Kennametal Inc. (KMT) Q4 2020 Earnings Report, Transcript and Summary

Good morning. I would like to welcome everyone to Kennametal's Fourth 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.

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, Finance and Corporate Controller; Franklin Cardenas, President, Infrastructure business segment; Pete Dragich, Chief Operating Officer in 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 lineup for questions. At this time, I would like to direct your attention to our forward-looking disclosure statement. Today's discussion contains comments that constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve a number of assumptions, risks and uncertainties that could cause the company's actual results, performance or achievements to differ materially from those expressed in or implied by such forward-looking statements. These risk factors and uncertainties are detailed in 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 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 specifically 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 in the 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'm pleased with our team came together to tackle the challenges. COVID-19 protocols we successfully implemented continue to allow us operate safely and serve customers globally. While all our facilities operated throughout the fourth quarter, with the notable exception of our Bangalore India plant, which was closed for approximately six 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 help align our costs more closely with demand and finish the year on a strong liquidity position despite the challenging environment. In addition, we continued 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 six since inception of the program, and is in line with our original target of five to seven 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 through financial performance throughout the economic cycle and improved 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 impart 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 buyers 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 expand our reach into a large segment of Metal Cutting that we previously had not focused on. 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. 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. Just in 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's 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 would translate to Q2 and beyond. So while many customers are hopeful for a continued improvement, they seem to feel improved due to the uncertainty of COVID-19, the plan for demand to be stable or only modestly improving through the end of calendar year 2020. 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 rationalized footprint with six 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 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 fueled growth. For example, in fiscal year '20, we won a five-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've 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 1st, 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 needs segment within Metal Cutting that significantly overlapped 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, and 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 customers’ 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. Built from a customer perspective and this is true across all 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 the 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%, 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 guilty on the effective tax rate as we finalize 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. Effective 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 under absorption. 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 FY20 simplification/modernization savings to $0.46. As Chris mentioned, our expectations for FY21 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 FY20 restructuring actions delivered approximately $33 million in run-rate annualized savings at the end of FY20. FY21 restructuring actions are expected to contribute an additional $65 million to $75 million of annualized run-rate savings by the end of FY21. The total year results in detail and the EPS bridge can be found in the appendix. Slides 9 through 11 detailed 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 in 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 under absorption, partially offset by reduced variable compensation and other cost control actions, increased simplification/modernization benefits, and then 90 basis point benefit from raw materials. On a sequential basis, adjusted operating margin decreased 540 basis points as lower volume 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 country wide COVID-19 shut down 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 or 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 large 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% remain 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 under absorption, 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 $200 million to $300 million notes maturing in February of 2022 and June of 2028, as well as a US $700 million revolver that matures in June of 2023. At fiscal year-end, we had combined cash and revolver availability of approximately $800 million. At quarter end, we we're 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 cost. 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 moments providing some additional thoughts regarding FY21 for modeling purposes. Turning the Slide 13. This slide shows how certain factors are expected to affect EPS and free operating cash flow during each half of FY21 on a year-over-year basis. As I mentioned earlier, we expect increased simplification/modernization benefits of approximately $80 million in FY21. 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 FY21, relative to the first half of FY20. However, as we look at the second half of FY21, the temporary cost control actions implemented in FY20 in the reversal of variable compensation, which we currently do not expect to repeat will create a year-over-year year headwind. As you'd expect from us, we will remain diligent in managing our costs, 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 face in the beginning of FY20 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 FY20. We currently expect our full-year tax rate in FY21 to be similar to the 33% adjusted effective tax rate we saw in FY20, 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 and earnings begin to improve in the second half, particularly in the US, our tax rates should improve. As we get back to more normalized environment, we still expect their long-term effective tax rate to be in the low 20s. Regardless of the effective tax rate, we expect cash taxes in FY21 to be approximately $10 million less than the $37 million paid in FY20. 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 impart on how market conditions evolve over the next several quarters. For the first half of FY21, 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 used as well, given the significantly depressed accounts receivable balance in Q4 of FY ‘20 and reduced accounts payable from decreased capital spending in FY21. We will continue to be diligent and 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 FY21, 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 fiscal year 2021, we will continue to focus on the things that we can control, so that we 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 and when markets recover and to achieve our adjusted EBITDA profitability target when sales reach a topline range of $2.5 billion to $2.6 billion [ph]. With that operator, please open the line for questions.

[Operator Instructions] Our first question comes from Stephen Volkmann with Jefferies. Please go ahead.

Hey, good morning, everybody.

Good morning, Steve.

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 lay out relative to ‘21. So I guess you should get a sense of benefits from modernization in ‘21. That's the number, not the run rate, correct?

That's correct.

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

Yes, we can, Steve. In FY20 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 FY21 -- in the second half of FY21.

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 ‘21 number ballpark?

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 FY21 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 worked through this stuff maybe?

So I guess what I would tell you, Steve, is 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 FY21.

Okay, that makes sense to me. All right, thank you. I will pass it on. I appreciate it.

Thanks, Steve.

Our next question comes from Julian Mitchell with Barclays. Please go ahead.

Hi, good morning. Maybe just the first question, you've talked in sort of dollars and cents around some of the margin for 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 six 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 weight of the balance of the new fiscal year?

Yeah, I mean I think, just I’ll lay the foundation here and Damon maybe he can provide some details inside this. But, you're right. Decremental margins were 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 decrements 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 we've seen before. Damon, if you want to add anything to that to dig inside those numbers, please do.

Yeah. I think Julian if you look at the first half of FY21, our decrements were likely be better than our average rates because we have two 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 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 decrements. As Chris said, we lever it 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.

Thanks. And on that point Damon, looking at temporary costs in aggregate for fiscal ‘21, we should assume that they were slight negative for the year as a whole year-on-year, is that fair?

Yeah. 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, when 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 have said, is the temporary actions we have right now we're 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'll 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. But I would have thought that that mix 30s ratio could bend down back towards 30% or so. And that's occurring alongside where it’s still a double-digit revenue reduction. So maybe just help us understand why the working cap -- with those two things, why it's not a cash tailwind?

Yeah, I think Julian, so what we're looking at here in the first half is a couple 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're 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 from your end of FY20 through the first half of FY21 is going to be a significant to reuse. And then if you look at the receivables given where we finish 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.

Great, thank you.

Our next question comes from Steven Fisher with UBS. Please go ahead.

Thanks. Good morning. 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? Curious on what the signals and triggers you need to see to bring those temporary costs back? And how long you need to kind of see those signals sustained.

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 kinds of disruptions, if it starts to get worse that would be something that will 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 our end market demand materializes as we go through the first six 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?

Yeah. Let me start with the now piece. As we 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 a good market share of customers who are using the Kennametal tooling. And they primarily look at us as a supplier for their very specific high-performance applications where we can finetune 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 meet. So we don't require, a lot of reach out to brand new clusters and 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 kinds of things. And so prior to modernization and as you know one of the reasons, we did modernization is because we were 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 really 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?

If we look at the voice of the customer, there is a lot of near end opportunities that we can target. We have some refinement to do our product portfolio, but that will happen overtime, 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 two 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 this capability. So we feel and get traction pretty quickly.

Okay. Thanks very much.

Our next question comes from Ann Duignan with J.P. Morgan. Please go ahead.

Hi, good morning, everybody. Just on the video and Industrial strategy, I mean, when those business were separated, I think a lot of those questions of strategic rationale. I'm wondering if Widia could really compete on its own and in its own right. Are you acknowledging today that that this was a flawed strategy and is your hope that you will regain share -- lost market share as opposed to gaining market share at fresh?

Yeah, and thanks for the question. I think -- I would characterize it as follows. When Ron De Feo, who was my predecessor, came in and set that up, he recognized a couple key things. He's looking at the technology that underlines the Widia portfolio and the brand recognition and he's talking to customers, he's like there's a lot here. This actually could be a diamond in the rough. And his philosophy was if I make it a P&L and part start to put resources to really go on 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. So what we've just moved to now and it's actually a combination 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 two 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 two bites of the same apple, it's actually going to be two separate apples that we uncovered. So I feel like, I'm not sure we would have gotten to the same strategy had we not started from the point that we were? Nevertheless, we're looking forward and I think it's a 40% larger opportunities than we've ever targeted before. And as I mentioned in my previous comments, we're kind of walking right past it, okay. Many customers want us to do this. They're just thinking that this is not something that we're interested and we've never focused on it.

Okay. That's helpful, I guess. And then in the same vein, just this whole 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, then moving back to being close to customer. Can you talk about like, why are we continuing on this low-cost countries strategy when I think first enough evidence that it's not a viable strategy long-term, because low cost countries end up being neutralized normalized and are no longer low cost.

Yes, I think that's right. So let me just clarify something. Our strategy is to move in region for region. So I think strategy is exactly what you said. We want to be closer to the customers. And I think you're also right, 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 has taken advantage of that. Just keep in mind, a lot of our production capability was in Germany. And 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 rationalized it around customer service, and what do 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 lower -- 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 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 our pension plans are actually in a really good shape. Our U.S. pension plans are actually over funded, and they improve the funded status in FY21 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 plan to…

Okay, thanks for sharing that [ph]. Thank you, I'll leave it there. I appreciate it.

Our next question comes from Dillon Cumming with Morgan Stanley. Please go ahead.

Hey, good morning guys. Thanks for the question. I guess starting off as you kind of released the channel inventory at the customer level, kind of curious who’s gotten a good sense across our end market mix as to where production rates are settling relative to pre-COVID levels? And I guess whether you’re kind of baking in any under production or de-stocking activity here in the first half of the year?

I think in terms of production levels, whether it be automotive or aero or really just about any end market, we haven't seen anyone return I guess yet to the pre COVID production levels. And so, as a result of that, we also feel like some de-stocking will certainly continue. I think generally there's as we talk to customers, they may start to see demand, they start to see things through but they're really not necessarily going to go out and order a bunch of inventory or 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 de-stocking for sure in the first quarter. And we’ll have to wait and see what happens in the second quarter and 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. Thanks Chris. And then maybe just to wrap it up, that's going to relate to the energy organic growth in the quarter. Obviously, no surprise business was going on with the recount, 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 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 have some maturity and then when recently you called out, is there any potential there to kind of offset some of the legacy of oil and gas business share gains elsewhere?

Yeah, I think there are 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 products 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, 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. We have 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 in other mining adjacencies and they happen to be outside the United States. So there's opportunity 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 is 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 the 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 are still opportunities for us to gain share even in the current configuration.

Okay, got it. That's helpful. Thanks for the time Chris.

Our next question comes from Joel Tiss with BMO. Please go ahead.

Hey guys, how's it going?

Hey, Joel.

I wonder if since as companies go under all this stress and 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, take another look at it? I don't think so. But I would say is just good business practice, Joel, we would 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 and acceleration from simplification, modernization of things that we had planned to do later in FY21 to sort of pull those things forward and take advantage of the opportunity we have right now. And I think that also includes 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 has helped us to accelerate and give us a platform to accelerate some things that we’re going to do anyway.

Okay, great. And then can you give us any examples of sort of winning in the recovery instead of -- versus winning in the 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 as I said, we've been talking to customers about this for a while. And before we made the physical consolidation, the two organizations we had put Ron Port and 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 has 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, thanks very much. You definitely cleared something up for us. We were all wondering if you were the one who created this illness. Thank you.

Our next question comes from Adam Uhlman with Cleveland Research. Please go ahead.

Hi, guys. Good morning. 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 kind of rebalance that thing. But we've also always said there, it wasn't a particular number we were 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 region and figure out how to get as much share as we can. And that requires the proper connectivity in 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 if 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 to other than we've got the lowest price. And customers get what they pay for and there's 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 three 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 get the business, it's a little more nuanced the risk 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. Thanks. And then back to your comments on the first quarter granted the visibility is obviously very low. But can you -- I think you mentioned that July sales were a little bit less worse. Could you share what that looks like? And then if -- 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?

Yeah. In terms of the July number taken in isolation, we try to put it in the context for you guys of what the application would mean from a Q4 to Q1 shift. The July number just an isolation. As I said, we've 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 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 continue to take those aggressive cost control actions. So we feel that we're still going to be a viable company for sure. Even at the volume stay at the current level. And it's like -- I believe that 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 then we feel quite confident that that'll be the case.

Okay. All right. Thanks.

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

Thanks a lot. Thanks for squeezing me in and good morning, everybody. A couple more questions on this video repositioning. First are the competitors in this incremental whitespace for Kennametal your traditional competitors or other companies? And then a couple 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 reshaped customer opinion of your products? And then lastly, if direct sales, will you really be increasing your commercial presence or relying on existing network of salespeople? And then do you expect SKU counting expansion to cover the market?

Okay. And 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 is 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 that we also sell that portfolio to, once they realize that we can make that kind of an offering. And Damon, what about the SKU count? I am not -- do you have a comment on the SKU.

I guess, I don't see -- there's not a material change in the number of SKUs. I think as we go through the product lifecycle management and we start to introduce new products and we take other ones that are out of service here longer term, you're not going to see a material change in the absolute number.

Okay, thank you very much.

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

Hey, good morning, guys.

Good morning, Walt.

Want 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 are to happen, some green shoots and then with the viruses going out they’re pulling back and that resulting in some of the tone that we're hearing on the call today.

Yes, I would -- 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 to 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, 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 are somehow pulling back now from, or my sense is that they're not necessarily pulling back from their 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 increase in cases. But my sense there is it’s just maybe more macro driven. 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. And so it's hard to pull that out of them because they just don't know.

Okay, thanks. I appreciate the color. Now, I wonder, early in the presentation, you talked about the long-term goals and how they're on track. I wonder if you could just review those for us and then maybe talk about the competitive situation. Has anything changed with your competitors or 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. 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 in summary of all that, including information for some of the smaller suppliers, is that we're all down about the same amount. It's kind of everyone's in the same boat. When you look at the year over year declines in 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 that's why we're so focused on not letting anything get in our way to do that, because that was 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 notice that throughout this entire period, and it 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 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 two things combined together along with the right commercial excellence strategy, and sales effectiveness strategy, we feel sort of the sky's -- sky's the limit for us. We're in the game here and we're here to take share.

Okay, great. Thanks. And just the goals again for EBITDA the target that you want to get to? And that's it for me. Thank you.

We have set that EBITDA target of 24% to 26% when sales reached somewhere around the $2.5 billion to $2.6 billion range. And we still feel quite confident that those goals will be achieved. And in fact, if you kind of look at it, just step back, we've already got about $180 million of EBITDA savings. And that was certainly on a much lower volume profile than we had envisioned when we set those original targets. Remember the $180 million was at the -- 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 of KeyBanc Capital Markets. Please go ahead.

Hi. Good morning.

Good morning.

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've participated in a little bit. If you look at my diagram and the slides, it indicates that we've been sort of touching or skirting that area. But 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 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, whenever that happens. Can you tell us again, what the competitive advantage is per video, 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 are not you giving us any of this product. They're like, well because you guys don't have products 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 this -- we also have a portfolio here and generally customers are interested and reducing the number of suppliers. And they have a lot of confidence in Kennametal and trusting 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 A team. They're happy to give us the opportunity to work on some of the search stuff, 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 already there. It's not like we 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. 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 have 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 back a little 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. In 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 want to do.

Yeah, I agree.

Yeah, and 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 got a tool that can cut three or four different metals. You don't have to buy a different tool for each specific type of metal. Now that may make sense in the performance and the things because that addition, that specialized tool gives you so much productivity on a critical part that it's worth it, but there’s still a great value proposition. And we only 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 FY21 after CapEx and cash restructuring?

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

Okay, thank 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. And 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 to Kennametal and reach out to Kelly if you have any follow up questions. Thank you very much.

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