Kennametal Inc.

Good morning. I would like to welcome everyone to Kenna Meadows third 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 the star and then the number one on your telephone keypad. If you would like to withdraw your question, please press star then the number two. Please note that 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 CannaMittal's third 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 June the 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 Brose, President, Vidya Business Segment. Franklin Cardenas, President, Infrastructure Business Segment. Pete Dragich, President, Industrial Business Segment, and Ron Port, Vice President and Chief Commercial Officer. 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 Ken Amedo's SEC filing. In addition, we will be discussing non-GAAP financial measures on the call today, reconciliations to GAAP financial measures that we believe are most directly comparable, can be found at the back of the slide deck and on our form 8K on our website. And with that, I'll now turn the call over to Chris.

Thank you, Kelly, and good morning, everyone, and thank you for joining the call today. To start off the call this morning, let me make some general comments on the quarter and how we are approaching the current environment. Despite the many headwinds we faced this quarter, we posted solid results. As you recall, even before COVID-19, we were experiencing industrial, downturn across all our end markets and had taken cost control actions accordingly. Well, with the onset of COVID-19, we quickly instituted additional cost control actions during the quarter, being careful to maintain operational capability and execute our strategic initiatives such as simplification, modernization that are fundamental to driving long-term shareholder value. Slide two details our approach during this period of uncertainty created by the COVID-19 pandemic. As you heard me say before, it is important to stay focused on the things we can control, and that is particularly important in a crisis environment. First and foremost, our approach has been to protect the health and safety of our employees while continuing to serve customers as an essential business. Early in the crisis, we instituted protocols at our facilities to ensure the safety of our workforce, including social distancing, increase cleaning protocols, self-quarantine, and other preventative measures, such as work from home, where possible. We also established a global task force to react quickly to the evolving challenges and share best practices and solutions in real time. And as a result, we were able to continue to operate with minimal disruption. The only exceptions have been when there was a government mandated lockdown in a region where we have a customer serving facility such as in China and India. As with many other manufacturers, our China operations were disrupted in the early part of Q3, but were operational before the end of the quarter. And our Bangalore, India plant, which was closed on March 26, is reopening this week. Continuing to operate during the crisis well positions us for the eventual recovery. We've already learned how to operate safely in a world with COVID-19. Our production and distribution employees are acclimated to the new protocols, and ramping up production of operational plants when the markets recover will be much easier than restarting plants that have been shut down. In addition, we've supported our customers so they can continue to operate, and that includes some customers that are on the front line of the COVID-19 battle. In fact, we are assisting with products and solutions for some customers that are converting their manufacturing lines to critical need products like ventilator components made from high strength aluminum. And of course, we continue to support other medical applications for customers within general engineering. Now, given the lack of visibility into the length and depth of the COVID-19 challenge, maintaining our strong liquidity position is, of course, a key focus. This quarter, we decreased our operating expenses by 18% year-over-year in dollar terms, maintaining our operating expense at target of 20% despite substantially reduced sales. This was achieved by early and aggressive cost control actions such as furloughs in the U.S. and similar actions around the world, reduced discretionary spending, and extensive travel restrictions. These actions, along with production furloughs aligned with volume decreases and reduced variable compensation, supported our margins, and helped maintain our strong liquidity position at quarter end. This not only allows us to continue to manage through these uncertain times, but also to continue with our simplification modernization program. Furthermore, these types of cost control actions allow us to manage our costs while minimizing the effect on our ability to react quickly once markets recover. Using furloughs and similar actions globally allow us to keep employees in place as much as possible. Looking ahead, it's our expectation that Q4 will be even more challenging than Q3. With that in mind, these kind of cost control actions will continue and may potentially need to increase depending on how long the economic environment and end markets remain depressed. Also, in keeping with our cautious approach in this environment, we preemptively drew on our revolver after quarter end and now have those funds available in cash. We took this precautionary measure to mitigate the potential increased uncertainty in capital markets due to COVID-19, consistent with our conservative philosophy to maintain our strong liquidity position. Together, these actions help enable us to continue our simplification modernization program, which I will talk in more detail about later. Now I'll move on to slide three to review our quarterly results. Organic sales declined by 17% in the quarter versus 3% growth in the third quarter last year. This is the third consecutive quarter of double-digit organic declines, which speaks to the severity of the downturn we are experiencing and weakened state of our end markets. The energy end market continued to be challenged, with a year-over-year percentage decline in the mid-20s again this quarter. Our expectation is that it will be tested further in Q4, given the recent extreme drop in oil price and the related effect on rig counts and the sector in general. Transportation weakened sequentially in Q3 from Q2 and posted a percentage decline year-over-year in the high teens, with several auto plant closures across the globe. General Engineering and Aerospace also saw year-over-year percentage declines in the high teens this quarter as well. and sequential declines from Q2, with the 737 MAX production challenges continuing and lower demand expectations worldwide due to COVID-19. Finally, Earthworks was negative year-over-year this quarter, but mixed, reflecting slight improvement in seasonal U.S. construction activity and pockets of growth in mining. By region, all posted double-digit declines this quarter and higher year-over-year declines compared to Q2. Although Asia Pacific experienced the smallest year-over-year decline, reflecting easier comps, it was the most affected, mainly in China, by COVID-19 in the quarter. By quarter end, we were seeing some signs of stabilization in China at low levels. EMEA and the Americas were less affected by COVID-19 this quarter, but our expectation is the effect will be amplified in Q4. Adjusted EBITDA margin decreased 80 basis points year-over-year to 18.6% on revenues that were down almost 20%. And sequentially, the margin improved by 720 basis points on lower sales. The year-over-year decline in margin was primarily driven by lower volume and associated under absorption. This was partially offset by positive raw materials, which contributed 280 basis points year-over-year, as well as increased simplification modernization benefits, lower variable compensation, and the previously discussed cost control actions. Adjusted EPS decreased year-over-year to 46 cents versus 77 cents in the prior year quarter, but increased sequentially by 31 cents. Before I turn the call over to Damon, I want to provide an update on the current environment and key focus areas going forward. Please turn to slide four. Given the uncertainty created by COVID-19, we are withdrawing our annual outlook. We do understand, however, the need for transparency and therefore want to provide some color around our expectations for Q4. Preliminary April sales were down approximately 35% year-over-year, which speaks to the severity of the market headwinds. Now, to put April in perspective within the corridor, it's important to consider that this is essentially the first month we are seeing the significant effects of COVID-19 outside of China. Therefore, April may not reflect the full effect that we can expect to see on sales in Q4. Considering these trends, our strong cost control actions will continue. Additionally, we expect the effect of raw materials to remain positive in Q4, but lower than the Q3 benefit. and be roughly neutral for the full year. To help you gauge profitability, assuming the April sales decline turns out to be indicative of the full quarter, we would expect to deliver a modest adjusted operating profit despite the significant decline in sales and would expect free cash flow to improve sequentially from Q3. This would be driven by continued strong cost control actions as well as simplification modernization benefits and implies decremental margins within our expected range. However, as we discussed, the biggest source of uncertainty is the effect of COVID-19 on volume, which of course remains to be seen. That being said, I am confident in the actions we are taking to manage the company through this period of uncertainty and in our ability to position the company for growth when markets recover. As I mentioned, using production furloughs and similar actions to adjust operational capacity enables us to keep employees connected so we can quickly ramp up when markets recover. Furthermore, we were able to continue with our strategic initiatives, such as launching new products like the Harvey 1 TE end mill. This is a new product for metal milling components for aircraft, automobiles, and other applications in general engineering. It sets a new performance standard by enabling machinists to use a single tool to mill many types of metals faster and more efficiently than the previous standard, which required multiple tools. And we were honored that the product was recognized recently as a gold medal winner by the prestigious Edison Awards. Even in the current market conditions, our sales for this product have exceeded expectations, which shows the power of innovation and the importance of continuing to focus on our strategic initiatives. So, let me take a minute to update you on our Strategic Simplification Modernization Program. Overall, we are pleased, having achieved an incremental $34 million savings fiscal year to date, and we still expect full-year savings this fiscal year to be modestly higher than the $40 million achieved last year, despite lower volumes. On our last earnings call, we indicated that our expectation was that approximately 90% of the incremental capital spent associated with simplification and modernization will be complete by this fiscal year end. And the remaining 10%, as we previously discussed, will be reserved for future volume needs. So really, not much change in our schedule, and we remain confident in delivering our adjusted EBITDA targets once markets recover such that we can achieve sales in the range of $2.5 to $2.6 billion. I'll now turn the call over to Damon, and then come back to provide some closing remarks.

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 adjusted basis. As Chris mentioned, demand trends remained soft in Q3 and deteriorated significantly at the end of March, driven by the effects of COVID-19. Sales declined 19% year over year, or negative 17% on an organic basis, to $483 million. Foreign currency had a negative effect of 1%, and iDivestiture contributed another negative 1%. Adjusted gross profit margin of 33.3% was down 170 basis points year-over-year, though up sequentially from 26.8% in the second quarter. The year-over-year performance was largely the result of the effect of lower volumes partially offset by the positive effect of raw materials in the amount of approximately 280 basis points and increasing benefits from simplification modernization. It should be noted that we still expect the effects of raw materials to be neutral for the full year. As Chris mentioned, adjusted operating expenses of $99 million were down 18% year-over-year and increased only 30 basis points to 20.4% on significantly lower sales. Although much of this decrease is temporary, it is reflective of our aggressive approach to managing costs as our markets have been weakening prior to the global onset of COVID-19. Taken together, adjusted operating margin of 12.2% was down 210 basis points year over year, though improved 740 basis points sequentially. Reported earnings per share was 3 cents versus 82 cents in the prior period. On an adjusted basis, EPS was 46 cents per share versus 77 cents per share in the previous year. The main drivers of our adjusted EPS performance are highlighted on the bridge on slide 6. The effect of operations this quarter amounted to negative 39 cents. This compares to negative 2 cents in the prior year period and negative 62 cents in the second quarter. The largest factors contributing to the $0.39 was the effect of significantly lower volumes and associated underabsorption. This was partially offset by positive raw materials of $0.16 and lower variable compensation. Simplification modernization contributed $0.15 in the quarter on top of the $0.11 in the prior year quarter and up from the $0.10 last quarter. This brings our year-to-date simplification modernization savings to $0.32. As Chris mentioned, our expectation for this fiscal year is that these simplification modernization benefits will be modestly higher than the 40 cents we achieved last year. The savings from our FY20 restructuring actions are now expected to deliver 30 to 35 million in run rate annualized savings by the end of FY20. The slight decrease of 5 million is due to the significantly lower volume assumption in the fourth quarter. We remain on track with our FY21 restructuring actions that are expected to contribute an additional 25 to 30 million of annualized run rate savings by the end of FY21. Slides seven through nine detail the performance of our segments this quarter. Industrial sales in Q3 declined 17% organically compared to 1% growth in the prior year. All regions posted year-over-year sales decreases with the largest decline in EMEA at negative 19%, followed by the Americas at 16% and Asia Pacific at 12%. The decline in Asia Pacific was partially affected by the lower demand associated with the early onset of COVID-19 in China and continued lower end market demand in India. From an end market perspective, the weakness in demand remains broad-based. with the biggest declines in transportation and general engineering down 17 and 18% respectively. This was primarily driven by continued decelerating global manufacturing and auto production activity, as well as the early effect of COVID-19 outside of China. Sales in aerospace experienced a significant decline both year-over-year and sequentially, driven by the 737 MAX production halt and corresponding effect on the supply chain, as well as demand declines associated with COVID-19. Adjusted operating margin came in at 13.1% compared to 18.3% in the prior year. This decrease was primarily driven by the decline in volume, partially offset by increased simplification modernization benefits and a 90 basis point benefit from raw materials. On a sequential basis, the adjusted operating margin increased approximately 240 basis points despite lower sales. The improvement was primarily driven by incremental simplification modernization benefits, lower raw materials, lower variable compensation, and aggressive cost control actions. Turning to slide eight for VIDIA. Sales declined 16% organically against positive 3% in the prior year period. Vidya faced similar macro challenges as the industrial segment during the quarter. Regionally, the largest decline this quarter was in Asia-Pacific, down 25%, EMEA down 14%, and the Americas down 10%. The decline in Asia-Pacific was primarily due to the continued transportation downturn in India, which is also affecting the general engineering market. This decline was further amplified in March when India initiated its countrywide COVID-19 shutdown. Adjusted operating margin for the quarter was 4.9%, an increase year over year due to increased simplification modernization benefits, a raw material benefit of 240 basis points, and lower variable compensation partially offset by volume declines. Turning to infrastructure on slide 9. Organic sales declined 17% versus positive 6% in the prior year period. Regionally, the largest decline was in the Americas at 21%, the Asian Pacific at 16%, and EMEA at 6%. By end market, these results were primarily driven by energy, which was down 29% year over year given the extreme drop in oil prices and the corresponding significant decline in the U.S. land-only rig count. General engineering and earthworks were down 17% and 6% respectively. These end markets reflected the general economic downturn. However, there were some bright spots, such as seasonal U.S. construction and earthworks, which was up year over year and which has continued into early Q4. Adjusted operating margin of 13% improved 130 basis points from the prior year margin of 11.7%. This improvement was mainly driven by favorable raw materials that contribute 550 basis points coupled with simplification and modernization benefits and aggressive cost actions partially offset by significantly lower volumes. Now turning to slide 10 to review our balance sheet and free operating cash flow. Before I review the numbers, I would like to emphasize that we view liquidity as extremely important, particularly in such uncertain times. Even in a normal macro environment, we operate in highly cyclical end markets and therefore know that a strong focus on cash flows, scenario analysis, and contingency planning are all part of the required skill set to navigate the uncertainty we deal with. This has become even more important now. Our current debt maturity profile is made up of two $300 million notes maturing in February 2022 and June 2028. as well as a U.S. $700 million revolver that matures in June of 2023. As of March 31st, we had combined cash and revolver availability of approximately $750 million. As Chris mentioned, in April, in an abundance of caution, we preemptively drew $500 million on a revolver. This action was taken due to our conservative approach to liquidity, coupled with the unprecedented environment we are dealing with as well as an uncertainty that COVID-19 could potentially bring in the capital markets. At quarter end, we were well within our covenants. We have two financial covenants in our revolver, which are net debt to EBITDA ratio of 3.5 times and an EBITDA to interest ratio of 3.5 times. Primary working capital decreased both sequentially and year over year to $656 million. On a percentage of sales basis, it increased to 33.4%, a reflection of the decline in sales in the quarter. Net capital expenditures were $57 million, the same level as the prior year. As Chris mentioned, we are pleased with the progress we have made in simplification and modernization. Under the current demand environment, we are taking a cautious stance towards capital expenditures in the short term while continuing to advance our simplification and modernization strategies. We now expect capital expenditures for the fiscal year to be approximately $240 million, which is at the low end of our original outlook. Our third quarter free operating cash flow was $2 million and represents a year-over-year decline of $37 million, reflecting lower income due to volume and increased cash restructuring costs. We expect to deliver increased free operating cash flow in the fourth quarter compared to the third quarter but given the current market environment, we expect free operating cash flow for the full year to be slightly negative given the $240 million of capital expenditures and cash restructuring charges. Overall, I remain confident in the strength of our balance sheet, even in the face of the current macro uncertainty. Our strong liquidity position coupled with our debt maturity profile and overfunded U.S. pension plan limit the significant near-term cash obligations, and allow us to stay committed to our simplification modernization initiatives. And as Chris said, we are nearing the end of the capital investment required for this program, which will significantly lower the capital spend in FY21. We will remain conservative to ensure the company has ample liquidity to weather the current environment, as well as continue to execute our strategy. Dividends were approximately flat year over year at 17 million. In this time of uncertainty, we reviewed our dividend program and believe that the current level is still appropriate given our strong liquidity position. Should demand trends deteriorate more significantly than we currently anticipate, we know our dividend program, like other cash flow and cost control actions, is a lever that could be used to preserve cash and liquidity. The full balance sheet can be found on slide 14 in the appendix. And with that, I'll turn the call back over to Chris.

Thanks, Damon. Please turn to slide 11. As discussed, we are focused on managing through this crisis with an eye to strengthening the company and being prepared for the recovery. We have a solid plan to navigate through these challenging times by aligning costs with volumes through aggressive but measured cost control actions to position us for when markets recover. We feel good about our liquidity position. and have the wherewithal to continue with our strategic initiatives like simplification, modernization, to drive improved customer service and profitability with more than half of the benefits yet to be realized. Furthermore, we are approaching the end of the incremental capex for the program, significantly lowering the overall capital spend in FY21. I have confidence that we will not only navigate through this environment successfully, we will also be in a better position for improved profitability coming out of it. And with that, operator, let's open the line for questions.

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 two. The first question today comes from Stephen Volkman of Jefferies. Please go ahead.

Excuse me. Hi. Good morning, guys.

Good morning, Steve.

So maybe I'll just kick it off. I appreciate the color on April, but I guess I'll see if I can push a little bit harder. Any sort of different trends that you might want to call out relative to kind of end markets or geographies? I'm trying to get a sense of kind of product mix. And then I'm curious how things sort of progress through the quarter. It sounds like you're not convinced that April's the low point, but I'm curious just kind of what you're seeing sequentially that might sort of support or cause issues there. Thank you.

Okay, thanks, Steve. Let me try to use the April sales to give you a flavor for what's going to happen on a regional basis in the end markets. So if I sort of say that the benchmark is this 35% year-over-year like we saw in April, I think from a regional perspective, we would expect the Americas to be down more than that, Steve. Last year, they had not yet seen the full effect of the industrial downturn, which started earlier in other regions, as you know, coupled with now the onset of COVID-19 this year. In the mean Asian Pacific, we think it'll probably be slightly better than that 35% down. And I think it's partially driven by easier year-over-year comps. And also remember, China was the first to experience COVID-19 last and was stabilizing at the quarter end on sort of these lower levels. And, in fact, our industrial segment actually saw growth in April on China. I think from an end market perspective, transportation we believe will be down more than the 35%. Simply put, the automakers are oiling production and running at low rates. I know they've recently announced that they're starting back up, but we think that it could be easily below that 35%. Aerospace and general engineering and energy, we think, will be around that sort of 35%. You know, energy is reflecting declines in the U.S. rig count, which, as you know, are down 40% year over year in April. So that would be kind of my color around using April as a directional indicator for the regions and the end market. And, you know, frankly, your comment about how we see this thing proceeding sequentially, therein lies the uncertainty. So we just don't really know, Steve, but I try to give you a little color in terms of the regions and the end markets based on the April sales anyway.

Okay. Are you willing to say whether the last week or two have sort of seen sequential declines as you've gone through the month, or is there some kind of more stabilization out there?

I mean, I think April was... was largely stable. It wasn't like it started off strong and then had a huge drop off at the end.

Great. I appreciate the color. Thanks.

The next question comes from Julian Mitchell of Barclays. Please go ahead.

Hi. Good morning. Just a first question on the profitability comments rather than the top line. So I think based on what you said about the June quarter, is it fair to assume a sort of low mid-30s decremental margin year on year, so similar to your gross margin? And that implies a sort of mid-single digit adjusted operating profit margin for the June quarter. Just wanted to check those rough assumptions were were not ridiculous. And also, it sounded like your fixed cost actions aren't really changing despite COVID, but you are doing a lot of temporary cost actions. Maybe help us understand why you're not stepping up the fixed cost extraction measures.

Let me start with the cost actions, and I'll let Damon comment on the decremental margins. So Julian, as you know, We were anticipating the effects of coven 19 we didn't really actually see much happen until really the kind of last week in March, but we were sort of ready for the worst worst case scenario, so we are using. You know furloughs and we're aggressively making sure that we're using those same actions to try to adjust product production levels in the plants. Now, we also understand that since we don't know the shape of the recovery and how long it will take, it could be a protracted period of time, we're also in parallel looking at structural cost changes, too. So what you've seen and what we've teed up for the fourth quarter are kind of the things that we can affect the change in right now. We need to adjust because the volumes have come off so quickly. But we also are planning for structural changes, some of which we had already been doing anyway. If you remember, we still had more – footprint rationalization is part of simplification and modernization. So some of that will naturally help us anyway in the lower volumes. But when you look at the shape of the recovery and the uncertainty, we also want to be responsible and look for other structural changes. So you'll have to stay tuned for what that will look like. Maybe we can give you some more color on that when we talk next quarter.

I think, Julian, in regard to your question on Q4 on the On the decrementals, I think as Chris alluded to on his comments related to April and looking forward, I think with revenues coming down, at least for us, as we look at some of the quarterly issues there, I would tell you the decrementals will likely be around our historical averages. We don't see, again, it's obviously going to be very subject to the volume in the quarter, but at least based on Chris's views for April, we'd be right in that sort of historical range.

Okay, thanks. Then maybe following up, Damon, perhaps this one for you, around the free cash flow outlook. So you talked about significant drop in capital spending in the next fiscal year. Maybe help us understand from this point, not for the June quarter so much, but looking further out, what's happening with restructuring charges as you sit here today and and then also the potential for freeing up more cash from working capital liquidation.

Yeah, I think, Julian, obviously we've given you some of our views on reduced capital. I think restructuring with what we've announced for the FY20, the FY21 restructuring actions, the cash outlays for those plans or for the FY21 restructuring plan next year will be lower cash than what we're going to experience this year. Working capital, Julian, it's a tougher question for me to answer personally only because I think it depends on the shape of the recovery. Obviously, we're going to experience some positive working capital here in the fourth quarter, given the receivables contraction. What I would tell you is if we see the recovery in the back half of next year, that's going to be a use of cash for the course of the year. But I don't see, you know, we'll continue to try to get our numbers closer to that 30%. We're trending a little bit north of that here in the third quarter, but we're continuing to try to adjust our inventory levels to bring that down. But, again, that overall working capital for 2021 is really going to be more influenced by the recovery.

Great. Thank you.

The next question comes from Ann Duden of J.P. Morgan. Please go ahead.

Hi, thanks. This is Sean McMullen on for Ann. Our question is, you're expecting a raw material tailwind for FQ4, as you stated in your presentation. Could you provide a little bit of color on your confidence in that impact? And do you see any notable raw material impact in FY21 at this point?

Yeah, in terms of the Q4 headwind, that's basically a fairly straightforward calculation. We have the We have the higher cost inventory actually running through our P&L, so we have a high degree of confidence in terms of what that number is. And it's going to be slightly less. That's why we're confident it's going to be slightly less than Q3. And just to give you some color around that, the Q3 expectation that we had for that calculation was very close. So high degree of confidence in the Q4 savings associated raw material. And at this point, we looked at tungsten carbide, which is our largest material input. And tungsten is kind of stabilized around the sort of 230 level. And I suppose if things get worse, it could drop off. So I guess it really depends on what we think happens to the overall business, which, as we've talked about, we have a lot of uncertainty around. But right now, it's been stable for some time at that sort of 230 level.

So, Sean, just for your math, we reported 16 cents of a tailwind in Q3. And when you look and we said basically net neutral for the full year, that puts about a 10-cent tailwind in Q4.

Great. Thanks. That's all I have. I'll pass it on.

Sean? The next question is from Joe Ritchie of Goldman Sachs. Please go ahead.

Thanks. Good morning, everyone.

Good morning, Joe.

Can you guys maybe quantify, like you just did with the raw mat tailwind, how much of an impact did variable comp have on your fiscal third quarter and what's embedded into the fiscal fourth quarter as well in that framework of profitability being up slightly year over year? Sure.

Joe, we didn't give out the specifics. I would tell you that it's less than the number we report for simplification and modernization, which we've said was $0.15 in the quarter, but it was a meaningful enough number that we felt it was appropriate to acknowledge it as part of the year-over-year change. It's not de minimis, but it's less than $0.15. I guess we'll sort of leave it in that range. Okay. Given that we're looking at The point is in Q4 we're only dealing with one quarter of change versus in this quarter we were sort of looking at all three quarters sort of accumulating together. So it'll be less of an impact, assuming things stay static here to our forecast in the fourth quarter.

Okay. Okay, great. And then assuming we're, call it April, May is the bottom from a growth perspective, How do you think that that's going to start to change over the next several quarters? Is it something that starts to reverse itself in fiscal 21? I'm just trying to get an understanding of how much of that portion is maybe more structural versus temporary in nature.

I'm trying to think about the same thing, Joel. You know, in a normal manufacturing sort of downturn that we've seen, and we were actually experiencing that before COVID-19, we have been down for several quarters, and you would think that certainly in FY21, we were going to start to come out of that scenario if you just look at sort of the historical cycles. But now we've got this thing called COVID-19 that's layered on top, and that That I think everyone believes that that will probably make it a more protracted period of time. But that's the real piece of uncertainty is just how much that's going to put a damper on demand across the globe. The other thing I think it's important to realize is that oftentimes when the recovery does happen, it usually snaps back quite quickly. So, you know, I think the main variable here that sort of, causing me to pause and not really try to project what's going to happen for FY21 is we just don't know the effect of COVID-19 and how long that's going to depress demand on a global basis. Otherwise, we would be, you know, the normal business had been down for several quarters, and we would be expecting that certainly sometime in the first half we would have expected some type of recovery.

Okay. That's very helpful. Thank you all.

The next question comes from Stephen Fisher of UBS. Please go ahead.

Thanks. Good morning. Just wanted to follow up on the cost reduction question. What are you looking for to pull back on some of these cost reductions that are maybe more temporary and variable in nature? How much of that is just tied to a certain level of year-over-year demand versus any of the regulations versus travel restrictions, things like that?

Yeah, the cost control actions, we largely are using furloughs and similar mechanisms to adjust the workforce, especially as it relates in the factories to the lower production volumes. It's a good way to keep people, keep employees connected because we do expect that at some point there's going to be a recovery and we're going to need that workforce to be there. So that's why we say they're sort of temporary in action. Effectively, when people are on furlough, they're not getting paid for kind of a week at a time. And we applied this across the board. It's not just for production employees. It starts with the executives and travels down through all the salary ranks too. So In that sense, we're trying to sort of pace ourselves and take out costs while we wait for the volume to recover. And what I had said before was that at some point, if that's going to continue over a protracted period of time, we're also in parallel looking at other structural things that we can do, some of which were already in the works based on simplification and modernization and some of the footprint rationalization that we were going to continue with. And then there's some other things that... that went beyond simplification modernization that could help us remove structural costs that we're also pursuing. And in fact, in this environment may cause us to accelerate some of those things.

Got it. That's helpful. And then just curious, as you think about a little bit longer term and the impact of the virus on some of the more important businesses here, aerospace, you know, you've made some strategic expansions in there. How do you think about whether it makes sense to continue expanding there? Do you think you need to change your strategy? And then what about the oil and gas business? Any thoughts on any structural changes or strategic changes needed there?

Yeah, let me take the arrow first. I mean, there's no question that I think that that market is probably going to be depressed for a while. But keep in mind, what we had done is we shifted – engineering capability, technical resources, uh, away from transportation, largely automotive into this aerospace environment. And the one thing I've said is that, uh, that the, uh, automobile companies are very good at supply chain management. And there was a lot of that business and engineering resources we were spending on business that simply wasn't profitable. So while we've now moved to, uh, some of those resources over to focus on Arrow, that business is profitable. And while maybe the growth trajectory is not as significant, I think it's still the right thing to do in terms of profitable growth for the company. The other thing is that the company hadn't really focused in that area. So we have a very, very great brand recognition, both Ken and Metal and Vidia brands, but we've never really focused on it. So we actually continue to add Aero customers even in this depressed environment. and feel like we're actually picking up share in that area. So I think that was a very good move, and we're going to stick with it. In terms of oil and gas, you know, the infrastructure business is no stranger to oil and gas. These cycles come and go, and we do think that there's, you know, kind of a reset going on in oil and gas for sure, and that maybe grid counts will be depressed for some period of time. But, you know, part of our simplification and modernization program was to prepare the company for those type of scenarios where there is depressed markets, lower the break-even point of the business, and still be able to have a profitable business and generating good cash flow even in that environment. So we don't see any major shift here in terms of what we're focused on. The product is still needed. We've got some investments going on in additive manufacturing, which has got a lot of companies excited in that space. And also keep in mind, our business, our big customers are the Schlumbergers, Baker Hughes's and, and Halliburton's. And those companies, even, even in a depressed market are going to be around for a while and they still need innovative suppliers. So, you know, we don't see a need to make a strategic change.

Okay. Thanks very much.

The next question comes from Kristen Curtis Longbow. Please go ahead.

Hey, morning guys. I guess kind of pulling the thread a little bit further on cost, I appreciate evaluating the fixed cost as kind of a constant journey here, but can you maybe give us a percentage or a rough size of the footprint that's been optimized globally? And when I say optimized, I mean like what feels like Rogers today?

Yeah, and part of the initial investment thesis for the simplification modernization was we said we would remove about 5% to 7%. uh, plants, we've already, um, achieved five plants. And in fact, one of the plants was, uh, on the, on the docket was Essin, but we, uh, because the workers council made an excellent proposal to, to basically just simply downsize that plan, not completely close it. We still achieved very good savings and improved our competitive position. So, um, so, you know, that, that was the initial, uh, that was the initial perspective on, on, on the footprint. But there's also more structural costs and footprint rationalization that can be done even beyond that, and we're focused on that. Do you want to add anything to that, Damon?

Well, I think, Chris, to your question on what looks like Rogers, again, I think, as you know, we're not modernizing every factory in the scope of what we did with Rogers. That was a very large one, and there are other factories that are maybe – Similar to that, but it's going to be a handful of those factories. But most of the remaining 40 factories are getting some form of modernization in pockets or cells or parts of the factory where we've identified significant opportunities to improve productivity, improve quality. improve reliability and at the same time take cost out of the system. But again, if you look at some of those factories, it may only be a small percentage because we weren't able to create investment that would drive the right level of return or reduce the break-even point enough. And so, you know, again, it's hard to give you a rule of thumb that X number of factories look like Rogers, but I would tell you of the remaining 40, the vast majority have had some sort of modernization that have gone on or will go on over the next year.

The other thing I would think of is that while we've spent or will spend by the end of the fiscal year sort of 90% of the capex associated with modernization, a lot of that modernized equipment is just going to be coming online through FY21. So we've said before that we've got more than half the benefits still ahead of us, and so that's another way to think of it. There may be a couple more Rogers type of things out there, but there's also just modernization across the whole footprint, which is going to drive a large benefit that's still yet to come.

Got it. Thanks so much for the color there, guys. And then, Chris, the footprint gets a lot of attention, rightly or wrongly. but it sounded like there were some other initiatives that you were looking at. We've done some skew rationalization. There's a lot of sourcing benefits. I guess, what else is kind of being worked on on that structural side, or is it kind of, should we stay tuned there?

Yeah, I mean, I think there's some more footprint rationalization to go. You know, even though we sort of, we kind of hit what we said went from the original investor day, there's still some more opportunity to rationalize that footprint. And I don't want to give too much color around that for obvious reasons at this point. But then we also, you know, there's also, we're also focused on commercial excellence. We've made the investment as a company in modernization, but we're also investing in commercial excellence, and it's one of the reasons why we appointed Ron Port as our chief commercial officer. I've said to you guys before, I look at the investment perspective the payroll that we spend each year on sales as an investment, just like capital. And are we challenging ourselves to get more productivity from that same investment and making sure that we're getting the proper returns? And I can tell you that we believe there's opportunity to bring productivity to that significant expense. And so we're also focused on that. So there are you know, there are sort of structural costs that can come out that don't necessarily tie to specifically to manufacturing.

Got it. Got it. That's helpful. Thank you, guys.

The next question comes from Walter Luteco, Seaport. Please go ahead.

Thanks. Good morning, guys. Good morning, Walt. I wanted to ask a little bit about April again to go back to that one. And You know, the down 35 in April, was that drop, do you think, related to, you know, your customers having to cut their production? Or do you think there was still inventory that was coming out of the channel?

Yeah, you know, if we looked at this, the normal market cycle pre-COVID-19, there was no question there was destocking already happening. But frankly... Well, I would have thought it would have kind of leveled off in Q3. That's where we were kind of thinking that would be kind of the end of destocking. So, you know, what we saw in April, I think, is there could be, you know, we've had some customers that have been shut down, but I think the majority of them have actually been continuing to operate, just maybe at reduced levels. What I think is that since they don't really know what's going to happen, they just stopped ordering things, and so they're there was even more destocking going on because they just needed to preserve cash and make sure that they were managing through this uncertain time. It may have been an overreaction, if you will. I don't know. That's part of the uncertainty. But certainly in just a normal manufacturing down cycle, industrial down cycle, we would have thought Q3 would have been kind of the bottom of the normal destocking, if you will. And in fact, China, as we said earlier, That really is sort of stabilizing low levels and looks like it's coming back.

Okay, yeah, and that was the next one I wanted to ask about China. When you say it's coming back, is China getting a V or is China getting an L? What kind of recovery is it?

I think China, when we said it's coming back, it's kind of leveled off at the lower levels. And then we just saw in April, we started to see some inkling that it's starting to tick back up now, whether that's because of a sort of pent up demand as they are rebounding from COVID-19 or not. It's, I think it's too early to tell. Um, but I wouldn't describe it as a step change in April or anything. I think it's ticking back up is the way I would look at it.

Okay. And then the last one for me related to China, uh, do you have supply chain coming out of China? And then kind of along those lines, are you hearing of any shortening of supply chain because the trade war is starting to heat up again? Maybe manufacturers looking for more local supply?

Yeah, in general, we have a, you know, in terms of our raw material, the tungsten carbide, obviously China has a lot of tungsten carbide ore, but we're not actually dependent on that ore at all for our production. So We're not really constrained by China in that regard. In terms of our product that we make shipping to customers, we have a model that's sort of made in region for region. And it's not a perfect model, but largely what's produced in China is sold in China. There is some export that happens. But if you keep in mind, we already went through the China trade war and had time to kind of rebalance our internal supply. So while it's not perfect, I don't see a lot more risk associated with that. I think what's more fundamental about China is obviously as the China economy goes, so goes the global economy, and it's more of that kind of risk as to what the uncertainty means to kind of the global recovery, if you will.

Okay, great. Thank you.

The next question comes from Jewel Tiss of BMO Capital Markets. Please go ahead.

Hi, guys. How's it going? Morning, Joel. So lots of questions on the cost side. How about the other side in terms of growth? Can you talk about sort of the size of the opportunity with the Harvey product line and maybe some other areas that you'd like to highlight?

Sure. You know, we had a question earlier about aerospace, and I mentioned that strategically we still think that was a good move. Because, again, our share was low, and we're actually growing quite aggressively in that space. You know, we had launched a program that we – actually in our video business segment, and we've used that program now, expanded it through industrial. But we've gotten really good traction. We're keeping track of the number of customers that we're actually adding, and these are customers that we never served before. That's going quite well. Now, the Harvey end mill is a product that can help you in that space because obviously there's a lot of aluminum being machined there, but it's also applicable to the general engineering space, and that's another area that we're focusing on. Again, we had taken a lot of resources that were focused on automotive where there was, I think, limited opportunity to grow and limited profitability and moved it into these general engineering aerospace locations, and That program is going pretty well. Now, I actually think that in this kind of environment, it's actually easier to tell the efficacy of your growth initiatives because if you actually are adding new customers in this kind of environment, it's easy to see because sometimes, Joel, what you see is that you're getting growth, but the market is dominating the growth, so it's kind of hard to separate the two. In this kind of environment, we're even more focused on adding new customers and understanding what's happening to us. Technology is certainly a big part of it in terms of driving productivity for customers. And frankly, it's been technology that we've applied to automotive and never really brought it into this general engineering aerospace. So it's not even stuff that we newly developed. It's stuff that we've always had. We just never brought it to that space. So we feel pretty good about those growth initiatives. Also, I mentioned additive manufacturing on the infrastructure side. You know, in oil and gas, there's a lot of focus on reducing weight and also, frankly, reducing costs for those services company. And additive manufacture is an opportunity to do that. And their customers are actually quite excited about our ability to apply that technology to tungsten carbide-based materials.

Okay. Okay. And, and, and the, the strategic focus more, it's more on, um, like, I guess for now you've got to start somewhere. It's more on changing the mix and improving the profitability of the company. Or are there any sort of, um, initiatives or, or plans to really try to change the game and, and really step up the, uh, like, like to get Kenna metal to be, you know, a much larger market share, you know, five, 10 years down the road.

Yeah. I think the, um, We'll continue with the investment in technology, but I don't think that that wasn't really Kenna Metal's problem. They always had good technology. But this investment goal in commercial excellence, I think, is key. You know, if you just think about what I said, it shouldn't have taken me to come into the company and know that it didn't take very long to figure out that playing in the transportation area was not going to be where you wanted to be long term. There's limited growth opportunities. Shifting to aero and general engineering, That should have already been happening as a company, and I think it's because fundamentally there hasn't been a focus on commercial excellence. And so commercial excellence is going to be the key to penetrating those markets. We have the product. We just don't necessarily have the right channel strategy. And in some cases, I think our brand positioning can be improved. So I really look at this commercial excellence as the thing that's going to – the next big thing that's going to help us pick up share – And keep in mind, it's coming at the right time because we're finishing up our modernization efforts, so we now have factories that have, you know, better cost position, but more importantly, factories that can deliver consistent quality. That's been part of the problem, too, is making these products on antiquated manufacturing equipment, you know, causes our quality to be, I guess, have too much variability in it, if you will. And now with the modernized processes, we... We're able to sort of guarantee that repeatability and that consistency, and we're improving the channels to market. So I see that combination as being powerful and to reverse the trend that kind of metal had seen where others were taking share of metal cutting. I see that that's our opportunity, and I'm confident that that's exactly what we're going to do.

That's great. Thank you so much.

The next question comes from Steve Barger of KeyBank Capital Markets. Please go ahead.

Yeah, good morning, guys. I think you just addressed this, Chris, but thinking about your comment that there's a lot of modernization benefit yet to come, when growth returns, you do expect a smoother ramp than you've seen in the past, or what does the ramp back to incremental margin look like from an efficiency standpoint?

Yeah, I mean, it We're continuing with the modernization. One of the things that was a challenge for us was we talked about the manufacturing inefficiencies that happen while you're closing down plants, while you've got high volume, you've got duplicate resources in the receiving location and the sending location. To the extent that we're taking advantage of this lower period of time and we clean that up, it should be easier for us when volume comes back to to have a cleaner ramp up, if you will. It's another reason why we are trying to use this furlough mechanism as opposed to layoffs. We want to keep the people connected. Because although we are less dependent on labor than we were in the past, now that we've modernized, you still need some people to run the machines. So we're trying to take a measured approach going through this downturn so that we can position ourselves to be to be ready for the upturn. And I really feel that, you know, with the modernization that we've done and the stuff that's already been completed, when we see the upturn here, the company's going to have better profitability than it's ever seen before in an upturn.

Yeah. And as you talk to customers where you sell direct that have either slowed or stopped production, can you describe how the conversation's gone in terms of what the restart looks like or what they expect from you? Or has that started yet?

Yeah, it's interesting. The automotive customers are just now, and you guys have probably read the same thing we have, and in some cases we've talked to the customers, of course, but they're kind of feeling their way through this thing. They You know, we brought entire plants up or never shut them down. They are in a mode now where I guess they're figuring out how to bring up maybe 10% or 15% of the time, so they're going pretty slowly. You know, we're going to be there to support them. We have made sure that, you know, we're not setting the high-moving inventory levels that require – You know, that basically that when the customer comes to buy it, if it's not on the shelf, they're going to go somewhere else. That's the high mover stuff, high profitability stuff. We've set those inventory levels and our service levels at a higher demand point. We're not adjusting those down to the current demand because the current demand, I think, is caused by COVID-19. It's not a real estimate of what the demand could be, and we want to be in a position that when demand snaps back, we can be there to support the customers. They actually take a lot of comfort in that type of statement because they're not really sure how quickly it's going to ramp back, but they need us to be there for them, and that's what we're endeavoring to do.

And presumably you can kind of parlay that into some increased market share, I would guess.

Yeah, I believe so. You know, if we're there to support them and we're the ones that are ready to, when they need to start machining stuff, they're going to have to do it. And if they can't, you do it with kind of metal tools because we don't have it, or vice versa. If someone else doesn't have it, then they've got to find something. So I think it's an opportunity for us.

Thanks for the time.

This concludes our question and answer session. I would like to turn the conference back over to Chris Rossi for any closing remarks.

Thanks, operator. Thanks, everyone, for joining the call today. As you can tell, we're navigating this difficult period by staying focused on protecting our employees, while continuing to serve our customers. We're taking aggressive and, I think, appropriate cost control actions, and our liquidity position is certainly strong. And we're absolutely committed to continuing to advance our strategic initiatives, including simplification, modernization. These are the types of programs that are going to set us up for continued success in the future. So we certainly appreciate your interest and support, and please reach out to Kelly with any follow-up questions. Thank you.

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