Q1 2020 Earnings Call
Good morning, I would like to welcome everyone to Kennametal first quarter fiscal 2020, <unk> earnings Conference call.
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After the speaker's remarks, there will be a question and answer session.
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I'd now like to turn the conference over to Kelly Boyer Vice President of Investor Relations. Please go ahead.
Thank you operator, welcome everyone and thank you for joining US tribute Kennametal first quarter fiscal 2020 result.
Yesterday evening, we issued our earnings press release, [laughter] posted a presentation slides on our website.
We will be referring to that slide deck throughout today's call and a recording of the call will be available for replay through December [laughter].
I'm Kelly Boyer Vice President.
Mr Relations joining me on the call today, our kids Roski, President and Chief Executive Officer, Damon Audia, Vice President and Chief Financial Officer, Patrick Watson, Vice President Finance corporate controller, Alexander Burrows, President video business segment, Pete drag it president.
Industrial business segment, and Rockport President infrastructure business segment.
After christen Demmons prepared remarks, we'll open the line up for questions.
At this time I would like to direct your attention to our forward looking disclosure statement.
Today's discussion contains comments the constitute forward looking statements as defined under the private Securities Litigation Reform Act of 1995.
Such forward looking statements involve a number of assumption.
Uncertainty that could cost the company actual results performance or achievements to differ materially from those expressed in or implied by such forward looking statements.
These risk factors and uncertainties are detailed in kennametal FCC filing.
In addition, we will be discussing non-GAAP financial measures on the call today reconciliations to GAAP financial measures that we believe are most directly comparable can be found at the back this slide deck and on our form 8-K on our website and with that I'll now turn the call over to Chris.
Thank you Kelly good morning, everyone and thank you for joining the call today.
Starting on slide two in the presentation back.
Our results in the first quarter were below expectations due to global market conditions deteriorated more significantly than we anticipated.
Primarily on the transportation energy and General Engineering end markets.
Danek sales declined by 11% versus 10% growth in the first quarter last year.
Adjusted EBITDA margins decreased 820 basis points, the 10.9% and adjusted EPS decreased to 17 cents versus 70 cents in the prior year quarter.
Decreases on margin and Aes were the result of three main factors.
First due to the rapid change in end markets organic sales decline magnified by unfavorable labor and fixed cost absorption.
We are adjusting to the lower volumes by reducing overtime and temporary workers and further adjusting production through the demand all.
Of course, the full benefit of these actions will not be reflected immediately.
Secondly, as expected and discussed on our fourth quarter earnings call Thompson prices have come down quickly.
To give you an idea of the magnitude of the drop tungsten was approximately $270 for most of fiscal year 19, and then dropped in the first quarter fiscal year 22 approximately $200.
Effect is the temporarily depressed margins in the short term until the higher priced inventory moves through the PML.
This accounted for approximately 360 basis points of the 820 basis point reduction in EBITDA margin.
We expect this effect will continue in Q2, and then abate in the second half of the year.
And finally as expected we are experiencing under absorption due to footprint rationalization.
We expect this effect to decrease as plants are close later this year and next.
Our operating expenses in dollar terms decreased 7%. However in percentage of sales terms increased slightly to 22% as a result of the decrease in sales our target for operating expense margin remains at 20%.
We are focused on improving financial performance throughout the economic cycle.
Juan simplification modernization contributed an incremental $8 million or seven cents year over year to our EPS on top of the 40 million achieved last year and roughly 10 million achieved year before that.
No that further benefits from footprint rationalization are still the comp and our weighted to the back half of the year.
Looking ahead. In addition to our focus on cost out actions, we continue to make gains on our growth initiatives.
For example, our high volume high margin products grew low single digits in the Americas, Despite the more challenging market environment.
In addition, we continue to get good traction on new products, which I will discuss in just a moment.
So we are encouraged by these results and our growth areas of focus fundamental weakness in global industrial activity increased during the quarter and therefore, we've reduced our expectation for organic growth this fiscal year.
We are no longer assuming a modest recovery in the second half for the year in transportation and energy, but rather expect the year will simply fall a more normal seasonal pattern from the current lower market environment.
As I said, our focus is on proven performance throughout the entire economic cycle. So we are driving forward with our simplification modernization program.
We continue to make good progress on restructuring actions and in fact recently ceased production at a facility in Germany, and then move work to lower cost facilities.
We expect the benefits from this and other pending plant closures to increase in the second half of this fiscal year.
By the ended the year RF why 20 restructuring actions are expected to reach a run rate savings level of $35 million to $40 million.
Fiscal year 21 restructuring actions will bring an additional $25 million to $30 million in run rate savings by the end of fiscal year 21.
Also our second half profitability will benefit as the effects of higher raw material costs and manufacturing inefficiencies from footprint rationalization abate.
Now, let's turn to slide three for a comparison of our current fiscal year forecast to historical results with similar revenue levels.
As you can see on the left hand chart, our adjusted EPS for fiscal year 20 is expected to be significantly higher than previous years with similar sales. This is primarily the result of the simplification modernization work already completed including structural cost out actions.
Noting powder and SKU reductions strategic pricing and portfolio rationalization.
And remember these numbers do not include the full run rate effects of the plant rationalizations that I just mentioned.
The right hand chart, we show the expected improvement in our forecasted cash flow from operations that is implied in our outlook.
Again this significant increase is due to the work done today to permanently removed cost out of the system through simplification modernization.
He is also important to recall that this year's cash flow is reduced by the temporary restructuring costs associated with footprint rationalization.
On slide four we highlight some of our recent product launches.
We are continuing to advance our growth initiatives, even in this period of lower end market demand in part through new product introductions.
Our growth areas of focus include aerospace and general engineering.
The Harvey Ultra Eightx is used by aerospace customers for rough milling titanium and offers market leading metal removal rates.
This tool was recently named a 2019 R&D 100 awards finalists, which is a testament to the innovation of the design.
The Harvey one TV is an end Mel used by general engineering customers. It delivers up to 50% increase in productivity and tool like depending on the application.
Another new product, which is also focused on aerospace growth is the core by an end mill for aluminum machining delivers a productivity increase of two times.
And finally, the ARPU reamer is focused on the specific growth area of electric vehicles.
This tool used in precision machining operations for drive trains and has produced using kennametal is proprietary additive manufacturing technology.
Which lowers the weight of the tool, allowing for faster setup and machining times.
Those are just some examples of the innovations that we are bringing to the market and with that I'll turn it over to Damon who will review the first quarter numbers in more detail.
Thank you, Chris and good morning, everyone.
It will begin on slide five with a review of our operating results on both the reported in an adjusted basis.
As previously mentioned demand deteriorated more significantly than previously expected across our end markets with the exception of aerospace.
This resulted in sales declining 12% year over year or negative, 11% on an organic basis to 518 million.
Foreign currency had a negative effects of 2% that was partially offset by a benefit from business days of 1%.
Adjusted gross profit margin of 27.5% was down 850 basis points year over year. This performance was largely the result of the timing of higher priced inventory that represented roughly 360 basis points and the effect of lower volumes.
As discussed last quarter, we expect the effect of the higher priced inventory to abate in the second half of the year.
Adjusted operating expenses were down 7% year over year and represented 22% of sales only 100 basis points increase but a 12% decline in sales. This reflects the continued focus on from across controls.
Adjusted operating margin of 4.7% was down 970 basis points year over year against our toughest first quarter comparable since fiscal year 2012.
Reported EPS was eight cents in 17 cents on an adjusted basis compared to 68 and 70 cents in the prior year period, respectively.
Turning to slide six I will spend a couple moments addressing the drivers of our EPS performance this quarter.
Operations were negative 60 cents.
This reflects the effect of significantly lower volumes as well as the temporary manufacturing inefficiencies related to our pending plant closures. In addition, it's worth noting that the temporary higher raw material cost affected the year over year performance by approximately 19 cents.
Simplification modernization initiatives contributed seven cents of the improvement and we expect these benefits to accelerate as we progress through the second half of the fiscal year, which I will discuss in more detail later.
So on slide seven through nine Oh provide some high level polar around the performance of our segments this quarter.
Industrial sales in Q1 declined 11% organically against positive 10% in Q1 fiscal year 2019.
The regional standpoint. This was both mostly in Asia Pacific with the decline of 15% followed by EMEA in Americas down, 12% and 7% respectively.
Our end markets were challenged mostly in transportation in general engineering, driven by the decelerated global manufacturing.
Auto production activity.
Aerospace continues to be a bright spot for us and though it was down a 1% year over year, we would have experienced slight growth. Excluding some nonrecurring package deliveries. We continue to see aerospace is a key growth and market.
As Chris mentioned, we continue to introduce new products like the Herbie Ultra index and the core five specifically designed for that end market. This gives us further confidence that we can maintain our growth in this strong and market.
The deployment volume was the major contributor to adjusted operating margins coming in at 9.8% compared to 18.3% in the prior year the effective higher raw material costs represented approximately 140 basis points of the year over year deployed.
Turning to slide eight for video.
Sales declined 10% organically against the positive 11% in the prior year period.
Regionally the performance was mixed as EMEA was flat year over year, while both America, and Asia Pacific experienced declines of 3% and 24% respectively.
Segment faced similar macro challenges of industrial during the quarter. However, it's worth noting that we saw positives from products that support the aerospace industry in both EMEA and Americas.
Adjusted operating margin for the quarter was a loss of 4.1%.
Similar to the other business segments higher raw material cost effective the views operating margins by approximately 430 basis points this quarter, but will abate in the second half.
During the infrastructure on slide number.
Organic sales declined 11% against positive 10% in the prior year period.
Regionally sales were up 9% EMU, while Asia Pacific and Americans were down, 11% and 14% respectively.
By end market. These results were primarily driven by energy, which was down 24%, reflecting declines in the us land drilling rig count.
Hi, Engineering, and Earth works were down, 4% and 1% respectively.
In earthworks share gains in Americas, and South Africa, where outweighed by lower market activity in China.
Infrastructure recorded an operating margin loss of 0.5% this quarter compared to a profit of 11.4% in the prior year period.
Remember infrastructure is significantly more sensitive to changes in raw material costs in two ways first they are a larger percentage of cost of goods sold this was particularly evident in the quarter as higher raw material costs affected margins by approximately 660 basis points.
Second certain customers prices adjust based on spot market prices of materials that can create a temporary timing difference, which further affected year over year changes in operating margins.
Looking forward, we expect to see an improvement in infrastructures profitability as higher raw material costs debate in the second half and aligned with customers pricing.
Additionally, we expect to see further benefits and infrastructures margins as we finalize the closure of our Irwin facility as well as the recently announced Newcastle divestiture.
Now turning to slide tend to review, our balance sheet and cash flow.
As expected primary working capital decreased both sequentially and year over year to 686 million.
On a percentage of sales basis, our primary working capital was 32.1%.
This slight increases the result of more modest inventory reductions versus our expectations as sales deploying more rapidly in the quarter than expected.
Additionally, we continue to hold safety stock to support our footprint rationalization initiatives, which will diminish over time.
Capital expenditures increased to 72 million compared to $42 million during the prior year period.
As Chris previously stated our simplification modernization efforts are on track.
Our first quarter free operating cash flow was negative 45 million consistent with normal seasonal patterns. This represents a year over year decline of 12 million with and increased capital expenditures of 30 million.
In the context of our updated outlook, we expect our free operating cash flow to improve throughout the year and be positive in the second half of our fiscal year.
Our cash balance ended the quarter at $114 million.
We remain well positioned in regard to our debt in over funded US pension plans continue to have no borrowings on our 700 million dollar revolver and have no significant debt maturities until February 2022.
Dividends were approximately flat year over year at 17 million and we remain committed to our dividend program.
Overall I'm confident in the strength of our balance sheet, our cash position and Unutilized revolver, coupled with our cash flow generation allows us to drive forward, our simplification modernization initiatives.
This will ultimately improve our financial performance and cash flows throughout the economic cycles.
The full balance sheet can be found on slide 15 in the appendix.
Turning to slide 11 for our acquired 20 outlook.
The current outlook expects delay in the global recovery that we have previously anticipated to occur in the second half to reflect this we know assume only normal seasonality for the year, while also reflecting easier comparables in the second half.
Our revised organic growth outlook is no the range of negative nine to negative 5%.
Our adjusted effective tax rate is expected to be in the range of 20% to 24%.
This resulted in an updated adjusted earnings per share outlook of $1.70 $2 intensive.
With regard to the cadence of our earnings we now expect roughly 80% of our full year earnings to occur in the second half of the year.
Unlike our sales outlook. This does not follow our normal seasonality and I'll walk you through some of the primary drivers.
As we detailed on our last call with temporary effect of higher raw materials is working its way through our piano.
Given the current prices of raw materials. This effect is expected to abate in the second half.
Further we are on plan with our simplification modernization efforts, including the previously announced plant rationalization work.
The run rate benefits of these pending plant closures and related under absorption effects are more favorably weighted to the back half of the year as we continue to execute on these actions.
To that point as Chris mentioned, we've recently cease production at our German manufacturing facility and we will begin to see the full run rate savings from this in the second half.
Moving on to free operating cash flow.
First as already discussed we're proceeding with our simplification monetization plans and maintaining our prior capital spending forecast of 240 to 260 million.
Our updated outlook assumes free operating cash flow in the range of 20 million to 50 million to reflect our lower earnings expectation.
We remain focused on the execution of our simplification modernization initiatives deliver increased profitability and improved cash flows through the economic cycles.
And with that I'll turn the call back over to Chris.
Thank you Damon turning to slide 12, let me take a minute to summarize the quarter and the fiscal year 20 outlook.
As we discussed already the slowdown we experienced in the first quarter was more than we anticipated in our original fiscal year 20 plan.
However, our updated sales outlook is in line with current market conditions and no longer assumed the second half recovery in transportation and energy, but rather reflects a more normal seasonal pattern from the current lower market conditions.
Strengthen our balance sheet and cash position allows us to continue with our simplification modernization initiatives.
Which are directed at improving customer service and our profitability through the economic cycle.
Finally, I remain confident we will achieve the structural cost savings needed to meet our adjusted EBITDA profitability target when sales reached the targeted range of $2.5 billion to $2.6 billion.
With that operator, please open the line for questions.
Thank you.
We'll now begin the question answer session.
And at this time simply press Star then my number one on your telephone keypad. He would like to withdraw your question. Please press Star then the number two again that's star then the number one to ask your question.
First question comes from Julian Mitchell of Barclays. Please go ahead.
Hi, good morning.
Yulian morning, I wouldn't newly drilled into sort of quarterly numbers I know you don't guide by quarter, but just given the.
The sort of seasonality shift and the guide down just now.
Just wanted to try and homing on Q2, specifically for a second.
So I think we'll you're guiding for is around about.
10% organic sales drawl similar to Q1.
Okay and around sort of 20 cents of adjusted EPS. So may be a decremental margin slightly narrower than what you had in Q1.
But not significantly is that a fed summary of how you're thinking about Q2.
Yes, it's a fair summary, Julian for sure.
And how do you think about the decremental margins moving in the March and June quarters, how quickly do they sort of normalize and I guess is the assumption that by Q4 the margins are flat.
Year on year, even if sales are still dropping.
Yes, I mean, if you look at the the numbers this quarter I think the decremental margin was around 87% and that this was driven by wasn't completely unexpected driven by lower volumes.
We have a temporary raw material cost effects and then as we mentioned in our our call last time. This is a transition year for comments, we have a lot of manufacturing efficiencies built in associated with modernization and plant closures, but if you take out the the raw material effect. The decremental was was sitting somewhere around.
Say, 55% so in general we feel that that decremental margin was in line with what we would expect especially given that the volume was a lot lower the first quarter than we than we anticipated and as you know it's hard to turn these factories on a dime and takes.
Take some time to adjust the volume, which we're working on so.
The good news is is that that situation should improve as we advance for the year and for sure as we had mentioned on our first call.
The benefits associated.
With plant closures and ramping up modernization those are going to continue to to increase and also by the same token the inefficiencies associated with putting those programs in place will will decrease sell so we're looking forward to improve margins as we progressed through the year based on those things and then the other thing I think to think about Julian is that.
Simplification and modernization is really focused on changing the breakeven point the company as well as driving higher customer service and so the company is going to.
As we advance modernization its ability to sort of the whether these these changes in demand either up or down it's improving as we advance modernization.
Thanks, and my last question, just a quick one around inventory levels.
He is very mixed things, depending on which short cycle industrial company, we speak to just wanted your perspectives on how inventories stand today.
You will distribute upon is you'll Oems annual sales versus normal seasonal levels.
Yes, Theres no question for example on the industrial and video side of business in the Americas. There certainly has been destocking throughout the first quarter, we expect that will continue in Q2.
In.
And on the infrastructure side, there's been some destocking.
And hard rock mining and surface mining and we also see destocking in oil and gas so I think that.
The distributors in the end users are sort of our understanding that this is an uncertain environment and they're sort of pulling a lever that we need this we'd rather be prudent in terms of inventory management.
While we sort of wait and see how this plays out.
Great. Thank you.
Thanks Julien.
Our next question comes from Ann Dai again of JP Morgan. Please go ahead.
Yes, hi, good morning.
Can you just address and the fact that you expect that tungsten raw material prices to abate in the second half.
So what you're saying a quarter ago, but no we're not going at much lower volume. So does that mean, it's going to take longer into Q3 for these costs to abate.
Yes, let me just make a couple of general comments.
As you know we buy this this inventory we source both internally and externally.
And you know the length of that supply chain or how the inventory stays in the system kind of depends on that that factor as to how well we can purge it.
We have a good handle on what cost to serve currently sitting in the inventory now and we run that through our models. So we're confident it will start to see the abatement in the second half and.
Including Q3 and Q4.
So.
So in terms of the financial benefit to the second half we have a lot of confidence in that in terms of how how it actually will transition through the PML that does vary on different factors, but our current view right. Now is that we feel like it will benefit in the second half and Damon is there anything else you would like to add to that in terms of how the mature.
Cost is going to change over time.
Well I think Dan is as Chris alluded to we know given the lead times over inventory, we have very good visibility looking out into the second half of the year and so with tungsten prices currently where they are who we know that it will turn into a a tailwind for us moving into Q3 in Q4, so with a fairly high level of competence.
Okay, and I suppose the and my second question in the run the saying with the free operating cash flow.
20 to 50 million.
Yeah.
What has to happen to working capital in order to achieved that goal and is there any risk that you just can't liquidate the inventory because the demand isn't there and we end up with negative free operating cash flow.
Yeah, when we look at our current outlook I think is based on a realistic view of what we think is going to happen in terms of the sales volume.
So we are we are certainly planning on a.
Inventory levels dropping so that is driving some of the working capital, but our current outlook.
Was in that minus five to minus 9% sales and the free free operating cash flow.
Is well in inside that range, if that's what volumes turn out to be so I don't I don't feel like we're going to be sitting on a lot of inventory based on net sales forecast.
Do you have an inventory reduction dollar amount embedded in that.
Hi, good.
Bill.
Yeah, I think what we what we said at the end of the or we finished the fiscal year ended just over 32% and what we said on our last calls our goal is to try to drive down.
Getting close to that 30%.
Mostly with the change in our sales outlook.
We're continuing to look at what that percentages book there is an inventory reduction that was planned at the start of this year and it'll be it's further increased as a result for the lower sales.
Okay I leave it there are the interest of time and I get back in queue. Thank you.
Our next question comes from Andy Casey of Wells Fargo Securities. Please go ahead.
Thanks, Good morning.
Morning, Andy.
And I'd like to hit on some of the demand trends few.
Other short cycle companies have indicated.
Trends kind of fell in our because.
In September from July .
Took another step down.
I'm wondering is that similar to what you saw near demand trends.
Yes, we don't necessarily comment on the months, but I can tell you that.
Of course, Q1 was down as everyone knows but we're expecting Q2 to be down from from Q1 in terms of markets.
I recognize that Kennametal does have we do have sort of a normal seasonality that that that we lay in there but in general in terms of end market demand, we're looking at with the exception of aerospace.
All markets in all regions would be down Q1 to two tool.
Okay, Thanks, and within that Chris are you seeing.
Not not things turning positive outside of aerospace, but are you seeing any stabilization in the in the pace of demand decline.
Yes, we look at.
And we've been kind of modeling this current situation, where we're with.
Slowdowns in the past like in 2015 and 20 in 2012.
And what our expectation is that.
Depending on what you look at you can be down at anywhere from four quarters to as much as seven quarters, ending 2012 was down about four quarters in a row in 2015 was down seven quarters. So.
For us that means that as it concerns that fly 20 were not expecting any kind of recovery.
The only in the only sales increase you had really see as associated with the normal seasonal trend. So it's looking like to us that probably at this follows up kind of an average course downturn.
It's an f. why 21 first quarter.
Subject for us in terms of when we might see recovery.
That's our view.
Okay. Thank you for that and then.
Just kind of a detail question one of the components of it.
Industrial margin headwinds in the in the quarter that was noted in the release moves.
Compensation expense was what drove that.
Several inflation, Andy and we have our annual merit increases and things of that nature and as well as you know for industrial labor as a higher percentage of the cost of goods sold a driver for them.
Okay. Thank you very much Damon.
Our next question comes from Joe Ritchie of Goldman Sachs. Please go ahead.
Thanks, Good morning, guys.
Hi, just just to be clear I know you guys don't like to guide quarterly, but I just want to be clear on the on the tungsten impact for Q2, it's expected to be as they called the 19 test that you did in one case, it's expected to be as as high as Q1 as well.
It will still be a headwind.
Joe It may not be the exact of Brazil battles, because it will start to abate a little bit, but you have generally speaking it's going to be.
Impact in that quarter will also be a headwind I think the other point that will point OCO is remember infrastructure you have that pricing dynamic we've talked about where the customers are going to pay at the lower levels of the current spot and thats going to for that will impact the margins in the second quarter, even more on infrastructure.
Okay, all right that that makes sense.
And I guess, maybe just asking just a just a little bit of a higher level question here.
Clearly the market.
I think surprised a lot of companies this quarter with with the the downturn that we saw but I guess.
Yes, as you look at your own business and the decremental margins that that that you posted this quarter. I guess were you surprised by you know by how much things de lever this quarter and then maybe talk about like how the via your simplification and modern it modernization initiatives, you're going to try to limit the maybe some of that cyclical.
30 on the go forward.
Yep.
I mean, obviously the volume lower volume was that was a surprise. We did we did expect and our plan that we would have lower volumes, but the market dropped off almost double what we what we thought in terms of thought.
Our planning process, if you look at that the.
The EPS bridge that we showed in terms of manufacturing operations at 60 cents.
No. We know that 19 cents of that is the raw material, which will be the second half. So thats kind of temporary issue and then and then if I just took the essentially $7 million change in sales year over year at our normal 40% operating margin. That's that's another 28 cents there and so the balance of 13 cents is one of the things that we.
We just talked about the normal inflation, that's built in terms of right. The payroll net type of things and then also we have of course, the volume related lower variable and fixed cost absorption.
Associated with the lower volume and then a temporary manufacturing inefficiencies due to modernization and preparing for plant closures.
So your question on in terms of how we can affect the change in that and that 13 senses. Obviously, we still have normal inflation. We have we have to deal with and drive productivity, but modernization is going to really get after this volume related lower variable and fixed cost absorption.
We have still have it in any given period when the volume drops, but essentially was certification and modernization, we're going to just be less dependent on labor. So our ability to react to that is is improved because we don't have to go through a process to shed those those direct labor workers. So the company I think is in a much better.
Place today than it than it was in the past we were at we have less we have less facilities or modernizing facility were less dependent on labor, but keep in mind. The benefits of modernization are still largely ahead of us. So how the company perform in this first quarter, which I don't think was actually too bad given this given the drop in volume.
We expect that we're going to performing better as weak as we get through up by 20, 521 and sort of complete this first first wave of.
A little surprise that even excluding that you're.
Kind of onetime headwind that you flagged from.
Projects or whatever the turkcell only growing a little bit and is there any mix impact that's happening between engines versus aerostructures versus.
Penetrators defense sales something like that that would be fully back the growth.
And I guess, you do have tough comps, but maybe talk through your confidence of.
On the sales trend across.
Turning to the business looks for the rest of the year.
Yes, I think there's a couple of things that would say first of all.
Correct, we had the sort of these large package orders that by definition don't recur.
I should say, it's more more like they're lumpy. Okay. They can occur at any given point time. So when you measure year over year. If you happen to define a period. The has won it doesn't that that that can change the number and those are actually fairly sizable orders. So they can they can move the needle even though aerospace is still a pretty good sized market for us.
The other off so so as we if we take that out for me quite and we look at our growth initiatives and one of the things that were that we track our actually new customers that we add.
We know if we're adding these new customers by definition, we're increasing share in that space I talked about the technology platforms that we that we launched in my section of the of the prepared remarks.
And again, we're tracking we track in those new product introductions, and they're not they're not actually displacing old kennametal tools are cannibalizing their after if they are displacing anybody it's up his prior comp as other companies tool. So we feel like that is going to that we're getting traction on those and then everything I will mention is that.
Video is saw the segment for video is basically general engineering, but we know that there's we know that inside that space Theres aerospace applications that are that are Don especially on the tier one tier two suppliers and so.
We also track that in terms of those applications and we know they were gaining traction in growing.
Those aerospace customer base that are that are considered part of general engineering, So all that equals style.
We still have a strong segment.
And when with the way we track this thing which is at a fairly detailed level. We're confident that we are getting traction.
And growing in that space.
Okay got it and then there's a couple of clarifications on pricing and material costs of what's your price realization positive this quarter and does that followed Thompson prices lower than as we start to think about the December March quarters. So that you will.
The kind of a price headwind and and then just related to the the 19th material cost headwind. This talk about that that's just a gross comment rights or is that net of what pricing was.
Yes, the 19 cents was.
Based on actual payment of saw our cost of inventory is throwing flowing through the PML so that.
It really does anything to do it necessarily the price covering Ross I think your question is though.
In general.
Kennametal has a history of price covering raw materials. We've also said that in any any period of time, we might be a little bit ahead, a little bit behind if we look at what's in our current forecasts for the full year, we're expecting price in rod it'd be pretty much in balance so essentially flat.
In terms of pricing in the marketplace.
As you know, we we put an initiative in place and fly 18 to really start to do strategic pricing and be less sort of cost plus pricing and so our our intention is that even though material costs are dropping other than the contracts that were required.
In infrastructure to to lower prices based on the change in the index, we feel pretty good that of our ability to hold on the price and we also feel like we've got enough discipline and the data to well understand where potentially a price change could actually help us drive a commensurate increase in volume, which would be the right.
Overall economics.
Equation to run for ourselves.
Okay. Thank you.
Our next question comes from Ross Gilardi of at Bank of America. Please go ahead.
Morning, guys Horny rush.
Chris I wanted just asking I mean, if you look at your entire manufacturing footprint net of what you are closing what portion of your footprint should be fully modernize to the extent that you know the company envision several years ago by the end of fiscal 2020.
Yeah on a percentage basis I think we're we're probably.
Now I characterize this.
By the end up by 20 were at least.
60% of the way there and remember we had a number of plant closures that we will continue we have some some nf why 20, but theres theres others UNEV why 21.
So until those plant closures calm.
Thats going to drive the balance and we had announced a second restructuring for up by 21, which has.
Some of these plant closures and so that's that's kind of on that basis I think that since the plant closures are the hardest in terms of the level of effort.
Thats all I think it's kind of up 60% this year, 40% because there's some heavy lifting that still needs to be done.
To close some of these larger plants.
In terms of effort Thats the way I see it.
So that's what I was kind of getting at so I wanted to ask you really about the $300 million of incremental capex.
To modernize kennametal.
Chris Your predecessor had come up with that figure I, if I remember correctly and you've you continue to work off that assumption.
How confident are you that it's the right figure to get the company, where where it needs to be I mean does that.
Because the margins that we've just seen health of the company's still got a lot of investment to make in factory automation. So that you can adjust to the slowdowns in pickups in a much more nimble fashion going forward.
Yes, I think in general the 300 million dollar number we still feel good about.
Right I did I did inherent that number but we've done a lot of work obviously since then I've been here over two years, a net that's still the number that I believe is in the in the right.
Ballpark, if you look at what we're spending in terms of Capex this year versus the prior years. We've got that 300 million dollar were zeroing in on that 300 million dollar number now we also talked on the last call that in some cases, we are expecting higher volumes and so we're not going to bring on additional capacity.
So the two just for the sake of having that capacity until the volume can support it. So if we're to fall short of 300 million by the end up by 20.
It might be 25 were $3 million subject that might carry over 21 large we expect that fight 21, we would return to more nominal capital spending than sort of that $120 million unless like I said, maybe $30 million of it or so that order of magnitude would carry over because we're at a lower volume physician.
Than we were before.
Do you have cash restructuring associated with the three German facilities baked into.
The free cash the current free cash flow guide.
Well, yes, okay, what would that number.
Ross, we didn't give out the specific cash costs for for the restructurings other than when you go back to the announcements that we made so the f. White 20 restructuring plan that we announced we said that was going to cost in the range of $55 million to $65 million in cash and we've said the majority of the vast majority of that would go out in.
Why 20, and then when we announced the F. White 21 restructuring. We've said that that was a 60 to 75 million dollar cash of the majority of that being cash and the majority of that going out in Hawaii 21, but there would be a portion of white 20, and so the combination of those numbers are built.
Into our free operating cash flow outlook for this year.
Okay. Thanks very much.
Our next question comes from Steven Fisher of you'd be yes. Please go ahead.
Thanks, Good morning.
So as you guys think about the trajectory of your various segments. When do you think infrastructure and video will return to profitability and how should we think about the exit rate over the various segments margins by Q4 do you think we're going to be back to the mid teens for both industrial and infrastructure by then.
Yes, we look at.
Well look at both video and infrastructure this quarter.
The raw material impact was quite substantial and so when you remove that that effect, which will be in the second half a year, they're going to returned to profitability, but underlying both of those are we continue with simplification monetization and portfolio pruning that effects.
For sure infrastructure and as we close some of the plants that were talking about it and.
Take some of the other portfolio pruning actions thats going to improve the product profitability of infrastructure and so based on our current forecasts and the volume that is going to run through that business for what we're expecting I feel pretty good actually about where we're going to be from profitability standpoint.
On the video on a video side, obviously, they are highly volume sensitive because it's a small small size business and as we've talked about before they are essentially a product portfolio inside the overall metal cutting space. They run inside the same.
Overall, kennametal factories, and so you can see profitability numbers that from a piano perspective that don't look great, but the fact that matter. This couple hundred million dollars of volume running through the same factories and again once you take out the material cost of impact we feel that that that business process is going to return to profitability. The other thing that we.
He said is.
You know a lot of video profitability is going to in terms of monetization is tied to closing of these plants. So their productivity improvements are definitely more back end loaded as it relates to some modernization.
So I mean overall I don't I don't really have I'm not sitting here thinking that we've got some profitability issues will either one of those businesses and then industrial continues to crank along and again once some of these onetime effects abate, we feel pretty good about that business also.
Okay. So it sounds like still.
Probably losses in second quarter, but you turn positive in Q3 Q4.
Second I guess can you just give us a sense of what growth rate you're seeing in your construction business within infrastructure in your three key regions.
Sorry, and what what region.
All.
Three key regions Americas, EMEA APAC yeah.
Okay.
Well, we've got we actually in terms of growth rates.
We're actually showing.
Let me just slip here.
So construction from Q4 to Q1, we feel was the markets are kind of flat. We see the same thing in Q1. The Q2, it's kind of a flat flat market. So other than the normal seasonality, that's kind of what we've baked into that into that forecast.
And is there any major variants within your regions there.
No that was that was across all regions Americas, EMEA and Asia Pacific.
Okay. Thanks, a lot.
Our next question comes from Chris Dankert of Longbow Research. Please go ahead.
Hi, good morning, guys.
Yes, I guess thinking with the end markets theme here.
As I look at energy, obviously infrastructure has got the pricing headwind to that's a pretty steep step down, though 24% I guess when I move up into energy in the industrial segment, what's the risk that growth rate kind of moves into the down double digits down team for the rest of the year. Just can you can you parse energy by segment a little bit.
Yeah. Unfortunately, if we look at.
We look at infrastructure the.
Q4 to Q1, we're saying it's going to be down also Q1 to Q2 and I believe on the infrastructure side in general we were just got we're expecting declines the continue through the year as the rig counts come down in terms of the metal cutting business.
We're anticipating something something similar to that it's really it's really across the board and Americas, EMEA and Asia Pacific. So we don't want I have a lot of hope that energy is going to turn around certainly in this year and I think we're kind of planning on that.
But does that will be a that will be a bit of a nice surprise for us.
Got it got it makes sense.
And then within industrial there you highlighted some temporary closures in the quarter to kind of backstop profitability I guess, how big a deal where those what would the incremental margins looked like without those stoppages, just any kind of comments there.
Yes in the quarter.
We then actually.
We didn't actually we were preparing for some closures.
And.
I mentioned, the I mentioned that that was one of the inefficiencies. It's buried inside that 13 cents of vps.
It's really the second quarter that we we begin to start closing facilities and it was at the end of October that one of the German facilities.
Stop production.
So that there wasn't much in terms of the first quarter other than preparing for these these closures.
That was inside those numbers, David Chris I think.
I think you other than the other question you may have been asking there is the production days that we alluded to before and I think to answer your question. As we said inventory we were taking we're planning to take inventory down this year and we were going to be adjusting production I think as Chris pointed as the markets moves so quickly.
We started to take production days out of the system and that really started in September and that's what we referred to again it doesn't necessarily in enhanced the margin put it reduces the decremental because otherwise we would have been producing inventory that there was no demand for so it's part of those ways that we're trying to reduce the cost as quickly as we can.
So to rightsize production with the market outlook.
Got it got that's helpful. Thanks, guys.
Our next question comes from Walter Liptak I've Seaport Global Please go ahead.
Hi, Thanks, Good morning, guys.
When did it just stick with the.
Saying, even go last questions with the inventory so it sounds like with these facilities closing this quarter the inventory, it's not going to come out.
Starting in your second quarter will be sometime in the second half is is that right.
Yes, I think.
The inventory then come down as much as we thought the first quarter, because we simply didn't have as much volume, but our expectation is it will still sales start to come out in the second quarter, then that'll continue would accelerate through Q3 in Q4.
Okay.
So these so are these.
The three German plant rationalizations, and the one closing that's that's what you're alluding to that that's where the extra inventories being held right now.
And that's that's right is what will come out in the second half.
That's right.
Okay, and you mentioned that benefits from the German factory closing.
And I presume that also includes the other three factories.
What kind of benefit we beginning from that.
Okay.
Yes, I think fit.
If you look at those restructuring actions that we talked about.
The.
Inside those inside those numbers are the associated benefits from from closure so.
Some of the closures are inside the FBI 20 restructuring action that was in the 30 $540 million range and the need for 21. The actions, which also had included some of the plant closure benefits that wasn't the 20 $530 million right.
Okay Yeah.
I'll, let Jim.
With these inventory levels since there is a 2021.
You know round to a larger facility closing.
What do you have to maintain inventory at higher levels, even going into 2021 because of those two we run into the same kind of inventory.
You know issue, where you won't be able to drop downs quickly.
Yes, I mean, the plant closures are.
There is a large plant closure in the first half of F. why 21, and so that does have some inventory associated with so even ask why 21. We will continue to ahead have a an elevated level, but the other plant closures are also there was also inventory elevated for those and as those start to close we don't we don't need that inventory. So we'll continue to drop off but you're correct the goods.
We'll be at an elevated slightly elevated level until we close that other facility in the first half by 21.
Okay.
Okay, and if I can just as good a quick one on just the negative trends on a global basis.
Are we going to synchronize.
Slowdown across all regions or you know EMEA is down more they start sooner or use Asia is not in the most.
They start start sooner and then it kind of went to me as in Americas are in there already regions, including like the closing closer to bother me.
Yes, I think as you know Asia Pacific started up.
Quite quite a while ago that was that was kind of first to go in and we see that that market is.
Is this continues to stay low levels, but I don't know that it's necessarily getting any any worse.
EMEA was then second and.
And that drop off a continues as you know many of the industrial countries inside of EMEA are so we're actually in a in a recession neri mode. So.
That situation is.
Has gotten worse in over the last few quarters.
But it seems to have I guess I could argue it seems that kind of stabilize it at the current levels and then the Americas, while it it has gotten a little weaker it's certainly not in as bad shape as those other two markets and so I think that my opinion is the Americas or just people trying to deal with trying to anticipate a b.
Prudent about planning for the.
Around these trade uncertainties and in the absence of more clarity there, they're just being prudent. So there is a there is a a slowdown but I wouldn't put on the same order magnitude as what we've seen in EMEA or Asia Pacific.
Okay, great. Thank you.
[noise] decay. Thank you operator, Oh go ahead [laughter]. This includes a question and answers fashion and I'll turn it back to Chris Rafi for closing remarks, alright. Thank you and thanks, everyone for joining us on the call today, we certainly appreciate your interest and support of Kennametal. Please reach out to Kelly if you have any follow up.
Yes. Thank you.
Hey, Rick.
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