KENNAMETAL INC Q1 2026 earnings call

Thank you, Operator. Welcome, everyone, and thank you for joining us to review Kennametal's first quarter fiscal 2026 results. This morning, we issued our earnings press release and posted our presentation slides on our website. We will be referring to that slide deck throughout today's call. 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. With that, I'll turn the call over to Sanjay.

Thank you, Mike. Good morning, and thank you for joining us. I'll begin the call today with a brief overview of the quarter, including some in-market commentary, followed by a spotlight on one of our growth focus areas, power generation. From there, Pat will cover the quarterly financial results as well as the fiscal year 2026 outlook. Finally, I'll make some summary comments, and then we will open the line for questions. Turning to slide three, let me begin by addressing some of the highlights from our strong first quarter. Our global commercial teams continue to advance our strategic growth initiatives. In the quarter, infrastructure secured two large project wins within our earthworks end market. Both wins were a direct result of our team's efforts with those customers to deliver high-quality technical support and superior product performance. That combination has and will continue to be a winning formula for us.

In metal cutting, we won projects in energy, aerospace, and defense, and transportation. For example, we increased our share of wallet with an aerospace customer to provide high-precision tooling solutions for machining military components. As you know, we continue to prioritize above-market growth, and these wins position us well in markets that are benefiting from long-term secular growth trends. We also continue to respond to the evolving tariff landscape, and we remain committed to fully offsetting the impact of tariffs through various actions, including product moves, supply chain optimization, and surcharges as appropriate. Separately, we have implemented pricing actions in response to the continuing rise in tungsten costs, which have increased since August and are at historically high levels. We remain confident in our ability to price to offset the rising tungsten costs.

On the cost improvement front, we realized $8 million in restructuring savings this quarter, and we continue to execute our plans to lower structural costs by reducing employment costs and consolidating manufacturing operations. Now, let's move to our quarterly results, which exceeded the sales and EPS outlook we provided last quarter. Compared to the outlook, sales were primarily driven by better-than-expected volume across all end markets. EPS benefited from the additional volume and a lower-than-anticipated tax rate. Year-over-year, sales increased 3% organically. That's our first quarter of organic growth in two years, and reflects modest relief from the broad market weakness that has impacted our end markets for the past eight quarters. As you may recall, historically, down cycles tend to last four to eight quarters. Adjusted EPS increased to $0.34 compared to $0.29 in the prior year quarter.

In terms of profitability, adjusted EBITDA margin was 15.3% compared to 14.3% in the prior year quarter. Cash from operating activities year to date was $17 million compared to $46 million in the prior year period. Free operating cash flow year to date was -$5 million compared to $21 million in the prior year. Finally, we returned $25 million to shareholders through share repurchases of $10 million and dividends of $15 million. Today, we're raising our sales and EPS outlook for fiscal 2026. This update reflects the modestly improved market conditions, additional price and tariff surcharges, and our favorable performance in the first quarter. Pat will provide more details on our updated outlook shortly. In summary, we are pleased with this quarter's results, and we continue to focus on delivering our commitments throughout fiscal 2026. Turning to slide four and our end market update.

As a reminder, our full year outlook reflects forecasts of specific market drivers and general market conditions. I will focus on the bottom half of the slide and address the two markets that have changed since our last call. First, IHS estimates for transportation slightly improved from the previous estimate, while still being in the negative low single-digit range. Volumes in the Americas have improved from the prior estimate, partially offset by pressure that continues to impact EMEA. Secondly, for aerospace and defense, expectations are improving as the aerospace industry has recovered from supply chain challenges and will benefit from the recent approval that will increase OEM production. Market factors remain mostly unchanged within the other end markets. Turning to slide five, we are seeing emerging opportunities in power generation driven by rising demand for both renewable and traditional energy sources to support the expansion of AI data centers.

This is an expanding opportunity for Kennametal across both of our segments, and we are capitalizing on this trend. As we shared last quarter, we secured a key win in metal cutting connected to the backup generators that are providing energy security to those data centers. It is our deep expertise in application engineering and machining complex engine components that is positioning us particularly well to support customers as they manufacture backup power generation systems and utility-scale gas turbines. With respect to the gas turbines, these applications require the same capabilities that we have long applied in aerospace and defense. This is also an area that we know very well. While this slide focused on metal cutting, the opportunity extends across both segments.

In infrastructure, our wear-resistant solutions and strong position in oil and gas extraction align with the growing need for natural gas as a reliable fuel source for uninterrupted power. While our recent wins are in backup power systems, the opportunity is much broader, and we're well positioned to capitalize on that as the trend continues. Now, let me turn the call over to Pat, who will review the first quarter financial performance and the outlook.

Thank you, Sanjay. Good morning, everyone. I will begin on slide six with a review of the first quarter operating results. Sales were up 3% year-over-year on both a reported and organic basis. At the segment level, metal cutting and infrastructure both increased 3% organically. By end market, on a constant currency basis, aerospace and defense grew 20%, earthworks grew 5%, energy increased 1%, general engineering was flat, and transportation declined 1%. Regionally, on a constant currency basis, sales in the Americas increased 7%, EMEA was flat, and sales decreased 1% in Asia-Pacific. The sales performance this quarter exceeded the outlook we provided last quarter. Relative to those expectations, share gains in earthworks, better-than-expected auto build rates, and overall modest volume improvements were the catalysts for the outperformance. I will provide more color when reviewing the segment performance in a moment.

Adjusted EBITDA and operating margins were 15.3% and 8.2%, respectively, versus 14.3% and 7.6% in the prior year quarter. The improved margin was driven by price and tariff surcharges and incremental year-over-year restructuring savings of $8 million. Partially offset by higher compensation costs, tariffs, and general inflation, and a prior-year benefit from net insurance proceeds of $4 million that did not repeat in the current year. Adjusted EPS was $0.34 in the quarter versus $0.29 in the prior year period. The main drivers of our EPS performance are highlighted on the bridge on slide seven. The year-over-year effect of operations this quarter was +$0.05. This reflects incremental restructuring benefits, favorable timing of price raw material costs, tariff surcharges, and the advanced manufacturing tax credit, partially offset by higher compensation costs, tariffs, and general inflation.

The headwind of $0.04 from the net insurance benefits received in the prior year due to the tornado that damaged our Rogers facility. You can also see $0.04 of transactional gains related to preferential Bolivia exchange rates. Slides eight and nine detail the performance of our segments this quarter. Reported metal cutting sales were up 5% compared to the prior year quarter, with 3% organic growth and favorable foreign currency exchange of 2%. Regionally, excluding the effects of currency, the Americas increased 6%, EMEA increased 1%, and Asia-Pacific declined 1%. Looking at sales by end market, aerospace and defense increased 16% year-over-year from improved build rates in the Americas and easing supply chain pressures in EMEA. Energy grew 12% this quarter due to data center power generation wins. General engineering was flat year-over-year from lower production activity, primarily in EMEA.

Lastly, transportation declined 1% year-over-year due to project timing in Asia-Pacific and an overall slowdown in EMEA and the Americas. Metal cutting adjusted operating margin of 8% decreased 20 basis points year-over-year, primarily from higher compensation costs, tariffs, and general inflation. These factors are partially offset by higher prices and surcharges and incremental year-over-year restructuring savings of approximately $6 million. Turning to slide nine for infrastructure. Infrastructure sales increased 3% organically, with reported sales growth of 1%, which was negatively affected 3 points from the divestiture which closed in June. Regionally, on a constant currency basis, Americas sales increased 7%, Asia-Pacific was flat, and EMEA sales decreased by 3%. Looking at sales by end market on a constant currency basis, aerospace and defense increased 28% from defense orders driven by continued execution on our growth initiatives in both EMEA and the Americas.

earthworks increased 5% due to mining share gains in the Americas and higher global construction demand, partially offset by Asia-Pacific mining market softness. General engineering was flat due to higher powder demand in the Americas and higher demand in Asia, partially offset by lower industrial activity in EMEA. Lastly, energy declined 5%, mainly in EMEA, driven by project timing and from a lower U.S. land breakdown. Adjusted operating margin increased 190 basis points year-over-year to 8.8%. Adjusted operating income of $17 million. Increased primarily due to the favorable timing of pricing compared to raw material costs, partially offset by prior-year net insurance proceeds of $4 million, and higher compensation costs and general inflation. Additionally, we recognized year-over-year restructuring savings of approximately $2 million. Now, turning to slide 10 to review our free operating cash flow and balance sheet.

Our first quarter net cash flow from operating activities was $17 million, compared to $46 million in the prior year period. The change in net cash flow from operating activities was driven by working capital changes, including a higher investment in inventory, primarily from rising tungsten prices. Because sales volumes declined less than normal from the fourth quarter of FY 2025 and pricing and tungsten value was up, working capital was a more challenging comparison this quarter. Our first quarter free operating cash flow decreased to -$5 million from +$21 million in the prior year, primarily from the lower cash flow from operations. On a dollar basis, year-over-year, primary working capital increased to $660 million, and on a percentage of sales basis, it increased to 32%. Net capital expenditures of $23 million declined modestly from $25 million in the prior year quarter.

In total, we returned $25 million to shareholders through our share repurchase and dividend programs. We repurchased 475,000 shares, or $10 million in Q1, under our $200 million authorization. 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 shareholders while executing our strategy to drive growth and margin improvement. We continue to maintain a healthy balance sheet and debt maturity profile with no near-term refunding requirements. At quarter end, we had combined cash and revolver availability of approximately $800 million, and we are well within our financial covenants. The full balance sheet can be found on slide 17 in the appendix. Now on slide 11 regarding the full year outlook. We now expect FY 2026 sales to be between $2.1 billion and $2.17 billion, with volume ranging from -1% to +3%.

Net price and tariff surcharge combined of approximately 7%. We anticipate approximately 2% tailwind from foreign exchange. We now expect adjusted EPS to be in the range of $1.35-$1.65. The increased outlook reflects additional pricing actions related to the rising cost of tungsten and additional surcharges in place to address the changes in policy since our August call. The adjusted tax rate for the year is now 27%, and as a result of the additional cash that we need to invest in inventory due to higher tungsten costs, free operating cash flow as a percent of adjusted net income is now 100%. All of the other elements of our outlook remain unchanged. Turning to slide 12 regarding our second quarter outlook.

We expect Q2 sales to be between $500 million and $520 million, with volume ranging from negative 4% to flat, price and tariff surcharge realization of approximately 7%, and a 2% positive impact from foreign exchange. One comment regarding the adjusted effective tax rate this quarter, the rate of approximately 30% assumes a discrete item that is driving the rate higher in Q1 than our full year outlook. We expect adjusted EPS in the range of $0.30-$0.40. The other key assumptions for the quarter are all noted on the slide. With that, I'll turn it back over to Sanjay.

Thank you, Pat. Turning to slide 13, let me take a few minutes to summarize. We delivered a solid first quarter thanks to modest improvements in a couple end markets, project wins on commercial side, and cost improvement actions. We continue to make steady progress on our strategic growth initiatives, lean transformation, and structural cost improvement, while also exploring ways to strengthen our portfolio over time. In parallel, we are monitoring external drivers such as trade and monetary policies and raw material prices and taking timely and necessary actions. We remain confident in our plan for long-term value creation for our shareholders. With that, operator, please open the line for questions.