Kennametal Inc

NYSE:KMT

Q3-2025 Earnings Call

[Operator]

Good morning. I would like to welcome everyone to Kennametal's Third Quarter and Fiscal 2025 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Michael Pici, Vice President of Investor Relations. Please go ahead.

[Michael Pici, executive]

Thank you, operator. Welcome, everyone, and thank you for joining us to review Kennametal's Third Quarter Fiscal 2025 results. This morning, we issued our press release and posted our presentation slides on our website. We will 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 would 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 you, Sanjay.

[Sanjay Chowbey, executive]

Thank you, Mike. Good morning, and thank you for joining us. I'll start the call today with some general comments on how we are advancing our key initiatives and then provide a review of the quarter, end-market conditions, followed by some key customer wins and finally, an overview on the current tariff situation. Then Pat will cover the quarterly financial results as well as the fiscal '25 outlook. Lastly, I'll make some summary comments and then open the call for questions.

Beginning on Slide 3. So let me start by saying that I am pleased by how the team executed this quarter and focused on advancing our key initiatives. At the beginning of the third quarter, we announced a new restructuring action to lower structural costs by reducing employment costs and consolidating manufacturing operations. To that end, in mid-April, we successfully ceased operations in our Greenfield, Massachusetts plant.

Commercially, we continue to execute on our share capture initiatives across various end markets despite overall market weakness. While we have recently seen a few positive macro data points on industrial production in the U.S., most of our markets have been modestly declining for over 30 months now. And while external factors are outside of our control, we remain focused on what we can control.

The team continues to execute on our growth initiatives, including in aerospace and defense, and we believe our performance is broadly in line, if not better, than the competition. A bit later in the call, I'll cover some of our more notable commercial success stories for the quarter.

Now, let's walk through the summary of quarterly results. Sales decreased 6% year-over-year with Metal Cutting sales declining 4% organically and Infrastructure declining 2% organically. We saw broad yet modest weakness across our 3 regions, with EMEA, as expected, remaining the slowest market, down 4% on a constant currency basis.

Overall sales were slightly below the midpoint of our outlook and below our normal sequential second quarter to third quarter sales improvement. Adjusted EPS was above our expectations, fueled mainly from an advanced manufacturing tax credit, which Pat will discuss in more detail.

We also achieved approximately $6 million of restructuring savings in the quarter. We are on pace to achieve the $15 million run rate savings we committed to in January. Looking ahead, we tightened our sales outlook and raised the EPS outlook to reflect favorable third quarter performance. Pat will provide more details on the outlook in his prepared remarks.

From an end market perspective, sales declined across all end markets, except aerospace and defense, which increased 7%, propelled by defense project wins in infrastructure. Transportation and general engineering were largely impacted by market conditions in EMEA and the Americas, primarily within the Metal Cutting segment.

Earthworks within the Infrastructure segment was impacted by lower mining activity in the Americas and Asia Pacific. While we are seeing short-term pressures across our end markets, we remain confident in the long-term megatrends for industrial production. We expect to see positive trends from a growing middle class impacting general engineering and medical applications. We also expect increasing long-term demand for energy, including power generation for data centers, opportunities for growth in hybrid vehicle applications and a strong order book for aerospace and defense customers.

Turning to profitability. Adjusted EPS increased to $0.47 compared to $0.30 in the prior year quarter. While volume were lower than the prior year period, restructuring benefits, the absence of price raw headwinds, which occurred in the prior year and the advanced manufacturing tax credit helped to increase profitability.

As part of our capital allocation strategy, we continued our share repurchase program with $25 million of shares bought back during the quarter and we paid $15 million in dividends. In the quarter, we also saw the uncertainty surrounding tariffs take center stage globally. While the economic impact of recent trade policies remain fluid, I will provide some insight on potential impact and mitigation actions in a few moments.

Finally, let me say that we remain committed to executing on our value creation pillars to deliver above-market growth, continuous improvement to drive margin improvement and optimization across our product and business portfolios. We have more work to do in all these areas and I look forward to updating you on our progress as appropriate.

Now turning to Slide 4. I want to take a moment to provide commentary on our end markets for the full year. As I stated earlier, we have tightened our fiscal '25 full year sales outlook to reflect the latest forecast of the specific market drivers and general market conditions.

By end market, the top section shows the assumptions we had in our prior outlook compared to the assumptions in our current outlook. The bottom section of the slide shows some of the key contributing factors by end market. First, general engineering. The key factors that drive our expectations are external IPI forecasts for the U.S. and EMEA regions and PMI data in China.

As I noted earlier, market conditions in EMEA have been challenging this fiscal year. External forecast for IPI in EMEA also remain down for the first half of calendar year 2025. The U.S. IPI forecast is expected to be flat in the first half of calendar year '25, and China PMI remains unchanged as well. Taken together, at the midpoint, we anticipate general engineering to remain down slightly year-over-year as previously communicated.

Second is transportation. The key external indicator we track here is IHS light vehicle production. The most recent IHS estimate projects production to be down 1%, which is consistent with the previous estimate. Once again, the pressure is primarily in EMEA with a slight slowdown in the Americas. It has been well documented the pressure OEMs in EMEA are facing. Given these production forecasts and customer challenges, we continue to expect the end market to be down year-over-year.

Third, our expectations for energy and earthworks remain consistent with previous expectations. U.S. land-based rig counts are forecasted to decline and sentiment among our customers remain cautious as the price of oil has fallen. We expect to see normal seasonality in the construction market within earthworks, while mining activity continues to decline in China and we expect lower U.S. coal exports.

Finally, expectations for aerospace and defense are unchanged with a slight increase year-over-year as the aerospace industry steadily recovers from supply chain and OEM production issues. In conversations with our customers and channel partners, there is a lot of discussion on the uncertainties surrounding tariffs.

With that, turning to Slide 5. I want to take some time to provide commentary on tariffs and how we are planning to mitigate the direct impact. Let me start by saying that it is our intention to fully mitigate the cost implications of tariffs. Near term, we expect headwinds as we implement the mitigation actions.

This slide provides a summary of how tariffs are projected to impact Kennametal globally and the actions underway to fully mitigate them. As you can see, we have bilateral trades globally. The estimated annual impact of the additional costs associated with the tariffs that were in effect as of April 30 is approximately $80 million.

From a mitigation standpoint, our actions include: first, utilizing our global footprint to optimize product flow; second, evaluating alternative supply options and opportunities to minimize the impact of shipments between regions; third, rebalancing production capacity; finally, while we are taking actions to minimize impact on our customers, we are implementing tariff surcharges as appropriate.

We are also seeing the opportunities across both our segments to capture market share, including powder sales, utilizing our U.S. footprint. Collectively, through all the actions I've just outlined, we are committed to fully mitigating the impact of tariffs and pursuing new potential growth opportunities. That said, the tariff landscape remains extremely fluid and we continue to monitor the situation and will adapt and evolve our plans accordingly.

Turning to Slide 6. I want to touch on some customer wins that demonstrate our continued focus on advancing our growth initiatives across both segments. Let's start with Metal Cutting. First, we secured an initial order with an OEM within the aerospace and defense end market. Our tooling helped reduce manufacturing cycle time while meeting challenging specifications.

Next, within the general engineering end market, we captured an order to provide indexable drills to an industrial pump manufacturer. Our solution exceeded the customers' expectations for lead time and performance. Within transportation, we provided a customized and differentiated solution to a manufacturer of high-speed railway switches.

Now moving to our Infrastructure segment. In the energy end market, our Conforma Clad corrosion-resistant solutions improved the production process for our customer in the battery industry. Within earthworks, we developed a custom solution for a trenching and mining equipment customer to meet their demanding needs. As you can see, we provide innovative and effective solutions to a very diverse set of applications for customers around the world.

Now, let me turn the call over to Pat, who will review the third quarter financial performance and the outlook.

[Patrick Watson, executive]

Thank you, Sanjay, and good morning, everyone. I will begin on Slide 7 with a review of Q3 operating results. The quarter's results show that we continue to execute our initiatives in the face of weak market conditions. Sales were down 6% year-over-year with an organic decline of 3% and unfavorable foreign currency exchange of 3%.

The sales performance this quarter was slightly below the midpoint of the outlook we provided last quarter relative to those expectations. And as you heard from Sanjay, we experienced continued pressure in EMEA and the Americas, which impacted our general engineering, transportation and earthwork end markets. Energy was in line with expectations. Year-over-year, we experienced modest weakness in all end markets and regions, except for aerospace and defense. I will provide more color when reviewing the segment performance in a moment.

Operating expense declined approximately $5 million, benefiting from restructuring savings and favorable foreign exchange despite year-over-year wage inflation. And adjusted EBITDA and operating margins were 17.9% and 10.3% respectively, versus 14.2% and 8.1% in the prior year quarter.

During the quarter, we had an approximate $10 million benefit from an advanced manufacturing production credit under the Inflation Reduction Act. We also achieved $6 million in savings from restructuring programs, $3 million of which is related to the employment actions announced in January of this year.

Lastly, foreign exchange was a $3 million headwind this quarter. The adjusted effective tax rate decreased year-over-year to 22.8%, primarily driven by a benefit from the advanced manufacturing production credit and geographical mix.

Adjusted earnings per share were $0.47 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 8. The year-over-year effect of operations this quarter was positive $0.06. This improvement reflects the absence of unfavorable price raw material, which occurred in the prior year, higher price and incremental restructuring benefits, partially offset by lower sales and production volume and higher wages and general inflation.

We also had a $0.10 benefit from the advanced manufacturing production credit, approximately $0.08 of which is related to a cumulative catch -up of prior period material costs. Inclusive of the effect on the tax rate, the advanced manufacturing production credit had an approximate $0.13 impact on adjusted EPS. Unfavorable currency and pension effects on EPS were $0.02 and $0.01 respectively. Other reflects benefits from lower share count and interest, which contributed $0.02.

Slides 9 and 10 provide an overview of our segment performance. Reported Metal Cutting sales were down 7% compared to the prior year quarter with a 4% organic decline and unfavorable foreign currency exchange of 3%. By region, on a constant currency basis, the Americas and Asia Pacific declined 1% each and EMEA declined 6%.

In the Americas, year-over-year performance was affected by lower industrial production activity in general engineering, partially offset by a modest improvement in the transportation end market. In Asia Pacific, we saw lower production volumes affect the general engineering end market, partially offset by project wins in transportation.

EMEA's year-over-year decline reflects weakness in the general engineering and transportation end markets, partially offset by strength in aerospace and defense. In our end markets, energy grew 2% this quarter from customer order timing in Asia Pacific. Aerospace and defense was flat year-over-year. We saw easing supply chains and improved build rates in EMEA that were offset by lower production in Asia Pacific from a customer quality issue and the slow ramp-up from the strike in the Americas.

Transportation declined 2% year-over-year from the overall slowdown in EMEA, partially offset by project wins in Asia Pacific and higher production volumes in the Americas. And lastly, general engineering declined 5% year-over-year from lower production activity, primarily in EMEA and the Americas.

Metal Cutting adjusted operating margin of 9.6% decreased 120 basis points year-over-year, primarily from lower sales and production volumes, unfavorable foreign exchange and higher wages. These factors were partially offset by improved pricing, incremental year-over-year restructuring savings of approximately $4 million and lower raw material costs. Additionally, as Sanjay previously mentioned, we ceased production at our Greenfield, Massachusetts facility mid-April.

Turning to Slide 10 for Infrastructure. Reported Infrastructure sales declined 4% year-over-year with an organic decline of 2% and unfavorable foreign currency exchange of 2%. Regionally, on a constant currency basis, EMEA sales increased by 5%, Asia Pacific declined by 1% and in the Americas, sales declined 5%. EMEA growth was primarily driven by defense projects and higher activity in earthworks, partially offset by lower industrial activity and project timing affecting general engineering.

Asia Pacific declined primarily from lower volume in underground mining as mine production is lower in response to lower coal prices, which was partially offset by project timing in energy and general engineering. The decline in the Americas was primarily from lower underground mining activity in earthworks and lower production activity in general engineering, partially offset by aerospace and defense project wins and higher construction activity.

Looking at sales by end market on a constant currency basis, continued execution of our growth initiatives drove a 28% increase in aerospace and defense sales with good growth and execution in both EMEA and the Americas defense. While the project nature of this business can make it lumpy, it's an example of how our team is executing on commercial opportunities.

Energy declined 3%, mainly in the Americas from lower U.S. land rig count and partially offset by project timing in Asia. General Engineering declined 4% from lower industrial activity in the Americas and EMEA. And lastly, earthworks declined 7% from lower underground mining activity in the Americas and lower volume in Asia Pacific, which was partially offset by higher activity in EMEA.

Adjusted operating margin increased 770 basis points year-over-year to 11.5% from the advanced manufacturing production credit of approximately $10 million and the absence of unfavorable price raw timing which occurred in the prior year period. We also achieved year-over-year restructuring savings of approximately $2 million. These factors were partially offset by lower sales and production volumes.

Now turning to Slide 11 to review our free operating cash flow and balance sheet. Our third quarter year-to-date cash flow from operating activities was $130 million compared to $163 million in the prior year period. The change in net cash flow from operating activities was driven primarily by working capital changes, mainly increased inventory as a result of lower demand.

Our third quarter year-to-date free operating cash flow decreased to $63 million from $84 million. On a dollar basis, year-over-year, primary working capital fell to $654 million and on a percentage of sales basis decreased to 31.6%. Net capital expenditures decreased to $67 million compared to $79 million in the prior year.

In total, we returned $40 million to our shareholders through our share repurchase and dividend programs. During the quarter, we repurchased 1.1 million shares or $25 million 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.

We remain committed to returning cash to our shareholders. This commitment reflects our continued confidence in our ability to drive long-term growth and margin improvement to create shareholder value. Our balance sheet remains healthy, and we have no near-term debt refinancing requirements.

At quarter end, we had a combined cash and revolver availability of approximately $787 million, and we're well within our financial covenants. The full balance sheet can be found on Slide 16 in the appendix.

Now on Slide 12 regarding our full year outlook. We now expect FY '25 sales to be between $1.97 billion and $1.99 billion, with volume ranging from negative 5% to negative 4% and net price realization of approximately 2%. As Sanjay noted, the expected market conditions in EMEA and the continued stagnation of industrial production in the U.S. remain unchanged.

We now anticipate an approximate 1% year-over-year headwind for foreign exchange based on the recently overall weaker U.S. dollar. The foreign exchange sales headwind is now expected to be approximately $20 million at the midpoint of our updated outlook. Specifically, as it relates to Q4, however, we anticipate a foreign exchange sales tailwind of approximately $13 million sequentially.

Year-over-year, we expect aerospace and defense to have slight growth; transportation to decline; general engineering, earthworks and energy to decline slightly. From a cost perspective, we expect to offset raw material, wage and general cost increases on a dollar basis and tungsten prices are assumed to be stable at current levels.

Foreign exchange and non-cash pension expense are expected to be headwinds of $4 million each. Approximately $14 million of rollover savings from our previously announced restructuring initiatives have been included. Our outlook also includes the impact of the FY '25 announced plant closures and restructuring actions, which combined are anticipated to generate approximately $15 million of annualized run rate savings by June 30.

For fiscal '25, we have included approximately $7 million in savings related to these actions. At the end of the fiscal year, we expect to have achieved a $65 million savings run rate against our $100 million savings target. Depreciation and amortization is expected to be approximately $135 million and we expect interest expense of approximately $27 million and an effective tax rate now of approximately 25%.

As a result of our performance in Q3, inclusive of the IRA tax credits and our current estimate of the impact of tariffs, we now expect adjusted EPS to be in the range of $1.30 to $1.45. This includes an approximate $0.05 negative effect from tariffs. As Sanjay outlined earlier regarding tariffs, we have several mitigation actions either implemented or in progress to fully mitigate the effects. We will provide an update on any impacts for FY '26 on our August earnings call.

On the cash side, the full year outlook for capital expenditures is now anticipated to be approximately $90 million, and the outlook for primary working capital is now 32% by fiscal year-end. Taken together, we continue to expect free operating cash flow to be greater than 125% of adjusted net income.

And with that, I'll turn it back over to Sanjay.

[Sanjay Chowbey, executive]

Thank you, Pat. Turning to Slide 13. Let me take a few minutes to summarize. We remain focused on staying the course despite the highly volatile macro environment, and we're executing on our value creation initiatives to deliver a strong finish to fiscal '25. We are obviously in our fourth quarter right now, and we are actively planning for the new fiscal year, which begins July 1.

I am looking forward to the conversation with you in August, where we will provide some color and context on several topics, including progress on my first year as CEO, our fiscal '26 annual outlook, and finally, an update on portfolio, footprint and structural cost initiatives.

And with that, operator, please open the line for questions.

[Operator]

[Operator Instructions] Today's first question comes from Angel Castillo with Morgan Stanley.

[Angel Castillo Malpica, analyst]

Just wanted to talk about the outlook a little bit more, maybe particularly for the fourth quarter. So, I think at this point, you talked a little bit about some green shoots and still kind of, I think, assuming a little bit of sequential improvement in some of the organic growth.

So can you talk about quarter-to-date, what you're seeing in terms of kind of demand trends as you think about April and May, particularly across some of the key end markets and how that's kind of progressing? And particularly, if you could also parse that out between what's kind of industry-specific versus share gain related?

[Sanjay Chowbey, executive]

Angel, yes, so I think, at this point, we continue to see a steady improvement. And as I outlined in our -- overall in the market trend slide, most of the things are staying about the same. As I had mentioned that general engineering, the IPI, other than Europe, I think U.S. and APAC basically staying relatively flat. EMEA continues to be slightly weak; transportation, same; EMEA is weak; rest of the market, relatively flat; Energy, definitely sentiments are cautious right now with the customers.

But again, for what we have said 3 months ago, very similar sentiment right now. In earthworks, again, same thing. Sentiments are similar, softness in U.S. coal exports and then also demand in China versus capacity equation putting price pressure there. Aerospace defense, slight improvement as things continue to get better with the OEM and the supply chain constraints.

So, I think at this point, we haven't seen anything different with respect to either buy ahead or any kind of impact of tariffs. So, I think that we expect more or less a steady path for overall market at this point. In parallel, we'll, of course, gain some market share as we are outperforming them in our -- both segments.

[Patrick Watson, executive]

Yes. I mean just one thing to give some color there on the Q4 sequentially, Angel. And that is as we think about -- I'll just reference the midpoint of the outlook here. A couple of things to contemplate. Number one is, we got a pretty significant FX change from Q3 to Q4. So that's about a $13 million sales tailwind for us.

Once you kind of pull that out, some of the incremental revenue associated with tariff surcharge, you're going to get right back to a number that's much more normalized in terms of sequential performance Q3 to Q4. And so, underlying the outlook is really normality from a progression of the business moving into Q4 here.

[Angel Castillo Malpica, analyst]

Got it. That's very helpful. And then maybe, could you just talk a little bit more about kind of the specific buckets you talked about on tariffs. You laid them out in the slide for mitigating the full kind of $80 million. Can you just maybe quantify each of those and just a little bit more kind of color as to maybe which of those are kind of fully underway, which might take a little bit more time or work and how we should think about them?

[Sanjay Chowbey, executive]

Yes. I think, at this point, we will not go into the quantification of each of the category. But I can tell you, on a high level first, repeating what I said in the prepared remarks, we are very confident that we'll fully mitigate the direct impact of tariffs.

Now, first, there are 3 items on the list there. It talks about how we are utilizing our global footprint in our supply chain network. And those things are in progress already. More than half or slightly more than half of our tariff direct impact is related to what we do between U.S. and China and then China to U.S. And those things, we already have begun implementation of some of those product moves and tooling moves and things like that.

Rest of that is in progress. We intend to complete those things as we go. We've already implemented tariff surcharges in U.S. for the Metal Cutting. And then, we are also taking surgical actions on Infrastructure business from a surcharge perspective. So, all in all, I will say the action implementation is coming along very well, and we are going to continue to implement rest of the actions in a timely manner.

[Angel Castillo Malpica, analyst]

That's very helpful. And just to clarify that because I guess the point of my -- what I was trying to get across is maybe there's a $0.05 headwind from tariffs, I think, in the fourth quarter. But is the implication, therefore, that by the first quarter, you'd kind of be fully offsetting everything? And I'll get back in the queue.

[Sanjay Chowbey, executive]

Yes. I think at this point, as Pat mentioned, the $0.05, some of the activities, obviously, tariff was effective in first part of April. We started to make sure and things have been very fluid, as we all know. So, we took -- started to take actions and notified our customers where we need to and also internal moves of tooling and production supply chain.

So, some of those things were in place by the end of April, early May, and that's part of that. And then remaining actions will continue to be worked on. I think that's the reason for us to say that we do have risk in Q4. We expect to provide more detail when we talk in August exactly where we are. But like I said, we do intend to fully mitigate all the direct impact of tariff.

[Operator]

The next question is from Steven Fisher with UBS.

[Steven Fisher, analyst]

I just wanted to bridge a little bit on the quarter itself relative to the guidance you had previously. And if we back out, the IRA credit and tax benefits related to that. Just kind of curious what you think were the kind of the biggest surprises relative to what you had thought before? Seems like it might have been price versus cost.

And I guess on the cost side of things, with the tungsten prices having gone up in the last few months, I'm just kind of curious how you expect that to flow through over the next few months and how much you think you might need to raise pricing here just to manage that higher cost and when that might hit?

[Patrick Watson, executive]

Yes. So let's start with that, Steve. As we just think about tungsten has moved up here. I think as we think about like our second quarter, so the December quarter, we would have seen like an average tungsten price like $335. As we got into Q3 here, February, it was up just slightly, just, I think, low-$340s. As we sit here today, it's closer to like $395 from an average perspective.

So, overall, I would say the last 60, 45 days, we've seen that those prices come up. And as we normally talk about, from a pricing standpoint, we do have some contracts, specifically in Infrastructure in the energy end market, they'll begin resetting. As that price rises, we'll see some favorable pricing come out of that as we move here into the fourth quarter.

And then, depending on where tungsten rolls here over the next couple of months, we'll probably see some additional favorability come through as well. In general, we always talk about, from a cost structure perspective, the costs that tend to flow through the P&L lag by about 2 quarters. And so, at the moment, we're still enjoying a cost base that's prior to the recent escalation here in prices.

As we think about the third quarter and the margin performance, I'll just talk about EPS terms here. Obviously, the big driver for us in terms of versus our expectations at the outset of the quarter was the advanced manufacturing tax credit. So that in and of itself sits at about $0.13 between the benefit of the tax credit itself and some favorability that also pulls through the effective tax rate.

And so, going into the quarter, we knew that, that was a, I'll call it, a known-unknown in terms of how much we would actually qualify. The treasury regs for that were finalized in the December quarter. We worked through that. And I think at this point in time, we'll continue to get an ongoing benefit from that. But the surplus from a catch-up perspective, getting caught up to the regs, that's all behind us here in the third quarter.

I think the other elements in terms of overall performance and sales was pretty much aligned with where our expectations were. Our cost structure came in a little better. I'd say a little bit of that was from restructuring. And we had a couple of things kind of break our way over the course of the quarter as well that helped us deliver the number.

[Steven Fisher, analyst]

Very, very helpful. And I just wanted to ask a little bit about the competitive dynamics and see if there's any tariff-related relevance here. You cited some competitive pressures in the Americas in the Infrastructure and I think it was specifically in earthworks. I'm just curious kind of what's the source of that? And then, sort of related potentially is, to what extent the tariff regime is creating any competitive advantage that you might have in the United States? And do you think you need to prepare for kind of competitors to be reshoring up or moving operations to -- within the United States?

[Sanjay Chowbey, executive]

Yes. Steve, first, let me address the issue of the earth cutting business comment on competitive pressure in the U.S. and China. And then I'll come back to the overall competitive landscape and tariff. With respect to earthworks, as we have said before, the coal exports coming out of U.S. has been soft. And then in China itself, the demand versus capacity equation has been lopsided for some time.

So, because of that, there has been price pressure, and we are able to compete and keep our business. But there is definitely some pressure on price from that. Now, we have not mentioned or we are not seeing anything from a price perspective or price pressure perspective for any other business as such.

Now coming to the overall competitive landscape. As we have said in our prepared remarks also that we are definitely keeping up or most likely performing better than our peers, especially who have reported in the public domain. And that has been there for several quarters now. And we believe our overall organic growth initiatives are working well. Our commercial initiatives, our sales marketing team, operations team have been really able to do a good job in customer service and able to provide good application support and continue to win.

We believe that that work will continue. We'll build upon that. For the time being, now again, talking back about the tariff situation, we do believe that as a company in our industry in cutting tool and wear component business, we are better positioned than others based on our overall footprint that we have strongly in U.S. and also, we have a strong footprint in Europe and APAC.

So we believe that we'll be able to utilize that to make the moves we need to for mitigation actions, but we'll also be able to utilize our U.S. footprint to make sure that we are taking growth opportunities and winning some market share, especially when it comes to powder sales in rods and some cutting tool opportunities.

[Operator]

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

[Jacob Moore, analyst]

This is Jacob Moore on for Steve. First one for me, kind of just staying on tariffs. I'm curious if you're seeing any pull forward or wait-and-see type demand pauses. It feels like component manufacturers have been more victims of pull forward, while larger, more complex goods are more wait and see. Just curious what your experience has been so far and maybe that's an opportunity for you to expand on specific mitigation efforts you'd like to call out as well.

[Sanjay Chowbey, executive]

Yes. First of all, in terms of pull forward, we have really not seen much, just in the couple million-dollar type of range. So for all realistic purpose, nothing much. And we don't expect that as such even in the coming weeks and months here. I believe that in our customer base, there has been definitely discussions about some production moves. As in the public domain, you have seen some of the automotive transportation OEMs, they have talked about some production moves, but some of those things will take time. In the meantime, we're staying very close to our customers and supporting them as they need to manage through this situation. We look forward to overall utilizing this opportunity to definitely gain some new business.

[Jacob Moore, analyst]

Great. That's helpful. And it kind of leads into my second question here, which is, do you think that any of this rapidly changing trade situation is an opportunity to look at M&A or portfolio optimization? I'm thinking about if there's lines of products you could consolidate or divest or assets that are getting closer to your M&A criteria. Just how are you thinking about those types of actions in the absence of a robust demand environment?

[Sanjay Chowbey, executive]

Yes. We have definitely been working on our strategic priorities and to see how those things are aligned with our inorganic portfolio actions. Now, with the tariff, definitely, it did bring a new front on this discussion because we bring some things to the table. So, of course, there are discussions, and we will share more information when we get to a certain point on that. But yes, there will be definitely some implications on that.

[Operator]

The next question comes from Julian Mitchell with Barclays.

[Julian Mitchell, analyst]

I just wanted to just focus on the guide changes first off. So, I suppose the EPS guide increase is sort of a composition largely of the production credit and then you've also $0.10 in the operating line. And then it seems like sort of $0.05 each coming from tax and FX versus the prior guide. Just wondered if there was anything else kind of moving around within that guide and put a finer point on the net tariff headwind that's dialed in for this year as a whole in EPS.

And sort of tied to that, trying to understand organic sales, doesn't seem like there's many surprises, but just wanted to confirm if in recent weeks, you've seen anything moving around versus normal seasonality.

[Patrick Watson, executive]

Yes. Just in terms of the outlook, I would say that the thumbnail version there, Julian, in terms of the approach we took on the outlook, because we obviously outperformed the expectations here in the third quarter. That got rolled into the full year. We do have the -- some benefits from the surcharge, but we've got costs associated with the tariff, that's the net exposure we've talked about. That's been rolled in.

FX, as we move through the quarter here, we're sitting at $1.135 euro versus we were at closer to $1.08. So we got some benefit on the weaker dollar. And then I would say, lastly, just based on where we think sales and the business will perform here, just tightened up the range, right, and narrowed it down given that we're in the fourth quarter of the year.

When I think about where we're at here from a sales performance in the month of April, and again, this is kind of how the outlook is built as well, pretty normal progression, right? And so, we've not seen from a demand perspective at this point in time, anything that's out of the ordinary. Obviously, as we think about the March and April time frame from year-to-year, you've got an Easter holiday effect in there, predominantly in Europe that can be a little wonky. But again, the business seems to be performing and demand levels seem to be pretty normal.

[Julian Mitchell, analyst]

That's helpful. And then just when we're thinking about the sales recovery whenever that comes, assume it's sometime, let's say, in fiscal '26. Just wondered really for Sanjay, I suppose, given you've almost been in the job for 12 months now as CEO, what kind of operating leverage are you kind of aiming for in that recovery? We can see the historic record and the restructuring efforts more recently, for example, since January that have been announced. But rolling everything together, what's the sort of operating leverage kind of entitlement Kennametal should have when your sales start to grow again?

[Sanjay Chowbey, executive]

Yes, Julian, we'll start with a simple answer of mid-40s, okay? That for sure we expect. As we have been working on our cost structure, and we'll share more details on overall portfolio analysis and cost structure, footprint and those actions. We do believe that we are continuing to improve our fixed cost. But at this point, you can definitely go with the mid-40s in terms of leverage.

[Operator]

The next question comes from Michael Feniger with Bank of America.

[Michael Feniger, analyst]

Just on inventories, I think your inventories, if I look at the quarter, actually increased sequentially. Revenue was a little flat. I'm just kind of curious how you feel with your inventory position, the quarter have a benefit from that absorption? Are you carrying a little bit more inventory? Is that strategic going into this type of environment now as we enter the back half of this year? That's my first question.

[Patrick Watson, executive]

Yes, a little bit of absorption there. When you look at finished goods inventory, it's up quite modestly sequentially from Q2 at December end. The bigger uptick will be in WIP and powder inventory. And so, that's where you've seen it.

I would say a couple of things about it. Number one, just given the change in demand that we've seen here and projected over the last couple of months, supply chain is relatively long. It does take a little bit of time to adjust the supply chain. I would also say, at the moment, given that a lot of that is WIP and raw material related, with the elevation of the tungsten prices, that's not necessarily a bad thing to have more inventory acquired at the lower cost either.

[Michael Feniger, analyst]

Fair enough. And if I just ask, did you guys provide a breakdown of your COGS from -- geographically from an area like China? I'm just trying to get a sense of is the impact mostly that China tariff is it that 10% for the rest of the world, maybe Europe to U.S.? And I guess with what you guys are factoring in, is it based on those rates from April 4 Liberation Day? If we wake up in a few weeks and we see a deal struck, is that upside to that $80 million? Just any help there would be helpful for us.

[Sanjay Chowbey, executive]

Yes, sure, Michael. Yes, we are using all the tariff rates, which were on effect on April 30. So, as negotiations happen and things like that, that $80 million itself will come down. But what we're also telling you, regardless of whether $80 million becomes $60 million or $50 million, we have action plans in place to fully mitigate the direct impact of tariff cost. And we are also, in parallel, definitely looking at opportunities for growth -- capitalizing on our footprint and supply chain network. To your comment, the risk will come down as the negotiations happen.

[Michael Feniger, analyst]

Fair enough, Sanjay. And if I could just sneak one more in, just to follow on with Julian's comment. I hear the point on 2026 with the incrementals. Just when we think of where you're going to end up in F-Q4, when we think of that normal seasonality to start the year for F-Q1, normally, seasonally, we see sequentially revenues go down anywhere high single digit to double digit. Is there anything that you guys are looking at now that you would say into next year, the seasonality standpoint from F-Q4, F-Q1 on the top line or bottom line that we should kind of be thinking about as we kind of turn the page?

[Patrick Watson, executive]

Yes. No, obviously, yes, the normal seasonality going into Q1, right. And we'll give an update on end markets and where we think that will precisely be, obviously, in about 90 days. I would say from a cost structure perspective, just a couple of things to be mindful out there as you guys put together your expectations for '26. We have had some benefits flow through this year in terms of the P&L that are non-repetitive in nature. And so that's going to be -- we've got about $6 million of proceeds from tornadoes -- insurance proceeds on the tornado that was a year ago in May, June in excess of cost.

So, obviously, that's not going to repeat. That's within the Infrastructure segment. We've talked already about on this call, the tax credit, although that will continue forward at this point in time based on tax legislation indefinitely until Congress changes the tax law. As we talk about the '25 to '26 progression, there's about $8 million of benefit in '25 that's not going to repeat in '26 because that's the catch-up amount.

And then the last thing I would just reflect upon would be in terms of restructuring programs, what we'll end -- at the run rate we'll end this year and what we already have in the pipeline to pick up about another $8 million of benefit in the first half of fiscal '26 as that annualizes out throughout the year. So, from a cost structure perspective, I think those are the 3 big things that are worth thinking about.

[Operator]

The next question is from Tami Zakaria with JPMorgan.

[Tami Zakaria, analyst]

I have 2 follow-up questions. So, my first question, just wanted a bit of clarity on the pricing outlook. I think you kept it unchanged at 2% for the year. And it seems like you're already taking some pricing action for tariffs. So, is 2% pricing still the right number to think about for the final quarter of the year?

[Sanjay Chowbey, executive]

Tami, yes, I think excluding tariff impact, approximately 2% is what we have said. So, yes, that will be the right number.

[Tami Zakaria, analyst]

So it could be higher if the current price increases flow through?

[Sanjay Chowbey, executive]

Yes. If you're adding the tariff on surcharge, yes, but I'm excluding the tariff surcharge that I'm saying that is like on top of tariff surcharge is simply to offset the tariff direct impact.

[Tami Zakaria, analyst]

Got it. Okay. And so my follow-up question is, are you able to share what price and price cost was in the third quarter?

[Patrick Watson, executive]

No. The only thing I would say there, Tami, is as we think about the business performance on a year-over-year basis, right, and is where -- this is given the timing elements that can move through the P&L, a year ago, third quarter in Infrastructure, they would have been on the wrong side of the price raw cycle. And so you would have seen operating income margin in Infrastructure of about, I think, 3.8% last year 3Q. And as we got to this year, price were off, from an Infrastructure perspectives and balance in Q3. And so neither a headwind or a tailwind, quite frankly, to note there.

[Operator]

The next question is from Joe Ritchie with Goldman Sachs.

[Joseph Ritchie, analyst]

So, just my first question, and this is just a higher-level question for Sanjay. Some of these tariff actions that you're taking in place on Slide 5, is it fair to presume regardless of what happens with the tariff situation, because I guess there's an expectation that at some point, this number is going down that these actions are kind of more structural in nature outside of maybe like the surcharges, there'll be structural movements to your supply chain that will continue?

[Sanjay Chowbey, executive]

Yes, Joe, for the most part, that will be correct assumption. I think if things went back to the way it was before, in that case, there could be some regrouping of production in terms of getting the economy up to scale because there are certain types of specialty products that we make today in one part of the world or the other and we ship around, but we are very capable of producing our general product, the standard products in all 3 regions. So those kind of moves we have already enacted very quickly in April.

But there are some specialty products. We'll revisit that depending on where the tariff levels go back. But assuming that there is some sort of tariff in place, I think these will be more in like a little bit more permanent shape. And we'll definitely -- in parallel, we're working on -- we're always looking for improvement as we are even doing this. And as part of continuous improvement mindset, we're not just saying that let's just do this to manage tariff.

When we're moving any of these things around, we are looking for cycle time improvement, uptime improvement and overall yield improvement. So our idea here is that we come out stronger from this situation.

[Joseph Ritchie, analyst]

Got it. That's helpful. And look, not that the current environment is supporting this, but if for some reason, we were to see some like real acceleration in the demand backdrop, I'm curious, like is there a risk to being able to supply the market if we do see an inflection point in your business? Typically, when you see these types of moves, sometimes you run into like this -- kind of like pig in a python problem. And I'm just curious like how you're managing and how much capacity you have if things were to inflect from a revenue perspective?

[Sanjay Chowbey, executive]

Yes. On a high level, we do not anticipate any risk. I think we have definitely -- like, if you go back a few years ago, we as a company and the industry, we have seen 30 months of slowdown in industrial production. So if you go back to even 5 years ago, we have more capacity to support aerospace and defense demand, same way for transportation, general engineering, so on and so forth, energy.

So, we can definitely handle, we'll be happy to handle some recovery in the market. And in parallel, as Pat also mentioned, we have definitely worked on our cost structure. We'll be exiting this year. In January, we announced the $15 million. We're well on track to complete that. So, I do believe that we will be able to handle in terms of demand, but also in terms of getting -- coming out with this better cost structure, too.

[Joseph Ritchie, analyst]

Got it. Great. One last one. I know we'll get the guidance next quarter. But just maybe you can comment, any changes to how you will guide, like in terms of the information you'll provide versus how you guided last year, either any incrementally new or less information when you do give the guidance?

[Patrick Watson, executive]

No, I think that's a question we'll answer, Joe, in about 90 days.

[Operator]

This concludes our question-and-answer session. I would now like to hand the call back over to Mr. Chowbey for closing remarks.

[Sanjay Chowbey, executive]

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.

[Operator]

The conference has now concluded. Thank you for your participation. You may now disconnect your lines.