function of volume. Hopefully that answers what you're looking for.

It does, thanks. I'll pass along.

Thank you. Our next question today is coming from Ann Dinan from J.P. Morgan. Your line is now live.

Hi, good morning, everybody. First of all, can you just remind us, did you tell us what your temporary cost reductions should be in Q2 versus Q1?

We did not. As I said, the vast majority of the $6 million was really travel-related. There's a little bit of stimulus, a little bit of furlough, but the vast majority, almost two-thirds of it, is travel-related. Now, we're in a different scenario. In Key 3, when we announced it as a COVID action, we were holding, we canceled all travel. Now, we're not under any type of travel restrictions other than do it safely from our end. And so, we're no longer counting that as a temporary item. As commercial activity comes up, travel will come back. And so... you know, and it won't, it's not really driven by us anymore. It's driven by the variable activity of our, from a commercial perspective. So with that and the bonus plan coming back and no more furloughs, we don't, we don't, we didn't provide any guidance of any expected travel savings in Q2. And I will point out that all of these were temporary actions that we said, you know, as commercial activity, um, return, we would let it expire. Also, with the clear acknowledgement that if volume doesn't continue to expand and I don't continue to see that incremental EBITDA versus the lost cost, then we'll have to look at temporary actions again. But right now, we're not there.

Okay. I appreciate that. And just, you know, taking a step back, I'm just curious because it's a question we have for most managements. You know, can you quantify your annual travel budget pre-COVID-19 and whether you expect that to go back to 100% of its pre-COVID levels, or do you anticipate any permanent reduction in things like travel? And maybe some other line items that you could address where you think, gee, we've been able to operate this way, so those costs will never go back to where they were, whether it's savings from trade shows or I'd just be interested in your color on those.

I'll comment on travel and then I'll let Jeff and Randy jump in on trade shows and other items. Clearly, how you do business and the nature of calls and all the creative things we've done from a commercial perspective and even just from a business leading perspective we would anticipate that some of that will stick and you won't do or see as much travel as you historically have, much like the travel and entertainment industry is expecting that. Typically, our T&E travel expense variable, it could be anywhere from two to four million and a quarter, and we may see that kick down and stay down going forward. But again, it's going to be variable driven and it'll be driven by activity. And as anyone would, there's nothing better than getting in front of a customer. And so we don't anticipate that going away. And so that's why I said, we expect it to increase once commercial activity returns.

Rick, I agree with what you've said that I think that there will be some structural changes in how we operate internally, but I don't believe that long-term an expectation is that their customers are going to suffer from not seeing us. We can't afford to let someone else sell to our end users. So whether it comes to a distributor or an actual user of the product, we want and intend to be back in front of them.

Okay, that's helpful. And any other big buckets of spending where you think, you know, they might not return to prior COVID-19 levels? That would be helpful.

From my expectation, I think the T&E is probably the one that is going to change a lot what we do. But everything else should gradually start coming back to a normalized run rate. We've learned how to work differently over the past almost one year now, and it certainly has changed a lot of companies. But I think travel and entertainment are the one that's going to structurally change.

Okay, that's helpful. I'll leave it there. Thank you.

Thank you. Our next question is coming from Mig Dobre from Robert W. Baird. Your line is now live.

Okay, thank you. Happy holidays, everyone. Thanks, Mig. I do want to stick with this cost discussion. Just clarification, because I seem to have some things mixed up, I guess, here. You know, if I'm looking year to date, I think your COVID initiatives combined have provided something better than six and a half million. But you're saying that travel and entertainment is only about two to four million per quarter. So I'm trying to understand exactly what else is in there. Is there a you know, furlough component that we need to be thinking about. And as we're thinking about the rest of the year, leaving travel to the side, what sort of potential cost headwinds might we see as some of the other discretionary actions are potentially reversing here?

So a couple of things. In the quarter of the $6 million, it was closer to 4 million of that being travel. And so that's when we spoke about the vast majority of it. Our savings for the quarter are just a little bit over 6 million, just rounded to 6 million, but definitely closer to 6 than higher. And again, about $4 million of that is travel. Then you do have a little bit of furlough, a little bit of stimulus, a little bit of 401 suspension. So the 401 , we expect that to come back in January. And the bonus was already in Q1. So the only real, and there was $500,000 of government, less than, of government stimulus in the quarter. The biggest, I guess, impact going forward would be this travel getting back to normal, but that'll come back to normal with commercial activity. From other variable costs, anything without going through a list, anything that's going to increase from an SAE perspective would also come with incremental commercial activity. We don't expect this, quote unquote, snapback of costs. Only the travel coming back. Q1 is essentially at a normal run rate, less travel. We got a little bit of furlough, but those things are not significant as a whole.

Got it. I say this because looking, for instance, at your slides from the fourth quarter call, right, I mean, you had better than $9 million of COVID savings, which I'm presuming a good portion of that actually had to do with furloughs, right? I mean, if travel is only $2 to $4 million, a good portion of that had to be something else. And that's kind of what I'm trying to get at here is we're thinking about the third quarter and the fourth quarter of fiscal 21 if there are some cost components that are programmatic that just like 401k matches, for instance, that you know are going to have to come back and we have to account for.

So about $9 million of COVID savings in Q4. It is heavily weighted. It's more weighted toward travel. I'm just trying to put that in my hand here. And it is, you know, of those that are coming back, there were definitely some furlough items in there. And we didn't give these breakdowns, but yes, the furloughs will expire. Um, and that's the 3 million, um, in large part, the 3 million Delta you see is comprised of furloughs and bonus, um, going away. Um, I think there was a little over a million dollars worth of furloughs and maybe a couple of million dollars, uh, bonus, um, in Q4. And that's the real driver of the $3 million Delta. Okay.

That's helpful. I mean, I'll follow up more offline on this. My second question really relates to the top line. And, you know, the question is in two parts. First, you talked about the backlog, the backlog being up. Can you help us understand if the backlog is up year over year or if this is just a sequential comment that you're making? And a sense for the magnitude would be helpful as well. And then the second part here is if we're thinking about the seasonality of the business, my recollection is that revenue is down sequentially in the second quarter relative to the first. Do I have that wrong and can backlog sort of alter this sequential dynamic at all? Thank you.

Well, that's exactly what I was speaking to on the call. You are correct. And if you just look at 2020, Q1 was down 5% from Q4, and Q2 was down 5% from Q1. And backlog is an indicator of, you know, the potential to counter that normal cycle just like we did in Q1. And so, you know, as we talked through the call about optimistic about continued sequential improvement, The backlog is just another indicator of that, and it is up year over year. We typically don't quantify the backlog, but it is up year over year. So when you look at what we've posted for December, look at the backlog, those are all, you know, help us to have optimism that the sequential improvement towards getting back to normal will continue.

Perhaps asking this question differently, my understanding is that your business, on the tool side at least, is not typically a backlog business. What sort of visibility do you feel you have within this backlog today versus a year ago or however historically, for instance?

Let me try to answer that. We track our bookings and billings, particularly on the tool side, on a daily basis. So we can see exactly what our book-to-bill ratios are. And what Rick is speaking to is whenever you see a business that starts to get a book-to-bill ratio that goes into that plus one, it means that we have some optimism of what's the coming quarter and the impact of the seasonality of the business. So as we said in the call, I think I said it and Rick did, and I'm not sure if Jeff specifically called out the sequential changes, but we don't believe that our second quarter will be sequentially weaker than our first, which is typically the case. And it's driven primarily by a positive book to bill, and part of that book to bill is being driven by a broad group of tools, both large and small.

Okay. Very helpful. Thank you, guys. And, you know, we've been showing the chart that shows sales dollars and order dollars. And, you know, through from Q3 to Q4 and Q1, you know, this plus one book-to-bill are positive signs. And we also have – heavy lift projects that will show up in the backlog because they are longer lead time. So all of that, you know, looking at the backlog gives us that comfort we're speaking of.

Great. Thank you.

Thank you. Our next question today is coming from Justin Berkner from G Research. Your line is now live.

Good morning and happy holidays, everyone. Morning.

Hey, Justin.

First question just relates to, I guess, trends among your distributors. Would you say that the first quarter, you know, was still experiencing destocking headwinds, or do you think your sales were pretty indicative of end market demand?

Yeah, I'll take that one. You know, I noted in my comments that we did see some restocking, and that's from some of our larger distribution. Primarily the comment was related to North America. You know, I look at – I don't think there was a particularly broad movement, you know, globally on restocking, but it's just something that we noted from some of the larger distributors. You can kind of tell what a stock order looks like when it comes across the bow. So – You know, generally though, I think we're still looking at when we get distribution orders, we consider them, you know, broadly speaking is that those are retail orders that are just being pushed through the system. So, I hope that answers your questions or not.

That's very helpful. Secondly, I'm just trying to understand, you know, do you have a sense as to how much in sales are being lost due to customer closures, particularly on the service side of the business. I guess I'm trying to get a sense for what could be the hopefully V-shaped potential for your business demand to rebound when these shutdowns cease due to vaccine implementation. Jeff, do you want to tackle that one?

Yeah, I'm trying to formulate the answer to it. I mean, there's no question that, especially in the Americas, you know, we talked about a little faster recovery in Europe. You know, clearly that's driven by end-user demand and our distributors. As we look across the verticals that we normally track, I think industrial MRO is one in the Americas that's really slower to recover. There's certainly pockets of of other industries that are suffering from the shutdown. So as those customers come back online, I can't give you a percentage or a dollar amount, but it's all part of the general recovery that we're speaking to regularly here. As those customers start to come back online, we do expect sales to pick up. And our first indication, as we've already talked about, is distributor confidence that their customers are starting to come back online. means that we're going to start to see a little bit more uptick, maybe not just from the larger distributors, but from our day-to-day general distribution. And that is a little bit of what we saw in the quarter in Europe, that general distributors, which had been lagging in terms of sales and retail through those, we did see that come back in Europe. So we look at that as a very positive sign and something that we're looking forward to happening in the Americas as well coming at us. Of course, it's all, you know, given what we're seeing on the pandemic front, you know, it's your guess, as good as ours. But we're hopeful that the vaccine starts to have some positive effect on that as well.

Okay. Yeah, I was trying to probe a little bit more on the service side of this, but I understand it's a hard sort of concept to quantify. Maybe just lastly – Have you quantified your renewables exposure? Is it sizable, more than 5% of the business? And then maybe just in closing, why not guide one quarter ahead at this point, given that you're almost two months through the quarter, and sort of adopt or readopt that practice first?

Well, let me cover that, the second part of your question first, because I think that there is – a sense of optimism that all of us would like to jump onto and say, I think we're on the backside of the impact of the pandemic and we can get back to a normal guiding process and things are being good. And then we remember what happened in March and April of this year, where within a two-week period, we saw a dramatic fall. And what we don't want to do is provide a guidance and then feel like we've misled the investor base that we have thought things are better than they actually are. So we're being very cautious. I think many companies are being very cautious. We'd like to see some actual results in terms of vaccinations and stabilization of infection rates and getting back to a normal world environment. Relative to the renewables, that is a nice growing segment of our business. We haven't called it out as a specific component of our verticals, but it is a vertical that we view as very positive, and it's one that has contributed nicely, particularly in our European operations. I think as it grows that we may, in fact, call it out as a separate piece of the power generation component of our vertical markets, but we haven't done that yet. Okay. Thank you for taking all my questions. Thanks, Justin.

Thank you. Our next question is coming from Jeff Hammond from KeyBank Capital Markets. Your line is now live. Hi, Jeff. Perhaps your phone is on mute.

Can you hear me?

Now we can. Please proceed.

Okay. Sorry about that. You know, just back on the guide, you know, it does seem clearly that you're saying kind of flat to maybe better than 1Q or But, you know, I look at the December orders and they're up. You've got the backlog up. You're seeing some service come in. But I think your guide implies kind of down, low double digits. So maybe just square that up.

Well, no intention to imply anything. And I think you can see from our orders chart that we are seeing improvement here. And the other thing, we're three weeks in, not two months. So we're three weeks into our quarter. We talked a lot about the sequential improvement with Q4 to Q1 of 7%. So I don't think it was our intent to imply up, down. I think the only thing we were implying that we expected it to buck the normal trend here. So not a whole lot more color than has already been provided, but still feeling optimistic.

Okay, thanks, guys.

And then just let me go back to the freight question. Freight is about 20% of our total. Air freight, rather, is about 20% of our total freight for the organization. Typically don't give the global number, but it is about 20% of our outbound, I'm sorry, inbound freight.

Thank you. We've reached the end of our question and answer session. Let's turn the floor back over to Randy for any further or closing comments.

Good. Thanks very much, everybody, for your participation today. And once again, we'd like to wish you a very safe and happy holidays, and we will talk to everybody in the new year. Thank you very much.

Thank you. That does conclude today's teleconference and webinar. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

All right.

Thanks very much.