KENNAMETAL INC Q2 2026 earnings call

Thank you, operator. Welcome, everyone, and thank you for joining us to review Kennametal's second 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'd like to direct your attention to our forward-looking disclosure statement. Today's discussion contains comments that constitute forward-looking statements and, as such, involve a number of assumptions, risks, and uncertainties that could cause the company's actual results, performance, or achievements to differ materially from those expressed in or implied by such statements.

These risk factors and uncertainties are detailed in Kennametal's SEC filings. In addition, we will be discussing non-GAAP financial measures on the call today. Reconciliation 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 will begin the call today with an overview of the quarter, including end 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 open the line for questions. Turning to slide 3, let me begin by addressing some of the highlights from our strong second quarter. Our global commercial teams continued to advance our strategic growth initiatives. In the quarter, the infrastructure team secured significant mining orders in earthworks from key distributors in Asia-Pacific and EMEA. Both wins were a direct result of our team's efforts with those customers to deliver high-quality technical support and superior product performance.

In Metal Cutting, we won projects that continued to advance our growth focus on Aerospace and Defense. We also secured engine and transmission wins in Transportation. In General Engineering, we increased our share with a pump manufacturer by providing them an innovative solution for machining valve seats. As you know, we have and will continue to prioritize above-market growth. In the quarter, we also implemented pricing actions in response to rising Tungsten costs, which are at historically high levels. We remain confident in our ability to price for the rising Tungsten costs and in our ability to offset the impact. On the cost improvement front, we realized $8 million in restructuring savings this quarter and continued to execute our plan to lower structural costs and consolidate manufacturing operations.

Some of these plans will extend beyond this fiscal year into fiscal 2027, and as a result, we have updated the impact in fiscal 2026, which Pat will address when he provides our updated outlook. Now, let's move to our quarterly results, which again exceeded the sales and EPS outlook we provided last quarter. Compared to the outlook, sales were better than expected on higher sales volume, which included the stronger than anticipated effect of customers buying ahead of price increases and modest improvement in certain end markets. EPS benefited from the volume and a lower than anticipated tax rate. Year-over-year, sales increased 10% organically. That's our second consecutive quarter of organic growth and reflects price realization, buy-ahead, and continued modest relief from the broad market weakness.

Excluding the effects of the buy ahead, sales volumes were modestly positive in the quarter, reflecting a continuation of gradual volume improvement we have seen since the fourth quarter of fiscal 2025. In terms of profitability, Adjusted EBITDA margin was 17.1%, compared to 13.9% in the prior year quarter. Adjusted EPS increased to $0.47, compared to $0.25 in the prior year quarter. The improvement in our profitability reflects the benefits from our strategic growth and restructuring initiatives, as well as price raw timing effects from the unprecedented increase in tungsten prices. As a result, today we are raising our sales and EPS outlook for fiscal 2026 to reflect the additional price raw timing benefit. 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 4 in our end market update. The top half of this slide shows our outlook at the midpoint and includes impact of price, growth initiatives, and market factors. I will focus on the bottom half of the slide and address the three markets that have changed since our last call: Transportation, Aerospace and Defense, and General Engineering. First, IHS estimates for Transportation slightly improved from the previous estimate of down low single digits to flat. Production volumes in Asia Pacific improved. In EMEA, the current forecast is a bit better, but it's still down, and the Americas declined slightly. Secondly, for Aerospace and Defense, the aerospace industry continues to show growth as OEM build rates continue to improve.

Finally, in general engineering, the IPI forecast in the Americas improved slightly, while other regions remain essentially unchanged. Also, the most recent GBI and ISM PMI surveys indicate expansion in the U.S. for the first time in almost a year. For our other end markets, conditions remain mostly unchanged from our previous forecast. Turning now to slide 5. I want to take some time to expand upon an opportunity we introduced last quarter, the rising global demand for electricity and what it means for Kennametal. Across the growing energy value chain, Kennametal has a broad range of products that help our customers run faster and longer from resource extraction through energy transmission, generation, and use. Electricity demand is projected to grow at about 3% annually through 2030, fueled by the rapid expansion of AI data centers, electric vehicle adoption, and continued grid build-out.

Data centers alone could represent 17% of U.S. power demand by 2030, along with EVs and hybrids growing at a strong double-digit CAGRs in the Americas from 2023 to 2027. As demand rises, the energy mix is diversifying. By 2030, incremental energy supply is expected to come from 45% natural gas, 35% solar, and 20% wind. Plus, coal is expected to remain a meaningful source as overall demand for electricity persists. The grid is also scaling quickly, with U.S. high power transmission lines forecasted to grow at a 20% CAGR through 2030. This source to generation opportunity represented approximately 17% of our fiscal 2025 sales. We anticipate this market to grow low single digits through 2030. Some areas, like gas and combustion turbines, are anticipated to experience relatively higher growth over this timeframe.

In our infrastructure segment, our wear-resistant solutions are used in oil and gas extraction, as well as trenching and foundation digging for wind turbines and transmission lines. In metal cutting, we supply products and solutions used in gas turbines and combustion engines, supporting both utility and AI data center power generation. Gas turbines are projected to grow at 15% CAGR in combustion engines for backup generators at 10% CAGR. We are well positioned to capitalize on these trends with the right products already in our portfolio and access to the right customers. And among those customers, we are well known for quality, reliability, and innovation, and we offer a global footprint that supports them wherever energy demand is rising. Kennametal is not just participating in the energy transition; we are powering it.

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

Thank you, Sanjay, and good morning, everyone. I will begin on slide six with a review of the second quarter operating results. Sales were up 10% year-over-year, with an organic increase of 10% and a favorable foreign currency exchange of 1%. The divestiture we concluded last year also had a negative 1% effect. At the segment level, Infrastructure increased 11% organically, and Metal Cutting increased 9%. On a constant currency basis, Americas sales increased 16%, Asia-Pacific sales increased 9%, and EMEA was up 2%. As Sanjay mentioned, our sales performance this quarter exceeded our expectations. Relative to those expectations, higher sales volumes, including the effect of customers buying ahead of tungsten-related price increases, were the catalysts for the outperformance.

By end market, on a constant currency basis, aerospace and defense grew 23%, earthworks grew 18%, general engineering grew 8%, energy increased 4%, and transportation increased 3%. I'll provide more color when reviewing the segment performance in a moment. Adjusted EBITDA and operating margins were 17.1% and 10.5%, respectively, versus 13.9% and 6.9% in the prior year quarter. The margin increase was driven by a favorable price raw effect of $17 million within the infrastructure segment, higher pricing and tariff surcharges in metal cutting, increased sales and production volumes in metal cutting, and year-over-year restructuring savings of $8 million.

These were partially offset by higher compensation costs, tariffs and general inflation, and a prior year benefit from insurance proceeds of approximately $3 million that did not repeat in the current year. Adjusted earnings per share were $0.47 in the quarter, versus $0.25 in the prior year period. The main drivers of our EPS performance are highlighted on the bridge on Slide 7. The year-over-year effect of operations this quarter was $0.22. This reflects approximately $0.15 of favorability from price raw material cost timing, price and tariff surcharges, and higher sales and production volume in Metal Cutting and incremental restructuring benefits. These are partially offset by higher compensation costs, tariffs, and general inflation. There was a headwind of $0.02 related to the net insurance proceeds received in the prior year due to the tornado that damaged our Rogers facility.

You can also see $0.02 of transaction gains related to preferential Bolivia exchange rates. Currency and pension impacts offset each other. Slides 8 and 9 detail the performance of our segments this quarter. Reported metal cutting sales were up 11% compared to the prior year quarter, with 9% organic growth and a favorable foreign exchange of 2%. Regionally, excluding currency exchange, the Americas increased 15%, Asia Pacific increased 9%, and EMEA increased 3%. Looking at sales by end market, aerospace and defense increased 19% year-over-year due to the absence of the Boeing strike that occurred in the prior year, improved build rates in the Americas, and easing supply chain pressures in EMEA, combined with our global strategic focus. Energy grew 11% this quarter due to data center power generation wins.

General Engineering increased 9% year-over-year due to indirect channel buy-ahead and price. And lastly, Transportation increased 3% year-over-year due to internal combustion engine and transmission wins in the Americas and price. Across all end markets, there was approximately $10 million of sales in the quarter as a result of customers buying ahead of price increases. Regionally, approximately half of the buy-ahead was in the Americas, with a third in Asia-Pacific and the balance in EMEA. Metal Cutting adjusted operating margin of 9.6% increased 360 basis points year-over-year, primarily due to price and tariffs surcharges, higher sales and production volumes, and incremental year-over-year restructuring savings of approximately $6 million. These factors were partially offset by higher compensation, tariffs, and general inflation. Turning to Slide 9 for Infrastructure.

Reported Infrastructure sales increased 8% year-over-year, with an organic growth of 11% and favorable foreign currency exchange of 1%, partially offset by a divestiture impact of 4%. Regionally, on a constant currency basis, Americas sales increased 17%, Asia-Pacific increased 8%, and EMEA sales decreased by 1%. Looking at sales by end market on a constant currency basis, Aerospace and Defense increased 33% due to defense orders, driven by continued focus on growth initiatives in the Americas. Earthworks increased 18% due to mining share gain and higher global construction volumes due to buy-ahead and share gain. General Engineering increased 5% due to price and higher powder demand in the Americas and Asia-Pacific, partially offset by lower demand in EMEA. And lastly, Energy was flat as higher prices offset weaker market conditions.

Within infrastructure, we saw approximately $3 million of sales as a result of customers buying ahead of higher prices. Adjusted operating margin increased 370 basis points year-over-year to 12.3%, primarily due to a few factors. The increase in operating income was primarily due to the $17 million effect from favorable timing of pricing compared to raw material costs, and year-over-year restructuring savings of $2 million, partially offset by higher compensation costs, prior year net insurance proceeds of $3 million, and general inflation. Now, turning to Slide 10 to review our free operating cash flow and balance sheet. Our second quarter year-to-date net cash flow from operating activities was $73 million, compared to $101 million in the prior year period.

Our second quarter year-to-date Free Operating Cash Flow decreased to $38 million from $57 million in the prior year, due primarily to working capital changes, including the increase in inventory from higher tungsten prices, partially offset by lower capital expenditures. On a dollar basis, year-over-year, primary working capital increased $97 million from an $85 million dollar increase in inventory to $690 million. On a percentage of sales basis, primary working capital increased to 31.9%. Net capital expenditures decreased to $34 million, compared to $44 million in the prior year. We returned $15 million to our shareholders through dividends. Due to the unprecedented increase in level of tungsten prices and the corresponding increase in our working capital, we did not repurchase shares in the second quarter.

Inception to date, we have repurchased $70 million or 3 million shares under our $200 million authorization. As we've had 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. During the quarter, we amended and extended our revolving credit agreement, which has capacity of $650 million and matures in November 2030. At quarter end, we had combined cash and revolver availability of approximately $779 million, and we're 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 $2.19 billion and $2.25 billion, with volume ranging from flat to +3%, and we anticipate an approximate 2% tailwind from foreign exchange. The increased outlook reflects additional pricing actions related to the increasing cost of tungsten since we provided our prior outlook. Despite the record level of tungsten, we remain confident in our ability to achieve the price. From a cost perspective, as Sanjay noted earlier, some of our immediate restructuring actions will take a bit longer to execute, and as a result, our updated range includes $30 million of savings. Depreciation and amortization, foreign exchange, and pension assumptions are unchanged and noted on the slide.

We now expect adjusted EPS in the range of $2.05-$2.45. This outlook includes approximately a $0.95 year-over-year benefit related to the timing of price and raw material costs. On the cash side, the full year outlook for capital expenditures is unchanged, and free operating cash flow is expected to be approximately 60% of adjusted net income. This revision reflects the additional working capital required by the rising cost of tungsten, as discussed earlier. Turning to slide 12 regarding our third quarter outlook. We expect third quarter sales to be between $545 million and $565 million, which reflects the effects of the buy-ahead that occurred in the second quarter. We expect volumes to range from -4% to flat.

If you were to adjust for the buy-ahead that occurred in the second quarter, volume at the midpoint would be positive 1% and would be the third consecutive quarter of improving volume trends. The outlook also includes price and tariff surcharge realization of approximately 13% to 5% positive impact from foreign exchange. We expect adjusted EPS in the range of $0.50-$0.60. This includes approximately $0.30 year-over-year benefit related to price raw timing. It's worth noting that the prior year's third quarter results included a $0.13 benefit from the advanced manufacturing tax credit. The other key assumptions for the quarter are 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 half of fiscal 2026, driven by price, modest improvements in a couple end markets, project wins on the 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. We remain confident in our plan for long-term value creation for our shareholders. And with that, operator, please open the line for questions.