Kennametal Inc (KMT) 2018 Q1 法說會逐字稿

Good morning.

I would like to welcome everyone to Kennametal's First Quarter Fiscal Year 2018 Earnings Call.

(Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Kelly Boyer, Vice President of Investor Relations.

Please go ahead, ma'am.

Thank you, Denise.

Welcome, everyone, and thank you for joining us to review Kennametal's First Quarter Fiscal 2018 Results.

We issued our quarterly earnings press release yesterday evening.

The release, along with the slide deck for today's call is posted on our website.

This call is being broadcast live on that website and a recording of the call will be available for replay through December 2.

I'm Kelly Boyer, Vice President of Investor Relations.

Joining me on the call today are Chris Rossi, President and Chief Executive Officer; Jan Kees van Gaalen, Vice President and Chief Financial Officer; Patrick Watson, Vice President, Finance and Corporate Controller; Chuck Byrnes, President, Industrial Business segment; Pete Dragich, President, Infrastructure Business segment; and Alexander Broetz, President, WIDIA Business segment.

Chris and Jan Kees will review the September quarter's operating and financial performance as well as our updated outlook.

After their prepared remarks, we will be happy to answer your 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 Kennametal's SEC filings.

In addition, we will be discussing non-GAAP financial measures on the call today.

Reconciliations to GAAP financial measures that we believe are most directly comparable can be found at the back of the slide deck and on our Form 8-K on our website.

With that, I'd now like to turn the call over to Chris.

Thank you, Kelly.

Hello, everyone, and thank you for your interest in Kennametal.

This is technically my second conference call as CEO of Kennametal.

You may recall that I was on the August 3 call 2 days after joining the company.

Well, I'm a bit more settled in now to both Kennametal and Pittsburgh, and certainly pleased to review the company's performance with you today.

Kennametal has gone through a significant amount of change in the last year, including reducing headcount by over 10%, reorganizing in the P&Ls and launching a set of growth simplification and modernization initiatives to improve margins and position the company to perform well in all market conditions.

Over the past 3 months, I've had the opportunity to meet with many employees and review our improvement plans in more detail.

I'm delighted to report that we have a committed and energized team that's aggressively driving a solid plan for improvement, and I'm focused on supporting them, making sure we accomplish what we've started and accelerating progress.

Turning now to our quarterly results.

I'll begin with some overview comments, Jan Kees will discuss the specific financial results and I will again provide a quick summary before taking your questions.

As Kelly noted in her introduction, the management team is also on the call today.

Let's begin on Slide 2 of the slide deck that's posted on your website.

Our first quarter fiscal 2018 results exceeded our expectation in a number of ways.

First, the growth rate for the quarter was 14%.

All segments experienced significant growth over the prior year period with infrastructure at 20%, industrial at11% and WIDIA at 10%.

Furthermore, all regions grew with Asia Pacific leading at 15%, followed by the Americas at 13% and EMEA at 8%.

All end markets reported growth as well.

I'll review the organic sales growth in more detail in a moment, but first, let me review the results on a total corporate basis.

Margins improved significantly this quarter versus prior year quarter.

Our adjusted operating margin increased 700 basis points to 11.7%, which reflects a 380 basis point increase in adjusted gross profit margin plus a 290 basis point improvement in operating expense margin.

Adjusted EPS for the quarter was $0.55 versus $0.11 in the prior year quarter.

Let's take a look at organic growth on Slide 3. In Q1 fiscal 2018, organic growth continues the positive trend started in Q2 of last year.

We're encouraged by the improving activity level of the end markets and are taking appropriate action to increase output.

In fact, given the substantial increase in demand since our headcount reduction program started in fiscal 2017, we're now pulling back on the additional planned reductions and consider that program closed, having achieved meaningful run rate savings of approximately $86 million.

In addition to the positive market environment, we're encouraged by the progress that we're making in our growth initiatives, and I'll talk more about that when I review each segment.

Let's turn now to Slide 4, which summarizes the quarterly results for our Industrial business.

Industrial posted a quarterly year-over-year sales growth rate of 11% on 9% organic growth.

This is the fifth consecutive quarter of organic growth for Industrial.

All regions showed revenue gains with Asia Pacific again leading at 14%, followed by the Americas at 8% and EMEA at 7%.

We saw good strength in all end markets, with our largest sales percentage gains in energy at 22% growth, followed by general engineering, aerospace and transportation each growing at about 7% year-over-year.

We continue to believe stock levels within our indirect channel are consistent with end market demand.

Adjusted operating margins increased year-over-year to 13.1% from 9% in the prior year quarter.

The first quarter margin improvement reflects progress on 3 strategic areas of focus: growth, simplification and cost reduction.

Regarding growth, Chuck and his sales team are making very good progress on customer segmentation and improving sales effectiveness through deployment of our CRM tool.

We expect both to continue to yield improvements as we gain more experience.

As part of improving sales effectiveness, we are actively selling the value inherent in our products to improve customer productivity.

This strong value proposition, coupled with the current increase in end market demand has increased the opportunity for value-driven price increases.

The sales team is also focused on transitioning certain customers from direct to indirect where appropriate.

This effort is proceeding as expected with approximately 4,200 customers being converted today.

It turns out that this transition has been more of a win-win for customers, distributors and Kennametal than we actually envisioned originally.

First, we do not believe we're seeing any margin erosion.

Second, our customers are now being served by a distributor that provides, in a single supplier, a much broader range of products and services.

And finally, for Kennametal, we gained access to end users that we never covered before.

Of course, an important enabler of this transition is to partner with our distributors and work with them to improve customer service levels.

As a testimony to our work and improving customer service levels, we are pleased to receive the Supplier of the Year award from FRISA, a manufacturer in the metals processing space operating principally in Mexico.

Regarding our simplification actions, again we're making very solid progress here.

Of course, like our growth initiatives, this work is never really complete as product life cycle management is an ongoing process.

We are on track, however, with regard to our SKU, coatings and powder formulation reductions as well as our minimum order quantity program.

These simplification actions are critical in reducing the complexity in our manufacturing processes.

This reduced complexity not only lowers our costs, but also lower the execution risks associated with implementation of our modernization programs.

On the cost reduction side, as I mentioned earlier, the headcount reduction program, which we have been updating you on, is now complete.

Regarding modernization, these programs are on track.

Of course, the main benefit will be felt incrementally over the next few years and thereafter.

In summary for Industrial, we have seen a major improvement in fiscal 2017 and the first quarter of fiscal 2018 in all 3 sets of initiatives.

There's still a lot of work to do here and with increased focus and speed and execution, certainly more success to come.

Turning to Slide 5, WIDIA.

Alexander and his team are doing a great job transforming WIDIA and capturing the intrinsic value of this historic and well-known brand.

WIDIA posted a 10% quarterly sales improvement with year-over-year organic growth at 9%.

This is the fourth consecutive quarter of growth for WIDIA.

All regions reported positive year-over-year quarterly numbers, with EMEA leading at 19%, followed by Asia Pacific at 8% and the Americas at 5% growth.

Adjusted operating margins improved to 1.9% in the quarter from an operating margin of negative 6.7% in the prior year quarter.

This positive operating income reflects progress on both the growth and cost side.

We've adopted a regional approach to managing the WIDIA business segment, so let me talk about each region now.

In EMEA, we're seeing strong growth due in part to our national distributor partners in Germany and Switzerland as well as the growth we are seeing in emerging markets in Eastern Europe.

In India, sales grew year-over-year by 14%, the highest sales growth in the region in over 4 years.

This is even more impressive given the lower general growth rate in the country overall.

We're continuing to successfully increase our manufacturing output at our Bangalore facility for both India and the global marketplace.

In America, WIDIA completed the channel partner program rollout and hosted the First Annual Distributor Conference as a separate business segment with good participation and feedback, which we will use to make further improvements.

In Asia Pacific, we completed the reorganization of the indirect channel partner networks and are focused on opening new demand streams to increase and diversify our sales.

Overall, I'm pleased with WIDIA's progress on all fronts.

This business is benefiting from Alexander and the team's focus on the strategic priorities to drive growth and expand margins.

On Slide 6. We have updated our Infrastructure business.

Infrastructure's adjusted operating margins increased significantly by over 1,000 basis points to 12.1% this quarter.

Sales grew 20% over the prior year quarter on year-over-year organic quarterly growth of 19%.

This is the third consecutive quarter for growth for Infrastructure.

All regions posted positive sales growth with Asia Pacific at 21%, the Americas at 20% and EMEA at 8%.

All end markets were positive during the quarter also.

Oil and gas activity continues to lead with sales in the energy and end markets up by 25%.

The average U.S. land rig count in the quarter was up over 100% year-over-year.

However, it should be noted that while oil and gas remained strong, the rig count stabilized during the quarter, ending the quarter at around 900 rigs.

Earthworks, which includes mining, grew by 13%.

Both underground mining and surface mining were up.

Sales in the construction end market also posted good results with 15% growth year-over-year.

The margin improvement resulted from work Pete and his team are doing on several fronts.

On the growth side, we're pleased to announce this quarter a partnership with Caterpillar that capitalizes on long-standing reputation of both Kennametal and Caterpillar in the road rehabilitation arena.

A full line of earth cutting tool technology and industry expertise will now be available to customers through the Cat dealer network worldwide.

The initial feedback with dealers globally is very strong, and we're excited to reach dealers with whom we have not had a relationship previously.

On the raw materials side.

With cost increasing, it's even more important that we continue to work to lower raw material unit costs through several initiatives such as improved product design, optimizing material science usage and strategically sourced material.

We also expect to increase pricing during this fiscal year, reflecting contractual arrangements and the increased value we deliver to our customers.

Also in the quarter, we're now seeing results from the investments we are making in the business.

This will, of course, gain traction as we move further into the multiyear plan.

In summary, Infrastructure continues to make great strides.

The markets are improving.

But more importantly, we're making progress on our growth and simplification and cost reduction initiatives.

These improvements will certainly help us stay healthy in the long run.

With that, I'd like to now turn over to Jan Kees, who will begin on Slide 7 with a detailed financial report.

Thank you, Chris.

Good morning, and hello, everyone.

Let me walk you through the net income statement starting on Slide 7 on both the reported and adjusted basis.

On a reported basis, EPS for the quarter was $0.48 per share compared to a loss per share of $0.27 in the prior year quarter.

Sales in the September quarter increased 14% to $542 million with organic sales growth posting in at 13%.

Currency tailwinds favorably impacted sales by 2%, partially offset by a 1% impact of fewer business days.

As Chris mentioned, sales grew in every end market and every geographic region.

Adjusted gross profit increased 28% to $186 million this quarter over prior year quarter.

Adjusted gross profit margin increased by 380 basis points year-over-year to 34.3%.

The main factors at the gross margin level were organic sales growth, incremental benefits from restructuring initiatives, favorable mix, higher productivity and fixed cost absorption and favorable foreign exchange, partially offset by higher compensation expense and higher raw material costs.

Adjusted operating expenses were held flat at $119 million despite increased volume.

On a percentage of sales basis, adjusted operating expenses improved by 290 basis points to 22%.

We are pleased with the progress we've made, particularly given the firmer end market environments, and we'll continue to focus on further improvements as we move forward.

The improvements in both gross profit margin and operating expense margin contributed to our operating income margin increasing significantly year-over-year to -- by 700 basis points in margin terms to 11.7%.

For the first quarter of fiscal 2018, the adjusted EBITDA was $89 million, up 81% from the prior year period.

The effective tax rate for the quarter on an adjusted basis was 18% versus 38.7% in the prior year quarter.

The change was primarily driven by U.S. losses in the prior year and U.S. income in the current year, neither of which can be tax affected due to a full valuation allowance on our domestic deferred tax assets.

Adjusted EPS improved year-over-year to $0.55 in the first quarter of fiscal 2018.

A complete bridge of the factors affecting adjusted EPS this quarter versus the first quarter of prior year is presented in the EPS bridge on Slide 8. Now let me walk you through the bridge.

The 400% increase in adjusted EPS year-over-year is primarily due to incremental restructuring benefits of $0.17, the net favorable effect of organic sales growth, mix, fixed cost absorption and productivity in aggregate amounting to $0.16 and lower taxes of $0.14.

For the first quarter of fiscal 2018, total savings from our headcount reduction initiative were approximately $21 million or $86 million annualized.

Benefits in the quarter from other restructuring programs amounted to approximately $19.5 million or $78 million annualized.

All of our prior existing restructuring programs have been substantially completed.

Approximate annualized savings for these programs are $165 million, and (inaudible) today charges amounts to $155 million.

Chris 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 earthworks.

The detail of our segment sales by region and end markets can be found on Slide 9.

All segments reported double-digit growth.

Industrial expanded adjusted operating margins by 410 basis points to 13.1% year-on-year, reflecting primarily incremental restructuring benefits and organic sales growth, partially offset by unfavorable mix and a higher compensation expense.

WIDIA reported adjusted operating margins up 860 basis points to 1.9% year-on-year, reflecting organic sales growth, incremental restructuring benefits and favorable mix.

Infrastructure's adjusted operating margin increased by over 1,000 basis points to 12.1% due primarily to organic sales growth, incremental restructuring benefits, favorable mix and a higher fixed cost absorption and productivity.

These were partially offset by higher raw material costs.

As shown on Slide 10, primary working capital was $714 million as at September 2017, an increase of $62 million from the June 30 figure reflecting growing volumes and higher inventory.

On a percentage of sales basis, primary working capital decreased to 40 basis points to 31% at September 30, 2017.

Slide 11 summarizes the cash flow statement.

First quarter free operating cash flow was negative $62 million as compared to negative $18 million in the prior year quarter.

The decrease in free operating cash flow is due primarily to increases in primary working capital, partially offset by higher cash from operations before working capital items in addition to lower restructuring payments.

Regarding capital spending.

Net capital expenditures were $42 million this quarter compared to $41 million for the quarter the prior year earlier.

Dividends paid out were $60 million consistent with last quarter, and we remain committed to maintaining our dividends.

Turning to Slide 12 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 at September 30 decreased to $111 million as compared to $191 million last quarter.

At the end of September, our net debt was $586 million.

With no current outstanding borrowings on our revolver, we have no significant maturities until November 2019.

Gross debt to adjusted EBITDA currently stands at 2.1x.

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

We are confident in our balance sheet and liquidity positions, and we will continue to focus on them as we execute our modernization initiatives.

And with that, I will turn it back over to Chris.

Thank you, Jan Kees.

Turning to Slide 13, the outlook for fiscal year 2018.

We are increasing our expectations for organic sales growth for full year 2018 to 5% to 7% and full year adjusted EPS to be between $2.30 and $2.60, reflecting the increased sales and continuing success in our growth, simplification and modernization initiatives.

The range for our effective tax rate remains at 18% to 22%.

The expectations for free operating cash flow and capital are also unchanged, with free operating cash flow remaining slightly positive for the full year, even in our increased capital spending levels.

We look forward to our upcoming Investor Day on December 12 to provide more detailed look at our multiyear plan.

To summarize on Slide 14.

Our Q1 was better than expected.

Our balance sheet improved over the quarter.

We are focused on executing on our improvement programs to create meaningful returns for our shareholders, great products and services for our customers and a great place to work for our team members.

Operator, please open it up for questions.

(Operator Instructions) And your first question this morning will come from Ann Duignan of JPMorgan.

Given the strength of Q1, could you just talk a little bit about what you're now contemplating first half, second half sales split and earnings split?

Just the cadence maybe?

Yes.

We're expecting the earnings split to be sort of in a more typical year in this -- 40% to 45% in the first half, with 50% to 55% on the second half on the earnings side of the sales front.

Sales will be more weighted to the back half.

To the back half.

Much more typical seasonality.

Okay.

Because I think last quarter, you had anticipated EPS about 33 to 67.

So we're not as back-end loaded now given the Q1 numbers.

Exactly.

We see it's a little bit more a typical year this year, Ann.

Okay.

Good.

And then, could you also address material costs versus pricing, what you have embedded in the forecast?

Yes.

Our forecast contemplates that we will basically be able to offset the -- any material cost increase with price in the marketplace.

So far, so good.

The market's reacted to that, because as you know, once our materials costs go up, that's an indication that there's a lot of activity in the marketplace.

So it's not completely unexpected by our customers, and we think that's a good assumption going forward.

Okay.

And I assume when you talk raw material cost increases, you're talking tungsten, primarily.

Is that correct?

We're talking tungsten, which is certainly the biggest driver for the company.

A distant second is cobalt and a distant third would be steel.

The next question will come from Stephen Volkmann of Jefferies.

Can I poke a little bit more on the price side of this?

And we had been hearing from the channel that there had been some price increases around October 1, which I guess, wouldn't have included this most recent quarter and obviously I might have just picked up a weird data point.

But I'm just curious, just on the pricing side itself, you mentioned in the prepared remarks, some opportunity to price for the value you're bringing and so forth.

Is the price side of the equation going to sort of ramp up as the year progresses from here?

Yes.

We -- I think, maybe what you're -- what you remember is that we had gone out with a price change in July, and we said that, that would begin to float to the P&L in October time frame.

And so pricing -- some price increases will sort of adjust automatically based on the contracts we have.

Others, Stephen, we have to go and sell to the marketplace.

But in many cases, clients have experienced improved productivity from our tooling over the years because we made improvements.

But we haven't actually gone out with a, what I would call, value pricing.

So Chuck and the other business segment leaders are committed to going to customers and saying look, "We're getting -- you're getting much more value from these tools.

We haven't had actually a price increase in several years." And so that's kind of an ongoing process and one that we're going to continue to push.

So it sounds like the price cost equation maybe gets a little bit more favorable in the remainder of the fiscal year.

Or am I putting words in your mouth?

I think that's fair.

Okay, great.

And then, can I just ask you for a little more detail on the customers that you're shifting to the indirect channel.

I think you said 4,200 so far.

What do we think the total will be, kind of where -- what inning of that game are we in?

I'm going to let Chuck give you some color around that whole initiative.

Sure, Stephen.

We're pleased with the progress that we've achieved to date on the 4,200-plus customers transition.

This process will never end.

We're always going to look for the proper way to service every end user customer and the value that our distributor partners can provide.

I would say, there's another 1,000 that we will probably approach in this fiscal year, and our hit rate is typically around 90%.

So I wouldn't think 5,000 total by the end of this fiscal year would be out of our reach.

Okay, great.

And if I could just sneak one more in.

Chris, now that you have a quarter under your belt, as you look at the plan that's been sort of laid out here, any tweaks that you want to make?

Or any kind of conclusions that you've come to in your first quarter of -- at the helm would be great.

Yes.

Obviously, Steve, that was first on my mind to really understand what the plan is and how we're going to execute it.

And I was delighted to find that it's really quite well thought out.

Obviously, we're putting more meat on the bone in terms of what's got to happen in 2019 because we have -- we're a year into this thing.

So -- but I was generally pleased that it is a solid plan.

There is a path there, and we really would look forward to updating you folks in more detail at our December 12 Investor Day.

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

This is actually Lee on for Julian.

Despite the strong improvement in sales and profitability for the year, starting out the year, the guide for slight positive cash flow is unchanged.

Can you just talk about the dislocation there?

We see the working capital going up a little bit in line with the increases in our business volumes.

And so we just want to remain a little cautious in terms of the free operating cash flow for the year.

It will be slightly moderately positive.

The capital expenditure also has still a range that we guide to.

So effectively, we intend to land at a moderate -- moderately positive cash flow.

Understood.

Unlike last quarter, the monthly sales trends were stable exiting the quarter.

Can you just touch on how demand trended through October?

Yes.

We're not going to comment on October at this point.

The next question will come from Adam Uhlman of Cleveland Research.

First, Jan Kees, on the earnings guidance, could you provide a split of how you're thinking about sales and EBIT performance for each of the segments for the year?

The Infrastructure segment's growing really nicely, the margins on both are up a whole bunch; whatever you could provide there would be helpful.

Adam, you know that we don't provide a segment disclosure in terms of our, how do you say, guidance for the year.

We're looking at this year, and we were seeing -- we're seeing, for the moment, markets that have been firmer than what we expected, as Chris mentioned.

And we're going to be playing it conservatively like we've typically done at this company and make sure that we basically delight our customers in terms of the products we sell and the productivity that we bring to them.

Okay.

Got you.

And then, maybe just on the CapEx guidance, we're kind of run-rating below the full year target here in the first quarter, flat year-over-year.

How should we think about the weighting of that through the year?

Is that something that accelerates as the year progresses, the modernization targets?

We're still on track with our spending for the year.

So to catch up, we have to ramp up.

You shouldn't interpret that, that we're necessarily behind.

That was kind of the planned ramp up anyway.

And so part of my deep dive to get comfortable with what we've been committed to in terms of the improvement plan, what I'm seeing in terms of our capital expenditure is pretty much consistent with that plan.

The next question will come from Steven Fisher of UBS.

I'm wondering if you just give some sense of the magnitude of the raw materials increase year-over-year and when you think that, that headwind could neutralize on a year-over-year basis if the raw materials prices were to hold at current levels?

Look, Steven, we typically haven't been providing a lot of information because this is competitive information with regards to the raw materials.

Typically, tungsten is the most important one.

And recently, the London Metal Bulletin tungsten prices has come off a little bit of the high that we've seen about a month ago.

In terms of the cobalt, which is the distant second raw material component, we've seen prices relatively stable in the high $60s over the last few months.

So not really a big change.

And then, the steel prices, you're probably better positioned to talk about the steel prices than I am, but the steel prices have been relatively flat over the last 2, 3 months.

Do you think (inaudible) maybe your fiscal Q3, you'd have a sort of a neutral impact year-over-year?

Look, at the end of the day, Stephen, we intend to increase prices on the basis of the productivity that we're providing to our customers, both on the industrial side as well as on the infrastructure side, and WIDIA, obviously.

We want to make sure that we add value and we add the productivity to our customers so that the price increases are acceptable to them, all right?

Fair enough.

And in terms of energy being an outsized grower this quarter, was that the favorable mix you mentioned a number of times?

And how should we think about your assumed mix over the next few quarters, particularly with rig counts flattening?

Yes.

I think -- I mean, if you remember in the energy market, if you -- versus the quarter -- prior year quarter, energy was still very much in the tank.

So we have such a huge recovery this quarter.

We just got to keep in mind, we started with it from a really low point.

But as I think we mentioned, rig counts is basically -- has -- are substantially up from the prior year quarter, but they've now stabilized.

And so we think that, that business is still going to be there, but we're not expecting it continue to grow but rather say stable over the next several quarters.

And was the energy the favorable mix that you've been discussing?

Or was it something else, product-oriented?

On Infrastructure, it was really pretty much product related.

And I guess that could be partially driven by...

Oil and gas.

By oil and gas.

The next question will come from Andy Casey of Wells Fargo.

Just a follow-up on the price cost short term in Q1.

You may have said it, I may have missed it.

But was that negative or neutral in Q1?

The question is -- could you just repeat the question a second, Andy, please?

Sure.

Price cost for the first quarter.

Was that -- you mentioned negative in Infrastructure.

I'm wondering, overall, was it negative and was it sizable?

I think -- I mean, we -- I think what -- quarter-over-quarter, prior year raw materials was one of the things that was unfavorable, one of the drivers.

And so that's part of the story.

That was offset by -- restructuring was positive, the organic sales growth, and then as we talked about, had some favorable mix here on balance too.

Okay, okay.

Slide 8, if I back into it, looks like restructuring added roughly $17 million year-over-year.

Should we expect about the same benefit in Q2?

And then, for that to dissipate a little bit in the second half?

Look, we will stop talking about the restructuring programs and the headcount reduction programs next quarter.

The programs are largely complete.

These programs will continue to run on in the background.

I'm not saying that we are going to reduce the benefits of those.

But the programs, as implemented and executed, are largely -- have reached their completion.

We're now focusing on the growth conditions and the firm market conditions that exist around us.

And we will see increasingly, as you will hear on the Analyst Day, the modernization effect starting to take grip.

Okay.

On that modernization, Jan, did you include any benefit in fiscal '18 guidance?

Or are we -- should we assume the tailwinds are really 2019 and beyond?

Yes.

I think the bulk of those savings are going to start to kick in, in 2019.

Okay.

And then lastly, if the current guidance for the last 3 quarters ends up being conservative, would you look to accelerate CapEx above current plan to accelerate those modernization benefits?

Or would you let that accrue to higher free cash, assuming working capital kind of stays where it's currently expected?

Yes.

I think, you ought to look at -- the modernization program is one that we're trying to accelerate just to reap the benefit sooner, but it's not going to be driven by how much cash we have on in terms of our ability to spend it.

So that project is -- it's being run as a project that we're trying to keep it on schedule and accelerate it, but it's not really -- the fact that we're generating more cash, we're going to try to go faster.

We just need to do it -- we need to do it carefully and the right speed based on the merits of the project and the benefits we're trying to derive from it.

The next question will come from Ross Gilardi of Bank of America.

Just on the price increases.

What are you hearing from your industrial -- from your distribution partners?

Clearly, your -- it's a battle for them to raise prices in this environment right now.

So their overall receptivity and you've been able to witness, what kind of success they are having passing your own price increases along?

Ross, this is Chuck.

No customer ever thanks you for a price increase, but our distributor partners are clearly selling on value just as we do.

They're providing productivity to customers, and frankly the response from the marketplace has been reasonably positive.

We see that the ability to pass this through, although maybe not 100% through our distributor channel, it is a very high percentage of their ability to pass it through.

Got it.

And I get what you're saying on the oil and gas side and the rig count and so forth.

Are you actually seeing order intake slow right now?

Or is it -- kind of on a year-on-year basis?

Or is it more of an expectation of kind of what's going to come?

Yes.

The way I would think about that is, we did see an increase, but we're going to stay at that increased level for a while.

Okay.

And then, just lastly on your plant modernization program.

So where are you now?

I mean, have you started to install a lot of the new machines?

And how is it going from an execution standpoint?

Have you experienced any type of production disruption as you bring these things online and incorporate them on the floor?

Yes, we're -- I guess we're in early stages of starting to commission a number of the machines.

But the way we're doing this is, we're trying to allow our current production process to operate in parallel and then ramp these up alongside them.

So it's a complex project.

There's never zero disruption.

But I think we've got a good plan in terms on how not to disrupt the supply chain and we're -- so far, we're managing that at this point.

The next question will come from Walter Liptak of Seaport Global.

A follow-on to the last one.

The markets are recovering pretty nicely.

Does that slow some of the CapEx?

You know you can't get the machine automation in place because people are busy with just the process flow within the factories?

No.

It doesn't necessarily slow it.

I mean, because we're -- like I said, we're trying to bring these modern processes online in parallel, for the most part.

So those capital expenditures are happening sort of independent on what the factory is trying to work on.

And then we also -- we're also trying to allow the manufacturing leadership to just continue to focus on meeting the customer commitments and driving the business.

We've set up a program management office to try to ramp up in parallel these modernization programs.

So we're not asking key operations people to work on both at the same time because that's a recipe that doesn't always work out very well.

Okay, got it.

Okay.

I wanted to ask about the guidance and just kind of your guidance philosophy in the organic revenue growth going up to 5% to 7%.

How did you -- what changed in the rest of fiscal 2018 to get to that?

Because first quarter was a lot stronger organically.

Now did you change the model for second quarter or the rest of 2018?

How are you thinking about the comps for the back half of your year?

Yes.

I think the -- look, the comps are going to get more difficult as we progress throughout the year.

But like anything, with the sales forecast, it's a bottoms-up view from all the regions.

And that process, inherently people tend to be a little bit more conservative.

They don't want to overpromise.

So we're not -- so I think if anything, that 5% to 7% is our best view at this point.

But I would expect that it's maybe a little conservative because the process -- and frankly, having been here just 90 days, I don't have my radar on in terms of the fudge factor that might be inside that number.

But my sense is that if anything, it might be a bit conservative, but we'll have to wait and see.

Okay, that sounds great.

So I guess, did you true-up the bottoms-up view after this quarter was over?

That's right.

You did true it up?

Okay.

Actually did a reforecast.

Yes, yes.

Okay.

And then, what operating leverage are you thinking about for the full year?

The operating leverage, 68%, was much stronger than it was last quarter.

Where do you think the business will operate on an operating leverage this year?

Typically, the operating leverage for this business sits around 40% to 50%, depending on the quarter.

We -- a little bit different per segment as you know, but the average is around 40% to 50%.

And that is typically what we look at.

Obviously, we tried to maintain strict control of costs, both on the cost of sales as well as operating expenses to make sure that as much as possible falls through to the bottom line.

The next question will come from Joel Tiss of BMO Capital Markets.

I just wonder -- and going in a little bit of a different direction, can you talk a little bit about what's happened to your market share if there's enough sort of -- enough runway that there's been an adjustment?

And I just wonder, if we can talk a little about the competitors too, who might be vulnerable or as you're connecting with all your customers, what's the feedback?

What are you hearing from them about what needs to be done and we're happy to see you back, that kind of stuff?

Any color in that direction would be very helpful.

Yes.

In terms of market share, I think it's -- we've got several periods of good organic growth.

We know we're getting traction on our growth initiatives.

But I think it would be too preliminary to say that we're necessarily taking market share.

There are some pockets of areas where we have developed new products and targeted new business that we weren't in before.

So clearly there's a share growth there.

But I think in general, it's too early to tell that we're actually taking market share substantially.

And on the competitor side, my basic rule of thumb is, I'm not going to really talk about the competitors in a format like this.

And then, how about the feedback that you're getting from customers?

What can you -- what do they say?

"Oh, this great, we want you to do more of" and what are other areas that you might have to readjust?

Yes.

I think, the -- our channel strategy and our approach now to partnering with distributors not only just moving from direct to indirect, but just treating these distributors as true partners and being able to grow together, that has been -- that's been very refreshing to customers, and ultimately benefits the end users.

So their reaction to Kennametal's new approach under Chuck's leadership and on the WIDIA side under Alexander has been very positive.

What -- there -- sorry, there was another piece to that.

What was the other piece you said?

No, just whatever sort of negative feedback that you feel like "maybe we need to go back and tweak the way that we're going to market or the way that we're approaching some of these different programs."

No, I don't think -- there really hasn't been a need to make substantial adjustments because we feel pretty good about how they're working at this point.

The next question will be a follow-up from Ann Duignan of JPMorgan.

Can you give us a little bit more detail on the partnership with Caterpillar?

And are you comfortable that you've adequately, conservatively guided for that business?

Anytime anyone goes into partnership with Caterpillars' dealers finds them extraordinarily independent and maybe tougher to do business with than anticipated.

So can you just expand a little bit on the partnership there and how you expect that to progress?

Yes.

I'll let Pete add a little color to this because it's really a great success story, and I'd like to have the opportunity to talk about it.

But generally with Caterpillar, we don't have a lot of business with Caterpillar.

And my feeling is that what we've got in the current forecast is really kind of small in terms of what the total potential could be someday.

This is going to take some time to ramp up.

So I think this has got a lot more upside than what we -- what we're currently contemplating -- in the longer term.

These things do take time to ramp up.

But in terms of what we have in the 2018 numbers, I think, what we have in there is fine.

It's not going to be a big driver.

But this is really something for the -- for 2019 and beyond.

Anything else you'd like to add to that?

No, thank you, Chris.

Thank you for the question.

We are really excited about the partnership that we've developed with Caterpillar.

I would say, as Chris said, it's certainly early to tell as far all this will develop, particularly in FY '18.

As you said, we have gone through quite a bit of -- a pilot with them prior to the announcement.

They gave us a good understanding of what it's like to deal with each of the individual dealers.

And as you said, there are challenges associated with that, but we have set ourselves up from an organization standpoint to support them around the world.

Soon after that announcement, we've had quite a large number of dealers contacting us.

The value that we bring to the relationship as far as our knowledge of road [building] and construction and (inaudible) equipment, so that excites them and us going forward.

So as Chris said, I expect this to develop into another significant contributor in the future.

And just as a quick follow-up, are you displacing some of the (inaudible) for the dealers also.

Caterpillar had a partnership in the past for the consumable tools that we'll be providing to them.

Obviously, that relationship has ended and now started with Kennametal.

As far as their involvement in this, the supply chain is changing, where instead of material going through the corporate Cat and then being distributed out to the dealers, we'll be doing that directly.

So that was part of the synergies and efficiencies that will come from us working with them.

So we are, with each of the dealers, shipping direct and working with their individual teams.

We have partnered Kennametal employees with each of their dealers to have a joint relationship going forward to customers as far as selling equipment and the consumable is a total package for them.

The next question will come from Steve Barger of KeyBanc Capital Markets.

Chris, just thinking about the portfolio of products and the physical footprint, anything you need add or subtract to further optimize in the near term?

No, nothing in the near term.

And I'm not even sure there's anything in the long term.

But frankly, after 90 days, that wasn't where my priority was.

But as I look at the business now, I wouldn't change anything in the short term, for sure.

Got it.

And Chuck, you talked about the 90% hit rate transitioning customers you approached, so obviously successful.

What is the sticking point for the 10%?

And just any comments on how the efforts have evolved based on lessons learned?

Sure.

We've said from the beginning, this would be the end users' decision on the best value they see from any particular supply chain, and we've really followed that rule.

If we provide more value going direct, then that end user is very welcome to stay direct.

It -- the 90% is -- most end users see the value our distributors partners bring or integrators bring to the supply chain and have chosen to switch.

Long term, I don't see that changing.

We do have some customers that truly believes being serviced by Kennametal direct is the best supply chain for them, and we're going to continue to service them that way.

And the bulk of the end users, they see the value our distributors bring, I believe, will continue to switch to that supply chain.

And just 1 follow-up.

Any change to how you're seeing e-commerce as part of your strategy?

Whether it's via the distributor partners or through your own efforts?

Yes, Steve.

All 3 businesses are looking at a digital experience improvement from the Kennametal side.

We've had some pilots with a few more e-focused sellers.

And I would say, the support from the Kennametal side is there.

The success rate hasn't probably been as great as we had hoped.

But we're continuing to play in this area and investigate new and alternative supply chains to get our products to end-users, however they'd like to buy.

The success rate not as great as hoped just because it's hard to get the customers to adopt it?

Or what's been the sticking point?

These are new channels.

And we learn every time we try to set up a new program with a new access to the market.

I didn't mean to say they were unsuccessful, they just have had mixed results.

And ladies and gentlemen, this will conclude the question-and-answer session.

I would like to turn the conference back to Chris Rossi for his closing remarks.

Thank you, everyone, for your ongoing interest in Kennametal.

I look forward to meeting many of you over the next coming months.

Please follow up with any questions you might have with Kelly.

Thank you very much.

Thanks, everybody.

Thank you.

Thank you, sir.

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