Kennametal Inc (KMT) 2018 Q4 法說會逐字稿

Good morning.

I would like to welcome everyone to Kennametal's Fourth Quarter Fiscal 2018 Earnings Conference 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.

Thank you, Denise.

Welcome, everyone, and thank you for joining us to review Kennametal's Fourth Quarter and Fiscal Year 2018 Results and Fiscal Year 2019 Outlook.

Yesterday evening, we issued our earnings press release and posted our call slide deck on our website, which we will be referring to throughout today's call.

This call is being broadcast live on that website, and a recording of the call will be available for replay through September 7. After our prepared remarks, we will be happy to answer your questions.

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

Joining me on the call today are Chris Rossi, President and Chief Executive Officer; Johannes Kees van Gaalen, Vice President and Chief Financial Officer; Patrick Watson, Vice President of Finance and Corporate Controller; Alexander Broetz, President, Widia business segment; and Pete Dragich, President, Industrial business segment.

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.

And with that I'll now turn the call over to Chris.

Thank you, Kelly.

Good morning, everyone.

Thank you for joining this morning.

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

I'm pleased to report that we have posted strong fourth quarter and total year results.

The quarterly growth rate of sales exceeded our expectations, both at the total sales level of 14% and at the organic level of 10%.

Every segment and every region posted strong growth.

Our quarterly adjusted operating margins increased 480 basis points year-over-year to 16%.

Adjusted EPS for the quarter increased 55% to $0.87, which is at the top of our outlook.

As shown on the slide, operating leverage increased significantly this quarter as expected.

The fourth quarter is more representative of how we will operate going forward, reflecting success and selectivity whereby we direct our manufacturing capacity to our most profitable products as well as continued progress on our growth, simplification and modernization initiatives.

This is true at the consolidated level and for all segments.

On a total year basis, sales increased 15%, an organic growth of 12%, also exceeding our expectation and outlook range.

Total year adjusted operating margin increased 450 basis points to 13.7% from 9.2% in the prior year.

Adjusted EPS improved 74% to $2.65, which was at the top of our outlook.

Our fiscal year 2018 results are in line with the multiyear profitability improvement plan that we presented at our last Investor Day in December, and again, the results show success in selectivity as well as progress in our 3 margin improvement initiatives.

Let's turn to Slide 3 to look at organic sales growth.

In the fourth quarter of fiscal year 2018, organic sales stayed strong at a 10% growth rate.

We are encouraged by the continuing strength of the end markets in addition to the progress we're making on our growth initiatives.

The demand levels in all our end markets remain at a high level, and we expect this to continue.

So the year-over-year growth rates may have slowed slightly due to the comps being more challenging, but the absolute level of demand is still very healthy.

On Slide 14 (sic) [Slide 4], we've graphed the quarterly sales for Kennametal for fiscal years 2017 and 2018.

The accelerating sales reflect our growth initiatives and the underlying strength of the sector, which typically has a multiyear growth period.

Remember, for industrials, we're barely 2 years into the cycle, and we see good continuing strength in our end markets.

Before I move on to the segment reviews, there's a few other topics that I'd like to comment on.

First, we've had a lot of questions in the last couple of quarters on price versus raw material cost inflation.

As you will see in the numbers, we have been able to cover these increasing costs throughout the year.

This is consistent with Kennametal's past.

Of course, as we've discussed, there may be a quarter or 2 where we're a little ahead or a little behind.

But in general, we were able to cover raw material costs and the current situation is the same.

Another topic we frequently are asked about is tariffs.

Talk about tariffs began in February, and it's an evolving landscape.

We addressed the topic on our last call, and our conclusions are still the same.

Based on our understanding of the current and expected steel tariffs, we do not believe the effect on cost for Kennametal will be material for a couple of reasons.

First, steel is now a large part of our raw material cost.

Secondly, due to our regional sourcing model, the tariffs, in many cases, don't apply to us.

Right now, we think the effect on steel cost will be in the range of about $1.5 million, so not material.

Tariffs on Chinese-supplied tungsten are also being discussed.

We have minimal exposure to this source of supply.

But should these tariffs be imposed, we have a flexible supply chain for tungsten and would minimize the effect through alternative sourcing.

Further, although the trade environment is fluid, given our regional sourcing model and sales structure, we currently do not anticipate a material effect on sales or cost structure.

And now let's review the strong quarterly results by segment.

Turning to Slide 5 for the Industrial segment overview.

Industrial posted a quarterly year-over-year sales growth rate of 16% on organic growth of 11%.

All regions showed revenue gains with Asia leading at 16% growth; followed by the Americas, also at a double-digit rate of 14%; and Europe, at 7%.

We saw good strength in all end markets in the quarter with our largest gains in general engineering at 15% growth, followed closely by aerospace at 14%, the transportation sector posted healthy growth at 8% and energy at 4%.

Adjusted operating margin increased 660 basis points year-over-year to 18.5% from 11.9% in the prior year quarter.

Our operating margin improved significantly in the quarter, reflecting increasing success with selectivity, the alignment of capacity of our most profitable products, managing pricing with a focus on profitability as well as traction on our simplification and modernization initiatives.

I'm very encouraged with these results.

We are on track with our multiyear plan with more opportunity for improvement and margin expansion to come as we modernize.

Turning to Slide 6 for WIDIA.

WIDIA posted a 12% year-over-year quarterly sales improvement with organic growth at 9%.

Again, all regions reported positive year-over-year quarterly numbers with, in this case, Asia leading at 31%, followed by EMEA at 8% and Americas at 1% growth.

For total year fiscal 2018, the rate of growth were 15% in Asia, 14% in EMEA and 4% in the Americas.

Adjusted operating margin at quarter increased by 400 basis points year-over-year to 4% from breakeven in the prior year quarter.

With regard to regional results for WIDIA.

In Asia Pacific, a 31% growth rate reflects solid progress in establishing our partner network in China and other Asia Pacific countries.

In India, despite the market growing only modestly, we were able to grow sales by 36% and continue to increase our manufacturing output at our Bangalore facility.

In EMEA, we're gaining traction in our growth initiatives in aerospace.

And in America, we continue to make progress in establishing the strong distribution network and are selectively exiting portions of the product portfolio to drive improved profitability.

All in all, I continue to be very encouraged with WIDIA's steady progress.

This business is clearly benefiting from focused leadership, and I believe the foundation is set for accelerating growth and margin improvement.

On Slide 7, we update our Infrastructure business.

Infrastructure reported quarterly sales growth over prior year of 12% on organic quarterly growth of 9%.

Again, all end markets and all regions reported positive growth.

Asia and the Americas posted double-digit growth at 17% and 10%, respectively.

EMEA grew by 2%, affected by some project delays in Poland in South Africa.

With regard to end markets, general engineering led the quarter at a 17% growth rate and energy at 13%.

Oil and gas activity continues to improve with the average U.S. land rig count increasing 17% this quarter over the prior year period.

Earthworks, which includes construction, trenching and mining, grew at a 1% growth rate, a rate lower than normal due to weather-related delays in construction as well as the lumpiness in the timing of projects that this end market can experience.

Adjusted operating margin increased 440 basis points to 15.4% this quarter.

This margin improvement reflects continued success on our initiatives.

Our simplification initiatives, including product redesign, are progressing well.

Sourcing initiatives are continuing, and our modernization improvements are on track.

And like Industrial, given the high level of end market demand, we are managing our portfolio selectively.

As in previous quarters, price actions covered raw material cost increases.

Our margin improvement is ahead of schedule with more to come in FY '19.

On Slide 8, we show before and after photos of an example of modernization at an Infrastructure plant.

The increase in efficiency is projected to be approximately 80%.

This is a good example of how we are completely rethinking our old manufacturing processes.

The result is not only lower cost through improved efficiency, but equally as important, we are driving excellence in customer service through improved delivery performance and quality.

Modernization, therefore, is really a key enabler for long-term profitable growth.

It's also important to note that the majority of modernization benefits are still ahead.

We moved past the conceptual design stage and are in execution mode of our detailed plans to deliver benefits in FY '19 and beyond.

With that, I now like to turn it over to JK, who will begin on Slide 9 with a detailed financial report.

Thank you, Chris, and hello, everyone.

I will begin by reviewing the income statement, starting with the quarterly results on Slide 9 on both the reported and adjusted basis.

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

Sales in the June quarter increased 14% to $646 million with organic sales growth posting at 10%.

Favorable foreign exchange effects contributed 3% of overall sales growth.

More business days were a slight pick up at 1%.

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

This quarter, adjusted gross profit increased 29% to $236 million over prior year.

Adjusted gross profit margin increased by 430 basis points year-over-year to 36.5%.

The main factors of growth at the gross margin level were organic sales growth, mix, favorable foreign exchange effects, incremental restructuring and modernization benefits, partially offset by higher raw material costs.

Price realization continued to cover raw material cost inflation.

Adjusted operating expenses increased by 12% to $129 million and, as a percentage of sales, improved by 40 basis points to 19.9%.

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

The absolute change in OpEx is primarily due to higher variable management and sales incentive expense as a result of higher-than-expected operating results and the -- an unfavorable effect of foreign exchange.

In dollar terms, adjusted operating income improved by 63% and 480 basis points in margin terms for the quarter.

EBITDA increased to $128 million with the EBITDA margin for the quarter at 19.7%.

Incremental pretax benefits from restructuring initiatives in the quarter were approximately $4 million compared to the prior year.

We recorded pretax restructuring and related charges of $6 million or $0.07 per share.

The charges are net of a $5 million gain from the sale of the Houston manufacturing facility, which was previously closed as part of our legacy restructuring programs.

In association with our simplification initiatives, we recorded $8 million of restructuring and related charges in the Industrial segment.

Annualized run rate pretax savings from this headcount reduction of approximately $10 million are expected to be materially complete by the end of the first half of fiscal 2019.

Our reported effective tax rate for the quarter is 21.1% and includes a 2.3% effect or $2 million benefit in dollar terms related to U.S. tax reform.

As discussed in the past 2 quarters, the Tax Cuts and Jobs Act of 2017 requires a onetime toll tax on unremitted earnings of foreign subsidiaries.

We recorded a $2 million benefit in this quarter to adjust the toll tax charge.

We expect to finalize the charge in the December quarter of fiscal year 2019.

The adjusted effective tax rate increased to 22.1% from the 16.8% in the prior year, primarily due to U.S. income in the prior year quarter not being tax affected and is reversing in the current quarter now that the valuation allowance is no longer recorded on U.S. deferred tax assets.

Our operating leverage improved significantly this quarter and is more representative of how we will operate going forward.

As we've discussed in the past, over the long term, an average leverage rate over the cycle would be in the 40% range without the benefits of modernization.

Leverage, of course, varies quarter-to-quarter based on segment, regional and product mix, foreign exchange and price to cover raw materials and will increase as we realize further benefits from modernization.

Adjusted EPS improved year-over-year by 55% to $0.87 in the fourth quarter of fiscal year 2018.

We are delighted with these results.

A complete bridge of the factors affecting adjusted EPS this quarter versus the fourth quarter of the prior year is presented in the EPS bridge on Slide 10.

Now let me walk you through the bridge.

The combined effect on volume, price, operating costs, mix, absorption and productivity amounted to $0.37 this quarter versus prior year.

Please note that price increases continue to cover raw material cost increases.

Benefits from simplification and modernization amounted to $0.04 this quarter and will increase as we move further into our simplification and modernization plans.

Incremental benefits from restructuring decreased to $0.04 this quarter as the effects of our 2017 headcount reduction program rolled off the yearly comparison.

And like the first 3 quarters this year, currency provided a tailwind this quarter, also amounting to $0.04.

Additional management and sales incentive this quarter, like the last 2 quarters, is due to the stronger-than-expected operational performance, the effect of which amounted to $0.07.

Remember that the annual incentive plans reset each fiscal year based on the new operating plan, as discussed, taxes are a headwind for us this year, and this quarter, this amounted to $0.06.

The expectation for the longer term is that we will have a normalized adjusted effective tax rate in the low 20s.

As already discussed, the strength of our end markets continues.

We continue to employ overtime and temp help, where needed, to meet the customer needs, and like last quarter, this amounted to $0.02.

All other items totaled to $0.03.

The full year financial results are summarized on Slide 11 on both a reported and adjusted basis.

On a reported basis, EPS for the total year increased to $2.42 from $0.61 in the fiscal year 2017.

Adjusted gross margins improved year-over-year by 300 basis points to 35.3%.

Adjusted operating expense as a percentage of sales decreased by 130 basis points to 21%, and adjusted EPS improved 74% to $2.65, which was clearly at the top of our outlook range.

The full year EPS bridge can be found on Slide 12.

Now let me walk you through this bridge.

In summary, the 74% increase in adjusted EPS year-over-year reflects the net favorable effect of organic sales growth, mix, fixed cost absorption and productivity in aggregate amounting to $0.92, the positive effects of incremental restructuring benefits of $0.52, currency of $0.13 and $0.09 of simplification and modernization.

These were partially offset by higher management and sales incentive expense of $0.15, salary inflation of $0.15, higher taxes of $0.10, overtime and temp help of $0.08 and $0.05 of other.

Chris talked about the segment sales trend earlier in the call.

The details by segment, region and end market are listed on Slide 13.

As already noted, we are seeing strength in all of our segments, end markets and regions, and the high level of demand is continuing.

Industrials operating margins improved by 660 basis points this quarter to 18.5%, primarily due to organic sales growth, mix, favorable currency exchange and incremental restructuring benefits.

This was partially offset by decreased manufacturing efficiency, in part due to the modernization efforts in progress and higher management and sales incentive expense due to the higher-than-expected operating results.

WIDIA's operating margins improved by 400 basis points this quarter to 4%, primarily due to organic sales growth, partially offset by unfavorable mix.

Infrastructure's adjusted operating margins improved by 440 basis points to 15.4% this quarter, primarily due to organic sales growth, favorable mix and incremental restructuring and modernization benefits.

This was partially offset by higher raw material costs and higher management and sales incentive expense due to the higher-than-expected operating results.

Total year fiscal 2018 operating margins are also shown on the slide with Industrial at 15.5%, WIDIA at 2.9% and Infrastructure at 13.8%.

As shown on Slide 14, primary working capital was $705 million as at June 30, 2018, an increase of $53 million from the prior year-end.

On a percentage of sales basis, primary working capital decreased 180 basis points from June 30, 2017, to 29.6% as at June 30, 2018.

As mentioned in previous calls, bringing our primary working capital to below 30% was one of our goals.

We are very, very pleased with this result, and we will continue to drive it lower.

Slide 15 summarizes the cash flow statement.

Fourth quarter free operating cash flow was $66 million.

Total year free operating cash flow was $121 million, an increase of $38 million from $82 million in the prior year.

This level is higher than outlook, mainly due to capital spending, which I will discuss next.

Capital expenditures were $171 million for the total year before $14 million of disposals mainly associated with our Houston plant sale.

The outlook for capital was to be at the lower end of our range of $210 million to $230 million.

The $171 million reflects slower-than-expected cash outlays on capital equipment.

These cash outlays will move into fiscal year 2019 and are not expected to affect our ability to reach our margin targets in fiscal year 2019.

Dividends paid out were $65 million, consistent with last year, and we remain committed to maintaining our dividends.

Turning to Slide 16 for a discussion of our balance sheet.

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

We have refinanced our 2019 bonds by issuing $300 million of new 10-year senior notes due in June 2028.

Net proceeds from the offering were $296 million, which were used in combination with cash on hand to pay out the $400 million 219 notes (sic) [2019 notes].

We completed the redemption of the 2019 notes on July 9, so both notes appear on the balance sheet as at June 30 with the 2019 bonds reclassified to current.

Also this quarter, we amended our existing revolving credit facility, expanding borrowing capacity from $600 million to $700 million and extending the maturity for a new 5-year term to June 2023.

Cash on hand at June 30 increased to $556 million as compared to $191 million last year, but was elevated by the cash raised from the new notes and subsequently used to redeem the $400 million of the 2019 notes.

At the end of June, our net debt was $436 million.

With no current outstanding borrowings on our revolver, we have no significant maturities until February 2022.

On a pro forma basis, adjusting June 30 figures for the repayment of the 2019 notes, gross debt to adjusted EBITDA was 1.4x.

Net debt to EBITDA decreased to 1.0x.

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

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

Now turning to Slide 17 for our FY '19 outlook.

We are expecting meaningful EPS growth in line with our Investor Day presentation projections.

Adjusted EPS is expected to be in the range of $2.90 to $3.20 with the first half-second half split for EPS expected to be typical 40% to 45% in the first half and 55% to 60% in the second half.

Free cash flow is expected to be in the range of $120 million to $140 million with an effective adjusted tax rate of 22% to 25% and capital spending of $240 million to $260 million.

Our assumption on organic sales growth is 5% to 8%.

And it is important to note that at the midpoint of the sales growth guidance range, approximately 1/2 of the increase is related to price covering raw material cost increases, which do not lever.

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

Thank you, JK.

Continuing on Slide 17, let me take a few minutes to talk about how we're thinking about FY '19, which is really a year focused primarily on margin expansion.

Our margin expansion expectations are in line with our Investor Day presentation, and we're going to get there by accelerating the benefits of modernization, continued simplification of our product portfolio, including pruning low-margin products and aligning our capacities to the most profitable products and end markets.

So effectively, we're focused on growing our most profitable core product portfolio at the 5% to 8% organically that JK mentioned while decreasing the sales of low-profitability products.

Fortunately, the current markets are very robust and we expect them to remain strong.

So this is a good time to pursue these efficiency and margin improvement actions.

In our outlook, we are assuming a modest level of sales growth by design despite the strong markets.

Remember, our multiyear improvement plan is principally focused on margin expansion and assumes a modest level of growth in order to keep the organization focused on taking cost out.

And so we expect FY '19 to be another year where we take a significant step forward in improve profitability.

So to summarize, on Slide 18, I am encouraged by the strong results of the quarter and the progress we've made on our growth and margin expansion initiatives.

We will continue to manage our operations with a focus on efficiency, manage sales with a focus on profitability and align capacity utilization to our most profitable products, which is different from how Kennametal has operated in the past.

Operating leverage increased significantly in every segment in the fourth quarter, and we delivered FY '18 results in line with our multiyear adjusted EBITDA improvement goals that we set 2 years ago.

FY '18 represented a huge step forward, and we are on track for FY '19 with another significant improvement in profitability.

We're transforming the company through simplification and modernization into a higher technology company that is more efficient, less people-dependent and that can reliably deliver excellence and customer service.

This translates into a more profitable and competitive company in the long term.

And with that, operator, let's open it up for questions.

(Operator Instructions) And your first question will be from Ann Duignan of JP Morgan.

Can you talk about, if FX remains at current rates, what would the negative impact or the net impact be on your revenues for fiscal '19?

JK, why don't you go...

1 to 1.5 points, Ann.

1 to 1.5, okay.

And that's not included in your organic sales growth guidance, I assume.

No, right.

No.

Yes, okay.

Just want to make sure.

And then can you talk about price cost?

We know you don't buy much steel, but you do buy tungsten and cobalt.

Can you talk about whether your expectation for fiscal '19 is to be price cost positive, price cost neutral?

Or have you issued an increase in, look, price -- talked about -- quantify how much the impact will be in '19.

Yes.

Good question, Ann.

I think the way to think about it is that we're deploying a strategic pricing process, which means that every segment, part of that is that they have to at least take actions to cover their cost increases.

And that's the way we modeled the plan here is that we at least cover that.

As you know, in any given quarter, we can be a little behind or a little ahead.

But on average, I think good way to think of FY '19 is that we'll continue to cover the material cost increases through price.

Okay.

So net neutral, is that the way to think about it?

Yes, I believe that's the way to look at it.

Okay.

And just one tiny follow-up.

On your earthworks business, you called out the weather and lumpy demand.

Can you just expand on that a little bit?

And I'll leave it there.

Yes.

The earthworks, there has been bad weather, a lot of rain that has sort of delayed the construction projects.

And so while we don't think those projects are lost, it's just they sort of slid into the first quarter as they extend the construction season to do the road repairs, et cetera.

They're just being delayed.

So they moved from what typically would be the fourth quarter into the first quarter.

So it's really a movement of projects, not necessarily a drop in demand, if you will.

But bad weather where?

I mean, the weather this past quarter has not been...

This was in -- a lot of this was in Europe.

I thought it was extraordinarily dry in Europe.

Anyway, I can follow up with you offline.

Okay.

The next question will be from Julian Mitchell of Barclays.

Also, I wanted to say Jan Kees, thanks for all the help in the last 3 years and then wish you well in retirement.

Thank you.

In terms of, I guess, the first question, maybe just clarify, am I right in thinking that your guidance for fiscal '19 embeds an incremental margin maybe in the sort of mid-30s range, all-in?

Just talk a little bit about the incremental you're assuming.

And also, what's the impact on incremental margin from currency?

I understand what the revenue impact is.

But is there any effect on margin rate from FX?

Yes.

Let me just start with the incremental volume discussion.

If you look at FY '18 Q4, that really marked the return to more normal operating leverage from incremental volume at around, Julian, about 40%.

And then on top of that, we would expect the benefits from simplification and modernization.

So that is the leverage figure that we have applied in this plan.

And I think it's important to note that maybe where you're calculating a slightly lower leverage, you have to recognize that in our growth projections, which I said are fairly modest, about half of that is price, which is used to cover material cost increases, and that doesn't really leverage.

So that's maybe why you're calculating something slightly less.

And then in terms of the FX, that is a slight headwind on EBIT in terms of the overall performance of the earnings.

JK, do you have anything you'd like to add to that?

The FX doesn't typically lever very well.

So Julian, Chris just mentioned it, it's a slight headwind for the 2019 operating plan.

Got it.

And then my second question would maybe be around the trajectory of your organic growth.

You've given the full year guidance of 5% to 8% organic, of which half is price.

When we think about the notion of comps and then the staging of your price increases, should we crudely just assume that in your guidance, you're assuming 7% or 8% growth for the first half and closer to 5% for the second half?

Or is there a different cadence on growth because of pricing or something?

No.

I think the growth would follow sort of our typical plan.

So we have slightly -- obviously, the growth always drops from Q4 to Q1, and then we'll go on the normal trajectory.

So the pricing actions that are rolling over, Julian, were -- a lot of that was taken in the prior year.

So I think those will unfold rather linearly throughout the year, if that helps you.

Yes.

And then last, very quick one, balance sheet leverage, extremely low now, only sort of 1x net debt to EBITDA.

Are you planning to use the balance sheet more aggressively in fiscal '19?

Or is it more a case of sticking with the focus on modernization and then leaving extra capital deployment for the out-years?

I think that's the right way to think of it.

We've got a lot of CapEx to install over the next few years, so we're going to keep our powder dry to do exactly that, focus on that.

We'll continue to evaluate, obviously, as we work through the year and in the out-years.

But I think you said it best, it -- really, this is about getting the foundation solidified.

And maybe in the out-years, we can think about other uses of that cash beyond modernization.

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

Yes.

I was wondering if we could start with -- if you could talk about the 5% to 8% growth that you expect this year.

Is there any meaningful difference between the segments?

And then by your end markets, kind of what markets are you feeling the most optimistic about that you'll be able to drive maybe above-average growth?

And what areas are you kind of more concerned on or watching closely that might be underperformers?

Yes.

Let me just take the growth.

WIDIA has a target that's higher than 5% to 8%.

Keep in mind, WIDIA, based on our investor presentation, they're trying to grow over the period that 9%-11% range.

They grew at 9% last year, and Alexander is challenging his group to at least grow comparably to that in 2019.

And then I think Infrastructure is sort of in that 5% to 8% range, along with Industrials.

Just in general commentary on the markets.

Aerospace is one of those markets where we have visibility to, I would call, the short to midterm production schedule for planes.

And so that is a growing area, and we expect to see growth there.

On transportation, there were some weakness earlier last year, but we've seen good numbers this year.

So we expect reasonable growth in that segment or reasonable growth in demand in that segment.

General engineering, it's been really strong and we expect that strength to continue.

And energy has also been a great performer.

We expect solid growth to continue there.

And then finally, as I said, in earthworks, we saw some weakness.

By weakness, I mean mid-single digits, and that was due to weather-related delays and some project timing issues that we talked about in our prepared remarks.

So really, we see good strength in that marked demand across-the-board and continuing.

So again, FY '19 is another year we see, like FY '18, where it's really very broad in terms of the growth opportunities for Kennametal.

Okay, got you.

And then could you remind me how much tungsten you can supply internally through your recycling efforts and other initiatives?

Yes.

I think -- well, I'm not going to give you the exact number, for competitive reasons.

But a great deal of our tungsten, we will call, internally supplied with some third-party supply to augment that.

Okay.

So definitely more than half, but probably not.

A lot more than half.

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

So what level of automation savings are baked into your fiscal '19 outlook?

And where will -- by the end of fiscal '19, where will that leave you with your total savings relative to the longer-term plan?

Yes.

I think relative to longer-term plan, we're still on track with what we presented at the last Investor Day.

And of course, we'll have an opportunity to update you guys again when we do our next Investor Day, probably sometime in early next calendar year.

In terms of the automation savings, we've got some leverage and increased income coming from volume, but over half of this is going to come from modernization and simplification in terms of the improvements.

So FY '19, again, we're trying to make it all about taking cost out, and so the weighting is definitely towards the productivity side of the equation versus trying to drive more volume through.

Okay, got it.

And what -- could you explain a little bit more why your CapEx undershot in fiscal '18?

You cited lower-than-expected outlays.

But why is that?

I mean, are there bottlenecks in getting the equipment?

Or are you delaying your automation investment at all?

No.

We're not -- we're definitely not delaying the investment.

Keep in mind, we -- you can have CapEx on order, and then the actual timing of the cash flows is when it gets recorded as CapEx.

So a lot of what we were trying to accomplish in terms of modernization, those expenditures were made in 2018.

And so -- as it affects 2019, we don't see much impact.

So the kind of cash outlays that we're talking about where we're a little behind what we estimated -- I wouldn't say behind.

It's just really more of an estimation error as to the actual timing of cash flows.

That's largely capital that's not being used until -- or deployed until the end of 2019 with an impact on 2020.

So as JK said, while the cash timing was a little different than we projected, and frankly, we're going to get better at that as we go, I think the important takeaway is it's not material.

It's not going to have a material impact on what we're anticipating in FY '19, and we don't think it'll materially affect the out-years of the plan either.

Got it.

And then just lastly, I'm just trying to understand your free cash flow outlook for fiscal '19.

Essentially, it's flat with '18.

But you got CapEx up, looks like $80 million to $90 million net income at the midpoint of your guidance.

I think it'll be up $30 million to $40 million.

So you must be counting on a -- I think like a $40 million to $50 million working capital source of cash, which seems a little bit tough when revenue growth is this strong.

So how will you -- first of all, is my math like directionally correct?

And how would you actually generate cash as you're continuing to ramp production from working capital?

Yes.

So we will continue to improve our inventories as well as receivables and improve the payables and focus on that and bring basically the primary working capital down a little bit further from where we ended up at 29.6%.

You're absolutely correct that we had a cash timing delay in terms of some of the CapEx, in terms of the cash-out, which is basically added to the capital expenditure for 2019 fiscal, and that will impact the cash flow.

So on the one hand, a little bit more CapEx than we originally had in the Investor Day plan.

On the other hand, a continued on the primary working capital.

So if you just sort of changed your payment terms and your collection terms, which would enable you to do this going forward, Jan Kees, on the working capital side?

Yes.

We're driving continued lengthening of the DPOs, and we've given a lot of attention to the DSOs, made good progress in the far east, also in the media and the U.S. So typically, a lot of follow-through and a lot of attention.

The next question will be from Andy Casey of Wells Fargo Securities.

Also, my thanks and good luck to Jan Kees.

Thanks, Andy.

A question on the revenue split.

Should we think about it as around 48% first half, 52% second?

Yes.

I think that's typical, and that's the way we're thinking about it also.

Yes.

Okay.

And then post your refinancing activity, should we expect any material change to the interest expense?

Interest expense will go up by $3 million, $4 million over the next fiscal year.

Okay.

And then kind of going back to the incremental margin question.

If I back in to the benefit, are you expecting about $20 million internal initiatives benefit for fiscal '19?

No, the number is larger than that.

Much larger.

Okay.

And then lastly, you mentioned some weather issues impacting Europe.

When I look at the Industrial growth rate, it didn't really change from the prior quarter.

Did you see any other end market ups and downs, particularly down, because there are some macro issues that seems...

Right.

No, we basically saw very good strength across-the-board and just on earthworks.

That's really in Infrastructure.

And frankly, our volume is actually quite low there.

So any little change on a percentage basis can be -- make a meaningful difference.

But to answer your question, Andy, broadly, we didn't see much weakness in any of the regions or the segments.

In fact, we think the demand is quite robust, and we expect that to continue in 2019.

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

So I wanted to ask about the organic growth to -- and maybe a way to ask it is in the fourth quarter and maybe for 2018, what was the volume growth?

Can you split the volume versus price growth?

Yes.

The volume growth in 2018 is probably, and I'm just going to -- I'm going to guesstimate here, it could've been an 80, sort of 80-20, 20% coming from price, 80% coming from growth.

But in FY '19, it's a much larger percentage.

As JK said, it's about half.

And that's because the pricing actions that we took in '18 are now rolling over into '19.

Does that help you?

Okay.

Yes, that helps.

So the -- you called out the growth rate that you're using for 2019 is modest, and with -- I would think that with the kind of growth that you're coming off of at the end of the year, that those volumes could be stronger, especially in the first part of the year.

I guess what are your assumptions for first half versus second half volume growth?

Yes.

I think the growth is -- it's pretty even throughout the year.

That was our assumption.

But I think you're picking up on, Walt, the fact that the organic growth, given how much of it is price, could be conservative because we think that the market demand is really -- could support more growth.

But we're also simultaneously -- I just want to keep in mind, simultaneously pruning out parts of our product portfolio that are low profitability.

So it's not an exact science as to how those -- how that math balances, but there is some calculation there that says, "Yes, we're growing our core products at the 5% to 8% range, but we're also backing off some things that we don't want to provide any longer because they're low profitability.

And then frankly, even with that math, because we've got so much that's carrying over on price, I really want to make sure that the organization is focused on making these numbers and driving the profitability improvement, the old fashioned way, taking the cost out versus just relying on volume.

Okay.

That sounds good, and it's a good segue to the WIDIA business.

The Americas growth looked kind of low.

It looks like most of your growth is coming from Asia and partly EMEA.

Is that profit proving what's going on with the WIDIA business?

And when do you get on easier comps there?

I think this quarter, we've been actually quite happy about the growth in WIDIA overall, in the Americas, specifically, since you mentioned it.

This particular quarter, you're actually seeing the phenomenon we just talked about.

They actually had good growth in areas that we wanted to grow, but simultaneously, Alexander is pruning some element to the product portfolio that, frankly, were not -- they're low profitability or no profitability.

And so that's why, at least, in Q4, you saw a low growth rate in America, but I think that's only because he's cut some sales on products that we no longer want to provide.

But in general, we still feel that WIDIA is -- we're looking at that 9% to 11% CAGR for that business as part of our Investor Day thesis.

And this year, they did 9% organic growth, and I think the team is just getting started.

So we feel pretty good about that 9%, 11% trajectory.

And as their volume increases, of course, that's going to drive a lot of their profitability improvement.

The next question will be from Steven Fisher of UBS.

You guys gave us some color on the organic growth by segment and by market.

Can you give us some color by your major geographies, please?

Do you have that somewhere?

And that's for fiscal '19, I'm asking.

Give us just a second here.

Let's see if we got -- Steve, we -- I don't have that here in front of me.

And as I think about it, it's pretty -- it's kind of competitive information, and I don't think we really want to share that level of detail.

Okay.

I was just curious if there were any geographies you expected generally to be faster than others or slower than others.

And then maybe specifically, within transportation also, if you could just kind of give us some general color by region there since you expect some reasonable growth, I think, is the wording you said.

Yes.

I think on a regional scenario, we -- the U.S. market still continues to be strong across all sectors.

But Asia Pacific as a region, given that we have -- we've got a good foothold there, but we don't have as much of our volume coming out of that area.

That is certainly an opportunity for us, if you want to focus on what region is going to offer the most growth next year.

And EMEA, we think, is -- it's got some opportunity.

But I think, again, if you're focused on the regions, the Asia Pacific area is one that we're targeting for opportunity.

Okay.

And would that hold for transportation as well?

Yes.

I think transportation is -- it's kind of percolating along.

And while it is a focused segment of ours, it's not one that's going to provide significant growth going forward, although it's one we're going to pay attention to and take the growth that can be there.

But we're not looking towards transportation as it relates to vehicles as providing a substantial amount of growth going forward.

Okay.

And then just lastly, energy looks like it's growing much faster in Infrastructure versus the Industrial segment.

Can you just remind me what's the difference there?

Yes.

In terms of Infrastructure, it's just a larger percentage of their overall business, and a lot of what Infrastructure is dealing with is related specifically to oil and gas and supplying products to oilfield services companies.

So that's driving the growth there.

These same companies, though, they also do metal cutting.

And while that's a smaller portion of their business, we classify them as metal cutting companies inside energy.

And so that is -- that is a growth opportunity, but it's not as directly tied towards what the oilfield services companies are doing.

Because in infrastructure, what oilfield service companies do, they actually need our product to accomplish that mission.

On the Industrial side, it just means their factory are maybe cutting a few more chips or something to have a little more volume, but it's not going to substantially drive a huge amount of growth on the Industrial side just because of where the products are used in the value chain of the oilfield sector.

The next question will be from Joel Tiss of BMO capital markets.

Just on 2 questions.

One, on the gross margin improvement, can you give us a little sense of some of the pieces behind that mix, price, volume increase?

On the margin improvement?

Yes, the gross margin, the 300 basis points.

Yes.

Give us a second here, Joel.

So volume and mix basically amounted to a large portion of that.

We also had considerable, obviously, additional price coming through.

Then some of that is obviously offset already by increasing raw materials.

But gross margins improved significantly.

So -- oh, sorry.

(inaudible) No, go ahead.

I was just going to say within the mix, is it mostly new product wins or volume improvements or the simplification part of it?

Or just a sense there.

There is -- there are some regions where we think we're winning, like we mentioned, the WIDIA product line and the growth that we're seeing in India as an example, and we have growth initiatives that are driving improvements.

But also, inside that volume mix bucket is the selectivity that we talked about, where we're just simply focused on our higher-profitable products and deemphasize the low profitability products.

And what that means is that in our manufacturing facilities, they're consuming -- these lower-profit products actually consume, dollar-for-dollar, more capacity than the higher profitability ones.

So part of this mix change is as we improve our customer service and our bill rates on the higher-volume standard products, those also carry better margins.

So that's definitely part of what's driving this volume mix.

That's very good color.

And then just on my follow-up is the customer feedback.

Can you just give us a little sense?

It sounded to me between the lines like 2018, '19, maybe some part of your fiscal '20 is going to be on the cost side and then restructuring and getting this all right, but then we're going to switch gears into kind of volume growth.

And I wondered what the customer feedback is about your modernization and how efficient you're interacting with your customers and if there's a lot more volume for you to gather from them as you switch your focus in the years ahead.

Yes, good question.

I think if we look at a little bit of the history, since Kennametal has under-invested in their manufacturing technology over the last -- we've talked about it, 15 years, 20 years, I think that had a direct effect on our market share.

They simply became less responsive, maybe less cost competitive, and also, they had quality -- in terms of reliability from a quality perspective, they were starting to lag behind the competition.

So once we put this modernization in place, we're going to have, really, excellent quality, consistency.

I think we're going to be able to be much more responsive because we got shorter-cycle times in our factory, and we can handle more volume with less people.

So I really see modernization as not only just the foundation for improved productivity and costs, but really to make sure that we're able to deliver the customer service level that's required to actually start to regain market share.

So it's like we got to shore up the foundation and correct what needed to be corrected over the last 15 years to 20 years, and then we feel quite good about our ability to start going after share because we're going to be able to execute very well with the customer service level that requires to do that.

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

I would like to hand the conference over to Chris Rossi for closing remarks.

Thank you, operator, and thanks, everyone, for joining us on the call today.

We very much appreciate your interest and support.

Please reach out to Kelly with any follow-up questions you may have.

As I said on the call, we had, really, an excellent year in 2018.

We're right on track with the multiyear plan that we set out.

And we feel like 2019 is going to be another great story, and we're going to make another great story step in terms of improving our profitability and setting the stage for profitable growth in the future.

Thank you very much.

Have a good day.

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