Kelly M. Boyer - Vice President-Investor Relations Donald A. Nolan - President, Chief Executive Officer & Director Jan Kees van Gaalen - Chief Financial Officer & Vice President Martha A. Fusco - Vice President-Finance & Controller.

Stephen Edward Volkmann - Jefferies LLC Ann P. Duignan - JPMorgan Securities LLC Julian Mitchell - Credit Suisse Securities (USA) LLC (Broker) Ross P. Gilardi - Bank of America Merrill Lynch Eli Lustgarten - Longbow Research LLC Walter Scott Liptak - Seaport Global Securities LLC Rudy A. Hokanson - Barrington Research Associates, Inc.

Joel Gifford Tiss - BMO Capital Markets (United States) Andrew M. Casey - Wells Fargo Securities LLC Christopher Schon Williams - BB&T Capital Markets.

Good morning. I would like to welcome everyone to Kennametal's Second Quarter Fiscal Year 2016 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Please note that this event is being recorded.

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

Thank you, Denise. Welcome, everyone, and thank you for joining us to review Kennametal's second quarter fiscal 2016 results. We issued our quarterly earnings press release earlier today. It is posted on our website at www.kennametal.com.

This call is being broadcast live on that website and a recording of the call will be available for replay through March 3. My name is Kelly Boyer and I've joined Kennametal as VP, Investor Relations. I'm very happy to be part of the Kennametal team, and I look forward to meeting investors and analysts of Kennametal in the coming weeks and months.

Joining me on the call today are Don Nolan, President and Chief Executive Officer; Jan Kees van Gaalen, Vice President and Chief Financial Officer; and Marty Fusco, Vice President, Finance and Corporate Controller. Don and Jan Kees will discuss the December quarter's operating and financial performance, as well as our updated outlook.

And we'll be referring to a slide deck, which is posted on our website. After their prepared remarks, we will be happy to answer your questions. At this time, I would like to direct your attention to our forward-looking disclosure statement.

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

Such forward-looking statements involve a number of assumptions, risks and uncertainties that could cause the company's actual results, performance or achievements to differ materially from those expressed in or implied by such forward-looking statements. These risk factors and uncertainties are 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 to those non-GAAP financial measures can be found on our Form 8-K on our website. With that, I would now like to turn the call over to Don..

Thank you, Kelly. Hello, everyone, and thank you for joining us today. First, let me take a moment to welcome Kelly to the Kennametal team. I know she'll add great value to our Investor Relations effort going forward. I would also like to take this opportunity to thank all of Kennametal's employees around the world for their hard work and dedication.

This is a time of change and challenge for Kennametal, our industry and our end markets. And I'm very proud of their achievements during this turbulent time. The second quarter of 2016 for Kennametal was a continuation of the work we began in earnest several quarters ago.

The economic environment remains very difficult and conditions continue to worsen during the quarter. However, we are making great progress in the items that we can control and remain steadfastly focused on them. Jan Kees and I will provide detail on those progress points in today's call. First, let's talk a bit about the current operating environment.

The global industrial operating environment continues to be very challenging. We are being impacted by the three Cs; China, commodity markets and currency. Developments in China and the U.S. are weighing down on the manufacturing activity around the world. China's economy has continued to decelerate especially in the heavy industries and mining sectors.

In the U.S., industrial production is being negatively impacted by the persistent and severe decline in oil and gas prices. In addition, industrial goods tied to exports have been impacted by the strong U.S. dollar. It's becoming more apparent that we are in an industrial recession in the U.S.

Getting a little more granular on some of our key end markets, U.S. oil and gas rig counts are down 61% year-over-year and declined 22% during our fiscal second quarter. This is a greater decline than we have previously anticipated.

Coal mining continued to decline in the Central Appalachian Basin, largely because of oversupply of coal leading to lower prices and the high operating costs associated with the difficult mining geography in that location.

Within aerospace, manufacturing activity has been tempered during the last two quarters in North America, where growth was flat, while in Western Europe, the market was much stronger, expanding at a rate close to 4%. In this harsh environment, we continue to focus on our strategy.

As outlined most recently in the December Analyst Day presentations, we are committed to invest in our supply chain to drive margin expansion, optimize our go-to-market strategies, and accelerate our leadership position and productivity solutions in digital manufacturing, we'll sustain our product leadership position.

We're having success in several areas. First, as previously announced, we completed the divestiture of non-core businesses, which yielded $61 million on a net basis after working capital adjustments and transaction fees.

This is a key step in our portfolio of simplification efforts, dramatically reducing our complexity and enabling us to concentrate our efforts on the businesses where we can truly add value. This transaction encompassed 18 total facilities, 11 manufacturing facilities and seven smaller facilities.

We are very pleased with the results and are looking forward to focusing on the efficiencies that result from the simplified portfolio. Second, we continue to focus on cost-saving initiatives and are on track to accomplish the goals we set in Phases 1 through 3 of our restructuring.

We have now achieved run rate savings of approximately $80 million, and we have fully anticipated continued progress going forward. We estimate that we will achieve a run rate of $130 million in fiscal year 2017 from Phases 1 through 3. These restructuring programs and portfolio realignment will position us well when our end markets recover.

Third, as we have mentioned in the last couple of calls, we have made good progress reducing our working capital, and we continue to focus on this area. Our goal is to be in the range of $600 million to $640 million in the fiscal year 2016 year end. Lastly, we continue to fortify our management team and commercial teams.

During the second quarter, in addition to Kelly, Chuck Byrnes also came on board as leader of our Industrial Segment. Some of you've met Chuck during our Analyst Day in December. Chuck brings a wealth of knowledge, more than 30 years of experience in the metal components industry, and we're very pleased to have Chuck as part of the Kennametal team.

In terms of the financial results in the second quarter of fiscal 2016, Kennametal reported sales of $524 million versus $676 million in the second quarter of fiscal year 2015. Our organic sales decreased 12% of that total 22% decline. Adjusted earnings per share in the second quarter was $0.14 compared to $0.52 in the second quarter of last year.

These results reflect the strong headwinds in our end markets as we discussed. Year-to-date, we generated $103 million of operating cash flow and $46 million of free operating cash flow, primarily driven by working capital improvements, which Jan Kees will go into detail on later in the call.

Now, to look at our operations from a segment point of view, first, let's take a look at our Industrial business. Regardless of the cyclical ebbs and flows and the near-term macroeconomic challenges faced in the space, we really like the long-term potential of our targeted global industrial markets.

As outlined in the December Analyst Day presentations, we are committed to investing to improve our supply chain to deliver margin expansion and in optimizing our go-to-market strategies to deliver growth as we maintain our position as the technology leader.

We continued our Feet on the Street initiative, adding both technical and commercial resources to win competitive conversions at the end user. Our initiative is already bearing fruit, and this is a critical and ongoing initiative for Kennametal.

As discussed during our second quarter, we saw a continuation of recent trends, weakness in commodity markets, particularly oil and gas and coal, and a strengthening U.S. dollar and deceleration in China. We've also seen the reduction in oil and gas activities spill over into the broader industrial economy.

These macroeconomic forces have clearly affected our sales, putting significant pressure on our energy and general engineering market sales particularly in the U.S. Further, we believe the recent destocking trends continued in the U.S. and China across our customer base, but particularly in our indirect channel.

Our customers reduced their purchases to support their lower sales, but they also brought down inventories to align with lower sales expectations and we believe destocking will continue in the second half of our fiscal year 2016. We did not fully benefit from the relatively strong U.S. auto sector in the second quarter.

However, we expect to see better results in our U.S. auto business over the next 12 months as a result of renewed investment in the area. It is important to point out that while we were experiencing a challenging industrial environment in the U.S.

and parts of Asia Pacific, we believe that we outpaced the overall market growth in several emerging markets. This validates an important premise and our focus on execution.

We are seeing sales growth as a result of what we have invested today and we'll continue to invest to ensure that we are in an optimal position to drive growth in these important emerging markets.

With regard to our customer focus, an example of how we are dedicated to helping our customers reaching the higher levels of efficiency, in the third quarter, we're launching our new Beyond Evolution line of tools, which will provide our industrial customers an opportunity to increase productivity by as much as 30%.

This new family of tools enables customers to cut deep grooves and cut off faster than ever due to improved geometries and increased lubrication cooling at the cutting head.

The execution of our strong customer-focused strategies, increased Feet on the Street and our best-in-class technology and on-time delivery will strongly position Kennametal to take advantage of the favorable long-term outlook in our targeted end markets.

Now, turning to the Infrastructure segment; although the Infrastructure business is going through tremendous turmoil, we believe the industry remains attractive on a long-term basis.

In terms of the breakdown of our current Infrastructure business by end market, an estimated 25% of our sales is directly or indirectly tied to global oil and gas markets. Process industries and general industry represents another 25%, and global mining accounts for approximately 20% of our Infrastructure business.

Construction accounts for approximately 15% and the remainder is other. Of the 25% of total Infrastructure sales linked to oil and gas, approximately 2/3 is sold directly to oil and gas customers and 1/3 to the Tier 1, Tier 2 suppliers of the oil and gas market. As discussed earlier, this sector has been hard hit.

We are working closely with the key players in this market on innovative solutions to their most challenging wear and cutting problems and have been successful at maintaining and in some cases growing our market share despite the downturn. Of the 20% total which is linked to global mining in our Infrastructure business, U.S.

coal mining represents approximately half of that, and we remain a market leader in this space, delivering high-performance tools designed to excel in the most difficult operating conditions such as those in Central Appalachia. As the price of coal has decreased, higher cost mines have closed or shut in. So, we have shifted our U.S.

mining strategy to regain market share in geographies outside of Central Appalachia, focusing on customers we believe will be the long-term winners in U.S. mining. The other half of our global mining business present significant opportunities given our relatively low market share in these huge markets.

For example, we currently hold less than 10% of the market share in China, which produces over 70% of the global coal. In addition to China, other international areas of focus will be Australia, South Africa and Poland. We have very strong technical solutions and proven technologies that are highly applicable to these growth markets.

Our construction business, which right now represents approximately 15% of Infrastructure sales, also represents a significant opportunity with renewed funding for road construction and maintenance projects in the United States.

We realized 5% growth in the second fiscal quarter largely from new projects outside the U.S., and we are positioning new product launches to take advantage of what we believe will be an improving market environment globally for road construction projects. A great example of such a product is our new Road King conical product for road rehabilitation.

The product is being launched this season and will be featured at the Bauma Trade Show this April. Its design significantly increases the life and performance of the tool and also helps to extend the life of the customer's equipment. The size of the highway systems worldwide is approximately 64 million kilometers.

And it is estimated that at any particular time, 20% to 30% of all highways are in maintenance. We are excited about the global potential of this product launch.

With the completion of the non-core business divestiture, lower raw material costs and crisp execution of our strategy, we expect the profitability of our Infrastructure business to improve significantly in the coming quarters. With regard to the outlook for the balance of fiscal year 2016, we expect the challenging macro environment and strong U.S.

dollar conditions to continue. On December 14, we announced a 30% to 60% decrease in our outlook for our earnings per share guidance range, and that we would provide more detailed information on our February earnings call.

Consistent with the expectations that we communicated in December, adjusted earnings per share for fiscal year 2016 is forecast to be in the range of $0.85 to $1.05, a 41% decrease midpoint-to-midpoint, and fiscal 2016 organic sales are expected to decline in the range of 10% to 13%.

Our full year CapEx is expected to be in the range of $125 million to $135 million. This represents a slight deferral in our capital spending program and is both a reflection of the progress of our capital programs the first half, as well as prudently managing through a difficult economic environment.

A strong balance sheet and our investment-grade ratings are of key importance to Kennametal and we are committed to maintaining them. I'll now turn it over to Jan Kees for a detailed review of our financials and outlook..

Thank you, Donald. Good morning, everyone. As Don mentioned, the December quarter experienced further weakness in end market demand.

We continue to focus on cost management and cash flow, delivering further reductions in overhead and improvements in working capital to not only bring our organization in line with the current challenging market conditions, but also to permanently raise our competitiveness in our industry.

We continue to believe that in the Industrial segment, when our distribution partners work through their stock of our products, we will see significant improvements. And when our end markets recover, we will be well-positioned to leverage the benefits of all actions taken and significantly profit from market improvement.

Now, let me walk through the key components of the income statement on slides 6 through 8. Remember that I will be at times referring to non-GAAP measures. Please see our Form 8-K and press release for the reconciliations to GAAP.

As a result of the weakening end markets, adjusted EPS for the quarter was $0.14 per share, which reflects lower-than-expected organic sales and related negative mix and fixed cost absorption impacts, offset partially by lower raw material costs and restructuring benefits. By comparison, last year's same period adjusted EPS was $0.52 per share.

The $0.14 per share includes a $0.04 per share of tax benefit. Our December quarter sales were $524 million compared with $676 million in the same quarter last year, a 22% decrease. The decrease reflects the 12% organic decline, a 6% unfavorable impact from foreign exchange, and a 4% decline due to the divesture.

On a regional basis, excluding the impact of currency exchange and divestiture, sales decreased in the Americas by 22%, Asia by 12% and EMEA was down by 2% when compared to the same period last year.

Excluding the impact of foreign exchange and divestiture, sales were down in all of our served end markets with declines of 33% in energy, 12% in general engineering, 18% in earthworks, 5% in transportation, and 1% in aerospace and defense. Our adjusted gross profit margin in the current and prior periods was 27.2% and 29.9%, respectively.

In line with the reduction in our sale, the decline in our margin was due to lower organic sales resulting in lower cost absorption. In addition, we experienced unfavorable currency exchange and business mix partially offset by lower raw material costs and restructuring benefits.

Adjusted operating expense as a percentage of sales was 22.9% for the current period and 19.8% in the prior year. Adjusted operating expense declined $14 million year-over-year primarily due to favorable currency exchange of $8 million and restructuring benefits and effective cost reduction actions totaling $8 million.

Turning to the sales by business segment on slide 8; Industrial segment sales decreased to $311 million in the second quarter, a 16% decrease from $372 million in the prior year quarter. We experienced weak demand in all end markets, particularly in the Americas and Asia.

The general engineering end market weakened considerably, while we believe there was a destocking in the indirect channel, particularly in the Americas and Asia. Infrastructure segment sales of $213 million decreased 30% from $304 million in the prior year period.

Sales were lower year-over-year due to persistent weak demand in oil and gas, general industry and U.S. underground mining. As Don mentioned, we continued to make progress with our current restructuring programs, Phases 1 through 3, and realized benefits of approximately $19 million in the December quarter.

In the prior year December quarter, we realized benefits of approximately $6 million. For more complete update on restructuring costs and benefits, please see slide 9 and slide 10. A bridge of the effective tax rate is presented on slide 11.

The fiscal year 2016 difference between reported and adjusted is primarily due to the divestiture and the asset impairment charge. The tax rate in the fiscal year 2016 is a reflection of the geographic shift in earnings and the impact of the permanent extension of the R&D tax credit in the current year, extenders, as well as look-through provisions.

The balance sheet is shown on slide 12. We believe that a conservative strong balance sheet is an important strength of Kennametal. Cash on hand stands at $139 million as compared to $105 million at June month end. Our current ratio stayed constant at 2.7 as of December 30, basically level compared to 2.6 as of June 30.

As shown on slide 13, primary working capital stands at $659 million, a decrease of $175 million from $834 million at June 30. We continue to focus on inventory and receivables. Primary working capital as a percentage of sales stayed relatively constant at 35%.

We continued to employ specific and targeted actions to maximize cash flow through working capital management, and this resulted in operating cash flow of $103 million year-to-date, as noted on slide 14, despite economic headwinds on our cash earnings.

In terms of uses of cash, we paid out approximately $16 million in dividends during the quarter and total expenditures, capital expenditures were $24 million. Total CapEx for fiscal 2016 is projected to be $125 million to $135 million. As I mentioned, we've always maintained a conservative balance sheet.

And we believe this is particularly important in the current economic environment. Our debt profile and maturities are shown on slide 15 and slide 16. We continue to reduce debt. At the end of December, net debt was $568 million and we only had $5 million outstanding on our $600 million revolving facility.

Our debt-to-capital ratio was 38%, slightly up from the last quarter's level of 36%. As shown on slide 16, we have no significant debt maturities until 2019. Our investment-grade ratings and dividends are of key importance to Kennametal, and we are committed to maintaining them.

We are split rated now as Moody (sic) [Moody's] (23:43) recently downgraded us by one notch to Baa3 citing the macroeconomic headwinds that we currently face. We remain committed to our conservative capital allocation principles and we'll continue to prioritize business reinvestment for profitable growth to drive shareholder value.

Turning to the outlook for the remainder of fiscal 2016 on slide 17 and slide 18; consistent with our December announcement, we have reduced our fiscal 2016 outlook. This reduction is driven by a number of factors. We are experiencing what we believe to be a U.S.

industrial recession as well as a deceleration in economic activity in China, the extent of which was not anticipated in our prior guidance. Both of our operating segments have been impacted by these factors.

Specifically related to the Industrial segment, our expectations for general engineering and energy end markets have declined by more than 5% for the fiscal year from prior guidance. This is in part driven by the U.S. and China slowdowns but also due to the primary and secondary exposures these end markets have to oil and gas.

On a regional basis, the majority of the decrease from prior guidance is within the Americas. Related to our Infrastructure segment, our expectations overall are also impacted by the U.S. industrial environment and to a lesser extent this China slowdown.

From an end market perspective, oil and gas and power generation expectations have fallen approximately 20% due to the factors that Don previously mentioned. We have also reduced our expectations around the process industries and our general engineering end market by approximately 15% from our prior guidance.

These are due to primary and secondary exposures to energy. We now expect fiscal 2016 total sales to decline in the range of 20% to 23% and organic sales to decline in the range of 10% to 13%. Previously, total sales decline was projected to be in the range of 10% to 14% with organic sales decline of 6% to 10%.

The divestiture impacted the total sales range by approximately 6% from the prior guidance and had no impact on our organic expectations. Organic decline within our Industrial and Infrastructure segments are expected to be approximately 8% and 13% at the midpoint of our consolidated organic sales range, respectively.

We understand we need to reduce our G&A costs, and we are focused on accelerating our cost reductions in the second half. With the decline in our U.S.

earnings expectations and the impact of the permanent extension of the research and development tax credit, our effective tax rate, excluding special charges for fiscal 2016, is now expected to be in the range of 11% to 13%. Our EPS guidance for fiscal 2016 is now expected to be in the range of $0.85 to $1.05.

This represents a decrease of approximately 40% from the previous guidance at the midpoint. Slide 18 highlights the key factors underlying the change in our guidance, midpoint to midpoint. As shown on slide, the primary factors are expected, decreases in organic sales, absorption in mix, partially offset by raw material cost reductions and taxes.

Our free operating cash flow for fiscal 2016 is expected to be in the range of $90 million to $110 million.

Free operating cash flow expectations have been negatively impacted by the reduction in earnings, offset partially by better-than-expected working capital improvements and our decision to defer capital expenditures for the second half of the year. I will now turn the call back over to Don for closing comments..

Thank you, Jan Kees. I'll wrap up by saying that several quarters ago we outlined our plan to position the business to deliver improved performance, and we are executing to that plan. Despite very challenging macroeconomic conditions, we are doing what we said we would do on that account.

We took aggressive actions to simplify our business, including streamlining our manufacturing footprint. We're making good progress in the factors that we can control, focusing on the productivity of our core businesses and reducing cost. We continue to deliver world-class safety and have improved our service levels to our customers around the world.

And we have fortified our leadership team with several key additions. Our free cash flow remains strong, and we are committed to maintaining a strong balance sheet.

We believe the actions we have taken and our focus on executing our strategy will position us to take share in accelerated growth in the future as the economy and our cyclical end markets recover. We look forward to continue to serve our customers and shareholders, and thank you for your interest and support today. We'll now open it up for questions..

Thank you, Mr. Nolan. And the first question will come from Stephen Volkmann of Jefferies. Please go ahead..

Hi. Good morning..

Hi, Stephen..

Bunch of questions, but maybe I'll just go sort of big picture and leave the details for later. But, Don, you've been there a year, a little bit more than that now. And we've been through quite a bit of this.

I guess, I'm trying to figure out what do you think this business can do once it gets to sort of a better state with regard to your restructuring and cost savings and so forth? I think you alluded to Infrastructure profitability improving significantly in coming quarters.

Is this a business that can earn its cost of capital at something like where we are now, which, I assume, is sort of bottom-of-cycle-ish-type end markets? Or do you have a view of what type of profitability we can drive down the road or what you're managing to internally? And I guess, sort of corollary to that, sorry for the long question, but have we sort of completed what we need to do with the restructuring or is there more to do here? Because, clearly, the returns really haven't turned yet.

So, sorry for the long question, but whatever insight you can give there would be great..

Sure. So a lot in there, Stephen, as you pointed out. So first, can each of the segments earn the cost of capital? Absolutely. We're happy with the divestiture. We think that is a key step in getting us positioned, so that Infrastructure can get to that cost of capital.

And we would target the cost of capital at the trough and improved returns at higher operating levels. So that's certainly our goal. And the plan that we laid out in Analyst Day, in that plan, we laid out how we would expand our margins by 400 points to 500 points over the coming quarters. And we're committed to that.

We continue to focus on delivering that. Phases 1, 2, and 3 were a significant part of that, but we also have mentioned in the past that we anticipate continued restructuring and dare we call it Phase 4. So, yes, there still is opportunity for us to take cost out. We will continue to focus on that 400 margin point to 500 margin point expansion.

As far as the cost of capital, absolutely, both segments not only can but need to be at the minimum above the cost of capital..

So, I guess, I was sort of thinking maybe we would start to hear something more about this Phase 4, let's call it.

Is it just too early or how do we think about the cadence of that?.

Very focused right now on executing Phases 1, 2, and 3, as we've talked about. Phase 1 was a lot about integration of acquisitions; Phase 2, a lot about footprint reduction; and Phase 3 was a combination of footprint reduction and G&A cost reduction.

Phase 4 will most likely be a combination, again, of footprint and G&A reduction, and it's in the works..

Okay. That's helpful. Thank you. And then, just a quick follow-up, if I may. Your new CapEx budget is a little bit lower but just by quick math it's still 6% or 7% of revenue, seems kind of high.

How much of that is sort of tied to restructuring and moving things around? And what should we be thinking about sort of a sustainable CapEx rate?.

So, almost none of that is tied to restructuring capital. So, we see terrific opportunities to invest in our core, opportunities to drive productivity or to invest in production of new products for growth.

That's what the capital's all about, and we felt that the increase in investment year-over-year was warranted because of the returns that we were getting on productivity. So, that's it. And quite frankly, we're just deferring. Those projects are still there, still offer tremendous returns.

But we think, at the lower volumes that we're running right now, it makes sense to defer those investments till next year..

Okay. Thank you. I'll pass it on..

Thank you..

The next question will come from Ann Duignan of JPMorgan. Please go ahead..

Hi, Ann..

Hi. Good morning. I appreciate the color you gave us on the end markets and also where you think some of the opportunities are. Could you give us a little bit more color? I mean, focusing on growth in coal mining in China seems a little more aspirational.

I mean, I'm assuming there are suppliers there already who don't really want to give up their markets.

Could you talk a little bit more about how you think you can penetrate some of these markets that you're not in today?.

So, first of all, we think that the markets we participate in also offer opportunities. I think, certainly, the U.S. market where we have high share, we continue to see opportunities to take share there, despite the decline in the market.

The mention of China and some of the external international markets outside the United States, we think, represent significant opportunities. We have a sales force in place, so it's not as if we don't. Part of this is our regional manufacturing strategy. So we're going to be moving production in region.

It enables us to be competitive from a cost standpoint, also, quite frankly, from a service and delivery standpoint. So, sometimes it's just simple, Ann..

Okay. Thank you. I appreciate the color. And your comments on the automotive, I think you said you didn't benefit from strong U.S. automotive production in the quarter or maybe in recent quarters.

Can you expand on that a little bit and what you're doing there?.

So, I think we've mentioned for a couple quarters now that we have opportunities in North America. We think that in this past quarter, although, not time to celebrate, because the region is shrinking. But we believe that we are holding our own as far as share goes now in North America.

And part of that is some of our investment we've made in a commercial team in automotive and in other areas to support our automotive business. So, we expect that to continue to improve over coming quarters and we'll keep you posted..

Okay. I'll leave it there and get back in line. Thank you. I appreciate it..

Thank you, Ann..

Thank you, Ann..

The next question will come from Julian Mitchell of Credit Suisse. Please go ahead..

Hi. Thanks. And....

Hi, Julian..

Hi, Julian..

Hi, hey, and welcome to Kelly. Just a first question really on the Infrastructure business; I'm assuming your guidance embeds that that gets back to a sort of positive EBIT in the second half. Maybe just confirm that that is the case.

And how much of that delta from the small loss in the first half is related to the divestment disappearing versus the underlying cost actions?.

Yes. So I'll start that and Jan Kees can answer your second question. So, yes, we'll certainly expect the business to be EBIT positive on the second half, so no doubt there. And then, on the divestiture, of course, that was, thought we said, earnings per share neutral..

Correct..

Do you want to comment on that, Jan Kees?.

Yes. The divestiture in terms of EBIT didn't have an impact. In terms of Infrastructure for the second half of the year, we're really looking at volume productivity to improve the numbers..

Thanks. And then just a follow-up on the Industrial business, where you've had a sort of a similar rate of overall revenue decline the last three quarters around the mid-teens. The decremental margin now seems to have got larger even with the cost cutting.

So, I just wondered, is that because of the destocking that's under way, so that's putting a lot of pressure on your own production? Is there something happening on price or mix behind that?.

Well, I think – so, certainly, oil and gas, we have, I would say, a higher proportion of oil and gas than many other players in this market. So, it's certainly impacted us, I would say, more than most. So, when it comes back, we would expect a significant impact, too. As far as the decremental margin, Jan Kees, do you want to....

Yes. Typically, the decremental margins were related to volume, mix and productivity during the second quarter and we expect those to improve in the second half..

Okay. Thank you..

Our next question will come from Ross Gilardi of Bank of America Merrill Lynch. Please go ahead..

Sure. Thanks..

Hi, Ross..

Hi. Thanks. Good morning.

Don, can you give a little more color on the implied second half ramp which, basically, has your earnings doubling versus the first half? And why assume that volume is going to improve in the Infrastructure business in the second half of the year?.

So, on the improvement in earnings as we look into the second half, one of the key drivers is going to be taking advantage of overall material costs. We expect or we know that we're going to see a significant impact on our second half, significantly more than the first half. So, that's a key driver..

Yes, I think, Ross, I've already touched upon them. In terms of Industrial, we're looking at improvements in volume mix and productivity and for Infrastructure volume and productivity, so, basically a better outlook in terms of the decrementals..

And the other thing on the Industrial is we're starting to see some impact from our Feet on the Street initiative, our focused efforts on the top line..

Yes. I mean, I guess I understand the productivity initiatives, just the volume.

Can you just give us a little bit more? I mean, are you seeing any type of order improvement to count on any volume improvement in the second half of the year, with the share gain tied to strategic initiatives and things like that?.

Yes. It's incremental tied to strategic initiatives, but most of this is all about cost reduction. I mean, let's just call it. This is about some of the things that we've already announced around taking out G&A, and removing (40:28) cost of manufacturing.

All of this has really come to roots in the third quarter and fourth quarter, and then raw materials, the impact of raw material costs coming down. Those are the two big drivers..

Yes..

Okay, got it. And can you talk a little bit more about the balance sheet and cash flow prioritization? I thought you said your main priority was to continue to reinvest for growth and I don't know if I heard that right, but I was kind of surprised to hear that.

I was curious as to where debt reduction fits in the pecking order and if you can just comment on the safety and confidence in the dividend?.

I'll tackle the capital and leave the rest for Jan Kees. But as far as investing in the business, I feel very comfortable with some of the deferred capital investments that we've announced. We have lower volume, so when you have lower volume moving through your plants, the productivity and the returns aren't quite as high.

So, we defer those investments that are incremental in that regard, and we'll come back to them in the first quarter of 2017. The rest, what we're investing will deliver a significant productivity or position us well as we roll out new products around the world..

Yes. In terms of debt repayments, we have continued debt repayment in the first half of the year as I've discussed compared to the June year end. And we will continue to make some progress on that, either on a net debt basis by building up a cash balance, and we will make sure that we get as much of the cash back to the U.S. as we can.

We will have a balanced approach to make sure that we invest in profitable growth both, as well as keep a conservative balance sheet..

I think the other thing I would – just on the same topic, we're committed to continuing to drive our working capital down. We see continued opportunities not only in the second half of this fiscal year but continuing into fiscal year 2017..

And just the dividend, your thoughts on the dividend?.

We're committed to it..

If the demand outlook turns out to be worse than you thought in the second half of the year and you weren't covering your dividend, would you borrow to pay it?.

Let me just say that we're on track with the forecast that we put together. So, the forecast that we have put on the top line, January looks in line with what we expected. So, we have no reason to think that our expectations won't be met..

Thanks a lot..

Our next question will come from Eli Lustgarten of Longbow. Please go ahead..

Thank you. Good morning, everyone..

Hi, Eli..

Hi. Good morning, Eli..

Just one quick question on the tax rate or so.

With the credit in the second quarter, are we looking at a low-teens tax rate for the third quarter and fourth quarter? And more importantly, does the tax rate go back to normalize into the low 20s next year or does it stay down at these levels?.

I think that question in terms of the 2017 tax rate, we will discuss it at the time of providing you 2017 guidance. It depends, to some extent, as to what the sources of earnings are geographically. Some of the new tax law that was implemented in the back end of 2015 is permanent, so that will help.

And in terms of the other elements, look-through provisions, et cetera, we will see if those are, how do you say, beyond the year 2016..

But the second half of the year will be in the low-teens, is that what we should expect?.

Yes. It will be in the low-teens. Yes. Correct..

Yes. And there's nothing structurally that would get to that. You should be expecting a more normalized tax rate next year versus this year, all things considered, so you don't have all these other effects.

Would that be a fair statement?.

Eli, that's correct..

Yes. Now, as far as looking out in the second half of the year, can you give us some feeling for what to expect profitability wise in both Industrial and in Infrastructure? I mean, Industrial, you have a 7% operating margin in the quarter.

Can we get back to double digits by the end of the year? And are we talking, as we originally expected, mid-single digits to low single digits in Infrastructure in the second half of the year in operating profitability? Is that a reasonable target?.

Eli, beyond the guidance that we gave on the slides, I don't want to go into further detail..

Okay. And one of the questions is about China and I know you've highlighted that about coal. The Chinese government had just banned the opening of any new coal mines for the next three years.

So, I mean, would that kind of environment more the investments and your strategy there just to be able to hold your own in China, because it's got to be a very competitive market that can't open any more coal mines?.

Yes. But actually it plays to our strength, because there's lots of estimates out there about how many coal mines are in China. I've heard anywhere from 7,000 coal mines to 9,000 coal mines out there. And what we expect to be happening is a consolidation.

So, that plays right into our hands and if you noticed, but the largest coal mine in China, they have removed as much coal from that mine as all the coal that's mined in the United States, but just one mine, one owner of mine. So, you can imagine what this will look like as it consolidates in the top 10 coal miners in China.

So, it plays into our hands. We're very good at working with large customers, and we've got some great technology that we continue to improve on. So, we think that the time is right for us to expand in China..

And one final question, inventory liquidation which you cited.

Do you think that the channels basically have gotten relatively clean? Or would declining volume in the second half of the year, I assume that there could be some more inventory liquidation and market related as opposed to just pure inventory liquidation, is that a fair outlook?.

Destocking has always been difficult for us to see, the magnitude. We hear from our customers quite frankly but difficult with numbers around. I would expect destocking to continue through the next quarter. And beyond that, I couldn't comment..

Yes. If I could sneak one in, what happened that you had negative automotive sales in the second quarter or so? Was that like a share (47:14) or model specific? What caused that to happen? That was sort of a surprise that you would lose share in automotive in what was a pretty strong production quarter..

Well, I hate to point out, Eli, but that's actually pretty consistent with where we've been, unfortunately. Our external report last quarter was similar. So, when we've mentioned this before, this is the target area for us, significant opportunity, and we're on it..

Yeah. All right, thank you very much..

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

Hi, Walt..

Hi. Just to follow up on the last question on the auto.

You've talked in the past about market share losses, is that primarily automotive or is it across the board in the different sectors of North America?.

Yes. We haven't actually discussed that in detail, Walt. But I think in automotive, it's pretty fair to say that automotive is growing and we're not. So, we need to get on that..

Okay. And as you're talking about adding Feet on the Street, I wonder if you could talk about just the numbers of new hires, incremental costs from new hires, et cetera.

And when do you expect to start seeing benefits from the Feet on the Street?.

Well, we're already seeing benefits. We're not in a position to talk about the number of people or where or how. We consider that competitive strategy. But I can tell you it's already having an impact, and we're continuing to – this will be a key initiative for some time to come. A lot of our focus is in North America.

We think that there's some significant white spaces there, where we can win and a few other emerging markets..

Okay. And then if I could switch gears just to the working capital accounts.

Your inventories, are you expecting to bring the inventories down further in the back half of the year and by how much?.

A lot of our focus, thus far, has been on raw materials in WIP and as we reduce complexity in our feeds. And so, now, going forward, a lot of the focus will be on finished goods.

And that, again, reducing complexity, focused on line simplification, a little more difficult, but certainly something that we're good at, and it'll be a focus for many quarters to come..

Okay.

And then kind of related on accounts receivable; what kind of shape are your receivables in, in terms of – are you seeing an increase in any bad debts related to oil and gas or any stretching in some of those terms?.

No, we're not seeing increases in bad debts. Typically, many of the people that we sell to in the oil and gas sector are investment-grade and the pay is on the dot..

Okay. Thank you..

The next question will come from Rudy Hokanson of Barrington Research. Please go ahead..

Thank you. I have a question....

Hi, Rudy..

Good morning. Good morning..

Good morning..

I have a question on your oil and gas business globally. As expectations are that the U.S.

service sector in oil and gas activity are certainly in a rapid decline and when they'll recover is questionable, there are thoughts that the price of the commodity will see a pickup by the end of the year and into next year in large part because of the U.S., is falling off.

And as you talked about opportunities in China and elsewhere with coal, I was wondering if you could give us a picture of what you see for Kennametal globally in the oil and gas market?.

Well, just maybe a little color, Rudy, around how we think about it. The oil-and-gas business for us is particularly large in the United States because of the fracking that's gone on here. There's a tremendous pull because of the equipment that's utilized in fracking versus more conventional drilling.

So, for us, the big balance would be a comeback in the U.S. of drilling. So right now, I think we had said 60% of the rigs are offline. To get those back online would have a really nice impact on our business.

So, globally, the cuts that we've seen around the world as units come offline, nothing's been as high an impact as what we see in the United States. So, for us, higher oil prices would be great and would love to see United States put more of those rigs to work..

Okay.

So, just to clarify, you're not looking at opportunities, for instance, in the Middle East as they may keep a fairly high level of activity simply because you don't feel your products fit as well?.

No. We do a lot of business in the Middle East, actually. Much of that is done through the United States, where service equipment is shipped actually from here to there. It's very strong business for us, and then directly in that region. So it's a good business for us..

And very strong share..

We have very strong share around the world, but....

Okay..

... the larger volumes are in the United States..

Okay. Thank you very much..

The next question will come from Joel Tiss of BMO. Please go ahead..

Hey, guys.

How's it going?.

Hi, Joel..

Yes, good morning, Joel..

I wonder if you could give us an update on when you first started, Don, you were talking about going through the different value streams inside of Kennametal and trying to figure out where the strengths were.

We heard a couple of little highlights, but I just wondered where you are in that process and what you've discovered and maybe not giving us numbers, but just an idea if there's more pieces that need to be divested or you think the business is in pretty much what's going to be there going forward..

No, I think, running through the two segments, on the Industrial segment, I'm very pleased with what I've found; some great markets. We have some great technology. And I've got some work to do which we already talked about on the commercial side. So I think it's clearly core to Kennametal and right in our sweet spot.

I think on the infrastructure side, I think the key will be continuing to simplify that portfolio; continuing to drive some product innovation through to the market. And it's all about execution.

I mean, Joel, when it comes down to it, we've got a great game plan laid out for us to expand our margins and put ourselves in a position where we can deliver outstanding earnings on the recovery. And so, that's our game plan. So, no, I don't see any significant divestitures in the near or distant future..

And then, one for Jan, just wondered the way that you have the guidance for the second half and the way you're thinking about the business, is it more that the end markets are just, kind of, flat with where we are, the run rate that we're at now or is there further deterioration or improvement baked into some of those trends? Thank you..

No. I think....

Yes, I mean we're seeing similar run rates, Joel. I mean, I don't – at this point, we're going to continue to see – in fact, as I mentioned, January, we saw exactly what we expected what was in our forecast. So, we're on track..

Great. Thank you so much..

Thanks, Joel..

Thanks, Joel..

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

Thanks. Hi, everybody..

Morning..

A couple questions around price cost.

With the sustained dollar strengthening, meaning it's been strong for a while now and the weaker end market conditions that you continue to run into, are you seeing or do you expect any deflationary pressure during the second half in any of your businesses?.

I think deflationary being price pressure, just to be clear, Andy, we're seeing some price pressure. Some of our contracts are tied directly to raw material movements. So, we have some of that built in to our business. But I got to tell you, on the most part, we are not experiencing significant profit pressure from that price pressure..

Okay. Thanks, Don.

And then I guess, it was kind of a lead in to the gap, the performance gap between Industry and your auto growth that you're not seeing any competitive pressure there or it's just product mismatch or what's going on?.

I'll just leave it as I think right now, we have the products. We have certainly the capabilities, the engineering capabilities. And we're executing much better as we sit today than we were a year ago. And I expect to see that business improve with a short-term to medium-term..

Okay. Thank you very much..

Thanks..

Thanks..

The next question will come from Schon Williams of BB&T Capital Markets. Please go ahead..

Hi. Schon..

Hi..

Hi, Schon..

Good morning..

Good morning..

Just a little bit of housekeeping, I was little confused in the press release, you actually look like the estimated savings for Phase 1 had ticked down.

Generally, in the past, it had been kind of $50 million to $55 million ticked down to $40 million to $45 million, yet, you'd already realized $52 million, so, I don't know, any clarity there?.

Yes, Schon, that is the effect of taking the venture savings up..

Divestiture..

Yes, so that was divesture....

Yes, sir..

...that we referred to..

Okay, okay. No, that makes sense. And then I just noticed the completion date on Phase 2 I guess was pushed out two years as of the, I guess, that was actually updated last quarter but I mean, just a little clarity on why was that extended so much further into the future? Originally, the date was....

Schon, Schon, this is Marty. I'll take that one. We have a large manufacturing project in there that the timing got extended just a little bit beyond where we were last quarter and to your point we did update that..

Okay. So you're saying this one project extended the timeline by two years..

That's correct. Yes..

Check..

Okay, all right. Thanks, guys. I'll get back in the queue now..

Thank you..

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