Luxfer Holdings PLC Q3 FY2020 Earnings Call

Good morning. My name is Stephanie, and I will be your conference operator today. Welcome to Luxfer's 2020 Third Quarter Earnings Conference Call. All lines have been placed on mute. After the speakers' remarks, there will be a question-and-answer session. Now, I will turn the call over to Mary Reed from Luxfer. Mary, please go ahead.

Thank you, Stephanie. Welcome to Luxfer's third quarter 2020 earnings call. We are happy to have you all with us today. I am Mary Reed from Luxfer, and with me today is Alok Maskara, Chief Executive Officer; and Heather Harding, our Chief Financial Officer. On today's call, we will provide details on our third quarter 2020 performance as outlined in the press release issued yesterday. Today's webcast is accompanied by a presentation that can be accessed at luxfer.com. Please note, any references to non-GAAP financials are reconciled in the Appendix of this presentation. Before we begin, a friendly reminder that any forward-looking statements made about the company's expected financial results are subject to future risks and uncertainties. Please refer to the Safe Harbor statement on Slide 2 of today's presentation for further details. Now, let me turn the call over to Alok.

Thanks, Mary, and welcome everyone. I hope you and your families remain healthy during these turbulent and uncertain times. Before I discuss our third-quarter performance, and provide an update on our transformation strategy progress, I want to thank our 1,500 employees around the world for working hard to ensure the health and safety of all our colleagues and their families while always putting our customers first. I am proud of our teams’ discipline and steadfast adherence to operating procedures as we navigate the COVID pandemic. While several of our end-markets remain challenged, we have been executing with agility as we recalibrate our cost structure to current demand levels, while also positioning Luxfer to fully capitalize on recovery. With that, let me provide some highlights of our quarterly performance and strategic focus. First, we delivered solid Q3 financial results despite challenging end-market conditions, and we are seeing sequential improvement across our businesses. Second, we generated very strong cash flow, further bolstering our already robust balance sheet. This gives us greater optionality as we invest in organic growth enablers and pursue potential inorganic opportunities. Third, we executed our transformation plan and made meaningful progress on initiatives to drive growth through new product development and commercial excellence. I will provide more details on these themes, and our CFO, Heather Harding, will then review our financial performance in greater depth and share guideposts for the remainder of 2020. Now please turn to Slide 3 for a summary of our third-quarter financial results. We delivered solid third-quarter results as we addressed the impact of COVID-related macro conditions on our end-markets with a focus on controlling costs and driving free cash flow. Total sales of $90.4 million declined 15.6% year-over-year, but we saw sequential improvements compared to the 21.1% decline in the second quarter. Third-quarter adjusted EBITDA of $14.2 million declined 15%, helped by cost actions to mitigate the gross margin impact of lower volumes. Our adjusted diluted EPS for the third quarter was $0.25, down 31% compared to the prior year. During the quarter, our focus on working capital resulted in $25.6 million of cash generation, including $1.4 million in cash restructuring expenses. This enabled us to reduce our net debt to $59.3 million, compared to net debt of $82.4 million at the end of the second quarter. Our net debt to EBITDA ratio improved to 1.1 times at the end of September, which is significantly below our covenants. Our balance sheet remains strong with additional liquidity from $150 million of an undrawn revolving credit facility providing us a lot of financial and strategic flexibility. We are currently operating most of our facilities at reduced capacity to serve the evolving needs of our customers and are encouraged by the sequential improvements in demand. All our locations are operating with additional COVID safeguards and as the number of positive cases continues to rise, the health of our employees, our customers, and our communities remains our number one priority. Now, please turn to Slide 4 for an overview of how Luxfer has adapted to the new normal. Over the eight months since the COVID pandemic began, we have effectively adapted and innovated better ways to serve our customers. We have retooled our manufacturing operational procedures, rearranged our patterns, and enabled remote work wherever possible to minimize the number of people in our facilities at any given time. We continue to limit the number of visitors to our facilities while making face masks and social distancing mandatory for all personnel. Some of our procedures are likely to result in more permanent change as we continue to adapt to an ever-evolving external landscape. If there is a silver lining, the pandemic allowed us to accelerate many of our lean initiatives and I believe Luxfer will be better positioned to capture growth in the future. Given the current environment, our customers are shifting preferences towards a localized supply chain. Luxfer is a beneficiary of this shift as most of our manufacturing is in-region for the region. For example, U.S.-based manufacturing generates greater than 90% of its sales in the U.S., and a similar situation is true in Europe. Lastly, greater remote connectivity allows for increased access through a broader talent pool as physical locations become less relevant for certain roles and positions. We will continue to leverage the skills and talent of our dispersed workforce even after the pandemic. Let’s now review our revenue performance by end-markets on Slide 5. As a reminder, our current sales can be classified into three approximately equal end-user markets: Defense, First Response, and Healthcare; Transportation, which is a combination of Alternative Fuel, Aerospace, and Automotive; and General Industrial. Before we review the performance of each, let me give you a sense of the shifting demand pattern we saw during the quarter. There was a gradual sequential improvement in sales after the very low levels experienced in April and May. Order rates continued to improve modestly in July and August, but plateaued in September, especially in the U.S. Two factors that may be impacting order patterns are uncertainty surrounding the U.S. election, which would be typical for defense orders, and the recent uptick in COVID cases across the country. We are closely monitoring our order rate and will execute additional countermeasures if business conditions deteriorate. In the Defense, First Response, and Healthcare markets, sales declined roughly 8% for the third quarter. We saw increased demand for our disaster relief products and chemical response kits, but that was offset by a decline in cylinder sales for fire extinguishers and SCBA. Sales in Transportation declined 19% in the third quarter; demand for luxury passenger auto improved modestly, and our auto catalyst products grew year-over-year. However, demand for aerospace applications weakened during the quarter as manufacturers implemented additional production cuts in response to a protracted slump in air travel. Alternative fuel returned to growth during the quarter, and we remain optimistic that this trend will continue going forward. Sales in the general industrial end-markets declined 19%, which represents a meaningful sequential improvement from the 27% decline in Q2. The sales decline was broad-based and impacted most of our industrial products. However, we are encouraged by the sequential month-over-month improvement as the quarter progressed. As expected, there were virtually no SoluMag sales during the quarter; despite our strong position, we expect SoluMag sales to remain challenged for the rest of the year. Now, please turn to Slide 6 for an update on our transformation strategy. We are successfully executing our transformation strategy with discipline and are creating incremental value for our shareholders. Successful completion of the simplification phase has significantly improved our balance sheet. The lower fixed costs enable us to better navigate the COVID pandemic and benefit from future recovery. Phase 2 of the transformation plan covers improvements in our high-performance culture and lean operations. Phase 3 is focused on growth through organic means and through portfolio optimization. We remain committed to completing the transformation plan and creating incremental value as the market recovers. Over the next few minutes, I would like to share some examples that will drive the successful Phase 2 and 3 of the transformation plan, starting with a review of our Environmental, Social, and Governance (ESG) Slide 7. Despite the challenging economic landscape, we have increased attention on developing sustainability initiatives that position us for a stronger recovery and long-term success. We are pleased to report that we will be publishing our first-ever Environmental, Social, and Governance report in the coming weeks. Our ESG report discusses key subjects of interest to our shareholders, such as the establishment of our 2025 environmental protection goals, disclosures of social statistics, and an overview of our governance structure. Our upcoming ESG report highlights our long-term sustainability activities and explains how these activities are driving our performance. The purpose of this report is to initiate consistent reporting on ESG matters, improve our transparency and disclosure, and formulate the basis for an informed conversation between us and our stakeholders. We realize that non-financial reporting is important to our stakeholders. As such, we hope that by periodically publishing an ESG report, we are creating a different platform through which we can connect about the ways we are creating value for all our stakeholders, including employees, customers, communities, the environment, and shareholders. We also hope that increased transparency in this regard can be a tool to promote our resilience and strengthen our ability to emerge stronger post-COVID. Now, please turn to Slide 8 for an example of one of our growth initiatives. As many of you know, our zirconium products are often used in the formulation of three-way catalysts for catalytic converters in gasoline-powered automobiles. Environmental considerations and changes in emissions regulations are increasing the demand for vehicles with our products. In addition, the shift from diesel to gasoline in Europe is offsetting the transition from internal combustion engines to electric vehicles for companies like us that are focused on gasoline-based products. To further capture growth from this end-market, we have recently launched a new nanotechnology-based product for gas particulate filtration. This new product utilizes our strong IP position and unique technology to deliver exceptional catalytic and filtration properties to our customers while minimizing any exhaust back pressure to optimize performance. We are optimistic that this new product, along with our other existing products for gasoline particulate filtration, will drive strong organic growth. We expect this product category to ultimately make up over one-third of our auto catalytic product sales. Now, please turn to Slide 9 for an example of our structure in the area of hydrogen fuel cell vehicles. When it comes to hydrogen fuel cell vehicles for public buses and medium to heavy-duty trucks, Luxfer is well-positioned with over 30 years of experience in hydrogen storage technology. Our competitive advantage in hydrogen is based on industry-leading lightweight cylinder technology and our capability for advanced systems design, manufacturing, and testing. We have a proven track record in partnering with customers to deliver hydrogen solutions, including the world’s first hydrogen double-decker bus, the first commercially available hydrogen garbage truck, and the first hydrogen-based train in the UK. We manufacture these lightweight cylinders in our state-of-the-art alternative fuel facilities in California and Canada, which also produce cylinders for compressed natural gas-based vehicles. Our systems are designed and assembled in our Nottingham UK facility using just-in-time development and manufacturing techniques. While this is a nascent industry and sales of our hydrogen storage products make up only about 1% of our total sales, we are excited about the growth potential in this space and will continue to invest in building our hydrogen innovation and manufacturing capability. Now, please turn to Slide 10 for an example of one of our lean manufacturing initiatives. Our Luxfer Magtech Cincinnati facility historically manufactured only flameless ration heaters and self-heating meals and beverages. But more recently, it has started the production of chemical response kits following the consolidation of our factory in Riverhead, New York. The expanded size and scope of the Cincinnati factory has generated scale economies. This has created the opportunity for us to deploy more lean talent and invest in manufacturing automation. The recent successful launch of new chemical response kits for decontamination, along with the COVID-related higher demand for emergency response, has placed additional strain on this facility. To satisfy our significantly increased customer needs, our team had to recruit a large number of temporary employees; attracting, training, and retaining temporary employees during COVID has been a challenge. So we have recently installed an automated packaging line for our self-heating meals to reduce the need for additional workforce. The new line will also increase the quality and consistency of our heater meals product while reducing the expected delivery time for our customers. The Cincinnati example is just one of the many lean automation transformations taking place in Luxfer facilities following recent footprint consolidation. Fewer larger factories are allowing us to deploy more lean resources and invest smartly to better serve our customers and increase productivity. Our internal manufacturing scorecard shows significant improvement in safety, quality, delivery, cost, and cash in our factories. These improvements will generate attractive returns and allow us to efficiently serve our customers. Now, let me turn the call over to Heather Harding, Luxfer’s Chief Financial Officer, for details on the transformation plan results and a summary of our third quarter financials.

Thanks, Alok, and good morning everyone. Thanks for joining us today. Following Alok's review of the strategic elements of our multi-year transformation, I wanted to summarize the financial impacts of this plan on Slide 11. Our focus on cost reductions and waste elimination has resulted in $18 million of net cost savings through the third quarter. In addition to cost reduction, the smaller footprint in our manufacturing has reduced our annual operating capital requirement by approximately $5 million to $6 million from our historical levels, further improving our cash generation. Our overall lower cost structure will deliver incremental profitability as our end-markets recover. We remain on track to deliver our committed $24 million of net cost reduction by the end of next year. However, based on the strength of our Q3 performance, we now expect to deliver an additional $1 million in savings this year for a total of $6 million to $7 million in savings in 2020. Now let’s walk through the third quarter financial results summary on Slide 12. Third quarter reported sales of $90.4 million declined 15.6% year-over-year, primarily due to the COVID-related impacts in our Transportation and Industrial end-markets. Consolidated adjusted EBITDA for the quarter was $14.2 million, down 15% versus the prior year. Despite the volume decline, the company executed on the transformation plan and delivered approximately $2.8 million of net cost reductions in the quarter. There were several one-time events in the quarter that impacted our results. The quarterly adjusted EBITDA was positively impacted by approximately $600,000 of net favorable non-recurring items, including a net benefit from a customer contract in the Gas Cylinder segment, and partially offset charges in the Elektron segment for obsolete processes and agency contracts. The quarterly adjusted effective tax rate was negatively impacted by $900,000 for the change in Canada tax rate affecting our deferred tax asset position. For a deeper dive into our two product segments, let's turn to Slide 13. Elektron sales of $45.4 million declined 14.2% from the prior year. The sales decline was primarily due to weakness in Magnesium, Aerospace, Graphic Arts, and Industrial Products, partially offset by strength in Heater Meals and chemical response kits. EBITDA declined 36.5% to $6.6 million due to lower sales performance and a net $1.2 million charge for a one-time non-recurring item. Gas Cylinder segment sales declined 17% to $45 million as COVID impacted European luxury auto, aerospace and industrial products, with alternative fuel returning to growth. EBITDA of $7.6 million increased 21% from the prior year, as cost reductions offset the sales volume declines and profitability included a $1.8 million net benefit from one-time non-recurring item. Now let's review our key balance sheet and cash flow metrics on Slide 14. We ended the third quarter with a stronger balance sheet. Our net debt improved to $59.3 million, leading to a net debt-to-EBITDA ratio of 1.1 times. Third quarter operating working capital of $89 million was $17 million lower than Q2. The resulting operating working capital as a percent of sales was 24.6%, which is slightly better than our prior year end level. This performance reflects the results of our working capital initiatives, which were primarily focused on aligning inventory to current demand levels. We expect to maintain most of these working capital improvements through the fourth quarter. We generated $25.6 million in free cash flow, a record for the third quarter, using approximately $1.4 million in cash for restructuring activities. This compares favorably to our prior year’s third quarter performance of $1.2 million cash outflow. On a trailing 12-month basis, we delivered 11.8% ROIC from adjusted earnings. Our balance sheet is solid, and we are generating positive free cash flow. We remain well positioned for strong cash conversion in 2020 and beyond. Now I would like to review our capital allocation priorities through Slide 15. As mentioned earlier in the call, we expect our cash conversion to average 100% of our net income through disciplined capital allocation. We are in great financial position with a strong balance sheet and ample liquidity to take further steps to drive profitable growth. This improves strategic evaluation of our business portfolio and identifying inorganic options to drive additional shareholder value. Our primary focus of capital allocation will be creating value through internal execution, which includes funding of new product innovation and talent development. We continue to fund our transformational cost savings initiatives with expected cash costs of approximately $40 million through the end of this year. We expect 2020 CapEx to be in the $8 million to $10 million range. We remain open to strategic acquisitions to supplement our organic growth. Our focus will be on businesses that provide one or more of the following criteria: a leading position in industrial material niches; the ability to expand our business in key product categories, markets, or geographies; strong engineering, IP or critical process technologies; significant synergies; and a strong cultural fit. We would expect ROIC to meet our hurdle threshold within three years. We will continue to return cash to shareholders via dividends. As a reminder, we’ve paid out over $90 million of dividends since 2013, including $3.4 million in the recent third quarter. During our June Annual General Meeting, we received approval from our shareholders for share buyback. However, we are not initiating a program at this point given market uncertainty. In the interest of transparency, let me provide our views on some of the key assumptions for the remainder of the year on Slide 16. The challenging current market environment is having significant impacts on our businesses. For the fourth quarter, we expect total revenue to remain essentially flat on a sequential basis. Importantly, this is despite our typical Q4 seasonality; we often experience a sequential sales decline from the third quarter. We expect both defense and transportation end-market sales to improve slightly from Q3 levels. Given the seasonal impacts, we expect industrial end-market sales to decline sequentially consistent with prior year. We remain focused on our cash initiatives for the year. We will ensure working capital and capital expenditure plans are aligned to track conditions without sacrificing investment in future growth and productivity initiatives. Building on our significant cash generation in Q3, we expect the cash generated in the fourth quarter to be used towards planned outflows, as well as the modest inventory build driven by seasonality and potential Brexit impacts. For the year, free cash flow will convert to more than 100%. With our strong balance sheet, we are confident in our ability to successfully navigate current market conditions and position Luxfer to capture growth as markets recover. Now I’ll turn the call back over to Alok for a wrap-up.

Thank you, Heather. Please turn to Slide 17. Let me wrap up by recapping that we serve attractive niche markets with proprietary products and technology. Our transformation plan has delivered results and will continue to make a positive impact for the next few years. After the transformation plan is complete, we have plenty of runway to create even more shareholder value by deploying the Luxfer business excellence standard toolkit to drive operational improvement and to accelerate growth. Once again, I want to thank all our employees around the world for safely operating our facilities while maintaining our commitment to always putting our customer first. Thank you for listening. We will now take questions.

Your first question comes from Chris Moore with CJS Securities.

Hey. Good morning guys. Thanks for taking the questions. I just want to make sure I am looking at the cost savings correctly. You talked about some COVID cost reductions to be permanent. And then, trying to understand if that is incremental to the transformation plan that is happening now or if that is incorporated in there? Any detail you could give us on the COVID cost reductions that could be permanent would be helpful.

Sure. So, Chris, I think from a COVID perspective, we had quite a bit of cost reduction that we needed to implement just to offset the gross margin impacts. Putting that aside, both cost decreases and higher costs exist; each of our factories is spending more on sanitization, cleaning, and there's inefficiencies. We have savings in areas such as travel, supply chain, and transportation. The total commitment on $24 million does not change, so that remains our net cost savings target. What we are more optimistic about is, once growth recovers next year and some of the one-time COVID-related costs are behind us, we will generate additional drop-through when the growth recovers. A simple way to look at it is to keep the cost out number at 24 and any upside in the future will come from better gross margin on sales that come back.

Gotcha. Alright. Thank you. On the revenue side, how much visibility do you have into fiscal 2021 with respect to the decontamination kits and the heater meals?

We have more visibility by the end of the year. At this point, we do expect the sales to continue going into next year at the same level as what we had in 2020. By the end of the year, we’ll have more confirmation in terms of orders. But right now, we expect that to continue.

Got it. I'd see new product development as important. Does R&D spending need to increase much over the coming quarters in order to take advantage of the opportunities that you are seeing at this point?

Not really. I think we are spending right about 1% and I think that number will remain in that range. We’ve been very efficient and focused on fewer bigger projects, and that seems to be paying off without the need to significantly increase our R&D spending. I think we should consider that 1% for the near future.

Got it. And last one from me, any thoughts on Brexit at this point in time? Is there any potential near-term impact that might be had on Luxfer?

Hey, Chris. I’ll take that one. Good morning.

Good morning.

Overall, certainly, we feel like we’ve planned for this a couple of times depending on the nature of the projects over the last four years or so. From our perspective, we feel like we’ve done the proper planning, and we don’t think we will be disadvantaged any more than other businesses depending on what logistical or new administrative requirements are enacted. As I mentioned, we are looking at some key inventory positions and making sure there are some key items that we will likely build a little bit up in the fourth quarter. Frankly, we think some of our key customers may be looking at that as well. So, overall, we don’t view it as a significant material impact on us as we get to the end of the year.

Got it. I appreciate that. I’ll jump back in line. Thanks guys.

Thanks, Chris.

Thank you. Your next question comes from Craig Irwin with ROTH Capital Partners.

Hi. Good morning, and thanks for taking my questions.

Hey, Craig.

So, one of the things I really like about Luxfer is you have an array of interesting growth opportunities in front of you, right? Everything from alternative fuels to new particulates technology and automotive catalysis to even things in medical markets. Can you maybe list your top opportunities for expanding 2021 contributions to the top-line? Can you maybe sort of expand on the proportionate impacts or maybe rank the impacts from a dollar perspective? And what you are looking for to get confidence there to be more bullish, so it seems like you are generally conservative, which I know is just the way you operate. But if you could maybe describe what you are waiting for from your customers to be more confident that these will all be a larger contribution?

Thanks, Craig. From our perspective, it’s hard to talk about growth given the deep COVID-related impact. But putting the macro aside, the area that we are most bullish on right now is alternative fuel. That's especially true with hydrogen, but also true for compressed natural gas. That product line has more than tripled over the past few years, and we already have a strong backlog of orders going into next year. We feel quite confident we will partner with great organizations to supply these solutions around the world. Also, keep in mind that we are very focused on heavy to medium-duty trucks; we do not play in the passenger auto market, which means we are specialized and are capturing fair or more than our fair share of growth in that space. Second, I would put our zirconium product line—that’s where gas particulate filtration belongs; we have acquired some medical opportunities in the pharmaceutical industry, and we also have some new product coatings based on similar nanotechnology. I think that’s another piece we see very confident about continuing to drive growth in that space. The third area that I would highlight would be decontamination kits, which are manufactured at our Cincinnati facility that we highlighted. Another growth area for us—another place where we have unique proprietary technology and significant market share. Those would be our one, two, and three: alternative fuel, zirconium products, and decontamination kits.

Thank you. So, if I could ask a follow-up on the alternative fuels side, so UPS is one of the most vocal customers in this market. Unfortunately, not a big customer for Luxfer, right? But they’ve gone out there and said multiple times on the record that their Class 8 trucks operate on alternative fuels because, even though they have higher maintenance costs, they still have superior economics to conventional diesel trucks. The emissions regulations that are coming online and tightening for diesel are really pushing things in the direction of alternative fuels. The reason I reference UPS is, are you seeing strength predominantly in the big rig market and Class 8 trucks? Or are you seeing broad strength across people looking for last mile delivery solutions, or small fleet service organizations, and everything in between? Or is there a change in concentration towards larger vehicles that tend to go back to depots?

Thanks for bringing that up. I mean, UPS on itself may not be a big customer, but there are others which run similar route-based delivery networks—companies such as Waste Management, or nowadays Amazon. In all of these route-based networks and public buses have a similar system, so those are clearly our target customers. We do supply some to UPS; although competition likely has a greater share in that existing customer base. Our current sales are focused more on route-based, last-mile delivery type opportunities. But we are seeing increasingly more companies looking at large Class 8 vehicles as well. However, the majority of our current sales are in medium chassis frame and looking at these, which are more last-mile delivery going back to the service networks. We remain optimistic about the Class 8 heavy-duty trailers as well, but that’s more of a nascent industry right now.

Understood. Understood. And then, just as a follow-up, there have been a couple of very large contracts given in the last year. I think one of them was a $500 million contract on a systems level, right? And there has been chatter about others, right? Amazon, that’s a name that’s out there. Can you maybe describe for us the tempo of procurement activity in this market? Do you see numerous contracts that are out there at the systems level, I guess, in the many hundreds of millions or few hundred million that come back to Luxfer?

So, globally, yes. We do see quite a few systems contracts. Keep in mind that we assemble our own systems in the UK. So there, we participate directly in the systems market and we see a very healthy pipeline. Some are optimistic about those opportunities converting into dollars, some may be less optimistic. We are not overly optimistic at that level; it would come down to larger players like Amazon making the final decision on their fleet. So far, CNG-based vehicles seem to meet all the environmental standards; they have excellent economics given the delta between CNG and diesel is still viable despite changes in the oil price. Frankly, from an environmental perspective, given that a lot of electricity is generated through coal or natural gas, this has a favorable environmental impact as well. So, yes, we remain very optimistic, while we can’t commit to a number like 100 or 500, it’s within that range, and some single opportunities with larger customers could be in that range on its own as well. So that’s an opportunity. We have tripled the sales here and we are prepared for sales to continue going up, and we’ll keep investing in capacity and technologies.

That’s fantastic progress. That’s really, really good to hear. So, my next question is, everybody understands why you are deemphasizing fire extinguishers? It’s obviously the right move for the company. But the impact on the top-line and the duration of this impact is something where it’s been a little bit difficult to model. Can you maybe describe for us what you expect the revenue impact to be for you over the next handful of quarters? How long does this last? And when does it start to show through in margins as these products are shed?

So first of all, you are right. It is absolutely strategically the right thing for us to do. This was a low-margin aluminum cylinder that hung on the wall where our lightweight value proposition wasn’t really valued by the customer. Right now, we look at this as about just over $1 million a quarter type impact, perhaps. We expect this to start lapping itself by early 2021. So, we have another couple of quarters of this $1 million a quarter type impact going forward.

Excellent. Thanks for taking my questions. I’ll take the rest of my questions offline. Congrats on the progress.

Thanks, Craig.

Thank you. Your next question comes from Sarkis Sherbetchyan with B. Riley Securities.

Good morning, and thanks for taking my question here.

Hey, Sarkis. How are you?

Well, thank you. I just first wanted to get a better understanding of the gross margin level of the quarter. Heather, maybe if you could talk about what the one-time impact in Elektron was, if that had an impact, or if it was just simply a mix impact? I have a few more questions.

Yes. Good morning, Sarkis. So, in terms of the one-timers, the bulk of the one-timers from a cost perspective did hit gross profit. Over $1 million of that one-time net cost did affect gross profit, which obviously impacted Elektron. If you restate it, Elektron would have been north of 17% excluding those items. That’s certainly a big hit. When you think about the gross margin, I know our reported gross margin is just over 20%. If you pull out the impact of the one-timers, we were closer to 21.7%, which we are still obviously impacted by the COVID sales decline. But if you look sequentially, relative to Q2, we posted some nice margin improvement on the gross margin line, just purely looking at an operating basis. So, hopefully that gives you some indication of kind of the impact of our cost reduction programs and how we are working through all the efficiency items in our plans.

Yes. So, thanks for that. And I think you mentioned in the prepared remarks, you expect sales to kind of remain flattish here sequentially. Maybe if you can talk about what you are seeing regarding order rates by either end markets? If you can also comment on the margin structure you’d anticipate. Should that be kind of in line with what we saw this quarter? Or improving given your cost out? Just help us understand that.

Sure. So, I will start with the order rates. It’s still quite uncertain, and our visibility remains less than ideal or less than before. If I think of defense in a broad bucket, I mean, order rates are strong there and there is a typical election year pause, which we anticipated and are facing. Putting that aside, order rates remain strong and we are bullish about getting that to be slightly growing in Q4 and going forward, as Heather mentioned. Transportation and Aerospace are weaker. Automotive is a little better. Alternative fuel is going to grow, as we talked about. So, net-net, I think that’s going to become a growth area for us going forward as well. Industrial is the area where it’s most challenging for two reasons. Q4 is sequentially lower for industrial. So, we are going to face that. I think we have seen more bouncing along the bottom—not getting worse, but we haven’t seen things getting a lot better either. So, that’s the one where we are facing uncertainty and looking at how to move forward. From a margin structure perspective, while in general, our margins are fairly comparable across the board, the industrial area has very healthy margins, but the auto that’s coming back is lower margin than aerospace. That does have a negative mix impact on us. It’s partially offset by defense being stronger. Overall, if I put the picture together, I would expect margins to remain stable going forward, excluding the one-time impact that Heather already mentioned and some of the cleanup items we did in Q3. Heather, anything to add to that? Or Sarkis, does that answer your questions?

The only thing I might add, Alok, is that the last part of the question was around cost reductions. Certainly, we’ve increased this year’s cost reductions from $6 million to $7 million that we are pulling forward. So, obviously, given the fact that we posted, I think, $4.5 million year-to-date, you could certainly model in continued cost reductions that we do expect to deliver in the fourth quarter.

That’s super helpful. And I guess, just to build off of that thought process, Heather, is the SG&A run rate for this quarter kind of the appropriate benchmark to look at going forward, considering your cost out? Or were there any unusual items in that number that would cause it not to be reflective of your outlook?

Yes. I think from our perspective, the SG&A is pretty indicative. There’s always a bit of quarterly things that happen, but overall, I would say it’s pretty indicative for you to use going forward.

Okay. Thank you. I’ll take the rest offline.

Thanks, Sarkis.

Thank you. Your next question is from Michael Leshock with KeyBanc.

Hey guys. Good morning.

Good morning, Michael.

So, first, just on the SCBA timing, you called that out as it was impacting sales in the quarter. I thought a majority of that was behind us at least pre-COVID. If you could talk about what happened there, and when you expect to realize the sales?

Sure. So I think on SCBA, the pre-COVID disruptions were around some certification, and that’s clearly behind us. Right now, what we are facing in SCBA is that we work very closely with our key customers, who you know, and all of us are facing some supply chain challenges and are retooling our factories for COVID, resulting in social distancing. We have had some timing-related issues there. This is just an unfortunate case of everybody operating under the new normal with COVID. But these are factories where people are often standing shoulder-to-shoulder, doing assemblies and kits; everyone had to just retool all operations. So, they are more operational and supply chain-related delays that we hope to catch up in Q4 and Q1 going forward. There are no demand issues at all.

Got it. That’s helpful. And then, moving on the M&A front, I just—out of curiosity—would you be targeting multiple niche transactions, or would you favor a larger deal?

I mean, I think we’ve talked about bolt-ons and what we are going to focus on from our perspective. We are not against larger transactions, but given past experiences and where we think we can add significant value, it’s going to be around niche end markets, where they have strong market positions similar to what we have with good attractive margins. But we are not looking at big transactions. Our focus will continue to be on bolt-on opportunities where we can achieve significant synergies. With regard to the target markets, we would focus on niches.

Is there any specific end markets that you might target more than others?

Our strength in Defense, obviously, is something that we like. So the whole first category we like quite a bit. We also like Aerospace. There are niches within Industrial that we like. So, no, not specifically; we try to avoid increasing the complexity of Luxfer. Alternative fuel is an area that we like quite a bit. So, those are areas where we feel strong, and where one plus one is greater than two.

Got it. Appreciate all the detail. Thank you.

Thanks, Michael.

Thank you. Your next question comes from Phil Gibbs with KeyBanc Capital Markets.

Hey, thank you. Alok, when you talk about the gasoline particulate filtration opportunity, I think your pitch was a 7.5 times sales increase in 2021 versus 2019. How much of that growth did you achieve in 2020? Because, presumably, you have been growing this year as well.

Yes. So we are growing. Now, keep in mind that 2.5 times is starting from a low base, so not all our sales are going into gas particulate filtration, and that will be about 30% of our autocatalyst sales going into gas particulate filtration. This year, I would say the—consistent with our previous rule. We only talk about new products when we reach about $1 million in sales, so that’s where we would be this year.

You are going to be about $1 million in sales in this segment?

Yes.

Okay. Okay. And so, should we consider that the level you are at in 2019 as well? So this is going from about $1.2 million to $2.5 million?

2019 was close to zero. So this year’s $1 million is all new sales.

Okay. Got it. And Heather, you talked a little bit about the cost savings. Clearly, this quarter was very strong in that regard. Do you expect incremental cost savings relative to the 3Q baseline? Or is the number that you increased mostly based on the year-to-year comparison? I’m trying to understand if there is incremental relative to this past September quarter?

Right. So, certainly, as you know, when we measure the cost reductions, that is based on year-over-year comparisons. So, we would expect a continuation of this program into Q4. We’ve taken significant cost actions here in the last two quarters, and so we are always looking for additional opportunities. I don’t expect material sequential cost reductions from Q3 to Q4; it’s a continuation of our current cost reduction plan.

Thank you.

Thanks, Phil.

An encore recording of this conference call will be available in about two hours. Telephone numbers to access the recording will be available at Luxfer’s website at www.luxfer.com. Thank you for joining us today. The next regularly scheduled call will be in February of 2021 when the company discusses its 2020 fourth quarter financial results. This ends the Luxfer conference call. You may now disconnect.