Kennametal Inc (KMT) 2017 Q4 法說會逐字稿

Good morning.

I would like to welcome everyone to Kennametal's Fourth Quarter Fiscal Year 2017 Earnings Call.

(Operator Instructions) 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.

Thank you, Kerry.

Welcome, everyone, and thank you for joining us to review Kennametal's fourth quarter and fiscal year 2017 results.

Yesterday evening, we issued our earnings press release and posted our call slide deck on our website.

Today on the call, we will discuss the June quarter and full year operating and financial performance as well as our outlook for fiscal year 2018, and we'll be referring to the slide deck throughout the call.

After our of our prepared remarks, we will be happy to answer your questions.

At this time, please direct your attention to our forward-looking disclosure statement.

Today's discussion contains comments that constitute forward-looking statements that involve a number of assumptions, risks and uncertainties that could cause the company's actual results to differ materially from those expressed in or implied by those statements.

These risk factors and uncertainties are detailed in Kennametal's SEC filings.

Also, 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 would now like to turn the call over to Executive Chairman of the Board, Ron Defeo.

Thank you, Kelly, and good morning, everyone.

Thanks for joining us on the call today.

I'm really pleased to introduce Chris Rossi, who, as of the 1st of August, assumed the role of President and CEO of Kennametal.

Chris comes to us from the Dresser-Rand operating units of Siemens.

In addition to his 30-plus years of leadership experience, he has an exceptionally strong operational background that will serve Kennametal well as we move forward with our modernization and end-to-end process improvement plans.

As Kelly mentioned, I've assumed the role of Executive Chairman, and this should be my last conference call.

I look forward to supporting Chris and the team going forward.

Chris?

Hello, everyone.

I'm honored to be joining Kennametal and happy to be on the call with you today.

I look forward to working with the team and getting to know our investors and analysts over the next several months.

The company has obviously made really great progress already.

Still, there's a lot more to do.

So I plan to roll up my sleeves and help improve on the good work that's already underway.

Thanks, and I'll turn the call back over to Ron.

Thanks, Chris.

Also on the call today, Johannes van Gaalen, our Chief Financial Officer; Patrick Watson our Corporate Controller, as well as the presidents of our 3 business segments: Chuck Byrnes for Industrial; Pete Dragich for Infrastructure; and Alexander Broetz for Widia.

Let me begin on page 2 of the slides that are posted to our website.

Our fourth quarter fiscal year 2017 results were in line with our expectations with some exceptions.

The growth rate for sales exceeded our expectations, both at the total sales growth level of 8% and at the organic growth level of 12%.

And of course, organic factors out currency effect and days of businesses.

Every segment posted strong quarterly growth.

Our quarterly adjusted operating margins increased 220 basis points year-over-year to 11.2%, but a bit worse than our expectations.

It should be noted that the quarterly margin was impacted negatively by 2.5 percentage points due to a LIFO charge and higher variable compensation versus year ago.

Adjusted EPS for the quarter increased to $0.56 from $0.44 in the prior year quarter.

The LIFO and increased variable compensation factors accounted for $0.13 negative in EPS in the quarter.

On a total year basis, fiscal year 2017 has been a year of significant and positive change at Kennametal.

I'm pleased to report that the results show progress in the 3 areas that we focused on: growth, simplification and cost reduction.

Excluding divestitures, sales increased 2% for the total year and organic growth was 4%, which exceeded our expectations.

Improved sales execution is evident in these results.

Total year adjusted operating margin increased 300 basis points to 9.2%.

Adjusted earnings per share improved to $1.52 from $1.11 in the prior year.

Now let's turn to Slide 3 and look at the organic sales growth.

We posted now 3 consecutive quarters of organic sales growth after 8 quarters of negative organic growth.

In the fourth quarter of fiscal year '17, organic sales increased 12%, a level of quarterly organic growth that we haven't seen since the fall of 2011.

All 3 months within the quarter showed good strength with April and May both at double-digit levels.

We're encouraged by the tone of the end markets, in addition to our progress on sales execution initiatives.

It certainly feels good to see end market showing improvement, although this strength presented some opportunities and challenges for us during the quarter.

Our headcount reduction program was largely on track, although some of the actions needed to be pushed out slightly in order to meet demand and avoid additional overtime and temporary help.

We're still targeting $90 million for total program savings, but as noted last quarter, we modified our target end date to be the end of calendar year 2017.

Nevertheless, this is a substantial cost reduction that will carry over into 2018 and beyond and is a major reason why we have earnings confidence with a modest revenue assumptions entering this year.

Now turning to Slide 4 of the Industrial segment overview.

We've included the revenue splits in the business by geography and end markets at the top of the slides for your quick reference.

This really has not changed much.

So there's nothing unusual here.

The Industrial team posted a quarterly year-over-year sales growth of 5% and 10% organic growth.

This is the fourth consecutive quarter of organic growth for the Industrial team.

All regions showed revenue gains with Asia leading at plus 14%, followed by the Americas at plus 9% and Europe at plus 4%.

Adjusted operating margin decreased year-over-year to 11.9% from 13.9% in the prior year quarter.

The fourth quarter margin was impacted negatively by 3.7 percentage points due to the LIFO charge and higher variable compensation year-over-year.

We saw good strength in all of our end markets with our largest sales gains in energy at plus 22%, followed by general engineering, plus 8%, aerospace at plus 6% and transportation, plus 5%.

We believe inventory or stocking levels within the indirect channel are consistent with our end market demand.

Over fiscal year 2017, we did make significant progress on all 3 areas of focus: growth, simplification and cost reduction.

Chuck Byrnes and the team have worked really hard on improving our sales execution and have completed our multi-tiered customer segmentation and implemented our CRM tool for sales planning.

Both of these accomplishments are expected to have significant impact on future results.

We continue to work with our customers on the transition from serving them directly to indirectly, where appropriate, with approximately 4,100 customers being converted to date with no margin erosion.

Of course, an important part of this move was improving our partnerships with distributors.

We're dedicated to continuing to work together with these partners to improve customer service levels.

During fiscal year 2017, this was a key area of emphasis, and we're extremely pleased to be named MSC's Supplier of the Year.

To emphasizes this point, with MSC, we went from seventh in tooling suppliers to first overall out of thousands of MSC suppliers.

To say the least, the team is very proud of this.

This is just one example, but an illustrative one, of the changes happening here at Kennametal and, more specifically and perhaps more importantly, the rate of change, the speed of execution that's at work here at Kennametal, all based on a better internal environment for effective decision-making.

With regard to the second set of initiatives, namely simplifying the company, we also made good progress.

This is an extremely important initiative, since without good product and process discipline, manufacturing will never be efficient.

We had simply, and for no good reason, become too complicated.

Over the fiscal year of '17, we eliminated approximately 8% of our SKUs on our pathway to eliminating 20%.

The number of codings we used, we've eliminated 30% on our pathway to over 40% coding reductions.

And our powder formulations, we eliminated 48% in the year on our pathway to 60% reduction.

Again, these changes help optimize supply chain engineering and manufacturing efficiency and, therefore, improved productivity in margins.

And keeping with this focus on margin improvement, we implemented minimum order quantities and are now above 80% complete in the implementation of this target.

On the cost-reduction side, as I mentioned, earlier on the call, the headcount reduction initiatives, we're basically on track with some small timing differences, frankly, due to the increased growth.

We are also on track with regard to our modernization and end-to-end process improvement plans.

Of course, the main benefits of these programs will be felt incrementally over the next 2 to 3 years and thereafter and is the reason why our capital spending is going up.

For Industrial, the key to success lies in both our growth and margin improvement initiatives.

We have major accomplishments that we've seen in 2017, but there's still a lot of opportunity, a lot of work to do and more success to come.

Turning to Slide 5 for a brief discussion of Widia.

Widia posted a 10% quarterly sales improvement with year-over-year organic growth of 14%.

Again, all regions reported positive year-over-year quarterly numbers with, in this case, the Americas leading at plus 15%, followed by Asia at plus 13% and EMEA at a 2% growth.

Adjusted operating margins fell in the quarter to breakeven.

Like Industrial, the margin was impacted negatively by a LIFO charge and increased variable compensation due to increased sales performance.

These 2 factors total 4.5 percentage points for the quarter.

With regard to the regional strategies of Widia, in America, the rebirth of the WIDIA-Hanita and WIDIA-GTD brands have helped grow sales, and we've completed the channel partner program rollout that got started earlier in the year.

In the AsiaPac region, we completed and reorganized the indirect channel partner network in China and established partnerships for the other AsiaPac countries.

In India, we were able to grow sales by 11% despite a market growing only modestly and have been successful increasing our manufacturing output at the Bangalore facility by 36% for both the India and global marketplace.

Finally, in EMEA, we faced challenges in fiscal year '17, but have good traction now.

In Germany, we replaced our national distribution partner, which had gone into bankruptcy, and in Switzerland, we have been successfully replacing our national distributor.

I'm happy to report that in both of these important countries, we're basically back on track at previous run rate levels.

Emerging markets in Eastern Europe have seen double-digit growth in 2017.

All in all, we're encouraged with Widia's progress.

This business is benefiting from focused leadership on the brand, and we're excited to continue this work, both for growth and margin improvement.

On Slide 6, we update our Infrastructure business.

Again, the noticed splits by geography and end markets for the year are shown in the pie charts at the top of the slide, but they are as anticipated.

Infrastructure had a great quarter and a great year.

In the quarterly performance, it reported year-over-year growth of 13% with year-over-year organic growth at 14%.

This is the second consecutive quarter of growth after 2.5 years of negative organic growth in the segment.

The Americas and Asia reported and posted positive sales growth at 22% and 11%, respectively.

European sales, however, declined at a rate of 11%.

With regard to end markets, oil and gas activity continues to improve with the average U.S. land rig count in the quarter up over 100% year-over-year.

This improvement is evident in our numbers with energy leading at plus 41% growth in the quarter.

Mining is showing some encouraging signs of improvement.

The result, in total, is an adjusted operating margin, which increased significantly by 760 basis points to 11% this quarter.

Like last quarter, this margin improvement reflects the work we're doing on a number of fronts.

First, the reorganization within Infrastructure into strategic business units.

This was an important part of our 2017 results.

We've been able to capture lower raw material unit cost through 3 distinct initiatives: improved product design, optimized material science usage and strategically sourced material.

Also, we completed the 3 plant closures announced earlier this year and the cost savings are flowing through the P&L.

The headcount reductions in Infrastructure are on track, and these cost reductions are accelerating in the numbers this quarter.

Finally, in 2017, we had a number of product launches, and we're seeing good volumes in both oil and gas as well as our road milling products.

In summary, Infrastructure continues to make great progress.

We're obviously pleased that the end markets are improving.

We're even more pleased with the margin improvements we've been able to capture.

Those are the improvements that will serve us well on the long run.

With that said, I'd now like to turn it over to Johannes van Gaalen, who will begin on Slide 7, with a more detailed financial report.

Jan Kees?

Thanks, Ron, and hello, everyone, Let me take a moment to also welcome Chris Rossi, my former and now new colleague to the team.

I will begin by reviewing the income statement, starting with the quarterly results on Slide 7 on both the reported and adjusted basis.

On a reported basis, EPS for the quarter was $0.30, compared to a loss of $0.83 in the prior year quarter.

Sales in the June quarter increased 8% to $565 million with organic sales posting at 12%.

Fewer business days as well as a 2% unfavorable currency exchange negatively impacted quarterly sales this year.

Sales grew in every end markets.

Adjusted gross profit increased 8% to $182 million this quarter over the prior year.

Adjusted gross profit margin decreased slightly by 30 basis points year-over-year to 32.2%.

The main factors at the gross margin levels were higher raw material costs, a LIFO inventory charge and higher performance-based compensation, partially offset by incremental restructuring benefits, organic sales growth and favorable mix.

Adjusted operating expenses decreased by 3% to $115 million and, as a percentage of sales, improved by 240 basis points to 20.3%.

We're really pleased with the progress we have made this year on operating expenses, and we want to continue to focus on further improvements as we move forward.

The favorable change in OpEx is due primarily to incremental restructuring benefits, offset partially by higher performance-based compensation.

These improvements in both the gross profit and operating expense lines contributed to improved adjusted operating income by 36% in dollar terms and 220 basis points in margin terms.

Versus our expectations, operating margins were impacted this quarter by a LIFO charge, an increased variable compensation, in addition to productivity challenges as a result of higher-than-anticipated organic sales.

For the fourth quarter of fiscal 2017, adjusted EBITDA was $89 million, up 17% from the prior year period.

Adjusted EPS, improved year-over-year by 27% to $0.56 in the fourth quarter fiscal of 2017.

Again, although this is an excellent improvement over last year, it is noteworthy, that the LIFO charge and increased variable compensation impacted the quarterly results in the amount of $0.13 per share.

A complete bridge of the factors affecting adjusted EPS this quarter versus the fourth quarter of prior year is presented in the EPS bridge on Slide 8.

Now let me walk you through the bridge.

The 27% increase in adjusted EPS year-over-year mainly reflects the positive effects of incremental restructuring benefits of $0.28, the net favorable effect of organic sales growth, mix, fixed cost absorption and productivity, in aggregate, amounting to $0.11.

This was partially offset by higher performance-based compensation of $0.11, a LIFO charge of $0.05, higher taxes of $0.04 and unfavorable currency exchange of $0.02 per share.

The full year financial results are summarized on Slide 9 on both the reported and in adjusted basis.

On a reported basis, EPS for the total year was $0.61 as compared to a loss of $2.83 in the fiscal year 2016, and adjusted EPS improved 37% to $1.52.

Adjusted gross margins improved year-over-year by 190 basis points to 32.3%.

Adjusted operating expense as a percentage of sales decreased by 90 basis points to 22.3%.

The full year EPS bridge can be found on Slide 10.

In summary, the 37% increase in adjusted EPS year-over-year reflects the positive effects of incremental restructuring benefits of $0.78, the net favorable effects of organic sales growth, mix, fixed cost absorption and productivity, in aggregate, amounting to $0.38, partially offset by higher performance-based compensation of $0.28, higher taxes of $0.25, inventory charges of $0.09 and unfavorable currency exchange of $0.08 per share.

The detail on our savings from both headcount reduction and other restructuring programs can be found in the appendix on the slide deck.

To summarize, for fiscal year 2017, total savings from our headcount reduction initiative was approximately $47 million.

Annualized savings from headcount reduction in the fourth quarter were approximately $80 million.

As Ron mentioned, we expect to reach the target of $90 million by the calendar year-end 2017.

Today, we have incurred charges of $56 million with this initiative and expect to incur approximately 10 more -- in $10 more million -- $10 million more in charges to complete the program.

With regards to the other restructuring programs.

Benefits in the quarter amounted to $17 million, and total year savings amounted to $62 million.

At completion, we continue to expect these programs to yield annual -- annualized savings of $75 million to $90 million.

Inception-to-date charges of $92 million have been incurred, and we still expect total charges to be in the range of $105 million to $125 million.

Ron talked about the segment sales trends earlier in the call.

We are seeing strength in all of our end markets, particularly oil and gas and general engineering.

The detail of our segment sales by region and end market can be found on slide 11.

Industrial and Widia operating margins were challenged this quarter by a LIFO charge and increased variable compensation compared to last year.

The negative impact of these items was mitigated by incrementally higher restructuring savings and organic sales growth.

Infrastructure's adjusted operating income increased by more than three-fold, due to primarily incremental restructuring benefits, favorable mix, organic sales growth and a higher absorption and productivity, partially offset by higher raw material costs and performance-based compensation.

As shown on Slide 12, primary working capital was $652 million, as at June 30, 2017, a decrease of $24 million from the March figure.

On a percentage of sales basis, primary working capital decreased by 90 basis points from March 31, 2017, to 31.4% as at June year-end.

Slide 13 summarizes the cash flow statement.

Fourth quarter free operating cash flow was $89 million, an improvement to both the fourth quarter of the prior year and the third quarter of fiscal 2017.

Total year free operating cash flow was $79 million, a decrease of $36 million from the $115 million in the prior year.

It is important to note, that the favorable impact of $33 million due to last year's divestiture did not repeat in the current year.

With regards to capital spending, the net capital expenditures were $113 million in the year compared to $105 million for the prior year.

Dividends paid out were $64 million, consistent with last year.

We remain committed to maintaining our dividends.

Turning to slide 14 for a discussion of our balance sheet.

Our conservative capital structure and investment-grade ratings are of key importance to Kennametal, and we continue our commitment to maintaining them.

Cash on hand as at June 30 increased to $191 million as compared to $101 million last quarter.

At the end of June, our net debt was $505 million with no current outstanding borrowers on our revolver.

We have no significant maturities until November 2019.

Gross debt to adjusted EBITDA currently stands at 2.4x.

The full balance sheet can be found in the appendix of the slide deck.

We feel comfortable with our balance sheet and liquidity positions, and we'll continue to focus on them as we execute on our restructuring, modernization and end-to-end initiatives.

And with that, I'll turn it over back to Ron.

Thank you, Johannes.

Turning to slide 15 with regard to our fiscal year '18 outlook.

We expect to see increasing demand in our end markets and organic sales growth to be within a 2% to 4% positive range.

Given the run rate at the end of fiscal year '17, we may have some upside potential here, but we will know this as we get deeper into the year.

Also, remember that comparables will get more difficult as we move into the second half of fiscal year '18.

In the meantime, we remain focused on productivity improvement and cost-reduction plans.

And if stronger revenue happens then, all the better.

We expect our tax rate to continue to be in the 18% to 22% range consistent with the rate for our total year 2017.

With revenue up 2% to 4%, our operating margins are expected to be up significantly, reflecting the traction that we've captured in our fiscal year '17 with our cost-out programs as well as continuing the work on these initiatives in fiscal year '18.

And frankly, the added compensation cost is embedded in our base year, and we will not have that incremental difference entering 2018.

Our EPS outlook for the coming year is $2 to $2.30 a share, on an adjusted basis, with the midpoint of which is up over 40% compared to 2017.

So with our current modernization and end-to-end process improvement programs now underway, our capital expenditures are expected to increase and be in the range of $210 to $230 million.

Therefore, free operating cash flow is expected to be within a $0 to $20 million range.

This is consistent with what we have communicated regarding our modernization plans.

So to summarize on Slide 16.

On balance, Q4 was a very good quarter.

And for the full year, our fiscal year 2007 (sic) [2017] has been a year of really significant change.

After reorganizing the company to allow for positive transformation, we got to work on those 3 key initiatives: growth, simplification, and lowering costs, which will now become modernization going forward.

We've achieved substantial progress in all 3 of these areas.

The markets are definitely cooperating with us more now than they have in the past couple of years.

This is good news.

Nevertheless, we continue to be laser-focused on getting costs out and margins up.

We have a strong team in place.

And now with Chris onboard, even that much stronger.

We're building the foundation today for sustainable improved performance into the future.

And with that, I'd now like to open it up for questions.

(Operator Instructions) The first question today will come from Ann Duignan from JPMorgan.

First of all, could you just talk about the cadence of organic growth that you anticipated?

I mean, I know the comps are tougher in the back half.

But would you expect back half flat or back half down year-over-year?

Just thinking through the guidance there please.

I don't think we'd expect a down year-over-year, Ann, in the back half of the year.

I think we're looking at the 2% to 4% overall.

That'll probably show meaningful organic growth in the first half of the year.

And frankly, if things happen and develop positively, we probably could show some growth in the back half of the year.

But right now, I think we're being a little bit guarded in our view of the overall revenue.

Okay.

I appreciate that.

And then just -- Chris, I know you're only a couple of days in, so this may be unfair.

But will you have the opportunity to review and potentially revise the CapEx spend plan as you see fit?

Or is this $210 million to $230 million, is that kind of locked and ready to go regardless?

I haven't had a chance to go into the details of all the capital, but at a high level, I've looked at the overall initiatives and where that spend is.

And these programs are really pretty far along and have been well-thought-out.

So I would expect that range is reasonable, and I wouldn't expect a big change to that because the initiatives are already sort of in the plan.

The next question will come from Julian Mitchell of Crédit Suisse.

This is Lee Sandquist on for Julian.

Firstly, just welcome aboard Chris and best of luck Ron.

What type of seasonality of earnings should we expect as we move into fiscal year '18?

Is it the traditional 40-60, one half-two half spilt, likely to continue?

From a revenue point of view, I think this year, we were more like 48-52, something like that, 48% first half, 52% second half and I think we're expecting something similar in 2018.

For an earnings per share basis, this past year, we really were more like 24% first half, 76% second half.

And if you were to take the LIFO adjustment and modify that, we actually had stronger earnings in the second half.

We don't think that pattern will exactly repeat in 2018.

We think it'll be more like 1/3-2/3, 1/3 first half, 2/3 second half.

Understood.

And how should we think about the divergence of growth rates between the 3 segments?

Should Infrastructure continue to lead?

I think Infrastructure will have excellent year-over-year performance, in part because the first half of the year was quite weak last year.

And so we're going against a very weak base period, and the Infrastructure team has really come up with great new products, great new initiatives that'll overcome that weakness and, frankly, a recovering energy market.

I think the Industrial businesses or the metalworking businesses will reflect the general economic trends more directly.

The next question comes from Walter Liptak from Seaport Global.

Welcome, Chris.

Thank you, Walter.

I want to ask about the bonus compensation.

And is it abnormal in the fourth quarter the way you guys did accruals?

Like did you accrue at the same level, based on your guidance going into the third quarter -- or in the third quarter as well as in the fourth quarter?

Yes, Walter.

See, this is pretty simple actually, if you think about it.

The prior year was a pretty bad year, and accruals were eliminated in the fourth quarter of last year, more or less.

And in this year, we had a pretty good year, and actually, accruals were probably increased a little bit because we actually outperformed some of our expectations.

But that whipsaws the earnings are little bit, as you might imagine, on a quarterly basis.

So relative to expectations, we spent a little bit more money.

Relative to the prior year, it was a substantial change.

Okay.

But were bonuses accrued through the full year?

Or just -- was it loaded into the fourth quarter?

Yes, they were accrued through the full year.

But the fourth quarter impact year-over-year was the most...

Important.

Yes.

Well, it was -- is the biggest deviation.

Okay, great.

I wanted to ask about the CapEx programs.

How are you guys looking at the return on investment for these?

Like what's the payback period on the CapEx, that you're doing?

Well, each project has its own precise payback and analysis.

We've kind of laid out a $200 million to $300 million capital plan at our Investor Day, which we said ought to generate, along with the related initiatives, $200 million to $300 million of savings, okay?

A capital investment of x also allows you to save money in y initiatives and other initiatives.

So I think, we're right on track with that.

Frankly, as we get into each individual capital project, we're learning.

So what we might have assumed in the beginning, we're modifying.

But despite that, the net is -- we believe there's a tremendous amount of savings and efficiency potential that's embedded in modernizing our operations.

I mean, what's acceptable?

The 3% cost of capital, if I get a 20% rate of return on a CapEx, I should be spending that money all day long, okay?

And that's the kind of situation we're in here at Kennametal.

The next question comes from Andy Casey of Wells Fargo.

Good luck, Ron, and welcome, Chris.

I wanted to ask a question.

Back on the fiscal Q4, I appreciate the discussion about higher variable comp in the LIFO charge.

I'm just wondering, the adjusted 56 was beneath -- and I'm using pennies here, Ron, so forgive me, was beneath the implied guidance of 60.

I'm just wondering, was the LIFO charge contemplated in the prior guidance?

And if so, kind of what are the -- other headwinds did you encounter?

The LIFO charge was not encountered in the prior guidance.

In fact, we did an analysis at the end of our third quarter and did not expect it.

But LIFO, by its very definition, requires unique analysis at the end of periods and at the end of the fiscal year.

So it was not encountered.

The additional headwinds beyond that were probably some additional variable compensation, okay?

But if you factor the small amount of variable compensation relative to our expectations in LIFO, we're pretty much right on expectations.

Okay.

And then a question on the outlook.

It looks like the embedded operating margins are somewhere around 11.5% at the midpoint.

That's very good progress, up 200 basis points in the low single-digit organic growth.

Within that, I mean, there's a lot going on within Kennametal.

Can you help us understand how much carryover cost-reduction benefit you're including in that margin expansion?

Just so we can kind of determine the core incremental margin you're forecasting in case the growth ends up being more than you expect?

Well, just to give you a rough estimate here.

From my standpoint, about 90% of the incremental margin improvement is coming from carryover cost-savings.

The next question comes from Ross Gilardi from Bank of America Merrill Lynch.

Guys, I want to focus on your COGS a little bit.

And your COGS -- your cost of goods sold was $1.4 billion in fiscal '17.

Can you remind us what portion of that is tied to industrial metals and the relative importance of tungsten over cobalt?

And kind of with that, are you experiencing big shortages of cobalt?

There's certainly a lot of articles about what electrification and technology, lot of technology, iPhones and so forth, are doing to these metals, there's been a lot of cost increases you guys haven't really talked about.

So I'm curious what you're also assuming for your raw material guide in fiscal '18 on that.

All right.

I'm going to let Pete address because he runs kind of our Infrastructure, which includes a lot of our raw materials side of the business.

Pete address the cobalt question and just the general raw material kind of outlook.

Pete?

Thank you for the question, Ross.

As you said, we've seen increases in cobalt over the last few months.

We do have supplier relationships and secured contracts to ensure that we have supply.

So that's not a concern for us at this point.

What we have done, from a cobalt standpoint, is put this in perspective.

In FY '17, that represented about 10% over all raw material costs.

So that can help you put in perspective relative to the tungsten.

So we have factored in -- that into the plan in the year-over-year increase in the cobalt.

I think that we have a situation where we're not concerned about supply.

Okay.

Just on that, the 10% of overall raw material costs, what are raw material costs again as percentage of COGS?

JK, do you have that number?

About 20%.

About 20%?

Okay.

In general, Ross, what we've done here is we've anticipated raw material cost increases, and we haven't anticipated pricing to recover those raw material cost increases.

We are expecting productivity offsets to those raw material cost increases.

We are, separately though, implementing pricing increases to try and offset it, if I can.

But it's not in our base plans.

So in other words, we don't want to assume that we can get it all in pricing, but we're going to operate as if we can get it all in pricing.

Got it.

That's helpful.

And then just -- can you explain what the LIFO charge was actually for?

like what's going on behind that?

And I apologize for some of my ignorance on the vagaries of LIFO accounting charges.

But what does this mean for fiscal '18?

Will this be an ongoing year-on-year margin headwind or it was just like kind of a onetime thing that impacted the fiscal fourth quarter?

So first of all, we are on LIFO.

So occasionally, there will be a LIFO charge or a LIFO credit that will be posted at the end of the year to the accounts.

This is typically a fourth quarter charge, but effectively reflects what may have happened in earlier quarters.

So you can't take the $0.5 and allocate it completely to the fourth quarter.

In terms of the details for the LIFO charge, Pat, you want to give some color to that?

Sure.

As Ron indicated, we did an estimate at the beginning of the fourth quarter, at that point in time, did not anticipate a charge.

The charge really came through based on our final inventory position versus our internal expectations.

LIFO has some benefits, some substantial benefits in terms of tax and other benefits.

But it has some risks, and this is one of those risks.

The next question comes from Adam Uhlman of Cleveland Research.

Welcome, Chris.

Thank you.

I wanted to start with -- on Slide 3. You detailed out the monthly sales trends, and it looked like the growth slowed in June.

You had mentioned that you ran into some productivity issues.

I was wondering if you had any shipping delays or anything that impacted the sales growth rates in June.

And has that bounced back so far or did it in July?

All right.

Well, we won't comment, Adam, on July.

But we would say that it is not unusual for the quarters to bounce -- for the months to bounce around within a quarter like this.

And frankly, I was delighted, and we were delighted, with our June numbers.

We weren't expecting April and May to be as high as they were, and I don't read anything into this.

And in fact, our view was that we were just going to ship our product the way we normally ship our product to close the year, and that's what we did.

And I wouldn't read anything into that.

I'd look at the monthly trends that are embedded and we've shared there, and you see, they jump around a lot.

Okay, got you.

And then just a clarification.

The corporate and other expense was income this quarter.

I guess, was there any unusual gains?

And then what's embedded within your fiscal year?

I think nothing is really embedded in our fiscal '18 guidance there and that -- I wouldn't read much into that corporate gain or loss of any consequence.

It's just a normal things that we do to finish the accounting of our year.

The next question comes from Samuel Eisner of Goldman Sachs.

Yes.

Good luck, Ron, and Chris, nice to work with you.

The -- just going back to the guidance.

If 90% of the incremental EBIT is coming from cost saves, I think I get something in the range of $6 million to $7 million of organic EBIT growth on something close to $60 million or $70 million of organic revenue growth.

So that comprise pretty weak organic incrementals relative to how this business has historically performed.

Just curious, what else is embedded in that incremental margin that you guys are using in order to kind of roll up your guidance?

Is it negative price cost?

Are you not seeing as much growth in more profitable categories?

If you can just help us understand why that number is so low relative to history?

That's great question, and in fact, I've given you some of the bread crumbs on that by saying we've got raw material cost increases in our -- embedded in our plan and virtually no pricing to offset that.

So we're taking a fairly conservative view on these things and saying, what if we can't get pricing, what if we can't get productivity.

We want to force the organization to work on, productivity improvements and cost-reductions.

But we are going after pricing, and we do expect to get productivity.

And we don't expect that we'll have weak incremental margins.

We just don't want to embed them in our business plans as we ended the year.

You guys want to add anything to that?

Got it.

And then looking out at the $200 million to $300 million that you guys have put out there and you highlighted in your Analyst Day of the modernization savings.

Is there any update to that?

I mean, Chris, I recognized that you're only a few days on the job here, but those are pretty large numbers that have been outlined in the past.

I'm just curious if -- are we sticking by those?

Or are we not touching them just yet, you want to understand the business a little bit more?

Just how do we think about more of the medium term at this point?

Yes.

I think based on what I've seen, these -- the plans for this capital have been in the work for some time, and they seem pretty well developed to me.

I'm also -- I also am supportive of them, and so I think that you guys should think about that number as that's kind of the best estimate that we have right now.

Obviously, as I get into more detail, maybe there'll be some change there.

But I think it's reasonable to expect that that's the range we're going to be in.

And Sam, at the time of the Analyst Day that we plan for mid-December, I think on the 12th, there will be an update.

And obviously, you will see certain of the estimates that we presented last year at the Analyst Meeting in November.

You will see them firming up for the first -- the first periods.

Yes.

I'll put my two cents in here, and I remain pretty committed to this as Executive Chairman of the Board, and say, I think all plans that are developed will be modified over time, but we believe pretty strongly that there is this amount of savings opportunity in front of us.

Exactly which projects and how those projects morph over time, that's kind of one of the reasons we want to get Chris onboard, to make sure we drive the right projects and lead the right changes and have those things become a reality.

But please remember, that we reported operating margins of 9.2% or 9.3% in fiscal year '17, our competition is at 20%, okay?

And we got huge opportunities still in front of us in this company to get our margins up, to get growth back, to recapture some market share, which we're doing, and this is part of the game plan.

So exactly whether it's the same projects we laid out or a few more or a few less, I think that's part of what we want this useful management team to take on.

That's helpful.

If I could sneak one more in here, just going back to the organic growth questions in first half relative to second half.

Curious if you can kind of parse out a few of the end markets that you guys sell into, in particular, what you're seeing -- or excuse me, what you have embedded in there, particularly for your energy business in Infrastructure related to rig counts.

Yes.

Why don't we have Pete talk a little bit about that.

Believe me, our end markets are complicated because they cross the lines between our metalworking business and our Infrastructure.

But Pete, energy in particular?

Yes.

Energy, in particular, as you saw year-over-year, we've had significant growth.

That's correlated with the doubling of the rig count.

We have seen, recently, slowing in the rate at which the rigs are being put back into service.

However, our sales are expected to continue to grow in FY '18.

That's embedded in the plan not only with the volume increases that we see with what we currently sell into the market, but with new product introductions, that we're in the process of having a pipeline currently.

So Chuck, why don't you comment on some of your end markets?

Sure.

Samuel, specific to energy, we had a very strong fourth quarter in the Industrial business.

However, we don't see that carrying through fiscal '18.

We're forecasting our energy business to be relatively flat through the period.

We do, however, continue to see strong growth in our General Engineering business, which is where we report our distribution sales.

That should still be our strongest growth area.

The next question comes from Joel Tiss of BMO capital markets.

I wanted, maybe Pete and Chuck, to give us a little -- just keep digging in the color of the businesses and kind of the -- I want to get a sense of what's the environment out there for you to be able to get mix -- to get higher mix business and -- for 2018 or even '18 and '19, we can fuzz it up a little bit, and the pricing environment.

Just more from a competitive standpoint.

Why don't you start Chuck?

Sure.

Joel, as I think you're aware, we did raise our custom solutions pricing in the spring.

It was effective April 15.

Those are longer lead time custom make-to-order items.

We're just starting to see the benefit at that pricing action.

We have announced -- our customers were informed this week, we are going with a general price increase effective October 1. And we feel there's a very strong likelihood we will be able to succeed in raising prices per our plan.

Thanks, Joel.

In the Infrastructure business as well, from a pricing standpoint, we have actions underway.

I have high confidence that where we've got large customers and in contracts in place, they're basically indexed off of the raw material increases we talked about earlier.

That will flow through.

A large portion of the Infrastructure business is make to order.

So every time we quote, we have the opportunity to take those raw material cost into consideration as we price.

And I would also say that we have ongoing efforts that will continue into FY '18 and beyond to make our supply chain more efficient.

And we do produce a lot of our materials internally, and a lot of projects are underway.

And it will be included in modernization.

That will increase that efficiency and improve our performance.

Beyond oil and gas, you see that we experienced growth in mining globally, pretty excited about that.

A lot of that came from our ability to introduce new products that have been very competitive.

Again, we've got additional products in the pipeline for FY'18.

Same applies in construction.

We did have some challenges in construction in '17, but I think that we're going to be able to turn that around as we go forward.

I'd like to make 1 or 2 more comments.

End markets, transportation, probably strong at some of the machinery categories, concerns, some potential weakness in North American auto, perhaps a little bit offset by some auto strength in China.

I think geographically, we're seeing positive trends in Asia and positive beginnings, even in places like Latin America, Brazil.

So if I were to characterize the overall economic environment we're in, it's a bias for a recovery across-the-board.

That's great.

Sorry to take so much time.

I just wondered -- one more nuances.

Are you able to sell or are you starting to sell products, kind of higher-end products that are coming off your new machining capabilities or it's a little bit too early for that still?

I don't see that as a way to differentiate our new machining capabilities.

I think what we're doing with our new machining capabilities is improving the quality of much of our existing products, tightening the tolerance, lowering the cost by having them be more automated.

So it's less about the inventions of new products and more about the performance in productivity and tolerance, tightness on our existing products.

Less scrap more uptime.

Yes, those kinds.

Less maintenance.

The next question comes from Steve Barger of KeyBanc Capital Markets.

Question for Chris.

As you look at the FY '18 plan, is your initial focus on driving incremental efficiency through the plans, given improving demand trends?

Or do you see more opportunity to drive upside to the organic growth range?

I think that as I look at the plan, and again, I've reviewed it over the last couple of days, like any plan, it has certain number of risks and opportunities.

And if I look on the growth side and -- my assessment is that those initiatives are well-thought-out and well underway, and I think the team is energize in driving those quite effectively.

And then on the operations side, I've had a lot of experience over the years of these type of initiatives.

And my assessment is that they're, again, well developed and well-thought-out and they're working on the right things.

So I'll certainly -- as I get into this, I'll certainly look for opportunities to accelerate where we can.

But right now, I can leave you folks with sort of my opinion is that this is an energized team.

They got a well-thought-out plan, and they're going to come to work every day and make it happen.

Understood.

And so Ron or any of the segment heads, can you talk about any additional initiatives for driving out growth in '18?

And any comments on penetration and -- new distributors, how that's going?

Well, let me just say this.

Each one of our leaders here has what we call big plays or big bets.

They've got major initiatives in critical potential growth areas that have the opportunity to help us succeed the embedded revenue targets that we communicated here today.

It would probably take a fairly long time to go through each one of them, Steve.

So we probably don't want to extend the call, but happy to do it in a more detailed follow-up conversation.

But Pete's got his new products and big significant initiatives, some of which we frankly don't even want to disclose to our competition, okay?

Chuck is the same way, and Alexander, certainly, is the same way.

We haven't talked about Widia, but Widia had a 10% growth, and we're hoping to have that brand accelerate its growth levels.

It probably has one of our biggest growth forecasts internally for 2018.

So it's a host of things.

But as a famous senator that's now deceased once said, "A penny here, a penny there, before you know it, it adds up to billions." And we're organizing growth from a lot of improvements and initiatives, and it's going to add up to meaningful change.

Got it.

And since you brought Widia, I'll ask one last one.

I heard you say you don't expect the back half to be down.

Is that true for all segments and for Widia, specifically?

Should we expect profitability in every quarter that ramps through the year?

I expect profitability every day, every week, every month, every quarter.

So I think we do expect Widia to be profitable each quarter, but it's going to get progressively stronger over the course of the year.

All right.

Welcome aboard, Chris, and Ron, I look forward to seeing your next job posting announcement.

I don't think so.

This concludes the question-and-answer session.

I would like to turn the conference back to Ron DeFeo for any closing remarks.

I appreciate everybody's support.

Thank you all that listened to our call, and please follow up with Kelly, myself and any of the leaders here.

And I want to especially wish Chris a great success as he takes over leadership of this fine company.

Thanks, Ron.

All right.

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