Kennametal Inc (KMT) 2019 Q2 法說會逐字稿

Good morning.

I would like to welcome everyone to Kennametal's Second Quarter Fiscal 2019 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, ma'am.

Thank you, operator.

Welcome, everyone, and thank you for joining us to review Kennametal's second quarter fiscal year 2019 results.

Yesterday evening, we issued our earnings press release and posted our presentation slides on our website.

We will be referring to that slide deck throughout today's call, and a recording of this call will be available for replay through March 5.

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

Joining me on the call today are Chris Rossi, President and Chief Executive Officer; Damon Audia, Vice President and Chief Financial Officer; Patrick Watson, Vice President, Finance and Corporate Controller; Alexander Broetz, President, WIDIA Business segment; Peter Dragich, President, Industrial Business segment; and Ron Port, President, Infrastructure Business segment.

After Chris and Damon's prepared remarks, we will open the line up for questions.

At this time, I would like to direct your attention to our forward-looking disclosure statement.

Today's discussion contains comments that constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements involve a number of assumptions, risks and uncertainties that could cause the company's actual results, performance or achievements to differ materially from those expressed in or implied by such forward-looking statements.

These risk factors and uncertainties are listed on Slide 1 and detailed in Kennametal's SEC filings.

We will also 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'll now turn the call over to Chris.

Thank you, Kelly.

Good morning, everyone, and thank you for joining the call today.

I'm very pleased to report that we have delivered another quarter of strong results with significantly improved earnings per share and margins.

The multiple actions we have implemented to improve our customer service levels and increased profitability have helped deliver 8 consecutive quarters of growth and the highest second quarter adjusted operating income margin in 7 years.

Consolidated sales growth rate for the quarter was 3% and 4% at an organic level, which represents solid growth given that it is on top of the 15% in the second quarter last year.

Every segment and every region reported growth, with Infrastructure at 5%, WIDIA 3% and Industrial 2%.

From a regional perspective, Americas led this quarter at a 9% growth rate year-over-year, EMEA at 5% and Asia Pacific grew at 2%.

Our quarterly adjusted operating margin increased significantly by 240 basis points year-over-year to 13.8% as a result of great execution by the team.

Operating leverage improved again this quarter, reflecting continuing progress in both our growth and simplification/modernization initiatives.

Again, as planned, the underlying operational performance of the business was augmented by our strategic initiatives.

Adjusted EPS increased 37% or $0.19 year-over-year to $0.71 in the quarter.

This is our best second quarter performance since 2012 and is really a testament to the fundamental improvements we are making to the business.

The increase of $0.19 for the quarter includes $0.10 from our simplification/modernization efforts, which was in line with our expectations.

As we expected, the benefits from the program continued to increase with more opportunity for further margin improvement ahead.

I'll now review the segment results for the quarter and discuss our thoughts about the state of our end markets.

Turning to Slide 3 for a review of the Industrial Business segment.

In the second quarter of fiscal year 2019, organic sales for Industrial was 3%.

This is on top for the very strong prior year quarterly growth of 14%.

In terms of regional sales results this quarter, Americas led with double-digit growth of 12%, EMEA grew at 5% and Asia Pacific decreased by 4%.

Growth in EMEA was dampened as German automotive customers work through the temporary challenges associated with diesel emission qualification testing.

Asia Pacific was significantly affected by the Chinese automotive market.

Absent China, however, we saw broad sales increase across the region.

Like everyone else, we are watching to see how China develops.

But to provide some perspective, based on fiscal year 2018, China was only approximately 11% of total Kennametal sales, with close to half of that related to Infrastructure, which has not seen in the same level of disruption.

Aside from the uncertainties in automotive, we continue to see good strength in our other end markets.

Aerospace is particularly strong, as it has been for several quarters, posting a growth rate at 22%.

And based on the outlook for the aerospace industry, we are optimistic this market will continue to be strong.

General engineering, our largest end-market, also remained at a healthy growth rate of 9%, as well as energy which posted growth of 6% for the quarter.

As you know, we are focused on growing in these end markets.

And I'm pleased with the traction the team is getting on our growth initiatives as well as our margin expansion efforts.

Adjusted operating margin, Industrial increased significantly by 560 basis points year-over-year to 18.6%, reflecting increasing success in our organic growth and simplification/modernization initiatives.

We continue to balance strong customer demand, while we execute on our multi-year margin improvement plan, with more opportunity for further margin expansions to come.

In fact, we are already improving fill rates on our high-volume, high-profitability products, which is helping to improve customer service levels and drive margin improvement.

Turning to Slide 4 for the WIDIA overview.

WIDIA posted 3% year-over-year quarterly sales growth, on organic growth of 4%, which on top of 9% quarterly organic growth last year is a very solid number.

All regions reported year-over-year quarterly growth with Asia Pacific leading at 12%, followed by EMEA at 8% and the Americas at 2%.

Double-digit growth of 12% in Asia Pacific reflects the continued strong performance and growth in India, where we are leveraging our operations in Bangalore.

In EMEA, we saw solid performance, mainly in aerospace.

In the Americas, demand remained strong.

However, our results were influenced by the changes we are making in our distribution network.

We continue to upgrade that network and also fine-tune our product portfolio to drive profitability.

Adjusted operating margin in the quarter increased by 230 basis points year-over-year to 3.7%.

Operating leverage was strong and customer service levels are increasing across all regions.

Turning to Slide 5 for our Infrastructure overview.

Infrastructure grew 5% year-over-year this quarter, on organic growth of 4%.

Again, a very strong level of growth when viewed in the context of the previous year's growth rate of 18%.

All regions reported growth.

The Americas posted strong growth at 7%; Asia Pacific at 7%; and EMEA, the smallest region for Infrastructure, posted 4% growth.

The energy end market delivered very strong growth at 19%.

Oil and gas activity continued to improve with the average U.S. land rig count increasing 17% year-over-year.

General engineering posted strong growth at 9%, and earthworks declined year-over-year by 7%.

We do not believe, however, that the decline is indicative of overall end market strength, but rather simply due to portions of the business being project based and the difference in timing of large project spends year-over-year that result in lumpy and inconsistent sales patterns.

Adjusted operating margin decreased year-over-year to 9.6% this quarter from 11.8% prior year.

As expected, margins compressed mainly due to the timing of customer raw material pricing index adjustments.

As material prices have now effectively stabilized since the start of the fiscal year, this timing issue should abate in the second half.

Consequently, we expect that full year operating margins will improve year-over-year.

Excluding this timing effect, Infrastructure's leverage was in line with our expectations.

We are on track with our multi-year margin improvement plan and expect margins will get stronger as we execute on our strategic initiatives.

Please turn to Slide 6 for example of simplification/modernization.

The photos show manufacturing operations that support both Industrial and WIDIA products.

The upgrade we are making are delivering significant improvements in operational results.

For example, the man-to-machine ratio is improving by up to 50% with output increasing up to 60%, and we've reduced scrap by as much as 70%.

Through projects like this, we're not only seeing financial benefits, but also adding value for our customers with increased product performance and quality.

And that is well positioning us for further growth.

From an employee standpoint, our team members are excited about our simplification/modernization initiatives.

They know the company had underinvested in manufacturing operations for many years.

And so naturally, they are excited about the future at Kennametal as they see the new investments coming online.

With that, I'll turn the call over to Damon.

Good morning, everyone.

Turn to Slide 7. Sales in the second quarter increased 3% year-over-year to $587 million, with organic sales growth of 4% and favorable business days' effect 2%, being partially offset by foreign currency headwinds of approximately 3%.

Sales grew in every segment and every geographic region at constant currency.

Adjusted gross profit in the quarter increased 4% year-over-year to $199 million.

Adjusted gross profit margin increased by 50 basis points to almost 34%, driven primarily by organic sales growth and the incremental benefits associated with our simplification and modernization initiatives.

These improvements were partially offset by higher raw material costs and a short-term increase in manufacturing expenses in certain facilities due to the timing of our simplification and modernization efforts underway.

Price covered raw material cost increases again this quarter, which is consistent with the last several quarters.

As you know, we've continued to demonstrate our ability to offset raw material cost increases with price over the cycle.

Adjusted operating expenses decreased $7 million or 6% to $115 million, due primarily to benefits from our simplification restructuring initiatives.

On a percentage of sales basis, adjusted operating expenses improved by 180 basis points, decreasing to 19.5%, as we continue to have success in reducing cost even with higher demand in our end markets.

Going forward, we would expect operating expenses as a percent of sales to be around 20% as a result of our actions taken to date, which is in line with our long-term outlook.

The improvement in both gross profit and operating expenses as a percentage of sales contributed to adjusted operating margin increasing significantly by 240 basis points to 13.8%, which is the best second quarter performance since fiscal year 2012.

The effective tax rate for the quarter on an adjusted basis was 21.3% versus 28.4% in the prior year quarter.

The decrease is primarily due to U.S. tax reform.

Adjusted EPS improved significantly year-over-year to $0.71 in the quarter versus $0.52 in the prior year.

Slide 8 illustrates the main drivers affecting adjusted EPS this quarter compared with the prior year.

The biggest driver in the quarter was the favorable effect of our simplification and modernization initiatives of $0.10.

The 37% increase in adjusted EPS year-over-year is also due to operations delivering an incremental $0.07, for this bridge operations is essentially the day-to-day running of the business.

In addition to these items, we've recognized the favorable effects of the lower tax rate of $0.07 in incremental currency headwinds of $0.02.

Turning to Slide 9, and our quarterly segment sales and profitability performance.

Year-over-year Industrial expanded adjusted operating margins by 560 basis points to 18.6%, reflecting primarily organic sales growth and incremental simplification and modernization benefits, partially offset by short-term manufacturing expenses in certain facilities due to the timing of our simplification and modernization efforts underway.

Selectivity, as a part of our simplification efforts and modernization are contributing to continued strong operating leverage.

Further, solid end market demand and our growth initiatives continue to fuel organic sales growth.

WIDIA reported adjusted operating margins up 230 basis points to 3.7% year-over-year, reflecting organic sales growth primarily in India.

Infrastructure's adjusted operating margins decreased by 220 basis points to 9.6%, due primarily to higher raw material cost, partially offset by organic sales growth, favorable mix and incremental simplification and modernization benefits.

As Chris mentioned, this margin compression was anticipated given the change in raw material costs over the last couple of quarters and is expected to abate in the second half of fiscal year 2019.

Turning to Slide 10.

Primary working capital as a percentage of sales decreased 60 basis points from 30.6% last December to 30% this quarter.

We expect to maintain primary working capital as a percentage of sales in this range, but we'll nevertheless continue to look for opportunities to further improve.

In dollar terms, primary working capital increased as a result of inventory, which is reflective of higher year-over-year commodity prices and increased strategic inventory on our high-volume, high-profitability products for improved customer service.

We continue to maintain a strong balance sheet with significant liquidity and investment grade credit ratings.

Cash on hand at December 31 was $96 million versus $160 million in December the prior year, a decrease of $64 million, primarily due to increased capital expenditures and primary working capital changes.

Free operating cash from the quarter was $9 million, down from $44 million in the prior second quarter, due mainly to the changes in primary working capital and increased capital spending.

Net capital expenditures were $43 million in the quarter compared to $37 million in the prior year second quarter.

As with previous years, we expect the capital spending to increase substantially in the second half of the year.

Dividends paid were $16 million, consistent with last year.

Overall, our free operating cash flow to date is in line with our 2019 outlook, and we expect free operating cash flow to increase as we proceed through the second half of the fiscal year.

Turning to Slide 11 for our fiscal year 2019 outlook.

Based on the environment we see today, we are reaffirming our outlook.

We continue to expect adjusted EPS in the range of $2.90 to $3.20 for the full year.

Even with the uncertainty in China and the Transportation segment, the headwinds associated with the continued strengthening of the U.S. dollar and the evolving landscape related to tariffs.

Our broad end market diversification helps us reduce our exposure to any one end market or region.

We are going in our key end markets and winning with key customers.

Those actions will help dampen the effects of volatility in any 1 particular end market or region, and as such we are confident in our assumption of organic sales growth of 5% to 8% for fiscal year 2019.

Free operating cash flow is expected to be in the range of $120 million to $140 million with capital expenditures of $240 million to $260 million.

As I mentioned earlier, we expect capital spending to increase substantially in the second half of the year, which is consistent with the prior year pattern.

And with that, I'll turn the call back to Chris.

Thanks, Damon.

Please turn to Slide 12 for my summary.

We delivered another strong quarter in Q2 and are holding our full year guidance despite the areas of uncertainty that we've discussed.

We continue to see growth in all business segments, and our financial performance each quarter continues to improve through the disciplined execution of our growth and simplification/modernization initiatives.

I'm really very pleased with the company's progress and remain confident in achieving our multi-year improvement plan.

The results through the first half of the year keep us on a trajectory to deliver our fiscal year 2021 EBITDA targets.

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

(Operator Instructions) And your first question will be from Joe Ritchie of Goldman Sachs.

This is Ashay Gupta on for Joe.

I guess, just to start off, I mean, the execution in the quarter came in pretty well.

Maybe just talk about the puts and takes between maintaining the broad guidance range and what's the difference between getting you to the high end versus the low end?

Yes.

That's good question.

First of all, we -- typically, the business has performed sort of an EPS split of this sort of 45% to 55% range.

And as we look at all the puts and takes and the macroeconomic environment with the additional of risk associated with China and FX headwinds and those type of things, we still feel that, that 45% to 55% is possibility for us.

And so I would -- that's the way I would think about that guidance range.

Got it.

And maybe just digging into Transportation and China auto for a second.

I mean, clearly the deceleration was pretty significant in the quarter.

Can you just may be parse out was China auto more specifically from a growth standpoint in 2Q?

And what's baked into your guidance for the back half of the year?

Yes.

We did see a significant decline in China.

Everyone understands the situation there and the fact that the automotive industry is actually depressed at this point.

I just want to make a couple of general comments, then we'll talk more specifically about China.

But just remember, we've got good diversification across all markets.

And while China is certainly an area of potential growth for us to put it in perspective for overall Kennametal, it was about 11% revenue subject based on last fiscal year and about half of that is associated with Infrastructure.

And as I said on the call, in our prepared remarks, Infrastructure hasn't seen that level of disruption in China.

So China is important, but it's not going to -- it's not going to overwhelm the company's results.

I think automotive is an important sector inside China, but also so is general engineering.

And while there's been some weakness there too, there's other markets in China, including aerospace and general engineering that are helping to offset that.

So I believe that our view of what's ahead for the rest of the fiscal year is quite realistic.

And we feel comfortable that we can match the guidance.

The next question will be from Julian Mitchell of Barclays.

May be just the first question around those Infrastructure margins.

I appreciate the conviction that they'll be up for the year.

But maybe just to help us understand that, if there was any way of quantifying what the cost headwind was to margins in the first half of the fiscal year?

And maybe just clarify, if the Q2 headwind was in line with what you thought or a bit worse?

Yes.

Just a couple of comments on raw materials in general.

As a company, Julian, we've typically covered our raw material cost and that was the case for the quarter, and we expected we'll still be able to do that in the long term as we have for several quarters.

Infrastructure, I think it's important to note, they're much more sensitive to price cost because they have a higher percentage of material cost.

And to answer your question, specifically, the margin compression we saw in Q2 was actually expected and it's also temporary in nature.

If you think about this business, the margin was mostly compressed due to a timing difference between customer raw material price indexes and adjustments.

So in other words, we have certain contracts that as soon as the APT index drops, we are required to lower the price, but we still have APT that we had bought at higher cost in our inventory that needs to flow through.

So the reason we can be quite confident that, that situation is going to reverse itself is that we're now buying the raw material at lower cost.

So that should flow-through to P&L and we feel pretty good about the second half in making those margins.

And my expectation is we will see a full year improvement in Infrastructure margins year-over-year as well as for the whole company.

Great.

And then my second question would be around the earthworks' revenue trajectory.

Flat sales in Q1, down a bit Q2.

I understand it's very lumpy and project-based to an extent.

So I appreciate any color you could provide on may be what the orders are doing in earthworks?

Or maybe where the backlog sits to help us understand how quickly the revenues can turnaround?

Yes.

I'm going to let Ron talk a little bit about that, but just to point on a couple of things.

Earthworks is -- it was negative and we -- and when we look at the detail behind it in the specific projects, we explained that just due to simply the timing of it.

But the underlying project backlog and the opportunities there still seem to be there.

And I don't know Ron, if do you want to add anything about the condition of your backlog or anything like that?

Yes.

You're absolutely right.

I mean, the conditions that we've experienced in the road construction and underground mining have been good.

The project business and trenching the foundation -- and foundation drilling is lumpy.

And the timing of those sales are totally based on the timing of those projects being released and the actual cutting conditions that customers see.

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

I wonder if you guys could just give us a little sense of the customer feedback you're hearing that gives you confidence, because it seems like -- in growth in the second half in organic volume because it does seem like things are kind of trending generally a little flatter.

And I just wonder -- and you guys have really good customer relationships and you're rebuilding them and all that.

And I just wondered if you could flow that through to help us bridge what we're seeing in the paper?

Yes.

There is a lot of noise out there sort of in broad terms.

And I think a lot of it's created because there's so much focus on China and we talked a little bit about the German automotive, but there's a lot of other industries out there in end markets and regions.

And frankly, we're either seeing sort of global demand sort of stay steady in these areas or in many market segments, it's actually -- actually it's still continuing to increase.

So all things considered, we don't -- we're not sort of taking just a high level of view, we actually go into the detail and break it down by region, by segment.

And to your point, we do have good customer intimacy in many of these areas.

So we feel that we have a good balanced view of what sales are going to be.

And the range that we're holding to our original guidance we feel is a good range to be.

There's possibility to get to the high end, and so we feel good about that.

And is gaining share or gaining share of wallet with customers, or any, is that a big part of what you guys are seeing for the second half?

Yes.

In some cases, I believe, that we are picking up shares in some of the specific markets.

Markets like aerospace, we haven't typically focused on, but we've got strategic initiatives to bring new products and a focus with our custom engineering solutions to that segment of the business, which fits quite well with our value proposition.

General engineering, we've always played in, but we have a -- I think, a heightened focus on that and how we can penetrate that market.

So it doesn't surprise me that we feel like we're picking up share in certain areas, but share is also one of those things that you kind of manage over time and measure over time.

But we feel good about the value proposition we got, the focus that the segments that we've set up bring to the marketplace, and so we absolutely expect to be picking up share.

The next question will be from Steven Fisher of UBS.

Just wanted to follow up on Joe's question there, about the assumption of reacceleration of organic growth in the second half.

Can you just be maybe a little bit more specific about which segments and end markets do you see driving that reacceleration in the growth in the second half?

Yes.

We've got -- we've kind of modeled it that automotive is going to continue to dampen the results and that's -- that will also be the case in Germany and China, so we're not expecting some recovery there.

But the growth that we continue to see in areas like India, which is kind of broad-based growth, it's not in any particular end market, so that's going to help to drive it.

Also -- again, the focus on aerospace, again, across all regions.

And the U.S. -- the good old U.S. is actually quite strong.

And obviously, we have a good presence here and that's going to help to drive that growth.

Okay.

That's helpful.

And then just really want to kind of check my model here.

On the Infrastructure margins, with the assumption that the margins would be up year-over-year, I mean, is that implying that we should see something like 14% for this segment for the year, implying really strong margins in the second half?

Yes.

We're going to see significant margin improvement.

And I think a lot of it is just driven by the fact that if we look at Q4 of fiscal year '18, the APT index was at -- this is not what we pay, this is just an index, was like $336 per metric ton unit.

And it's dropped already to $263 in Q3.

The average in Q2 was around $274.

So it's come down significantly.

And that's why we have a lot of confidence it's going to drive that margin improvement.

Plus, Ron and his team are also focused on simplification/modernization.

We have one of our very first modernization plant-wide projects for Kennametal with the Rogers facility.

And that project is starting to -- is almost 100% complete.

And so we have pretty good visibility to the productivity that's coming out of that.

So those 2 things combined give us confidence that he's going to make the margin improvements that we're forecasting.

So, does that imply then maybe like a spike up in the fourth quarter to, say, kind of a mid-teen margins in the Infrastructure segment?

Yes, I think...

Go ahead, Damon.

I think you will see it sort of grow sequentially because as Chris alluded to APT cost has been coming down over the last 6 months, and so you're going to see that sort of raw material cost get lower as we move into the third quarter and then lower in the fourth quarter.

So it will -- again, you have to look at the raw material costs will improve.

The year-over-year change on some of the pricing actions will be the other effect.

So net-net, you would expect, generally speaking, fourth quarter to be a little bit stronger than the third quarter.

Right.

But we're not going to have to wait for it all in the fourth quarter.

Correct.

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

I wanted to ask you about the CapEx programs in the second half.

It sounds like those are going to be ramping.

I wonder if you can give us some detail about regions of the world, where those are going in?

And you're going to be going into a busier period than the first half, have you found that these projects enhance the businesses immediately?

Or can they be disruptive to production and to revenue?

Yes.

The first part of your question in terms of the CapEx, is it's not on any specific region.

These are sort of broad-based programs that are covering the entire Industrial and WIDIA product portfolios, as well as we have project-specific infrastructures.

So they're pretty broad based and there's not a particular region where more spend is happening versus another.

And then, I think, the way to think about the modernization is there is a time lag.

You do spend the capital.

You start to install the equipment, then you got to turn it on.

So it is quite a long gestation period.

But we expect that the improvements from simplification and modernization are going to continue to accelerate as we move through modernization.

And something that we talked about on our last Investor Day is that while the progress year-over-year will be fairly linear, it's maybe a little bit back-end loaded, but fairly linear and only back-end loaded because some of the plan consolidations are happening late.

As you progress through any given set of quarters, it may be a little more lumpy, all right, because it's not -- these things aren't being turned on smoothly across all regions.

So it's really hard to give any more specifics because there's just so much detail behind and so much activity, but that's the way I would think in broad terms that we're still on track for the 2021 EBITDA targets.

And we still expect the simplification and modernization benefits, you'll still see those in our results each quarter going forward.

Okay.

All right.

And let me try one on the organic growth and the guidance.

You're tracking towards, I guess, the lower end of organic growth with the first 2 quarters of the year.

How should we think about the growth to get to the high end of the EPS guide?

You'd have to have a pretty big reacceleration in the high end of your organic revenue growth range and vice versa for the lower organic growth in the second half?

Yes.

I mean, if we do the math, the low growth for the second half to be at the low end, it will be about 3.5%; and at the high end, it will be 9%.

So we do have scenarios and the things we're working on to get to that high end.

That's why we're reaffirming that guidance.

And I think, the reality is we're going to be somewhere probably in the middle of that, between that 3.5% and 9% organic growth in the tail end of the year.

Now keep in mind, we do have -- it's not all just market recovery based, that growth, we've got a number of initiatives we're starting to get traction on that we're -- as we lay those into our forecast, those are the things that are going to cause you to be towards the higher end.

Organic growth for the first half, Walt, was about 7%.

So I think we're fairly in line with our guidance year-to-date.

The next question will be from Michael Feniger of Bank of America Merrill Lynch.

Just -- I know there's a lot of focus on the organic growth.

I mean, energy and Infrastructure are still pretty strong.

We're seeing some of your customers cutting CapEx.

I'm just curious what you're seeing on that end?

If there's been any change there in the start of the second quarter -- or third quarter?

Yes.

Our projections for energy, in general, in Americas, it's still trending upwards.

But we've got sort of in our model, at EMEA and Asia Pacific are going to be flat on the energy side.

Perfect.

And then just, can you give a little bit more color on the inventory build in the quarter?

What area was that specifically?

And are you seeing anything with inventories with your distributors?

Yes.

On the distribution side, we're not seeing anything unusual.

No unusual activity that you wouldn't see this time of the year.

If we look at the inventory, a large part of that increase is associated with higher material costs versus last year.

And so that all, obviously, naturally come down as we replace the higher cost inventory with lower cost raw materials.

There's also a portion of the inventory that was increased related to improving customer service on our high-volume, high-profit SKUs.

So I -- the way I look at that increase is that was actually a terrific investment.

A lot of that is what's driving the operating leverage improvement that you saw in -- especially in the Industrial business.

So that's very good -- that's a very good investment for us.

And overall, we're pretty happy with the level of working capital.

We'd always been trying to target to be around that 30%, and we continue to address trying to drive initiatives to go below that.

But right now, we feel like we're in a good place with the inventory build and feel like that was done with a business thought process and with a return on investment thought process.

If I could just ask on that, do you know -- is there a way you can quantify how much that inventory build in Industrial helped or benefited the margin in the quarter?

It didn't really -- sequentially, the inventory really wasn't up that much.

So again, if you look at it year-over-year, the bigger piece of the increase was the raw material cost.

The next question will be from Chris Dankert of Longbow Research.

I guess, to kind of dig on the last question a little bit more here.

Is there any -- the increase you guys saw inside Industrial for the margin was impressive in the quarter.

Is there any way to kind of breakout price benefit versus restructuring versus kind of the mix and selectivity benefit?

Or is it just too convoluted to kind of break apart?

Yes.

I think on the -- sort of the restructuring bucket, if you will, which is -- I would classify that as simplification.

I want to just point out that we've got the operating -- the OpEx of the company below -- at that 20% or below, which is kind of where our target was.

And a lot of that improvement that we saw quarter-over-quarter -- or excuse me, year-over-year, a good portion of that was driven in the Industrial space, where we've got simplification and part of that was driving sales productivity.

So definitely simplification initiatives around sales productivity has helped to take that cost out.

You can see on the EPS bridge, we had a good chunk of simplification and modernization.

And then on the price, we have, obviously, raised prices to cover material cost.

But a lot of the pricing activities that's happened in Industrial and WIDIA and to a lesser extent in Infrastructure is that we have adopted this, what I would call, strategic pricing model, where we're not just simply putting a price out there because we think that's the right market price, we're actually trying to go out and quantify the value proposition for the customers.

And in many cases, as we dug into that, we realize that we have been undercharging for many years for this product.

And so we raised prices quite significantly in some cases.

And our customers interestingly enough in most cases, they accepted it once we explain the value proposition.

So it just tells me that the company had probably been leaving a lot of money on the table before.

But I can't -- it's hard for me to break out that combination of selectivity and the pricing thing I just described, it's all kind of blended together.

But it was definitely all driven by this notion of simplification, where we just can't try to be everything to everybody, and we need to focus our limited manufacturing capacity and engineering capacity on the high profitable products and the ones, frankly, that we're best able to deliver value on.

Got it.

That's really helpful.

And I guess kind of just to pick at that a little bit more.

When you think about selectivity and kind of revisiting your value proposition on the pricing side of the thing, is there any way to quantify like how far you are down that path insofar as what percent of the portfolio has kind of been evaluated and repriced versus kind of what's left to do there?

Yes, it's a good question.

I think we still have more work to do, but we definitely made significant progress in the last year and you're starting to see that roll into the P&L.

So it's an ongoing initiative.

I think that we've -- like with any kind of productivity improvement, especially in a situation where the company may be didn't have the proper focus before and we now brought the focus, you always get the low-hanging fruit is there.

And so I think, the improvements we've seen have been -- they've been quite substantial.

I don't think you can sustain that forever because now you got to get in and do the hard work, but we do expect it to continue through next year.

Will you get the same pop next year as we lap these comps?

You won't.

Just the nature of the comparable math, but also just the nature of continuous improvement as you go with the low-hanging fruit and then you got to do some more hard work to get the next incremental benefits.

The next question will be from Ann Duignan of JPMorgan.

Two quick clarifications.

The 2 extra days that you had in the quarter, when did we lose those 2 days?

Or do we lose them in the back half?

Do want to take Damon or Pat?

There's fractionally negative days in the back half, Ann.

And wouldn't that be fractionally negative on your normalized 45%-55% split?

I mean, won't that be a headwind?

I guess, that was my question?

It's baked in the 45%, 55%.

It's baked into the 45%, 55%, okay.

And then my second question is on Infrastructure margins.

It's unusual for me to hear a company talk about giving up pricing coincident with the raw material index.

So can you talk about why you have to give it up immediately?

Generally, there is a lag for price increases, but then there's also a lag on the down side as well.

So if you could just give more color on that, I would appreciate it.

Ron, do you want to describe how the contracts work?

Yes.

So we have 2 areas that we deal with this.

One with our energy customers, which are based on index pricing against APT.

There is a lag at the point that, that lag starts stabilize -- that the prices stabilize, it becomes consistent sequentially quarter-to-quarter.

On the other part of the business, where we sell our powders, that's more of a spot buy and that tends to trend towards where those raw material indices are.

Okay, that's helpful, actually on the powder side.

That makes sense.

Can you quantify any of that, like how much of your spend is powders or how much is powder-related coincident with change in index versus how much lags?

No, Ann, we -- I mean, we don't want to give up that level of detail.

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

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

Thank you, operator.

Let me close by saying that I'm really very pleased with our second quarter performance.

The team delivered another strong earnings per share result, margin improvement year-over-year and -- as we talked about eighth consecutive quarter of sales growth.

These results are clearly representative of the continued transformation that's underway at Kennametal and the progress that we've made on our strategic growth and simplification/modernization initiatives.

I want to thank everyone as usual for joining the call today.

We certainly appreciate the time and your continued interest in Kennametal, and please, by all means, reach out to Kelly with any follow-up questions.

Thank you.

Have a good day.

Thank you, sir.

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