Q1 2021 Kennametal Inc Earnings Call
[music].
Good morning.
Welcome everyone to Kennametal first quarter fiscal 2021 earnings conference call.
All lines have been placed on mute to prevent any background noise.
After the speakers 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 to leave.
Please note that this event is being recorded I would now like to turn the conference over to Kelly Boyer Vice President of Investor Relations. Please go ahead.
Thank you operator, welcome everyone and thank you for joining us to review Kennametal first quarter fiscal 2021 results.
Yesterday evening, we issued our earnings press release and posted our presentation slides on our website, we will be referring to that slide deck throughout todays call.
I'm Kelly Boyer Vice President of Investor Relations, joining me on the call today.
Chris Raucy, President and Chief Executive Officer.
And Damon Audia, Vice President and Chief Financial Officer.
After Chris and Damons 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 companys 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 SEC filings.
In addition, we will be discussing non-GAAP financial measures on the call today.
Reconciliations to GAAP financial measures that we believe are most directly comparable can be found at the back of the slide deck and on our form 8-K on our website.
And with that I'll now turn the call over to Chris.
Thank you Kelly good morning, everyone and thank you for joining us today.
I'll start today's call with some general comments on the level of industrial activity. We are currently seeing.
Then briefly review the quarter, our strategic initiatives and expectations for Q.
Damon will then go over the quarterly financial results in more detail.
Finally, I'll make some summary comments before opening the call for questions.
Getting on slide two in the presentation deck.
Sales this quarter outpaced the typical 10% seasonal Q4 to Q1 decline.
That increasing sequentially by 6% of which 3% was due to FX.
General Engineering and transportation end markets are showing the highest levels of recovery.
As a reminder, those two end markets total more than 60% of our sales.
On a year over year basis organic sales declined by 21%.
On top of an 11% year over year decline in the prior year quarter.
However through disciplined execution on several fronts, we were able to effectively maintain profitability.
Adjusted EBITDA margin improved by 40 basis points to 11.3% versus.
Versus 10.9% in the prior year quarter.
And our operating leverage was strong as well.
Continued double digit declines in volumes and associated under absorption.
Proven and EBITDA margin was driven by lower raw material costs precinct.
Leasing benefits from simplification modernization and effective cost control actions.
Operating expense as a percentage of sales increased to 23% due to lower sales. However in total dollar terms decreased 18% year over year.
Our target for operating expense remains at 20%.
Adjusted EPS was three cents compared to 17 cents in the prior year quarter, reflecting the factors I, just named as well as a higher adjusted effective tax rate.
Looking ahead.
Of course visibility in this environment is still limited due to COVID-19 still remains extremely difficult to forecast, how our customers as well as our end markets will be affected spec.
Especially with additional shutdowns being contemplated in some regions do you.
Recent spikes in COVID-19 cases.
So we will not be providing a full year outlook for fiscal year 21, However, I would like to provide some color on what we might expect in the second quarter.
Based on the monthly sales results in Q1.
Early indications from our October sales.
Assuming that there is no additional second wave of Cove at 19, Lockdowns on the quarter.
We expect Q2 to see low to mid single digit growth sequentially.
Which would be above our normal sequential growth pattern of 1% to 2%.
Well it feels like the economic recovery may be gaining momentum as I said, it is still difficult to predict the pace and trajectory.
So we continue to focus on the things we can control such as us executing our operational excellence and commercial excellence strategies gained share and improve operating results throughout the economic cycle.
On the operational excellence side simplification modernization initiatives are on track to deliver approximately $80 million and benefits. This year increase of 67% over last year.
That will bring the total cumulative savings from inception of the program to $180 million.
Which is within the original target we set in December 2017, despite much lower volumes than we envisioned at that time.
As a reminder, we expect to complete our original footprint rationalization activities with closure of the Johnson City, Tennessee plant.
Downsizing of the Essen, Germany plant by the end of this fiscal year.
Also the capital spending associated with the simplification modernization program is substantially complete.
This will result in significantly lower capex levels going forward.
Excluding this fiscal year were total capex is expected to be reduced by approximately 50% to 110 and $130 million.
In addition to our focus on these transformational operational excellence initiatives.
We are equally focused on driving commercial excellence.
Turning to slide three.
As you recall last quarter, we announced the combination of our two metal cutting business segments.
Enabling us to direct our commercial resources products and technical expertise more effectively toward capturing a larger share of wallet.
In addition, we discussed our new brand strategy to reposition the video brands and portfolio to the multibillion dollar fit for purpose application space within metal cutting.
Which we previously have not focused on.
This strategy opens a 40% increase in served market opportunity, while offering better service and tooling options to our customers.
Progress on this initiative is tracking with our expectations.
I'm pleased that we already have several wins with new customers and existing customers.
During a recent win at a major machine tool builders to apply fit for purpose tooling as standard on new machines they sell.
Also the reaction from our channel partners has been broadly positive.
Actually to be able to operate in the market with clear brand positioning.
Due to win share in the full solution application space as well with a share gain and a major machine tool builders manufacturing facility.
And we are successfully leveraging one of our proven tooling solutions developed for a wind turbine manufacturer in China to capture share a similar projects in India.
And of course, we remain committed to product innovation to better serve customers and gain share.
For example, during the quarter and the full solution application space within General Engineering, we introduced to best in class products gauge.
Hps solid carbide drill, which delivers two to three times more productivity than competing products.
45, based milling cutter, which offers greater flexibility and a cost effective user friendly solution for a broad range of CNC machinists.
Based on our continued ability to deliver products that are highly valued by customers and the positive reaction to our brand repositioning we are even more confident in our ability to gain share and drive topline improvement.
In addition, as you know we are also focused on improving the bottom line. Please turn to slide four.
The last time the company experienced a sales decline of this magnitude was during the great recession.
Trailing 12 month sales as shown on the left and corresponding adjusted operating margin is shown on the right.
See the improvement in profitability compared to the earlier downturn illustrating the benefits of simplification monetization strong.
Stronger cost control actions and.
And remember the present day numbers do not yet include the full run rate effect of the monetization activities. We are currently undertaking.
By executing our commercial excellence and operational excellence strategies, we are positioning the company for improved performance throughout the economic cycle, but.
With that I will turn the call over to Damon who will review the first quarter numbers in more detail.
Thank you, Chris and good morning, everyone, who will begin on slide five with a review of Q1 operating results both on a reported and adjusted basis.
As Chris mentioned demand trends improved off low levels throughout the quarter and outpace the 10% sequential seasonal decline we normally experience in Q1.
The quarter sales declined 23% year over year.
Total organic basis sales were down 21% year over year.
Foreign currency and the business divestiture, each had a negative effect of 1% in the quarter.
However, sales did increased 6% on a sequential basis with approximately 3% attributed to foreign currency.
Adjusted gross profit margin of 27% was down 50 basis points year over year.
Year over year performance was primarily due to the effect of lower volumes and associated under absorption, partially offset by the positive effect of raw materials, which contributed approximately 650 basis points for mental simplification monetization benefits in temporary cost control actions.
Adjusted operating expenses of 93 million were down 21 billion or 18% year over year.
Adjusted EBITDA margin was 11.3% up 40 basis points from the previous year quarter.
Adjusted operating margin of 2.9% was down 180 basis points year over year.
Adjusted effective tax rate in the quarter of 33.4% was higher year over year due to the combined effects of geographical mix and the continued effect of guilty on the low level of us taxable income.
Although we expect our adjusted effective tax rate to remain elevated in the low to mid 30% range with these lower levels of earnings we still expect our tax rate to be in the low to mid 20% range. When we return to higher levels of profitability.
We reported a GAAP earnings per share loss of 26 cents versus earnings per share of eight cents in the prior year period, reflecting the reduced volumes and higher tax rate, partially offset by raw materials simplification monetization benefits and temporary cost control actions.
On an adjusted basis EPS was three cents per share versus 17 cents in the prior year.
The main drivers of our adjusted EPS performance are highlighted on the bridge on slide six.
The effective operations this quarter amounted to negative 28 cents. This compares positively to both the negative 60 cents in the prior year period, and the negative 68 cents in Q4 of fiscal year 2020.
The largest factors contributing to the to the 28 cents was the effect of significantly lower volumes and associated under absorption, partially offset by positive raw materials of 30 cents and strong cost control actions.
Simplification monetization benefits increased again this quarter totaling 20 cents on top of seven cents in the prior year.
This brings the total benefit since inception from simplification monetization to 123 million.
As Chris mentioned, our expectations continue to be that simplification modernization benefits will be approximately 80 cents for fiscal year 2021, driven by actions already taken orally dosed and bringing the total expected cumulative savings to 180 million by the end of fiscal year 2021.
Incremental savings from our restructuring actions contributed $17 million of the $22 million in simplification monetization savings. This quarter remember restructuring is a subset of our simplification modernization program.
Slide seven and eight detailed the performance of our segments this quarter.
Metal cutting sales in the first quarter declined 23% organically on top of an 11% decline in the prior year period.
All regions posted year over year sales decreases the largest decline in the Americas at negative 29% followed by EMEA at 24% Asia Pacific posted smallest year over year decline at 9%.
Performance in Asia Pacific reflects more positive economic activity in the region with approximately 10% growth in China year over year, partially offsetting weakness in other countries such as India.
From an end market perspective, although improving sequentially, we still experienced year over year declines and transportation of 21% and general engineering of 20%.
Sales in aerospace experienced more significant declines year over year was also down sequentially driven by the COVID-19 associated effects on demand and the supply chain.
Relatively speaking energy was the best performing end market in metal cutting on a year over year basis with positive trends in wind and renewable energy. However, it is worth noting that the oil and gas portion of the energy end market continues to be significantly challenged.
Adjusted operating margin came in at 1% compared to 7.9% in the prior year quarter.
The decrease was primarily driven by a decline in volume and mix, partially offset by incremental simplification modernization benefits temporary cost control actions in raw materials that contributed 230 basis points.
Turning to slide eight for infrastructure.
Organic sales declined 18% on top of a decline of 11% in the prior year period.
Other factors affecting infrastructure total sales were divestiture, a 4% partially offset by a benefit from business days of 1%.
Regionally again, the largest decline was in the Americas at 27% then EMEA at 9% with this time, followed by a 1% growth in Asia Pacific.
By end market. The results were primarily driven by energy, which was down 31% year over year, reflecting the effect of the significant decline in the U.S land only rig count.
General Engineering was down 14% earthworks was down 11%, reflecting the continued production decline in Appalachian coal.
Adjusted operating margin of 6.5% was up 700 basis points year over year.
This increase was mainly driven by favorable raw materials, which contributed 1330 basis points.
Publication monetization benefits and temporary cost control actions, partially offset by lower volumes and associated under absorption.
Now turning to slide nine to review, our balance sheet and free operating cash flow.
Can you to remain conservative to ensure the company has ample liquidity to weather the current environment as well as continued to execute our strategy.
Our current debt maturity profile is made a book to $300 million notes maturing in February of 2022 in June of 2028, as well as a use $700 million revolver that matures in June of 2023.
At quarter end, we had combined cash and revolver availability of approximately $760 million in largely we repaid the $500 million revolver draw from last quarter.
During the quarter, we also amended our credit agreement to improve our flexibility given the continued uncertainty in the economic recovery.
At quarter end, we were well within these financial covenants.
Primary working capital decreased year over year to $623 million, but was up sequentially as the decrease in inventory was more than offset by an increase in accounts receivable and accounts payable.
As a percentage of sales basis primary working capital increase of 36.4% a reflection of the continued decline in sales.
Capital expenditures were 39 million a decrease of approximately $33 million from prior year as expected.
Continue to expect fiscal year 21 capital expenditures will be between 110 to 130 million with the majority in the first half.
Our first quarter free operating cash flow was negative 29 million that represents a year over year improvement of 15 million largely reflecting the decline in capital expenditures. In addition, we paid the dividend of $17 million in the quarter.
Full balance sheet can be found on slide 14 in the appendix.
Before I turn the call back over to Chris I want to spend a moment reviewing our fiscal year 21, EPS and free operating cash flow drivers, we laid out last quarter on slide 10.
As a reminder, this slide details how we expect key factors affecting EPS and free operating cash flow to play out during each half of fiscal year 21 on a year over year basis, and our expectations have not significantly changed since last quarter.
I've already mentioned, our expectations for increasing benefits from simplification monetization this year, resulting in a year over year tailwind in both the first and second half of the year.
Temporary cost actions will continue to be a year over year tailwind in the second quarter, although less of a benefit than in the first quarter as we are increasing our customer visits and rolling back certain temporary cost control actions.
Financially the increasing costs in the second quarter will be in the range of $5 million to $10 million.
This continuation of these actions will result in a second half year over year headwind as we discussed last quarter.
Tungsten prices remaining in the 210% to 30 range raw materials are expected to continue to be a tailwind in the second quarter, although at a reduced rate and neutral for the second half on a year over year basis.
Although depreciation and amortization was flat year over year in the first quarter, we still expected to be $10 million to $20 million higher for the full year, starting in the second quarter as our new equipment comes online.
Terms of cash flow as Chris as I already mentioned capital expenditures will be significantly down this year a tailwind in both the first and second half.
Year over year cash restructuring will be higher in both helps as we execute the restructuring programs.
Once of working capital will be dependent upon the timing of the market recovery with both accounts receivable and accounts payable likely use of cash in the year offsetting planned inventory reductions.
As a reminder, our target for working capital remains 30%.
Finally, as it relates to Q2 as Chris mentioned, we expect sales to be up low to mid single digits sequentially. Despite fewer working days in Q2 versus Q1.
And with that I will turn the call back over to Chris.
Thank you David turning to Slide 11, let me take a few minutes to summarize.
I'm pleased that we have continued to make significant progress on our initiatives.
We are advancing commercial excellence, including a focus on fit for purpose customer applications.
Drive growth and market share gain.
As demonstrated in the margin grass earlier in the presentation. We have also made significant progress on operational excellence with our simplification modernization program.
Including footprint rationalization.
We expect to be at target savings of $180 million for the program by the end of this fiscal year, despite much lower volumes.
Timing of the completion of our simplification monetization program as well as the renewed focus on commercial excellence will serve us well in a recovery.
Strength of our balance sheet and cash position will allow us to optimize capital allocation, while improving customer service and profitability even further throughout the economic cycle.
So I'm fully confident we will achieve our adjusted EBITDA profitability target of 24% to 26% when markets recover such that sales reached the target sales range of two and a half to two point.
With that operator, please open the line for questions.
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 as a reminder, we ask that you. Please limit yourself to two questions.
You have additional questions you may reenter the question queue.
The first question today comes from Stephen Volkmann of Jefferies. Please go ahead.
Great. Good morning, guys. Thanks for taking the question.
I guess, if I could kick off Chris you made a couple of comments around sort of that so it seems like the trend through the quarter and into October and I guess I'm just trying to understand I mean your sales.
Our kind of at the low end I guess of what we would see across the industrial universe. These days I guess part of that's probably oil and gas related maybe a little bit of mining, but can you just provide a little bit more color on the end market trends through the quarter and then specifically do you think theres still de stocking going.
On your in your end markets and kind of whats the outlook for that as we move forward. Thank you.
Yes, Steve I think if we look at Q1 sort of month to month.
Sequential pattern.
October also would suggest that we sort to see improvement in the markets that we talked about transportation really across all regions is starting to is starting to recover or is still well below the pre pre over 19 levels.
Back on effect with general engineering again that seems to be.
Across all regions.
Narrow space, we thought that aerospace may have bottomed out in Q4, but it actually looks like you got a little weaker.
Ross really across all regions. So.
Hey, it may be selling at this low level right now, but that one we have to still wait and see and as you said energy is energy energy was down.
So I think you know as we look at the lift in the quarter in total.
We gave this low to mid single digits. This is kind of our best estimate of.
What equals the normal seasonal pattern and then be sort of positive trends that we've seen.
Things that give me a little pause and probably everybody is when you start to talk about.
Well with 19 cases, increasing for example in Europe, and maybe the government will have to react, but I I think left to its own devices. We should continue to see some recovery short of.
Government stepping in and making some other kind of action Steve.
Okay, Thanks, and any commentary on inventory Destocking, maybe in the distributor channel or anywhere else you might be seeing.
Yeah. Thanks for that follow up yes, we think that Destocking is has leveled off as of the end of Q1 with the exception of probably aerospace and oil and gas.
In the Americas.
I think I think the Destocking is largely largely behind us.
But we could see just a little bit more in Q2, but I think we're kind of at the at the lower levels.
Levels. There. We did we do think that may be in Japan, and Korea, there could be some additional destocking.
Happening there, but thats not a big part of our business anyway.
No question.
Signed the deal oil and gas.
Customers are still paying very much attention to their their inventory and.
Cost accordingly, so we still see some destocking in.
And would do you think you'd be all done by year end calendar year end.
That's my that's my sense, Steve I suppose.
Beyond that but my sense right now if I had to guess would be issued.
Largely behind us by the end of calendar year end.
Okay. Thank you I'll pass it on I appreciate it.
The next question comes from Julian Mitchell of Barclays. Please go ahead.
Hi, good morning.
Maybe just the first question around margin so.
Yes, looking sequentially, you had revenue up in metal cutting and flat in infrastructure.
Margins, though.
Sequentially.
Down in both so maybe just help us understand.
Thats. Despite I think good execution on simplification and modernization. So is there something going on with the mix.
Or some kind of sequential move saying that the tungsten tailwind just trying to understand.
The drivers that sequentially on margin step down.
That's a good question and.
I think what I'd like Damon to do is kind of walk everyone through.
Drivers, especially sequentially from Q.
A lot of moving pieces and if you Miss one of them you can thrive at the wrong conclusion, but.
Largely the margins and decrementals for that matter once.
Once we factor in what we think was going to happen on material and our and our temporary cost actions that we're actually pretty happy with the decrementals.
But David maybe you could walk them through the different elements of it.
The right view from Q.
Yes, I think Julie.
Driver.
That we tried to articulate in the last quarter call was the change in what we were seeing in the temporary cost actions and all of the cost control actions that were in place in the in the fiscal fourth quarter and if you remember as a fourth quarter. We did reverse a lot of our variable comp in the fourth quarter given the effects that covidien.
Looking ahead on our profitability.
And we were in a good position I think going into the third and fourth quarter and so what you saw there was a large reversal variable comp coupled with a lot of pretty much no discretionary spending is travel was locked down as we were curtailing any cost that we could and so as we moved into the first quarter that variable comp reverse.
So again, which was almost a full year effect in the fourth quarter did not repeat and when you look at those changes sequentially versus what we told you those temporary cost actions, we're going to be in the range of say around $10 million to $15 million into this quarter and last quarter. We told you that was in the range of 40 to 45, so you're looking at about a $30 million.
Headwind just because of the timing of some of those temporary actions flowing through and that's the big driver as Chris said when you back out the raw materials versus this quarter. The decrementals in this quarter aligned with what we would have expected.
Thank you Damon that's very helpful.
And as we are looking.
I suppose that let's say at the December quarter, and the balance of the year.
How sizable should that temporary cost reversal will be.
For the next three months or nine months and I think you mentioned revenue up sequentially low mid single digit in December.
We assume margins moving up sequentially with that.
So I think Julien what weve. So what we've said, we'll still have temporary cost actions in place here in the second quarter.
So as again from a year over year perspective, those will still be a tailwind would if we think about the sequential walk from Q1 to Q2 as we start to see our Costar salespeople visit customers more here as we start to roll back. Some of these temporary cost actions, we would expect that the sequential headwind in income.
Minimal costs would be in the range of $5 million to $10 million from what we saved or what we monetized hearing the first quarter.
And then as we move into the third quarter in the fourth quarter. What we've said is we would expect hopefully all of those things to be behind us.
And then you will see so sort of call. It another sequential headwind from Q2 to Q3.
Similar range and then again, if you look at Q3 and Q4 year over year, you are going to start to see some year over year challenges because as you remember we started to institute. Some of these temporary cost actions in Q3, and then we had a very large portion of that in Q4 again going back to the variable comp.
Comment that I made earlier and so year over year, you're going to start to see those view of bigger headwind as we go as we look at it in the third and fourth quarter.
Thanks, and just a follow up David on that so when you're looking at the second quarter with the extra five to 10 million headwind sequentially on cost does that mean, the margins are probably stable sequentially on the operating basis.
Yes.
If you look at the height of low to mid single digit revenue increase coupled with what we're saying for $5 million to $10 million of sequential increase cost year during the break ballpark.
Thank you very much.
Your next question comes from and Beekman at JP Morgan. Please go ahead.
Hi, Thanks. This is Sean Mclaughlin on for Ann can.
Can you discuss a little bit of how much the $80 million incremental its implication monetization savings is by independent and is there scope for higher savings the volumes continue to recover.