Kelly M. Boyer - Kennametal, Inc. Christopher Rossi - Kennametal, Inc. Damon J. Audia - Kennametal, Inc. Peter A. Dragich - Kennametal, Inc..

Stephen Edward Volkmann - Jefferies LLC Ashay Gupta - Goldman Sachs (India) Securities Pvt Ltd. Ann P. Duignan - JPMorgan Securities LLC Julian Mitchell - Barclays Capital, Inc. Adam Uhlman - Cleveland Research Co. LLC Andrew M.

Casey - Wells Fargo Securities LLC Walter Scott Liptak - Seaport Global Securities LLC Steven Fisher - UBS Securities LLC Ross Gilardi - Bank of America Merrill Lynch Chris Dankert - Longbow Research LLC Joel G. Tiss - BMO Capital Markets (United States).

Good morning. I would like to welcome everyone to Kennametal's First Quarter Fiscal 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Please note that this event is being recorded.

I would now like to turn the conference over to Kelly Boyer, Vice President of Investor Relations. Please go ahead ma'am..

Thank you, operator. Welcome everyone and thank you for joining us to review Kennametal's first quarter fiscal year 2019 results. Yesterday evening, we issued our earnings press release and posted our presentation slide on our website.

We will be referring to that slide deck throughout today's call and a recording of the call will be available for replay through December 6. 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 of Finance and Corporate Controller; Alexander Broetz, President, WIDIA Business segment; Pete Dragich, President, Industrial Business segment, and Ron Port, President, Infrastructure Business segment.

After Chris and Damon's prepared remarks, we will open the 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. 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'll now turn the call over to Chris..

Thank you, Kelly. Good morning, everyone, and thank you for joining the call today. As this is Damon's first quarterly earnings call, I'd like to take this opportunity to welcome him to Kennametal. As many of you know, he brings to this role more than 25 years of finance experience in manufacturing companies.

We're delighted to have him join the team, Damon welcome. Turning to slide 2, I'm pleased to report that we've delivered another strong quarter. The consolidated sales growth rate for the company remains solid at 8% and 10% at an organic level. For the seventh consecutive quarter, every segment, region and end market reported positive growth.

I was very pleased with the performance across all three segments with Infrastructure posting 9% growth and both Industrial and WIDIA posting 8% growth. From a regional perspective, Asia-Pacific and the Americas grew at double-digit rates year-over-year at 14% and 12%, respectively, and EMEA grew at 5%.

Our quarterly adjusted operating margin increased 350 basis points year-over-year to 14.4%, with a significant improvement in gross profit margin as a result of great execution by the team. The operating margins were further strengthened by a substantial improvement in operating expenses as a percentage of sales.

Operating leverage improved again this quarter, reflecting continuing progress in our growth and simplification, modernization initiatives. As we plan, the underlying operational performance of the business was augmented by our strategic initiatives. Adjusted EPS increased 27% or $0.15 year-over-year to $0.70 in the quarter.

This is our best first quarter performance in seven years and demonstrates the strength of Kennametal brand in the market and the improvements we are making inside our facilities. The increase of $0.15 for the quarter includes $0.09 from our simplification, modernization efforts.

And as a reminder, $0.09 is as much as we achieved in all of that FY 2018 demonstrating that as expected, the benefits from the program have accelerated with more opportunity for further margin improvement as we move through our multi-year plan. Let's turn to slide 3 to look at organic sales growth.

In the first quarter of fiscal year 2019, organic sales stayed strong at a 10% growth rate. I'm very pleased with these results. Remember, last year in the first quarter, we grew 13% for a total of 24% over the last two years.

These results are a testament to the team leveraging the strong market conditions while implementing our growth and simplification strategies. Looking forward, we continue to be encouraged by the strength of the end markets as well that the progress we are making on our growth initiatives.

Remember we are barely two years into this cycle and typically for Industrials, the cycle is multi-year. Now, let's review the strong quarterly results by segment. Turning to slide 4 for the Industrial segment overview. I want to take a moment to reflect on my time at the IMTS trade show this September. As I think there are a couple of key observations.

First, for those of you who attended this year, I think you would agree that the views expressed by most attendees were optimistic. I also think that the fact that there was record attendance at the event further reinforces the views of a positive market environment.

We talked a lot with our customers and there was great enthusiasm about the future of manufacturing. Second, you've heard me talk a lot about our plans for growth and simplification modernization. These are critical of course for our future.

At the same time, however, we cannot forget that Kennametal is a technology innovator and we are continuously introducing new products to help improve our customers' performance. At IMTS we highlighted several new products to further strengthen our customer offerings.

For example, the HARVI Ultra 8X is a market-leading rock milling tool for titanium applications with unmatched metal removal rates, particularly well-suited for aerospace applications. We also highlighted the KenTIP FS, which is a modular drill system.

KenTIP FS provides the user with 15% more productivity in their machining, while delivering a 15% improvement in tool life. It's these types of innovations, coupled with the continuation of our simplification, modernization plans to give us confidence in our ability to execute over the long term. Now looking at the quarter.

Industrial posted a quarterly year-over-year sales growth rate of 8%, on organic growth of 10%. All regions delivered healthy rates of growth with the Americas leading at 13% followed by Asia-Pacific at 12%, and Europe at 7%.

We saw a good strength in all end markets in the quarter, with the largest percentage gain in aerospace at 18%, a key growth area for us. General engineering our largest end market in Industrial also grew double-digits at 10%. Transportation posted solid growth at 7% and energy at 5%.

Adjusted operating margin increased 620 basis points year-over-year to 18.3%, reflecting increasing success on our 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 expansion to come.

Turning to slide 5 for the WIDIA overview. WIDIA posted 8% year-over-year quarterly sales growth, on organic growth of 11%. As with the Industrial Business segment, all regions reported positive year-over-year quarterly numbers with Asia-Pacific leading at 24% followed by EMEA at 11%, and the Americas at 2%.

Adjusted operating margin in the quarter increased by 330 basis points year-over-year to 4.4%. With regards to the regional results for WIDIA, In Asia-Pacific, the 24% growth rate reflect strong performance and continued growth, mainly in India.

In addition, we are making steady progress in our operational and capacity improvements at our Bangalore facility to help us grow our WIDIA brand. We're also progressing and establishing our distributor partner network in China and other Asia-Pacific countries to further accelerate our growth in the region.

In EMEA this quarter, we saw a solid performance particularly in aerospace. In the Americas, we are strengthening our distribution network and continue to exit select portions of the portfolio to drive profitability. As you can see WIDIA is making steady improvements and I am pleased with the progress.

Turning to slide 6, for our Infrastructure overview. Infrastructure grew 9% year-over-year this quarter, on organic growth of 10%. All end markets reported positive growth. Asia-Pacific and the Americas posted double-digit growth at 13% and 12% respectively.

EMEA, the smallest region for Infrastructure, decreased slightly by 2%, mainly due to a temporary disruption in coal production in South Africa. With regard to end markets, energy delivered the strongest growth at 18%, oil and gas activity continues to improve with the average U.S. land rig count increasing 12% year-over-year.

General engineering also posted strong double-digit growth at 13%. Earthworks was flat due primarily to the effect of the South African coal industry mentioned earlier. Adjusted operating margins increased slightly year-over-year to 11.4% this quarter from 11.2% prior year.

Although, margins only improve slightly year-over-year, I think it's important to note that our Infrastructure segment is more exposed to commodity cost than Industrial. Our team did an excellent job ensuring price covered raw materials in the quarter.

Excluding the effect of price over raw materials, Infrastructure's leverage was in line with our expectations. In addition, margin improvement was further enhanced due to our simplification, modernization initiatives, including product redesign and product portfolio pruning.

The multi-year margin improvement plan is on track and our margins will get stronger as we continue to execute on our strategic initiatives. For example, turning to slide 7, you can see another example of simplification, modernization.

I thought this was a particularly interesting case in point since it illustrates the inefficiency of many of our processes before modernization. In this case, we are putting product through old machines multiple times in some cases as many as 10 times.

The loading and unloading was manual with poor process flow all leading to an inefficient model and higher labor costs. Now through our modernization efforts, we have updated machinery and automated loading and unloading with optimized flow. The result is improved quality and delivery performance, increased throughput and decreased costs.

In fact, the amount of labor has been reduced to less than half. Not only has this improved our process, allowing us to increase our efficiency by over 100%, but this type of advancement also improves our flexibility during potential downturns given the increased automation and reduced labor.

Keep in mind that this is just one example inside the company and the majority of the simplification, modernization benefits are still ahead and expected to deliver further benefits in FY 2019 and beyond. It's an exciting time at Kennametal. We are learning as we go and applying these learnings to other simplification, modernization projects.

With that, I'll turn it over to Damon who will begin on slide 8 with a detailed financial report..

Good morning, everyone. I'm excited to be joining Kennametal at such an instrumental point as we execute on our growth, simplification and modernization plans. After my first month here, which has included several site visits, I can say that I'm even more excited about our opportunities.

I look forward to seeing and getting to know many of our investors and analysts over the next several months. We will begin with a review of our results of our operations on both a reported and adjusted basis.

Sales in the September quarter increased 8% to $587 million with organic sales growth of 10% being partially offset by foreign currency headwinds of approximately 2%. Sales grew in every end market, geographic region and segment at constant currency. Adjusted gross profit in the quarter increased 15% year-over-year to $211 million.

Adjusted gross profit margin increased by 220 basis points year-over-year to 36% driven by organic sales growth, favorable mix, and incremental benefits associated with our simplification and modernization initiatives.

These improvements were partially offset by higher raw material cost and temporary manufacturing inefficiencies in certain facilities, in part due to strong market demand coupled with the progress of our modernization efforts. Price covered raw material cost increases again this quarter which is consistent with the last several quarters.

As we've mentioned before, the timing of our pricing actions versus the impact of raw material cost in our cost of goods sold may not always align in the quarter. However, over time we have demonstrated our ability to offset raw material cost increases with price. Adjusted operating expenses were effectively flat on higher sales.

On a percentage of sales basis, adjusted operating expenses improved by 120 basis points, decreasing to 21% as we continue to focus on cost containment even with higher demand in our end markets.

The improvements in both gross profit margin and operating expense as a percentage of sales contributed to adjusted operating margin increasing by 350 basis points to 14.4%. The 14.4% is our highest first quarter adjusted operating margin since the first quarter of fiscal year 2012.

One item to note, in the quarter we implemented the new accounting standard with respect to where pension-related charges are shown in the income statement. In accordance with GAAP, we've historically recorded this cost in cost of goods sold and operating expense, which are components of operating income.

The change now requires us to record most of the components of pension cost in non-operating income. Given our unique position, this change resulted in approximately $3.6 million of net pension income shifting to non-operating income in the first quarter. The prior-year amount of $4.3 million has also been adjusted to reflect this change.

The effective tax rate for the quarter on an adjusted basis was 23.6% versus 18% in the prior-year quarter. The increase is primarily due to the effect of the U.S. tax reform in the current year and the timing of the release of the valuation allowance on our U.S. deferred tax assets, which occurred in the second quarter of fiscal year 2018.

Reported EPS for the quarter was $0.68, compared to $0.48 in the prior year. Adjusted EPS improved year-over-year to $0.70 in the quarter versus $0.55 in the prior year. Slide 9 illustrates the main drivers affecting EPS this quarter compared to the prior year.

The 27% increase in adjusted EPS year-over-year is due to operations delivering an incremental $0.15, which for this bridge is essentially the day-to-day running of the business.

It excludes the favorable effects of our simplification and modernization initiatives of $0.09 in the quarter, as well as the unfavorable effects from taxes of $0.06 and currency headwinds of $0.02. Slide 10 summarizes our quarterly segment sales and profitability performance.

Year-over-year Industrial expanded adjusted operating margins by 620 basis points to 18.3%, reflecting primarily organic sales growth, favorable mix and incremental simplification and modernization benefits, partially offset by temporary manufacturing inefficiencies in certain facilities due in part to strong market demand coupled with the modernization efforts in progress.

As Chris mentioned, selectivity as part of our simplification efforts and modernization are contributing to continued strong operating leverage. Further robust end markets and our growth initiatives continue to fuel double-digit organic sales growth.

WIDIA reported adjusted operating margins up 330 basis points to 4.4% year-over-year, reflecting organic sales growth, primarily in India. Infrastructure's adjusted operating margin increased by 20 basis points to 11.4% due primarily to organic sales growth and favorable mix, partially offset by higher raw material costs.

As Chris highlighted, Infrastructure is more heavily impacted by the price versus raw materials equation. This impacted the margins as we generally look to have price offset raw material changes as it did in the quarter. Excluding these impacts Infrastructure would have deliver strong leverage in the quarter and in line with our expectations.

As shown on slide 11, primary working capital as a percentage of sales was effectively flat at 29.8% versus our June year-end figure. Even having achieved levels of less than 30% for two consecutive quarters, we will continue look for opportunities to further improve our primary working capital.

Turning to slide 12, and an update on the balance sheet and liquidity metrics. We continue to maintain a strong balance sheet with significant liquidity and investment grade credit ratings.

With the early redemption of our $400 million of notes in the first quarter, we now have $600 million of term debt outstanding and no maturities until February 2022, which provides us significant flexibility going forward.

Cash on hand at September 30, was $102 million a decrease from $556 million in June due primarily to the early redemption of the $400 million of notes. At the end of September, our net debt was $490 million. The full balance sheet can be found in the appendix of the slide presentation.

First quarter year-to-date free operating cash flow was negative $33 million, which improved from negative $62 million in the prior-year first quarter.

The $29 million year-over-year improvement is reflective of the improved higher cash from operations and lower restructuring payments, offset partially by higher working capital and increased capital expenditures.

Regarding capital spending, net capital expenditures were $42 million in the quarter in line with our expectations, compared to $22 million in the prior-year first quarter. I would like to note that we recorded an adjustment to the presentation of capital expenditures in the prior-year quarterly statement of cash flows.

A description of the adjustment is included in the footnotes on slide 17. The adjustment did not affect free operating cash flow in any period nor the full annual statement of cash flows. Dividends paid were $16 million in quarter consistent with last year, and we remain committed to maintaining our dividends.

Overall, we are pleased with our free operating cash flow in the quarter, and as we discussed at our December 2017 Investor Day, we expect free operating cash flow to increase, as we proceed through our simplification and modernization plans. Now turning to slide 13 and our fiscal-year 2019 outlook. As Chris said, we are off to a strong start.

Based on the environment we see today, we continue to expect adjusted EPS in the range of $2.90 to $3.20 for the full year, which is in line with what we communicated in August during our fourth quarter fiscal year 2018 call. We are maintaining this outlook even with the increased headwinds associated with the continued strengthening of the U.S.

dollar, which we saw in the first quarter and the evolving landscape related to tariffs. In regard to tariffs, there are multiple components we are actively assessing to understand the impact in our potential corresponding mitigation actions.

As we said last quarter, based on our understanding of the steel tariffs, we do not believe the net effect to be material, as steel is not a large part of our overall raw material costs.

With respect to tariffs on tungsten powders from China, we continue to expect just to have a minimal impact on our earnings as the majority of our tungsten procured would not be subject to such tariffs. Given our global operations, we will experience some tariffs related to cost as we ship products around the world.

As such, we are evaluating alternatives to mitigate these impacts via alternative production sites or other actions to help minimize the potential effects. Currently, we believe we will be able to address the net impact related to these tariffs in our current EPS outlook.

The macro effect of the tariffs on our customers in general business conditions is a more difficult question to answer. We are watching the end markets closely, particularly in China for any changes. Right now with all regions and end markets showing growth, we remain encouraged by the general health of the markets.

Further, our broad end market diversification helps us reduce our exposure to any one end market or any one region. Therefore, we remain 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. We continue to expect our effective adjusted tax rate to be in the range of 22% to 25%. Now, I'll turn the call back over to Chris..

Thank you, Damon. So to summarize on slide 18, we're off to a strong start for the year with sales and margins up year-over-year. FY 2019 is all about execution and our FY 2019 margin expansion expectations remain in line with the targets we presented at our December 2017 Investor Day.

As I said before, we are transforming into a company that operates with a focus on efficiency, manage it sales with a focus on profitability and service the customer with the most innovative products and best service levels possible.

These are the changes that will result in a transformed Kennametal, a significantly more profitable and competitive company is well-positioned for the long-term. And with that, operator, let's open it up for questions..

Thank you, Mr. Rossi. We will now begin the question-and-answer session. And your first question will be from Steve Volkmann of Jefferies. Please go ahead..

Hi. Good morning, everybody..

Good morning, Steve.

How are you?.

I am well, thank you for asking. I wanted to just ask about the $0.09 of improvement benefits that you saw in the quarter, if I remember, I think the goal for the first half was $0.10, so it sort of feels like you're running a little bit ahead of your plan.

But just wanted to see if I'm reading that right and if you've had any change to what you think sort of the full-year impact might be?.

Yeah, Steve. I don't recall us giving a specific number for the full year, let alone breaking it down by us. But – and we feel good about the progress on the $0.09 and you know as we've talked about before sort of the cadence working through the year, it's hard to actually predict that quarter-to-quarter; it can be a little bit lumpy.

But generally, we feel good about the $0.09 and as you know; our overall plan for FY 2019 is pretty much right on track of where we said would be on Investor Day. So the $0.09, I wouldn't read it we're somehow ahead or behind it, so you know we feel like we're on track of what we thought we'd accomplish in FY 2019..

Okay, fair enough.

And then maybe just a quick follow-up, on Infrastructure, you mentioned price cost a couple of times in your prepared remarks, were you actually price cost-positive in Infrastructure specifically, or was that actually a bit behind?.

Actually, in Infrastructure, we were slightly ahead..

Okay. Thank you..

Thanks, Steve..

The next question will be from Joe Ritchie of Goldman Sachs. Please go ahead..

Hi. Good morning, everyone..

Good morning, Joe..

This is Ashay on for Joe..

Okay..

Just starting off with the guidance for a second, so you guys, obviously, had a great quarter from a growth standpoint, price cost was good, simplification came through.

So could you maybe just talk us through what went behind the thinking of not raising the guide and maybe touch on the puts and takes of the high-end versus the low-end for the year?.

Yeah. It's a good question. I mean first of all, let me just make some general comments. We feel very good about the guidance, because if you think about it, we had stronger FX headwinds than we planned and we've also absorbed the impacts of any tariffs in the current forecast.

Now, as it relates to growth, our basic philosophy here in Kennametal is to stay conservative on growth estimates because we really want to challenge the organization to focus on taking cost out, execute, simplification, modernization and not try to make their numbers or margin improvements using more volume.

So generally, we feel quite good about the guidance and the other thing I would say is, look it's still early in the year, there is a lot of moving pieces here and we'll have to see how the macro environment plays out as we go forward.

But generally speaking, we feel quite good about reaffirming the guidance given the uncertainties that we've overcome..

And just to put – this is Damon. And just to put the FX in perspective. So in our first quarter, the impact relative to our original outlook is about $0.02 impact and as we look at the currency rates as they sit today, we would expect that full-year headwind to be in the range of $0.07 to $0.09 based on current currency..

Got it. Very helpful. And I guess as a follow up. So the $0.09 from simplification, like I know you guys didn't have targets where I think it surprised everyone to the upside.

As you're working through these initiatives could you maybe touch on, like, if you discovered new areas where you can put in more investment et cetera, obviously recognize that you maintained the FCF guide for the year, we're just curious if you're finding new areas of investment?.

Yeah. I think you know first of all, we kind of have a multi-pronged approach, we're going in different regions across multiple facilities. And you know my assessment is that we're learning as we go. We feel good about the savings potential that we can achieve.

And I think because our program was so broad and pretty well thought in terms of rethinking the real important end-to-end processes, it's about what we expected.

But you know one of the things that you know I've learned in my experience when you're doing these types of changes is you always find things where there's opportunities or things you hadn't thought about.

So we'll continue to look for those, but for now because the program is so broad we believe that you know it's essentially unfolding like we thought in terms of the upside.

Now, I'll let Pete make a couple of comments, because he's a little closer to details on the biggest part of modernization, industrialization, see if he's seeing some additional upside and things we hadn't talk about..

Thank you, Chris. And in fact as we go through thing, Chris said, you learn as you go and we certainly have a vision of what the future looks like which is very exciting.

As we are moving forward as a team, we do see things that are additional opportunities, but with anything like this also think that potentially might not work out exactly like we planned. So overall at this point, given where we are with overall modernization, I think it's balanced in that regard and in line with what we expected..

Thanks, Pete..

Got it. Thanks a lot..

And the next question will be from Ann Duignan of JPMorgan. Please go ahead..

Hi, good morning..

Hey Ann..

Hey, Chris, I was just giggling here because generally when we talk about seeing record attendance at a trade show at the time that we're at the peak of the cycle. So just fingers crossed that's not the case..

Okay..

I wanted to ask a little bit about mix both in Industrial and Infrastructure, if you could just talk about whether there was any positive mix maybe from aerospace in Industrial or any negative mix from energy in Infrastructure? So if you could just talk us through just mix and what you're thinking about the mix for those two businesses for the remainder of year? Thank you..

Yeah. On the Industrial side, we saw – one of our focus areas is to grow in aerospace and we saw very good growth and traction there, so that would – I would say that was a favorable mix if you will. On the Infrastructure side, I don't really think there was any strong changes in mix.

We explained that most of the leverage situation in Infrastructure is related to price cost.

The other thing that we're doing that I think could fall "in the category of mix" is we've talked to you folks about selectivity where we're really conscious in our product lifecycle management, well understanding what products are in end market delivering the most profitability to us.

And given that we have high utilization in factories, we're deemphasizing some parts of the product portfolio and shifting the focus to other parts where we have an opportunity to be more profitable.

And in particular, general engineering on the Industrial side has very good market fundamentals, strong growth potential and so as we've pruned the product portfolio, we've been able to liberate some capacity to improve our fill rates in that area.

And that's actually driven a favorable mix, too, for that business and has helped to, certainly, improve the operating leverage year-over-year in that business..

And your outlook going forward, I mean would you anticipate aerospace remaining as strong as it was or if you could talk about that? And then the same on energy, please? And I'll leave it there. Thank you..

Yeah. I mean the underlying fundamentals in aerospace and even in energy, which is largely EMEA and the Americas for us on the Infrastructure and Industrial side. The fundamentals of those industries still look very sound to us. And so we're focused on them and continue to be encouraged by the potential to grow in those areas..

Okay. I'll leave it there in the interest of time. Thank you..

Thanks, Ann..

The next question will be from Julian Mitchell of Barclays. Please go ahead..

Thank you, and just wanted to issue a warm welcome to Damon. In terms of, I guess, my first question really around the Infrastructure margins, you talked about commodity cost headwinds in the June quarter as well as this one.

When we're thinking about sort of looking ahead, I'm sure the margins will be up sequentially just from seasonality in Q2, but when do you think we start to see more traction year-on-year in Infrastructure? Is it a question of just the phasing of price increases and maybe just help us understand those?.

Yeah, I mean, as we said, the Infrastructure business has got a lot of exposure to the raw material costs. So just the fact that raw material costs moved as much as they have, and we've covered it with price. That's dampening the leverage that you'll see in the business.

But as we peel back the onion in the different pieces, we feel quite good about the actual operating leverage in the Infrastructure business. And it's a combination of – I think we're getting benefit from modernization, and I think frankly there're – we're running some of our plants in the business in general better than we have in the past.

Starting with some of the initiatives that Pete had put in before he was moved over Industrial, and Ron has continued on the Infrastructure side. So we should continue to see improvement in the operating margin on the Infrastructure, once you take out the effect of this price covering cost..

Thank you. And then my second question would just be around the Transportation segment. Obviously, a lot of concerns about automotive production the last three or four months, your own growth rate has held up very well there in the September quarter.

When you're thinking about the growth outlook for the balance of the year, firm-wide, you've got I guess a 6.5% midpoint against the 10% you just did.

Should we assume that auto or Transportation in general, that's one of the areas that will see the sharpest slowdown in the next f six months to nine months? And maybe just talk a little bit about your expectations on that transport market?.

Yeah, I think Transportation is a little bit of a mixed bag. And one of the things that we try to look at are the production numbers versus the actual sales numbers, as I think that's more indicative of when the cars are produced and are consuming our tools.

If you look at the Americas, I think that I would characterize as stable to slightly positive production numbers. EMEA, it looks like it's a little bit flat or I'd characterize that as stable production. And then there is questions in Asia Pacific, mainly concerned around China, but the projections at this point are to be flat.

So you know I think the only area that is question mark is – and everyone's asking the same question about what's the impact on the macro-environment for China. So we have those same questions, but we also look at automotive as an opportunity. We have a good chunk of our business in that space.

But really our strategies, if you look at it, to grow are not so much in automotive, they're really in the general engineering areas and aerospace and some of these other segments. So the fact that automotive is sort of stable is just fine with us. It's not an area that we're emphasizing in terms of growth going forward..

Understood. Thank you..

Thanks, Julian..

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

Hi, good morning. Welcome, Damon. I wanted to go back to the margin outlook for the year because you had mentioned that there were facility disruptions this quarter that hurt efficiency and it does seem like the Infrastructure segment incremental should be improving going forward. So there's a lot of moving pieces.

Any kind of guidance you can give us on how you're thinking directionally about the margins as we progress through the fiscal year?.

Yeah. You mentioned the manufacturing inefficiencies. And you know last year, we experienced the temporary and over time that really started in the second quarter and that was about $0.02 per quarter as we expected it kind of remain at that level throughout the year.

So the reason we referenced another $0.02 in this quarter is that we had an experience in the prior-year quarter, but it's basically in line with what we said we think we've got "inefficiency" due the temp labor and higher over time as we try to modernize in busy facilities. We've got that baked into our forecast going forward.

So I don't believe that versus where we planned our operating leverage to be and our margins that the temporary labor, over time and the use of temp labors is any different than what we expected.

So on the Infrastructure side specifically, as I said, once we pull out price covering costs, we actually had – we're very pleased with the operating leverage that we're getting, which means that they're progressing their simplification and modernization initiatives, some of which we talked about on the call already..

Okay.

And then secondly, I think you mentioned the earnings impact from currency that's now in the outlook, could you give us what that the revenue forecast is related to currency?.

Yeah. I think the revenue from a consolidated total sales growth that headwind could be in the area of 2% to 3% based on our current estimates of what's happening with FX..

Thank you..

And the next question will come from Andy Casey of Wells Fargo Securities. Please go ahead..

Thank you. Good morning, everybody.

How has everybody going?.

Good.

How are you doing, Andy?.

I'm doing fine. Thanks.

Chris, for the $0.09 of simplification, modernization that you highlighted in the chart was that skewed to any specific segment?.

Yeah. I think as we've talked about before in terms of simplification, modernization, Infrastructure business was actually ahead. For example, the Rogers, the Rogers facility is the first facility that we did and that happens to be an Infrastructure facility.

So I would say that naturally, given the way we've sequenced the simplification, modernization plan that – it's more heavily weighted towards Infrastructure, but really the opportunity as we keep talking about is on the Industrial side, and that's where the future improvements will start to come from.

But there were some improvements in Industrial too..

Okay. Thank you.

And then you've kind of answered this, but I wanted to directly ask the question, were there any other items that also dampened Infrastructure margins in the quarter outside of price cost?.

No, I don't see anything..

Okay. Excuse me. Thank you. And then some companies have reported, already noted a U.S. demand slowdown toward quarter-end in September. It doesn't look like it from your numbers, but did you see anything like that in the U.S.

or any other region?.

No, we did not see that in the U.S. In terms of China, I think that would be the only other area, where there was so much talk about, what's happening with the tariff situation that we saw just a little bit of tail off in September. But that's an area we got to continue to watch. But I would say, in the U.S.

we definitely didn't see it, in most the other sectors, it will continue to be strong. So the only thing that we've already talked about is kind of an uncertainty around China.

Now, the other thing I'd point out is, China by itself is about – based on last year's sales is about a 11% to 12% subject for us in terms of the total revenue of the company, so we are – I feel very well diversified both across end markets and a number of regions..

Okay. Thank you very much..

Thanks, Andy..

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

Hi, thanks. Good morning, guys..

Hey, Walt..

I wanted to ask about – a question about the automation and simplification.

What inning would you say that we're in now in terms of implementation, again, benefits?.

Yeah. I think we're still in the early innings of the game here.

I don't know, I would say second inning, how is that sound to you?.

Sounds all right to me..

Okay. And then the, as you roll this out are you seeing any differences between you know rolling it out in the U.S.

versus Europe or any other parts of the world? Or should we expect that maybe get out of the U.S., things start to get a little bit more difficult with simplification, automation?.

Yeah. It's a good question. The reality is we're actually – we've picked lead facilities and they happen to be based in various regions around the world. So it's not a question of we're modernizing for example, in the U.S. first, then we're going to move to China and India and Europe. We've got these programs going on in the various regions.

And in terms of characterizing the challenges, I think it's – I don't think there's really any difference between where you are operating in the world. We're transforming the facilities and it seems to me that you have the same kind of challenges you do in the U.S. as you do in EMEA, as you do in China.

And the good news about that is that as I said we're learning as we go, so we're making sure that we've got a process here to share those learnings across the regions. So bottom-line is it's a multi-pronged approach in various regions and it's not a question of one is simpler than the other..

Okay. All right. Great. Thank you..

Thanks, Walt..

The next question will be from Steven Fisher of UBS. Please go ahead..

Thanks. Good morning..

Hi, Steve..

Wondering if you could just to clarify your latest thinking on the trajectory of how this self-help margin improvement will come through over the next couple of years.

I think if we go back maybe a year or so ago, we were talking about it is going to have a hockey stick kind of benefit at the – towards the end of the program to get to your targeted margins.

Just curious, I mean has that changed at all? Are you thinking now that it's a more smoother trajectory, maybe more front-end loaded? If you could just provide some color on that, that would be great..

Yes Steven, just to reiterate what I had said back in December at our Investor Day, I don't believe we characterized it as a hockey stick. We said that the savings should come on a more smooth basis as you said.

But maybe the part you're thinking about is we did say though that in terms of footprint rationalization, those types of programs would tend to be back-end loaded. But we haven't really changed our view of that scenario at this point..

Okay.

So the margin – bottom line margin benefits should be ratable over the next two to three years?.

Right. That's the way we characterized it back in, at the December 2017 Investor Day..

Okay.

And then I'm sorry if I missed this, but I wondered if you could just talk a little bit about the price cost dynamic? And it sounds like you're seeing it more in Infrastructure and why not seeing that in Industrial as well to the same extent?.

No, I think we are seeing that we are covering – we are covering price and cost in Industrial and the reason it doesn't flow through in the margins as it does in Infrastructure is that just the material cost content as far as is much less portion of it overall total cost of the product..

Okay. Easy enough. Thanks a lot..

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

Good morning, guys. Thank you..

Hey, Ross..

Hey, Chris. So on pricing just some of the Industrial distributor, distribution customers seem to be struggling a little bit on gross margins.

Does it get harder to raise prices incrementally from here, because I would just think typically if your customers are having a harder time raising prices, it would at some point come back to you, what are you seeing there?.

Yeah. I mean I would – if we look at the whole subject of pricing, first of all the pricing actions that we've taken, our feeling is – in talking to our customers is that we're still competitive in the marketplace and many of the actions we're taking are consistent with what the competition is doing.

You know part of Ross, where we had an opportunity where you know we're focused on more strategic pricing. I don't think Kennametal historically has done a good job of understanding the value proposition of some of their products and then pricing accordingly.

And so part of the improvement that you saw in the Industrial operating leverage reflects the fact that we're now pricing based on value and we haven't really – you know I don't think any of our end customers are delighted to have a price increase, but you know the feedback is that we've been pretty consistent with what the competition is doing..

Got it. Thanks. And then the earlier question on Transportation, I mean I understand that you're maybe diversifying away from auto over time but nonetheless, it's still a relatively important part of your business today.

Could you just shed a little bit more light on the outgrowth that you are seeing? I mean clearly, as you walk through the global end market was not growing 7% last quarter.

So is it new platforms or some type of other share gain up for you and is that sustainable? And can you help us out at all just on auto versus truck within Transportation, and how much is coming from China auto?.

Yeah. I think what's happening with Transportation when you see growth is that I think we're actually – we're doing a better job of understanding the value that the product portfolio brings. So in many cases we simply are raising prices significantly based on some of the custom solutions that we provide in that business.

The other thing that's happening is as we liberate capacity by de-emphasizing some custom solutions where they either will not pay the price and we can't make good money at, that's liberated capacity to put some more product on the shelf because the automotive industry also consumes more of the standard products.

So that's helped fuel the growth there. In terms of China exposure, we basically sell through distributors, most of those distribution channels are focused on automotive I would say. So I'll turn it over to Pete here to see if he wants to add anymore color to that..

Yeah. And Chris to you point, I think we've had great success with understanding where we bring differentiation and value to the Transportation market. The team's done an excellent job from a commercial standpoint executing on that.

And in addition to as Chris said as we freed up capacity, we've had the opportunity to service customers that have higher profitability. The other thing I would say, too, is we look at Transportation, particularly in China going through distribution.

We are looking to diversify there as well with additional distributors outside of the Transportation end market..

Thanks, guys..

Thanks, Ross..

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

Hey, good morning, everyone, and welcome, Damon..

Thank you..

Just wanted to – and I apologize if I missed it here, but have you guys quantified the South Africa coal delays and is that back on track? Just any kind of color there would be hopeful?.

Yeah, I mean first of all, we haven't qualified the number, given it externally, but I would just say that it's – in terms of the overall context as Kennametal, it's a very small number.

And then my understanding of the situation that's causing it is there was a couple of mines in South Africa that had gone bankrupt, and the players that are still there are planning to ramp up capacity to offset that. But they're slow to ramp up.

So we don't necessarily see a drop-off in demand, I think demand is still there, they're just bringing the new capacity online to offset the mines that went bankrupt is the issue. But you know frankly, if we hadn't broke out the segments and try to be specific to earthworks in that region, it would be something we would never talk about..

Got it, got it. Thanks. And then just following up, obviously, there is a lot of hammering broadly in the market about China auto and that kind of thing. But you guys posted pretty impressive organic growth across-the-board in Asia.

Anything you break out there, whether it's growth in India or elsewhere, just to help give a better picture of what's driving the double-digit growth there?.

Yeah. I would say that the major growth driver for Asia Pacific from our internal numbers is really India, that's where the bulk of the growth comes from. As a company, we – well, I think we've done a good job of bringing the WIDIA brand back to front and center.

We used to be in a number one market share position, when I think the company originally bought that WIDIA brand. And so, Alexander and his team have done a good job of getting traction, putting Kennametal and WIDIA back in the game in India, that's what's driven a lot of that Asia-Pac growth..

Got it. Thanks so much, guys..

And the next question will be from Joel Tiss of BMO Capital Markets. Please go ahead..

Hey, guys.

How's it going?.

Good, Joel.

How are you?.

All right.

So just a couple little ones here, can you give us any sort of characterization or idea like what percent of the products are still on the radar to be de-emphasized over the next couple of years?.

Yeah, the whole simplification initiative, if you remember we – Kennametal had been operating in an environment where they were trying to generate 40% of sales from new products and what that amounted to was we had a lot of incrementalism in our product portfolio.

So products were different, but they weren't different enough to differentiate them in the marketplace and didn't have a value proposition that we could necessarily change price for.

So part of simplification was to start to unwind that history of incremental innovation, really streamline the product portfolio, and I think there's still more opportunity to derive benefits from that, and I think a lot of that will largely play out over this year. And then, we'll go into more of a maintenance mode beyond that.

But I don't have a specific number that I can characterize for you in terms of percentage and those types of things, so I just wanted to kind of describe the process, and how we're thinking about it..

Okay. That's fair.

And then as we get to the other end of the modernization efforts, a couple of years down the road, can you give us any sense of just sort of like the way that we should be thinking about the decremental margins? And also, like what would you view as the run rate free cash flow or your free operating cash flow numbers, as we go out a couple of years down the road? Thank you..

Yeah. On the free operating cash flow side, what we said, and based on our EBITDA projections, it's clear that we're going to continue to generate free cash flow throughout the entire cycle, despite the fact that we're increasing the CapEx spend. So we feel that that's still the way it's going to play out.

And I'm not sure I understood your question on the margins, could you repeat that?.

Yeah, the decremental margins have, historically, been kind of incrementals 30%, 35%, decremental similar, maybe a little bit lower.

And I wonder if we should be thinking that maybe that framework would change a little bit, maybe your profitability, you'd be able to hold onto your margins a little bit tighter, as we go into whatever sort of downturn may be coming over the next couple of years or whenever you get to the end of your modernization?.

Yeah I think the way it works, the way we think about it is the incremental underlying operational leverage as we go through modernization should be in that sort of 40% range that we said. And of course in any given quarter, it can move around a little bit, based on some of the things that we've even talked about in this particular quarter.

So I'm kind of thinking that is you got the sort of 40% was the underlying leverage for the business. And then as we do modernization and simplification, that's going to augment that and be added on top. And then in terms of a down cycle, like we talked about on the example in the slide, as we modernize we're going to be less dependent on labor.

And so it should actually help us in a downturn because two things are happening. First of all, we're not going to end up having to carry all of this extra head count waiting for the market to come back because we're less dependent on labor. And then fundamentally, we're lowering the breakeven point of the company.

So we should see better margin performance all things being equal compared to a period where we hadn't modernized..

Okay. Thank you very much..

And ladies and gentlemen, that will conclude our question-and-answer session. I would like to hand the conference back to, Chris Rossi, for his closing remarks..

Thank you, operator. In closing, let me make three points. First, I'm really proud of our team and the strong results that we delivered for the shareholders in the first quarter. Secondly, we continue to make progress on our growth and simplification, modernization initiatives.

Our focus through fiscal year 2019 will remain on executing these plans, while simultaneously balancing the strong market demand that we're seeing. And third, we remain confident as we are on track to deliver our original fiscal 2019 adjusted EPS outlook and feel quite good about reaffirming our guidance.

Thank you, everyone, for joining the call today. We appreciate your time and continued interest in Kennametal. Please reach out to, Kelly, with any follow-up questions you may have. Thank you..

Thank you sir. Ladies and gentlemen, the conference has concluded. A replay of this event will be available approximately one hour after its conclusion. To access the replay you may dial toll-free within the United States 877-344-7529. Outside of the United States you may dial 412-317-0088.

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