Kennametal Inc (KMT) 2020 Q4 法說會逐字稿

Good morning.

I would like to welcome everyone to Kennametal's Fourth Quarter Fiscal 2020 Earnings Conference Call.

(Operator Instructions) After the speakers' remarks, there will be a question-and-answer session.

(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.

Thank you, operator.

Welcome, everyone, and thank you for joining us to review Kennametal's fourth quarter and 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.

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 of Finance and Corporate Controller; Franklin Cardenas, President, Infrastructure Business segment; Pete Dragich, Chief Operating Officer, Metal Cutting Business segment; and Ron Port, Chief Commercial Officer, Metal Cutting Business segment.

After Chris and Damon's prepared remarks, we will open the line up for questions.

At this time, I would like to direct your attention to our forward-looking disclosure statements.

Today's discussion contains comments that constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements involve a number of assumptions, risks and uncertainties that could cause the company's actual results, performance or achievements to differ materially from those expressed in or implied by such forward-looking statements.

These risk factors and uncertainties are detailed in 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.

With that, I'll now turn the call over to Chris.

Thank you, Kelly.

Good morning, everyone, and thank you for joining us on the call.

For today's call, I will start with some general comments on the year, followed by a quick overview of the fourth quarter.

After that, I will discuss fiscal year '21 and our strategic agenda that will well position the company as markets recover.

From there, Damon will review the quarterly financial results in more detail.

Finally, I'll make some summary comments before opening it up for questions.

Beginning on Slide 2. I would describe our fiscal year '20 as a year of significant challenge but also a year of significant progress on our strategic growth and profitability improvement initiatives.

As you recall, we began the year in what was already considered an industrial downturn.

737 MAX production halt and the significant decline in the price of oil followed soon after.

Last but certainly not least, COVID-19 significantly affected end markets in all regions in the second half of our fiscal year, especially in Q4.

As a result, organic sales declines occurred throughout the year and got worse as the year progressed.

However, we focused on the things we could control, by implementing aggressive cost control actions, staying the course to advance our strategic agenda, including positioning the company for profitable growth and to gain share as markets recover.

These actions resulted in strong decremental margin performance in the second half as well as substantially completing our planned simplification/modernization capital spend.

I am pleased with how our team came together to tackle the challenges.

COVID-19 protocols we successfully implemented continue to allow us to operate safely and serve customers globally.

So all our facilities operated throughout the fourth quarter, with the notable exception of our Bangalore, India, plant, which was closed for approximately 6 weeks due to a government-mandated lockdown.

Some examples of our cost control actions are the acceleration of planned structural cost reductions associated with our simplification/modernization program and further temporary cost control actions to mitigate COVID-19 headwinds, such as increased furloughs, salary and variable compensation reductions and reduced production schedules.

These measures helped align our costs more closely with demand and finish the year on a strong liquidity position despite the challenging environment.

In addition, we continue to make significant progress on our strategic initiatives.

Yesterday, we announced our intention to close a plant in Johnson City, Tennessee, as part of our simplification/modernization program.

This brings the total number of plant closures to 6 since inception of the program and is in line with our original target of 5 to 7 plant closures.

That does not include the significant downsizing of the Essen, Germany facility.

We expect the Johnson City closure to be substantially complete by fiscal year-end with production consolidated into other newly modernized Kennametal facilities.

We are also substantially complete with the spending on simplification/modernization capital, which marks a significant milestone in our journey to fundamentally reduce our cost structure, improve financial performance throughout the economic cycle and improve customer service to enable share gain.

As we navigate through another challenging fiscal year, we will see the benefits from simplification/modernization increase.

This is driven in part as we recognize full year run rate savings from fiscal year '20 actions, bring additional modernized processes online and recognize the benefits from accelerating the simplification/modernization structural cost actions.

Also, of course, as volumes return, the savings will grow from increased utilization of our modernized processes and rationalized footprint.

In addition to simplification/modernization, we continue to advance our strategic growth initiatives, including launching new high-value-added products and preparing to extend our reach into a large segment of metal-cutting that we previously had not focused on.

And I will talk more about these growth initiatives in a minute.

But first, let me quickly review on Slide 3, the fourth quarter results, which, as you know, like other industrial manufacturing companies, we experienced significant headwinds due to COVID-19.

In Q4, the company reported an organic sales decline of 33% on top of the 2% decline in the prior year quarter, which is the worst quarterly organic decline since the Great Recession in 2008.

All segments reported negative organic growth for the quarter, with Industrial declining by 36%; WIDIA, 32%; and Infrastructure at 29% compared to negative 4% and 3% for Industrial and WIDIA and Infrastructure at 1% growth in the prior year quarter.

Also, all regions were negative, with the Americas posting a 39% decline; EMEA, 34%; and Asia Pacific, 24%.

Remember that Asia Pacific saw COVID-19 related declines earlier than EMEA, followed by the Americas.

Adjusted operating expenses declined 18%, reflecting our cost control measures.

These actions in the quarter, combined with benefits from our simplification/modernization program, significantly mitigated the effect of lower volumes on operating leverage.

Adjusted EBITDA margin for the quarter was 17.7%, a decrease of 330 basis points from 21% in the prior year.

Turning to Slide 4. Due to COVID-19, it remains difficult to forecast how our customers as well as our end markets will be affected.

As a result, we will not be providing an annual outlook for fiscal year '21.

However, I would like to provide some color on what we might expect especially in the first quarter.

Based on our July sales and the month-to-month sequential sales pattern throughout Q4, market demand in Q1 would seem so far to be stable or modestly improving from Q4 levels for many end markets and regions.

But as you know, the company typically sees on average an approximately 10% seasonal decline in revenues from Q4 to Q1.

So as customers continue the reopening process in Q1, the resulting improvement in demand may not be sufficient to fully offset the normal seasonal pattern.

Also, note that there can be a lag of a few months from when customers increase production to when we see a corresponding increase in demand.

Beyond Q1, it's helpful to consider customer sentiment, which seems to be that while there are signs of improvement from Q4 to Q1, there is still a lot of uncertainty because of COVID-19 on how these signs will translate to Q2 and beyond.

So while many customers are hopeful for continued improvement, they seem to feel it prudent, due to the uncertainty of COVID-19, to plan for demand to be stable or only modestly improving through the end of calendar year 2020.

But regardless of how end-market demand unfolds in fiscal year '21, we will continue our cost control actions to protect margins and liquidity.

Regarding capital expenditures for fiscal year '21, capital spending will be significantly reduced by over $100 million to be in the range of $110 million to $130 million for the full year.

The reduction, of course, is as expected given we are substantially through the capital spend for the simplification/modernization program.

The benefits of these investments will continue to increase in fiscal year '21, bringing savings since inception to approximately $180 million at fiscal year-end, including total company headcount reduced by approximately 20% and a rationalized footprint with 6 fewer plants and more production moving to lower-cost countries.

So we are successfully managing through the current environment while still advancing simplification/modernization and our other strategic initiatives to drive growth and share gain as markets recover.

For example, on Slide 5, in fiscal year '20, we continued to launch new products with great value propositions for customers in key end markets.

As you can see from the customers' feedback, they speak of the incredible versatility and performance of Kennametal products.

We are creating tremendous value for our customers and differentiating ourselves from the competition.

These types of innovations fuel growth.

For example, in fiscal year '20, we won a 5-year strategic supplier agreement with a leading aircraft OEM and a complete tooling program from a leading wind power bearings manufacturer.

And these are just a few examples of how creating value for customers is driving new business growth.

We have also continued to advance our commercial excellence initiatives to gain share when markets recover.

As you can see on Slide 6, we announced yesterday that as of July 1, we combined Industrial and WIDIA into a single metal cutting organization.

This move will enable us to more effectively direct our commercial resources, products and technical expertise toward capturing a larger share of wallet in addition to executing a new brand strategy.

Previously, WIDIA operated to serve a customer need segment within metal cutting that significantly overlap the Kennametal brand positioning.

Our new approach is to reposition the WIDIA brand and portfolio to serve a multibillion-dollar segment within metal cutting that we previously have not focused on.

We expect that this approach will open up a 40% increase in served market opportunity while offering better service and tooling options to our customers.

More specifically, in speaking with our customers, we know they need technical support and high-performance tooling optimized around specific applications, but they also have a need for high-quality, fit-for-purpose tools that are readily available and have the versatility to offer performance across a broad range of applications.

It is this part of the customer's metal cutting share of wallet that we are targeting by repositioning the WIDIA brand and product portfolio, which will leverage our newly modernized manufacturing capabilities for improved delivery and cost performance.

So from a customer perspective, and this is true across all end markets, we are providing customers access to the company's full metal cutting suite through both direct and indirect channels, in effect, a one-stop-shop model to cover a broader range of their metal cutting needs.

And with that, I'll turn the call over to Damon.

Thank you, Chris, and good morning, everyone.

I will begin on Slide 7 with a review of our Q4 operating results on both reported and adjusted basis.

As Chris mentioned, demand trends already at depressed levels from the industrial downturn deteriorated significantly in Q4 driven by the effects of COVID-19.

For the quarter, sales declined 37% year-over-year, in line with the decline seen in April or negative 33% on an organic basis to $379 million.

Foreign currency had a negative effect of 2%, and our divestiture contributed another negative 2%.

Adjusted gross profit margin of 27.7% was down 790 basis points year-over-year.

The year-over-year performance was primarily due to the effect of lower volumes and associated absorption partially offset by cost control actions, including furloughs, increasing benefits from simplification/modernization and the positive effect of raw materials, which amounted to approximately 140 basis points.

Adjusted operating expenses of $68 million were down 41% year-over-year and decreased to 18% as a percentage of sales.

Although much of this decrease is temporary, it is reflective of our aggressive approach to managing costs in this environment.

EBITDA margin was 17.7%, down 330 basis points from the previous year quarter.

Taken together, adjusted operating margin of 8.8% was down 700 basis points year-over-year.

The adjusted effective tax rate in the quarter was significantly higher at 51.2% due to the combined effects of geographical mix changes in our taxable income as well as the magnified effect of GILTI on the effective tax rate, as we finalized actual full year taxable income versus estimates.

It's worth noting that our adjusted effective tax rate for the full year was approximately 33%.

We reported a GAAP earnings per share loss of $0.11 versus earnings per share of $0.74 in the prior year period, which reflects the reduced volume and higher tax rate partially offset by our cost control actions, coupled with restructuring items.

On an adjusted basis, EPS was $0.15 per share in the quarter versus $0.84 in the prior year.

The main driver for our adjusted EPS performance are highlighted on the bridge on Slide 8.

The effect of operations this quarter amounted to negative $0.68.

This compares to negative $0.08 in the prior year period and negative $0.39 in the third quarter.

The largest factor contributing to the $0.68 was the effect of significantly lower volume and associated underabsorption.

This was partially offset by cost control actions, including lower variable compensation as well as positive raw materials of $0.08.

Simplification/modernization contributed $0.14 in the quarter on top of the $0.10 in the prior year.

This brings the total FY '20 simplification/modernization savings to $0.46.

As Chris mentioned, our expectations for FY '21 is that the simplification/modernization benefits will be in the range of $0.80 driven by actions already taken or announced.

Remember, restructuring is a subset of our simplification/modernization program.

In terms of benefits from our restructuring program, the savings from our FY '20 restructuring actions delivered approximately $33 million in run rate annualized savings at the end of FY '20.

FY '21 restructuring actions are expected to contribute an additional $65 million to $75 million of annualized run rate savings by the end of FY '21.

The total year results in detail in the EPS bridge can be found in the appendix.

Slides 9 through 11 detail the performance of our segments this quarter.

Industrial sales in Q4 declined 36% organically on top of a 4% decline in the prior year period.

All regions posted year-over-year sales declines, with the largest decline in the Americas at negative 40%, followed by EMEA at 38% and Asia Pacific at 27%.

The slightly better performance in Asia Pacific reflects more mixed results in the region with growth in wind energy and improvement in China slightly offsetting significant contraction in other countries, such as India.

From an end market perspective, the weakness in demand remains broad-based with significant declines in transportation and general engineering, down 45% and 32%, respectively.

This was primarily driven by the demand effects of COVID-19 as well as related customer shutdowns that continued throughout Q4.

Sales in aerospace also experienced a significant decline both year-over-year and sequentially, driven by the associated effects on demand in the supply chain from COVID-19.

Adjusted operating margin came in at 7.7% compared to 18.3% in the prior year quarter.

The decrease was primarily driven by the decline in volume and associated underabsorption partially offset by reduced variable compensation and other cost control actions, increased simplification/modernization benefits and a 90 basis point benefit from raw materials.

On a sequential basis, adjusted operating margin decreased 540 basis points as lower volumes were partially offset by aggressive cost control actions and lower variable compensation.

Turning to Slide 10 for WIDIA.

Sales declined 32% on top of a negative 3% in the prior year period.

Regionally, the largest decline this quarter was in Asia Pacific, down 41%; the Americas, 31%; and EMEA, 28%.

The decline in Asia Pacific was mainly driven by India with its countrywide COVID-19 shutdown for approximately half of the quarter.

Adjusted operating margin for the quarter was negative 2.9%, due to volume declines partially offset by lower variable compensation and other cost control actions, a raw material benefit of 220 basis points and increased simplification/modernization benefits.

Turning to Infrastructure on Slide 11.

Organic sales declined 29% versus positive 1% in the prior year period.

Other items that negatively affected Infrastructure sales included a divestiture of 4%, FX of 2% and fewer business days of 1%.

Regionally, the largest decline was in the Americas at 39%; then EMEA, at 22%; and Asia Pacific, at 14%.

By end market, these results were primarily driven by energy, which was down 47% year-over-year given the extreme drop in oil prices and the corresponding decline in the U.S. land-only rig count.

General Engineering and Earthworks were down 31% and 17%, respectively.

Adjusted operating margin of 12.7% remained relatively stable sequentially but decreased 280 basis points from the prior year margin of 15.5%.

This decrease was mainly driven by lower volumes and associated underabsorption partially offset by reduced variable compensation and other cost control actions, favorable raw materials that contributed 200 basis points and benefits from simplification/modernization.

Now turning to Slide 12 to review our balance sheet and free operating cash flow.

Before I review the numbers, like I did last quarter, I would like to emphasize that we view liquidity as extremely important particularly in these uncertain times.

We will 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 USD 700 million revolver that matures in June of 2023.

At fiscal year-end, we had combined cash and revolver availability of approximately $800 million.

At quarter end, we were also well within our covenants.

Primary working capital decreased both sequentially and year-over-year to $596 million.

On a percentage of sales basis, it increased to 35.4%, a reflection of the significant decline in sales in the quarter.

Net capital expenditures were $38 million, a decrease of approximately $20 million from the prior year, bringing the total capital spend for the year to $242 million, as expected.

Our fourth quarter free operating cash flow was $39 million and represents a year-over-year decline, reflecting lower income due to volume and increased cash restructuring costs.

Total free operating cash flow for the full year was negative $18 million.

As mentioned on our last call, while we expected positive cash flow in the fourth quarter, free operating cash flow for the full year was projected to be slightly negative given the level of capital expenditures and cash restructuring charges.

In addition, we paid the dividend of $17 million in the quarter.

Full balance sheet can be found on Slide 20 in the appendix.

Before I turn the call back over to Chris, I wanted to spend a couple of moments providing some additional thoughts regarding FY '21 for modeling purposes.

Turning to Slide 13.

This slide shows how certain factors are expected to affect EPS and free operating cash flow during each half of FY '21 on a year-over-year basis.

As I mentioned earlier, we expect increased simplification/modernization benefits of approximately $80 million in FY '21.

The accumulated benefits will increase as we move through the year.

As we think about the temporary cost control actions that we've announced in June, they will generate a savings of $10 million to $15 million per quarter in the first half of FY '21 relative to the first half of FY '20.

However, as we look at the second half of FY '21, the temporary cost control actions implemented in FY '20 and the reversal of variable compensation which we currently do not expect to repeat will create a year-over-year headwind.

As you would expect from us, we will remain diligent in managing our cost, and we will take the appropriate actions if markets continue to be challenging.

Based on current tungsten spot prices, raw materials will be a positive in the first half due to the headwinds we faced in the beginning of FY '20 and will be roughly neutral for the rest of the year.

Depreciation and amortization will step up to a range of approximately $130 million to $140 million compared to approximately $120 million in FY '20.

We currently expect our full year tax rate in FY '21 to be similar to the 33% adjusted effective tax rate we saw in FY '20, but it could fluctuate significantly in any given quarter depending on the effects of geographical mix and the sensitivity to lower pretax income.

However, should trends in earnings begin to improve in the second half, particularly in the U.S., our tax rate should improve.

As we get back to a more normalized environment, we still expect our long-term effective tax rate to be in the low 20s.

Regardless of the effective tax rate, we expect cash taxes in FY '21 to be approximately $10 million less than the $37 million paid in FY '20.

In regard to free operating cash flow, capital expenditures will be significantly lower versus last year, as Chris mentioned, by approximately $120 million.

However, I want to note that the total spend for the year will be weighted to the first half, mainly due to the timing of cash payments associated with machine deliveries.

Primary working capital will depend in part on how market conditions evolve over the next several quarters.

For the first half of FY '21, although we will reduce inventory levels based on current market conditions, the net accounts receivable and accounts payable will likely still be a working capital use.

In the second half, assuming market conditions improve, we would expect working capital to be in use as well given the significantly depressed accounts receivable balance in Q4 of FY '20 and reduced accounts payable from decreased capital spending in FY '21.

We will continue to be diligent on inventory while ensuring that we do not compromise on customer service, which is essential for our high-volume, high-margin products.

Lastly, cash restructuring charges are expected to be a negative factor year-over-year in both the first half and second half due to our accelerated restructuring activities announced in June.

We currently expect cash restructuring charges to be $25 million to $35 million higher in FY '21, with the majority of this increase in the first half.

And with that, I'll turn the call back over to Chris.

Thanks, Damon.

Before we open up for questions, I'd like to make some closing remarks.

Please turn to Slide 14.

Looking ahead to FY '21, we will continue to focus on the things that we can control so that we'd manage through the current market headwinds and prepare the company to outperform during the recovery.

We'll continue our approach to aggressively manage costs and aligning production to demand while operationalizing our modernization investments for incremental benefits.

Second, we are committed to maintaining solid liquidity with a focus on optimizing cash flow through lower capital spend, working capital management and cost control actions.

Finally, we'll continue to pursue our strategic growth initiatives so that we can position the company for profitable growth and share gain as end markets recover and to achieve our adjusted EBITDA profitability target when sales reach a top line range of $2.5 billion to $2.6 billion.

With that, operator, please open the line for questions.

(Operator Instructions) Our first question comes from Stephen Volkmann with Jefferies.

So I guess just a lot of moving pieces as we try to get our head around '21 and recognizing volume is probably the most important one, which none of us can forecast.

But there's a number of things, I think, we started to kind of lay out relative to '21.

So I guess you should get $0.80 of benefits from modernization in '21.

That's the number, not the run rate, correct?

Correct.

That's correct, Steve.

Good.

And can you say how much you benefited in '20 from these temporary cost reductions that will come back?

Yes, we can, Steve.

The -- in FY '20, that was about $0.40 to $0.45, and that included the furloughs, lower incentive comp, reduced travel, austerity measures, that sort of thing.

And that was about a positive $0.40 to $0.45, which, as Damon mentioned in his remarks, would become a headwind in FY '21, in the second half of FY '21.

Right.

But not in the first half, right, because you're going to get that $10 million to $15 million per quarter of continued benefit?

That's correct.

That's correct.

Okay.

And then finally, the restructuring, I think one of you said $65 million to $75 million run rate in '21, what's the sort of the '21 number ballpark?

Yes.

So Steve, that would be embedded in the $80 million of simplification and modernization savings.

So what we're getting as part of this restructuring through FY '21 is going to flow into that $80 million.

Got it.

Okay.

And is any of the cadence of that sort of more second half loaded for -- just as you sort of work through this stuff maybe?

Yes.

So I guess what I would tell you, Steve, is as we -- the announcement in June with the 10% headcount reduction, that will transpire here over the first half, depending on where in the world those are happening.

And so I would tell you that the savings will be -- the full annualized savings will be more recognized in the back half of FY '21.

Okay.

That makes sense to me.

All right.

I will pass it on.

I appreciate it.

Your next question comes from Julian Mitchell with Barclays.

Maybe just a first question.

You've talked in sort of dollars and cents around some of the margin or EBIT puts and takes.

Just wanted maybe to look at it from a margin rate standpoint, just to understand what kind of decremental margin you're managing the business to.

So you did in the last 6 months an overall decremental margin around the mid-20s, understanding that included tailwinds from tungsten prices.

So when we roll together all the bits and pieces on Slide 13, should we assume that as long as sales are falling, the decremental margin is around that mid-20s rate over the balance of the new fiscal year?

Yes.

I mean I think just I'll lay the foundation here, and then, Damon, maybe you can provide some details inside this.

But you're right, the decremental margins were sort of in that mid-20s kind of percent.

If you back out raw materials and then also the incentive comp and all these temporary cost control actions, we're looking at decrementals that are pretty consistent with what we would expect with this business, including contribution margin and, of course, that we have to cover some fixed costs.

So it looks to me like that's going to be very consistent with what we've seen before.

Damon, if you want to add anything to that to dig inside those numbers, please, please do.

Yes.

I think, Julian, as you look at the first half of FY '21, our decrementals will likely be better than our average rates because we have 2 positives.

We have a raw material tailwind here, as we talked about in the first half, which will help.

And then we also have these temporary cost actions in the first half of the year which should lead to slightly above average.

I think to your point, a lot depends on the second half will depend on the actual sales and what happens there.

But generally speaking, we would expect to get more into our traditional decrementals.

As Chris said, we lever at around 40% on average plus some sort of fixed cost absorption, which would be more likely, given no significant changes to how we run the business, would likely be the second half.

And on that point, Damon, looking at temporary costs in aggregate for fiscal '21, we should assume that they're a slight negative for the year as a whole, year-on-year.

Is that fair?

Yes.

Yes, the way I would look at that, Julian, as Chris said, we were $0.40 to $0.45 of savings in the fourth quarter, a little bit more in the -- if you add the third quarter, where we did start to initiate the furloughs plus some variable comp, that would put us just north of, let's say, $0.50 for the back half of the year.

And what we've said is the temporary actions we have right now are ranging $10 million to $15 million per quarter.

So let's call that $25 million for the first half plus maybe a little bit of travel and other cost reductions.

But net-net, it will be a headwind for the full year.

That's really helpful.

And then my second topic is just around the working capital.

So I see on Slide 12, you ended the year with that sort of primary working cap to sales in the mid-30s.

I guess in that light, I was surprised looking at Slide 13 that working cap is a headwind in the first half because I would have thought that that mid-30s ratio could bend down back towards 30% or so and that's occurring alongside what is still a double-digit revenue reduction.

So maybe just help us understand why the working cap -- with those 2 things, why it's not a cash tailwind.

Yes.

I think, Julian, so what we're looking at here in the first half is a couple of moving pieces.

So one is we do expect inventory to come down in the first half of the year.

However, as we talked about, we are going to see a significant reduction in the payables given the reduced level of capital expenditures that will go through here in the first half.

So the payables will -- from year-end of FY '20 through the first half of FY '21 is going to be a significant in theory use.

And then if you look at the receivables, again, given where we finished fiscal year '20 at, if you look at what Chris alluded to for the first quarter plus any sort of seasonal pattern we would see in Q2, we would expect the receivables to be a use of cash.

So between the AR and the AP, our expectations are that that would offset the reduction in inventory we're seeing.

So I would call it more of a modest use of cash in the first half based on that.

Our next question comes from Steven Fisher with UBS.

Just on those -- the follow-up on the temporary cost savings, how definite would you say is the transition from those being a savings in the first half to a headwind?

And how confident or how definite is the timing around that?

Just curious on what the signals and triggers you need to see to bring those temporary costs back and how long do you need to kind of see those signals sustained.

Yes, we're -- it's going to basically be triggered by what we see the end market demand doing.

If it gets worse for where -- any number of reasons we're all thinking about COVID-19 and those kind of disruptions, if it starts to get worse, that would be something that would trigger us to, again, make sure that we're focusing on preserving our decremental margin performance and also liquidity.

So it's really going to be largely dependent on how end-market demand materializes as we go through the first 6 months of the year.

Okay.

That's helpful.

And then on the new WIDIA strategy, I'm curious what has changed that redirects customers' focus to make this work and why is now the right time to do this?

So let me start with the now piece.

As we look at the fit-for-purpose segment, which is the segment within metal cutting, and it's consistent across the customers, whether they're in aero or transportation or general engineering, and we have good market share of customers that are using the kind of metal tooling.

And they primarily look at us as a supplier for their very specific high-performance applications where we can fine-tune the tooling to extract the most productivity.

But they have a whole host of applications within the same facility in many cases where they just really don't think of us for this sort of fit-for-purpose tools.

And we obviously have that in our portfolio.

WIDIA is capable of serving that portfolio.

So they're kind of just passing us by and not considering us for those opportunities.

And now we've got -- with one organization, we've got the ability to coordinate or collaborate and bring the customer the full portfolio they're going to need.

So we don't require a lot of reach out to brand new customers.

There's plenty of business inside the existing customer base.

However, if you're going to provide these fit-for-purpose tools, you also need to really have super high performance in terms of availability and consistency and quality and those kind of things.

So prior to modernization, and as you know, one of the reasons we did modernization is because we're actually falling behind in those areas.

But now we feel with the modernized manufacturing process we have, that we can actually deliver the operational performance in terms of availability to target this market.

And then the other thing is, frankly, the fact that the demand is low right now, I think it's a great time for us to be able to go to customers who are going to ramp up, and they're all going to be kind of ramping up at the same time.

And to have another supplier like Kennametal that can provide their tooling needs not just for the high-performance end but for all their needs, I think it's a great opportunity for us to pick up share in that sort of fit-for-purpose area.

And so how quickly do you think this could start to have a material impact on flowing through the financials?

So we have -- if we look at the voice of the customer, there's a lot of near-in opportunities that we can target.

We have some refinement to do our product portfolio, but that will happen over time.

But the existing product portfolio can actually bring us these opportunities right now.

And one of the things we started to move in this direction when I put Ron Port in charge of Commercial Excellence for metal cutting, and that was really a way to take 2 organizations that are operating separately and bring them together at a point where we could actually go and target some of these customers.

So we've actually already started with certain customers, offering them this capability.

So we feel we can get traction pretty quickly.

Our next question comes from Ann Duignan with JPMorgan.

Just on the WIDIA and Industrial strategy, I mean, when those businesses were separated, I think a lot of us questioned the strategic rationale.

Wondering if WIDIA could really compete on its own and in its own right.

Are you acknowledging today that this was a [planned] strategy?

And is your hope that you will regain share -- lost market share as opposed to like gaining market share afresh?

Yes.

Ann, thanks for the question.

I think I'd characterize it as follows.

When Ron DeFeo, who was my predecessor, came in and set that up, he recognized a couple of key things.

He's looking at the technology that underlines the WIDIA portfolio and the brand recognition.

And when he's talking to customers, he's like, there's a lot here, okay?

This is actually -- could be a diamond in the rough.

And his philosophy was, if I make it a P&L and start to put resources to really go in and figure out how to grow that brand and understand what's going on, I think that's the best thing to do at the time.

And so it was -- so what we've just moved to now, Ann, is actually a culmination of the things that the WIDIA people have been working on, and they're the ones that have brought to the table this fit-for-purpose opportunity.

So I think it's just a logical conclusion of the journey that we started before I even got here in terms of evaluating just where can we position this thing for the most growth.

And before the approach was we're kind of looking for some white spaces, and we're kind of making sure that the 2 brands aren't competing with each other and looking for other opportunities.

But as we went through that process, we actually discovered that, no, really, the opportunity here is -- we talked about one -- 2 bites of the same apple.

It's actually going to be 2 separate apples that we uncovered.

So I feel like I'm not sure we would have got to the same strategy had we not started from the point that we were.

Nevertheless, we're looking forward, Ann, and I think it's a 40% larger opportunity than we've ever targeted before.

And as I mentioned in my previous comments, we're kind of walking right past it, okay?

There are customers -- many customers want us to do this.

They're just thinking that this is not something that we're interested in because we've never focused on it.

Okay.

That's helpful, I guess.

And then in the same vein, just this one notion of continuing to move manufacturing to low-cost countries when the whole -- I think the whole rest of the world is doing the opposite and moving back to being close to customer, can you talk about like why are we continuing on this low-cost country strategy when I think there's enough evidence out there that it's not a viable strategy long term because low-cost countries end up being neutralized and normalized and are no longer low cost?

Yes.

I think that's right.

So let me just clarify something.

Our strategy is to move sort of in region, for region.

So I think strategy is exactly what you said.

We're -- we want to be closer to the customers.

And I think you're also right.

There -- 20 years ago, there was a lot of low-cost countries.

That's not necessarily the case.

Now there are lower-cost countries, and we've talked about that, and our footprint rationalization is taking advantage of that.

Because keep in mind, we had heavy -- a lot of our production capability was in Germany, right?

I don't think anyone would argue that Germany is the lowest-cost option.

But we didn't necessarily move out of Germany or rationalize our footprint just around cost.

We rationalize it around customer service and what have we got to do to have the right availability and delivery performance and then still optimize the structure.

So it hasn't been optimized around low cost.

That being said, we do have an excellent facility in India, which happens to have low labor costs.

We have a facility in Vietnam, which also happens to have low labor costs and also China.

But the strategy is really driven about by what do we need to do to serve the customers and penetrate that market while we also look for opportunities to continue to improve our profitability.

Got it.

And if I may, just a quick clarification.

You didn't mention pension and the impact of low interest rates on fiscal '21.

Would you anticipate any incremental costs from pensions going into this fiscal year?

No.

So Ann, our pension plans are actually in a really good shape.

Our U.S. pension plans are actually overfunded, and they improved the funded status in FY '21 from 103% to 105%.

So we're actually generating pension income, and you see that in the other income and other expense line, and that would be around $14 million last year, and we would expect it to be around the same this year.

And there's no (inaudible) plan.

Our next question comes from Dillon Cumming with Morgan Stanley.

I guess starting off, as it kind of relates to channel inventories at the customer level, kind of curious, you've gotten a good sense across your end market mix as to kind of where production rates are settling relative to pre-COVID levels and, I guess, whether you're kind of baking in any underproduction or destocking activity here in the first half of the year?

Yes.

I think in terms of production levels, whether it be automotive or aero or really just about any end market, we haven't seen any one return to the, I guess, yet to the pre-COVID production levels.

And so as a result of that, we also feel like some destocking will certainly continue.

I think generally, there's -- as we talk to customers, they may start to see demand [single] and start to see things improve, but they're really not necessarily going to go out and order a bunch of inventory, restock the inventory in the channels until I think they get a little bit further into this thing and see how it plays out.

So we could see some more destocking for sure in the first quarter.

And we'll have to wait and see what happens in the second quarter.

It could start to improve or it could be that they're just going to use that period of time to sort of stabilize their inventory and then decide what to do.

Okay.

Got it.

And then maybe just to wrap it up as it kind of relates to energy organic growth in the quarter.

Obviously, no surprise based on what's going on with the rig count.

But I guess, as we think about kind of post COVID trends, is that a business that you see as more kind of structurally challenged going forward?

Or is the expectation that you can eventually grow that business back to pre-COVID levels?

And I guess kind of related to that, it seems like you had some share gains in wind recently that you called out.

Is there any potential there to kind of offset some of the legacy oil and gas business with share gains elsewhere?

Yes.

I think there's a couple of moving pieces.

First of all, as it relates to Infrastructure and Energy, we've been at this game for a long time, and we understand how to run the business in this sort of cyclical environment.

And a lot of the modernization projects and things we've done have helped to really lower the breakeven point of that business so that we're in a better position to sort of weather the cyclicality.

The other thing is that I think -- and we've talked about this on previous calls is our energy exposure and infrastructure is really in the U.S. And we brought in a new executive in Franklin Cardenas, who has a lot of expertise in running businesses internationally, and he's identified many opportunities, I think, to grow outside the U.S., and we're setting ourselves up to focus on that.

And one example is in mining, okay?

We had a lot of exposure to Appalachian coal, and that's all gone.

A lot of that has been permanently reduced.

But we can use that same tooling technology and other mining adjacencies, and they happen to be outside of the United States.

So there's opportunities to grow there.

And then I would also say one of the technologies that we mentioned was in the earthworks area for road rehabilitation and road construction.

So there's opportunities to grow some of the other spaces around this to give us some diversification, if you will.

And then I think Energy, as I said, it's been largely focused in the U.S., but there are opportunities to grow in other regions.

But I think the bigger opportunity is we still have technology to bring to bear in that space.

There's still plenty of business there.

A lot of the oilfield services companies are our biggest customers.

And they're still expecting us to advance our technology and looking for opportunities to still grow.

So while it is cyclical, there's still opportunities for us to gain share even in the current configuration.

Our next question comes from Joel Tiss with BMO.

I wonder if -- since -- as companies go under all this stress, anything coming out of that that gets you to think about sort of the next round of restructuring and simplification or any product lines that may not be as strong as others or anything that kind of comes out of this experience, positive or negative?

Well, I think in terms of portfolio shaping, that's something we kind of do as a matter of course.

But as it relates to this current environment, was there anything that prompted us to say -- to take another look at it, I don't think so.

But I would say it's just good business practice, Joel, we would be doing those kind of things anyway.

And so I think the main thing that this -- maybe the one thing that did come out of this crisis is it did give us an opportunity to accelerate some things that we did.

And we talked about the major acceleration from simplification/modernization of things that we had planned to do later in FY '21 to sort of pull those things forward and take advantage of the opportunity we have right now.

And I think that also equals some significant changes to what our manufacturing footprint is in Europe and Germany.

And that can be a challenging process to effect change in, but our workers' council representatives have been very cooperative, very open-minded and have -- they're good business people, and they see what's happening in the overall economic environment.

And that sort of has given everyone, I would say, a burning platform to make the necessary changes.

So if anything, Joel, it's helped us to accelerate and give us a platform to accelerate some things we were going to do anyway.

Okay.

Great.

And then any -- can you give us any examples of sort of winning in the recovery instead of -- versus winning in the downturn?

Other companies have talked about sort of how do we play offense and come out of this much better off than we thought we would have been a year ago.

Yes.

I would say that this expansion into the fit-for-purpose tools is a big opportunity for us because we're -- as I said, we've been talking to customers about this for a while.

Before we made the physical consolidation of the 2 organizations, we had sort of put Ron Port and kind of an ad hoc team together to try to target some of these customers ahead of making the structural change.

And so what we learned through that process is that customers are very interested and they're maybe even a little concerned that as they do have to ramp up quickly, they're happy to see Kennametal there to provide them not only things that we would normally provide them but this whole other space where we can support them and add another significant supplier to that effort.

Because what's going to happen is everyone gets busy real fast, and they want to make sure that they have plenty of supply chain power to help them ramp up quickly.

So that's one thing that I think that's kind of come out of this thing, and it's a big opportunity for us, which is why -- I didn't create COVID-19, but if there was any positive to it, this is a good opportunity for us to enter this type of market, I would say.

All right.

You definitely cleared something up for us, but we were all wondering if you were the one who created this illness.

Our next question comes from Adam Uhlman with Cleveland Research.

Just a follow-up on the WIDIA change here.

Is there going to be a change in the distribution strategy at all to execute this plan?

And then can you also speak to the profitability implications from -- it sounds as if you're shifting more towards mid-market or at least lower market than what you had been targeting before.

Could you maybe share any thoughts on that?

Yes.

Our approach to distribution, we have a direct and an indirect model.

And through simplification, we obviously had kind of rebalanced that thing, but we've also always said there, there wasn't a particular number we're looking for, like so much percent direct, so much percent indirect.

Our philosophy there from a commercial excellence perspective is to look at a potential market segment or a region and figure out how to get as much share as we can, and that requires the proper connectivity and sales channel.

So we'll continue to optimize the direct versus indirect equation based on that type of philosophy.

In terms of the margin issue, I would just make one point first before I talk about it in more general terms is the -- you notice there's a low-cost segment of that market, which is really provided by people that are just selling on price.

There's not much the value proposition other than we've got the lowest price.

And customers get what they pay for, and there are some customers that have a need for that type of area, but that's not an area that we're talking about.

So there's still differentiation that can happen in this fit for purpose.

And we had set some targets for margins for the Industrial and WIDIA segment in our Investor Day some 3 years ago.

And so the way we're looking at it is we believe that we can still grow in this fit-for-purpose segment and still maintain those margin targets that we had set back at our last Investor Day.

So this is not necessarily a just lower the price and you get the business, it's a little more nuanced.

There is value proposition that has to happen there, which is why we want to play in that space and not in the low-cost competing on price-only space.

Okay.

Got you.

And then back to your comments on the first quarter, granted, the visibility is obviously very low, but can -- I think you mentioned that July sales were a little bit less worse.

Could you share what that looks like?

And then if the quarter ends up being close to typical seasonality, I guess, would you expect to be able to remain profitable?

Or is that too big of a jump?

Yes.

In terms of the July number taken in isolation, we try to put it into context of -- for you guys of what the implication would mean from a Q4 to Q1 shift.

The July number just in isolation, as I said, that coupled with the month-to-month sequential pattern we saw in Q4 gives us some indication that many markets have sort of stabilized or are modestly improving.

So the July number in isolation is not really particularly helpful because we actually have a seasonal pattern inside a quarter, so you need to put it in the overall context.

So I think the best way to look at what we experienced in July is, yes, there's signs of some markets improving and some are stabilizing.

In terms of the overall profitability, we're managing the company aggressively through cost control.

Our philosophy in terms of planning for liquidity and making sure that the company weathers this COVID-19 storm is to continue to take those aggressive cost control actions.

So we feel that we're still going to be a viable company for sure even if the volumes stay at the current level.

And it's like -- I believe that there will -- we will come out of this thing at some point.

But the way Damon and I are looking at the leadership team is let's sort of plan for the scenario where it stays down for a while and make sure that the company can survive that, and we feel quite confident that that will be the case.

Our next question comes from Andy Casey with Wells Fargo Securities.

A couple more questions on this WIDIA repositioning.

First, are the competitors in this incremental white space for Kennametal your traditional competitors or other companies?

And then a couple of other questions.

Would these fit-for-use products go through a third-party kiosk?

Or do they really require direct sales support to, as you put it, reshape customer opinion of your products?

And then lastly, as direct sales, will you really be increasing your commercial presence or relying on existing network of salespeople?

And then do you expect SKU count expansion to cover the market?

Okay.

Andy, you might have to remind me of all those questions.

Let me try to knock them off here.

In terms of the competitors, it would be the traditional competitors, I guess, you could argue.

So you've got -- Sandvik has some different brand segments that are targeting that fit for purpose.

The IMC Group also does.

So I think they're the traditional competitors.

In terms of the direct versus indirect, again, we're optimizing around what is the best thing for that particular customer in that particular region.

So the fit-for-purpose, a lot of small general engineering type of customers are in that sort of -- require that broader application portfolio which are perfect for fit for purpose.

So in that sense, a lot of that will be through distribution.

But there are also a number of customers that are currently direct, that we will also sell that portfolio to once they realize that we can make that kind of an offering.

And Damon, what about the SKU count?

Do you have a comment on the SKU count?

Yes, I guess, Andy, I don't see -- there's not a material change in the number of SKUs.

I think as we go through the product life cycle management, we start to introduce new products and we take other ones out of service here longer term, you're not going to see a material change in the absolute number.

Our next question comes from Walter Liptak with Seaport.

I wanted to ask about just some of the trends that you might be seeing in the cutting tool, metalworking markets.

I think from my perspective, as we were going into June, some of the virus cases were coming down, and then things seem to have gotten worse here as we go into the summer.

Is -- are your customers kind of following that trend with maybe recoveries that start to happen, some green shoots, and then with the viruses going up, they're pulling back and that resulting in the -- some of the tone that we're hearing on the call today?

Yes.

I wouldn't -- so if I start with transportation, particularly in Americas, as I looked at what the automotive companies are doing, they seem to be still committed to ramping up their production.

And while there's been an increase in cases and particularly in the U.S., I didn't get the sense from them that they were slowing down.

They were going to continue their ramp-up.

And I think that's actually the case for aerospace and sort of the energy companies.

So I think we see aerospace, transportation and energy kind of being flat in terms of market demand from Q4 to Q1, but it's not -- it's more of macroeconomic than they're somehow pulling back now from -- or my sense is they're not necessarily pulling back from the ramp-up plans.

And then general engineering, which has got a lot of smaller size machine shops and that type of customer, there could be a little bit of them pulling back as they try to ramp up and there's increasing cases.

But my sense there is it's just maybe more macro-driven.

Their -- the demand signal hasn't quite caused them to want to ramp up.

So I don't know if the COVID-19 disruption is necessarily affecting it, but that is one thing that they're all worried about, and they're not really sure, which is why it's very difficult for them to speculate beyond even the first quarter.

So it's hard to pull that out of them because they just don't know.

Okay.

Yes, I appreciate the color.

Now I wonder -- early in the presentation, you talked about your long-term goals and how they're on track.

I wonder if you can just review those for us and maybe talk about the competitive situation.

Has anything changed with your competitors?

Are they just similarly suffering through the virus and the volumes going down?

And as the markets heal up at some point, that the market returns to prior levels?

Yes, I'll start with the last part of your question first.

The -- some -- Sandvik, of course, is a publicly traded company.

So we have some insight as to what they're experiencing.

The IMC Group, which is the next larger metal cutting supplier, that we have some competitive intelligence on.

And our summary of all that, including information from some of the smaller suppliers is that we're all down about the same amount.

It's kind of everyone is in the same boat when you look at the year-over-year declines and that type of thing.

So everyone's kind of going through this and experiencing the same thing.

In terms of our opportunities here, one of the things that we've been really focused our capital allocation and a lot of management attention was fixing -- or bringing our manufacturing capability to a point where we can be competitive again.

And so we -- that's why we're so focused on not letting anything get in our way to do that because that was sort of foundational and fundamental.

And so now the fun starts where we can start to leverage that capability in areas like the fit-for-purpose tools.

You also noticed that throughout this entire period and also -- there was also a commitment by the company to keep the investment in R&D and keep launching new products, we made the shift to focus from -- to focus less of our engineering capability and transportation, where it was difficult to get paid for that value, into a place like aerospace, where you can get paid for that value.

And while that market is down right now and probably will stay down for a while, we still feel that, that was a very good move because it still has good long-term growth prospects and it certainly has a much better profitability profile than in transportation.

So we've always been a technology company.

We're going to leverage that investment.

We've now got the opportunity around this modernized footprint, which has lower cost and better performance capability.

And those 2 things combined together, along with the right commercial excellence strategy and sales affecting the strategy, we feel sort of the sky's the limit for us.

We're in the game in here, and we're here to take share.

Okay.

Great.

And just the goals again for EBITDA or the target that you want to get to, and that's it for me.

Yes, we had set that EBITDA target of 24% to 26% when sales reached somewhere around the $2.5 billion to $2.6 billion range.

And that's still -- we still feel quite confident that those goals will be achieved.

And in fact, if you kind of look at it, just to step back, we already got about $180 million of EBITDA savings, and that was certainly on a much lower volume profile than we envisioned when we set those original targets.

Remember, the $180 million was at the lower end of our total range.

So all that combined, I got a lot of confidence that we're going to hit those EBITDA targets when the volumes come back.

Our next question comes from Steve Barger with KeyBanc Capital Markets.

Chris, first, just a clarification.

Did Kennametal participate in this fit-for-purpose market in the past and exited because of service levels or you've never been in that market even though you have the tools in the portfolio?

Yes.

I think that we participated in a little bit.

If you look at my diagram in the slides, it indicates that we've been sort of touching or skirting that area.

But I don't think -- I think they really have largely focused on the performance end.

And in fact, when you look at some of the acquisitions they've done over the years, including WIDIA which was done quite some time ago, their strategy seemed to be to pull that -- those brands into this performance segment.

So we haven't really focused on it like we're setting the organization up to do now, even though, to your point, we actually had product to penetrate that market.

Outside of imagining the short-term demand ramp, whatever that happens, can you tell us again what the competitive advantage is for WIDIA given you'll be the new entrant into a market defined by established competitors?

Yes.

We've got -- keep in mind, we're looking at existing customers that we've talked to that, when you ask them, why aren't you giving us any of this product, they're like, well, you guys don't have a product to fit that portfolio.

That's not where you guys play.

They perceive us to be excellent at helping them with their difficult machining applications and providing technical support.

But we also have a portfolio here.

And generally, customers are interested in reducing the number of suppliers.

And they have a lot of confidence in Kennametal and, trust me, in helping them with the very high precision, very process-defined applications that generally are part of factories that those processes need to run, and that's where you put your -- sort of your A team.

They're happy to give us the opportunity to work on some of this other stuff which is not quite as -- which is more broader in application, still needs to have excellent quality and work well.

So they already perceive that we have the ability to meet those requirements, they just were not aware or thinking of us in that space.

So that's the basis where we have the opportunity.

So I think it's going to be easy for us to get traction in there because we're kind of already there.

It's not like we've got to go out and meet 10,000 new customers and push our way in the door.

There'll be some of that, and I think we'll have opportunity to add new customers based on this, but our strategy at this point is just to get out of our own way and actually allow this thing to happen what would naturally happen anyway and let customers really have access to our full capability in our -- and I think our single organization approach with the commercial excellence under Ron Port, we're going to be nimble enough to be able to take advantage of those opportunities, which are really already there for us.

We just had to set ourselves up to go after them.

So if you're selling some of the WIDIA tools into performance tools right now and you're going downstream for lack of a better word to fit for purpose, will that affect pricing on the current sales to the performance tool customers?

No.

We've got to be careful that, that doesn't happen.

And our pricing discipline process that we started back in 2018, which is really a value proposition-based pricing, those controls, I feel pretty good, are in place.

And so just lowering the price, that would kind of erode -- that would not be a good thing, and that's not something we're going to do.

Yes, I agree.

Yes.

So -- and we're going -- we're even going to price the fit-for-purpose based on value.

But it's reasonable for customers to -- when they look at the broader applications, there's still a great value proposition.

You've got a tool that can cut 3 or 4 different metals.

You have -- you don't have to buy a different tool for each specific type of metal.

Now that may make sense in the performance end of things because that addition, that specialized tool give you so much productivity on a critical part that it's worth it.

But there's still a great value proposition in being able to use one tool for multiple services, and we plan on pricing that accordingly.

Understood.

And one quick one, Damon.

Slide 13, do you expect to have positive free cash flow for FY '21 after CapEx and cash restructuring?

I think, Steve, it's a lot -- I guess I would tell you, a lot of that is going to depend on how the markets unfold.

I think our sales is going to be the biggest driver.

As I look at what we tried to explain to you guys, the areas on the chart that talk about cash flow, between lower capital expenditures next year, lower cash taxes, higher depreciation and slightly higher cash restructuring, those numbers in total are about $115 million better year-over-year.

The bigger driver is going to be what the sales are for the full year and then what the corresponding impact is on working capital, but I'm going to leave that one to you.

This concludes our question-and-answer session.

I would like to turn the conference back over to Chris Rossi for any closing remarks.

Thanks, operator.

Thanks, everyone, for joining the call.

As I said, we really feel quite good about the progress we made this year despite the challenging environment.

Our efforts on simplification/modernization and cost controls, as you can see from our numbers, have allowed us to protect margins and put us in a good liquidity position.

And also, we're focused on executing our strategy and preparing the company for growth as markets recover.

So we certainly appreciate your interest and support at Kennametal and reach out to Kelly if you have any follow-up questions.

Thank you very much.

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