Good morning. I would like to welcome everyone to Kennametal's Third Quarter Fiscal 2020 Earnings Conference Call [Operator Instructions]. 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 Kennametal'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 5. 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 Broetz, President, Widia 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 lines 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 risks factors and uncertainties are detailed in Kennametal'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 8-K 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'll 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 2 details our approach during this period of uncertainty created by the COVID-19 pandemic. As you've 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, increased 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 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 pre-emptively 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 3 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 $0.46 versus $0.77 in the prior year quarter, but increased sequentially by $0.31. 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 4.

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 quarter, 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 are able to continue with our strategic initiatives, such as launching new products like the HARVI I 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 spend associated with simplification/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 billion 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 our divestiture 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 $0.03 versus $0.82 in the prior period. On an adjusted basis, EPS was $0.46 per share versus $0.77 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 $0.39. This compares to negative $0.02 in the prior year period and negative $0.62 in the second quarter.

The largest factors contributing to the $0.39 was the effect of significantly lower volumes and associated under absorption. 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 $0.40 we achieved last year. The savings from our FY 2020 restructuring actions are now expected to deliver $30 million to $35 million in run rate annualized savings by the end of FY 2020.

The slight decrease of $5 million is due to the significantly lower volume assumption in the fourth quarter. We remain on track with our FY 2021 restructuring actions that are expected to contribute an additional $25 million to $30 million of annualized run rate savings by the end of FY 2021.

Slides 7 through 9 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 Widia, sales declined 16% organically against positive 3% in the prior year period.

Widia 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%, and 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%, then Asia 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 in 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/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 $700 million revolver that matures in June of 2023. As of March 31, we had combined cash and revolver availability of approximately $750 million.

As Chris mentioned, in April, in an abundance of caution, we pre-emptively drew $500 million on our 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/modernization.

Under the current demand environment, we are taking a cautious stance toward capital expenditures in the short-term while continuing to advance our simplification/modernization strategy. 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 FY 2021. We 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 FY 2021. 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..

[Operator Instructions] The first question today comes from Stephen Volkmann 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 progressed 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..

Thanks, Steve. Yes, 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 early in other regions, as you know, coupled with now the onset of COVID-19 this year. In EMEA and Asia Pacific, we think it will 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 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 idling production and running at low rates. I know they've recently announced that they're starting back up, but we think that they could be easily below that 35%. Aerospace and general engineering and energy, we think, will be around that sort of 35%. 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 frankly, your comment about how we see this thing proceeding sequentially that - therein lies the uncertainty.

So we just don't really know, Steve, but I tried 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 kind of more stabilization out there?.

No. I mean I think April 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. Maybe 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 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..

Yes. 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 COVID-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-case scenario.

So we are using furloughs, and we're aggressively making sure that we're using those same actions to try to adjust 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 as part of simplification/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 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 decrementals, I think as Chris has alluded to on his comments related to April and looking forward, yeah, I think that 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' views we'd be right in that sort of historical range..

Okay, thanks and then maybe following up, Damon, perhaps this one's for you, around the free cash flow outlook. So you talked about a 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 then also the potential for freeing up more cash from working capital liquidation?.

Yes. I think, Julian, obviously, we've given you some our views on reduced capital. I think restructuring, with what we've announced for the FY 2020, the FY 2021 restructuring actions, the cash outlays for those plans or for the FY 2021 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 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 we'll continue to try to get our numbers closer for 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 Duignan of JPMorgan. 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 impacts in FY 2021 at this point?.

Yes. In terms of the Q4 headwind, that's basically a very straightforward calculation. 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 to raw material. And at this point, we look at tungsten carbide, which is our largest material input, and tungsten has kind of stabilized around the sort of $230 level.

And I suppose if things get worse, it could drop off. So it's hard I guess it really depends on what we think happens to the overall business, which as we've talked about, where 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 $0.16 of a tailwind in Q3. And when you look and we said basically net neutral for the full year. So that puts about a $0.10 tailwind in Q4..

Sure. Great, thanks. That's all I have. I'll pass it on..

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

Thanks, good morning everyone.

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?.

Joe, we didn't give out the specifics. I would tell you that it's less than the number we report for simplification/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. So it's not de minimis, but it's less than $0.15.

I guess we'll sort of leave in that range..

Okay. And I guess and that's….

Given that we're looking at it, 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 will 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? So is it something that starts to kind of reverse itself in fiscal 2021? I'm just trying to get an understanding of how much of that portion is maybe more structural versus temporary in nature..

Yes. I think we if we I'm trying to think about the same thing, Joe. And the on 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 FY 2021, we are 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, 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 I think the main variable here that's sort of causing me to pause and not really try to project what's going to happen for FY 2021 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 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 Steven 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?.

Yes. The cost control actions, we've 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 for 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 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. In aerospace, 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?.

Yes. Let me take the aero first. I mean it's there's no question that I think that the that market is probably going to be depressed for a while. But keep in mind, what we had done is we shifted engineering capability and technical resources away from transportation, largely automotive, into this aerospace environment.

And the one thing I've said is that the 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 some of those resources over to focus on aero, 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 great brand recognition, both Kennametal and Widia brands and but we've not 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, the Infrastructure business is no stranger to oil and gas. These cycles come and go.

And we do think that there's kind of a reset going on in oil and gas, for sure, and that maybe rig counts will be depressed for some period of time.

Part of our simplification/modernization program was to prepare the company for those type of scenarios where there is depressed markets, lower the breakeven 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 big customers are the Schlumbergers, Baker Hughes and Halliburtons.

And those companies, even in a depressed market are going to be around for a while, and they still need innovative suppliers. So we don't see a need to make a strategic change..

Okay, thanks very much..

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

Hey, good morning guys. I guess kind of pulling the thread a little bit further on cost.

I appreciate evaluating the fixed cost is 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 optimize, I mean, what feels like Rogers today?.

Yes. We and part of the initial investment thesis for the simplification/modernization was we said we would remove about five to seven plants. We've already achieved five plants.

And in fact, one of the plants was on the docket was Essen, but we because the workers' council made an excellent proposal to basically just simply downsize that plant, not completely close it, we still achieved very good savings and improved our competitive position.

So that was the initial perspective 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 anything 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, there's difference 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 costs out of the system.

But again, if you looked 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 breakeven plan enough. And so 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 FY 2021. 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. So there's 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. And then, Chris, the footprint gets a lot of attention rightly or wrongly. But it sounds like there were some other initiatives that you were looking at. We've done some SKU rationalization. There's a lot of sourcing benefits.

I guess what else is kind of being worked out on that structural side? Or is it kind of should we stay tuned there?.

Yes. I mean I think there's some more footprint rationalization to go. 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 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, the payroll that we spend each year on sales as an investment, just like capital, and are always 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 sort of structural costs that can come out that don't necessarily tie to specifically to the manufacturing..

Yeah, I think that's helpful, thank you guys..

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

Thanks, good morning guys..

Good morning..

I wanted to ask a little bit about April again to go back to that one.

And the down 35% in April, was that drop, do you think, related to your customers having to cut their production? Or do you think there was still inventory that was coming out of the channel?.

Yes. 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 what we saw in April, I think, is there could be we've had some customers that have been shut down, but I think the majority 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 there was even more destocking going on because they just needed to preserve cash and make sure that they are managing through this uncertain time. It may have been an overreaction, if you will, I don't know. That's part of what'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, that really has sort of stabilized at low levels and looks like it's coming back..

Okay. Yes. And that was the next one. I wanted to ask about China.

When you say it's coming back, is it is China getting a V? Or is China trying to get an L? What kind of recovery is it?.

No. 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 sort of pent-up demand as they are rebounding from COVID-19 or not, I think it's too early to tell.

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.

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 of the trade wars starting to heat up again, maybe manufacturers looking for more local supply?.

Yes. In general, we have a 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 this, the China trade war, and have 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, if 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 the kind of the global recovery, if you will..

Okay, great. Thank you..

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

Hi guys.

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 HARVI product line and maybe some other areas that you'd like to highlight?.

Sure. We got 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.

We had launched a program that we in our actually, in our Widia 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, so that's going quite well.

Now the HARVI end mill is a product that can help you in that space because obviously there's a lot of aluminum beam machined there. But it's also applicable to the general engineering space. And that's another area that we've that we're focusing on.

Again, we have taken a lot of resources that we're focused on, automotive, where there was, I think, limited opportunity to grow and limited profitability and move that into these general engineering and aerospace locations. And that program is going pretty well.

Now I actually think that in this kind of an 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, too. In this kind of environment, we can actually we're even more focused on adding new customers and understanding what's happening to us. So 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 and aerospace. So it's not even stuff that we newly develop. 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. In oil and gas, there's a lot of focus on reducing weight and also, frankly, reducing costs for those services company and added a manufacturer as 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. And the strategic focus, more it's more on 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 initiatives or plans to really try to change the game and really step up the like to get Kennametal to be a much larger market share five, 10 years down the road?.

Yes. I think the we'll continue with the investment in technology, but I don't think that, that wasn't really Kennametal's problem. They always had good technology. But this investment, Joel, in commercial excellence, I think, is key.

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 want 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 modernizations efforts.

So we now have factories that have 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 causes our quality to be, I guess, have too much variability in it, if you will.

And now with the modernized processes, we're able to sort of guarantee that repeatability and that consistency, and we're improving the channels to market. So I see those that combination as being powerful. And to reverse the trend, to Kennametal it seemed 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 KeyBanc Capital Markets. Please go ahead..

Yeah, good morning guys. I think you've 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.

And or what does the ramp back to incremental margin look like from an efficiency standpoint?.

Yes. I mean we're continuing with the modernization. So one of the things that we that was a challenge for us was the we talked about the manufacturing inefficiencies that happen while you're closing down plants. While you got high volume, you've got duplicate resources in the receiving location and the sending location.

So to the extent that we're taking advantage of this slower period of time, and we clean that up, it should be easier for us when volume comes back 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, okay? So we're trying to take a measured approach going through this downturn, so that we can position ourselves to be ready for the upturn.

And I really feel that with the modernization that we've done and the stuff that's already been completed, when we see the upturn here, the company is going to have better profitability than it's ever seen before in an upturn..

Yes.

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?.

Yes. 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 we brought entire plants up or never shut them down.

They are in a mode now where they're I guess they're figuring out how to bring up maybe 10% or 15% of the time. So they're going pretty slowly. We're going to be there to support them.

We have made sure that we're not setting out the high moving inventory levels that require to 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 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..

Yes, I believe so. 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 do it with Kennametal 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. Well, 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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