Q3 2021 Kennametal Inc Earnings Call
[music].
Good morning, I would like to welcome everyone to kind of metals third quarter of fiscal year 2021 earnings conference call.
All lines have been placed on mute to prevent any background noise.
After the Speakers' remarks, there will be the question and answer session.
If you would like to ask the question. During this time simply press Star then the number one on your telephone keypad if.
If you would like to withdraw your question. Please press Star then the number two please.
Please note that this event is being recorded.
I would now like to turn the conference over to Kelly Boyer of director of Investor Relations. Please go ahead.
Thank you operator, welcome everyone and thank you for joining us turnkey the kennametal third quarter fiscal 2021 without.
Yesterday evening, we issued our earnings press release.
Most of our presentation slides on our website, we will be referring to that slide deck throughout today's call.
I'm Kelly Boyer Vice President of Investor Relations joining me on the call today are Chris Rossi, President and Chief Executive Officer, and Damon Audia, Vice President and Chief Financial Officer.
After Chris on Damon's prepared remarks, we will open the line for questions.
At this time I would like to direct your attention to our forward looking disclosure statement.
Today's discussion contains comments that constitute forward looking statements and as such involve a number of assumptions risks and uncertainties that could cause the company's actual results performance or achievements to differ materially from those expressed in or implied by such statements.
These risk factors and uncertainties are detailed in kennametal, if the SEC filings.
In addition, we will be discussing non-GAAP financial measures on the call today.
Conciliation to GAAP financial measures that we believe are most directly comparable can be found at the back of the slide deck and on our form 8-K on our website and with that I'll now turn the call over to Chris.
Thanks Kelly.
Everyone. Thank you for joining us today.
I'll begin today's call with some general comments kind of brief review of the quarter.
Q4 expectations.
<unk> will then review of the quarterly financial results and Q4 assumptions for modeling purposes in more detail.
Finally, I'll make some summary comments before opening the call for questions.
Beginning on slide two in the presentation.
I'm encouraged by our third quarter results, which reflects strong sales and operating leverage driving solid cash flow generation.
The three sales increased 10% sequentially outpace.
Outpacing our mid to high single digit expectations, reflecting both market improvements and growth from our strategic initiatives.
On a year over year basis organic sales declined 1% on top of the 17% decline in the prior year.
Transportation of General Engineering continue to leave the end markets with positive year over year growth for the first time in 10 and seven quarters respectively.
Energy and aerospace continued to be challenged but both of showing signs of improvement.
Regionally, we saw Asia Pacific returned to growth, while EMEA and the Americas are still negative on a year over year basis.
All regions improved sequentially.
Our margins improved 330 basis points sequentially on.
On stronger sales and improved manufacturing productivity. Despite the continued lifting of temporary cost control actions, which David will discuss in more detail.
The improvement in margins sequentially is really a testament to the structural cost savings, we've made through simplification and modernization.
Operating expense as a percentage of sales remained flat sequentially at 22%, but was up year over year as costs continue to come back into the business.
Our target for operating expense remains at 20%.
Adjusted EPS was <unk> 32 versus <unk> 46 from the prior year quarter, reflecting the factors adjusted name.
So overall, we are pleased with our execution as market conditions have improved and.
And we expect markets to continue strengthening.
However, the effects of COVID-19 restrictions in some regions and customer supply chain challenges may temporarily suppressed the recovery trajectory from what we saw in Q3.
Therefore, because of these uncertainties, we have estimated sequential sales growth in the mid single digits.
Recognizing that our end markets may strengthen even more in Q4, if these uncertainties do not materialize.
But regardless of the shape of the recovery, we will stay focused on executing our operational and commercial excellence initiatives.
Aimed at driving share gains and improving profitability throughout the cycle from.
For operational excellence, we continue to execute simplification modernization posting $63 million in incremental savings year to date.
On track for $80 million this fiscal year, and 180 million since program inception, which is in line with the target originally set despite much lower sales volumes.
The commercial excellence I'm encouraged again this quarter by the results of our fit for purpose and other growth initiatives and believe progress will continue accelerating as COVID-19 restrictions are lifted and markets recover further.
In addition, we continued to execute a disciplined pricing process to reflect pricing based on value added as well as changes in commodity costs.
So our teams in both business segments are planning pricing actions in the fourth quarter, reflecting the changes in raw material costs expected as markets recover.
We do not expect the recent increases in raw material cost to affect us until early fiscal year 'twenty two.
As you know historically, we have demonstrated an ability to offset raw material cost increases with price and expect to do so for this current economic cycle.
Finally, as I mentioned at the outset of the call free operating cash flow was strong this quarter, particularly when compared to adjusted net income, reflecting improved productivity strong working capital management and lower capital spending.
Now, let's turn to slide three for an update on how we have performed this downturn relative to past downturns.
As a reminder, the last time the company experienced the sales decline close to the current one was during the great recession in 2009.
The slide shows trailing 12 month sales on the left chart and the corresponding adjusted operating margin on the right chart.
Starting with the left chart.
The that the trough level of trailing 12 months sales is similar at.
At approximately $1 7 billion for the current and 2009 downturn.
Also of note is that the current downturn is more elongated.
And we've been hovering around the $1 7 billion level for two quarters.
Now looking at the profitability chart on the right you can see that we have been able to maintain significantly higher levels of profitability throughout this downturn.
This quarter, there was roughly 600 basis points of adjusted operating margin improvement compared to the 2009 downturn due to the structural improvements we've made and the timely aggressive cost control actions taken last year.
With regard to Q4 margins, we expect our adjusted operating margin to improve modestly both year over year and sequentially, which David will provide more detail on later.
Summary, I am encouraged by our Q3 results and the underlying leverage demonstrated this quarter.
We have maintained higher profitability levels and are well positioned to outperform as markets recover further because of the initiatives we executed over the last several years.
With that I'll turn the call over to Damien who will review the third quarter and Q4 outlook in more detail.
Thank you, Chris and good morning, everyone.
We'll begin on slide four with a review of Q3 operating results on both the reported and adjusted basis.
As Chris mentioned, the sequential performance of our sales outpaced our expectations.
The year over year basis, total sales were essentially flat declining 1% organically with the FX contributing approximately 2% and business days negative 1% in the quarter.
Year over year margin comparisons in Q3 of our difficult given the timing of the pandemic the temporary cost actions last year and the ongoing effects on end markets like aerospace and energy.
Although adjusted gross profit margin of 31, 6% was down 170 basis points year over year and adjusted operating expenses as a percent of sales were up 190 basis points. These are not reflective of the continued underlying improvement in the business.
Given the magnitude of the decline last year from COVID-19, and the current pace of the economic recovery is better to evaluate our performance on a sequential basis as shown on slide five.
Sequential walk better reflects our underlying business performance in a more normal although still both volume environment.
As you can see on the bridge sales improved $44 million sequentially, including $10 million from foreign exchange and adjusted operating income improved $19 million.
The new lifting of temporary cost actions was the sequential headwind of approximately $10 million, but is fully reflected in Q3 and going forward.
The operations bar is reflective of the margin associated with the higher sales as well as manufacturing productivity and breadth and representative of what we would expect under more normalized conditions.
It's this type of performance that gives us confidence that our operational and commercial excellence initiatives are working and that we will continue to see improved profitability as sales continue to grow.
Turning to slide six you can see the primary drivers affecting adjusted EPS on a year over year basis.
The effect of operations this quarter amounted to negative <unk> 33.
Comparing positively to negative 39 in the prior year quarter.
The main factors contributing to the 33.
The year over year changes in compensation less favorable mix related to softer end markets like aerospace and energy lower production and the lifting of temporary cost control actions that were in effect last year.
Remember the timing of the onset of the pandemic last year resulted in several effects, making the year over year comparison more challenging.
First the cost of our variable compensation program, where reset lower starting in the third quarter last year.
Second as the severity of the pandemic was not fully felt until Q4. The majority of our factories were still loaded at higher levels of production in Q3 last year, creating a year over year headwind this quarter.
Finally, the third quarter last year does not reflect the full reduction in aerospace and oil and gas activity due to the pandemic. This effect was not fully evident on total fourth quarter.
Incremental simplification monetization benefits year over year totaled $18 million or <unk> <unk>.
The total cumulative savings this quarter to $164 million.
As Chris mentioned, our expectation continues to be that simplification monetization benefits for the total year will be approximately $80 million and approximately $180 million of cumulative savings from the program by the end of this fiscal year, which is in line with our original target despite lower volumes.
Slide seven and eight detailed the performance of our segments of this quarter.
Metal cutting sales in the third quarter were flat organically versus the 17% decline from the prior year period.
Asia Pacific sales increased 10% year over year, the first increase in nine quarters.
Net sales were flat and sales in the Americas were down 9% consistent with the timing of the onset of the pandemic last year.
Sequentially, we saw improvement in all regions.
The performance in Asia Pacific relative to other regions reflects more positive economic activity led by the recovery in China of over 20% and India up in the high teens year over year.
Note that despite the strong performance this quarter in India. We are monitoring closely the potential effects on consumer buying activity from the recent escalation of COVID-19 cases, and the resultant of Lockdowns.
On a year over year basis, the best performing end market was transportation, which returned to growth in the quarter increasing 11%.
Transportation end market also grew 11% sequentially, despite global supply chain challenges, which had a greater effect on customers of assembly operations on their metal cutting operations like engine plants power.
However, given the increased level of disruption from the supply chain challenges, we expect the momentum in this end market to be dampened temporarily until the customers are able to stabilize their semiconductor supply.
For the other end markets General Engineering also returned to growth with sales up 1% year over year and energy declining 16%.
Aerospace continues to be the most challenging market with sales down 34% year over year as COVID-19 continues to affect production levels and air travel.
Although still at low levels, we did see aerospace improved 7% sequentially.
Adjusted operating margin of eight 2% was down 380 basis points year over year, but improved sequentially from six 1% in Q2.
As with the consolidated numbers the year over year decrease was driven primarily by increased compensation lifting of other prior year temporary cost controls mix and lower production, partially offset by incremental simplification monetization benefits.
Turning to slide eight for infrastructure.
Sales declined 3% organically on top of the 17% decline in the prior year period.
Other factors affecting infrastructure sales were a benefit from foreign exchange of 2%, partially offset by a negative 1% effect from fewer business days.
Julie again Asia Pacific led with the 30% year over year increase driven by the easing of the prior year of COVID-19 disruptions in China, who has followed the growth of positive 1% last quarter.
The Americas declined year over year of 11% and EMEA declined 13%.
Sales improved across all end markets and regions sequentially.
Year over year General Engineering was the best performing end market with growth of 2% associated with the rebound in China offset by declines of both earthworks and energy at negative 3% of negative 14% respectively.
Adjusted operating margin of 10, 1% was down 290 basis points year over year due to similar factors that drove declines in the total company and metal cutting seven figures.
As expected raw materials were effectively neutral this quarter, both year over year and sequentially.
Since the start of the calendar year, the price of tungsten has increased approximately 23% to around $270 per metric ton.
Increase in raw material costs will begin to affect us in early FY 'twenty, two and as Chris mentioned, we remain confident in our ability to offset these material cost increases over time with pricing actions.
In the fourth quarter certain sales more correlated to tungsten market prices will create a modest margin benefit and infrastructure as we continue to recognize the lower priced tungsten and our cost of goods sold for a period of time.
Now turning to slide nine to review, our balance sheet and free operating cash flow.
Continue to believe that of conservative financial profile as appropriate to ensure liquidity and the ability to continue to execute our strategy, having successfully completed the refinancing and repayment of our 2022 notes in the third quarter, our new debt profile is made up of $2 million to $300 million notes maturing in 2028 and <unk>.
31, as well as the U S $700 million revolver that matures in 2023.
Given the lower interest rate of the new bond versus the one recently repaid we expect annualized interest expense to be approximately $28 million versus the historical run rate of around $32 million.
At quarter end, we had combined cash and revolver availability of approximately $784 million.
The primary working capital decreased year over year to $615 million, given our continued focus on inventory.
On a percentage of sales basis primary working capital increased year over year to 36, 7%.
This is above our target of 30% of sales remain at depressed levels, but we remain committed to getting back to this level of sales increase.
Capital expenditures were $25 million this quarter and down 32 million from the prior year period as expected given the spending on simplification modernization is substantially complete.
Year to date, we've spent $94 million and we expect capital expenditures for the year to be approximately $120 million.
Free operating cash flow for the quarter improved year over year to $47 million up from $2 million in the prior year quarter due to the working capital management and lower Capex.
Essentially free operating cash flow improved from $29 million last quarter due to improved profitability.
Consistent with prior quarters, we paid the dividend of $17 million.
Full balance sheet can be found on slide 14 in the appendix.
Before I turn the call back over to Chris I want to spend a few minutes on our Q4 assumption for modeling purposes.
Turning to slide 10.
This slide summarizes how we expect key factors to affect Q4, EPS and free operating cash flow.
As already mentioned, we expect sales to be up mid single digits sequentially and are confident that our underlying operating leverage of the business will continue within the expected range.
Simplification modernization is expected to be approximately $80 million in FY, 'twenty, one, which implies approximately $17 million of incremental year over year savings in the fourth quarter.
Sequentially, there will be no headwinds related to the lifting of the temporary cost control actions. However on a year over year basis temporary cost control actions will be a significant headwind of $40 million to $45 million, reflecting the elimination of incentive compensation and the aggressive cost control actions. We took last year in the form of <unk>.
Furloughs.
We expect our Q4 adjusted effective tax rate to be approximately 28% compared to 26% this quarter and approximately 25% for the full year.
However, the Q4 tax rate could fluctuate depending upon the ultimate geographic mix of earnings.
Other items that are not individually itemized on the slide include depreciation and amortization.
<unk>, which we expect to be slightly higher sequentially and raw materials, which we do not expect to be materially different sequentially or year over year.
As Chris mentioned rising raw material costs will not begin to affect us until early FY 'twenty, two and we're confident in our ability to offset these increases with both business segments of initiating pricing actions in the fourth quarter.
In terms of free operating cash flow drivers capital spending for the year is expected to be on approximately $120 million, which implies around $25 million in Q4.
We continue to expect cash restructuring spend for the full year to be higher by approximately $20 million.
As such cash restructuring payments will be around $5 million higher year over year and around $5 million lower versus the approximately $17 million paid in Q3.
Given our strong inventory reductions year to date and continued improving market conditions, we expect working capital to be of modest sequential use of cash in Q4.
Free operating cash flow is expected to remain positive in Q4, albeit of a slightly lower level, both year over year and sequentially.
And with that I'll turn the call back over to Chris.
Thanks, Damon turning to slide 11, let me take just a few minutes to summarize.
Im encouraged by our results this quarter, we posted strong sales manufacturing performance and free operating cash flow and most importantly, our underlying operating leverage is within the expected range.
Our commercial and operational excellence initiatives are progressing well to drive growth market share gains and improved profitability the.
The benefits from these initiatives, which we began three years ago are evident as shown in the margin chart with more benefits to come as volume increases.
This gives us confidence in our expectation to achieve adjusted EBITDA margin of 24% to 26% when sales reach the range of $2 five of $2 6 billion.
And the strength of our balance sheet and cash flow of allow us to optimize future capital allocation, while continuing to focus on improving profitability customer service and share gain throughout the economic cycle.
And with that operator, please open the line for questions.
Thank you we will now begin the question and answer session.
If you would like to ask the question Brian.
On the number one on the telephone keypad.
If you would like to withdraw your question. Please press Star then the number two.
And today's first question comes from Steve Volkmann of Jefferies. Please go ahead.
Hi, Good morning, guys. Thanks for taking the question.
Steve.
Maybe I'll just start if it's okay, Chris kind of short term here you talked about a number of uncertainties in the fourth quarter and sort of intimated that things can be a little better if those things don't happen I guess I'm. Just wondering if you can flesh that out for us a little bit those uncertainties, our day relative to your own operations.
<unk> or your customer operations, and maybe you can give us some color on on where and what those sort of uncertainties are for you. Thanks.
Yes, Steve there the principally with our with our customers.
From a transportation perspective, it's obviously the chip issue that's driving that.
And then as Damon mentioned in his prepared remarks that India has seen a nice recovery and thats been driven by consumer buying behavior, especially in the transportation area.
And these lockdowns and the situation there, we think that thats going to temper.
Temporarily depressed demand and so they will have to adjust production schedules accordingly.
Really those are really the two things that are driving it and also EMEA, which has seen a nice recovery in transportation. They also had some COVID-19 issues and sort of lockdowns that that could potentially dampen demand. So that's really the basis of that.
<unk>, we when we did our forecast for for Q3, we had anticipated that some of these effects other than we didn't know about the India. We anticipated some of these effects, especially on the supply chain.
For automotive May of we may have actually seen that in Q3, but we didn't really see much of it in Q3, but we're expecting that it could happen in Q4 because of the situation has gotten worse.
Great and then just a quick follow up you mentioned price cost the number of times in the prepared remarks, it sounds like that's perhaps a little bit of a tailwind in the fourth quarter and then youre expecting some.
Somewhat of a headwind in the first how does that play out in 'twenty. Two is it a headwind in like the first half and then you get it back in the second half of it how are you thinking a little bit longer term about that.
Well I think I think the way to look at it for fiscal year, 'twenty, two or any sort of any 12 month period is that we think the price will cover raws and as you know Steve at any point in the cycle you can be a little bit ahead of the blue behind.
So infrastructure for example, we see that.
Because of the contracts on.
Certain certain on materials at certain customers the.
The price adjust.
But as Damian said, we still have some of the lower cost material running through our P&L. So that can provide a little bit of a tailwind.
In that regard and then as the situation changes in the prices come down you have the reverse of that so I would I guess the way I would think about it is there's really not going to be much of a headwind or tailwind it's material for Q4.
And frankly for the first half of second half of next year I think we'll just have to kind of wait and see how it plays out and make those comments as part of our FY 'twenty two outlook.
Okay. Thank you I'll pass it on.
And our next question today comes from Julian Mitchell of Barclays. Please go ahead.
Hi, good morning.
Maybe just the first question on the fourth quarter.
So I think in the third quarter of the sequential.
The incremental margin was around about.
40% or so maybe a touch above.
When we're looking sequentially of Q4 is that roughly the same level of.
Quinn from operating leverage we should expect.
Totally understand the year on year, there's mix of temporary cost headwinds and all of the rest of it but sequentially is that the right way to think about it.
Yes, when we talked about before Julian is that you have that sort of 40% number that you said and thats, what we would expect to see on incremental margins.
But we also said there'll be some fixed cost absorption on top of that.
So some of some of you on the phone of use the model of around 50% on the incremental sales for your models and that seems that seems reasonable to us. So that's the way we would think about the leverage on the incremental sales.
That's very helpful. Thank you and then if we look at.
Full year 'twenty two.
Can we assume that the kind of simplification and modernization of savings.
The net neutral relative to temporary costs and said when we're thinking about margins for next year.
Really a function of that operating leverage number of sort of 40%.
And then what have we want to assume from raw materials, including the <unk> sort of beyond that.
I think Julien so we haven't given a specific.
Outlook for simplification monetization is wrapping up but to your point, we have about $25 million of temporary cost actions that will affect us in the first half of next year I think as we look at some of the actions. We have done this year, coupled with the things still to be executed in the fourth quarter really of the Johnson city.
I would say there'll probably be close.
Tween the two I would caution you remember there is actual incremental inflation year over year that we will have the deal with in regard to wage inflation and other things on top of the temporary cost and so im not sure of that temporary plus inflation would be fully offset.
By the simplification modernization savings.
Hey, Julien so I mean.
As of the technical modeling we.
We have to factor those things in the Damon said, but.
On a look at fiscal year 'twenty two is.
Something that we're all as the management team looking forward.
So seeing the volumes run through our modernized factories now we still are ramping up processes, even in even in fiscal year 'twenty, two but it's going to be.
It's going to be really the first year that we're going to be able to operate with this new equipment and so we're really excited about the opportunity for improved profitability.
Better customer service and leveraging that footprint too.
To gain share so it's kind of like the clean year from that perspective, if you will.
That's great. Thank you.
And our next question today comes from Goldman with Jpmorgan. Please go ahead.
I've heard a lot of different pronunciations of by name, but that will most probably the most unique Nick thank.
Thank you.
Can you just remind us how big is India in terms of dollars of revenue.
Both the metal cutting on infrastructure if it it's important in infrastructure I know you've called the that metal cutting but I'd be pleased size that business for us.
Yes, and we don't we have not broken out India as the specific country or what we have said is for the quarter.
Asia Pacific was about 24% of our overall revenue. We've said China is the biggest country in there and Directionally, it's about call it 10% plus or so of our overall revenue in view would be number two behind that so again slightly smaller than that than the China percentage.
But it's spelled quite sizable.
Yes.
Okay.
That's helpful. Thank you and then.
Can you talk but.
Other than tungsten and chips for the other supply chain issues are you facing are you facing any labor shortages.
And if you could rank order the issues as you're seeing them today and.
I've spoken to the number of Ceos in the last couple of days, who say this is the worst of they've ever seen net net.
Some things. So if you could just talk to us a little bit about what you guys are seeing on the supply chain side and.
From your perspective of how bad does the that their.
Both from raw materials from the costs from labor and all of the other issues that you are.
Trying to do all of it.
Yes.
Well the first the first supply issue, which is not a which is not.
On the ability to supply the material, but from a cost driver perspective, as the <unk> and I think we address debt in the script and as.
As you know we have the ability to do.
Adjust prices accordingly, so that's.
That's probably our biggest cost driver perspective, we do have.
The second I guess second important material is cobalt and again, we're not really seeing any delivery issues with net prices is also escalated, but thats kind of a distant second the apta and then in terms of steel that's really spiked, but steel is such a small part.
Part of our overall cost structure, it's not really material and again in the case of all of those raw materials. We believe that we can do.
Do the proper things from a pricing perspective too to offset.
As far as labor shortages from our perspective, we.
We're not experiencing anything more on than we normally would do.
We have we of plants in small towns and sometimes they're competing with other other companies but.
It's not it's not a situation, where we can't get workers, because theyre all off on unemployment or something or they don't want to come back to work. So that's not that's not our situation.
In terms of our customers.
The fact that matter is as customers were always there was always sort of a.
A high demand for experienced machine tool operators and technical people. So I don't I don't think the current.
The dynamic created by COVID-19 are affecting that situation, that's always kind of been of challenges one of the reasons why a lot of companies like ours have been moving more towards towards automation. So I sit on the board of another company and the types of supply chain issues that theyre seeing we're not really seeing that type of thing where shortages of steel or they can't get material from from the supply.
Here's because of their supply chain issues, we're not really experiencing that and kind of modeling.
Okay. That's helpful on having those small factories geographically spread I guess helps in some of occasions.
For modeling purposes could you just remind us what the normal seasonal growth rate would be for Q4 versus Q3 and I'll leave it there. Thank you.
On a consolidated basis, the typical seasonality would be sort of 3% to 4%.
Okay. Thank you.
Some of our next question today comes from drew.
Yes.
Uh huh.
Hey, guys. Thank you dawn.
The Joel how are you.
Alright, So can you just help us a little more clarifying the.
You gave us a lot of pieces about 2020 and I know.
Youre not ready to give guidance on all of that but when you look at sort of the price cost simplification.
And some of the other costs coming back can you give us a sense if <unk>.
Maybe the first half we won't see the kind of Incrementals that you guys are going to do on a clean year.
<unk> through and it'll be more second half or just sort of how do we think about that.
I think Joel so a lot will depend on the volume as we've talked about again, if we continue to see continued improvement will continue to see leverage I think as Chris alluded to.
We saw on the third quarter that we're optimistic in the fourth quarter to your point, though when you start to look at it year over year in the first half there will be around $15 million of temporary cost headwinds related to the actions. We did last year of this current year excuse me and we will have about another $10 million in Q2, everything else I think as Chris alluded to.
We're not overly concerned about the timing of price versus raw materials, we don't expect that the material as we see of today, but we'll give you guys more updated information as we get through our fourth quarter call.
And in that same vein have a free cash flow and sort of on the first clean year or the free operating cash flow.
We will see we will see sort of a run at a normal kind of 100 of $150 million kind of run rate.
Or that's that's still going to depend on on everything else on all of the uncertainties.
Yeah again, Joel we're not going to give an outlook for 2022, just yet, but what I would tell you is from a primary uses of cash were behind the.
Heavy lifting related the simplification modernization is behind US as you see we're trending at around $120 million on capital. This year I don't expect the material difference next year in 2022 working capital obviously, we've done a great job. The team has done a phenomenal job with inventory. This year, we will see how receivables and payables.
Panel again, assuming the markets recover and call. It neutral maybe a slight use on the <unk> side everything else is relatively going to be influenced by that that top line.
Okay, and then last one just for Chris you mentioned that sort of oil in the aerospace we're passing the bottom can you give us any little little color, one way or the other about.
Some of the things you are seeing.
Not so much of a forecast just kind of some some some little trends that debt.
Give you confidence.
Thank you Beth.
On the energy side.
I think we were pleasantly surprised that the the rig count has ticked up as much as much as it was.
Not really expected or of that wasn't what our view was going to be in Q2.
And in fact.
It should turn positive year over year on Q4.
As far as oil and gas for.
For metal cutting and and of course infrastructure in the Americas.
We think thats going to continue to strengthen.
The aerospace sales.
As David mentioned, it's still down considerably year over year, but we did see.
We did see sequential improvement.
And the other thing that we've noticed is.
Is it some of our customers when the.
The when the COVID-19 first hit in aerospace.
<unk> went down.
Everyone was trying to predict when it's when is it going to come back and how long is going to take to get back to sort of pre COVID-19 levels of net net still maybe a few years out but I've noticed that therefore, the forecast is that they were predicting two years are now maybe it's maybe it's 18 months, okay or something less so so the good news is that it's moving in the right direction and I think.
There is some optimism that it could recover even even faster.
But that.
It was encouraging to see on a sequential basis, it's starting to pick up both from an energy oil and gas and aerospace so.
We're encouraged by that.
That's great. Thank you so much.
And our next question today comes from Bill on <unk> with Morgan Stanley. Please go ahead.
Great. Good morning, guys. Thanks for the question I actually wanted to piggyback off of them kind of Joes question on that I think Damian you mentioned the energy in A&D was still kind of holding back the margin performance of the company on just given the kind of the negative impacts of mix and I guess thinking about next year do you feel like you still have some kind of what's the job in terms of footprint rationalization, there assuming the mentioned.
The more targeted towards the end markets.
You kind of comfortable kind of holding some excess manufacturing capacity there until those end markets recover.
Yes.
Expect to do any sort of facility rationalization.
Many of the one of the products that we make for these end markets are part of the factories that will serve as many end markets and so for US it's more of an absorption within that factory that we deal with rather than the facility itself being tied up so I don't expect anything significant in 'twenty two related to the facilities.
We've said we're at the end of simplification monetization where were operationalized in the equipment.
Chris said, we're ready to leverage that footprint here as volumes recover.
Okay got it that's helpful. Thanks, Amy and then maybe just wondering if you can kind of update us on the different purpose of initiatives now.
The other things of reopening of bit maybe youre able to get out and from the customers a bit more so just curious kind of what's the kind of traction youre seeing there and then I guess kind of going forward now that you've been.
And the through a few quarters now how would you kind of ever consider breaking out the kind of different purpose revenues just the.
It kind of get the measure of how those initiatives are progressing.
Yeah I think.
To answer your question about how is it going.
We're getting very good traction on these.
In the space and also to your point that as the COVID-19 restrictions are lifted and that just becomes easier too.
Talk with customers interact with customers to convert them, whether that would be fit for purpose or any other kind of mental brand tooling. So.
That's going to on if we're getting good traction now.
Should get even better traction as the COVID-19 restrictions.
Continue to list.
In terms of your question about breaking that out separately I don't think we're going to break it out.
As a separate.
So our sales item.
But we are sort of at the early stages of thinking about how we can.
Measure relative performance and talk to you about it without jeopardizing competitive information because I think you can appreciate that some of that some of that granularity is actually.
Information of our competitors are like the half, but let me just let me just say that in general.
If you look at the fit for purpose area.
<unk> engineering market is.
Is where a lot of that is sold so one of the things. We look at is our performance versus how that market's growing.
And again, it's one of the largest target markets for fit for purpose and thus far we believe we're outpacing that market growth in this area and then the other thing. We do is that we have this targeted account process and we are approaching our customers with the attitude that we want our growth larger share of their wallet.
So we we well understand what theyre complete tooling spend is today.
And then we can measure how much of that we're getting in the future and as we look at that.
From our existing customers and also adding new customers again in this in this application space called fit for purpose. We believe that we're gaining share. So those are those are two directional indicators that the.
It allow us to feel comfortable that where we're getting good traction on this fit for purpose space.
Okay, great. Thanks for the color I appreciate the time.
And our next question today comes from Steven Fisher with UBS. Please go ahead.
Hey, Thanks. Good morning, just wanted to follow up on some of the mix related impacts.
Just sort of confirm my understanding of the year over year profit headwind that you had from mix by my calculations it was somewhere around.
Round of $20 million headwind year over year.
There really wasn't much impact from the the <unk>.
Lower volume year over year is that is that about right would you had in your calculations.
Yes.
We don't we don't disclose or break out mix I would tell you as I alluded to in my comments. So the getting the factories were loaded at a at a higher level in Q3 last year than they were this year that obviously you had a significant effect on the overall profitability as you saw coming through this year on that Cup.
<unk> with the richer mix in aerospace and energy on metal cutting and then there's some mix issues on infrastructure. So all of that together sort of is getting you to the the delta that Youre youre looking at.
Okay and have you seen as we've gotten into the fourth quarter the.
The mix headwind getting smaller already on the year over year basis.
Yes, well I was going to say that we think the headwind is on a year over year basis is near the bottom both regionally and by end market.
Especially as we start to lap the COVID-19 effects.
And then you do see for example.
As I mentioned, the sequential growth in Aero and energy, indicating the we're coming off the bottom so I think.
I think going forward, it'll be less and less of a conversation at the well.
Okay.
And the volume you called out lower volumes year over year in the quarter or was that entirely in January and February and the did you see that flip in March.
Positive or is that inflection is still yet to come.
I'm not sure I'm understanding the question do you know what he's asking yes, I think yes. So I think Steve we don't we don't really breakout.
<unk> sales or production, but I think as Chris alluded to we have seem to given that we are giving you an outlook of of mid the mid single digit sequential growth. We saw improvements I guess more as we move through the quarter would be the way to look at it.
Okay. Thanks very much.
And our next question today comes from Ross Gilardi with Bank of America. Please go ahead.
Hi, guys good.
The morning Ross.
I had a question on capital allocation on you guys have done a lot of refinancing you think markets seem to think market the bottom youre essentially done with the restructuring and just how does that influence your thoughts on capital allocation. I mean is FY 'twenty two potentially year debt you shift away from debt reduction and really protecting the dividend is something more on the offensive be it M&A.
The dividend increases or buybacks or something like that and I had a follow up too.
Yes, so I think Ross for us.
Obviously, we're still very focused on liquidity here in FY 'twenty one as we do we look at FY 'twenty two as Chris alluded to we're feeling good if the markets continue as we've said in the past, but we're going to take a holistic approach on capital allocation now that we're at the backend of the simplification modernization you've heard us say before we may look at some smaller scale.
The projects to improve efficiencies. These will have to have their own high return standalone returns against not part of simplification monetization and these would be smaller in size, but we'll continue to look at that we have said that we will look at inorganic opportunities.
Our indication will be more likely on the bulk of bolt on type size businesses, where we can leverage either our footprint and access new markets that we feel we're under indexed and where we can price for the value that we bring to the customers and if we don't find things that meet the right returns on either of those we're going to look directly we're going to look back to the direct returns to shareholders.
And whether that's in the form of increasing the dividend or a share buyback I don't know, yet, but thats sort of how we're looking at it and we'll know more as we build our plan for FY 'twenty two.
Okay, great. Thanks, Damon and then.
I just wanted to ask you about your commentary just longer term on on EBITDA margins and so forth. I mean, you guys have been unflinching in saying that you think you can.
Still do 24% to 26% margins of two five to $2 6 billion in sales I mean those of revenue numbers that you did back in fiscal 2014 to 15 in fiscal 18, you did yes.
Just under $2 four of the peak, but if we do the math I mean that implies over a 50% incremental EBITDA margin from where you seem likely to finish in fiscal 'twenty, one even though your restructuring actions will be substantially completed this year. So the first question is how realistic do you think $2 5 million to $2 6 billion is or is it just sort of.
Just the hypothetical number given that the aerospace energy and mining seem unlikely to get back to where they were in the $13 15 time period and then just whatever the next peak revenue number is we are on it.
Even though if you call of peak of whatever we want on whats soon how should we think about incremental margins from here. If the end markets that I. Just mentioned are a smaller portion of the mix than you would have initially envisioned back in late fiscal 2017, when you came up with those targets.
Well I'd say a couple of things in terms of the revenue on and I'll, let David comment on the sort of the profitability underlying property assumptions so on.
We said that two four to $2 6 billion.
Youre right. We did have a focus on arrow and I think I think arrow. Our expectation is <unk> is going to recover is going to recover such that the.
It doesn't it doesn't affect our view of the two 4% to six I even think in energy.
Ross will then that's something that you may have to watch over the next.
Maybe 10 year Horizon I don't know about you, but I have been reading about the peak peak demand for oil.
That was the net business for 30 years and it kind of moving out of 20 years at a time. So I think as we look out a reasonable timeframe of five years. We do think that we can still get in that $2 four of $2 $6 billion range, even with I think conservative estimates for what's happening with the.
With oil and gas and part of that is we have we have on offset.
As we told you on infrastructure as we're expanding.
And the other mining adjacencies.
Fact of the matter is as we build more green machines the need for some of these minerals and that type of mining is going to actually increase.
So we feel we feel like those sort of areas that you mentioned energy and.
In aerospace are not going up they're not going to prevent us from getting this $2 four on $2 6 billion. The other thing is is that when I came into the company and sort of reiterated debt that guidance.
At our Investor Day way back in December 2017.
I think our plan for the <unk>.
For purpose wasn't it wasn't fully developed we had we had sort of video as a separate segment of it you might remember it was kind of set up as a separate segment. So we can kind of figure out what we wanted to do with it shine a light on it and see what we need to do to make that business more profitable on growth and I think our expectations for.
That sort of fit for purpose space.
I think are even greater than what we thought we could accomplish under the previous setup. So again from a revenue perspective, I think we I think we can get there.
I'll, let Damon comment on the profitability assumptions I think Ross two comments I think the other comment I'd make on top line is remember we're also a fairly low share in aerospace and we still see significant opportunities to gain so even if that market is slower from a growth standpoint, there is still opportunities for us to grow within.
That market that I think gives us confidence in aerospace in the long term potential there, but I think from a margin perspective again, when we gave you the outlook in December of 2017, right. What we've what we talked about with simplification monetization of what you hear us talking about this next wave is operational excellence, where we're now have the new modern equipment in there.
For us, it's about driving incremental productivity that to the extent there may be some sort of a mix issue that we're not seeing at least today, we're looking to hopefully offset that with incremental productivity going forward. So when we look at our long term plan, we still feel and operator, we'd see the opportunities to get to that 24% to 26%, which is why we reaffirm it on the calls because we do.
See it.
As achievable for us.
Okay. Thanks, very much guys.
Ross.
Next question today comes from Joe Ritchie of Goldman Sachs. Please go ahead.
Hi, Thanks, good morning, everyone.
Morning, Joe.
So I have I have a near term and a longer term question on the on the auto business day, maybe the near term first you talked about it would be your strongest end market in your fiscal third quarter and you've got the guidance out there for sequential growth of the entire portfolio of mid single digits I guess, what's the implied.
Growth rate for your auto business in the fourth quarter and then maybe if you could just provide a little bit more color just around both India and the supply chain constraints that would be great.
Four.
For the transportation metal cutting.
Again, the the impacts of the chip shortage are going on in fact, the Americas as well as.
As well as in EMEA.
And then of course of <unk> is also being hit by sort of the COVID-19 COVID-19 wave potentially.
For Americas, and EMEA in terms of transportation.
From Q3 to Q4, we actually see and sort of factoring in it can kind of be down a little bit alright, because of those effects and while transportation in China is.
How should continue to get stronger.
I think that's going to be offset by sort of India for the reasons, we talked about with the.
The potential of Lockdowns.
And the effect on consumer buying activity. So I would say transportation for Asia Pacific All things consider from Q3 to Q4 is kind of flat if you will of stool net out.
That's the way we're looking at okay.
Okay, Yes, that's helpful, Chris and maybe maybe just on this.
The longer term question on transportation and really just trying to understand.
How you guys are positioned longer term for EV I'm just curious.
Maybe if you could just provide some examples I don't know if its the right.
The number is like a hike of content.
Content per vehicle.
Capex intensity.
Metal cutting.
For Evs versus traditional.
It would be helpful to hear kind of like your perspective on how you think that end market is kind of look for you in the next five to 10 years.
Sure.
Well, there's no question, there's going to be changes in the mix of cars produced I think something around just over 90% of the cars produced or internal combustion engines today.
And of course, this is going to move towards greater vehicle production over the next decade.
However, we think that they will initially be a greater shift of hybrid vehicles and.
Which have both the internal combustion engine as you know on electric motor propulsion systems, and we expect that that the.
The hybrids will account for about 75% of the market in 10 years.
And as you as you mentioned or alluded to the hybrid vehicles actually consume more cutting tools then the current internal combustion engines. So we view that there may actually be an uptick in metal cutting tool demand.
During the transition to electric vehicles.
I think it's also worthwhile, noting that.
While <unk> vehicles require less metal cutting to produce than the the ice of the hybrids the underlying demand for for all of vehicles in the globe is still growing so we expect the sort of net of all of these variables for demand for cutting tools and transportation to growth sort of in this 1% to 2% range over the next 10 years, that's kind of of our long term view of that.
Got it that's helpful. Thank you Bob.
The next question today comes from Steve Barger with Keybanc capital markets. Please go ahead.
Hey, good morning, everybody. This is Ken Newman on for Steve.
Yes.
So from my first question I was just curious if you guys could just talk to.
Broad inventory levels or visibility that you have in the channel from your customers.
Specifically I'm trying to get a better sense. If you think that you have seen any kind of restock from customers.
Pull ahead of supply chain issues within this quarter and how do you think about the potential for pull ahead orders in your <unk> Guide.
Yep.
Well I would say from a momentum colors perspective that we're seeing gradual improvement in stocking orders.
The distributors and customers are still at.
<unk> care on a little bit cautious about burning too much cash until I think the demand signals of little stronger.
So Q4.
The price increase that we're <unk>.
Putting through that could lead to some pull ahead of orders with distributors in Americas and EMEA.
But from the most part.
And those two areas I think that the significant restocking is still is still ahead.
And it's not clear that it's going to.
To break loose in Q4, but.
But I suppose that's possible.
We're not we're not counting on that in our <unk>.
On our current guidance, so that debt I think as potential upside.
In terms of infrastructure of the customer inventory levels, we would say appear to be normal to low across all end markets, including oil and gas so.
For the most part of their normal, but there are still split of holding lower inventory levels. So there's still there's still I think.
A tailwind there that could come on the infrastructure side.
Understood.
And then just from a modeling perspective, obviously, you're kind of guiding.
Operating margins on both sequentially and year over year should we think that margins are up sequentially for both segments in the fourth quarter, just given how tough the comp or how.
How difficult the comp was in the <unk> of last year.
Year over year, you're kind of I don't I mean, what we're saying is you kind of there'll be a significant amount of the temporary cost headwinds.
That are probably more focused on infrastructure sort of on metal cutting versus infrastructure, given the amount of labor that they deal with their I would also tell you that on the infrastructure again because of the way that they price their products with raw material cost you may see a slight benefit for them year over year as they are.
Starting to recognize a little bit of the benefit pricing wise from the tungsten increase and so I would tell you that probably a little bit more disproportionately negative to the metal cutting year over year versus metal versus infrastructure.
Got it.
And then last one from me within infrastructure, you know Americas, and EMEA were both down double digits, Obviously Asia Pac was up 30%.
Notwithstanding all of the issues kind of going on within India right now.
Would you expect positive growth in all three of the regions this coming quarter.
Yes, it's hard to it's hard to say, what what's going to happen with India.
<unk>.
But.
With the exception of that we are we are thinking that we'll have good positive growth in the other.
The regions.
India is a little bit of.
Kind of a wait and see.
Alright.
Thanks Kelly.
Ladies and gentlemen. This concludes the question and answer session I would like to turn the conference back over to Chris Rossi for closing remarks.
Thanks, operator, and thanks, everyone for joining the call today, we really appreciate your interest and support.
Made fundamental improvements to the company and we're really excited about the opportunity to further demonstrate the benefits of these improvements and the investment in monetization.
The not only drive higher returns for investors, but also our ability to improve customer service and facilitate our ability to take share. If you have any follow up questions on today's call. Please don't hesitate to call and reach out to Kelly have a great day.
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