Good morning. I would like to welcome everyone to Kennametal's Fourth Quarter Fiscal 2021 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. [Operator Instructions] Please note that this event is being recorded. I'd now like to turn the conference over to Kelly Boyer, Vice President of Investor Relations. Please go ahead.

Thank you, operator. Welcome, everyone, and thank you for joining us to review Kennametal's fourth quarter and fiscal 2021 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 to today's call. I'm Kelly Boyer, Vice President of Investor Relations. Joining me on the call today are Chris Rossi, President and Chief Executive Officer; and Damon Audia, Vice President and Chief Financial Officer. After Chris and Damon's prepared remarks, we will open the line 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 and as such, involve a number of assumptions, risks and uncertainties that could cause the company's actual results, performance or achievements to differ materially from those expressed in or implied by such forward-looking statements. These risk factors and uncertainties are detailed in Kennametal's SEC filings. In addition, we will be discussing non-GAAP financial measures today. Reconciliations to GAAP financial measures that we believe are most directly comparable can be found at the back of the slide deck and on our Form 8-K on our website. And with that, I'll now turn the call over to Chris.

Thank you, Kelly. Good morning, everyone. And thanks for joining the call today. For today's call, I'll start with some general comments on the year, followed by an overview of the fourth quarter. From there, Damon will review the quarterly financial results and our outlook in more detail. And finally, I'll make some summary comments before opening the line for questions. Now turning to slide two. In fiscal year '21, despite the obvious COVID-19 challenges, we continue to operate safely to serve customers and invest in our commercial and operational excellence initiatives, including simplification/modernization. We ended the year on a particularly strong note, with positive momentum heading into fiscal year '22, enabled by continued market recovery and advancement of our strategic initiatives that are transforming the company. The additional simplification/modernization savings in fiscal year '21 brought the total savings achieved from the program to $186 million, in line with the target range we announced in our December 2017 Investor Day, despite lower volumes than we envisioned at that time. This is a notable achievement. And while fiscal year '21 may have marked the end of investment in our simplification/modernization program, we will continue to drive benefits from this investment. In fact, the structural cost savings for the program are already contributing to strong underlying operating leverage, as volumes recover, which we saw in Q3 and Q4 of fiscal year '21 and expect to continue in fiscal year '22 and beyond. In addition, our investment in modernized processes will drive future growth and share gain. These investments enable higher levels of customer service and new product innovation, some recent examples of which include the HARVI I TE end mill, which was a 2021 Golden Edge Award winner for Best Product Innovation at the China International Machine Tool Trade Show and is…

Thank you, Chris. And good morning, everyone. I will begin on slide six with a review of our Q4 operating results on both a reported and adjusted basis. As Chris mentioned, demand trends improved significantly year-over-year and our results highlight the strong operating leverage we are now demonstrating from our continued focus on commercial and operational excellence. For the quarter, sales of $516 million improved 36% year-over-year and 29% on an organic basis from the low of $379 million in the fourth quarter last year. Foreign currency had a positive effect of 6% on sales and business days contributed another 1%. Adjusted gross profit margin of 34.5% was up 680 basis points year-over-year. Adjusted operating expenses increased year-over-year to $108 million, reflecting the reversal of temporary cost actions taken last year. Nevertheless, we were able to hold our operating expenses at 20.9% of sales, close to our target of 20% this quarter. Adjusted EBITDA margin increased to 19.2%, up 150 basis points from the prior year quarter and adjusted operating margin of 12.8% was up 400 basis points year-over-year. The 19.2% adjusted EBITDA margin is another validation point related to the successful execution of commercial and operational excellence. The last time adjusted EBITDA margins were over 19% was in the third and fourth quarters of fiscal year 2019. And that was based on quarterly sales of approximately $600 million or 15% higher than this quarter. This is yet another data point of the structural cost improvements we have made in confirming our ability to achieve the 24% to 26% adjusted EBITDA margin target as sales reached the $2.5 billion to $2.6 billion level. The improved year-over-year performance was related to higher volumes and associated absorption, benefits from simplification/modernization and a slight positive from price and raw materials, partially offset by…

Thank you, Damon. Before we open the line for questions, I'd like to make some closing remarks. Please turn to slide 12. Looking ahead in fiscal year '22, we are excited to build off Q4's momentum by leveraging our modernized footprint and strong operating leverage to drive growth and higher profitability, as well as cash flow at approximately 100% of net income. We expect the end market recovery to continue. And though visibility remains limited right now, we expect growth to outpace our normal quarterly sequential trends throughout the year. This sales performance will be driven both by market growth and our commercial excellence initiatives, aimed at gaining share in targeted end markets, including growth of our fit for purpose offering. In summary, I believe fiscal year '22 will be a year where we further demonstrate the ability to achieve our adjusted EBITDA target when sales reached $2.5 billion to $2.6 billion by continuing to execute on our strategic operational and commercial excellence initiatives. And I look forward to further outlining the details of these strategic initiatives at our next Investor Day, which is tentatively planned for early next calendar year. We'll provide more details on that as we get closer to the date. And with that, operator, please open the line for questions.

Thank you. [Operator Instructions] Our first question comes from Stephen Volkmann from Jefferies. Please go ahead.

Hi. Good morning, guys. I wonder if we can spend a minute on sort of the distributor channel, what are you seeing there relative to growth? And also any comment on kind of inventory levels or shortages or lack thereof in the distributor channel specifically? Thanks.

Yeah. We're - I guess in terms of restocking, Steve, I think that in metal cutting, we're starting to see modest restocking activity mainly in Asia Pacific and EMEA and a little more modestly in the US. But you know, overall, I think customers still have this attitude of being a little bit cautious in trying to align inventory with demand. So that's what we see there. On the infrastructure side, we think the customer inventory levels appear normal across really all the end markets. But again, the big issue for metal cutting is, as you know, in the industry when there's a recovery, there usually - there can be a snapback caused by a lot of restocking. But we don't see that. We see a little bit more methodical approach but still moving in the right direction.

Okay. Great. And then maybe, Damon, can you just take us through some more detail on kind of price cost? It looks it was positive in both segments. And can you just sort of take us through that and your outlook for the next few months?

Yeah, Steve. So we were - excuse me, we were positive in both of the business units marginally in the fourth quarter, as we had mentioned on the third quarter call. The team had put some pricing actions in place in both sides of the business. And the raw materials that increases that we were seeing normally have about a two quarter lag for us, and so we did see some positive price versus raws in Q4. I think as you heard in my pre - remarks here, we will see that benefit as well here in Q1, as those pricing actions are now in place in the first quarter the raw materials were really not - won't really start to flow into our cost of goods sold until Q2. And so our expectations are that price versus raws, as we've said in the past, that price will offset raws, but you will see a slight benefit here in Q1.

Great. Thank you so much. I'll pass it on.

The next question comes from Steven Fisher from UBS. Please go ahead.

Great. Thanks. Wondering if you could just talk a little bit about how mix affected margins in this quarter and what you expect over the next couple of quarters or whatever you have visibility to. I know there's been some relative drag from auto strength versus aerospace and energy. But it seems like the tide might be turning there. So maybe just kind of give us a little color on mix?

Sure. In fact [ph] the Q4 results a little differently than what we had thought. It's one of the reasons why we had better margins. In particular, Steven, we thought that for metal cutting that we knew the transportation would be down and affected by the chip issue, but we're trying to estimate what that might look like. And we underestimate the fact transportation was actually lower than we thought. But the good news is that general engineering was actually stronger than we thought. And since general engineering carries higher margin than transportation, you saw improved margin performance on metal cutting from what our expectations were. And something similar happen in infrastructure. Normally, the fourth quarter is the high construction season. And while that's good business, it's actually less profitable than Energy. And oil and gas surprised us. And not only surprised us, it surprised our customers because we do a fair amount of detailed customer voicing [ph] and it surprised them, too, that oil and gas bounce back as strongly as it did. So again, since oil and gas has higher margins, that helped to raise the margin above what we thought was going to happen on the infrastructure side.

Okay. That's very helpful. And also just maybe a follow-up on Steve's question. Really just kind of looking to understand how much the operating leverage could be less robust in the second half of the year versus the first half. I'm not sure if there's any way you can kind of quantify that. But maybe also related, if you could just give us a sense of what's happening with tungsten capacity because I imagine that's going to have an impact on it on what the direction of that input cost might be?

Yeah. I'll let Damon speak to the leverage here. But relative to tungsten, I think we are expecting that tungsten prices will increase as demand increases. But one thing that we've - we think we've factored in, in terms of our outlook so far, we've factored in what we think tungsten's going to be, and that's kind of in our estimates, especially for the first quarter. Beyond that, we also know that this industry, and we've demonstrated in the past that we – you know, tungsten, if there's a big move in tungsten prices, we have the ability to raise prices and adjust accordingly. And that's kind of been the history of this type of industry where price does covers raws. And as you know, on the infrastructure side of the business, some of that is - some pricing is actually indexed to the price of APT. So we feel pretty good that even as APT rises, the good news is, is that if it's not going up, that means demand for our product is going up, but we also believe that we can cover that with price over the course of the year. Damon, do you want to talk about the operating leverage?

Yeah. I think, Steve, going to the operating leverage. What we've said is we would expect to have strong full operating leverage here for the full year. And I think as we've said on some prior calls, it's 40% plus some absorption. So we've been using that 50% sort of rule of thumb. And so as we look at full year FY '22, we would expect to lever at around that 50% mark. I think to your point, we will see a little bit higher leverage here in the first quarter and the first half, and then as some certain costs come back into the system. So we go through our annual merit, we'll have inflation that we'll deal with. Travel will start to flow back into the system throughout the course of the year, at least as we sit today, again, very hard to predict the second half of our fiscal year. But we would expect probably slightly weaker leverage in the second half versus the first half, given some of those costs that would flow back in.

And I think overall, Steven, for the year, the model that many of you have been using is this 40% plus some fixed cost absorption and some of you using around 50%. So we would expect that even though the margins - the operating leverage might be higher in the first half, you know, net across the year, that 50% model that some are using is a pretty good estimate.

Terrific. Thanks very much.

The next question comes from Julian Mitchell from Barclays. Please go ahead.

Hi, good morning. Thank you for that color just now on the operating leverage. I just want to focus on it a little bit and maybe help us understand within that sort of 50%-ish number for the year and I understand it's higher than that in the first half by the sound of it. What's embedded maybe in the half and the year from pricing and raw materials? You noted, I think, 100 bps benefit in Q4 from raw materials. But if we look at the sort of combination of price and raws, how much of a margin tailwind is that embedded in the guide, please?

Yeah. So Julian, we don't give specifics related to pricing and raws. But I guess what I would tell you is, the raw material cost increases that we're seeing with tungsten escalating really won't flow into our cost of goods sold starting until Q2. And then it would sort of be sort of a run rate at that point in time. The pricing activities that the teams have put in place here started either in late fourth quarter or early first quarter here. And so we'll start to see that materialize here in the first quarter. And so again, what I would tell you is we think about from a leverage standpoint, price and raws will be a positive contributor to the leverage here, the delta between those two in the first quarter. And then as that raw material cost starts to increase into our cost of goods sold, it will negate itself more into the second quarter and in the back half.

That's very helpful. Thank you. And just sort of wondered around the operating leverage across the two divisions. I think you called out some surprises on mix, specifically in the fourth quarter within metal cutting and infrastructure. But as you're looking at the sort of mix today and your assumptions, how are you thinking about operating leverage between the two segments for the balance of '22?

Yeah. I think what I would say is you know, that, as we talked about before, Julian, metal cutting is more labor-intensive, which is one of the reasons why we're so focused on modernizing the factories. We're less dependent on labor today than we were before. But you need - you still need more volume to run through those factories and they have a larger sales expense. So we would expect that metal cutting margins will overtake the infrastructure margins by the time we get to the end of the year based on our current volumes. You'd add to that, Damon?

Great. Thank you.

The next question comes from Joel Tiss from BMO Capital Markets. Please go ahead.

Hey, guys. How is it going?

Hi, Joel. Good morning.

I wonder if we could take a little bit of a different direction. And can you highlight some of the markets or the customers where you feel like you're really gaining momentum because this is just sort of tangentially related to your not great visibility for 2022. So I just wondered if maybe some of the pieces you might have better visibility on - on some of the pieces?

Some of the end market pieces, is that what you mean?

Yes, or customers, whichever direction you feel like you've had really good discussions and you're gaining momentum. And all of a sudden, they're really noticing all the changes you've made and all the improvements and they're really buying into it.

Yeah. Well, look, in the general engineering space, we launched our fit for purpose product portfolio, which affects customers in all markets. But as you know, they have sort of - in general engineering, they have high end, high performance needs for tooling, but they also have what we call fit for purpose. And the fit for purpose segment was never one that Kennametal really focused on. And as I said in my opening remarks, it's basically because without a modernized footprint, we really weren't at the right price point and couldn't deliver with the right availability. So now that we're nearing the end of our modernization journey, we're able to sell at the right price point and still make the margins that we feel are acceptable in this business, and have the right availability and customers because they're - they have - they always have this need for this tooling, but they never were necessarily looking to Kennametal. They're starting to see that we can offer this tooling. We already have the brand recognition. So they feel good about that. In general engineering, we expect is going to continue to strengthen from Q4 to Q1 and throughout the year across all the regions. So every region, whether it's Americas, EMEA or Asia Pacific, we have examples, for instance, where we had an existing distributor. We've now given them access to this portfolio. And we're displacing some of their other metal cutting products with those customers. And in the case of brand new customers, in some cases, we've added some channel access to those customers, and again, we're now selling new to them. And we also have a program where we have target accounts, where we actually have a list of top accounts in general engineering, aerospace and in fact, energy. And we're looking at our entire product portfolio and saying that you currently are only buying x amount from us, and we want a larger share of your wallet. And so we have - we are keeping track of the wins in those spaces where we can actually measure that in some customers, we've gone from maybe 5% share to 30% share because of the way we approach them and also in part because we now can offer this fit for purpose tooling. So those are some examples that you know, when I said in my opening remarks that we're encouraged by the traction we're getting fit for purpose. And also, just generally speaking, this modernized footprint, which is helping us to actually add things to our products, innovations that we couldn't have added before because we simply couldn't manufacture them. And then also the increased availability and customer service level and the price point, all that is - all that equals that we feel like we're gaining share and on the uptick in that direction, if you will.

That's awesome. And then with your balance sheet rapidly repairing, can you talk a little bit about, you know, you're looking - are you going to look at acquisitions? Or are you going to be more focused on share repurchase? And in terms of acquisitions, what would make sense or maybe it doesn't make sense at this point because you don't want to layer on to all your modernization benefits?

Yeah. I would say in terms of the capital allocation, you know, I think the best use - we feel that the best use for our excess cash is to continue to invest in the business. So while we launched this initial simplification/modernization program, and we're going to continue to lever that, it's not like we're going to stop investing in internal processes. Of course, every one of those has to have the required returns. So we think that investments there to continue to improve our manufacturing operations and also advance our technologies. And also advance things like from a commercial excellence perspective with digital commoners and these type of things or digital connectivity to customers, those are all good areas that are going to help us drive growth and improve the underlying business. I think next is, you know, it is worthwhile looking at acquisitions. My philosophy on that is they have to be well aligned with your strategy. So probably this is going to be more of a bolt-on scenario where we can actually have an opportunity to target a specific market segment and maybe attack that market more quickly or grow faster or maybe even augment our technology portfolio. But we're going to stay inside our fairway, if you will. And then the last thing is more of a direct return to shareholders. And it's one of the reasons why we have announced the share buyback. It's a vehicle by which we can do that. We for sure, can at least help to offset dilution. But I would say that's kind of the priority sequence, investing ourselves in the organic business, don't shy away from acquisitions, but make sure they're strategically aligned and in your fairway and you can get them at the right price. And then also more of a direct shareholder return. That's the way we're thinking about it.

That’s great. Thank you so much.

The next question comes from Dillon Cumming from Morgan Stanley. Please go ahead.

Great. Good morning, guys. Thanks for the question. I guess just to start, this might be a bit kind of harder to quantify. But I was just curious if you can kind of give us a sense of what growth would look like over the next quarter or some of these issues in transportation you know, moderate maybe a bit faster than expected or maybe it's already accounted for in the high end of the outlook range. But I was just curious what your view is in terms of you know, whether or not those issues in the supply chain, the transportation side actually do kind of improve faster than expected?

Yeah. I think if I could just use the first quarter as a gauge for the full year. We have - we're expecting the transportation - we saw a decrease from Q3 to Q4, largely because of the supply chain disruptions. And we think that that's going to stay at about the same level as we saw in Q4. So to your point, Dillon, if - it actually alleviates more readily than we should move towards the higher end of our guidance. And that actually is something you could think about for the whole year. We did say that we should outperform given our current - we should be able to perform given our current view of what the markets look like, and it is a challenge because there's a lot of uncertainty. But generally, we feel like given the uncertainty we know about now, we should be able to, for the full year, achieve sales that are in excess of our normal sequential growth. But obviously, if markets become stronger or some of the supply chain shortages are alleviated more readily. And that's the only thing that does is help us and drive us towards the higher end. It's hard to tell how that's going to play out, but I really think that if things are going to go in the direction they're going to go in the direction of things get better, faster, but we're - it's hard to predict, which is why we didn't give you a full year outlook.

Yeah. No, certainly understandable. I appreciate that color. And then kind of last question for me. I think you guys had called out wind a few times in your prepared remarks. Just curious what level of growth you're seeing out of that business today? I guess, first of all, in the context of some of those government subsidy headwinds you called out and then I guess what you're kind of penciling in for fiscal '22 in terms of growth out of that business?

Yes. We talked about the - the subsidy is going away in China, which has cut the growth, but the growth is still significant, right. It's still growing quite significant year-over-year. It's a good chunk of the energy business that we report in metal cutting in Asia. So while the subsidies aren't there, it's still growing and a growth engine for us. So we feel like - we'd love to have the subsidies back, but we still feel like it's a great business and it's continuing to grow at a - over - certainly over - well, I don't want to give you an exact number, but it's a substantial growth.

Got it. Thanks for the time, Chris.

The next question comes from Steve Barger from KeyBanc Capital Markets. Please go ahead.

Hey. Good morning, guys. Chris, going back to the commercial excellence and the increased opportunity coming from fit for purpose, what do you think your growth rate should be relative to domestic or global industrial production? Is there a relationship you think about there for gauging performance?

Yeah. One of the measures that we're using is we're looking at how that fit for purpose portfolio for us is because it's a fixed portfolio, we know exactly what we're selling at any given point. And we also have models of how general - the general - overall general engineering market is moving, including our existing Kennametal brands that we're selling into that space. And the fit for purpose is outpacing that growth. And it's not outpacing it by just a small amount, it's actually quite significant. Now we're starting with a low base, but we measure this quarter-after-quarter, and we're very encouraged by the fact that the growth is outpacing fit for purpose than it would be in the normal general engineering space. And that gives us a good indication that we're gaining share. Plus we also, as I said, we kind of track this customer-by-customer, so we kind of know why we're winning and where we're winning, and we know we're picking up share with those customers. So that's our gauge of how we're measuring success, if you will, or getting an understanding that we're moving in the right direction in that fit for purpose space.

So I guess if you think about the portfolio on a consolidated basis, if we - on the outside are assuming that we see IP growth of 4% or pick a number, what do you think the relationship to Kennametal's growth is? Is it in line with IP? Is it two times? Any kind of framework that you think about?

Yeah. Maybe just a couple of things. If you're looking at IPI, that really is - as we use that as one of the inputs into our growth model, it mostly would affect the general engineering space. And - so if you had a specific IPI in mind of, say, like 5%, that would - that's a little bit more than what we're assuming in our full year kind of forecast. So I just threw 5% out there as an example number. If you - if you think IPI is going to be higher than that, then we're going to see general engineering beyond what we've given you. If you think it's going to be slightly less than that, then you might be closer to our range that we're in.

I understand. And I know it's hard to predict the back half, but just thinking about that and using your assumption of continued end market strength and no new shutdowns, is it fair to say the 11% revenue growth rate expected in consensus for FY '22 is reasonable? Or do you think that there's more or less opportunity as you go into the back half?

Yeah. I mean, I was kind of looking at - if you just took the middle of our range for Q1 and then did our normal - the middle of the range of our normal sequential pattern, that's like an 8% growth. But we said we're going to be higher than that. And if you just use Q1, typically, we're down Q4 to Q1, about 10% on average and mid point of us would - our guidance would be somewhere around 7%. So you can pick up - you're [ph] on 300 basis points better there. So you're 11% sort of high single digits, low double digits, I think, is kind of right in the right ballpark. And again, if the supply constraints turn out to be not as bad and all those kind of things, then that just helps to push it up, if you will.

Sure, understood. Thanks for the color.

The next question comes from Walter Liptak from Seaport. Please go ahead.

Hey, thanks. Good morning, guys.

Morning, Walt.

I wanted to ask about maybe a follow-on to some of these full year and longer term growth questions. But the infrastructure bill that's on the table, what do you think the benefits would be from that? It looks like there's going to be a 5 year road bill that comes back and you've got some exposure there and some of the other infrastructure could help some of the construction markets. How are you thinking about that, maybe as you get into the end of 2022 or into 2023?

Yeah. The infrastructure bill is a net positive for us, for sure. It depends a little bit on how much money is allocated to road rehabilitation. But we're not just road rehabilitation. We're also involved in trenching and drilling and - so even when you talk about expansion of the Internet, stuff that requires a lot of trenching for example. So we're quite optimistic that it might actually happen, Walt, you know, people have been talking about it for a long time, but that will be a very good thing for our infrastructure business.

Okay, great. Thank you.

The next question comes from Adam Uhlman from Cleveland Research. Please go ahead.

Hey, guys. Good morning.

Hi, Adam.

Hey, Damon on the working capital goals for the year, I guess, what are the main levers that you're looking to pull to get to 30% of sales by year end?

Yeah. I think, Adam, what I would tell you is - it's generally that we're not going to going to see most of our inventory relatively flat. It's more that the sales growth as we expect here over the course of the year will help reduce the percent, as a percent of sales. But I would expect a slight use of - slight use on AR and inventory, offset by a slight positive. So when you look at the numbers that I talked about on the call, trending to that 30% mark, you start to see working capital is maybe a slight use in cash for fiscal year '22, but not material from that overall use standpoint.

Okay. Got you. And then unrelated to that, but - can we go back to what you guys are seeing in the business in China, I guess, outside of the wind energy market. I guess what sectors are you excited about and seeing optimism and maybe are there signs of slowing in other sectors that you serve?

Yeah. I think in terms of China, in particular, we still see that general engineering is on an uptick there. They were obviously also affected by shortages from transportation. But in fact, from Q3 to Q1, we saw a decline. We think that's going to kind of level out here Q4 to Q1. But then transportation should be back on track there. So China for us is - well, it may have kind of slowed a little bit here because of the transportation disruption, it's still on an upward trajectory in general. And remember, their growth rate may slow over time and maybe a little bit - maybe slowing relative to other markets, but they are also further along in terms of the recovery. They started earlier. But we still think that it's going to be very positive for us going forward this year.

Okay. Thanks.

This concludes the question-and-answer session. I'd like to turn the conference back over to Chris Rossi for closing remarks.

Thanks, operator. And thanks, everyone, for joining the call today. As we detailed today on the call, we've made significant progress this year on our transformational journey. We stayed focused on advancing our strategic initiatives and demonstrated the type of leverage that we contain with our newly modernized equipment as volumes recover. I look forward to hosting the Investor Day early next year to present more details on our strategic plans for our continued profitability improvement and growth outpacing markets. It will also be an opportunity for you to meet our segment Presidents and Chief Technology Officer and view some of our newest product innovations. And finally, please be on the lookout for our second annual ESG report, which will be released along with our annual report and proxy later this summer. As always, we appreciate your interest and support for Kennametal. And if you have any questions, please reach out to Kelly. Thank you.

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