Kennametal - Earnings Call - Q2 2025

Executive Summary

• Q2 FY25 revenue was $0.482B and diluted EPS was $0.23 (adjusted EPS $0.25), with sales at the low end of expectations amid worsening EMEA demand; adjusted operating margin was 6.9% vs 6.0% a year ago, and adjusted EBITDA margin rose to 13.9% from 12.4% YoY.
• Management cut FY25 guidance: sales to $1.95–$2.00B (from $2.0–$2.1B) and adjusted EPS to $1.05–$1.30 (from $1.30–$1.70), citing weaker EMEA and a stronger USD; capex trimmed to ~$100M (from ~$110M).
• Cash generation remained solid: YTD CFO $100.9M and FOCF $57.3M; $31M returned to shareholders in Q2 ($15M buybacks, $16M dividends).
• Structural cost-down remains a central catalyst: additional actions announced Jan 14 expected to yield ~$15M annualized savings by FY25 year-end; total program pacing to ~$65M of the $100M multi-year target by FY25 year-end.

What Went Well and What Went Wrong

• What Went Well

  • Adjusted EBITDA margin expanded YoY to 13.9% (vs 12.4%) on lower raw materials, pricing, restructuring savings (~$6M), and one-offs in Infrastructure (insurance recovery and production credit).
  • Aerospace & Defense strength: company-level A&D grew 14% YoY; segment commentary highlighted continued execution and easing supply chain challenges.
  • Cash discipline: YTD CFO $101M (vs $88M), FOCF $57M (vs $36M), with inventory/work-capital actions underway; primary working capital was 31.3% and targeted to ~30% by FY-end.
  • Quote: “This quarter we once again generated strong cash flow from operations” — CEO Sanjay Chowbey.

• What Went Wrong

  • Demand softness: Consolidated organic sales -6% with EMEA weakness driving declines in Transportation (-9%) and General Engineering (-4%); US IPI stagnation also pressured volumes.
  • Metal Cutting underperformed: sales -4% (organic -7%); adjusted operating margin fell to 6.0% (from 8.4% YoY) on lower volume and inflation.
  • Guidance cut: FY25 sales, EPS, and capex all lowered; FX headwinds ~ $40M at guidance midpoint; higher ETR also a drag.

Transcript

Operator (participant)

Good morning. I would like to welcome everyone to Kennametal's second quarter and fiscal 2025 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, please press star, then the number two. Please note that this event is being recorded. I'll now like to turn the conference over to Michael Pici, Vice President of Investor Relations.

Michael Pici (VP of Investor Relations)

Thank you, Operator. Welcome, everyone, and thank you for joining us to review Kennametal's second quarter fiscal 2025 results. This morning, we issued our press release and posted our presentation slides on our website. We'll be referring to that slide deck throughout today's call. I'm Michael Pici, Vice President of Investor Relations. Joining me on the call today are Sanjay Chowbey, President and Chief Executive Officer, and Pat Watson, Vice President and Chief Financial Officer. After Sanjay and Pat's prepared remarks, we will open the line for questions. At this time, I'd like to direct your attention to our forward-looking disclosure statement. Today's discussion contains comments that constitute forward-looking statements and, as such, involve a number of assumptions, risks, and uncertainties that could cause the company's actual results, performance, or achievements to differ materially from those expressed in or implied by such statements.

These risk factors and uncertainties are detailed in 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 turn the call over to Sanjay.

Sanjay Chowbey (President and CEO)

Thank you, Mike. Good morning, and thank you for joining us. I'll start the call today with some remarks regarding our recent announcements, followed by a review of the quarter and some in-market commentary. Then Pat will cover the quarterly financial results as well as the fiscal 2025 outlook. Finally, I'll make some summary comments and then open the call for questions. Now, let's start with the two announcements we issued in mid-January. The January 14th announcement highlighted actions we're taking to address our investor day commitments around plant closures and navigate current market conditions. In support of our commitment to long-term competitiveness, we announced actions to reduce our structural costs and our footprint. Within the metal cutting segment, we announced the closure of a facility in Greenfield, Massachusetts, and the consolidation of two facilities near Barcelona, Spain, into a single modern facility.

The operations in Greenfield, Massachusetts, are expected to cease in April 2025, and the plant closure is expected to be substantially complete by December 31st, 2025. The consolidation of Barcelona and Spain facilities are expected to be substantially complete by June 30th, 2025. Additionally, in an effort to mitigate the current market conditions, mainly in EMEA, we announced a global reduction in professional workforce. These combined actions are expected to deliver annualized run rate, pre-tax savings of approximately $15 million by the end of fiscal 2025. We expect pre-tax charges of approximately $25 million in connection with the execution of these actions. The breakdown is as follows: approximately $10 million is for cash-related facilities charges, approximately $5 million is for non-cash facilities charges, and approximately $10 million for severance-related cash expenditures.

These facility closures and other cost actions keep us on track to deliver our commitment to close three to five plants and achieve $100 million cost savings by fiscal 2027 that we committed to at our Investor Day in September 2023. The second announcement was an organizational change within the infrastructure segment. Effective January 20th, Faisal Hamady was named President of the infrastructure segment, reporting to me. Faisal succeeded Franklin Cardenas, who served in that role for the past five years. I want to thank Franklin for his contributions to Kennametal and wish him the best. Faisal has been with the company since July, serving as the Vice President of Value Creation Systems. Prior to that, he served in various roles with increasing responsibility at Eaton Corporation since July 2007. His most recent role at Eaton was as the General Manager of its $600 million hydraulics and actuation portfolio.

Additionally, he held positions in finance, sales, and manufacturing operations prior to his General Manager role. Faisal is a great addition to the infrastructure team, bringing strong and well-rounded business experience in commercial operations and general management. He's a strategic thinker and true collaborator and is already hard at work with the team as they continue to grow and improve our infrastructure business. Additionally, continuous improvement remains an important focus area for us, so Faisal's Value Creation Systems responsibilities will be integrated with existing roles at Kennametal. This will provide a strong alignment between business, operations, and continuous improvement efforts across the company. Now, turning to our results. On slide three, let me begin by saying this was a disappointing quarter from both a sales and profitability perspective, especially in metal cutting. From an industry and macroeconomic viewpoint, our sales continue to be impacted by challenging market dynamics.

In our second quarter, market conditions worsened further in EMEA, and that is impacting several of our end markets. Additionally, industrial production in the U.S. remained soft. Together, these factors led our sales to come in at the low end of our expectations for the quarter. As we have said before, while we cannot control external factors like these, we do focus our efforts on things we can control. For example, the announcements in mid-January that I just talked about not only align with our longer-term objectives, but they also demonstrate our commitment to positioning the company for competitiveness and improved profitability. Now, for our quarterly results, sales decreased 3% year-over-year. At the segment level, infrastructure decreased 4% organically, while metal cutting was down 7%. On a constant currency basis, Americas' sales were flat at 0%. Asia-Pacific sales decreased 3%, and EMEA declined 7%.

Organically, this marks the fifth consecutive quarter of negative organic growth. As a reference point, historically, cycles tend to last four to eight quarters. While managing near-term challenges, we remain committed to executing on our strategic priorities to drive above-market growth, continuous improvement initiatives targeting margin and working capital improvement, and to optimize our product and business portfolio. We have more work to do across all these areas and look forward to updating you as we make progress on each. Moving now to our end markets. By end market, aerospace and defense grew 14%, energy grew 1%, general engineering declined 4%, earthworks declined 7%, and transportation declined 9%. Transportation and general engineering were largely impacted by market conditions in EMEA and, to a lesser extent, the Americas, primarily within the metal cutting segment.

In EMEA, we have seen lower production volumes and realignment of investments among our customers in response to changes in EV subsidies. In addition, there are two other contributing factors impacting the transportation end market broadly: consumer preference and EV infrastructure readiness. But remember, we remain very well positioned in this end market, regardless of engine type, with strong product offerings and application support for internal combustion engine, hybrid, and full EV platforms. In infrastructure's earthworks market, we saw lower mining capital investment in Asia, while the Americas was impacted by lower mining activity. Turning to profitability for the quarter, adjusted EBITDA margin was 13.9% compared to 12.4% in the prior year. Adjusted EPS decreased to $0.25 compared to $0.30 in the prior year quarter. Cash from operating activities year-to-date was $101 million compared to $88 million in the prior year period.

Operating cash flow year-to-date was $57 million, up from $36 million in the prior year. And finally, we continued our share repurchase program with $15 million worth of shares bought back during the quarter. These results were at the lower end of our revenue expectations and in line with our EPS midpoint we provided last quarter. When looking at the current quarter results, a few general comments regarding the end market performance. First, aerospace and defense continues to perform well. We have seen slight improvement in aerospace as production moves forward after the resolution of the recent strike. Order timing has driven the performance within defense, mainly in EMEA. Second, growth initiatives in energy offset the impact of lower rig counts in the Americas. Third, mining activity in Asia and Americas continued to be soft.

Finally, the worsening market conditions in EMEA and the continuation of low PMI and IPI levels in the U.S. put pressure on both transportation and general engineering. Turning to slide four, I want to take a moment to provide additional commentary on our end market for the full year. As a reminder, our updated outlook for the full year reflects the forecast of specific market drivers and general market conditions, both of which have weakened. These market drivers, combined with strengthening U.S. dollar and associated higher foreign exchange impacts, were the main contributors to our lowered full year outlook. By the end market, the top section shows the assumptions we had in our prior outlook compared to our current outlook. The bottom of the slide shows some of the key factors and what has changed by end market.

Let me call your attention to the general engineering, transportation, and aerospace and defense end markets as those assumptions have changed. First, General engineering. The key factors that drive our expectations are external IPI forecasts for the U.S. and EMEA and PMI data in China. As I noted earlier, we have seen conditions in EMEA continue to worsen since the start of our fiscal year. Prior external forecasts for IPI and EMEA were a slight improvement in the first half of calendar year 2025. That forecast has now shifted to down slightly. The U.S. IPI forecast was also previously expected to be up slightly in the first half of this calendar year, and that has not happened. In fact, the latest data indicates a flat U.S. market. China IPI remains unchanged.

Taken together at the midpoint, we now anticipate this end market to be down slightly year-over-year as compared to flat previously communicated. Second, Transportation. The key external indicators we track are IHS light vehicle production. The prior IHS forecast was for vehicle production to increase 1% versus prior year, and the most recent estimate is for production to be down 1%. Once again, the pressure is primarily in EMEA with a slight slowdown in the Americas. It has been well documented the pressure OEMs in the EMEA region are facing. Given these production forecasts and the customer challenges, we now anticipate that end market to be down year-over-year compared to up slightly as previously anticipated. Third, Aerospace and defense is anticipated to increase slightly now as the aerospace supply chain and OEM production issues have been steadily improving.

The forecasted production levels are expected to increase slightly compared to moderate assumptions previously. Defense continues to benefit from our growth initiatives. The order patterns with these customers tend to be lumpy period to period, but we do continue to see the benefits of our efforts. Finally, our expectations for energy remain relatively consistent with previous expectations. U.S. land-based rig counts are forecasted to decline, and sentiment remains cautious, while earthworks continues to experience normal seasonality in construction and mining continues to decline in China and lower U.S. exports. Now, let me turn the call over to Pat, who will review the second quarter financial performance and the outlook.

Patrick Watson (VP and CFO)

Thank you, Sanjay, and good morning, everyone. I will begin on slide five with a review of the second quarter operating results. Sales were down 3% year-over-year, with an organic decline of 6%, partially offset by favorable workdays of 3%. As Sanjay discussed, sales this quarter were at the lower end of the expectations we provided last quarter. Relative to those expectations, we experienced continued pressure, most notably in EMEA and the Americas, which impacted our general engineering, transportation, and earthworks end markets.

Energy was a bit stronger than we had anticipated due to project volume. Year-over-year, we experienced pressure in most end markets and regions, with the exception of aerospace and defense and energy. I will provide more color when reviewing the segment performance in a moment. Adjusted operating expense as a percentage of sales increased 100 basis points year-over-year to 22.7%. Adjusted EBITDA and operating margins were 13.9% and 6.9%, respectively, versus 12.4% and 6% in the prior year quarter.

During the quarter, we realized approximately $6 million in savings from the previously announced restructuring program. This action has successfully delivered annualized run rate pre-tax savings of approximately $35 million. Lastly, foreign exchange was flat this quarter. The adjusted effective tax rate increased year-over-year to 26.9%, primarily driven by discrete items recognized in the prior year quarter, an unfavorable geographical mix partially offset by an increase in the Advanced Manufacturing Production Credit under the Inflation Reduction Act. Adjusted earnings per share was $0.25 in the quarter versus $0.30 in the prior year period. The main drivers of our EPS performance are highlighted on the bridge on slide six. The year-over-year effect of operations this quarter was positive $0.06.

This reflects the absence of unfavorable price/raw in the prior year and incremental restructuring benefits and $0.02 of an Advanced Manufacturing Credit, partially offset by lower sales and production volume, higher wages, and general inflation. We also received a net benefit of $0.03 of insurance proceeds related to the tornado that damaged our Rogers facility in the fourth quarter of FY 2024. You can also see the effects of the tax rate on our results. The year-over-year change, as we noted on our prior call, was anticipated to be a $0.12 headwind, and this was the largest driver impacting our EPS performance. Currency and pension impacts on EPS are -$0.02 and -$0.01, respectively. Other reflects lower share count, which contributed $0.01. Slides seven and eight detail the performance of our segments this quarter.

Reported metal cutting sales were down 4% compared to the prior year quarter, with a 7% organic decline, partially offset by favorable workdays of 3%. By region, on a constant currency basis, the Americas were flat, Asia-Pacific declined 1%, and EMEA declined 10%. Americas' year-over-year performance this quarter was driven by the execution of our growth initiatives in aerospace and defense, offset by declines in the general engineering and transportation end markets. Asia-Pacific's decline was primarily driven by lower production in the aerospace and defense end market and reflects a slight decline in China. EMEA's year-over-year decline reflects weakness in the transportation and general engineering end markets, partially offset by strength in aerospace and defense. Looking at sales by end market, aerospace and defense grew 7% year-over-year as our strategic initiatives continued to drive results along with easing supply chain challenges and improved build rates in EMEA.

Energy declined 1% this quarter due to customer order timing in EMEA. General engineering declined 4% year-over-year due to lower production activity, primarily in EMEA and project timing in the Americas, and lastly, transportation declined 9% year-over-year due to an overall slowdown in EMEA and the Americas, partially offset by Asia-Pacific project orders. Metal cutting adjusted operating margin of 6% decreased 240 basis points year-over-year, primarily from lower sales and production volumes and higher wages and general inflation. These factors were partially offset by pricing, lower raw material costs, and incremental year-over-year restructuring savings of approximately $4 million. Turning to slide eight for infrastructure. Reported infrastructure sales were flat year-over-year, with favorable business days of 3% and favorable foreign currency exchange of 1%, offset by an organic decline of 4%.

Regionally, on a constant currency basis, EMEA sales increased by 5%, the Americas were flat, and Asia-Pacific declined by 6%. Growth in EMEA was primarily driven by defense order timing and higher activity in earthworks, partially offset by general engineering. The decline in the Americas was primarily from lower mining activity and mine closures and earthworks, offset by defense and energy project timing. The decline in Asia-Pacific primarily reflects lower volume and order timing in underground mining. Looking at sales by end market on a constant currency basis, we grew our aerospace and defense sales by 35% by continuing to execute on our growth initiatives in both EMEA and the Americas. Energy increased 2%, mainly in the Americas, driven by project timing, partially offset by lower U.S. land rig count. General engineering declined 2% from lower industrial activity in EMEA, partially offset by ceramics in Asia.

Lastly, earthworks declined 7% from a customer mine closure and lower mining activity in the Americas, lower mining capital investment levels in Asia-Pacific, partially offset by higher activity in EMEA. Adjusted operating margin increased 670 basis points year-over-year to 8.6%, primarily due to a few factors: the absence of unfavorable pricing in the prior year, a net benefit of $2 million from insurance recoveries related to the tornado that struck Rogers, Arkansas facility in late fiscal 2024, the Advanced Manufacturing Production Credit under the Inflation Reduction Act of approximately $2 million, and incremental year-over-year restructuring savings of approximately $2 million. These factors were partially offset by lower production volumes and higher wages and general inflation. Now, turning to slide nine to review our free operating cash flow and balance sheet.

Our second quarter year-to-date net cash flow from operating activities was $101 million compared to $88 million in the prior year period. The change in net cash flow from operating activities was driven primarily by working capital changes, partially offset by lower net income compared to the prior year period. Our year-to-date free operating cash flow increased to $57 million from $36 million in the prior year. Primary working capital this quarter was down from the prior year. The company continues to focus on optimizing inventory levels and remains focused on driving improved working capital. On a dollar basis, year-over-year, primary working capital decreased to $592 million, and on a percentage of sales basis, primary working capital decreased to 31.3%. Net capital expenditures decreased to $44 million compared to $52 million in the prior year quarter.

In total, we returned $31 million to shareholders through our share repurchase and dividend programs. We repurchased 525,000 shares for $15 million in Q2 under our $200 million authorization, and as we have every quarter since becoming a public company over 50 years ago, we paid a dividend to our shareholders. Our commitment to returning cash to shareholders reflects confidence in our ability to execute our strategy to drive growth and margin improvement. We continue to maintain a healthy balance sheet and debt maturity profile with no near-term refunding requirements. At quarter end, we had combined cash and revolver availability of approximately $821 million and were well within our financial covenants. The full balance sheet can be found on slide 15 in the appendix. Turning to slide 10 regarding our third quarter outlook.

We expect Q3 sales to be between $480 million and $500 million, with volume ranging from -6% to -2%, price realization of approximately 2%, and a 3% negative impact from foreign exchange. Let me share some details on the sales assumptions and trends impacting the Q3 outlook. Our Q3 range at the midpoint reflects growth that is slightly below our historical norms due to the current market conditions. The high end of our range remains in line with our normal sequential trends. On a year-over-year basis, aerospace and defense growth continues, albeit at a slower pace as North American OEM production takes time to recover. Energy and general engineering are anticipated to be down slightly. Transportation is expected to decline, mainly from lower volumes in EMEA, and earthworks decline slightly due to continued competitive market conditions.

Foreign exchange and non-cash pension expense is expected to have a negative impact of approximately $3 million and $1 million, respectively, on a pre-tax basis. Interest expense is assumed to be approximately $7 million and an effective tax rate of approximately 27.5%. Lastly, we expect adjusted EPS in the range of $0.20-$0.30 per share. Now, on slide seven regarding the full-year outlook. We now expect FY 2025 sales to be between $1.95 billion and $2 billion, with volume ranging from -5% to -2%, net price realization of approximately 2%, and we anticipate an approximate 2% year-over-year headwind from foreign exchange. As Sanjay noted in his prepared remarks, the worsening market conditions in EMEA and the continued stagnation of industrial production in the U.S., coupled with the strengthening U.S. dollar, are the key factors behind the updated outlook.

Foreign exchange sales headwinds are approximately $40 million at the midpoint of our updated outlook. Using the euro as a proxy for U.S. dollar strength, we've seen the dollar strengthen from approximately $1.08 to the euro in the first and second quarters to a range of $1.03-$1.05 in January. Year-over-year, we expect aerospace and defense to have slight growth, transportation to decline, general engineering to slightly decline, and earthworks and energy to decline slightly. From a cost perspective, we expect offset raw material wage and general cost increases on a dollar basis and that foreign exchange and non-cash pension expense are expected to be headwinds of $8 million and $4 million, respectively, on a pre-tax basis. Approximately $14 million of roll-over savings from our previously announced restructuring initiative has been included and is anticipated to have a slight impact in the second half of the fiscal year.

Our outlook also includes the effects of the plant closures and the new restructuring actions, which combined are anticipated to generate approximately $15 million of annualized savings. For fiscal 2025, we've included approximately $6 million in savings related to these actions. From a timing perspective, we anticipate a significant majority of the savings to be recognized in the fourth quarter. Our current outlook includes the $0.02 associated with the advanced manufacturing credit as part of the Inflation Reduction Act. We anticipate that we will be eligible for similar credits in the future, assuming there are no changes to the existing legislation. The depreciation and amortization is expected to be approximately $135 million. We expect interest expense of approximately $27 million and an effective tax rate of approximately 27.5%. We expect adjusted EPS to be in the range of $1.05-$1.30.

On the cash side, the full year outlook for capital expenditures is now approximately $100 million, and the outlook for primary working capital is approximately 30% by fiscal year end. Taken together, we continue to expect free operating cash flow to be greater than 125% of adjusted net income. Lastly, as it relates to the outlook, I do want to comment on the developing trade situation. The outlook we provided today does not consider any additional costs, favorable or unfavorable market developments that may occur as a result of the changing international trade landscape. And with that, I'll turn it back over to Sanjay.

Sanjay Chowbey (President and CEO)

Thank you, Pat. Turning to slide 12, let me take a few minutes to summarize. As I discussed at the top of the call, we have clearly faced challenging market conditions so far this year and have been actively managing those challenges.

That said, I'm still disappointed with our most recent results, and even though we didn't see progress this quarter, we remain committed to above-market growth and margin improvement. As it relates to growth, we are confident in our competitive position and are performing better or keeping pace with the overall market. We continue to advance initiatives targeting customer wins in all our focused growth areas. Now, as it relates to margins, continuous improvement is a key strategic lever to improving our profitability. For example, we recently hosted special Kaizen events in several of our large plants focused on process and efficiency improvements. Those events yielded tangible results and played an important role in the evolution of our culture to one that prioritizes continuous improvement in everything we do.

We have also recently taken actions to improve our cost structure, which will help us achieve the targets we laid out at our September 2023 Investor Day, specifically the $100 million structural cost improvement plan by the end of fiscal 2027. By the end of this fiscal year, we anticipate to be about 65% complete on achieving those run rate savings. We'll also continue to monitor market conditions and take appropriate mitigation actions as needed. These actions taken together demonstrate progress, but we certainly know we have more to do. We'll continue to work on actions within all three pillars and leverage our competitive advantages to deliver long-term shareholder value. With that, operator, please open the line for questions.

Operator (participant)

If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, please press star then the number two. Our first question will come from Julian Mitchell with Barclays. You may now go ahead.

Julian Mitchell (Equity Research Analyst)

Hi, good morning. Hey, good morning, Julian. Good morning. Maybe just the first question around the sort of current demand environment, I suppose, particularly in general engineering, because it seems as if the sort of soft data and things like surveys have been better for a couple of months. Several short-cycling industrial peers of yours have talked about improving customer sentiment, and some distributors have mentioned that as well. Just wondered sort of what you're seeing in general engineering by region. I realize it's a pretty tough environment, but you didn't change your sales outlook much for that piece. So maybe just some update there and how demand has trended in the last couple of months in that piece.

Sanjay Chowbey (President and CEO)

Yeah. Hey, good morning, Julian. So let me just first comment on overall what we are seeing right now, definitely some improvement, especially as we have gone to the second half of January. Our order incoming rates have improved, and of course, our billing rates also. So there is definitely sequential improvement we are seeing. However, one of the things that you see in the outlook that was based on our assumptions early in the year in August when we talked, that had assumed much more improvement in the U.S. and also continued improvement in China. India continued to grow. Europe at the time, we were thinking that there will be challenges. Actually, we kind of pointed that out, but things have gotten a little bit more challenging in Europe.

So I think that's why we reduced our overall outlook in terms of second half, but we are seeing definitely things improving in the recent weeks.

Julian Mitchell (Equity Research Analyst)

That's great. Thank you. And then just my follow-up question. When you're thinking, Sanjay, more broadly about the cost structure at Kennametal, and you have the extra measure announced January 14th, but sort of overall looks like operating margins this year for the total company may be running around sort of 8%-8.5% or so. That's lower than the 10- or 20-year average, and that's with a lot of restructuring actions in the past 10-plus years. Realized demand is soft, and of course, that's pushing margins down a bit short-term. But is there sort of a view that maybe another much broader plan might be needed with sort of multiple plants to get the through cycle margins higher?

Sanjay Chowbey (President and CEO)

Yes, Julian. First, let me summarize again the things that we have already done and also in process right now. As we mentioned that we laid out $100 million cost structure type of actions in the Investor Day. With the recent actions and announcement, we'll get to $65 million worth of that. And of course, like you said, when we have shortfall in volume, not all of that is going to show up in the bottom line, but we know that these are the right things to do, and we continue to do that. But along with what you see in the restructuring numbers and all that, we also have been managing what I will call non-headcount-related actions where restructuring may not be involved, for example, short work week and other tools that we have at our disposal. So we continue to work on that.

At this point, we will continue to monitor the market conditions and take necessary actions. But in parallel, like I've always talked about, that with continuous improvement pillar, we'll continue to improve our overall margin and working capital.

Julian Mitchell (Equity Research Analyst)

Great. Thank you.

Operator (participant)

Our next question will come from Angel Castillo with Morgan Stanley. You may now go ahead.

Angel Castillo (Head of US Machinery and Construction Equity Research)

Hi, good morning, and thanks for taking my question. Sanjay, I was hoping we could just go back to that first commentary around the improvement that you've seen in orders in the second half of January. Was that specific to general engineering? Was it more broadly? And if it was just specific to general engineering, could you talk about the order trends you're seeing in some of the other key end markets in January, as well as same kind of question, but for regionally, was that order pickup in any particular region versus broader trends you're seeing?

Sanjay Chowbey (President and CEO)

Yeah. Angel, first of all, yeah, that definitely consisted of both general engineering and also other industries that we serve and markets we serve. One area where we have, again, continued to monitor more closely is the EMEA. There also, we have seen improvement in the last couple of weeks of January, but it is overall across the board.

Angel Castillo (Head of US Machinery and Construction Equity Research)

That's helpful. Thank you. And then maybe just in terms of the implied kind of fourth quarter guide, I think the EPS pickup is a little bit more substantial than you would normally see based on your Q3 guide. I think, if I'm reading this correctly, the bridge would just be some of the savings that you start to get in the fourth quarter. So could you just help us understand maybe how much of it is just these savings starting to flow through versus any kind of assumed start kind of a rebound in end market demand?

Patrick Watson (VP and CFO)

Yeah, Angel, I would say a lot of that is going to be the savings from the additional restructuring program that really drives that improvement, I would say, beyond what we would normally experience in Q4. As you know, Q4 is normally our strongest profitability quarter. In particular, just overall sales volumes tend to be higher, and as well as in the infrastructure business, that tends to be the heavy quarter for construction season, which drives some additional volume through the infrastructure business.

Angel Castillo (Head of US Machinery and Construction Equity Research)

Very helpful. Thank you.

Operator (participant)

Our next question will come from Steve Barger with KeyBanc Capital Markets. You may now go ahead.

Steve Barger (Managing Director and Equity Research Analyst)

Thanks. Sanjay, you've replaced both segment heads in the past six months. Can you just give us some specifics for each of their plans for what they expect to do differently going forward, just trying to get a sense for how that management change should result in broader changes?

Sanjay Chowbey (President and CEO)

Yeah, thank you, Steve. I think the focus areas will be pretty much aligned with what I have laid out in the slides, like the last slide, which talks about our delivering growth. They both bring very good commercial, strong experience in product management, sales, marketing, and also in continuous improvement because they have both been a practitioner of that. So we expect to continue to see improvements in margin and working capital through that.

And then on portfolio, in terms of overall, in portfolio, we'll look at all different things, like we have talked before, our product, SKU optimization, and all of that, along with what we need to do in terms of pruning the portfolio we have and along additionally targeted M&A that really, really creates shareholder value. So I think over and then foundational element, building further, strengthen our talent, those will be the focus areas.

Steve Barger (Managing Director and Equity Research Analyst)

So to that point, we've been talking about commercial excellence for years now. Do you have product lines that are consistently break-even or loss-producing that are dragging on new product wins? And if so, why not start to divest those or shut them down?

Sanjay Chowbey (President and CEO)

Steve, as we have mentioned before that we do not disclose by product line margin and all that, but just to give you a directional answer here, yes, we are looking at that, and we are taking some actions, and there are more things in the works right now, and we'll communicate as we go forward. When we get to a point, we have a little bit more solid action and dates, but I can assure you that our overall goal here is to definitely improve our portfolio mix with both pruning of current portfolio that we have and also building and diversifying our overall revenue mix.

Steve Barger (Managing Director and Equity Research Analyst)

Got it. If I could just get one last one. We've talked a lot over the years about the footprint potentially being too big, just too many rooftops. Sales have been flat for quite a few years now. Is there any thought to accelerating that process and consolidating plants at a faster rate?

Sanjay Chowbey (President and CEO)

We're working very diligently on that, Steve. I think we have to balance between making sure that we maintain customer service and not lose business because of that. So I think overall, we'll continue to work on it. As you said, yeah, with lower volume, that definitely has been one of the focus areas for us also.

Steve Barger (Managing Director and Equity Research Analyst)

Understood. Thanks.

Operator (participant)

Our next question will come from Mike Feniger with Bank of America. You may now go ahead.

Michael Feniger (Senior Equity Research Analyst)

Hey, guys. Good morning, everyone. Thank you for taking my question. Just on the tariff side, I understand it's a very fluid situation. We're seeing some short-cycle suppliers kind of starting to already think about the China piece. Just any color you could kind of help us on when we think of the China piece, but also Mexico, Canada, how we kind of think about where your footprint fits and how much gets imported to the U.S., just any color there and how that would change your view on the pricing side, just the cost side, as we kind of monitor this dynamic situation?

Patrick Watson (VP and CFO)

Yeah, Mike, a couple of things that I think are worth going over there. I think everyone's aware in terms of our absolute China exposure runs about 10% of the total portfolio. Canada is about half of that, and in Mexico, it's around $40 million, right?

So in terms of the size of all three of those, I think a couple of things that are important as you put those numbers in context, and that is on any of those trading relationships, that tends to be bilateral. So we tend to import some products. We export some product from the U.S. as well. One of the things that, as we think about potential responses to any tariff regimes that would be put in place, would be we do have a global footprint, our ability to leverage that global footprint to offset potentially some of the costs of that, as well as in terms of what's happened here over the last couple of days, obviously looking for where are the exclusions? Are they going to be broad-based? Are they going to be more targeted? And then lastly, what's the competitive environment for the product?

So we're monitoring that situation. Those are kind of all the factors that we're taking into consideration. Obviously, we service global customers globally. We want to be able to remain and do that and to do that responsively to their needs and at good pricing and good costs for us. And so we'll try to balance all those operational considerations out as this landscape evolves.

Michael Feniger (Senior Equity Research Analyst)

Helpful. And just inventories, it did seem like there was a little progress on the inventory side for your own inventories. Just can you help us understand as you go to the end of the year and we kind of go and think about Q3 in the back half, where you think your inventories are going to end up for the year? Do you still have to take some out? And then just a follow-on question with that, given some of the reset on the end market commentary, how you feel like your customers on inventories or your distributors are kind of feeling right now as we're kind of heading into the first half of 2025 or for you guys to come to the back half of your fiscal year?

Patrick Watson (VP and CFO)

Thank you, everyone. Yeah. So just in terms of inventory, I'll put this in the context also, Mike, in terms of the outlook. So yeah, I'd say given where sales developed here in the quarter, our inventory levels are probably a little bit elevated where we would like them to be. We're going to take some action here as we move through the balance of the fiscal year to constrain production a bit and bring inventory levels back to where we would want them to be.

Again, I'd say our objective, as we think of total working capital, is to drive that primary working capital to approximately 30% by the end of the year. Now, obviously, in doing that, we're prioritizing generating the cash from inventory efficiency, over, I'll say, the non-cash benefit associated with some fixed cost absorption. That's kind of how we'll think about that. Over the course of the year, I think you'll see a little bit of that happen in Q3 from an inventory reduction perspective, and then some additional happen here in Q4 as well. As we think about inventory that's out there in the channel, I don't think at this point in time, based on what we're hearing from customers, that inventories are misaligned to where demand is. I think inventory at the customer level is pretty well controlled, even in spite of some of the changing market conditions.

Operator (participant)

Our next question will come from Stephen Fisher with UBS. You may now go ahead.

Steven Fisher (Managing Director and Senior Equity Research Analyst)

Thanks. Good morning. Just wanted to follow up on a comment I think you made about competitive dynamics in earthworks. Sounded like there was some additional pressures there. Can you just provide a little more color on that? Is this a new source of competition? Is it new dynamics that you hadn't been seeing before? Can you just talk a little bit more about that, please?

Sanjay Chowbey (President and CEO)

Yeah. It's not necessarily something new, new. I mean, there are two parts of the equation here. One is in China. I think overall capital investment has been down. So when that happens, that puts a little bit more pressure because the market has excess capacity.

And also some of the things that we supply, including our drums products, those are more expensive, almost falls in the CapEx type of category. So we are seeing some pressure there, but we are holding our own and competing quite well. In the U.S., there is definitely some reduction in production and also construction. That's where we have seen some of the price pressure, and we compete. At times, we have actually also lost some business, but in many cases, customers have come back to us because of our overall value proposition. So we do see some dynamics there.

Steven Fisher (Managing Director and Senior Equity Research Analyst)

Okay. That's helpful. And I apologize if you covered this earlier in the call, but just in the context of your broader guidance for this year that's now updated in terms of the organic growth, thinking back to your Investor Day framework of contributions from new products and market penetration, can you just update us on how you're thinking about that contribution for this year embedded within your organic growth targets?

Sanjay Chowbey (President and CEO)

Yeah. I think what we discussed during the Investor Day, roughly, let's just say 2% market, 2% strategic growth, and 2% price. At this point, we still feel very confident about approximately 2% on price and approximately 2% on organic growth, but market has been a bigger headwind. So as we see, the unit volume definitely is affected by that. So I think we're still thinking that way. Overall, when you look at the PIR data and all that, that will also indicate that we are maintaining or performing slightly better in that.

Steven Fisher (Managing Director and Senior Equity Research Analyst)

Okay. Thank you very much.

Operator (participant)

This concludes our question-and-answer session. I would like to turn the conference back over to Sanjay Chowbey for closing remarks.

Sanjay Chowbey (President and CEO)

Yeah. Thank you, Operator, and thank you, everyone, for joining the call today. As always, we appreciate your interest and support. Please don't hesitate to reach out to Mike if you have any questions. Have a great day. Thank you.

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