Q1 2025 Kennametal Inc Earnings Call

Patrick Watson

Thank you, Sanjay, and good morning, everyone. I will begin on slide 7 with a review of Q1 operating results. The quarter’s results show that we continue to execute our initiatives in the face of challenging market conditions. Sales were down 2% year over year, with an organic decline of 2% and unfavorable currency exchange of 1% partially offset by favorable workdays of 1%.
Sales this quarter were at the lower end of the expectations we provided last quarter. Relative to those expectations, we experience slower market conditions, most notably in the Americas and EMEA in 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 experience market headwinds in most end markets and regions with the exceptions of aerospace and defense and energy end markets in the Asia Pacific region. I will provide more color when reviewing the segment performance in a moment.
Adjusted EBITDA and operating margins were 14.3% and 7.6% respectively versus 16.6% and 9.9% in the prior-year quarter. During the quarter, we realized approximately $5 million in savings from the previously announced restructuring program. This action has successfully delivered annualized run rate, pretax savings of approximately $35 million.
Lastly, foreign exchange headwinds from the strong US dollar were approximately 1% this quarter. The adjusted effective tax rate increased year over year to 25.1%, primarily driven by discrete items recognized in the prior year quarter, an unfavorable geographical mix partially offset by a benefit of $1 million from the favorable resolution of a tax dispute in India.
Adjusted earnings per share were $0.29 in the quarter versus EPS of $0.41 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 negative, reflecting lower sales and production volumes, higher wage and general inflation, and the impact of temporary plant shutdowns.
These shutdowns were for routine maintenance and process improvements within the infrastructure segment and were partially offset by favorable timing of raw material costs and incremental restructuring benefits.
We also received a net benefit of $0.04 from insurance proceeds related to the tornado that damaged our Rogers facility in the fourth quarter of FY24. You can also see the effects of the tax rate and pension on EPS with taxes and pension costs of negative $0.02. Other reflects lower share count which contributed $0.01.
Slides 9 and 10 detail the performance of our segments this quarter starting with metal cutting. Reported metal cutting sales were down 4% compared to the prior-year quarter with a 4% organic sales decline and an unfavorable foreign currency effect of 2%, partially offset by favorable workdays of 2%.
By region, on a constant currency basis, Asia Pacific grew 3%; the Americas declined 1%; and EMEA declined 6%. Asia Pacific’s growth was primarily driven by the transportation end market and reflects modest improvement in China and continued strength in India.
America’s year-over-year decline this quarter was due to slower conditions in the transportation and general engineering end markets, partially offset by the execution of our growth initiatives in aerospace and defense.
EMEA’s year-over-year performance reflects weakness in general engineering and transportation end markets most notably, in Germany.
Looking at sales by end market, aerospace and defense grew 5% year over year as our strategic initiatives continue to drive results. These initiatives are partially offset by OEM production challenges. Energy was flat with strength in EMEA from project work, offset by the Asia Pacific region as we continue to experience a slower market and project delays.
Transportation declined 2% year over year due to EV and hybrid project winds in the prior year and an overall slowdown in EMEA and the Americas partially offset by Asia Pacific project orders. And lastly, general engineering declined 4% year over year, with modest growth in Asia Pacific offset by lower production activity in EMEA and order timing in the Americas.
Metal cutting adjusted operating margin of 8.2% decreased 300 basis points year over year due to lower sales and production volumes, higher wages, and general inflation and foreign exchange of $2 million partially offset by lower raw material costs, restructuring savings of $4 million and price.
Turning to slide 10 for infrastructure. Reported infrastructure sales were flat year over year with organic sales growth of 1%, offset by unfavorable business days of 1%. Regionally, on a constant currency basis, EMEA sales increased by 12%; Asia Pacific increased 1%; and Americas sales declined by 3%.
EMEA growth was primarily driven by order timing in aerospace and defense and general engineering. Growth in Asia Pacific reflects strength in general engineering, partially offset by slower demand in China which impacted earthworks. The Americas’ decline was due to lower mining activity in earthworks and project order timing in general engineering partially offset by defense growth.
Looking at sales by end market on a constant currency basis, aerospace and defense increased 42% from our continued focus on growth initiatives in EMEA and the Americas. Energy increased 2% mainly in the Americas driven by project timing, partially offset by lower US land-based rig count.
General engineering was flat due to temporary plant shutdowns in the Americas offset by order timing in EMEA and Asia. And lastly, earthworks declined 6% due to customer mine consolidation and lower mining activity in the Americas and Asia Pacific and prior-year orders.
Adjusted operating margin declined 110 basis points year over year to 6.9%, primarily due to the following factors: the previously mentioned plant shutdowns from maintenance and process improvements, higher wages, and general inflation. These factors are partially offset by net insurance proceeds of $4 million, favorable price raw material timing, restructuring savings, and higher sales volume.
Now turning to slide 11 to review our free operating cash flow and balance sheet. Net cash flow from operating activities was $46 million compared to $26 million in the prior-year period. The change in net cash flow from operating activities was driven primarily by working capital changes and the $5 million received from the favorable resolution of a tax dispute in India, partially offset by a lower net income compared to the prior-year period.
Our free operating cash flow increased to $21 million from negative $3 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 $624 million. And on a percentage of sales basis, primary working capital decreased to 31.8%.
Net capital expenditures decreased to $25 million compared to $29 million in the prior-year quarter. In total, we returned $31 million to shareholders through our share repurchase and dividend programs. We repurchased 600,000 shares for $15 million in Q1 under our new $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 our 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.
The full balance sheet can be found on slide 17 in the appendix. Turning to slide 12 regarding our second quarter outlook. We expect Q2 sales to be between $480 million to $500 million, with volume ranging from negative 5% to negative 1%, price realization of approximately 2%, and a neutral effect from foreign exchange.
Let me share some detail on the sales assumptions impacting the Q2 outlook. Our Q2 range at the midpoint reflects growth that is generally in line with our historical norms. On a year-over-year basis, aerospace and defense growth continues, albeit moderately, as North American OEM production disrupted by the strike will impact the second quarter.
Energy is anticipated to be flat. General engineering declined slightly but similar to Q1 levels. Transportation is expected to climb mainly due to prior-year project winds and lower volumes in EMEA, and earthworks is anticipated to be flat.
Non-cash pension expense is expected to have a negative impact of approximately $1 million on a pretax basis. Interest expense is assumed to be approximately $7 million and an effective tax rate of approximately 27.5%. Lastly, we expected adjusted EPS in the range of $0.20 to $0.30. The EPS range reflects the year-over-year change in the Q2 tax rate, which at the midpoint is approximately a $0.13 headwind to EPS.
Now on slide 13 regarding our full-year outlook. We continue to expect FY25 sales to be between $2 billion and $2.1 billion, with volume ranging from negative 3% to positive 2%, net price realization of approximately 2%, and we anticipate an approximate 1% year-over-year headwind from foreign exchange.
Our EPS outlook remains $1.30 to $1.70 and free operating cash flow remains at greater than 125% of adjusted net income. The other assumptions embedded in our outlook also remain unchanged.
As Sanjay noted in his prepared remarks, there have been some developments over the last quarter that have placed some additional pressure on our end markets, namely the strike in aerospace and defense and macro challenges in EMEA. To get to the top end of our sales outlook would require a quick rebound in aircraft production from the just-resolved strike as well as a turnaround in EMEA.
From a macro perspective in the US, we would need industrial production growth to resume. These types of events would give us sequential sales growth a bit above our recent seasonality. The midpoint of our outlook reflects seasonality in line with our historical averages. As such, we expect year over year, aerospace and defense to have moderate growth, transportation to increase slightly, general engineering to be flat, and earthworks and energy to decline slightly.
And with that, I’ll turn it back over to Sanjay.

Sanjay Chowbey

Thank you, Pat. Turning to slide 14. Let me summarize. Overall, although macro conditions remain challenging in the short term, the global megatrends that drive market growth over the long term remain intact. As always, we remain committed to driving growth and managing costs in line with market conditions.
And in all cases, we will be guided by our value creation pillars of growth, continuous improvement, and portfolio optimization while strengthening our foundation so that we can deliver long-term shareholder value.
And with that, operator, please open the line for questions.

Operator

(Operator Instructions) Steven Fisher, UBS.

Steven Fisher

Thanks. Good morning. Wondering if you can just help us frame the margin assumptions you have for the second quarter sequentially compared to the first quarter, excluding the benefit from the insurance proceeds? I think typically, seasonally, they should be lower. But I’m just curious, kind of what you’re embedding in there in your assumptions and maybe you could just kind of bridge the key items for us?

Patrick Watson

Yes, certainly. So I would say we think going Q1 to Q2, more or less flattish from a margin perspective. A couple of things to think about. There’s certainly — going from Q1 to Q2, pull out the benefits from the insurance proceeds we had in Q1; non-operating item but obviously, we’ve got a little bit of benefit from the resolution of that Indian tax dispute in there as well.
We’ll see a little bit of pickup because as we talked about some of those plant shutdowns, that will go away and some of the expense we had around some trade shows goes away as well. On the other side of that, we’ll see a modest tick up in compensation as compensation normally goes up for us here on October 1; that’s generally when a lot of our employees on a global basis receive their annual salary adjustments. So those are kind of the major puts and takes. But overall, flat margins.

Steven Fisher

Okay. That’s very helpful. And then, the guidance does imply a nice recovery in organic growth in the second half. Just talk about where you have the most confidence in that recovery or it’s perhaps the bias at this point as in any other information that we should be kind of gearing towards the lower end of the range?

Sanjay Chowbey

Yes, Steven, Sanjay here. First of all, as we said last quarter also that we assumed slight recovery in the second half of the calendar year ’25 in the industrial production and also in the oil rig counts. And as you might have seen, the oil rig count is down right now to 565.
As of right now, the [sphere’s] outlook is that it’s going to stabilize around 590, 600. And then when you start to look at the auto production, that also assumes slight improvement globally, especially like in US and China. EEMA, at this point, we continue to see some pressure on auto production and auto sales but — and then you start to move into oil and gas.
I mean, sorry, the earthworks — relatively stable in that. In aerospace and defense, at this point, our assumption includes slight improvement. We know that there were some issues, a slight improvement in that also. It depends on how much supply constraints they can resolve. But that’s the way we are looking at it. Slight improvement in the second half of the year. Long term, obviously, much better outlook for aerospace and defense.

Steven Fisher

Terrific. That’s very helpful. I appreciate it.

Operator

Julian Mitchell, Barclays.

Julian Mitchell

Hi, good morning. Maybe just the first question, if you could elaborate a little bit on China, and I suppose broader Asia Pacific. You had decent low-single-digit growth there year on year in the first quarter.
But we have very mixed things on industrial demand in China versus, say, construction where the news is uniformly more negative. So maybe help us understand kind of what you’re assuming for the balance of the year in terms of Asia Pac or China revenue trends, please?

Sanjay Chowbey

Julian, first of all, let me start with China. As you said, construction and mining continue to be under pressure. And beyond that, we have seen stable and slightly improving markets in other major end markets that we serve.
India continues to be stable and improving or not only improving, but it has been strong, I should say. So overall, APAC, the way I will describe here, despite pressure on construction and mining, we think it’s going to be stable and slightly improving.

Julian Mitchell

That’s helpful. Thanks very much. And then just wanted to circle back, when we think about that, I suppose we’ll look half on half, but you have a fairly typical second-half increase in operating margins, total company in the back half versus the first half normally. Pretty similar, I suppose this year seems to be dialed in.
So any color you could provide as we think about kind of the weighting of that margin ramp, maybe third versus fourth quarter? Anything to bear in mind in that sense? And understanding that I think second-quarter margins are kind of flattish sequentially. So we know that base and then you have kind of a couple of points of back half step up, I think.

Patrick Watson

Yeah, a couple of things I’d reflect on. What drives a lot of that margin performance in the second half is just the seasonal uptick in volume. So that is the primary driver of what’s going on from a margin perspective. So as you think about what the normal cadence is, Q3, Q4 — Q4, typically, is our higher margin — quarter just again, based on margins.
The only other thing I would layer in on that is as we continue to work on operational excellence and productivity in those things, that stuff will ramp as we move throughout the year as well. And then lastly, and just in terms of lapping type of restructuring things again, this is more of a year over year, but you’ll see more of that restructuring benefit come in the first half and you’re going to see it come in the second half again on a year-over-year basis.

Julian Mitchell

Great. Thank you.

Operator

Steve Barger, KeyBanc Capital Markets.

Steve Barger

Sorry about that. Yeah, Pat, starting with slide 8, that bridge. You showed the negative impact of lower production volumes. Working capital as a percentage of sales looks pretty flat over the last few years and you’ve had negative volume growth over the past year.
Can you just talk about where you are now for inventory relative to demand? Do you need to continue to take production days out or how are you positioning relative to the potential back-half improvement that Sanjay talked about?

Patrick Watson

Yeah, I mean, overall, I would just reflect on the general trajectory of what we’re trying to do in particular with inventory, Steve, is we’re trying to take inventory out of the system. And so, I would say simply over the long run, that implies that production would be slightly below where demand is, right? You saw inventory come up from Q4. I think there’s a little bit of FX in there, I think about $11 million sequentially.
So after you kind of pull that out, I would say pretty normal seasonal adjustment in terms of inventory in Q1. Our objective here really is to get primary working capital as a percent of sales down to about 30% as our outlook is by the end of the fiscal year. That will require us again, as part of our long-run strategy here, to kind of constrain production in a reasonable way to get that down and get the benefit of higher sales volumes over time and on lower inventories.

Sanjay Chowbey

Let me just add one more thing, Steve on that. We have been making — as part of the overall continuous improvement, a lot of basic improvements in our sales operations planning and the supply chain network, like what we move from where in the world, and all that. And we’ve been making a sustainable progress on that. And that will continue. So to Pat’s point, we will very closely monitor markets, but at the same time, we expect that we will continue to improve our overall working capital.

Steve Barger

Understood. Thanks. And then on that same slide, is there an opportunity around the temporary shutdowns for maintenance and process improvement? Meaning that you can use those shutdowns and just a generally softer environment right now to move some product lines and accelerate plant closures to lock in structural cost savings for when we do see the markets improve?

Sanjay Chowbey

Yes, Steve. I think that we have mentioned there about the temporary plant shutdown. These are relatively short, targeted at very specific assets, preventive maintenance and overall process improvements. That’s what we have done here. These are not long enough to make major changes in terms of footprint.
We are working on footprint on a separate initiative and we will come back to all of you at the appropriate time when we are ready to discuss more of that. But as we have said at the Investor Day, those actions will be a little bit more back-half loaded of the — our timeline horizon of that.

Patrick Watson

Let me just add that, Sanjay. I think over time, Steve, and we did this, I think two years ago in the December quarter. I think our ability from a sales and operations planning perspective is as market conditions change and as we think about what we need to do to be responsive to the customers, being able to more finally dial in where we can have production and take advantage of opportunities when they present themselves in terms of again, managing production in a thoughtful manner.

Steve Barger

Appreciate the detail. Thanks.

Operator

Angel Castillo, Morgan Stanley.

Angel Castillo

Hi. Thanks for taking my question. I just wanted to talk about, maybe put a finer point on kind of the near-term trends. What are you seeing kind of September, October versus what you saw in the first full fiscal 1Q general kind of trends across that markets, please?

Sanjay Chowbey

Yeah, Angel, overall, industrial production and oil and gas, as I mentioned earlier, these are going to stay relatively stable or flattish. As Pat talked about the Q2 outlook, where we see continued pressure right now, which we already have built in our outlook is transportation industry and market in Europe.
And then mining construction also continue to stay soft, in our opinion, in the second quarter. But overall, like I said, globally, our view is that things will be more in the stable range.

Angel Castillo

And maybe switching over to price/cost. Just can you talk about what you’re seeing in terms of both tungsten and just general kind of cost inflation? And then your degree of confidence around getting the 2% realization and just broader price/cost thoughts would be helpful.

Patrick Watson

So we’ll start with Tungsten. So tungsten has been in a range of about, let’s call it [3.05% to 3.25%]. So it’s been relatively steady here over the past couple of quarters. As we’ve talked about in the past, that we generally get the visibility about two quarters out. So I would say, as we think about price/cost in particular in the infrastructure segment, we’ve got reasonable stability here. I would not anticipate a significant price/cost tailwind or headwind at this point in time again, looking out this quarter and then the following quarter.
Overall, I think from an inflation perspective, there are main pockets where there is some additional price being pushed on by the supply base. But I would say in general, we’ve seen this trend of continued moderation in terms of inflation rates pretty much across the Board. And so, that’s kind of what we’re looking at there.
Sanjay, do you want to comment anything on the pricing?

Sanjay Chowbey

Yeah, pricing-wise, at this point, we continue to — we did implement the metal cutting price in July and we had some strategic pricing on this infrastructure side. Our goal is obviously to make sure that we are offsetting inflation on that.
And Angel, I would like to also go back in your broader question on the market. I didn’t talk about aerospace and defense. I want to just give you a little bit more color on it. In the near term, which is Q2 for us, we don’t expect major change even though the labor dispute has been resolved. We think some of those improvements will come in the calendar year ’25.

Angel Castillo

Very helpful. Thank you.

Operator

Tami Zakaria, J.P. Morgan.

Tami Zakaria

Hi, good morning. Thank you so much. So my first question is historically, how does fed rate cuts impact you? Do you see a pickup in demand maybe at a one or two quarters lag? What are you hearing from customers now that finally rates have started to come down? Is there a sense of optimism amongst customers?
So any thoughts on how you’re thinking about this rate cut environment transitioning hopefully to a lower rate scenario?

Patrick Watson

Yeah, I think overall, lower rates will be constructive. I think, as always, the case with monetary policy, that lag period is variable, right? And so, I would think if you look back historically, it’s probably several quarters before that really starts turning around. Obviously, the feds — we’re not going to take action here in the near term on that.
I think from an overall customer perspective, there’s a customer belief that’s out there as well. The rate cuts are constructive to the long term, growth potential. That being said, if we balance that against current period indicators like PMI here in the US, you really haven’t seen that turn from a customer sentiment yet.

Tami Zakaria

Got it. That’s helpful. And my other question is, just to clarify, can you tell us what — how the model and the business days impact for the next — for the remainder of the year for the next three quarters?

Patrick Watson

Yeah, in Q2, there’s basically about a half a day, — half a day, up year over year. I think Q3 is about a half a day in the other direction down and about — I think it’s about a half a day again. In Q4, it should be down. So it’s kind of a [wash] for the most part.

Tami Zakaria

Got it. Thank you.

Operator

Chris Dankert, Loop Capital Markets.

Christopher Dankert

Hey, morning. Thanks for taking the questions. First off, a quick housekeeping item and apologies if I missed it. But did you delineate what the [realized] restructuring savings were in the quarter?

Patrick Watson

Yes, it’s $5 million discretely in the quarter year over year. Since the inception of the program, run rates is $35 million on an annual basis. So if you think about it in the quarter from baseline, it’s $35 million, about over [$4 million].

Christopher Dankert

Okay, perfect, perfect. Thanks for that. And I guess just to drill down a little bit more on the margin at metal cutting. I guess, it’s a pretty hefty decremental — it seems like it’s [2x] typical. I think typically, you call it 40% decremental on volumes despite some of the cost actions. Maybe can you just help us understand? Is it mixed? What else is going on under the hood there in terms of margins for metal cutting here?

Patrick Watson

Yeah. Well, first off, when we think about margin decrementals from metal cutting, we talk about average being in the mid-40s there. And I’ve always said metal cutting is north of that, right? And so, metal cutting will tend to have higher incremental decrementals than the average of the business. As we think about what the performance of the segment was here in the first quarter, big reduction in volume. That’s coming through both on the sales side and on a production basis as well, right?
And on top of that, you’ve got a couple of other things. Obviously, you’ve got the restructuring benefits coming through in the quarter. However, on the other side of that, and we talked about this going into the quarter, we would see some temporary costs flow through Q1 as well that would kind of suppress the margin a little bit here on some of the trade shows we went to and the like.
And so, a couple of cross [currents] there. But the big story is almost always the case in metal cutting is what’s going on from a volume perspective.

Sanjay Chowbey

I think on top of that, we had one event, a one-time gain last year that we let out last quarter.

Christopher Dankert

Thanks for the detail.

Operator

Joe Ritchie, Goldman Sachs.

Joseph Ritchie

Hey, guys, good morning. Really helpful slide on the metal cutting share gains. I guess, in Europe specifically, I guess the question I have is, as you kind of think about hopefully a potential recovery in that end market, do you expect to keep these types of share gains if the market were to recover?
And then just — what are you looking at as maybe leading indicators and maybe just focusing on the German market that can maybe give you some confidence once that market starts to turn?

Sanjay Chowbey

Yes, Joe, I think as I mentioned earlier based on the IHS data and publicly available information from the OEMs, we think that the near-term pressure will be there. In the meantime, like we also said earlier in the prepared remarks, that our GAAP versus the trade group, it might also be driven by the fact that they would impact the other partner, other parties were impacted by lower export sales.
So I wouldn’t say that we will see any major deviation from what we see here. But the market overall is going to be under pressure. And in the meantime, of course, we continue to do things with respect to new project wins as customers are also going through the mix change in terms of — they were going a little bit strong on electric vehicles. That adjustment is happening where the shift is going to happen a little bit more towards hybrid.
So there’s going to be some of those comp issues because of that. But we believe that we are very well-positioned to support our customers, whether they go for [ice] engine or hybrid or battery, we are there to support them. So overall, we will continue to do above-market growth there.

Joseph Ritchie

Okay, helpful. And then Sanjay, you’re going to be my first election question. So post yesterday, how are you thinking about these potential implications for your business? Also with the prospect of potential tariffs on the comp. How does that potentially change your either competitive dynamics here or abroad? Just any thoughts that you have? Broad thoughts on the outcome from yesterday?

Sanjay Chowbey

Yeah, I think we know we have to learn more in coming months to see how the overall policies come out. But what we will expect is that industrial production is going to be one thing that we want to watch to see how that affects because that has the biggest effect on our overall business. With respect to tariffs, I’ll let Pat also add his opinion, but we don’t — we are a global business, we do business in all different continents and in a lot of cases, we are making things where we sell.
There is not going to be a lot of direct effect on it. But how does it affect overall sentiments? That, we have to watch. And then on the material cost, it might have some impact, but too early for us to tell much detail at this point.

Patrick Watson

Yeah, I would just say — I would reiterate that, Sanjay, in the sense that from a manufacturing footprint perspective, we’re global. We aim to support customers locally with production where we can and so that tends to minimize some of the effect of tariffs on the business. That being said, the big feedback loop there is based on any government policy that affects overall consumer confidence and therefore, industrial production is going to have a feedback loop on us, positive or negative.

Joseph Ritchie

Okay, guys, thank you.

Operator

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

Sanjay Chowbey

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

A replay of this event will be available approximately one hour after its conclusion. (Operator Instructions) The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.