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Kennametal Inc (NYSE:KMT)
Q1 2020 Earnings Call
Nov 5, 2019, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. I would like to welcome everyone to Kennametal's First Quarter Fiscal 2020 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Kelly Boyer, Vice President of Investor Relations. Please go ahead.

Kelly Boyer -- Vice President of Investor Relations

Thank you, operator. Welcome everyone and thank you for joining us to review Kennametal's first quarter fiscal 2020 results. Yesterday evening we issued our earnings press release and posted our presentation slides on our website. We will be referring to that slide deck throughout today's call and a recording of the call will be available for replay through December 5th.

I'm Kelly Boyer, Vice President of Investor Relations. Joining me on the call today are Chris Rossi, President and Chief Executive Officer; Damon Audia, Vice President and Chief Financial Officer; Patrick Watson, Vice President, Finance and Corporate Controller; Alexander Broetz, President, Widia business segment; Peter Dragich, President, Industrial business segment; and Ron Port, President, Infrastructure 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 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.

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

Christopher Rossi -- President and Chief Executive Officer

Thank you, Kelly. Good morning everyone and thank you for joining the call today. Starting on Slide 2 in the presentation deck, our results in the first quarter were below expectations, due to global market conditions deteriorating more significantly than we had anticipated, primarily in the transportation, energy and general engineering end markets. Organic sales declined by 11% versus 10% growth in the first quarter last year. Adjusted EBITDA margins decreased 820 basis points to 10.9% and adjusted EPS decreased to $0.17 versus $0.70 in the prior year quarter. Decreases in margin and EPS were the result of three main factors. First, due to the rapid change in end markets organic sales declined, magnified by unfavorable labor and fixed cost absorption. We are adjusting to the lower volumes by reducing overtime and temporary workers and further adjusting production to the demand outlook. Of course, the full benefit of these actions will not be reflected immediately.

Secondly, as expected and discussed on our fourth quarter earnings call, tungsten prices have come down quickly. To give you an idea of the magnitude of the drop, tungsten was approximately $270 for most of fiscal year 2019 and then dropped in the first quarter of fiscal year 2020 to approximately $200. The effect is the temporarily depressed margins in the short term, until the higher priced inventory moves through the P&L. This accounted for approximately 360 basis points of the 820 basis point reduction in EBITDA margin. We expect this effect will continue in Q2 and then abate in the second half of the year.

And finally, as expected, we are experiencing, under absorption due to footprint rationalization. We expect this effect to decrease as plants are closed later this year and next. Our operating expenses in dollar terms decreased 7%. However, in percentage of sales terms, increased slightly to 20% as a result of the decrease in sales. Our target for operating expense margin remains at 20%.

We are focused on improving financial performance throughout the economic cycle. Q1 simplification, modernization contributed an incremental $8 million or $0.07 year-over-year to our EPS, on top of the $40 million achieved last year and roughly $10 million achieved the year before that. So, the further benefits from footprint rationalization are still to come and our weighted for the back half of the year.

Looking ahead, in addition to our focus on cost out actions, we continue to make gains on our growth initiatives. For example, our high volume, high margin products grew low single digits in the Americas despite the more challenging market environment. In addition, we continue to get good traction on new products, which I will discuss in just a moment. Though we are encouraged by these results in our growth areas of focus, fundamental weakness in global industrial activity increased during the quarter and therefore we've reduced our expectation for organic growth this fiscal year. We are no longer assuming a modest recovery in the second half of the year in transportation and energy, but rather expect the year will simply follow a more normal, seasonal pattern from the current lower market environment.

As I said, our focus is on improving performance throughout the entire economic cycle. So we are driving forward with our simplification/modernization program. We continue to make good progress on restructuring actions and in fact recently ceased production at a facility in Germany and have moved work to lower cost facilities. We expect the benefits from this and other pending plant closures to increase in the second half of this fiscal year. By the end of the year, our FY20 restructuring actions are expected to reach a run rate savings level of $35 million to $40 million. Fiscal year 2021 restructuring actions will bring an additional $25 million to $30 million in run rate savings by the end of fiscal year 2021. Also, our second half profitability will benefit as the effects of higher raw material costs and manufacturing inefficiencies from footprint rationalization abate.

Now let's turn to Slide 3 for a comparison of our current fiscal year forecast to historical results with similar revenue levels. As you can see on the left-hand chart, our adjusted EPS for fiscal year 2020 is expected to be significantly higher than previous years with similar sales. This is primarily the result of the simplification/modernization work already completed including structural cost out actions, coating, powder and SKU reductions, strategic pricing and portfolio rationalization. And remember these numbers do not include the full run rate effect of the plant rationalizations that I just mentioned.

On the right-hand chart, we show the expected improvement in our forecasted cash flow from operations that is implied in our outlook. Again, this significant increase is due to the work done to date to permanently remove cost out of the system through simplification/modernization. Its also important to recall that this year's cash flow is reduced by the temporary restructuring costs associated with footprint rationalization.

On Slide 4, we highlight some of our recent product launches. We are continuing to advance our growth initiatives even in this period of lower end market demand in part through new product introductions. Our growth areas of focus include Aerospace and General Engineering, the HARVI Ultra 8x is used by Aerospace customers for rough milling titanium and offers market leading metal removal rates. This tool was recently named a 2019 R&D 100 Award Finalist which is a testament to the innovation of the design.

The HARVI TE is an hand mill used by general engineering customers, it delivers up to 50% increase in productivity and tool life depending on the application. Another new product, which is also focused on Aerospace growth is the KOR 5, an end mill for aluminum machining which delivers a productivity increase of two times. And finally, the RIQ Reamer is focused on the specific growth area of electric vehicles. This tool is used in precision machining operations for drivetrains and is produced using Kennametal's proprietary additive manufacturing technology, which lowers the weight of the tool, allowing for faster setup and machining times. Those are just some examples of the innovations that we are bringing to the market.

And with that, I'll turn it over to Damon, who will review the first quarter numbers in more detail.

Damon Audia -- Vice President and Chief Financial Officer

Thank you, Chris and good morning everyone. I will begin on Slide 5 with a review of our operating results on both the reported and an adjusted basis. As Chris previously mentioned, demand deteriorated more significantly than previously expected across our end markets with the exception of Aerospace. This resulted in sales declining 12% year-over-year or negative 11% on an organic basis to $518 million. Foreign currency had a negative effect of 2% that was partially offset by a benefit from business days of 1%. Adjusted gross profit margin of 27.5% was down 850 basis points year-over-year. This performance was largely the result of the timing of higher priced inventory that represented roughly 360 basis points and the effect of lower volumes. As discussed last quarter, we expect the effect of the higher priced inventory to abate in the second half of the year.

Adjusted operating expenses were down 7% year-over-year and represented 22% of sales, only a 100 basis point increase on a 12% decline in sales. This reflects the continued focus on strong cost controls. Adjusted operating margin of 4.7% was down 970 basis points year-over-year against our toughest first quarter comparable since fiscal year 2012. Reported EPS was $0.8 and $0.17 on an adjusted basis, compared to $0.68 and $0.70 in the prior year period respectively.

Turning to Slide 6. I will spend a couple moments addressing the drivers of our EPS performance this quarter. Operations were negative $0.60. This reflects the effect of significantly lower volumes, as well as the temporary manufacturing inefficiencies related to our pending plant closures. In addition, it's worth noting that the temporary higher raw material cost affected the year-over-year performance by approximately $0.19. Simplification/modernization initiatives contributed $0.07 of the improvement and we expect these benefits to accelerate as we progress through the second half of the fiscal year, which I will discuss in more detail later.

Now on Slide 7 through 9 I'll provide some high level color around the performance of our segments this quarter. Industrial sales in Q1 declined 11% organically against a positive 10% in Q1 of fiscal year 2019. From a regional standpoint, this was felt mostly in Asia Pacific with the decline of 15%, followed by EMEA and America's down 12% and 7% respectively. Our end markets were challenged, mostly in Transportation and General Engineering, driven by the decelerated global manufacturing in Auto production activity.

Aerospace continues to be a bright spot for us and though it was down 1% year-over-year, we would have experienced slight growth excluding some non-reoccurring package deliveries. We continue to see Aerospace as a key growth end market. As Chris mentioned, we continue to introduce new products like the HARVI Ultra 8x and the KOR 5 specifically designed for that end market. This gives us further confidence that we can maintain our growth in this strong end market. The decline in volume was the major contributor to adjusted operating margins coming in at 9.8% compared to 18.3% in the prior year. The effect of higher raw material cost represented approximately 140 basis points of the year-over-year decline.

Turning to Slide 8 for Widia. Sales declined 10% organically against the positive 11% in the prior year period. Regionally, the performance was mixed as EMEA was flat year-over-year, while both America and Asia-Pacific experienced declines of 3% and 24% respectively. The segment faced similar macro challenges as Industrial during the quarter, however, it's worth noting that we saw a positive in some products that support the Aerospace industry in both EMEA and Americas. Adjusted operating margin for the quarter was a loss of 4.1%. The move to the other business segments, higher raw material cost affected Widia's operating margins by approximately 430 basis points this quarter, but will abate in the second half.

Turning to Infrastructure on Slide 9. Organic sales declined 11% against positive 10% in the prior year period. Regionally, sales were up 9% in EMEA, while Asia-Pacific and Americas were down 11% and 14% respectively. By end-market, these results were primarily driven by energy, which was down 24% reflecting declines in the US land drilling rig count. General engineering and earthworks were down 4% and 1% respectively. In Earthworks share gains in Americas and South Africa were outweighed by lower market activity in China.

Infrastructure recorded an operating margin loss of 0.5% this quarter compared to a profit of 11.4% in the prior year period. Remember, Infrastructure is significantly more sensitive to changes in raw material costs in two ways. First, they are a larger percentage of cost of goods sold. This was particularly evident in the quarter as higher raw material costs affected margins by approximately 660 basis points. Second, certain customers prices adjust based on spot market prices of materials that can create a temporary timing difference which further affected year-over-year changes in operating margins.

Looking forward, we expect to see an improvement in Infrastructure's profitability as higher raw material cost abate in the second half and align with customers pricing. Additionally, we expect to see further benefits in Infrastructure's margins as we finalize the closure of our Irwin facility, as well as the recently announced New Castle divestiture.

Now turning to Slide 10 to review our balance sheet and cash flow. As expected, primary working capital decreased both sequentially and year-over-year to $686 million. On a percentage of sales basis, our primary working capital was 32.1%. This slight increase is the result of more modest inventory reductions versus our expectations as sales decline more rapidly in the quarter than expected. Additionally, we continue to hold safety stock to support our footprint rationalization initiatives which will diminish over time. Capital expenditures increased to $72 million compared to $42 million during the prior year period.

As Chris previously stated, our simplification/modernization efforts are on track. Our first quarter free operating cash flow was negative $45 million, consistent with normal seasonal patterns. This represents a year-over-year decline of $12 million, but on increased capital expenditures of $30 million. In the context of our updated outlook, we expect our free operating cash flow to improve throughout the year and be positive in the second half of our fiscal year.

Our cash balance ended the quarter at $114 million. We remain well positioned in regard to our debt and overfunded US pension plans. We continue to have no borrowings on our $700 million revolver and have no significant debt maturities until February 2022. Dividends were approximate flat year-over-year at $17 million and we remain committed to our dividend program. Overall, I'm confident in the strength of our balance sheet, our cash position and unutilized revolver coupled with our cash flow generation allows us to drive forward our simplification/modernization initiatives. This will ultimately improve our financial performance and cash flows throughout the economic cycles. Our full balance sheet can be found on Slide 15 in the appendix.

Turning to Slide 11 for our FY 2020 outlook. The current outlook expect a delay in the global recovery that we had previously anticipated to occur in the second half. To reflect this, we now assume only normal seasonality for the year, while also reflecting easier comparables in the second half. Our revised organic growth outlook is now in the range of negative 9% to negative 5%. Our adjusted effective tax rate is expected to be in the range of 22% to 24%. This result in an updated adjusted earnings per share outlook of $1.70 to $2.10.

With regard to the cadence of our earnings, we now expect roughly 80% of our full year earnings to occur in the second half of the year. Unlike our sales outlook, this does not follow our normal seasonality and I'll walk you through some of the primary drivers. As we detailed on our last call, the temporary effect of higher raw materials is working its way through our P&L. Given the current prices of raw materials, this effect is expected to abate in the second half. Further, we are on plan with our simplification/modernization efforts including the previously announced plant rationalization work. The run rate benefits of these pending plant closures and related under absorption effects are more favorably weighted to the back half of the year as we continue to execute on these actions. To that point, as Chris mentioned, we recently ceased production at our German manufacturing facility and will begin to see the full run rate savings from this in the second half.

Moving on to free operating cash flow. First, as already discussed, we are proceeding with our simplification/modernization plans and maintaining our prior capital spending forecast of $240 million to $260 million. Our updated outlook assumes free operating cash flow in the range of $20 million to $50 million to reflect our lower earnings expectation. We remain focused on the execution of our simplification/modernization initiatives to deliver increased profitability and improved cash flows through the economic cycles.

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

Christopher Rossi -- President and Chief Executive Officer

Thank you, Damon. Turning to Slide 12, let me take a minute to summarize the quarter and the fiscal year 2020 outlook. As we discussed already, the slowdown we experienced in the first quarter was more than we anticipated in our original fiscal year 20 2020 plan. However, our updated sales outlook is in line with current market conditions and no longer assumes a second half recovery in transportation and energy, but rather reflects a more normal seasonal pattern from the current lower market conditions.

Strength of our balance sheet and cash position allows us to continue with our simplification/modernization initiatives, which are directed at improving customer service and our profitability through the economic cycle. Finally, I remain confident we will achieve the structural cost savings needed to meet our adjusted EBITDA profitability target when sales reach the targeted range of $2.5 billion to $2.6 billion.

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

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions]

Our first question comes from Julian Mitchell of Barclays. Please go ahead.

Julian Mitchell -- Barclays Capital, Inc. -- Analyst

Hi, good morning.

Christopher Rossi -- President and Chief Executive Officer

Good morning Julian.

Julian Mitchell -- Barclays Capital, Inc. -- Analyst

Morning. I wouldn't normally drilling into sort of quarterly numbers, because I know you don't guide by quarter, but just given the sort of seasonality shift and the guide down just now. Just wanted to try and hone in on Q2, specifically for a second. So I think what you're guiding for is around about a 10% organic sales drop similar to Q1 and around sort of $0.20 of adjusted EPS. So may be a decrement al margin that's slightly narrower than what you had in Q1, but not significantly. Is that a fair summary of how you're thinking about Q2?

Christopher Rossi -- President and Chief Executive Officer

Yes, it's a fair summary, Julian, for sure.

Julian Mitchell -- Barclays Capital, Inc. -- Analyst

And how do you think about the decremental margins moving in the March and June quarters, how quickly do they sort of normalize? And I guess is the assumption that by Q4 the margins are flat year-on-year even if sales are still dropping?

Christopher Rossi -- President and Chief Executive Officer

Yes, I mean if you look at the numbers this quarter, I think the decremental margin was around 87% --

Julian Mitchell -- Barclays Capital, Inc. -- Analyst

Yes.

Christopher Rossi -- President and Chief Executive Officer

-- and that of course is driven by -- it wasn't completely unexpected driven by lower volumes. We have a temporary raw material cost effects and then as we mentioned in our call last time, this is a transition year for Kennametals, we have a lot of manufacturing efficiencies built in, associated with modernization and plant closures. But if you take out the raw material effect, the decremental was sitting somewhere around, say, 55%. So in general, we feel that that decremental margin was in line with what we would expect especially given that the volume was a lot lower in the first quarter than we had anticipated. And as you know, it's hard to turn these factories on a dime and takes -- it takes some time to adjust the volume, which we're working on. So, the good news is that -- that situation should improve as we advance through the year. And for sure, as we had mentioned on our first call, the benefits associated with plant closures and ramping up modernization, those are going to continue to increase and also by the same token, the inefficiencies associated with putting those programs in place will decrease. So we're looking forward to improve margins, as we progress through the year based on those things.

And then the other thing I think to think about, Julian, is that simplification and modernization is really focused on changing the break-even point of the company, as well as driving higher customer service and so if the company is going to -- as we advanced modernization, its ability to sort of -- whether these changes and demand either up or down, it's improving as we advance modernization.

Julian Mitchell -- Barclays Capital, Inc. -- Analyst

Thanks. And my last question, just a quick one around inventory levels. We hear very mixed things, depending on which short-cycle industrial company we speak to. Just wanted your perspectives on how inventories stand today? Your distributor partners, your Em's and yourself versus normal seasonal levels?

Christopher Rossi -- President and Chief Executive Officer

Yes. There is no question, for example, on the Industrial and Widia side business, in the Americas, there certainly has been destocking throughout the first quarter and we expect that will continue in Q2. On the Infrastructure side, there has been some destocking in hardrock mining and surface mining and we also see destocking in oil and gas. So I think that the distributors and the end-users are sort of understanding that this is an uncertain environment and they are sort of pulling a lever that we need to -- we'd rather to be prudent in terms of inventory management while we sort of wait and see how this plays out.

Julian Mitchell -- Barclays Capital, Inc. -- Analyst

Great, thank you.

Christopher Rossi -- President and Chief Executive Officer

Thanks. Julian.

Operator

Our next question comes from Ann Duignan of JP Morgan. Please go ahead.

Ann Duignan -- JPMorgan -- Analyst

Yes, hi, good morning. Can you just address the fact that you expect that tungsten raw material prices to abate in the second half. That's what you were saying a quarter ago. But now we're looking at much lower volume. So, does that mean it's going to take longer into Q3 for these costs to abate?

Christopher Rossi -- President and Chief Executive Officer

Yes. Let me just make a couple of general comments. As you know, we buy this inventory, we source both internally and externally. And the length of that supply chain or how the inventory stays in the system kind of depends on that factor as to how well we can purge [Phonetic] it. We have a good handle on what cost is currently sitting in the inventory now and we run that through our model, so we're confident that we'll start to see the abatement in the second half and including Q3 and Q4. So, in terms of the financial benefit to the second half, we have a lot of confidence in that. In terms of how it actually would transition through the P&L, that does vary on different factors, but our current view right now is that we feel like it will benefit in the second half. And Damon, is there anything else you would like to add to that in terms of how the material cost is going to change over time?

Damon Audia -- Vice President and Chief Financial Officer

Well, I think Ann, as Chris alluded to, we know given the lead times our inventory we have very good visibility looking out into the second half of the year. And so with tungsten prices currently where they are, we know that it will turn into a tailwind for us moving into Q3 and Q4. So with a fairly high level of confidence.

Ann Duignan -- JPMorgan -- Analyst

Okay, and I suppose my second question is around the same risk, the free operating cash flow, $20 million to $50 million, what has to happen to working capital in order to achieve that goal and is there any risk that you just can't liquidate the inventory because the demand isn't there and we end up with negative free operating cash flow?

Christopher Rossi -- President and Chief Executive Officer

We look at our -- the current outlook I think is based on a realistic view of what we think is going to happen in terms of the sales volume. So we are certainly planning on inventory levels dropping, so that is driving some of the working capital. But our current outlook was in that minus 5% to minus 9% sales and the free operating cash flow is well inside that range if that's what volumes turn out to be. So, I don't feel like we're going to be sitting on a lot of inventory based on that sales forecast.

Ann Duignan -- JPMorgan -- Analyst

Do you have an inventory reduction dollar amount embedded in that market?

Christopher Rossi -- President and Chief Executive Officer

We do.

Damon Audia -- Vice President and Chief Financial Officer

I think what we said at the end of the -- we finished the fiscal year-end with just over 32% than what we've said on our last calls, our goal is to try to drive down, getting closer to that 30%. Obviously, with the change in our sales outlook we're continuing to look at what that percent is. But there is an inventory reduction that was planned at the start of this year and it will be it's further increased as a result of the lower sales.

Ann Duignan -- JPMorgan -- Analyst

Okay, I'll leave it there in the interest of time, and I'll get back in queue. Thank you.

Operator

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

Andy Casey -- Wells Fargo Securities -- Analyst

Thanks, good morning.

Christopher Rossi -- President and Chief Executive Officer

Good morning, Andy.

Andy Casey -- Wells Fargo Securities -- Analyst

I'd like to hit on some of the demand trends, a few other short cycle companies have indicated trends kind of fell in August and September from July and then took another step down in October. I'm wondering is that similar to what you saw near demand trends?

Christopher Rossi -- President and Chief Executive Officer

Yes, we don't necessarily comment on the months, but I can tell you that, of course, Q1 was down as everyone knows, but we are expecting Q2 to be down from Q1 in terms of markets. Recognizing that Kennametal does have -- we do have sort of a normal seasonality that we lay in there, but in general in terms of the end market demand, we're looking at with the exception of Aerospace, all markets and all regions would be down Q1 to Q2.

Andy Casey -- Wells Fargo Securities -- Analyst

Okay, thanks. And within that, Chris, are you seeing, and not things turning positive outside of Aerospace, but are you seeing any stabilization in the pace of demand decline?

Christopher Rossi -- President and Chief Executive Officer

Yes, if we look at the -- and we've been kind of modeling this current situation where with slowdowns in the past, like in 2015 and in 2012. And you know what our expectation is that, depending on what you look at, you can be down with anywhere from four quarters to as much as seven quarters. I think 2012 was down about four quarters in a row and 2015 was down seven quarter. So for us, that means that it's a -- concerns FY 2020, we're not expecting any kind of recovery. The only sales increase you would really see is associated with the normal seasonal trend. So, it's looking like to us that probably if this falls kind of an average course downturn, it's an FY 2021 first quarter subject for us in terms of when we might see a recovery, that's our view.

Andy Casey -- Wells Fargo Securities -- Analyst

Okay, thank you for that. And then, just kind of a detailed question. One of the components of Industrial margin headwinds in the quarter that was noted in the release was compensation expense, what drove that?

Damon Audia -- Vice President and Chief Financial Officer

Just general inflation and we have our annual merit increases and things of that nature. And as you know, for Industrial, labor is a higher percentage of the cost of goods sold which was a driver for them.

Andy Casey -- Wells Fargo Securities -- Analyst

Okay, thank you very much Damon.

Operator

Our next question comes from Joe Ritchie of Goldman Sachs. Please go ahead.

Joe Ritchie -- Goldman Sachs -- Analyst

Thanks, good morning guys. Just to be clear, I know you guys don't like to guide quarterly, but I just want to be clear, on the tungsten impact for Q2, it's expected to be as, call it, the $0.19 that you did in 1Q, it's expected to be as high as Q1 as well?

Christopher Rossi -- President and Chief Executive Officer

It will still be a headwind Joe, it may not be the exact percent, because it will start to abate a little bit, but yes, generally speaking, it's going to be the impact in that quarter will also be a headwind. I think the other point that I will point out though is, remember Infrastructure you have that pricing dynamic we've talked about where the customers are going to pay at the lower levels of the current spot and that's going to -- that will impact the margins in the second quarter even if more on Infrastructure.

Joe Ritchie -- Goldman Sachs -- Analyst

Okay, alright. That makes sense. And I guess maybe just asking just a little bit of a higher level question here. Clearly the market, I think, surprised a lot of companies this quarter with the downturn that we saw. But I guess, as you look at your own business and the decremental margins that you posted this quarter, I guess, were you surprised by how much things delevered this quarter? And then maybe talk about like how via your simplification and modernization initiatives you're going to try to limit maybe some of that cyclicality on the go forward?

Christopher Rossi -- President and Chief Executive Officer

Yes, I mean obviously the lower volume was a surprise. We did expect in our plan that we would have lower volumes, but the market dropped off almost double what we thought in terms of our planning process. If you look at that, the EPS bridge that we showed in terms of manufacturing operations at $0.60. We know that $0.19 of that is the raw material which will abate in the second half, so that's kind of a temporary issue.

And then if I just took the essentially $7 million change in sales year-over-year at our normal 40% operating margin, that's another $0.28 there. And so, the balance of $0.13 is one of the things we just talked about, the normal inflation that's built in, in terms of rise of payroll and type of things. And then also, we have of course the volume related lower variable and fixed cost absorption associated with the lower volume. And then the temporary manufacturing inefficiencies due to modernization and preparing for plant closures.

So your question on in terms of how we can affect the change in that $0.13 is, obviously we still have normal inflation and we have to deal with that and drive productivity. But modernization is going to really get after this volume related lower variable and fixed cost absorption. We still have it in any given period when the volume drops, but essentially with simplification and modernization we're going to just be less dependent on labor. So, our ability to react to that is improve, because we don't have to go through a process to shed those direct labor workers.

So the company I think is in a much better place today than it was in the past. We have less facilities, we are modernizing the facility, we're less dependent on labor, but keep in mind the benefit modernization are still largely ahead of us. So, how the company performed in this first quarter, which I don't think it was actually too bad given this given the drop in volume, we expect that we're going to performing better as we get through FY20 and FY21 and sort of complete this first wave of modernization.

Joe Ritchie -- Goldman Sachs -- Analyst

Got it. That makes sense. Thank you.

Operator

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

Adam Uhlman -- Cleveland Research -- Analyst

Hi guys, good morning.

Christopher Rossi -- President and Chief Executive Officer

Good morning.

Adam Uhlman -- Cleveland Research -- Analyst

Just wondering if you could expand a bit on what you're seeing with the Aerospace markets. Because I was a little surprised that even excluding your kind of one-time headwind that you flagged from projects or whatever that you are still only growing a little bit. And is there any mix impact that's happening between engines versus aerostructures versus penetrators, defense sales, something like that, that would be holding back the growth, considering, I guess, you did have tough comps, but maybe talk through your confidence of other sales trend across that chunk of the business looks for the rest of the year.

Christopher Rossi -- President and Chief Executive Officer

Yes, I think there's a couple of things I would say. First of all, you're correct, we had the sort of these large package orders that by definition don't reoccur. I should say it's more like they're lumpy, OK, they can occur at any given point in time. So when you measure year-over-year, if you happen to find a period that has won a dozen that can change the number. And those are actually fairly sizable orders so they can move the needle even though Aerospace is still a pretty good size market for us. The other -- so, if we take that out from the equation and we look at our growth initiatives and one of the things that we're -- that we track are actually new customers that we add, then we know if we're adding these new customers by definition, we're increasing share in that space.

I talked about the technology platforms that we launched in my section of the prepared remarks. And again we're tracking those new product introductions and they're not actually displacing old Kennametal tools or cannibalizing them, they're -- if they're displacing anybody, it's prior -- its other companies' tools. So we feel like that is going to -- that we're getting traction on those.

And then the other thing I would mention is that, Widia is -- the segment for Widia is basically general engineering, but we know that there is -- we know that inside that space there is aerospace applications that are done, especially in the Tier 1, Tier 2 suppliers. And so we also track that in terms of those applications and we know that we're gaining traction and growing those aerospace customer base that are considered part of general engineering. So all that equals, we still have a strong segment. And the way we track this thing, which is which is at a fairly detailed level, we're confident that we are getting traction and growing in that space.

Adam Uhlman -- Cleveland Research -- Analyst

Okay, got you. And then just a couple of clarifications on pricing, and material costs. So, was your price realization positive this quarter and does that follow tungsten prices lower than as we start to think about the December and March quarters, so that you'll have a kind of a price headwind? And then just related to the $0.19 material cost headwind that you talked about that. That's just a gross comment right or is that net of what pricing was?

Christopher Rossi -- President and Chief Executive Officer

Yes, the $0.19 was just based on actual payment of -- or cost of inventory that's flowing through the P&L. So that -- that really doesn't have anything to do with necessarily the price covering rods. I think your question is though, in general Kennametal has a history of price covering raw materials. We've also said that in any period of time, we might be a little bit ahead or a little bit behind. If we look at what's in our current forecast for the full year, we're expecting price and raw to be pretty much in balance, so essentially flat.

In terms of pricing in the marketplace, as you know, we put an initiative in place in FY 2018 to really start to do strategic pricing and be less sort of cost plus pricing. And so our intention is that even though material costs are dropping, other than the contracts that were required in Infrastructure to lower prices, based on the change in the index, we feel pretty good of our ability to hold on to price. And we also feel like we've got enough discipline and the data to well understand where potentially a price change could actually help us drive a commensurate increase in volume, which would be the right overall economic equation to run for ourselves.

Adam Uhlman -- Cleveland Research -- Analyst

Okay, thank you.

Operator

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

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

Hey, good morning guys.

Christopher Rossi -- President and Chief Executive Officer

Good morning, Ross.

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

Chris, I wanted to just ask you, I mean if you look at your entire manufacturing footprint, net of what you were on closing. What portion of your footprint should be fully modernized to the extent that the company envisions several years ago by the end of fiscal 2020?

Christopher Rossi -- President and Chief Executive Officer

Yes, on a percentage basis, I think we're probably, now I characterize this, but the end of FY 2020, we're at least 60% of the way there. And remember, we had a number of plant closures that will continue. We have some in FY 2020, but there is others in FY 2021. So until those plant closures come, that's going to drive the balance. And we had announced a second restructuring for FY 2021 which has some of these plant closures and so that's kind of on that basis. I think that since the plant closures are the hardest in terms of the level of effort and that's why I think it's kind of 60% this year and 40% because there are some heavy lifting that still needs to be done to close some of these larger plans. So in terms of the effort, that's the way I see it.

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

So that's what I was kind of getting at. So I wanted to ask you really about the $300 million of incremental capex to modernize Kennametal. Chris, your predecessor had come up with that figure, if I remember correctly and you continue to work off that assumption. How confident are you that it's the right figure to get the company where it needs to be? I mean does the big hit to margins that we've just seen tell us that the company still got a lot of investment to make in factory automation, so that you can adjust to these slowdowns and pickups in a much more nimble fashion going forward?

Christopher Rossi -- President and Chief Executive Officer

Yes, I think in general, the $300 million number, we still feel good about. You're right. I did inherit that number, but we've done a lot of work, obviously since then, I've been here over two years and that -- that's still the number that I believe is in the right ballpark. If you look at what we're spending in terms of capex this year versus the prior years, we've got that $300 million -- we're zeroing in on that $300 million number. Now we also talked on the last call that in some cases, we were expecting higher volumes and so we're not going to bring on additional capacity to just for the sake of having that capacity until the volume can support it. So if we were to fall short of $300 million by the end of FY 2020, it might be $25 million or $30 million subject that might carry over in FY 2021, but largely we expect that FY 2021, we would return to a more nominal capital spending and sort of that $120 million, unless like I said, maybe $30 million of it or so of that order of magnitude would carry over, because we're in a lower volume position than we were before.

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

You have cash restructuring associated with the three German facilities baked into the free cash -- the current free cash flow guide?

Christopher Rossi -- President and Chief Executive Officer

We do, yes.

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

Okay. What was that number?

Damon Audia -- Vice President and Chief Financial Officer

Ross, we didn't give out the specific cash cost for the restructurings, other than when you go back to the announcements that we made, so the FY 2020 restructuring plan that we announced, we said that was going to cost in the range of $55 million to $65 million in cash. And we said the majority -- the vast majority of that would go out in FY 2020. And then when we announced the FY 2021 restructuring, we've said that that was a $60 million to $75 million cash of the majority of that being cash and the majority of that going out in FY 2021, but there would be a portion in FY 2020 and so the combination of those numbers are built into our free operating cash flow outlook for this year.

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

Okay, thanks very much.

Operator

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

Steven Fisher -- UBS -- Analyst

Thanks, good morning. So as you guys think about the trajectory of your various segments, when do you think Infrastructure and Widia will return to profitability? And how should we think about the exit rate of the various segments margins by Q4? Do you think we're going to be back to the mid-teens for both Industrial and Infrastructure by then?

Christopher Rossi -- President and Chief Executive Officer

Yes, if we look at -- if we look at both Widia and infrastructure this quarter, the raw material impact was quite substantial and so when you remove that effect which will abate in the second half of the year, they're going to return to profitability. But underlying both of those are -- we continue with simplification/modernization and portfolio pruning that affects, for sure, Infrastructure, and as we close some of the plants that we're talking about and take some of the other portfolio pruning actions that's going to improve the profitability of Infrastructure. And so based on our current forecast and the volume that's going to run through that business for what we're expecting, I feel pretty good actually about where we're going to be from a profitability standpoint.

On the Widia side, obviously they're highly volume sensitive because it's a small sized business. And as we talked about before, they're essentially a product portfolio inside the overall metal cutting space. They run inside the same overall Kennametal factories and so you can see profitability numbers that from a P&L perspective that don't look great, but the fact of the matter is, there's a couple of hundred million dollars of volume running through the same factories. And again, once you take out the material cost of impact, we feel that business is going to return to profitability.

The other thing that we've said is, a lot of the Widia profitability is going to -- in terms of modernization is tied to closing of these plants. So, their productivity improvements are definitely more back-end loaded as it relates to modernization. So, I mean overall, I don't really have -- I'm not sitting here thinking that we've got some profitability issues with either one of those businesses. And then Industrial continues to crank along and again, once some of these one-time effects abate, we feel pretty good about that business also.

Steven Fisher -- UBS -- Analyst

Okay. So it sounds like still -- probably losses in the second quarter, but you turn positive in Q3, Q4. Second, I guess, can you just give us a sense of what growth rate you're seeing in your construction business within Infrastructure Infrastructure in your three key regions?

Christopher Rossi -- President and Chief Executive Officer

Sorry, in what regions?

Steven Fisher -- UBS -- Analyst

All your three key regions, Americas, EMEA, and APAC, yes.

Christopher Rossi -- President and Chief Executive Officer

Well, we've had -- we actually -- in terms of growth rates, we're actually showing -- let me just look here. So, construction from Q4 to Q1, we feel was -- the markets are kind of flat, and we see the same thing in Q1 to Q2, it's kind of a flat market. So, other than the normal seasonality that's kind of what we've baked into that forecast.

Steven Fisher -- UBS -- Analyst

And is there any major variance within your regions there?

Christopher Rossi -- President and Chief Executive Officer

No, that was across all regions, Americas, EMEA and Asia Pacific.

Steven Fisher -- UBS -- Analyst

Okay, thanks a lot.

Operator

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

Chris Dankert -- Longbow Research -- Analyst

Hey, morning guys. I guess, sticking with the end markets theme here. As I look at energy, obviously Infrastructure has got the pricing headwind, and that's a pretty steep step down though to 24%. I guess when I move up into energy in the Industrial segment, what's the risk if that growth rate kind of moves into the down double-digits, down teens for the rest of the year? Just can you parse energy by segment a little bit?

Christopher Rossi -- President and Chief Executive Officer

Yes. Unfortunately, if we look at infrastructure, the Q4 to Q1, we're saying is going to be down, also Q1 to Q2. And I believe on the Infrastructure side, in general, we're expecting declines to continue through the year as the rig counts come down. In terms of the metal cutting business, we're anticipating something similar to that, it's really across the board, the Americas, EMEA and Asia Pacific. So we don't -- we now have a lot of hope that energy is going to turn around certainly in this year and I think we're kind of planning on that. So if it does, that will be a bit of a nice surprise for us.

Chris Dankert -- Longbow Research -- Analyst

Got it, got it. Makes sense. And then within Industrial there, you highlighted some temporary closures in the quarter to kind of backstop profitability. I guess how big a deal where those? What would the incremental margins look like without those stoppages, just any kind of comments there?

Christopher Rossi -- President and Chief Executive Officer

Yes, in the quarter we did not actually -- we didn't actually -- we were preparing for some closures. And I mentioned the -- I mentioned that that was one of the inefficiencies that's buried inside that $0.13 of EPS. It's really the second quarter that we begin to start closing facilities and it was at the end of October that one of the German facilities stop production. So that -- there wasn't much in terms of the first quarter other than preparing for these closures that was inside those numbers. Damon

Damon Audia -- Vice President and Chief Financial Officer

Chris, I think the other question you may have been asking there was the production days that we alluded to. And I think to answer your question is, we said inventory, we were taking -- we are planning to take inventory down this year and we were going to be adjusting production. I think as Chris point -- as the markets move so quickly, we started to take production days out of the system and that really started in September and that's what we referred to. Again, it doesn't necessarily enhance the margin, but it reduces the decremental because otherwise we would have been producing inventory that there was no demand for. So, it's part of those ways that we're trying to reduce the cost as quickly as we can to rightsize production with the market outlook.

Chris Dankert -- Longbow Research -- Analyst

Got it, got it. That's helpful, thanks guys.

Operator

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

Walter Liptak -- Seaport Global -- Analyst

Hi, thanks, good morning guys. When -- just stick with the same, the last questions with the inventory. So, it sounds like with these facilities closing this quarter, the inventory is not going to come out starting in your second quarter, it will be sometime in the second half, is that right?

Christopher Rossi -- President and Chief Executive Officer

Yes, I think the inventory didn't come down as much as we saw in the first quarter, because we simply didn't have as much volume. But our expectation is that it will still -- it will start to come out in the second quarter and then that will continue to accelerate through Q3 and Q4.

Walter Liptak -- Seaport Global -- Analyst

Okay. So these -- so are these, the three German plant rationalizations and the one closing, that's what you're alluding to the -- that's where the extra inventory is being held right now? And that's what will come out in the second half?

Christopher Rossi -- President and Chief Executive Officer

That's right.

Walter Liptak -- Seaport Global -- Analyst

Okay and you mentioned the benefits from the German factory closing and I presume that also includes the other factories, what kind of benefit will you be getting from that, can you quantify it?

Christopher Rossi -- President and Chief Executive Officer

Yes, I think that, if you look at those restructuring actions that we talked about, the -- inside those numbers are the associated benefits from closures. So, some of the closures are inside the FY 2020 restructuring action that was in the $35 million to $40 million range, and then the FY 2021 actions which also had included some of the plant closure benefits that was in the $25 million to $29 million range.

Walter Liptak -- Seaport Global -- Analyst

Okay. Yes, right, it all flows in. With these inventory levels, since there is a 2021 round of a larger facility closing; one, you have to maintain inventory at higher levels even going into 2021 because of those; two, were you running to the same kind of the inventory issue where you won't be able to drawdown as quickly?

Christopher Rossi -- President and Chief Executive Officer

Yes, I mean the plant closures are -- there is a large plant closure in the first half of FY 2021 and so that does have some inventory associated with it. So even in FY 2021 we will continue to have an elevated level, but the other plant closures are also -- there was also inventory elevated for those and as those start to close, we don't need that inventory. So it will continue to drop off. But you're correct, it could still be at an elevated, slightly elevated level until we close that other facility in the first half of FY 2021.

Walter Liptak -- Seaport Global -- Analyst

Okay, OK. And then if I could just ask a quick one on just the negative trends on a global basis. Are we in a synchronized slowdown across all regions or EMEA is down more, did they start sooner -- or I guess, Asia is down the most, did they start sooner and then it kind of went to EMEA, then Americas or in that -- are any regions looking like they are closer to bottoming?

Christopher Rossi -- President and Chief Executive Officer

Yes, I think as you know, Asia Pacific started quite a while ago. That was kind of first to go and we see that that market is continuing to stay at low levels, but I don't know that it's necessarily getting any worse. EMEA was then second and that drop off continues as you know in many of the industrial countries inside of EMEA are -- some of them were actually in a recession, narrowed mode. So, that situation has gotten worse in the last few quarters, but it seems to have, I guess, I could argue it seems kind of stabilized at the current levels.

And in the Americas, while it has gotten a little weaker, it's certainly not in as bad a shape as those other two markets. And so I think that my opinion is the Americas are just people trying to deal with or trying to anticipate to be prudent about planning for the -- around these trade uncertainties. And in the absence of more clarity there, they're just being prudent. So, there is a slowdown, but I wouldn't put on the same order of magnitude as what we've seen in EMEA or Asia Pacific.

Walter Liptak -- Seaport Global -- Analyst

Okay, great. Thank you.

Operator

This concludes the --

Christopher Rossi -- President and Chief Executive Officer

Okay, thank you, operator -- well, go ahead.

Operator

This concludes the question-and-answer session. And I will turn it back to you, Chris Rossi, for closing remarks.

Christopher Rossi -- President and Chief Executive Officer

Fine. Thank you and thanks everyone for joining us on the call today. We certainly appreciate your interest and support with Kennametal. Please reach out to Kelly if you have any follow-up questions. Thank you.

Operator

The replay of this event will be available approximately one hour after its conclusion. To access the replay, you may dial toll-free within the United States, 877-344-752 , outside of the United States, you may dial 412-317-0088. You will be prompted to enter the conference ID 10132355, then the pound or hash symbol. You will be asked to record your name and company. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 57 minutes

Call participants:

Kelly Boyer -- Vice President of Investor Relations

Christopher Rossi -- President and Chief Executive Officer

Damon Audia -- Vice President and Chief Financial Officer

Julian Mitchell -- Barclays Capital, Inc. -- Analyst

Ann Duignan -- JPMorgan -- Analyst

Andy Casey -- Wells Fargo Securities -- Analyst

Joe Ritchie -- Goldman Sachs -- Analyst

Adam Uhlman -- Cleveland Research -- Analyst

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

Steven Fisher -- UBS -- Analyst

Chris Dankert -- Longbow Research -- Analyst

Walter Liptak -- Seaport Global -- Analyst

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