Kennametal Inc (KMT) Q1 2022 Earnings Call Transcript

Good morning. I would like to welcome everyone to Kennametal's First Quarter Fiscal 2022 Earnings Conference Call. 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 you, operator. Welcome, everyone, and thank you for joining us to review Kennametal's first quarter fiscal 2022 results. Yesterday evening, we issued our earnings press release and posted our presentation slides on our website. We will be referring to that slide deck throughout today's call. 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 statements. Risk factors and uncertainties are detailed in Kennametal's SEC filings. In addition, we will be discussing non-GAAP financial measures on the call today. Reconciliations to GAAP financial measures that we believe are most directly comparable can be found at the back of the slide deck and on our Form 8-K on our website. And with that, I'll now turn the call over to Chris.

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, and finally, I'll make some summary comments before opening the call for questions. Beginning on Slide 2 of the presentation deck. We posted strong results this quarter by successfully executing our commercial and operational excellence initiatives as underlying demand continued 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 aerospace returning to growth this quarter after eight quarters of decline. Transportation increased as well, with 14% growth year-over-year and outpacing 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 an adjusted EBITDA margin improving significantly by 730 basis points to 18.6%, demonstrating the benefits of the investments we have made over the last few years. Operating expenses 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 $0.44 compared to $0.03 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 customers' production levels in the near-term are being affected to varying degrees by supply chain bottlenecks and other uncertainties. For example, there hasn't 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 to constrain customer production levels in Q2. However, public comments from auto companies suggest the situation may start to improve in the second half of fiscal year '22. So, 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. Another source of uncertainty is related to potential power disruptions in certain regions like China, where 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 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, inflation, 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. Our proactive pricing approach, we believe, will continue to be effective in dealing with inflationary pressures. So, as always, we'll continue to focus on what we can control. 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 3 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 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. Our focus on channel access and fit-for-purpose video brand tooling, we have seen success in displacing competitors at aerospace tier suppliers in Asia Pacific. We continue to deliver innovative solutions for machining components and renewable energy equipment like wind turbines, where we provided a new drilling solution, improving productivity by 200% and extending tool life by 700%. Finally, we continue to drive share gains through our focus on expanding our wear-resistant solutions to mining adjacencies like surface mining. So, collectively, our product innovations and commercial and operational excellence are a winning value proposition, driving 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 4 with a review of Q1 operating results on both the reported and adjusted basis. As Chris mentioned, we leverage 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 and 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 and a slight 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 $0.43 versus an earnings per share loss of $0.26 in the prior year period. On an adjusted basis, EPS was $0.44 per share versus $0.03 in the prior year. The main drivers of our improved adjusted EPS performance are highlighted on the bridge on Slide 5. The effect of operations this quarter was $0.33, which included approximately $0.04 of simplification and modernization carryover benefits and the negative effect of approximately $0.12 from temporary cost control actions taken last year. The factors contributing to a substantial improvement are the same as the drivers of our strong margin performance this quarter that I just reviewed. Taxes and currency contributed $0.04 and $0.02, respectively. Slide 6 and 7 detail the 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 lower 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%, a 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 and modernization carryover. These were partially offset by temporary cost control actions taken in the prior year. Turning to Slide 7 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 at 28%, EMEA at 8% and Asia Pacific at 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 and modernization carryover benefits, partially offset by temporary cost control actions taken last year. Now, turning to Slide 8 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 quarter end, we had combined cash and revolver availability of $807 million and we're well within our financial covenants. Primary working capital decreased year-over-year to $608 million and 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 '22 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 a 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 9 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 aren't 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. When coupled with the timing of annual merit increases and incremental depreciation and amortization, the sequential increase in costs 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 that 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 and modernization carryover benefits. 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 serve as a 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 time frame, such as the full year, is more representative of the underlying performance of the business. Moving on to other variables, they are essentially unchanged from last quarter. This includes depreciation and amortization increasing $15 million to $20 million year-over-year to a range of $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 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 me take a few minutes to summarize. We posted an excellent quarter and this is demonstrated by our strong operating leverage; simplification and modernization investments are contributing to improved financial performance. Furthermore, our product innovations and commercial and operational excellence initiatives have positioned us to drive share gain and improve 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 '22 and are confident in driving strong full-year operating leverage. The strength of our balance sheet and free operating cash flow gives us the flexibility to both continue investing in our strategic initiatives and optimize capital allocation. And I remain fully confident we will meet our adjusted EBITDA profitability target of 24% to 26% when sales reach the range of $2.5 billion to $2.6 billion. And with that, operator, please open the line for questions.

Our first question comes from Steve Volkmann from Jefferies.

Maybe, Damon, I'd just pick up on sort of some of the last things you were saying, and I'll take you up on your offer to look at leverage on a longer-term basis. Can you say what you think the full year '22 sort of bookends would be for how we should think about that leverage? And then maybe even as we kind of normalize into '23, what's the right way to think about that?

So, Steve, when we consider the underlying operating leverage, we've been discussing a standard margin of around 40%, with some incremental absorption due to our facilities' utilization. I believe you all have agreed that we can expect this to approach 50% for the full year. Looking at the first quarter and adjusting for temporary cost actions, we performed better than that. We anticipate strong leverage in the second quarter as well, along with the timing of raw material benefits starting to impact the back half of the year. This will bring our average down to about 50% for the full year. Looking further ahead, Chris and I have mentioned that due to the strength of our footprint, along with our simplification and modernization efforts, we expect to maintain an average of around 50% over the longer term. However, this can vary in any given quarter due to timing issues with pricing and raw materials or other factors that could affect a specific quarter.

And then the quick follow-up, just on the OpEx target at 20%, what has to happen to get there? Is that just basically trying to hold the lid on that and grow revenue or is there something that you can do to actually lower the denominator?

I think, Steve, it's really going to be more holding that number, 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 expenses not growing in kind with the revenue growth.

The next question comes from Ann Duignan from JPMorgan.

If I could just ask a quick follow-up on the last question, it wasn't really clear to me. If you look at your operating leverage in fiscal Q1, can you just tell us what operating leverage you're calculating in the quarter? Just want to understand what you're taking out of the denominator.

So, Ann, we don't calculate the leverage directly. Instead, we provide the tools for you to do that. However, we have indicated that when you examine the change in sales compared to the change in EBIT or operating income, that represents our concept of leverage. For this quarter, keep in mind that you need to add back the $15 million of temporary cost actions from last year related to the pay reductions we implemented. From a sales standpoint, we don't expect to leverage the costs that were artificially reduced last year. Therefore, when you assess the change in sales against the change in operating income, after adjusting for that $15 million, you will see strong operating leverage this quarter, significantly exceeding the 50% benchmark we've mentioned for our cycle. This is largely influenced by the timing of the pricing actions taken by our teams before the rise in raw material costs began affecting our cost of goods sold in Q1, as well as some ongoing simplification and modernization benefits we experienced in Q1, which will lessen as we progress through FY '22.

I just wanted to make sure we were adding back the right numbers to last year. Then on a more fundamental basis, can you talk about how much your earthworks business was down in China? Specifically, you called out Asia, down 14% quarter-over-quarter, but how much was China down?

I think, Ann, we don't give specifics by end market by country. What I would tell you is I think China, as a total for us last year was around 13% of revenue, and that's both Metal Cutting and Infrastructure. But we don't go into specifics by country, by end market.

And I would just add to that, in China, there was a series of mine inspections that occurred. And I think that lowered the number beyond what we typically would see. So, that's not going to repeat in Q1, and we expect it to recover.

And then just real quick along the same lines. Any big differences in end market demand in EMEA between one segment was up 21% and the other was up 8%. Just any big differences there or just timing and different comps?

Yes, I think it's just timing and different comps.

Our next question comes from Julian Mitchell from Barclays.

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. Metal Cutting, obviously, still lagging quite a bit versus prior peaks. So maybe help us understand how quickly it can get back there and overtake the infrastructure margins. And what are the one or two main drivers? Is it really just about mix as you see transport and aerospace coming back that should automatically give you kind of super normal leverage and push the Metal Cutting margins back to that mid-high teens prior peak?

Let me summarize by saying that we still expect, as discussed in the last call, that the Metal Cutting margins will surpass Infrastructure by the end of the fiscal year, Julian. As a point of reference, both segments are experiencing margin improvement. However, it's important to note that Infrastructure has a higher material content, which makes it more sensitive to fluctuations in raw material prices. As Damon mentioned, this trend is quite favorable in the first quarter and certainly in the first half of the year, contributing to the differences we see. On the other hand, Metal Cutting margins are affected by higher labor costs and sales expenses, which creates a stronger sensitivity to volume and absorption. By increasing the volume in the Metal Cutting factories and optimizing our sales force, we will be able to enhance those margins. I appreciate your comments about achieving exceptional margins in these areas, and we are indeed focused on facilitating that growth naturally by increasing our volume.

And maybe just following up, you mentioned the price cost or material headwinds perhaps in Infrastructure that could build over the balance of the year. So I just wanted to ask two things on that point. One is what's the type of price realization you're seeing right now in your organic revenue line, just sort of order of magnitude would be helpful. And then on a net basis, should we think about price versus cost for Kennametal firm-wide being a headwind in the second half of the fiscal year or it's just kind of more neutral at that point?

I think just basically on pricing, as you know, you studied 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 costs with price, and we expect that trend to be able to continue. And I think what Damon was saying is that there's a higher level of favorability in the first half of the year, 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 inflationary costs. That's kind of how we see it. Then in terms of the realization of pricing, as I said, we've had success in the industry to bring forward price increases. So, it's never 100%, Julian. There's always some exceptions, but it's in the very high 90s, I would say, in terms of our effectiveness.

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 and volume?

I think price is a driver there. But the underlying volume, I think, is the bigger driver for sure, Julian.

The next question comes from Steven Fisher from UBS.

I'm looking at the energy business in both Metal Cutting and Infrastructure and I'm curious why the growth rates differ so much between these two segments, with 37% in Infrastructure and only low single-digits in Metal Cutting. It seems like China might be a factor, but Chris, I believe you mentioned that there haven't been any changes in demand there yet. Is there anything specific happening in these two segments for the energy business?

I think it's important to note that a significant portion of the energy sector for Metal Cutting is linked to components for wind turbines. These are considered part of the energy market. In contrast, as you mentioned, the Infrastructure segment is primarily influenced by oil and gas, which has seen a notable increase. This distinction is key. Additionally, as we discussed in last quarter's call, the wind subsidies in China were not renewed, leading to a decline in the wind turbine components business. Although it remains a strong business with a long-term growth trajectory, the removal of subsidies has caused some adjustments. That highlights the main difference.

And Steve, those subsidies ended in December, so you're going to see a couple of quarters of year-over-year decline when comparing that part of the business in Metal Cutting energy.

And just a 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 focused on how you go to market versus with what products you're actually going to market with, sort of quality of product or offering versus distribution channels and your approach to the sales effort? Well, if you remember, Steve, for Metal Cutting, as an example, we are repositioning the Widia brand to serve the fit-for-purpose application segment. And that application segment goes across all sort of end markets. And part of that was to do some channel expansion and re-engineering, and so we've realigned them. Each region in the world is a little bit different. So, that is part of it. And then the other piece of it is that the Widia product portfolio which was sort of competing and was in the same space as the Kennametal portfolio, we are adjusting that through a value engineering and value analysis effort to make sure that it's got the right value proposition at the right price and profitability for us. And so that's the other big piece is leveraging that channel to bring this other portfolio to both our existing customers as well as new customers that will be served through this channel. So, there's a little bit of both going on: some channel work and then also this product portfolio repositioning, if you will.

The next question comes from Dillon Cumming from Morgan Stanley.

Can you provide some insight into the top line guidance? It seems like demand in your end markets could support performance above the usual seasonality for the next quarter. Please correct me if I'm wrong, but I don't think transportation typically provides a significant sequential boost quarter-over-quarter, even in a normal year. Do you believe the main issue is more about supply chain constraints at the customer level, excluding transportation, that could be affecting the typical pattern, rather than an actual outperformance compared to normal seasonality? Is there anything else we should consider that might be limiting growth?

I believe you analyzed transportation well, but the issue we are facing is that transportation problems are hindering our market despite other end markets appearing strong. If we didn't have these transportation chip issues, I think our Q2 results would align more closely with prior expectations. This transportation slowdown is a significant factor for us. We also discussed a slight slowdown in China due to power uncertainties. However, since our last discussion, we have gained a clearer understanding of how the chip issue impacts transportation within our business. That is the main concern. From what automakers are publicly stating, we anticipate this situation will begin to improve in Q3 and Q4, and we expect transportation to rebound accordingly. This is the primary driver of our outlook.

And then maybe just to wrap it up, you're obviously not embedding any kind of level of restocking activity in your forecast. I mean, that's a huge surprise. But just given that inventories are so low kind of across the initial complex, your own production capacity 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 restock and what the kind of appetite for that is at the customer level?

I think, like we said, customers are being cautious in terms of the amount of stocking levels that they're carrying. And I think it's because they're looking at all these uncertainties, and that's affecting their decision, but so we expect the restocking is 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.

The next question comes from Ross Gilardi from Bank of America.

I just had a question on your share repurchase. You dipped the toe in a bit this quarter, and I'm just wondering your appetite to step that up with just your presumably improving seasonal free cash generation over the rest of the year.

For us, it's an open market repurchase, and we plan to stay flexible based on cash flow generation and other cash uses. As I mentioned in the last call, our minimum goal is to offset the annual dilution from equity-based compensation, which could be around 800,000 to 1 million shares. We'll be opportunistic, but we'll base our decisions on free cash flow and consider that as our guide compared to other cash uses we foresee moving forward.

Could you elaborately discuss tungsten along with your primary raw materials and what trends you are observing in those markets? Additionally, are you taking any steps to secure long-term supply considering the cyclical recovery you anticipate over the next several years?

APT is our largest cost driver and represents the biggest portion of our direct material expenses. To put it into perspective, in the fourth quarter, the index price was around $2.70, while the average in the first quarter was approximately $3.03, slightly above that figure. We can't purchase this material in advance or hedge against its price, which means we have to be strategic with our pricing and inventory planning. The second largest expense is cobalt, which has seen some price increases but has recently stabilized. Steel is a much smaller expense in comparison. APT has a significant impact on our costs, and this is reflected in our financial results. This is why we note the fluctuations in operating leverage from quarter to quarter, largely influenced by changes in raw material prices, given its substantial contribution to our direct costs.

And I think, Ross, you're well aware, again, we have affiliations with mines in Bolivia and so access to material is not really an issue for us. Again, the 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're 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 procure that if necessary. So, I think from an availability 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.

The next question comes from Chris Dankert from Loop Capital.

Why don't you guys were able to quantify for us, fit-for-purpose growth in the quarter, I guess, if you can break it out separately or maybe just the contribution to Metal Cutting growth, any detail you can give us on kind of the relative success there this quarter.

Chris, we are closely monitoring this important strategic initiative, which allows us to access approximately 40% of a market we weren't serving previously. It is still in the early stages, but we are encouraged by the traction we've gained. One of the ways we evaluate our progress is by comparing our growth to the general engineering market, and we've seen continued strong growth in this area this quarter. Our trajectory is steeper than that of the general market, which boosts our confidence in gaining market share. Additionally, we are seeing sales growth among existing customers who previously did not purchase this type of tooling from us, indicating that we are well-positioned. We've also expanded our channel in regions such as China, where companies are shifting from a local brand to purchasing Widia products. While we are not providing separate disclosure on this yet, we plan to share more information on its significance to our overall growth strategy at our next Investor Day.

And then just more of a housekeeping question, I suppose. Thinking about incentive compensation, can you just kind of remind us what the impact was on kind of the first quarter and kind of how that shifts into 2Q here?

From a profit standpoint or from a cash flow standpoint, Chris?

Sorry, from an EBIT standpoint, yes.

It was de minimis in Q1 from de minimis Q2 year-over-year or sequentially.

You would have considered that the incentive compensation would have been accounted for in the fourth quarter of last year.

Yes, I mean, we're accruing it's what I'll call normal targets last year and target this year. So, no real material change year-over-year in Q1 or expected for Q2.

Our next question comes from Steve Barger from KeyBanc Capital Markets.

Can I just go back to raw material for a quick second? Are you modeling sequential raw material increases as you go through Q3 and Q4 similar to what you're seeing in Q2, 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 Q1 levels?

Tungsten has continued to increase in the first quarter. Typically, this increase takes about two quarters to impact our profits and losses, so we expect to see these higher prices reflected in the latter half of the year. We are committed to being disciplined with our pricing strategies and will take necessary steps to mitigate these impacts. Our goal is to maintain a price point that is at least neutral compared to raw material costs for the entire year. Furthermore, we may actually be ahead of this goal due to the pace at which we are implementing pricing changes.

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're 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?

I believe our pricing strategy is very thoughtful, starting with our value proposition. That's how we approach discussions. We also address costs, which is important given that everyone is raising prices. However, we prioritize our value proposition. Some price increases would have occurred regardless, but in our fit-for-purpose segment, customers are more focused on value, making price a different matter; here we discuss costs more. It's a careful balancing act, but I feel we are approaching it with the right level of aggressiveness. As Damon noted, pricing remains an opportunity for us to cover raw material costs and other inflationary pressures, as we base our pricing 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 slides, 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?

We have an effective by SKU cost accounting system that accurately indicates our margins on these parts. However, our pricing strategy is not based on cost-plus pricing. When we pursue market share, particularly in transportation, we've previously discussed how, upon my arrival at the company, we were involved in many business segments where our margins were not satisfactory. Consequently, we've either distanced ourselves from that business or increased our prices. In many instances, customers are willing to pay the higher prices due to the value we provide. We've already made that shift, and we won't revert to merely acquiring market share. Our focus is on profitable growth. Regarding PV, only a few metal cutting competitors are capable of competing in this arena. Winning bids against these competitors demonstrates that our technical solution offers the best value proposition, which is not easily replicated. This gives us confidence as we transition to EV or hybrid vehicles, as each victory further solidifies our position in that market segment.

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 us on the call today. 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. Thanks.

A replay of this event will be available approximately 1 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. You will be prompted to enter the conference ID 10150733, then the pound or hash symbol. You will be asked to record your name and company. The conference has now concluded. Thank you for attending today's presentation. You may disconnect your lines.