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Text: We will be referring to that slide deck throughout today's call, and a recording of the call will be available for replay through June 5.
I'm Kelly Boyer, Vice President of Investor Relations.
Joining me on the call today are Chris Rossi, President and Chief Executive Officer; Damon Audia, Vice President and Chief Financial Officer; Patrick Watson, Vice President, Finance and Corporate Controller; Alexander Broetz, President, Widia Business segment; Franklin Cardenas, President, Infrastructure business segment; Pete Dragich, President, Industrial business segment; and Ron Port, Vice President and Chief Commercial Officer.
These risks 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.
Despite the many headwinds we faced this quarter, we posted solid results.
As you recall, even before COVID-19, we were experiencing industrial downturn across all our end markets and had taken cost control actions accordingly.
Well, with the onset of COVID-19, we quickly instituted additional cost control actions during the quarter, being careful to maintain operational capability and execute our strategic initiatives, such as simplification/modernization that are fundamental to driving long-term shareholder value.
Slide two details our approach during this period of uncertainty created by the COVID-19 pandemic.
As you heard me say before, it is important to stay focused on the things we can control, and that is particularly important in a crisis environment.
First and foremost, our approach has been to protect the health and safety of our employees while continuing to serve customers as an essential business.
Early in the crisis, we instituted protocols at our facilities to ensure the safety of our workforce, including social distancing, increased cleaning protocols, self-quarantine and other preventative measures such as work from home where possible.
We also established a global task force to react quickly to the evolving challenges and share best practices and solutions in real time.
And as a result, we were able to continue to operate with minimal disruption.
The only exceptions have been when there was a government-mandated lockdown in a region where we have a customer-serving facility, such as in China and India.
As with many other manufacturers, our China operations were disrupted in the early part of Q3, but were operational before the end of the quarter.
And our Bangalore, India plant, which was closed on March 26, is reopening this week.
Continuing to operate during the crisis well positions us for the eventual recovery.
We've already learned how to operate safely in a world with COVID-19.
Our production and distribution employees are acclimated to the new protocols and ramping up production of operational plants when the markets recover will be much easier than restarting plants that have been shut down.
In addition, we've supported our customers so they can continue to operate, and that includes some customers that are on the front line of the COVID-19 battle.
In fact, we are assisting with products and solutions for some customers that are converting their manufacturing lines to critical need products like ventilator components made from high-strength aluminum.
And of course, we continue to support other medical applications for customers within general engineering.
Now given the lack of visibility into the length and depth of the COVID-19 challenge, maintaining our strong liquidity position is, of course, a key focus.
This quarter, we decreased our operating expenses by 18% year-over-year in dollar terms, maintaining our operating expense at a target of 20% despite substantially reduced sales.
This was achieved by early and aggressive cost control actions, such as furloughs in the U.S. and similar actions around the world, reduced discretionary spending and extensive travel restrictions.
These actions, along with production furloughs aligned with volume decreases and reduced variable compensation, supported our margins and helped maintain our strong liquidity position at quarter end.
This not only allows us to continue to manage through these uncertain times, but also to continue with our simplification/modernization program.
Furthermore, these types of cost control actions allow us to manage our costs while minimizing the effect on our ability to react quickly once markets recover.
Using furloughs and similar actions globally allow us to keep employees in place as much as possible.
Looking ahead, it's our expectation that Q4 will be even more challenging than Q3.
With that in mind, these kind of cost control actions will continue and may potentially need to increase depending on how long the economic environment and end markets remain depressed.
Also, in keeping with our cautious approach in this environment, we pre-emptively drew on our revolver after quarter end and now have those funds available in cash.
We took this precautionary measure to mitigate the potential increased uncertainty in capital markets due to COVID-19, consistent with our conservative philosophy to maintain our strong liquidity position.
Together, these actions help enable us to continue our simplification modernization program, which I will talk in more detail about later.
Now I'll move on to slide three to review our quarterly results.
Organic sales declined by 17% in the quarter versus 3% growth in the third quarter last year.
This is the third consecutive quarter of double-digit organic declines, which speaks to the severity of the downturn we are experiencing and weakened state of our end markets.
The energy end market continued to be challenged with a year-over-year percentage decline in the mid-20s again this quarter.
Our expectation is that it will be tested further in Q4, given the recent extreme drop in oil price and the related effect on rig counts and the sector in general.
Transportation weakened sequentially in Q3 from Q2 and posted a percentage decline year-over-year in the high teens with several auto plant closures across the globe.
General engineering and aerospace also saw year-over-year percentage declines in the high teens this quarter as well and sequential declines from Q2, with the 737 MAX production challenges continuing and lower demand expectations worldwide due to COVID-19.
Finally, earthworks was negative year-over-year this quarter, but mixed, reflecting slight improvement in seasonal U.S. construction activity and pockets of growth in mining.
By region, all posted double-digit declines this quarter and higher year-over-year declines compared to Q2.
Although Asia Pacific experienced the smallest year-over-year decline, reflecting easier comps, it was the most affected mainly in China by COVID-19 in the quarter.
By quarter end, we were seeing some signs of stabilization in China at low levels.
EMEA and the Americas were less affected by COVID-19 this quarter, but our expectation is the effect will be amplified in Q4.
Adjusted EBITDA margin decreased 80 basis points year-over-year to 18.6% on revenues that were down almost 20%.
And sequentially, the margin improved by 720 basis points on lower sales.
The year-over-year decline in margin was primarily driven by lower volume and associated under absorption.
This was partially offset by positive raw materials, which contributed 280 basis points year-over-year as well as increased simplification/modernization benefits, lower variable compensation and the previously discussed cost control actions.
Adjusted earnings per share decreased year-over-year to $0.46 versus $0.77 in the prior year quarter, but increased sequentially by $0.31.
Given the uncertainty created by COVID-19, we are withdrawing our annual outlook.
We do understand, however, the need for transparency and therefore, want to provide some color around our expectations for Q4.
Preliminary April sales were down approximately 35% year-over-year, which speaks to the severity of the market headwinds.
Now to put April in perspective within the quarter, it's important to consider that this is essentially the first month we are seeing the significant effects of COVID-19 outside of China.
Therefore, April may not reflect the full effect that we can expect to see on sales in Q4.
Considering these trends, our strong cost control actions will continue.
Additionally, we expect the effect of raw materials to remain positive in Q4, but lower than the Q3 benefit and be roughly neutral for the full year.
To help you gauge profitability, assuming the April sales decline turns out to be indicative of the full quarter, we would expect to deliver a modest adjusted operating profit despite the significant decline in sales, and would expect free cash flow to improve sequentially from Q3.
This would be driven by continued strong cost control actions as well as simplification/modernization benefits and implies decremental margins within our expected range.
However, as we discussed, the biggest source of uncertainty is the effect of COVID-19 on volume, which of course, remains to be seen.
That being said, I am confident in the actions we are taking to manage the company through this period of uncertainty and in our ability to position the company for growth when markets recover.
As I mentioned, using production furloughs and similar actions to adjust operational capacity enables us to keep employees connected so we can quickly ramp up when markets recover.
Furthermore, we are able to continue with our strategic initiatives, such as launching new products like the HARVI I TE end mill.
This is a new product for metal milling components for aircraft, automobiles and other applications in general engineering.
It sets a new performance standard by enabling machinists to use a single tool to mill many types of metals faster and more efficiently than the previous standard, which required multiple tools.
And we were honored that the product was recognized recently as a gold medal winner by the prestigious Edison Awards.
Even in the current market conditions, our sales for this product have exceeded expectations, which shows the power of innovation and the importance of continuing to focus on our strategic initiatives.
So let me take a minute to update you on our strategic simplification/modernization program.
Overall, we are pleased, having achieved an incremental $34 million savings fiscal year-to-date, and we still expect full year savings this fiscal year to be modestly higher than the $40 million achieved last year despite lower volumes.
On our last earnings call, we indicated that our expectation was that approximately 90% of the incremental capital spend associated with simplification/modernization will be complete by this fiscal year-end, and the remaining 10%, as we previously discussed, will be reserved for future volume needs.
So really, not much change in our schedule, and we remain confident in delivering our adjusted EBITDA targets once markets recover such that we can achieve sales in the range of $2.5 billion to $2.6 billion.
I will begin on slide five with a review of our operating results on both a reported and adjusted basis.
As Chris mentioned, demand trends remained soft in Q3 and deteriorated significantly at the end of March, driven by the effects of COVID-19.
Sales declined 19% year-over-year or negative 17% on an organic basis to $483 million.
Foreign currency had a negative effect of 1% and our divestiture contributed another negative 1%.
Adjusted gross profit margin of 33.3% was down 170 basis points year-over-year, though up sequentially from 26.8% in the second quarter.
The year-over-year performance was largely the result of the effect of lower volumes, partially offset by the positive effect of raw materials in the amount of approximately 280 basis points and increasing benefits from simplification/modernization.
It should be noted that we still expect the effects of raw materials to be neutral for the full year.
As Chris mentioned, adjusted operating expenses of $99 million were down 18% year-over-year and increased only 30 basis points to 20.4% on significantly lower sales.
Although much of this decrease is temporary, it is reflective of our aggressive approach to managing costs as our markets have been weakening prior to the global onset of COVID-19.
Taken together, adjusted operating margin of 12.2% was down 210 basis points year-over-year, though improved 740 basis points sequentially.
Reported earnings per share was $0.03 versus $0.82 in the prior period.
On an adjusted basis, earnings per share was $0.46 per share versus $0.77 per share in the previous year.
The main drivers of our adjusted earnings per share performance are highlighted on the bridge on Slide six.
The effect of operations this quarter amounted to negative $0.39.
This compares to negative $0.02 in the prior year period and negative $0.62 in the second quarter.
The largest factors contributing to the $0.39 was the effect of significantly lower volumes and associated under absorption.
This was partially offset by positive raw materials of $0.16 and lower variable compensation.
Simplification/modernization contributed $0.15 in the quarter, on top of the $0.11 in the prior year quarter and up from the $0.10 last quarter.
This brings our year-to-date simplification/modernization savings of $0.32.
As Chris mentioned, our expectation for this fiscal year is that these simplification/modernization benefits will be modestly higher than the $0.40 we achieved last year.
The savings from our FY 2020 restructuring actions are now expected to deliver $30 million to $35 million in run rate annualized savings by the end of FY 2020.
The slight decrease of $5 million is due to the significantly lower volume assumption in the fourth quarter.
We remain on track with our FY 2021 restructuring actions that are expected to contribute an additional $25 million to $30 million of annualized run rate savings by the end of FY 2021.
Slides seven through nine detail the performance of our segments this quarter.
Industrial sales in Q3 declined 17% organically compared to 1% growth in the prior year.
All regions posted year-over-year sales decreases with the largest decline in EMEA at negative 19%, followed by the Americas at 16% and Asia Pacific at 12%.
The decline in Asia Pacific was partially affected by the lower demand associated with the early onset of COVID-19 in China and continued lower end market demand in India.
From an end market perspective, the weakness in demand remains broad-based, with the biggest declines in transportation and general engineering, down 17% and 18%, respectively.
This was primarily driven by continued decelerating global manufacturing and auto production activity as well as the early effect of COVID-19 outside of China.
Sales in aerospace experienced a significant decline, both year-over-year and sequentially, driven by the 737 MAX production halt and corresponding effect on the supply chain as well as demand declines associated with COVID-19.
Adjusted operating margin came in at 13.1% compared to 18.3% in the prior year.
This decrease was primarily driven by the decline in volume, partially offset by increased simplification/modernization benefits and a 90 basis point benefit from raw materials.
On a sequential basis, the adjusted operating margin increased approximately 240 basis points despite lower sales.
The improvement was primarily driven by incremental simplification/modernization benefits, lower raw materials, lower variable compensation and aggressive cost control actions.
Turning to slide eight for Widia.
Sales declined 16% organically against positive 3% in the prior year period.
Widia faced similar macro challenges as the Industrial segment during the quarter.
Regionally, the largest decline this quarter was in Asia Pacific, down 25%, EMEA down 14% and the Americas down 10%.
The decline in Asia Pacific was primarily due to the continued transportation downturn in India, which is also affecting the general engineering market.
This decline was further amplified in March when India initiated its countrywide COVID-19 shutdown.
Adjusted operating margin for the quarter was 4.9%, and an increase year-over-year due to increased simplification/modernization benefits, a raw material benefit of 240 basis points and lower variable compensation, partially offset by volume declines.
Turning to Infrastructure on slide nine.
Organic sales declined 17% versus positive 6% in the prior year period.
Regionally, the largest decline was in the Americas at 21%, then Asia Pacific at 16% and EMEA at 6%.
By end market, these results were primarily driven by energy, which was down 29% year-over-year, given the extreme drop in oil prices and the corresponding significant decline in the U.S. land-only rig count.
General engineering and earthworks were down 17% and 6%, respectively.
These end markets reflected the general economic downturn.
However, there were some bright spots, such as seasonal U.S. construction in earthworks, which was up year-over-year and which has continued into early Q4.
Adjusted operating margin of 13% improved 130 basis points from the prior year margin of 11.7%.
This improvement was mainly driven by favorable raw materials that contribute 550 basis points, coupled with simplification/modernization benefits and aggressive cost actions, partially offset by significantly lower volumes.
Now turning to slide 10 to review our balance sheet and free operating cash flow.
Before I review the numbers, I would like to emphasize that we view liquidity as extremely important, particularly in such uncertain times.
Even in a normal macro environment, we operate in highly cyclical end markets and therefore, know that a strong focus on cash flows, scenario analysis and contingency planning are all part of the required skill set to navigate the uncertainty we deal with.
This has become even more important now.
Our current debt maturity profile is made up of two $300 million notes maturing in February 2022 and June 2028 as well as a USD700 million revolver that matures in June of 2023.
As of March 31, we had combined cash and revolver availability of approximately $750 million.
As Chris mentioned, in April, in an abundance of caution, we pre-emptively drew $500 million on our revolver.
This action was taken due to our conservative approach to liquidity, coupled with the unprecedented environment we are dealing with as well as an uncertainty that COVID-19 could potentially bring in the capital markets.
At quarter end, we were well within our covenants.
We have two financial covenants in our revolver, which is our net debt-to-EBITDA ratio of 3.5 times and an EBITDA to interest ratio of 3.5 times.
Primary working capital decreased both sequentially and year-over-year to $656 million.
On a percentage of sales basis, it increased to 33.4%, a reflection of the decline in sales in the quarter.
Net capital expenditures were $57 million, the same level as the prior year.
As Chris mentioned, we are pleased with the progress we have made in simplification/modernization.
Under the current demand environment, we are taking a cautious stance toward capital expenditures in the short-term while continuing to advance our simplification/modernization strategy.
We now expect capital expenditures for the fiscal year to be approximately $240 million, which is at the low end of our original outlook.
Our third quarter free operating cash flow was $2 million and represents a year-over-year decline of $37 million, reflecting lower income due to volume and increased cash restructuring costs.
We expect to deliver increased free operating cash flow in the fourth quarter compared to the third quarter, but given the current market environment, we expect free operating cash flow for the full year to be slightly negative given the $240 million of capital expenditures and cash restructuring charges.
Overall, I remain confident in the strength of our balance sheet even in the face of the current macro uncertainty.
Our strong liquidity position, coupled with our debt maturity profile and overfunded U.S. pension plan limit the significant near-term cash obligations and allow us to stay committed to our simplification/modernization initiatives.
And as Chris said, we are nearing the end of the capital investment required for this program, which will significantly lower the capital spend in FY 2021.
We remain conservative to ensure the company has ample liquidity to weather the current environment as well as continue to execute our strategy.
Dividends were approximately flat year-over-year at $17 million.
In this time of uncertainty, we reviewed our dividend program and believe that the current level is still appropriate given our strong liquidity position.
Should demand trends deteriorate more significantly than we currently anticipate, we know our dividend program, like other cash flow and cost control actions, is a lever that could be used to preserve cash and liquidity.
The full balance sheet can be found on slide 14 in the appendix.
As discussed, we are focused on managing through this crisis with an eye to strengthening the company and being prepared for the recovery.
We have a solid plan to navigate through these challenging times by aligning costs with volumes through aggressive but measured cost control actions to position us for when markets recover.
We feel good about our liquidity position and have the wherewithal to continue with our strategic initiatives like simplification/modernization to drive improved customer service and profitability with more than half of the benefits yet to be realized.
Furthermore, we are approaching the end of the incremental capex for the program, significantly lowering the overall capital spend in FY 2021.
I have confidence that we will not only navigate through this environment successfully, we will also be in a better position for improved profitability coming out of it.

user
q3 sales $483 million versus refinitiv ibes estimate of $515.9 million.
q3 earnings per share $0.03.
excluding china, effect of covid-19 on q3 was minimal from a revenue standpoint.
all but one production facility is operating, and this facility is expected to reopen mid-may.
company is taking other aggressive cost-control measures to offset market headwinds.
cost cutting measures include, reductions in all discretionary spending, furloughs, extensive travel restrictions.
company is withdrawing its previously announced outlook for fiscal year 2020.
kennametal - has adequate liquidity & access to credit to meet cash flow requirements & expects to remain in compliance with relevant debt covenants.

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