Kennametal Inc.

Good morning. I would like to welcome everyone to Kenna Metals first quarter fiscal 2021 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 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 Kenna Meadows' first quarter fiscal 2021 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. I'm Kelly Boyer, Vice President of Investor Relations. Joining me on the call today are Chris Rossi, President and Chief Executive Officer, and Damon Audia, Vice President and Chief Financial Officer. After Chris and Damon's prepared remarks, we will open the line for questions. At this time, I would like to direct your attention to our forward-looking disclosure statement. Today's discussion contains comments that constitute forward-looking statements and, as such, involve a number of assumptions, risks, and uncertainties that could cause the company's actual results, performance, or achievements to differ materially from those expressed in or implied by such statements. These risk factors and uncertainties are detailed in Ken Amedo's SEC filings. 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, 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 us today. I'll start today's call with some general comments on the level of industrial activity we are currently seeing, then briefly review the corridor, our strategic initiatives, and expectations for Q2. Damon will then go over the quarterly financial results in more detail. Finally, I'll make some summary comments before opening the call for questions. Beginning on slide two in the presentation deck. Sales this quarter outpaced the typical 10% seasonal Q4 to Q1 decline, that increasing sequentially by 6%, of which 3% was due to FX. General engineering and transportation end markets are showing the highest levels of recovery. As a reminder, those two end markets total more than 60% of our sales. On a year-over-year basis, organic sales declined by 21%, on top of an 11% year-over-year decline in the prior year quarter. However, through disciplined execution on several fronts, we were able to effectively maintain profitability. Adjusted EBITDA margin improved by 40 basis points to 11.3% versus 10.9% in the prior year quarter. and our operating leverage was strong as well, despite continued double-digit declines in volume and associated under-absorption. Improvement in EBITDA margin was driven by lower raw material costs, increasing benefits from simplification, modernization, and effective cost control actions. Operating expense as a percentage of sales increased to 23% due to lower sales. However, in total dollar terms, decreased 18% year-over-year. our target for operating expense remains at 20%. Adjusted EPS was 3 cents compared to 17 cents in the prior year quarter, reflecting the factors I just named, as well as a higher adjusted effective tax rate. Looking ahead, of course, visibility in this environment is still limited due to COVID-19, so it remains extremely difficult to forecast how our customers, as well as our end markets, will be affected. especially with additional shutdowns being contemplated in some regions due to recent spikes in COVID-19 cases. We will not be providing a full year outlook for fiscal year 21. However, I would like to provide some color on what we might expect in the second quarter. Based on the monthly sales results in Q1, early indications from our October sales, assuming that there is no additional second wave of COVID-19 lockdowns in the quarter, We expect Q2 to see low to mid single-digit growth sequentially, which would be above our normal sequential growth pattern of 1% to 2%. While it feels like the economic recovery may be gaining momentum, as I said, it is still difficult to predict the pace and trajectory. So we continue to focus on the things we can control, such as executing our operational excellence and commercial excellence strategies to gain share and improve operating results throughout the economic cycle. On the operational excellence side, simplification modernization initiatives are on track to deliver approximately $80 million in benefits this year, an increase of 67% over last year. That will bring the total cumulative savings from inception of the program to $180 million, which is within the original target we set in December 2017, despite much lower volumes than were envisioned at that time. As a reminder, we expect to complete our original footprint rationalization activities with closure of the Johnson City, Tennessee plant and downsizing of the Essendon, Germany plant by the end of this fiscal year. Also, the capital spending associated with the simplification modernization program is substantially complete. This will result in significantly lower CapEx levels going forward, including this fiscal year, where total CapEx is expected to be reduced by approximately 50% $110 and $130 million. In addition to our focus on these transformational operational excellence initiatives, we are equally focused on driving commercial excellence. Turning to slide three. As you recall, last quarter we announced the combination of our two metal cutting business segments, enabling us to direct our commercial resources, products, and technical expertise more effectively toward capturing a larger share of wallets. In addition, we discussed our new brand strategy to reposition the video brand and portfolio to the multi-billion dollar fit for purpose application space within metal cutting, which we previously have not focused on. This strategy opens a 40% increase in serve market opportunity while offering better service and tooling options to our customers. Progress on this initiative is tracking with our expectations, and I'm pleased that we already have several wins with new customers and existing customers, including a recent win at a major machine tool builder to apply fit-for-purpose tooling as standard on new machines they sell. Also, the reaction from our channel partners has been broadly positive, especially to be able to operate in the market with clearer brand positioning. We continue to win share in the full solution application space as well, with a share gain at a major machine tool builder's manufacturing facility. And we are successfully leveraging one of our proven tooling solutions developed for a wind turbine manufacturer in China to capture share of similar projects in India. And of course, we remain committed to product innovation to better serve customers and gain share. For example, during the quarter in the full solution application space within general engineering, we introduced two best in class products. The HPX solid carbide drill, which delivers two to three times more productivity than competing products. KCFM 45 face milling cutter, which offers greater flexibility and a cost effective user friendly solution for a broad range of CNC machinists. Based on our continued ability to deliver products that are highly valued by customers and the positive reaction to our brand repositioning, we're even more confident in our ability to gain share and drive top line improvement. In addition, as you know, we are also focused on improving the bottom line. Please turn to slide four. The last time the company experienced a sales decline of this magnitude was during the Great Recession. Trailing 12-month sales is shown on the left, and corresponding adjusted operating margin is shown on the right. See the improvement in profitability compared to the earlier downturn, illustrating the benefits of simplification modernization, stronger cost control actions. And remember, the present-day numbers do not yet include the full run rate effect of the modernization activities we are currently undertaking. By executing our commercial excellence and operational excellence strategies, we are positioning the company for improved performance throughout the economic cycle. For that, I'll turn the call over to Damon, who will review the first quarter numbers in more detail.

Thank you, Chris, and good morning, everyone. We'll begin on slide five with the review of Q1 operating results, both on a reported and adjusted basis. As Chris mentioned, demand trends improved off low levels throughout the quarter and outpaced the 10% sequential seasonal decline we normally experience in Q1. For the quarter, sales declined 23% year over year. On an organic basis, sales were down 21% year over year. Foreign currency and a business divestiture each had a negative effect of 1% in the quarter. However, sales did increase 6% on a sequential basis, with approximately 3% attributed to foreign currency. Adjusted gross profit margin of 27% was down 50 basis points year-over-year. Year-over-year performance was primarily due to the effect of lower volumes and associated underabsorption, partially offset by the positive effect of raw materials, which contributed approximately 650 basis points. incremental simplification modernization benefits, and temporary cost control actions. Adjusted operating expenses of 93 million were down 21 million or 18% year over year. Adjusted EBITDA margin was 11.3% of 40 basis points from the previous year quarter. Adjusted operating margin of 2.9% was down 180 basis points year over year. Adjusted effective tax rate in the quarter of 33.4% was higher year over year due to the combined effects of geographical mix and the continued effect of GILTI on the low level of U.S. taxable income. Although we expect our adjusted effective tax rate to remain elevated in the low to mid 30% range with these lower levels of earnings, we still expect our tax rate to be in the low to mid 20% range when we return to higher levels of profitability. We reported a GAAP earnings per share loss of $0.26 versus earnings per share of $0.08 in the prior year period, reflecting the reduced volumes and higher tax rate partially offset by raw materials, simplification modernization benefits, and temporary cost control actions. On an adjusted basis, EPS was $0.03 per share versus $0.17 in the prior year. The main drivers of our adjusted EPS performance are highlighted on the bridge on slide six. The effect of operations this quarter amounted to negative 28 cents. This compares positively to both the negative 60 cents in the prior year period and the negative 68 cents in Q4 of fiscal year 2020. The largest factors contributing to the 28 cents was the effect of significantly lower volumes and associated under absorption partially offset by positive raw materials of 30 cents in strong cost control actions. Simplification modernization benefits increased again this quarter, totaling 20 cents on top of 7 cents in the prior year. This brings the total benefits since inception from simplification modernization to $123 million. As Chris mentioned, Our expectations continue to be that simplification modernization benefits will be approximately 80 cents per fiscal year 2021, driven by actions already taken or announced, and bringing the total expected cumulative savings to 180 million by the end of fiscal year 2021. Incremental savings from our restructuring actions contributed 17 million of the 22 million in simplification modernization savings this quarter. Remember, restructuring is a subset of our simplification and modernization program. Slide 7 and 8 detail the performance of our segments this quarter. Metal cutting sales in the first quarter declined 23% organically on top of an 11% decline in the prior year period. All regions posted year-over-year sales decreases the largest decline in the Americas at negative 29%, followed by EMEA at 24%. Asia Pacific posted the smallest year-over-year decline at 9%. Performance in Asia Pacific reflects more positive economic activity in the region, with approximately 10% growth in China year-over-year, partially offsetting weakness in other countries such as India. From an in-market perspective, Although improving sequentially, we still experienced year-over-year declines in transportation of 21% and general engineering of 20%. Sales in aerospace experienced more significant declines year-over-year and was also down sequentially, driven by the COVID-19 associated effects on demand and the supply chain. Relatively speaking, energy was the best performing end market in metal cutting on a year-over-year basis, with positive trends in wind and renewable energy. However, it is worth noting that the oil and gas portion of the energy end market continues to be significantly challenged. Adjusted operating margin came in at 1% compared to 7.9% in the prior year quarter. The decrease was primarily driven by decline in volume and mix, partially offset by incremental simplification modernization benefits, temporary cost control actions, and raw materials that contributed 230 basis points. Turning to slide 8 for infrastructure. Organic sales declined 18%, on top of a decline of 11% in the prior year period. Other factors affecting infrastructure total sales were divestiture of 4%, partially offset by a benefit from business days of 1%. Regionally, again, the largest decline was in the Americas at 27%, then EMEA at 9%, but this time followed by a 1% growth in Asia-Pacific. By end market, the results were primarily driven by energy, which was down 31% year-over-year, reflecting the effect of the significant decline in the U.S. land-only rig count. General engineering was down 14%. Berthorx was down 11%, reflecting a continued production decline in Appalachian coal. Adjusted operating margin of 6.5% was up 700 basis points year-over-year. This increase was mainly driven by favorable raw materials, which contributed 1,330 basis points, simplification modernization benefits, and temporary cost control actions, partially offset by lower volumes and associated under-absorption. Now, turning to slide nine to review our balance sheet and free operating cash flow. We continue to remain conservative to ensure the company has ample liquidity to weather the current environment as well as continue to execute our strategy. Our current debt maturity profile is made up of two $300 million notes maturing in February of 2022 and June of 2028, as well as a US $700 million revolver that matures in June of 2023. At quarter end, we had combined cash and revolver availability of approximately $760 million and largely repaid the $500 million revolver draw from last quarter. During the quarter, we also amended our credit agreement to improve our flexibility given the continued uncertainty in the economic recovery. At quarter end, we were well within these financial covenants. Primary working capital decreased year over year to $623 million, but was up sequentially as the decrease in inventory was more than offset by an increase in accounts receivable and accounts payable. On a percentage of sales basis, primary working capital increased to 36.4%, a reflection of the continued decline in sales. Capital expenditures were $39 million, a decrease of approximately $33 million from prior year, as expected. Continue to expect fiscal year 21 capital expenditures will be between 110 to 130 million with the majority in the first half. Our first quarter free operating cash flow was negative 29 million and represents a year over year improvement of 15 million, largely reflecting the decline in capital expenditures. In addition, we paid the dividend of 17 million dollars in the quarter. Full balance sheet can be found on slide 14 in the appendix. Before I turn the call back over to Chris, I want to spend a moment reviewing our fiscal year 21 EPS and free operating cash flow drivers we laid out last quarter on slide 10. As a reminder, this slide details how we expect key factors affecting EPS and free operating cash flow to play out during each half of fiscal year 21 on a year-over-year basis, and our expectations have not significantly changed since last quarter. I've already mentioned our expectations for increasing benefits from simplification modernization this year, resulting in a year-over-year tailwind in both the first and second half of the year. Temporary cost actions will continue to be a year-over-year tailwind in the second quarter, although less of a benefit than in the first quarter as we are increasing our customer visits and rolling back certain temporary cost control actions. Consequentially, the increase in costs in the second quarter will be in the range of $5 to $10 million. This continuation of these actions will result in a second half year-over-year headwind as we discussed last quarter. With tungsten prices remaining in the $2.10 to $2.30 range, raw materials are expected to continue to be a tailwind in the second quarter, although at a reduced rate and neutral for the second half on a year-over-year basis. Although depreciation and amortization was flat year over year in the first quarter, we still expect it to be $10 to $20 million higher for the full year starting in the second quarter as our new equipment comes online. In terms of cash flow, as Chris and I already mentioned, capital expending will be significantly down this year, a tailwind in both the first and second half. Year over year, cash restructuring will be higher in both halves as we execute the restructuring programs. The sequence of working capital will be dependent upon the timing of the market recovery, with both accounts receivable and accounts payable likely a use of cash in the year, offsetting planned inventory reductions. As a reminder, our target for working capital remains 30%. Finally, as it relates to Q2, as Chris mentioned, we expect sales to be up low to mid-single digits sequentially, despite fewer working days in Q2 versus Q1.

And with that, I'll turn the call back over to Chris. Thank you, Damon. Turning to slide 11, let me take a few minutes to summarize. I'm pleased that we have continued to make significant progress on our initiatives. We are advancing commercial excellence, including the focus on fit-for-purpose customer applications, drive growth, and market share gain. As demonstrated in the margin graphs earlier in the presentation, we have also made significant progress on operational excellence, with our simplification modernization program, including footprint rationalization. We expect to be at target savings of $180 million for the program by the end of this fiscal year, despite much lower volumes. Timing of the completion of our simplification modernization program, as well as the renewed focus on commercial excellence, will serve us well in our recovery. Strength of our balance sheet and cash position will allow us to optimize capital allocation while improving customer service and profitability even further throughout the economic cycle. So I'm fully confident we will achieve our adjusted EBITDA profitability target of 24% to 26% when markets recover such that sales reach the target sales range of 2.5% to 2.6%. With that, operator, please 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. As a reminder, we ask that you please limit yourself to two questions. If you have additional questions, you may reenter the question queue. The first question today comes from Steven Volkman of Jefferies. Please go ahead.

Great. Good morning, guys. Thanks for taking the question. I guess if I could kick off, Chris, you made a couple of comments around sort of the themes of the trend through the quarter and into October. And I guess I'm just trying to understand, I mean, your sales are kind of at the low end, I guess, of what we would see across the industrial universe these days. I guess part of that's probably oil and gas related, maybe a little bit of mining. But can you just provide a little bit more color on the end market trends through the quarter? And then specifically, do you think there's still destocking going on in your end markets? And kind of what's the outlook for that as we move forward? Thank you.

Yeah, Steve, I think if we look at Q1 sort of month-to-month sequential pattern, you October also would suggest that we sort of see improvement in the markets that we talked about. You know, transportation really across all regions is starting to recover. Of course, still well below the pre-COVID-19 levels. Knock on effect with general engineering. Again, that seems to be across all regions. Aerospace, you know, we thought that aerospace may have bottomed out in Q4, but it actually looked like it got a little weaker. really across all regions. So it may be settling at this low level right now, but that one we have to still wait and see. And as you said, energy was down. So I think, you know, as we look at the quarter in total, you know, we gave it this low to mid single digits. This is kind of our best estimate of, you know, what equals the normal seasonal pattern and then these sort of positive trends that we've seen. Things that give me a little pause, and probably everybody, is when you start to talk about COVID-19 cases increasing, for example, in Europe, and maybe the governments will have to react. But I think left to its own devices, we should continue to see some recovery short of a government stepping in and making some other kind of action, Steve.

Okay, thanks. And any commentary on inventory destocking, maybe in the distributor channel or anywhere else you might be seeing it?

Thanks for that follow-up. Yeah, we think that destocking is leveled off as of the end of Q1, with the exception of probably aerospace and oil and gas. In the Americas, I think the destocking is largely behind us, but we could see just a little bit more in Q2, but I think we're kind of at the low levels there. We do think that maybe in Japan and Korea there could be some additional destocking happening there, but that's not a big part of our business anyway. And there's no question in the infrastructure design that the oil and gas customers are still paying very much attention to their inventory and cost accordingly. So we could still see some destocking.

And do you think it would be all done by year end, calendar year end?

That's my sense, Steve. I suppose my sense right now, if I had to guess, would be it should be behind us by the end of calendar year.

Okay. Thank you. I'll pass it on. Appreciate it.

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

Hi. Good morning. Maybe just the first question around margins. So just looking sequentially, you had revenue up in metal cutting and flat in infrastructure. Margins, though, sequentially down in both. So maybe just help us understand, and that's despite, I think, good execution on simplification and modernization. So is there something going on with the mix or some kind of sequential move saying that the tungsten tailwind, just trying to understand, you know, the drivers there sequentially on that margin step down.

That's a good question. And, you know, I think what I'd like Damon to do is kind of walk everyone through drivers, especially sequentially from Q4. A lot of moving pieces, and if you miss one of them, you can arrive at the wrong conclusions. Largely the margins and decrementals for that matter, once we factor in what we think was going to happen on material and our temporary cost actions, we're actually pretty happy with the decrementals and don't see any. But, Damon, maybe you could walk them through the different elements so that we have the right view from QP.

I think, Julian, the biggest driver that we tried to articulate on the last quarter call was the change in what we were seeing in the temporary cost actions and all of the cost control actions that were in place in the fiscal fourth quarter. As a fourth quarter, we did reverse a lot of our variable comp in the fourth quarter, given the effects that COVID-19 had on our profitability. And we were in a good position, I think, going into this third and fourth quarter. And so what you saw there was a large reversal of variable comp. coupled with a lot of pretty much no discretionary spending as travel was locked down as we were curtailing any cost that we could. And so as we moved into the first quarter, that variable comp reversal, again, which was almost a full-year effect in the fourth quarter, did not repeat. And when you look at those changes sequentially versus what we told you, those temporary cost actions were going to be in the range of, say, around $10 million to $15 million into this quarter. And last quarter, we told you that was in the range of 40 to 45. So you're looking at about a $30 million headwind just because of the timing of some of those temporary actions flowing through. And that's the big driver. As Chris said, when you back out the raw materials versus this quarter, the decrementals in this quarter align with what we would have expected.

Thank you, Damon. That's very helpful. I suppose that let's say at the December quarter and the balance of the year, how sizable should that temporary cost reversal be for the next three months or nine months? I mean, I think you mentioned revenue up sequentially below mid-single digit in December. Do we assume margins moving up sequentially with that?

So I think, Julian, so what we've said, we'll still have temporary cost actions in place here in the second quarter. So as, again, from a year-over-year perspective, those will still be a tailwind. But if we think about the sequential walk from Q1 to Q2, as we start to see our salespeople visit customers more here, as we start to roll back some of these temporary cost actions, we would expect that the sequential headwind in incremental costs would be in the range of $5 to $10 million from what we saved or what we monetized here in the first quarter. And then as we move into the third quarter and the fourth quarter, what we've said is we would expect hopefully all of those things to be behind us. And then you'll see, so sort of call it another sequential headwind from Q2 to Q3 in a similar range. And then again, if you look at that Q3 and Q4 year over year, you are going to start to see some year-over-year challenges because, as you remember, we started to institute some of these temporary cost actions in Q3, and then we had a very large portion of that in Q4, again, going back to the variable comment that I made earlier. And so year-over-year, you're going to start to see those be a bigger headwind as we go, as we look at it in the third and fourth quarter.

Thanks. And just a follow-up, Damon, on that. So when you're looking at the second quarter with that extra $5 million to $10 million headwinds sequentially on cost, does that mean the margins are probably stable sequentially on an operating basis?

Yes. If you look at the low to mid-single-digit revenue increase coupled with what we're saying for $5 million to $10 million of sequential increased costs, you're in the right ballpark.

Thank you very much.

The next question comes from Anne Diegmann of JP Morgan. Please go ahead.

Hi, thanks. This is Sean McMullen. I'm for Anne. Can you discuss a little bit of how much the $80 million incremental simplification modernization savings is volume-dependent, and is there a scope for higher savings if volumes continue to recover?

Yes, Sean. I think the $80 million, what we said on the last call, that particular restructuring action associated with simplification and modernization is largely structural, non-volume dependent. There is obviously a volume dependency associated with modernization in total, which is why we said since the inception of the program, by the end of this year, we'll be at $180 million. There's a fair amount of that that we'll actually do better on because we're going to have higher volumes as we drive higher volumes through these factories, you're also seeing improvement. But in terms of your question of the $80 million, that's really structural and volume dependent.

Great, thanks. And my second question is related to aerospace. Have you seen any signs of improved demand with the 737 MAX expecting to return to service? And if not, when would you expect to see some improvement?

In aerospace, As I mentioned when Steve was on the phone, we saw it actually decline slightly from Q4 to Q1. And as it relates to the 737 MAX, what we're hearing from Boeing is that they're still running at low levels of production on the 737 MAX, but they do expect to start to ramp up at the start of next calendar year, sort of 31 per month. Right now they're running lower than that. That was based on the Boeing's earnings call, so I think that's probably the best information is that they should start ramping that up, they think, at least at the start of the calendar year.

Great, thanks for your time. I'll hop back in queue.

The next question comes from Dan Ullman of Cleveland Research.

Hi, guys. Good morning. Hey, just to start from a level perspective, What do you think the best-case scenario is for the company to return to year-over-year organic sales growth? Do we have a shot at getting that in the March quarter, or do we have to wait until the comparisons get really easy in the June quarter?

Yeah, that's hard to say, but clearly the comps get easier as we go through the year. So, you know, one of the reasons we didn't provide Outlook is I'd love to be able to have – clarity around that question, but there's so much uncertainty, Aidan, that I'm obviously reluctant to say something. But I think in general, the comps do get easier, so we're certainly hopeful that if there continues to be this recovery, that that is possible. But it's really difficult to predict exactly when that's going to happen.

Okay, understood. Secondly, I was hoping you could expand on your thoughts of the revamped commercial strategy. And then could you maybe just talk about what's happening in the channel between Kenna Metal and Vidya distributors? I believe some Kenna Metal distributors have the ability maybe in some areas to bring on the Vidya brand, but I didn't know if that works the other way around. If you could provide some more thoughts on that, that would be great. Thanks.

Yeah, generally the reaction from the channel partners has been positive. They especially like the fact that now there's clarity in the brand positioning. And, you know, if you think about the video distributors, really not very much change with them other than they're getting their product portfolio updated modified slightly in position and better in terms of price as we take cost out of the product to maintain margins, they're getting a product that they can actually sell, I think, more effectively than they had before. And then the Kenna Metal distribution channel will also benefit from access to the VIDIA product portfolio, which, you know, they're already, many of these distributors are serving customers that actually need that fit-for-purpose tooling. But we haven't really set ourselves up to provide that tooling, and that's what we're doing now. So that's why I said in my opening comments that it's probably been a very positive experience for the channel partners because they see this as an opportunity to bring really the full capability of Kenna Metal's metal cutting prowess to their existing customers. So it's been a net-net positive for everyone.

The next question comes from Joel Tis of BMO Capital Markets. Please go ahead.

Hey, guys. How's it going? Hi, Joel. You're still feeling disruption, like operational, you know, some challenges internally, or is this more just all about kind of end market weaknesses?

Yeah, I think, well, I think there's a couple things going on. Clearly there's end market weakness. That's the biggest driver of the, as Damon talked about, the year-over-year financials. But we are still, as you know, Joel, we are still closing plants. And even some of the restructuring and the plant closures we did last year were ramping up the production in new facilities. So there's still some inefficiencies associated with that. I don't know if I look at it year over year, I don't know if they're any more significant than they were in the first quarter of last year, but they still are in the system. And as you know, once we stop those activities at the end of this year, those costs will go away. But they're still in the system right now, but I'm not sure they're any higher than they were in previous years.

Okay. But still kind of like a transition year for this year, given all the uncertainty that you know, internally and externally for sure. Is there any way to gauge if you guys are gaining share and some maybe highlight some different areas where you might be like you feel a little more positive than what you were thinking just in terms of that?

Yeah, I think, you know, as you know, share gain is the kind of thing you need to kind of measure it over multiple quarters. And as we look at what's happened to our volumes versus other companies such as our competitors that are publicly traded or that we have pretty good intelligence on, we all seem to be experiencing roughly the same sort of decline in end market demand. And then we also have, internally, we have the ability to track how much business we're doing with customers. We have a great sort of commercial excellence tool to really understand what the customers are buying and So we can look at our customers literally individually and be confident that we're not actually losing any business. But we also know that we're adding business in areas that we never focused on. And I talked about a couple of examples just in this fit for purpose segment where we got a major machine tool builder that we know we had a very low share of them, and they've made a decision now to give us new business there. I mentioned also in the energy, in particular the renewable space, There's a lot of manufacturing that goes on with these wind turbines. It's directly attributable to OEMs, but it also flows through general engineering in the form of bearings and these type of things. And we know we're adding new customers because of our solutions in those spaces. So, I mean, I think it's something we have to watch over time, but we feel like in the areas that we're focusing on, because we have winds and we're sort of tracking them customer by customer, that we, by definition, are picking up share.

That's great. Thank you so much.

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

Yeah, good morning, guys. I was just wondering, on the tax rate, can you just, I realize it's tied to the low level of profitability, but Any more color on what's driving that 30% rate just geographically and what level of revenue and profitability do you actually need to return to to get back to kind of the low to mid-20s?

Ross, the low level of profitability here in the U.S. is sort of triggering, as you heard me on my opening remarks, the GILTI, which I sort of refer to as that alternative minimum tax that we're dealing with here in the U.S., which is elevating the rate there. And it can exclude certain deductions that we get with some of our foreign income. And so that's the big driver. I guess I would, when you think about getting back into the low 20s, I think if you go back to when we started fiscal year 20 and we thought that we would see revenues closer to that $1.9-plus billion range, we were guiding you to a tax rate in the low 20s. So again, I think without lack of clarity on geographic mix or things of that nature, I would tell you that's probably where we've got to get back up into. I do expect as we grow in profitability, that rate will come down. It's not necessarily going to be linear. But, you know, we've got to get back up into where we were a year or two ago.

Got it. Thanks. And then my follow-up, I guess, for Chris. Chris, I think you've had some management changes. And I know Pete Dragich left, and I'm not sure if you had one or two other. But could you just comment on that a little bit? I mean, is that tied to the reorg of the metal cutting division? And just how do you – sustained continuity with everything the company has done over the last couple of years? Because obviously this has been a long journey that you're on. And just wondering if the new folks are pivoting at all in a different direction, how you kind of manage that?

Yeah, that's a good question, Ross. The way I look at the leadership team is... At any point in time, do we have the talent sitting around the table to take us to the next level? And you mentioned Pete, and he's done a terrific job for the company. Everyone has to make personal decisions about their own situation. But one of the things that Pete made sure is that we had a good handoff with the person that is taking Pete's place. And that particular person has a lot of experience but what I would call industry 4.0 and basically leveraging the kind of investment that we've made in our simplification and modernization. As you know, Ross, it's one thing to put the equipment in, but to fully leverage that investment, you've got to operate it in a different way and schedule your plants in a different way and connect with your customers in a different way. And also, I think... you know, train the talent in the factories and raise the game of everyone. And the guy, Naeem Rahman, that we've added to replace Pete has all those experiences. And so we look at him as being able to take us, very well qualified to take us to the next level of performance. So we wish Pete well. And he's done a terrific job for us. But one of the things that is a mark of a good leader is he's left us with a situation where we've got a terrific leader that's coming in right behind him.

Thank you.

The next question comes from Chris Stanker of Longbow Research. Please go ahead.

Hey, morning, everyone. Just heading back to fit for purpose, you had some really nice wins there, Chris. I guess thinking sequentially going from the fourth quarter to the first quarter, was there any divergence between kind of growth in the fit for purpose versus kind of the more highly engineered portion of the portfolio? Anything that's worth calling out in terms of, hey, we're really seeing measurable traction yet, or is it still too early days?

Well, I think it's still too early days. When you originally were asking your question, I was trying to think – What are customers more focused on? And clearly in the full solutions area, that requires closer interactions with our engineers and customers starting to test tooling and those type of things. And they're starting to ramp that up. So that activity had kind of slowed down during the pandemic. So that is ramping up. The fit-for-purpose switch is a little – and transition is maybe a little easier for customers. So it could be – They could be going a little faster on that, but I'm not sure. I think it's still too early to tell. I wouldn't read too much into it. I think they're both opportunities. And as customers come back online and return to something that's more normal, as Damon said, that's one of the reasons why we're going to have some higher expenses is our people are now starting to interact with the customers more and doing some more travel. So still a ways away from what I would say whatever equals the new normal, if you will. But that's all positive activity that they're now running their factories and now getting on with the business of driving more productivity, whether it be fit for purpose or the full solutions.

That's very fair. Very fair. Thanks. I guess kind of to that point on kind of the return of some cost into the model here. With the internal sales force now kind of pushing the fit for purpose, are we kind of through all the incremental cross-training, through any kind of incremental additional hires? Just how do some of these investment costs kind of run to the business as we move through this particular year?

Yeah, in terms of – the good news about the fit for purpose is that – One of those things that we weren't focused on, but it doesn't require a different skill set or body of knowledge. So our sales people and our technical people for sure already have that capability. It's just a question of positioning the product portfolio in the right place. So I don't see any major investment associated with making that transition to fit for purpose because we largely already have the product portfolio. We're doing some value analysis, value engineering to make sure that we can sell it at the right price point and still make the proper margins. We've got lots of opportunity to take costs out of the product, as it turns out. But none of those things, including the training of the sales force, are going to require a material investment, if you will.

Sorry, just to follow up on that, I guess. That includes kind of any additional commercialization changes that you guys are rolling out?

Yeah, we have a general, a broad commercial excellence strategy where we're reassessing our channels, not just around fit for purpose, but making sure that we have the proper coverage in whatever region that we're in. And so that work continues. We continue to advance our commercial excellence tools, but those investments and those tools have already been made. We just get better at using them every year. So I don't see any really – substantial investment or changes along those lines, and just more in the spirit of continuous improvement, and that's where we drive anyway.

Got it. Well, thanks so much.

Next question comes from Steve Barger of Cuban Capital Markets. Please go ahead.

Hey, good morning, guys. Can we just go back to slide 11, the primary EPS drivers? If 2Q is going to look like 1Q plus or minus with a small revenue increase and similar margin, and then I look at the challenges in the second half, it looks like EPS will be down versus FY20. I just want to make sure. Am I reading that slide right?

FY20?

Well, no, I'm saying you already talked earlier about 2Q saying it's going to be low to mid single-digit revenue growth, but I think you said the margin would be stable plus or minus with 1Q, right? So that means we can have a pretty good look at what the first half looks like. And then I look at your second half walk here on slide 11, and just thinking about it, it makes me think that EPS is going to be down for the full year versus FY20.

Yeah, well, I guess the comment was going to depend upon what your view of the top line is. I think, as we've said, we don't have a lot of visibility on where the revenues are. I think what we've tried to show you is where some of those cost actions or those year-over-year headwinds will affect the margin. You'll have to make a decision on where you think the revenues will be, as Chris alluded to earlier. If we see the markets recover, one of the earlier questions about when we start to see organic growth, that will influence the profitability significantly and hopefully will more than offset these incremental year-over-year headwinds we would see in Q3 and heavily in Q4.

Yeah. I mean, where do you think organic growth would have to come in or what the sequential step-up two-half from one-half would have to look like from a revenue standpoint? to be able to show some year-over-year earnings growth.

I guess I'm not – I can't do the math on the phone here, but, you know, again, if you think about what we tell you guys is every million dollars of cost is the equivalent of around a penny. We tell you we leverage at 40% on average plus some fixed cost absorption. Right now, given the low levels of profitability, so you can sort of use that as a revenue proxy. And so, you know, we can – if you want, we can back into that later on, but I don't think I want to tie up the call trying to do that math on the phone right now.

Sure, fair enough. And with the $120 million of CapEx and $95 million of restructuring, which is mostly cash, this is going to be a pretty significant cash burn year, again, unless you have a really significant step up in revenue, which would affect operating cash flow. Is that fair?

Yeah, I think if we look at the things that we can control, you know, CapEx is significantly down year over year. We're in that 110 to 130 range. You know, we do have an elevated level of restructuring this year as we've pulled forward some of our commercial excellence. And what we've said is that would be in $25 to $35 million higher this year and then hopefully dropping off next year. You know, cash taxes are a little bit lower, you know, but we're positioning ourselves, I think, for strong cash flow generation as this market recovers.

Got it. And then if I can just squeeze in one more. On the infrastructure slide, number nine, just reading through that, the contribution from favorable raw material was by itself 1,330 basis points. Is that correct? Correct. So meaning margin would have been negative 6.8% all else equal before the other items on that line. I just want to make sure I understand the magnitude. Yep. Okay. Thanks very much.

The next question is from Dylan Cumming of Morgan Stanley.

Great. Good morning, guys. Thanks for the question. I just wanted to go back to Steve's kind of original question on the inventory levels. You know, Chris, you talked about your sequential revenue guidance being kind of a bit above normal seasonality, and it feels like some Capco's companies in the channel, you know, have been talking about holding more production-related inventory, kind of given all the uncertainty in the market, and just general concerns around the supply chain. So I guess, Is there any concern that you might have been seeing some revenue pull for, maybe even some restock here, kind of given all of the case spikes?

No, I don't think so, Dylan.

Okay.

It's more of a decline in workdown of inventories and caution in terms of adding things back.

Okay, got it. Thanks for clearing that up. And then maybe switching over to wind, you know, that's kind of been an end market you've been calling out for a couple quarters now. You know, some of your peers have been seeing more sustained strength there as well. Can you just kind of level set how big of a business that is for you today and to what extent growth there can kind of continue to offset some of the weakness in oil and gas?

Yeah, we're not going to give necessarily the size of the business, but I can tell you you're absolutely right. It is growing. You know, when we talk about energy, especially on metal cutting, there is – in the U.S., the energy is mostly oil and gas related, but as it relates to China – energy, that is largely driven by the renewable. Also, we're seeing some good growth in India. I would say that it's a market that we have been focusing on within the last few years, so we still have a fairly low share, so the opportunity for us is to grow quite substantially.

Got it. Thanks. And then maybe just one last one, you know, appreciate all the uncertainty you kind of outlined around COVID and some of the recent case specs in Europe, but just wanted to make sure to date, have you seen anything tangible by way of kind of customer shutdowns in Europe or, or kind of government mandates that might impact your production over the coming quarter here?

No, we haven't seen anything yet. Um, we have, you know, our, our, when we talk to our, our, our people in Germany, um, I'm not sure just how much of an appetite there is there to shut things down. I think people are really trying not to do that, but it still is a possibility.

Okay, got it. Appreciate the time.

The next question is from Steven Fisher of UBS. Please go ahead.

Great, thanks. Good morning. You basically addressed this previously for Q2 profitability with the revenues and then the margin commentary. But I just want to make sure I understand all the year-over-year moving pieces like you gave us last quarter. So if we start with the $24 to $25 million of operating profit last year, it sounds like maybe there's a $5 to $10 million year-over-year tailwind or benefit from the temporary cost. And then would we think about the simplification and modernization benefits year over year in the second quarter as, say, something like in the $40 million range? And then there's just the volume impact, which we would assume somewhere in that 40-plus percent leverage range. Is that the way to think about the moving pieces year over year? And are there any other things in there that I would have missed?

So, Steve, I guess a couple things. One is simplification, modernization. Last quarter was $22 million. I think for the full year we said it's going to be around $80. So I think it'll change a little bit quarter to quarter as things roll over and new things come on. But I think you're probably more inclined to be in that sort of range of that $22 million, give or take, in the second quarter. So that would be different. And the other thing year over year is raw materials will still be a benefit to year-over-year in the second quarter, not to the same order of magnitude of what we saw here in the first quarter, but, you know, in the, you know, call it mid-20 cent range, year-over-year would be a positive year-over-year coupled with the other comments you made on the temporary cost actions and then the volume. Does that help?

Yeah, and the decrementals in that kind of 40% to 45% range on the organic volume,

Yeah, we don't give specific decrementals, but we try to give you the raw materials. We try to give you the temporary cost to allow you to sort of back that out to figure out what you think they are. But we would accept them to be in line with our normal decrementals. And, again, we expect them to be lower given the raw material versus given the raw material benefits we'll see in Q2.

Okay. And then given some of the increased – lockdowns we're seeing in Europe and some of the increased uncertainty around COVID. Are you thinking at all about extending some of these temporary cost reductions at this point?

Yeah, we're basically assessing the temporary cost control actions sort of on a quarter-by-quarter basis. The ones that we rolled back in March talking about rolling back here at the end of Q2. We feel confident that that's the right thing to do, all things considered for the business. But a lot of the other cost control actions are still in place, largely because of the reasons you said. There's still a lot of uncertainty out there, and we need to sort of monitor this thing. So I guess the only thing I would say is that we are going to continue to look at the situation quarter by quarter, month by month, as we're doing today, and we'll make the necessary adjustments to our liquidity and make sure that we're protecting our margins, too, all things considered.

Just to clarify that, if the sales don't continue the improvement trajectory that you're seeing now, you would consider extending those temporary benefits?

Yeah, I think we talked about rolling back. I was speaking of the $5 million to $10 million that Damon talked about on the rollback. Some of that is engaging with customers with travel and those types of things. So obviously if volumes are not continuing to improve and customers are shutting us out, then we're not going to travel. We'll tighten up those expenses. But some portion of that was also related to reinstating pay at normal levels. And that rollback, that's going to stay in place for this fiscal year.

Okay. Thanks very much.

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

Thank you, operator, and thanks everyone for joining us on the call today. We certainly appreciate your interest and support. Before we sign off, I would like to mention that we recently posted our first ever ESG report on our website. While we've been addressing ESG related items for many years, this is the first time that we've compiled a comprehensive summary outlining our progress and opportunities in this area. If you have any questions on that report or any follow-up questions on today's call, please don't hesitate to reach out to Kelly. Have a great day. Thank you, everyone.

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