Kennametal Inc.

Good morning. I would like to welcome everyone to Kenna Metal's second quarter fiscal 2020 earnings conference call. All lines have been placed on you to prevent any background noise. After the speaker's 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 two. 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. Ms. Boyer, please go ahead.

Thank you, Operator. Welcome, everyone, and thank you for joining us to review CannaMetal's second quarter fiscal 2020 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 today's call, and a recording of the call will be available for replay through March the 5th. 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 Brose, President Video Business Segment, Pete Dragich, President Industrial Business Segment, and Ron Port, President Infrastructure Business Segment. After Chris and Damon's prepared remarks, we will open the lineup 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 as defined under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements 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 forward-looking statements. These risk factors and uncertainties are detailed in Kenna Metal'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 8K 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 the call today. Let me begin by making some general comments before reviewing the quarter. Though we are currently experiencing the downturn across all our end markets, we remain focused on the things that we can control. We are seeing results from the simplification and modernization actions completed to date, and these actions as well as those still to be completed, will drive improved profitability and leverage when our end markets begin to strengthen. Starting on slide two in the presentation deck, organic sales declined by 12% in the quarter versus 4% growth in the second quarter last year. This is the second consecutive quarter of double-digit organic decline and highlights the weakened state of our end markets. While we had expected end markets in the second quarter to decline sequentially, a few countries, specifically the U.S., Germany, and India, declined more significantly than we had anticipated. Furthermore, the challenges in the aerospace end market related to the 737 MAX and trickle-down effect in the supply chain exacerbated the already weak market conditions. Adjusted EBITDA margin decreased 740 basis points to 11.4%, but improved 50 basis points sequentially, despite lower sales this quarter. Adjusted EPS decreased to 17 cents versus 71 cents in the prior year quarter. The decreases in margin and EPS were the result of three main factors. First, the decline in volume was a significant contributor as all our end markets declined year over year. Second, the negative volume effect and the associated underabsorption were magnified by manufacturing inefficiencies related to the recent plant closures from our simplification modernization efforts. That said, the disruptive effect of plant closures is expected to decrease in the second half of this fiscal year. Third, as we discussed on our last earnings call, raw material headwinds continue to temporarily depress our margins in the quarter. Although as expected, the magnitude of the effect improved sequentially from the first quarter, it still represented 130 basis points of the year-over-year decline in our margins, or 7 cents of EPS. This situation will reverse in the second half since the higher cost raw material inventory worked through the P&L in the first half of fiscal year 20. And our expectation is that the full year effect will be roughly neutral. These negative factors were partially offset by the progress we are making on simplification modernization, which contributed an incremental 10 cents of EPS year over year. This quarter, we achieved an incremental $11 million in savings from simplification modernization and $19 million year-to-date, bringing the total since inception of the program to $69 million. As a reminder, we still expect our full year savings this fiscal year to be modestly higher than the $40 million achieved last year, reflecting increased savings in the second half from footprint rationalization and manufacturing modernization. We closed two manufacturing facilities in the second quarter. The savings from these closures are part of the fiscal year 20 restructuring actions. which are expected to deliver $35 to $40 million in run rate annualized savings by the end of fiscal year 20. We also remain on track with our fiscal year 21 restructuring actions that are expected to contribute an additional $25 to $30 million of annualized run rate savings by the end of fiscal year 21. And we now expect to achieve these savings at a lower cost. We've decided to downsize the ESSEN operation rather than closing it after reaching a compelling agreement with local employee representatives to improve profitability given by increased required work hours per week and lower operating costs. We're also evaluating the acceleration of other facility closures as part of our ongoing restructuring activities. As you've heard me say before, In an unpredictable market environment such as this one, it's important to stay focused on the things that we can control, such as discipline, cost management. Our adjusted operating expense of 21.3% represents a decrease of 6% year-over-year in dollar terms. And we will continue to look for opportunities to reduce costs, especially in the current market environment. Looking ahead, the lower end market demand we experienced in Q2 as well as our current expectations for further weakness through the remainder of the fiscal year, have necessitated a reduction in our total year outlook. Let's turn to slide three to discuss some of the changes since our last earnings call that have lowered our expectations. As you can see on this slide, many macroeconomic indicators for our key end markets have changed significantly over this last quarter versus what was forecasted at the end of the first quarter. U.S. manufacturing production was positive in the first quarter and unexpectedly turned negative in the second quarter. Similarly, India was indicating signs of recovery with September industrial production forecasted to be positive 4%. However, actual performance was negative 4% and consistent with the further deterioration that we saw in Q2. The transportation end market continued to weaken further than expected in the quarter, with a decrease in German industrial production of negative 5% versus the forecast of negative 3% at the start of the quarter. The developments with the 737 MAX affected our second quarter and full-year outlook as well. At the time of our last call, Boeing's actual monthly production levels were 42, and they were forecasting an increase to 52 by fiscal year end. And, of course, the subsequent production halt also affected the associated supply chain. Finally, the energy end market was significantly lower as seen in the drop in U.S. land-only rig count, which was forecasted to stabilize around 850 at the time of our last call and is now around 800 and expected to stay at approximately these levels for the balance of the fiscal year. Despite these challenges across our end markets, we continue to improve our long-term profitability as seen on slide four. Part of simplification modernization is reduction in our manufacturing footprint to reduce structural costs, as well as leveraging our modernized manufacturing processes for improved productivity. Since the start of this journey, we've reduced the footprint by five and require considerably less employees to operate the business. Note that the reduction in footprint does not include the significantly downsized Essin operation or other facility closures currently under evaluation. These actions today are reflected in the improvement in our cash flow from operations as shown in the chart, comparing the first half of this year to a similar revenue period. As you can see, there's a significant improvement in our cash flow as we focused on simplification modernization, including Simplifying and value-based pricing our product portfolio and services, improving productivity through automation and modernized manufacturing processes, and removing structural costs through footprint rationalization. Overall, we are making good progress. Today, we've reduced our footprint by five versus the December 2017 investor day projection of five to seven. and expect to spend approximately 90% of the incremental $300 million in modernization capex by the end of this fiscal year. This will complete the $300 million of incremental capital spend required for our simplification modernization program, except for approximately 10%, which we expect will be needed to add capacity once markets recover. It's important to note that much of the productivity improvements from the modernization capital are still to come, As we've discussed, the plant closures would happen toward the end of our simplification modernization program, and we are on track with that. The productivity of the modernized processes that enable consolidation of entire plants into a smaller footprint are significant. And these benefits of modernization are still ahead of us as we bring the new processes online and complete the transfer of products throughout fiscal year 20 and 21. So in summary, I remain confident that we will deliver the savings needed to achieve our adjusted EBITDA target of 24 to 26% once our sales are within the $2.5 to $2.6 billion range. Before I turn the call over to Damon, I'd like to discuss the executive changes announced last week. Ron Port, who is currently leading our infrastructure business segment, has moved into the newly created role of Chief Commercial Officer for our metal cutting businesses. In this new role, Ron will drive best practices across our metal cutting segments to improve sales and marketing effectiveness and accelerate growth with target customers by leveraging the company's full metal cutting portfolio. Franklin Cardenas is joining our team as of February 10th and will lead the infrastructure business segment. He comes to us from Donaldson Company, where he held various business and general management positions with responsibility for commercial and operations. He was most recently VP of Asia Pacific. Welcome, Franklin, to the Continental team. And with that, I'll turn it over to Damon.