Q1 2022 Kennametal Inc Earnings Call
[music].
Yeah.
Good morning, I would like to welcome everyone to Ken and metals first quarter fiscal 2022 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. If you'd like to ask a question. During this time simply press Star then the number one on your telephone keypad, if you'd like to withdraw your question. Please press Star then the number two please note. This event is being recorded.
I would now like to turn the conference over to Kelly Boyer Vice President of Investor Relations. Thank.
Thank you operator, welcome everyone and thank you for joining us to review Cana metals first quarter fiscal 2022.
Yesterday evening, we issued our earnings press release and posted our presentation slides on our website, we will be referring to that's why backdrop 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.
Damon Audia, Vice President and Chief Financial Officer.
After Chris and Dennis prepared remarks, we will open the line for questions.
At this time I would like to direct your attention to our forward looking disclosure statements.
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 statements.
Risk factors and uncertainties are detailed in kennametal SEC filings.
In addition, we will be discussing non-GAAP financial measures on the call today reconciliations to GAAP financial measures that we believe are most directly comparable can be found at the back of the slide deck and on our form 8-K on our website and with that I'll now turn the call over to Chris.
Good morning, and thank you for joining us today.
I'll start today's call with some general comments on our strong results this quarter and some recent strategic wins as well as our expectations for Q2 and the full year.
Damon will then go over the quarterly financial results and the outlook in more detail.
Finally, I'll make some summary comments before opening the call for questions.
Beginning on slide two of the presentation deck.
We posted strong results this quarter by successfully executing our commercial and operational excellence initiatives is underlying demand continues to improve.
Our sales performance was in line with our expectations, increasing 19% organically year over year, and outpacing our normal quarter over quarter seasonal trend.
Year over year, we experienced growth in all regions and end markets due to our strategic initiatives and improvement in underlying demand.
Within our end markets. The strongest performance was in general engineering energy and aerospace with Arrow returning to growth this quarter after eight quarters of decline.
Transportation increased as well with 14% growth year over year.
Outpace the normal sequential decline.
That said increasing production cuts due to chip shortages and other supply chain challenges limited transportation customer demand in the quarter.
Our strong operating leverage resulted in adjusted EBITDA margin improved significantly by 730 basis points to 18, 6% demonstrating the benefits of the investments we've made over the last few years.
Operating expense as a percentage of sales decreased year over year to 21%.
And sequentially was flat on lower sales.
Our target for operating expense remains at 20%.
Adjusted EPS improved significantly to 44.
Third to three in the prior year quarter.
Free cash flow was approximately breakeven, which is significantly better than our typical Q1 use of cash.
As a reminder, cash flow in the first quarter of the fiscal year is affected by the payment of performance based compensation.
We also began our recently announced share repurchase program buying back $13 million of shares in the quarter.
Reflecting the high level of confidence we have in our growth and margin improvement initiatives and free cash flow generation.
Looking ahead.
We believe the underlying market demand is strong however, some first production levels in the near term are being affected to varying degrees by supply chain bottlenecks and other uncertainties.
For example, there has not yet been a notable improvement in the supply of semiconductor chips, which affects the metal cutting operations of our transportation and associated General engineering customers.
And although we do not expect the situation to get worse. We believe it is likely to continue the constrained customer production levels in Q2.
However, public comments for model companies suggests the situation may start to improve in the second half of fiscal year 'twenty two.
We expect revenue growth in transportation and associated General engineering to improve when our customers are able to increase production to meet the pent up demand.
The other source of uncertainty is related to potential power disruptions in certain regions like China.
They are rationing power to varying degrees in some provinces, which could affect customer production levels.
Thus far we've not seen a material effect on customer demand, but it is a source of uncertainty going forward.
Nevertheless, despite the production slowdowns related to the chip shortages and other uncertainties, we expect Q2 sales to be up 9% to 14% year over year and in line with the normal sequential growth pattern of 1% to 2%.
Which highlights the relative strength of our other end markets outside of transportation.
Now as it relates to our own operations.
Patient supply chain bottlenecks and other uncertainties are presenting some challenges.
But we believe to a far lesser extent than some of our customers and other manufacturers.
We're benefiting from our in region for region local supply chain setup and inventory planning geared toward increasing on time performance and availability levels.
And our proactive pricing approach, we believe we will continue to be effective at dealing with inflationary pressures.
As always we will continue to focus on what we can control and.
And despite the existing market and supply chain uncertainties, we remain confident in driving strong underlying operating leverage for the full year.
Now, let's turn to slide three for an update on our commercial excellence initiatives aimed at gaining share.
We've always had world class application engineering expertise and product innovation.
And we continue to leverage these core strengths to win with customers.
In addition, the investments we've made over the last few years have improved quality and delivery performance, resulting in higher levels of customer service.
As you can see from the slide our.
Our commercial excellence initiatives continue to deliver.
Through our innovation and leadership in machining electric vehicle components, we continue to win business with auto manufacturers as they add more hybrid and electric vehicles to their product portfolios.
So our focus on channel access and fit for purpose video brand tooling.
We are seeing success in displacing competitors at arrow to your suppliers in Asia Pacific.
We continue to deliver innovative solutions for machining components and renewable energy equipment like wind turbines, where.
Where we provided a new drilling solution, improving productivity by 200% and extending to life by 700%.
Finally, we continue to drive share gains through our focus on expanding our wear resistant solutions to mining adjacencies like surface mine.
So collectively.
Our product innovations and commercial and operational excellence are a winning value proposition.
Diving share gains and strong operating leverage.
And with that I'll turn the call over to Damon who will review the first quarter financial performance in more detail.
Thank you, Chris and good morning, everyone I will begin on slide four which review of Q1 operating results on both a reported and adjusted basis.
As Chris mentioned, we leveraged our modernized footprint to drive strong results this quarter.
Sales increased by 21% year over year, and 19% on an organic basis with foreign currency contributing 2%.
On a sequential basis sales declined only 6%, which is less than our normal Q4 to Q1 seasonal decline.
Adjusted gross profit margin increased 650 basis points to 33, 5%.
Adjusted operating expense as a percentage of sales decreased 210 basis points year over year to 21, 2% approaching our target of 20%.
Adjusted EBITDA and operating margins were up significantly by 730, and 870 basis points respectively.
The strong year over year margin performance was due to significantly higher volume and associated absorption as well as strong manufacturing performance, including some simplification modernization carryover benefits.
Price and mix were also positive contributors.
These factors were partially offset by the removal of $15 million of temporary cost control actions taken in the prior year.
<unk> headwind from higher raw material costs, beginning to flow through the P&L.
The adjusted effective tax rate in the quarter of 26, 9% was lower year over year, primarily as a result of higher pretax income.
We reported GAAP earnings per share of <unk> 43.
Versus an earnings per share of loss of 26 in the prior year period.
On an adjusted basis EPS was <unk> 44 per share versus <unk> <unk> in the prior year.
The main drivers of our improved adjusted EPS performance are highlighted on the bridge on slide five.
The effective operations this quarter were <unk> 33.
Which included approximately <unk> of simplification modernization carryover benefits and the negative effect of approximately <unk> 12 from temporary cost control actions taken last year.
The factors contributing to the substantial improvement are the same as the drivers of our strong margin performance this quarter, but I just reviewed.
Taxes, and currency contributed <unk> <unk> and <unk>, respectively.
Slide six and seven detailed performance of our segments this quarter.
Metal cutting sales in the first quarter increased 19% organically year over year compared to a 23% decline in the prior year period.
A foreign currency benefit of 2% was partially offset by fewer business days, which amounted to 1%.
All regions posted year over year sales growth with the Americas, leading at 22% followed by EMEA at 21%.
Asia Pacific posted more modest growth at 7% reflective of the timing of the economic recovery from the pandemic reduced government subsidies for wind energy year over year as well as slower industrial activity mainly in transportation.
Year over year, all end markets also posted gains this quarter with general engineering, leading with strong growth of 23%.
Aerospace grew 19% year over year and transportation, 14%.
Energy grew 1% year over year.
Adjusted operating margin increased substantially to 10, 2% and 920 basis point increase over the prior year quarter.
The increase was driven by higher volume mix favorable pricing versus raw material increases and manufacturing performance, including benefits from simplification modernization carryover.
These were partially offset by temporary cost control actions taken in the prior year.
Turning to slide seven for infrastructure.
Organic sales increased by 19% year over year compared to a decline of 18% in the prior year period.
A foreign currency benefit of 3% was partially offset by fewer business days of 1%.
Again, all regions were positive year over year with the Americas, leading a 28% EMEA at 8% and Asia Pacific up 7%.
The strength in the Americas was driven mainly by the improvement in the U S oil and gas market as seen in the continued increase in the U S land only rig count.
By end market energy was up 37% year over year and general engineering was up 23%.
Earthworks was also up 3%, but down sequentially, reflecting the typical seasonal decline we experienced in Q1 related to the traditional road construction season.
Adjusted operating margin improved by 760 basis points year over year to 14, 1%.
This increase was driven by higher volume favorable pricing exceeding raw material increases and manufacturing performance, including some simplification modernization carryover benefits.
Partially offset by temporary cost control actions taken last year.
Now turning to slide eight to review, our balance sheet and free operating cash flow.
We continue to maintain a strong liquidity position healthy balance sheet and debt maturity profile at.
At quarter end, we had combined cash and revolver availability of $807 million and were well within our financial covenants.
Primary working capital decreased year over year to $608 million. It was effectively flat on a sequential basis.
On a percentage of sales basis primary working capital was 32, 1% a decrease both year over year and sequentially.
Net capital expenditures were $17 million, a decrease of approximately $22 million from the prior year.
We continue to expect fiscal year 'twenty, two capital expenditures to be in the range of $110 million to $130 million.
Our first quarter free operating cash flow was negative $2 million, an improvement of $27 million from the prior year quarter, reflecting the strong sales and operating performance this quarter.
We also paid the dividend of $17 million in the quarter.
And finally, as Chris noted, we repurchased $13 million of shares during the quarter under our recently announced repurchase program.
The full balance sheet can be found on slide 14 in the appendix.
Now, let's turn to slide nine to review the outlook in more detail.
Starting with the second quarter, we currently expect sales to be up approximately 9% to 14% year over year and in the range of $480 million to $500 million.
As Chris mentioned this implies sequential growth in line with our normal seasonality of around 1% to 2%, reflecting the challenges in the transportation end market and continued uncertainty in the general macro environment offsetting strength in aerospace energy and general engineering.
At the midpoint, we've assumed transportation sales to be approximately flat sequentially. Given the continued production challenges our customers are dealing with due to the chip shortage.
Additionally, we do not expect disruptions due to supply chain or energy issues to worsen.
Lastly, given that we believe customers will continue to maintain their cautious behavior, we arent forecasting meaningful restocking.
Adjusted operating income is expected to be a minimum of $46 million, implying continued strong operating leverage year over year, excluding $10 million of temporary cost actions taken last year.
Sequentially higher raw material costs will begin to flow through the P&L as expected.
Coupled with the timing of annual merit increases and incremental DNA the sequential increase in cost will be approximately $10 million.
Lastly for Q2, we expect the adjusted effective tax rate to remain in the range of 25% to 28% and free operating cash flow to be positive.
Turning to slide 10 regarding the full year.
We believe the recovery is still underway, but the uncertainties, we discussed make the pace and trajectory difficult to forecast.
That said, we expect sales in the second half to exceed normal sequential patterns, assuming the transportation starts to recover in Q3 and other market uncertainties do not worsen.
On that basis as Chris mentioned, we expect year over year growth and strong operating leverage on an annual basis, excluding temporary cost control headwinds from the prior year.
In terms of the sequential cadence, we continue to expect operating leverage to be more favorable in the first half due to the timing of strong net price versus raw material benefits and simplification modernization carryover benefits on.
On a year over year basis, the second half will be affected by the above normal leverage we saw in the fourth quarter last year due to net price versus raw material benefits. The second half will also be affected by other inflationary pressures.
Nevertheless, we remain committed to driving strong operating leverage for the full year.
The above average leverage in the first half and these effects in the second half servers reminder of the unevenness that can occur in year over year operating leverage comparisons from quarter to quarter. This is why as we've discussed looking at leverage over a longer timeframe such as a full year is more representative of the underlying.
<unk> of the business.
Moving on to other variables they are essentially unchanged from last quarter.
This includes depreciation and amortization, increasing 15% to $20 million year over year to a range of a $140 million to $145 million capital expenditures to be in the range of $110 million to $130 million and working capital to trend towards our 30% goal by fiscal year end.
Together over the full year these assumptions translate to free operating cash flow generation at approximately a 100% of adjusted net income in line with our long term target further demonstrating our progress transforming the company.
And with that I'll turn the call back over to Chris.
Thanks, Damon turning to slide 11, let.
Let me take a few minutes to summarize.
We posted an excellent quarter and as demonstrated by our strong operating leverage.
Simplification modernization investments are contributing to improved financial performance.
Furthermore, our product innovations and commercial and operational excellence initiatives.
Well positioned us to drive share gains and improved margins as markets continue to recover.
And although supply chain bottlenecks and other uncertainties are limiting visibility. We currently expect to exceed normal sequential quarterly growth patterns in the second half of fiscal year 'twenty two.
And our confident in driving strong full year operating leverage.
Strength of our balance sheet and free operating cash flow gives us the flexibility to both.
Continue investing in our strategic initiatives and to optimize capital allocation.
And I remain fully confident we will meet our adjusted EBITDA profitability target of 24%, 26% when sales reached the range of $2 five to $2 6 billion and with that operator. Please open the line for questions.
If you'd like to ask a question. During this time simply press Star then the number one on your telephone keypad, if you'd like to withdraw your question. Please press Star then two.
Our first question comes from Steve.
Volkmann from Jefferies. Please go ahead.
Oh, Hey, good morning, everybody. Thanks for taking the question.
Steve.
Maybe Damon I would just pick up on sort of some of the last things you were saying and I'll pick up on your offer to look at leverage on a longer term basis can you say, what you think the full year 'twenty two sort of <unk>.
<unk> would be for how we should think about that leverage and then maybe even as we kind of normalize into 'twenty three what's the right way to think about that.
So I think Steve for Us when we think about the underlying operating leverage what we've been talking about for the last several quarters is sort of a 40% standard margin plus some of this incremental absorption that we've been picking up.
Given the level of the utilization of our factories and I think so.
You guys and we've agreed that Directionally. We've said that's around 50% is sort of what we would expect for the full year.
Operationally is what Youre seeing here when you look at the the first quarter and you adjust for the temporary cost actions, obviously, we levered better than that in the first quarter. We would expect to have strong leverage here in the second quarter as well and then as some of the timing of the raw material benefits and you look at it year over year start to come into effect in the back half of the.
A year, that's going to bring our average down to around 50% for the full year and then I think as you look longer Chris and I have been talking about is given the strength of our footprint with simplification and modernization efforts. We would expect on average through the cycle to do at around 50% for the longer term, but again that can fluctuate in any give.
Quarter based on some of these timing of pricing actions versus raw materials or other things that can sort of influence one particular quarter.
Okay, Great. That's clear. Thank you and then the quick follow up just on the Opex target at 20% what has to happen to get there or is that just basically try to hold the lid on that and grow revenue or.
Is there something that you can do there to actually lower that denominator.
Yes.
Steve its really going to be more holding that number we're trying to keep costs under control and relatively flat here as the merits flow into it into Q2, but really more of revenue growing and operating expense is not growing in kind with the revenue growth.
Understood. Thank you guys.
The next question comes from.
<unk> from J P. Morgan. Please go ahead.
Yes, if I could just ask a quick follow up on the last question wasn't really clear to me.
You look at your operating leverage in fiscal Q1 can you just tell us what.
Operating leverage you're calculating in the quarter and just wanted to understand what you are taken out of the denominator. Thank you.
Yes, so and we really don't.
We calculate the leverage.
We sort of give you guys the tools to do that but what we have said is when you look at the change in sales versus the change in EBIT or change in operating income.
That is sort of what we would term the leverage here again. This quarter you have to go back and you have to add back the $15 million of temporary cost actions that were in effect last year because of the pay reductions that we had in place and what we've said is from a sales perspective, we wouldn't ever expect to be able to leverage on those costs.
That were artificially lower last year. So when you look at the change in sales versus the change in operating income adjusting for that $15 million you see a very strong operating leverage in the quarter well north of this 50% that we've been talking about as sort of a rule of thumb for the cycle for us and Thats partly are heavily influenced.
By the timing of the pricing actions that our teams put in place before the raw material costs have really started to flow into our cost of goods sold here in Q1 also some of the carryover simplification monetization benefits.
That we saw in Q1, and those will sort of reduce themselves as we move through the year here in FY 'twenty two.
Okay I appreciate the clarification and then just wanted to make sure we were adding back the right numbers to last year.
And then a more fundamental basis can you talk about how much.
<unk> business was down in China, specifically, you called out Asia down 14%.
John required to parse how much was China then.
Yes, I think and we don't give specifics by end market by by country. What I would tell you I think as you.
China as a total for US last year was around 13% of revenue and Thats, both metal cutting and.
And infrastructure, but we don't go into specifics by country by end market.
I would just add to that.
In China, There was a series of mine inspections that occurred.
I think that that lowered the number beyond what we typically would see.
That's not going to repeat in Q1, we expect it to recover.
Okay. Thank you and then just read back along the same lines.
Any big differences in end market.
Demand in.
EMEA.
Mid teens.
<unk> segment was up 21, and the other was up eight just.
Any big differences, there just timing and different comps.
I think it's just timing and different to different comps.
Okay. Thank you I'll leave it there.
Okay. Thanks, Dan.
Our next question comes from Julian Mitchell from Barclays. Please go ahead.
Hi, good morning.
Just wanted to.
Explore a little bit perhaps the margin difference between metal cutting and infrastructure infrastructure has come back close to prior peak margins.
Already now for a couple of quarters, so very very good performance there.
Cutting obviously is still lagging.
Quite a bit versus prior peaks.
Maybe help us understand how quickly it can get back there and overtake the infrastructure margins.
And what are the one or two main dry but is it really just about mix as you see transport and arrow coming back that should automatically give you kind of super normal leverage and push the metal cutting margins come back to that mid high teens prior peak.
Yes, let me just.
I guess to give you the punch line, we still expect like we talked about last on the last call that the metal cutting margins will overtake infrastructure by the end of the fiscal year Julien.
And then just in the way of background.
Both segments of course are seeing margin improvement, but keep in mind with infrastructure. They have a higher material content and that leads to greater sensitivity to this price raw timing and as Damon said, that's that's quite favorable in Q1 and certainly in the first half. So that's driving part of the difference for sure then our model cutting margins they have a high.
Labour content and also a higher sales expense so that leads to much greater sensitivity to volume.
And the related absorption so as we drive more volume through through the metal cutting factories and leveraging that sales force.
That's going to help drive the.
Higher margins.
Like what you said about Super Duper margins and these other other areas and so we're certainly focused on growing those but it will happen naturally just by bringing more volume through.
That's helpful. Thank you, Chris and maybe.
Just following up you mentioned.
The price cost or material headwinds, perhaps an infrastructure that could build over the balance of the year.
So just wanted to ask two things on that 0.1.
One is.
What's the type of price realization, you're seeing right now in your organic revenue line.
Sort of the order of magnitude would be helpful.
And then on the net basis should.
Should we think about price versus cost.
And the metal firm wide being.
A headwind in the second half of the fiscal year or it's just kind of more neutral at that point.
Yes, I think just just basically on pricing as you know you're studying this industry for a while we've had a lot of success in being able to offset in this case, we're talking about material cost with price and we expect that trend to be able to continue.
And I think what Damon was saying is that there is.
Higher level of favorability in the first half of the year of price versus raw versus the second half of the year, but over the course of the full year, we still expect to be neutral to maybe even have some upside to cover other other inflationary costs, that's kind of how we see it.
And in terms of the realization of pricing.
As I said, we've had we've had success in the industry to.
Bring forward price increases so it's never it's never it's never 100% Julien Theres always some exceptions, but it's in the very high 90% I would say in terms of our effectiveness.
ICEE and Chris any sort of color on within the organic sales growth right now in the first half of the fiscal year kind of any split of price in battle price versus volume.
I think price is a driver there but.
The underlying volume I think is the bigger driver for sure Julien.
Great. Thank you.
The next question comes from Steven Fisher from UBS. Please go ahead.
Thanks, Good morning.
At the energy business in both metal cutting and infrastructure and just curious why the growth rate just so different.
Between those two segments with 37%.
In infrastructure and kind of low single digits.
Metal cutting it seems like maybe China could be a difference, but I think Chris you said you werent seeing.
Any changes in demand there yet so just curious.
If there is anything in particular going on in those two segments of it.
For the energy business.
I think the thing to keep in mind energy for metal cutting is has a high percentage of associated with components for wind wind turbines.
Technically that's a piece of equipment operates in the energy markets and we classify it as energy versus.
You correctly pointed out infrastructure is more driven by oil and gas and there's been a large uptick in that so that's the difference and as we talked about.
I think last last quarter's call.
The wind subsidies in China.
It had been.
Not renewed in that country and so we saw a decline in the components business for wind turbines.
It's still it's still very good business and still has a long term growth trend, but in terms of point of subsidies you saw this sort of this adjustment.
So that's the that's the main difference Steve those subsidies ended in December so youre going to see a couple of quarters of year over year decline compare comparing that to the for those that particular part of the business and metal cutting energy.
Got it.
And just.
Follow up more of a strategic question I know you guys have focused on gaining market share. So I'm curious how much of the key to your competitiveness.
Is <unk>.
Focus on how you go to market.
Versus with what products, you're actually going to market with.
The quality of product or offering versus.
Distribution channels and your approach to the sales effort.
Yeah, well, if you remember Steve for metal cutting so as an example.
We are repositioning the video brand too.
To serve the fit for purpose applications segment.
That application segment goes across all.
Alternative end markets and part of that was too.
Do some channel expansion and reengineering and so we've realigned them in each region of the world and a little bit different.
So that is part of that is part of it and then the other the other piece of it is is that the video product portfolio, which was sort of competing and within the same space as.
Kennametal portfolio, we are adjusting that through value engineering and value analysis effort to make sure that it's got the right value proposition at the right at the right price and profitability for us.
And so that's the other that's the other big pieces leveraging that channel too to bring this out our portfolio to both our existing customers as well as new customers that will be served through this through this channel.
So there's a little bit of both going on some channel channel work and then also this product portfolio repositioning if you will.
Got it thanks a lot.
The next question comes from <unk> coming from Morgan Stanley. Please go ahead.
Hey, good morning, guys. Thanks for the question I Wonder if I can just start asking about kind of the topline guidance I mean, it feels like demand across your end markets would appear to kind of support performance above normal seasonality for next quarter. I mean, you can correct me if I'm wrong, but I don't think transportation is normally a huge sequential tailwind for you guys kind of quarter over quarter, and I guess and that's even in normal years.
Do you feel like is it more supply chain constraints that come to the customer level outside of transportation that might be driving the more normal sequential pattern versus the level of outperformance.
Or kind of is there something else to keep in mind, there that's actually constraining growth a bit.
Yes, I think it's really.
I know you did your math on transportation, but it's really.
Transportation was.
What I would say, even if even at their normal levels.
We wouldn't be having this conversation.
To your point the other markets end markets seem to be strong and but the transportation ship issue as you know is basically slowing slowing.
Following that that that market down but without that we.
Q2, I think it would be more in line with what your prior expectations were in terms of consensus. So that's really the that's really the driver.
We talk to us a little bit of a potential slowdown in China. There is some power uncertainties in those type of things but.
Frankly, it's from what's changed from the last time, we talked to you guys was we now have a better feel of what the impact of the chip issues, having on transportation as it relates to our business. So it's really to me it's about that.
And that's the big uncertainty our current feeling is that.
Based on what the automakers are saying publicly any way that that situation. So you should start to improve in Q3 and Q4.
And so we look for transportation to to come back accordingly.
The big driver, though.
Got it that's helpful. Chris and then maybe just to wrap it up you are obviously not embedding any level of restocking activity in your forecast when we get the huge surprise because given that inventories are still open across the industrial complex your own production capacity it seems to be a bit more isolated from some of the supply chain pressures can you just talk a little bit about when you might expect a more meaningful restocking what they kind of.
Thanks, Ed.
<unk> level.
Yes, I think.
Customers are being cautious in terms of the amount of that.
Stocking levels that they're carrying.
And I think its because theyre looking at all of these all of these uncertainties and that's affecting their decision but.
So we expect that restocking is still there's still an opportunity. That's ahead of us and as Damon talked about at least in Q2, we don't expect that to change significantly.
Maybe it will start to improve in the later half of the year.
As another opportunity.
Got it thanks for the time.
The next question comes from Ross Gilardi from Bank of America. Please go ahead.
Hey, good morning, guys.
Hey, Ross.
Yes, just had a question on your share repurchase you dip your toe in a bit this quarter and I'm just wondering your appetite to step that up with just.
You're presumably improving seasonal free cash generation over the rest of the year.
Yes, I think Ross.
For us, it's sort of an open market repurchases or what we've said is we're going to be flexible based on cash flow generation and other uses of cash I think as I said on the last call or at a minimum our goal would be to try to offset the annual dilution that we deal with as a company with equity based compensation and that could be somewhere in the range of.
Given your 800000 to maybe a million shares so we're going to be opportunistic.
But I don't think we're going to we'll look at those based on free cash flow and sort of use that as our guide versus other uses of cash that we see here going forward.
Okay got it.
And then obviously you guys have addressed some of it is the price cost issues, how youre thinking about it but could you talk a little bit more about.
Tungsten and your key raw materials, and what you're really seeing in those markets.
Are you doing anything to and are there opportunities to secure longer term.
Apply given the.
Cyclical recovery that.
You guys seem to anticipate for the next several years.
Yeah.
Yes so.
<unk> is the biggest cost driver for us is definitely the biggest spend we have for <unk>.
Material perspective.
And just to put it in perspective, Rod I think in Q4 it was around this.
This is an index price of $2 70.
And Q1 average was around 303 or just slightly above so.
There is no mechanism to buy that material and advance our hedge it or anything like that so it kind of is what it is and we have to that's why we have to be strategic about our pricing in those type of things and also our inventory planning.
The second <unk>.
Spend would be called out and it's quite a distance spend.
Dan.
That is also seeing some increases but its recently its stabilized and then the third of course would be steel and that's it.
The smaller part of our overall spend so the big effect for US is on <unk>.
And you can see it in the numbers that's why we talk about this.
Unevenness in quarter to quarter operating leverage that can be driven a lot by this price price raw material, because because it's such a big part of our our direct cost and I think Ross Youre well aware again, we have in mind, we have affiliations with mines in Bolivia, and so access to material is not really an issue for us you're going to price as Chris alluded to is something we.
Deal with and we've been very effective in raising prices, but in addition to those affiliations with the mines again I think you are aware. We also have a very robust global recycling program that allows us to get access to material back to our factories and then we do have some third party contracts, where we can buy for procure that if necessary. So I think from an.
<unk> standpoint, we're not overly concerned and as Chris said, we've been diligent in addressing the pricing side of the house to address the inflation on the cost.
Got it thank you very much.
The next question comes from Chris Dankert from Loop capital. Please go ahead.
Hey, good morning, everyone.
Why don't you guys were able to quantify for US just fit for purpose growth in the quarter I guess, if you can break it out separately or maybe just the contribution to metal cutting grows it in any detail you can give us on kind of the relative success. There this quarter.
Yes, Chris.
It's something we're watching closely because as I said its important strategic initiative and it opens up.
Basically a 40% part of the market that we werent really serving before.
So we track it closely still early stages, but we feel quite good about the traction that we're getting.
And.
And one of the ways that we.
Measure ourselves isn't growing faster than.
And then the normal general engineering market by itself and.
Sequentially that happened again this quarter. So we're getting very good traction on it it's on a trajectory that's different than the Gen. Gen end market, a steeper and steeper trajectory. So that gives us some confidence that we're growing share and also because we.
We measure this.
Sales of that to existing customers, where they werent buying this type of tools from us before anecdotally that tells us again that were.
We're positioned in the right place and then actually we've had some places where we've now expanded.
Our channel for example in China.
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And they were the <unk>.
Companies were buying a local brand and Theyre now buy and Theyre not buying video. So we feel like we're getting good traction.
We're not breaking it out separately for public disclosure.
But when we have our next Investor day, I think we'll be able to give a little more color on.
And where we see that thing heading and how important it is to our overall growth strategy.
Got it I think thanks for that Chris that's helpful.
And then just more of a housekeeping question I suppose I'm thinking about incentive comp can you just kind of remind us what the impact was on kind of the first quarter and kind of how that shifts into into <unk> here.
From a profit standpoint or from a cash flow standpoint, Chris sorry from a from an EBIT standpoint, yeah.
It was de Minimis in Q1.
And there'll be dominion's Q2 year over year or sequentially.
You would have taken them.
Incentive comp would have been reserved in Q4 last year, yes, I mean, we're accruing at what I'll call. It a target last year and target this year.
No real material change year over year in Q1 were expected for Q2.
Perfect. Thanks, so much guys.
Our next question comes from Steve Barger from Keybanc capital markets. Please go ahead.
Hey, Thanks, good morning.
Can I just go back to raw material for a quick second are you modeling sequential raw material increases as you go through <unk> and <unk> similar to what Youre seeing in <unk>, which will be a drag on gross margin and incrementals or are you going to be price cost neutral in the back half, meaning gross margin grows from <unk> levels.
So we are so steep tungsten as I as Chris just said on one of the prior questions. Tungsten has continued to increase here in the first quarter I think as you know that generally takes around two quarters to lag into our P&L and so we will start to see these higher prices flow through here in the back half.
Chris has also said is again, we're going to remain disciplined on our pricing actions and we will do what we need to do to offset those.
We'll be at a minimum price versus raws neutral for the full year and I think as Chris alluded to earlier, we might be a little bit ahead of that based on the speed at which we are putting our pricing actions in effect.
Understood and I know getting pricing right is always hard, but just broadly speaking through earnings season, we're seeing mid single digit to low double digit price increases across the industrial space.
Are you driving more price from the value added strategy, you are putting in place or more from cost covering price increases and just in general why not be a little more aggressive on price given the environment.
Yes, I think we're.
I think our pricing is very strategic and we always start with the value the value proposition.
And so.
That's the basis in which we go in.
And we also talk about we also talk about cost and and that's a conversation that also kind of helps because as you know the environment is everyone's raising prices right.
But we start with.
With our value proposition discussion some of these price increases we would've put in any way on that basis.
But for example in our fit for purpose segment.
There those customers are looking more at value.
So price is at a different point and so there may be the conversation is more around cost.
And so it's about it's a balancing act, but I think we're being I think we've got the right aggressiveness and at statement payment pointing it out.
Price.
It should still be an opportunity for us in terms of not only covering the raw material costs, but also.
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Other inflation other inflationary pressures and the reason for that is because we're also pricing based on value.
So if I can just ask a quick follow up when you talk about a major win at an auto OEM for instance, like in the slide is that taking 100% of that cutting tool business and does that volume usually come at the expense of margin or how do you gauge what's acceptable as you try and go into the market and take share.
Yes.
Yeah.
We have a very good.
By SKU, a cost accounting system that tells us exactly what kind of margin, we're making on these on these parts, but we do not price necessarily based on it's not definitely it's definitely not a cost plus pricing.
So when we when we're taking a share, especially in transportation and we've talked about this before because when I first came in the company.
We had we had ended up taking I think as a company, we're taking a lot of business, where we werent necessarily making acceptable margins and we either moved away from that business or raised our prices.
And in many cases, the customers actually pay the higher price because they because of the value of our delivery. So we've already sort of made that transition and we're not going to let ourselves fall back into just getting.
Buying share if you will what we're looking for is profitable growth.
And when Youre talking about.
PV. Some of these applications are there's only a few metal cutting.
Competitors that can even have a shot at this and we're bidding are bidding against those.
Those competitors and so when you win it tells you that your technical solution was was brought the best value proposition and it's not something that just anyone can deliver and that's what gives us confidence that.
As we move to EV or even hybrid vehicles.
With every one of these wins I think we strengthened our position in that in that segment.
Thanks very much.
This concludes the question and answer session I would like to turn the conference back over to Chris Rossi for closing remarks.
Thanks, operator, and thanks to everyone for joining us on the call today as.
As we said this was a strong quarter and I think another data point, demonstrating that our strategic initiatives to drive share gain and margin improvement and strong operating leverage are working.
Also just a quick reminder, we issued our second annual ESG report, which is now posted on our website.
And as always we appreciate your interest and support please don't hesitate to reach out to Kelly. If you have any questions on today's call.
Have a great rest of your day.
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