Kennametal Inc.

Good morning. I would like to welcome everyone to CanonMetal's first quarter fiscal 2020 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, Please press star, then the number 2. Please note this event is being recorded. I would 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 to review Canada Metals' first quarter fiscal 2020 results. Yesterday evening, we issued our earnings press release. and posted our 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 5th. I'm Kelly Boyer, Vice President of Investor Relations. Joining me on the call today are Chris Rossi, President and Chief Executive Officer, Damon Audia, Vice President and Chief Financial Officer, Patrick Watson, Vice President, Finance and Corporate Controller, Alexander Broats, President, Vidya Business Segment, Pete Dragich, President, Industrial Business Segment, and Ron Kors, President, Infrastructure Business Segment. After Chris and Damon's prepared remarks, we will 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 that constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements 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 forward-looking statements. These risk factors and uncertainties are detailed in Kenna Meadows' SEC filings. In addition, we will be discussing non-GAAP financial measures on the call today, reconciliations to gap financial measures that we believe are most directly comparable can be found at the back of the slide deck and on our form, aka 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 deck, our results in the first quarter were below expectations due to global market conditions deteriorating more significantly than we anticipated. primarily in the transportation, energy, and general engineering end markets. Organic sales declined by 11% versus 10% growth in the first quarter last year. Adjusted EBITDA margins decreased 820 basis points to 10.9%, and adjusted EPS decreased to 17 cents versus 70 cents in the prior year quarter. Decreases in margin and EPS were the result of three main factors. First, due to the rapid change in end markets, organic sales declined, 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 to the demand outlook. Of course, the full benefit of these actions will not be reflected immediately. Secondly, as expected and discussed on our fourth quarter earnings call, Tungsten 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 of fiscal year 20 to approximately $200. The effect is the temporarily depressed margins in the short term until the higher-priced inventory moves through the P&L. This accounted for approximately 360 basis points of the 820 basis point reduction in EBITDA margins. 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 underabsorption due to footprint rationalization. We expect this effect to decrease as plants are closed 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. Q1, simplification, modernization contributed an incremental $8 million or 7 cents year over year to our EPS on top of the $40 million achieved last year and roughly $10 million achieved the year before that. Note that further benefits from footprint rationalization are still to come and are 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. Though we are encouraged by these results in 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 of the year in transportation and energy, but rather expect the year will simply follow a more normal seasonal pattern from the current lower market environment. As I said, our focus is on improving 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 had moved 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 end of the year, our FY20 restructuring actions are expected to reach a run rate savings level of $35 to $40 million. fiscal year 21 restructuring actions will bring an additional $25 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, coating, powder, and SKU reductions, strategic pricing, and portfolio rationalization. And remember, these numbers do not include the full run rate effect of the plant rationalizations that I just mentioned. In 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 remove costs out of the system through simplification and modernization. It is also important to recall that this year's cash flow is reduced by the temporary restructuring costs associated with footprint rationalization. On slide 4, 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 8X 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 finalist, which is a testament to the innovation of the design. The Harvey 1TE is an end mill used by general engineering customers. It delivers up to 50% increase in productivity and tool life, depending on the application. Another new product, which is also focused on aerospace growth, is the Core 5, an end mill for aluminum machining that delivers a productivity increase of two times. And finally, the RIQ Reamer is focused on the specific growth area of electric vehicles. This tool is used in precision machining operations for drivetrains, and is produced using Kenna Metal's 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. I will begin on slide five with a review of our operating results on both a reported and an adjusted basis. As Chris 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 effect 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 a 100 basis point increase on a 12% decline in sales. This reflects the continued focus on strong cross 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. Report of EPS was $0.08. and 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 of moments addressing the drivers of our APS 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 costs 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. Now, on slide seven through nine, I will provide some high-level color around the performance of our segments this quarter. Industrial sales in Q1 declined 11% organically against positive 10% in Q1 of fiscal year 2019. From a regional standpoint, this was felt mostly in Asia Pacific with a decline of 15%, followed by EMEA and Americas down 12% and 7% respectively. Our end markets were challenged mostly in transportation and general engineering, driven by the decelerated global manufacturing and auto production activity. Aerospace continues to be a bright spot for us, and though it was down 1% year over year, we would have experienced slight growth excluding some non-recurring package deliveries. We continue to see aerospace as a key growth end market. As Chris mentioned, we continue to introduce new products like the Harvey Ultra 8X and the Core 5, specifically designed for that end market. This gives us further confidence that we can maintain our growth in this strong end market. The decline in volume was the major contributor to adjusted operating margins coming in at 9.8% compared to 18.3% in the prior year. The effect of higher raw material costs represented approximately 140 basis points of the year-over-year decline. Turning to slide 8 for VIDIA. 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. Segments faced similar macro challenges as 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 costs affected VDEA's operating margins by approximately 430 basis points this quarter, but will abate in the second half. Turning to infrastructure on slide nine. Organic sales declined 11% against positive 10% in the prior year period. Regionally, sales were up 9% in EMEA, while Asia Pacific and Americas were down 11% and 14% respectively. By end market, these results were primarily driven by energy, which was down 24%, reflecting declines in the U.S. land-only grid count. General engineering and earthworks were down 4% and 1%, respectively. In earthworks, share gains in Americas and South Africa were 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 infrastructure's profitability as higher raw material costs abate in the second half and align with customers' pricing. Additionally, we expect to see further benefits in infrastructure's margins as we finalize the closure of our Irwin facility as well as the recently announced Newcastle divestiture. Now, turning to slide 10 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 increase is the result of more modest inventory reductions versus our expectations as sales declined 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 and 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 but 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 and overfunded U.S. pension plans, continue to have no borrowings on our $700 million 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 and 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. Turn to slide 11 for our FY20 outlook. The current outlook expects a delay in the global recovery that we had previously anticipated to occur in the second half. To reflect this, we now assume only normal seasonality for the year while also reflecting easier comparables in the second half. Our revised organic growth outlook is now in the range of negative nine to negative 5%. Our adjusted effective tax rate is expected to be in the range of 22 to 24%. This results in an updated adjusted earnings per share outlook of $1.70 to $2.10. 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, the temporary effect of higher raw materials is working its way through our P&L. 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 underabsorption 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 recently ceased production at our German manufacturing facility and 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 are proceeding with our simplification modernization 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 to 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 assumes a second half recovery in transportation and energy, but rather reflects a more normal seasonal pattern from the current lower market conditions. Strength of 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 reach the targeted range of $2.5 to $2.6 billion. With that, operator, please open the line for questions.

Thank you. We will now begin the question and answer session. And at this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, please press star, then the number two. Again, that's star, then the number one to ask a question. Our first question comes from Julian Mitchell of Barclays. Please go ahead.

Hi, good morning. Morning, Julian. Morning. I wouldn't normally drill into sort of quarterly numbers because I know you don't guide by quarter, but just given the sort of seasonality shift and the guide down just now, Just wanted to try and home in on Q2 specifically for a second. So I think what you're guiding for is around about a 10% organic sales drop similar to Q1 and around sort of 20 cents of adjusted EPS, so maybe a decremental margin that's slightly narrower than what you had in Q1 but not significantly. Is that a fair summary of how you're thinking about Q2?

Yeah, 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?

Yeah, I mean, if you look at the numbers this quarter, I think the decremental margin is was around 87%, and that, of course, wasn't completely unexpected, driven by lower volumes. You know, we had the temporary raw material cost effects, and then, as we mentioned in our call last time, this is a transition year for condominiums, so we have a lot of manufacturing inefficiencies built in associated with modernization and plant closures. But if you take out the raw material effect, the decremental 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 in the first quarter than we anticipated. And as you know, it's hard to turn these factories on a dime and takes some time to adjust the volume, which we're working on. So the good news is that that situation should improve as we advance through 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 increase. And also, by the same token, the inefficiencies associated with putting those programs in place will decrease. So we're looking forward to improved margins as we progress 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 break-even point of 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 weather 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. You know, we hear very mixed things depending on which short cycle industrial company we speak to. Just wanted your perspectives on how inventories stand today, your distributor partners, your OEMs and yourself versus normal seasonal levels.

Yeah, there's no question, for example, on the industrial and video side of the business in the Americas, there certainly has been destocking throughout the first quarter, and we expect that will continue in Q2. And on the infrastructure side, there's been some destocking in hard rock mining and surface mining, and we also see destocking in oil and gas. So I think that, you know, the distributors and the end users are sort of understanding that this is an uncertain environment and they're sort of pulling the lever that 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, Julia.

Our next question comes from Anne Dagen of J.P. Morgan. Please go ahead. Yeah, hi.

Good morning. Hi, Anne. Can you just address the fact that you expect the tungsten raw material prices to abate in the second half? That's what you were saying a quarter ago, but now we're looking at much lower volumes. So does that mean it's going to take longer into Q3 for these costs to abate?

Yeah, let me just make a couple of general comments. As you know, we buy this inventory. We source both internally and externally. And The length of that supply chain or how the inventory stays in the system kind of depends on that factor as to how well we can purge it. We have a good handle on what cost is currently sitting in the inventory now, and we run that through our model, so we're confident that we'll start to see the abatement in the second half, including Q3 and Q4. So in terms of the financial benefit to the second half, we have a lot of confidence in that. In terms of how it actually would transition through the P&L, 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 material cost is going to change over time?

Well, I think, Ann, as Chris alluded to, we know given the lead times of our inventory, we have very good visibility looking out into the second half of the year. And so with tungsten prices currently where they are, we know that it will turn into a tailwind for us moving into Q3 and Q4, so with a fairly high level of confidence.

Okay. And I suppose my second question is around the same risk if the free operating cash flow 20 to 50 million. You know, what has to happen to working capital in order to achieve 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, well, we look at our – the 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 certainly planning on a – inventory levels dropping, so that is driving some of the working capital. But, you know, our current outlook was in that minus 5% to minus 9% sales, and the preoperating cash flow is well inside that range if that's what volumes turn out to be. So I don't feel like we're going to be sitting on a lot of inventory based on that sales forecast.

Do you have an inventory reduction dollar amount embedded in that?

Yeah, we do. Yeah, I think, Ann, what we said at the end of the, you know, we finished the fiscal year end at just over 32%, and what we said on our last call is our goal is to try to drive down getting close to that 30%. You know, obviously with the change in our sales outlook, we're continuing to look at what that percent is, but, you know, there is an inventory reduction that was planned at the start of this year, and it'll be its further increase as a result of the lower sales.

Okay, I'll leave it there in the interest of time, and I'll 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. I'd like to hit on some of the demand trends. A few other short cycle companies have indicated trends kind of fell in August and September from July and then took another step down in October. I'm wondering, is that similar to what you saw in your demand trends?

Yeah, 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 Q1 in terms of markets. Recognizing that Kenna Metal does have, we do have sort of a normal seasonality 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 and all regions would be down Q1 to Q2.

Okay, thanks. And within that, Chris, are you seeing not things turning positive outside of aerospace, but are you seeing any stabilization in the pace of demand decline?

Yeah, if we look at – and we've been kind of modeling this current situation with – slowdowns in the past, like in 2015 and 2012. And our expectation is that depending on what you look at, you can be down anywhere from four quarters to as much as seven quarters. I think 2012 was down about four quarters in a row, and 2015 was down seven quarters. So for us, that means that as it concerns FY20, we're not expecting any kind of recovery. The only sales increase you would really see is associated with a normal seasonal trend. So it's looking like to us that probably if this follows kind of an average course downturn, it's an FY21 first quarter subject for us in terms of when we might see a recovery. That's our view.

Okay, thank you for that. And then just kind of a detailed question. One of the components of industrial margin headwinds in the in the quarter that was noted in the release was compensation expense. What drove that?

Just general inflation. We have our annual merit increases and things of that nature. As you know, for industrial, labor is a higher percentage of the cost of goods sold, which was 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. Morning, Joe. Just to be clear, I know you guys don't like to guide quarterly, but I just want to be clear. On the tungsten impact for Q2, it's expected to be as, you know, call it the 19 cents that you did in 1Q, it's expected to be as high as Q1 as well?

It will still be a headwind. Joe, it may not be the exact percent, because it will start to abate a little bit. But, yeah, generally speaking, it's going to be, you know, the impact in that quarter will also be a headwind. I think the other point that we'll point out, though, 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 spots, and that will impact the margins in the second quarter even more on infrastructure.

Okay. All right. That makes sense. And I guess maybe just asking just a little bit of a higher-level question here. Clearly, the market, I think, surprised a lot of companies this quarter with the downturn that we saw. But I guess as you look at your own business and the decremental margins that you posted this quarter, I guess Were you surprised by how much things de-levered this quarter? And then maybe talk about how, via your simplification and modernization initiative, you're going to try to limit maybe some of that cyclicality on the go forward.

Yeah. I mean, obviously, the lower volume was a surprise. We did expect in our plan that we would have lower volumes, but the market dropped off almost double what we thought in terms of our planning process. If you look at the EPS bridge that we showed in terms of manufacturing operations, that's $0.60. We know the $0.19 of that is the raw material, which will abate the second half, so that's kind of a temporary issue. And then if I just took the essentially $7 million change in sales year over year at our normal 40% operating margin, that's another $0.28 there. And so the balance of $0.13... is one of the things that we just talked about, the normal inflation that's built in, in terms of rise to payroll and that 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 the temporary manufacturing inefficiencies due to modernization and preparing for plant closures. So your question in terms of how it can affect the change in that 13 cents is, Obviously, we still have normal inflation, and we have to deal with that and drive productivity. But modernization is going to really get after this volume-related lower variable and fixed cost absorption. We still have it in any given period when the volume drops, but essentially with simplification and modernization, we're going to just be less dependent on labor. Our ability to react to that is improved because we don't have to go through a process to shed those direct labor workers. The company, I think, is in a much better place today than it was in the past. We have less facilities. We're modernizing the facility. We're less dependent on labor. Keep in mind, the benefits of modernization are still largely ahead of us. How the company performed in this first quarter, which I don't think was actually too bad given the drop in volume, we expect that we're going to perform even better as we get through FY20 and FY21 and sort of complete this first wave of modernization.

Got it. That makes sense. Thank you.

Our next question comes from Adam Allman of Cleveland Research. Please go ahead.

Hi, guys. Good morning.

Good morning.

I was wondering if you could expand a bit on what you're seeing with the aerospace markets. I was a little surprised that even excluding your kind of one-time headwind that you flagged from projects or whatever, that you're still only growing a little bit. And is there any mixed impact that's happening between engines versus aerostructures versus penetrators, defense sales, something like that, that would be fully back the growth? You know, considering, I guess, you do have tough comps, but maybe, you know, talk through your confidence of how the sales trend across that chunk of the business looks for the rest of the year.

Yeah, I think there's a couple of things I would say. First of all, you're correct. We have the sort of these large package orders that by definition don't reoccur. I should say it's more like they're lumpy, okay? They can occur at any given point in time. So when you measure year over year, if you're having to find a period that has one and doesn't, that can change the number. And those are actually fairly sizable orders, so they can move the needle, even though aerospace is still a pretty good-sized market for us. So if we take that out from the equation and we look at our growth initiatives, and one of the things that we track are actually new customers that we add. Then 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 launched in my section of the prepared remarks. And, again, we're tracking those new product introductions, and they're not actually displacing old metal tools or cannibalizing them. If they're displacing anybody, it's other companies' tools. So we feel like we're getting traction on those. And then the other thing I would mention is that, you know, VIDIA is – the segment for VIDIA is basically general engineering. But we know that there's – we know that inside that space, there's aerospace applications that are done, especially in the Tier 1, Tier 2 suppliers. And so we also track that in terms of those applications, and we know that we're gaining traction and growing applications. those aerospace customer base that are considered part of general engineering. So all that equals we still have a strong segment, and 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, gotcha. And then just a couple of clarifications on pricing and material costs. Was your price realization positive this quarter? And does that follow tungsten prices lower then as we start to think about the December and March quarters so that you'll have a kind of a price headwind? And then just related to the, you know, the 19-cent material cost headwind that you talked about, that's just a gross comment, right, or that net of what pricing was.

Yeah, the 19 cents was – know just based on actual payment of uh or cost of inventory that's throwing flowing through the p l so that um that really doesn't have anything to do with necessarily the price covering rods i think your question is though um in in general canada metal 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 forecast for the full year, we're expecting price in raw to be pretty much in balance, so essentially flat. In terms of pricing in the marketplace, as you know, we put an initiative in place in FY18 to really start to do strategic pricing and be less sort of cost plus pricing. And so our intention is that even though material costs are dropping, other than the contracts that were required in infrastructure to lower prices based on the change in the index. We feel pretty good of our ability to hold on to 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 economic equation to run for ourselves.

Okay. Thank you.

Our next question comes from Ross Gilardi of Bank of America. Please go ahead.

Hey, morning, guys. Morning, Ross. Chris, I want to just ask you, I mean, if you look at your entire manufacturing footprint, net of what you are closing, what portion of your footprint should be fully modernized to the extent that you, you know, the company, you know, envisioned several years ago by the end of fiscal 2020?

On a percentage basis, I think we're probably, how would I characterize this? By the end of FY20, we're at least 60% of the way there. And remember, we had a number of plant closures that will continue. We have some in FY20, but there's others in FY21. So until those plant closures come, that's going to drive the balance. And we had announced a second restructuring for FY21, which has some of these plant closures. And so that's kind of on that basis, I think, that since the plant closures are the hardest in terms of the level of effort, that's why I think it's kind of 60% this year and 40% because there's some heavy lifting that still needs to be done to close some of these larger plants. So in terms of effort, that's the way I see it.

So that's what I was kind of getting at. So, you know, I wanted to ask you really about the $300 million of incremental CapEx, you know, to modernize Canon Metal. You know, Chris, your predecessor had come up with that figure, if I remember correctly, and you continue to work off that assumption. You know, how confident are you that it's the right figure to get the company where it needs to be? I mean, does the, you know, the, you know, big hit to margins that we've just seen, tell us that the company's still got a lot of investment to make in factory automation so that you can adjust to these slowdowns and pickups in a much more nimble fashion going forward?

Yeah, I think in general, the $300 million number we still feel good about. You're right, I did inherit that number, but we've done a lot of work, obviously, since then. I've been here over two years, and that's still the number that I believe is 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. We're zeroing in on that $300 million number. Now, we also talked in the last call that in some cases we were expecting higher volumes, and so we're not going to bring on additional capacity just for the sake of having that capacity until the volume can support it. So if we were to fall short of the $300 million by the end of FY20, you know, it might be $25 or $30 million subject that might carry over to FY21. But largely, we expect that FY21, we would return to more nominal capital spending and 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 in a lower volume position 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?

We do, yes.

Okay, what was that number?

Ross, we didn't give out the specific cash costs for the restructurings other than when you go back to the announcements that we made, so the FY20 restructuring plan that we announced, we said that was going to cost in the range of $55 to $65 million in cash, and we said the vast majority of that would go out in FY20. And then when we announced the FY21 restructuring, we said that that was a $60 to $75 million cash, the majority of that being cash, and the majority of that going out in FY21. But there would be a portion in FY20. 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 UBS. 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 of the various segments margins by Q4? Do you think we're going to be back to mid-teens for both industrial and infrastructure by then?

Yeah, we look at... If we look at both video and infrastructure this quarter, the raw material impact was quite substantial. And so when you remove that effect, which will abate in the second half of the year, they're going to return to profitability. But underlying both of those are we continue with simplification, modernization, and portfolio pruning that affects, for sure, infrastructure. And as we close some of the plants that we're talking about take some of the other portfolio pruning actions, that's going to improve the profitability of infrastructure. And so based on our current forecast and the volume that's going to run through that business, for what we're expecting, I feel pretty good actually about where we're going to be from a profitability standpoint. On the video side, obviously they're highly volume sensitive because it's a small size business. And as we've talked about before, they're essentially a product portfolio inside the overall metal cutting space. They run inside the same overall kind of metal factories. And so you can see profitability numbers that from a P&L perspective that don't look great, but the fact of the matter is it's a couple hundred million dollars of volume running through the same factories. And, again, once you take out the material cost impact, we feel that that business is going to return to profitability. The other thing that we've said is, you know, a lot of the video profitability is going to, in terms of modernization, is tied to, closing to these plants, so their productivity improvements are definitely more back-end loaded as it relates to modernization. So, I mean, overall, I don't really have – I'm not sitting here thinking that we've got some profitability issues with either one of those businesses. And then industrial continues to crank along, and, again, once some of these one-time effects abate, we feel pretty good about that business also.

Okay, so it sounds like still – Probably losses in the second quarter, but it turned 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, in what region?

Your three key regions, Americas, EMEA, and APAC, yeah.

Well, we actually, in terms of growth rates, we're actually showing, let me just look here. So construction from Q4 to Q1, we feel the markets are kind of flat. We see the same thing in Q1 to Q2. It's kind of a flat market. So other than the normal seasonality, that's kind of what we baked into that forecast.

And is there any major variance within your regions there?

No, that was across all regions, America, Zambia, and Asia Pacific.

Okay, thanks a lot.

Our next question comes from Chris Dankert of Longbow Research. Please go ahead.

Hey, morning, guys. I guess sticking with the end markets theme here, As I look at energy, obviously, infrastructure has got the pricing headwind, and that's a pretty steep step down, though, to 24%. I guess when I move up into energy in the industrial segment, what's the risk that that growth rate kind of moves into the down double digits, down teens for the rest of the year? Can you parse energy by segment a little bit?

Yeah. Unfortunately, if 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're expecting declines to continue through the year as the rig counts come down. In terms of the metal cutting business, we're anticipating something similar to that. It's really across the board. America's EMEA and Asia Pacific. So we don't 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. So if it does, that'll 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, you know, how big a deal were those? What would the incremental margins look like without those stoppages? Just any kind of comments there?

Yeah, in the quarter, we didn't actually – we didn't actually – we were preparing for some closures, and – I mentioned that that was one of the inefficiencies that's buried inside that 13 cents of EPS. It's really the second quarter that we begin to start closing facilities. It was at the end of October that one of the German facilities stopped production. There wasn't much in terms of the first quarter other than preparing for these closures. that was inside those numbers.

David? Chris, I think the other question you may have been asking there is the production days that we alluded to. And I think to answer your question is we said inventory. We were planning to take inventory down this year. and we were going to be adjusting production. I think as Chris pointed, as the markets moved 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 enhance the margin, but it reduces the detrimental because otherwise we would have been producing inventory that there was no demand for. So, you know, it's part of those ways that we're trying to reduce the cost as quick as we can to right-size production with the market outlook.

Got it. That's helpful. Thanks, guys.

Our next question comes from Walter Liptak of Seaport Global. Please go ahead.

Hi. Thanks. Good morning, guys. I wanted to just stick with the same, you know, the last questions with the inventory. So it sounds like with these facilities closing this quarter, the inventory is not going to come out. starting in your second quarter. It will be sometime in the second half. Is that right?

Yeah, I think the inventory didn't come down as much as we thought in the first quarter because we simply didn't have as much volume. But our expectation is it will start to come out in the second quarter, and then that will continue to accelerate through Q3 and Q4.

Okay. So are these the three German plant rationalizations and the one closing? That's what you're alluding to. That's where the extra inventory is being held right now, and that's what will come out in the second half? That's right. Okay. And you mentioned the benefits from the German factory closing, and I presume that also includes the other three factories. What kind of benefit will you be getting from that? How can you quantify it?

Yeah, I think that, you know, if you look at those restructuring actions that we talked about, inside those numbers are the associated benefits from closure. So some of the closures are inside the FY20 restructuring action. That was in the $35-$40 million range. And then the FY21 actions, which also had included Some of the plan closure benefits, that was in the $25 to $30 million range.

Okay, Kurt. Yeah, right. It all flows in. You know, with these inventory levels, you know, since there's a 2021, you know, round of a larger facility closing, won't you have to maintain inventory at higher levels even going into 2021 because of those two where you run into the same kind of inventory issues? you know, issue where you won't be able to draw them down as quickly?

Yeah, I mean, the plant closures are, there is a large plant closure in the first half of FY21, and so that does have some inventory associated with it. So even in FY21, we would continue to have 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 need that inventory. So it will continue to drop off, but you're correct. It could still be at an elevated, slightly elevated level until we close that other facility in the first half of Y21.

Okay. Okay. And if I could just ask a quick one on just the negative trends on a global basis. Are we in a synchronized, you know, slowdown across all the regions? Or, you know, EMEA is down more, you know, and did they start sooner? Or I guess Asia is down the most. Did they start sooner and then they kind of went to EMEA than Americas? And are any regions looking like they're closer to bottoming?

Yeah, I think, as you know, Asia Pacific started quite a while ago. That was kind of first to go. And, you know, we see that that market is continuing to stay at low levels, but I don't know that it's necessarily getting any worse. EMEA was then second, and... And that drop-off continues. As you know, many of the industrial countries inside of EMEA are, some of them are actually in a recessionary mode. So that situation has gotten worse in the last few quarters. But it seems to have, I guess I could argue, it seems to have kind of stabilized at the current levels. And then the Americas, while it has gotten a little weaker, it's certainly not in as bad a shape as those other two markets. And so I think that, you know, my opinion is the Americas are just people trying to deal with or trying to anticipate and be prudent about planning around these trade uncertainties. And in the absence of more clarity there, they're just being prudent. So there is a slowdown, but I wouldn't put it on the same order of magnitude as what we've seen in EMEA or Asia Pacific.

Okay, great. Thank you.

This concludes the question and answer session, and I'll turn it back to you, Chris Rossi, for closing remarks.

Thank you. And thanks, everyone, for joining us on the call today. We certainly appreciate your interest and support of Kenna Metal. Please reach out to Kelly if you have any follow-up questions. Thank you.

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