Kelly M. Boyer - Vice President-Investor Relations Ronald M. DeFeo - President, Chief Executive Officer & Director Jan Kees van Gaalen - Chief Financial Officer & Vice President Charles Michael Byrnes - Vice President, Kennametal Inc. and President, Industrial Segment Peter A. Dragich - Vice President, Kennametal Inc.

and President, Infrastructure Segment.

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

Jorge Baptista Pica - Wells Fargo Securities LLC Samuel H. Eisner - Goldman Sachs & Co. Steve Barger - KeyBanc Capital Markets, Inc..

Good day and welcome to the Kennametal's Fourth Quarter and Fiscal Year 2016 Financial Results Conference Call and Webcast. All participants will be in listen-only mode. Please note today's event is being recorded. I would now like to turn the conference over to Kelly Boyer, Vice President, Investor Relations. Please go ahead..

Thank you, Rocco. Welcome, everyone, and thank you for joining us to review Kennametal's fourth quarter and fiscal 2016 year-end results. We issued our quarterly earnings press release yesterday evening and it's 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 September 2. I'm Kelly Boyer, Vice President of Investor Relations.

Joining me on the call today are Ron DeFeo, President and Chief Executive Officer; Jan Kees van Gaalen, Vice President and Chief Financial Officer; Marti Fusco, Vice President, Finance and Corporate Controller; Chuck Byrnes, President, Industrial Business Segment; and Pete Dragich, President, Infrastructure Business Segment.

Ron and Jan Kees will discuss the June quarter and total year operating and financial performance as well as our outlook for fiscal year 2017 and we'll be referring to the slide deck posted on our website. After their prepared remarks, we will be happy to answer your questions.

At this time, please direct your attention to our forward-looking disclosure statement. Today's discussion contains comments that constitute forward-looking statements and involve a number of assumptions, risks and uncertainties that could cause the company's actual results to differ materially from those expressed in or implied by those statements.

These risk factors and uncertainties are detailed in Kennametal's SEC filings. Also, 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 on our Form 8-K on our website. With that, I would now like to turn the call over to Ron..

Thank you, Kelly, and hello, everyone, and thank you for your interest in Kennametal. I'm going to begin with some overview comments which are on page three of the presentation. Jan Kees is going to discuss the specific financial results and then I'll provide a summary of our outlook and strategy before taking your questions.

The management team is here today to support me on those questions as Kelly noted. With the management team we now have in place, we've confirmed substantial opportunities to improve our company, despite, quite frankly, the challenging times that we're operating in. Simply stated, we've not grown and we have costs that are too high.

Both of these issues are being addressed. To grow we need to improve our commercial acumen and our sales execution. We rely too heavily on products alone. We have great products and we do have great brands. We need to add great service, pricing, availability, a balanced channel strategy and better sales execution to our mix.

We're making progress in these areas today with more intensity than ever but this is going to take time. On the cost side, the opportunity to lower costs and improve productivity is immense around here. This will need substantial improvements to margins even without growth.

Today, nearly 70% of our costs are labor and material based split about two-thirds, one third. So, for us to succeed, we have to do more with less of these cost components and these changes are also underway. In fact, it started at the top of the company.

Six of the nine members of the management team are new to their positions within the past year, but only two are new to the company. We've eliminated over 20% of the top 100 paid positions in the company in the past few months. We've found the talent we need from within the company. Change happens from the top down.

I'll discuss more details about our initiatives to lower costs and improve productivity when I discuss the outlook later on in the call. With regard to the fourth quarter, noted on slide four, our adjusted results are as expected. We reported a fourth quarter loss of $0.83 a share versus fourth quarter earnings in fiscal 2015 of $0.26.

On an adjusted basis, fourth quarter EPS of $0.44 per share was flat versus last year's EPS of $0.44 as well. The press release details the specific adjustments that were made. Total year results are on slide five with a loss of $2.83 per share in fiscal year 2016 versus a loss of $4.71 per share in fiscal year 2015.

On an adjusted basis EPS was $1.11 compared to fiscal year 2015 adjusted EPS of $2 per share. Slide five also details the full year revenue splits by geography and by end markets for your information. So, now, let me turn to the results by business segment regarding our Industrial business on slide six.

The adjusted operating margin for the quarter was 12.4%, an improvement over the previous three quarters, but still below year ago. Margins were positively impacted by lower raw material costs and lower operating costs despite an organic sales decline of 8%, which was the biggest negative factor impacting year-over-year margins.

We continue to experience weak end markets. Energy, commodities and general engineering have been weak for over a year. We did see some slight recovery in the last quarter in some of our markets, and we believe that destocking has stabilized.

We expect to see some modest improvement in some of our end markets in 2017; however, as I said in our last earnings call whether a slight recovery happens or not, we have a lot we can do on our own to improve. We also mentioned on our last call our initiatives to build the indirect channel and be where the customer wants to buy.

We estimate that our Industrial business is now slightly above 50% indirect. The important point to note here is that we're focused on making this change without sacrificing customer service and support. This is about efficiency, best value for the end user, and making the right decisions for profitability.

Looking to the future, we're positioning ourselves for when the markets recover but even without much growth, we know margin improvements are possible. Turning to page seven on our Infrastructure business. This business improved profits despite an 11% decline in revenue.

The adjusted operating margin for the quarter was 3.4%, which is above last year's adjusted margin of 1.1% and well above the losses in the first half. This reflects increased commercial success such as with the launch of the Road King product, for example, continuing progress in cost savings programs as well as lower raw material costs.

Energy and mining end markets continue to be challenged and while any growth in the next few quarters may not be significant, our focus on profit margins should allow us to improve the results. Now I'd like to turn the presentation over to Jan Kees, who will provide a more detailed financial report.

Jan Kees?.

Thank you, Ron. Good morning, everyone. As Ron mentioned, the June quarter experienced continued weakness in the end-market demand. We are focusing on cost management and cash flow, delivering further reductions in operating expenses and overhead.

We, here at Kennametal, believe the actions that we are taking to achieve margin improvement even in a no-growth environment will strengthen the company irrespective of when our markets improve. Let me walk you through the key components of the income statement beginning with the quarterly results on slide eight.

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. Adjusted EPS for both the current quarter and the prior year quarter were $0.44 per share.

This reflects organic sales decline and related negative mix, in addition to unfavorable currency exchange offset by lower raw material costs, incremental restructuring benefits and a more favorable effective tax rate. We recorded a discrete tax charge of $81 million associated with the valuation allowance with regards to the U.S. deferred tax assets.

I will provide further detail on this later in my remarks. The adjusted EPS bridge for the quarter is shown on slide nine. Our June quarter sales were $521 million compared with $638 million in the same quarter last year, an 18% decrease. 9% of that decrease is due to the impacts of the divestiture in the second quarter.

The remaining 9% is due to organic decline driven in part by continued end market weakness, prior year tiered (10:16) volume purchasing from our customers that did not repeat in the current year, and pricing softness in mining and construction sales. Sequentially sales increased $23 million or 5% from the third quarter sales of $498 million.

On a regional basis, excluding the impact of divestiture and currency change, sales decreased in the Americas 13% and in Asia 11%. EMEA sales remained flat when compared to the same period last year.

Excluding the impact of the divestiture and currency exchange, sales decreased approximately 21% in energy, 13% in earthworks, 9% in general engineering and 4% in transportation, while aerospace and defense sales increased approximately 6%. Our adjusted gross profit margin improved in the current period to 32.5% versus 31.2% in the prior year.

The primary tailwinds year-over-year were lower raw material costs and higher restructuring benefits. Headwinds included lower organic sales, unfavorable business mix and currency exchange. Adjusted operating expense, as a percentage of sales, was 22.7% for the current period and 21.2% in the prior year.

Of this 1.5% increase, 2.3% is due to declining sales offset partially by a 0.8% decrease due to lower operating expense. Adjusted operating expense declined $5 million year-over-year, primarily due to restructuring benefits and effective cost reduction actions. Turning to the sales by business segment on slide 10.

Industrial segment sales were $329 million in the fourth quarter, an 8% decrease from $358 million in the prior-year quarter. We experienced weak demand in energy, general engineering and transportation, partially offset by improvements in aerospace and defense.

The general engineering market was weak globally, but most notably in the Americas, where sales to the indirect channel were lower but in line with end user purchases. The global transportation market was mixed with generally favorable conditions in EMEA and the Americas and offset by lower deliveries in Asia.

Aerospace sales grew across all regions with stronger growth occurring in EMEA and Asia. Sequentially, Industrial segment sales increased $12 million or 4% from the third quarter sales of $316 million. Sales increased sequentially in aerospace and defense, general engineering and transportation, while sales remained flat in energy.

Compared to the third quarter, fourth quarter sales increased in all regions, led by Europe, then Asia, and then the Americas. Infrastructure segment fourth quarter sales of $193 million decreased 31% from $280 million in the prior-year period, driven by the divestiture impact of 20%, and an organic sales decline of 11%.

The energy end market was impacted by continuing weakness in oil and gas end markets with the U.S. land rig count taking another step down from earlier this year.

Additionally, challenging conditions in underground mining continue to drive sales declines, particularly in North America, while highway construction sales showed improvement in conjunction with the road rehabilitation season. Sequentially, Infrastructure segment sales increased $11 million, or 6%, from the third quarter sales of $181 million.

Sequential increases were driven primarily by earthworks, and to a lesser extent, by general engineering, offset partially by a decrease in energy. Sequentially, fourth quarter sales increased in all regions, led by Europe, then Asia and the Americas. Turning to the fiscal year results on slide 11.

2016 consolidated sales were $2.1 billion compared with $2.6 billion last year, a 21% decrease. 5% of that decrease is due to the impacts of divestiture in the second quarter. The remaining 16% is due to an 11% organic decline and 5% unfavorable impact from currency exchange.

Full year adjusted operating income was $126 million compared to $235 million last year.

Adjusted operating income decreased primarily due to our organic sales decline, unfavorable product mix, lower fixed cost absorption, and unfavorable currency exchange offset partially by lower material costs, incremental restructuring benefits and manufacturing productivity improvements.

Adjusted EPS were $1.11 in the current year compared to $2 in the prior-year period. The bridge is on slide 12. The update on restructuring costs and benefits is shown in detail on pages 13 and 14 of the slide deck. We completed substantially all of Phase 1 of restructuring initiatives in the quarter.

In total, the Phase 1 initiatives delivered fiscal 2016 incremental annual savings of $14 million. Life-to-date exchange charges of $59 million were incurred to deliver annual run rate savings of $40 million to $45 million.

We are also implementing additional restructuring initiatives to align our cost structure with the current operating environment through rationalization of certain manufacturing facilities and through head count reductions.

This new 2017 program is currently estimated to achieve an additional $15 million to $20 million of annualized savings and incur $20 million to $30 million of pre-tax charges as it's being implemented over the next 15 months. These benefits are time-phased and included in our outlook.

Combined with the previously announced programs underway, estimated annual savings for these programs are expected to be $75 million to $90 million with total charges of $105 million to $125 million. These benefits from restructuring and cost savings initiatives are mitigating the impacts of economic headwinds.

The full-year incremental savings in 2016 were $44 million. The year-over-year leverage for Industrial and Infrastructure segments was 33% and a negative 3% respectively, contributing to consolidated year-over-year leverage of 8%. The bridges of the effective tax rate are presented in the appendices.

The year-over-year change in the adjusted quarterly effective tax rate is driven primarily by a favorable jurisdictional geographical mix of earnings and a higher benefit from the RD&E credit in the current year quarter.

The year-over-year change in the adjusted annual effective tax rate is driven primarily by a favorable jurisdictional mix of earnings, a favorable impact related to a U.S. provision to return adjustment and a higher benefit from the RD&E credit.

Our outlook for 2017 includes an effective tax rate of 13% to 17% due to the effect of the recording of a U.S. deferred tax valuation allowance in 2016. We are in a cumulative loss position in our U.S. legal entity.

This cumulative loss was primarily driven by charges for asset impairment, restructuring and loss on divestiture, further worsening with the rolling off of a profitable year 2013 from the cumulative computation.

A cumulative three-year loss is considered significant negative evidence that is very difficult to overcome when evaluating the realizability of deferred tax assets. We determined that a valuation allowance is required to record our U.S. deferred tax assets at their net realizable value.

We recorded a valuation allowance of $106 million of which $81 million was recorded in the fiscal 2006 (sic) [2016] tax provision and $25 million was recorded through other comprehensive income. The accounting treatment of this non-cash item has no effect on the ability of the company to use its tax assets to reduce future cash tax payments.

The valuation allowance is subject to a reversal upon the company's return to sustained profitability in the U.S. As we have emphasized many times, we believe that a conservative, strong balance sheet is an important strength of Kennametal. The balance sheet is shown on slide 15.

Cash on hand stands at $162 million as compared to $105 million last June. Our current ratio was 2.5 as of June 30, 2016, compared to 2.6 as of June 30, 2015. As shown on slide 16, primary working capital was $648 million as of June 30, 2016, a decrease of $186 million from $834 million as of June 30, 2015.

Primary working capital as a percentage of sales decreased 150 basis points from 35.8% as of June 2015 to 34.3% as of June 2016. Strong free operating cash flow has been a consistent strength of Kennametal through the years, through both troughs and peaks.

As shown on slide 17, year-to-date free operating cash flow is $115 million, despite the severe economic headwinds that we have faced this year. For fiscal year 2016, the total year adjusted EBITDA was $247 million versus prior-year adjusted EBITDA of $366 million.

Adjusted EBITDA for the current quarter was $77 million versus prior-year fourth quarter adjusted EBITDA of $86 million. Adjustments for EBITDA are detailed in our earnings release on our Form 8-K. In terms of uses of cash year-to-date, net capital expenditures were $105 million.

We paid out approximately $64 million in dividends, and we reduced our gross debt by $51 million to $701 million as of June yearend. Our conservative capital structure and dividends are of key importance to Kennametal, and we continue our commitment to maintaining them. Our debt and liquidity positions are shown on slide 18.

At the end of June, our net debt was $540 million with no current outstanding borrowings on our revolver, we have no significant maturities until 2019. We will continue to prioritize business reinvestment for profitable growth and reduction of cost of sales and operating expenses to drive shareholder value. Now, I'll return the call back to Ron..

Industrial, Infrastructure and WIDIA. We know we need to outperform the market. By simplifying and empowering the organization, we believe we can achieve faster growth but it will take time for the organization to digest this and execute on this at a very peak level.

Therefore, we've announced the workforce reduction of approximately 1,000 people, targeting annual savings of $100 million to $110 million on a run rate basis. So we expect to hit that run rate leaving fiscal year 2017. The estimated cost for this is $80 million to $95 million. Neither the costs nor the benefit is in our outlook.

We are, however, almost half way complete with this recently announced initiative to reduce our workforce. Perhaps more interesting to investors is that we've also developed a list of productivity and investment programs that are expected to yield $200 million to $300 million in savings over the next two to three years.

We expect to have less than two-year paybacks on most of these projects. Later this calendar year, we will highlight key programs and projects for investors. This is part of our fix-in-place manufacturing strategy. There's a lot to do to improve this company that's already been identified.

We will be going about prioritizing and putting in place teams of people to begin to harvest what is clearly big opportunities for us. So, to summarize, on slide 21. We have a solid consumables business with strong free cash flow through the cycle.

We expect to maintain our conservative capital structure and dividend policy and the challenging end markets have driven us to try and make bolder changes within the enterprise. This will improve our franchise for the mid and longer term.

The challenging end markets aren't going to change but the performance of the company needs to and that's what we're about. So Rocco, I'd now like to open it up to questions..

And today's first comes from Ann Duignan from JPMorgan. Please go ahead..

Hi. Good morning..

Good morning, Ann..

Good morning, Ann..

Ron, could you just walk us through your expectations by quarter or maybe first half, back half as we go to fiscal 2017? Do we lose a day in Q1 because we gained a working day in Q4? And just talk us through the mechanics of how we should think about modeling. That would be great..

I think pretty much we've spent some time on this. And the simplest way to answer that question is we expect 2017 to pattern itself in a fairly similar way to 2016. It won't be identical. There are a couple days here or there that change but we do expect pretty much 2016 to split our earnings and our revenue in a fairly similar pattern..

So that was about what 48%/52%, is that the way to think about it?.

Something like that. That's for revenue but for earnings it's more like 25%-ish first half, 75%-ish second half on an EPS basis..

Okay. That's helpful. And then if you could talk about Industrial versus Infrastructure. What specifically – I know you said maybe destocking is done, maybe end markets stabilizing.

Maybe just a little bit more color by end market?.

Okay. I will start on that but I will let Pete and Chuck to make a couple of comments as well. Just so I frame 2017 a little bit. When we report the first quarter, we are going to report with WIDIA broken out. So, WIDIA is now reported in Chuck's Industrial business and that will be pulled out.

The impact of that will provide a looking backward detail but it will take some business out of our North American area and actually make Chuck's business is a little bit more concentrated in Europe than might be readily apparent.

And WIDIA is, revenue-wise, probably in the range of $170-ish million, maybe a little bit more, maybe a little bit more but in that range, so, for people's perspective. End-market wise, it's really pretty tough out there across a range of end markets.

I guess I would say in the Industrial side, aerospace, maybe automotive to a little bit of the extent. And in Infrastructure, pick your poison, mining, commodities. The only positives, I think, are a little bit in the earthworks kind of business some in the construction side. But, just general, it's tough to get ahead of the prior year.

The good news I think as we look forward is that we have a little bit easier comps to go against, but one of the concerns we have is that while we're calling our revenue to be basically flat year-over-year, we're not sure how confident for us to really be on that.

So, that's in fact one of the reasons why we were a bit more aggressive on thinking about further cost reduction.

But any more comments on end markets, Chuck or Pete?.

Sure. Ann, thank you for that question. In Industrial, we definitely have seen the end of the de-stocking. For four straight months, March through June, our sales have been right in line with the point-of-sale data that we get from our customers.

I believe July will be in line, so we do not see any further de-stocking in our previous four to five months..

And Ann, just to add to that, for the Infrastructure business, year-over-year what we're expecting is flat sales with some of end markets slightly down. In oil and gas, we've had now several weeks of encouraging news relative to rig counts. We're cautiously on domestic that we'll see some improvement in oil and gas as we go through FY 2017.

So mining continues to be a challenge for us. We did see continued deterioration. The second half of FY 2016 has somewhat stabilized but we're having to take a number of actions in order to maintain competitiveness. As Ron said, construction has been a very bright spot for us. Year-over-year we did grow about 6%.

We have had great success with the new product introductions that you've had the exposure to and the bottom line has shown (32:22) that has continued, and we're very happy with the performance that we've got out of that product in our end markets.

Aerospace continues to be a growth area as well and we saw a slight improvement year-over-year in growth there and we expect to continue into FY 2017..

Okay. And if rig counts were to decline again, just with the oil back then below $40, would that be a negative headwind for you in Infrastructure? And then, I'll leave it there. Thanks..

Yeah. Yes, Ann, I think that we're all wondering what's going to happen with the price of oil. Rig counts improved a little bit. The price of oil has now gone back down. Yeah, it would be negative if rig counts – if those trends reverse, for sure..

Okay. Thank you. I'll leave it there. Appreciate it..

And our next question comes from Julian Mitchell of Credit Suisse. Please go ahead..

Hi. Good morning. Just, firstly, on the medium and longer term, you've announced these extra restructuring measures today.

I guess I just wondered what percent of the overall current head count base is that 1000 people number that you mentioned? And then, related to that, what's the end goal here in terms of medium or long-term profit margins when you were figuring out how many heads to cut and what the extra cost measures be on that, should be?.

Well, I think our long-term objective is to be as efficient and as customer service effective as we possibly can, and to find that right balance, okay? We know where our competition performs. I would like to say that we're not anywhere near where that is at this stage. So we've got a lot of runway.

But there's nothing within this company that should suggest that we should be anything but at least equal if not better than our competition. So that kind of frames the situation. Total head count at Kennametal today is a little bit over 12,000. So 1,000 coming out of the organization is about an 8% drop.

But if you think about the company, today we're 21% smaller than we were a year ago. Some of that is a result of divestitures and took some head count out as a result of that divestiture. But if you also reflect on the fact that 45% of our total cost is labor-related, we obviously have work to do to make this proportionate.

I think these reductions are a little bit greater than proportionate, but this should allow us to get our operating margins up to the double-digit type levels, which we think they should be at, in a fairly no-growth environment.

But to get us past that, we've now identified automation, productivity improvements, things that we can invest in that will drive further productivity within the company around the globe. And we've identified projects with savings in the range of $200 million to $300 million, with costs that approximate the same level.

And while we're saying paybacks should be two years or better, frankly, a lot of the projects we've identified have almost one-year payback. So a lot of work that could be done by applying capital prudently to our manufacturing operations so that we can really, really improve our efficiency in our manufacturing process.

We're a little bit late to the party here, frankly. But honestly, this gives us a chance to advance beyond where our competition is, at least that's my point of view..

Very helpful. And then just my follow-up would be on the shorter term. Just a boring question maybe for Jan Kees looking at that EPS bridge on slide number 12, that you helpfully provided.

If I'm rolling that forward to fiscal 2017, is the right way to think about it that you have about $0.20, $0.25 of restructuring benefit, maybe $0.10 of tax headwind? So that gives you $0.10 or $0.15 of EPS growth? And then the other sort of five items are fairly neutral.

Is that roughly right or there are some things you'd call out in those other items beyond restructuring and tax?.

Well, first of all, the taxes are going to come in a little bit below what you mentioned. The guidance that we gave is somewhat below. I think you mentioned 13% to 17% guidance. Say, if you just take the midpoint there I think it's a little bit less than what you gave. And, yes, there will be restructuring benefits to the level that you indicate.

There will also be a little bit more raw material benefit not as much as in 2016 but a little bit more and the rest you are directionally correct..

Very helpful. Thank you..

And our next question comes from Eli Lustgarten of Longbow Securities. Please go ahead..

Good morning, Eli..

Good morning, everyone. Can we talk a little bit about your expectations for operating profitability? I guess, we talked last time about the possibility of the tax rate normalizing and we are still going to be in 15%. So we're still 5% to 10% below what would be a more normal tax rate.

How long does that continue? And with the lower tax rate than I think a lot of us expected, your implication is that your operating profitability for 2017 will remain relatively similar, or maybe a little bit higher, but not much change from 2016.

Can you give me some guidance of what you expect operating margins in Industrial and Infrastructure can look like?.

Okay, Eli. Let me take that and I'm not sure we're going to provide forward views on each segment because when we report, those segments are going to look differently, okay? But in the company overall, we expected our forward tax rate to be in the 22% to 25% range. We expected that until we had to book the valuation allowance in the United States.

Because we booked that valuation allowance in the U.S., it reduces our tax rate going forward; therefore, the benefit of 13% to 17% that range with the midpoint of about 15%, that will continue until we demonstrate, which we're confident we will, sustained profitability in our U.S. legal entity. That will take a couple of years.

So the go-forward profitability, from a tax rate point of view, will be impacted from a beneficial, fairly lower rate. If we did have a capitalized U.S. tax asset, we'll return back to that 22% to 25% tax rate. So that kind of frames that..

Thank you..

From an operating point of view, 2017 is a year where we have to recover a substantial amount of cost, okay? We had savings for the wrong reasons in 2016 because we didn't pay bonuses, because we were restricted in some of our merit increases, because some of our benefit costs are going up.

So we're going to have to recover in a non-inflation oriented environment, a lot of those costs in planning. But despite that, we're seeing a fairly meaningful increase in our operating profit, even including recovering some of those costs. Would we like it to be greater? Yes, we would.

So, therefore, that's why we initiated some of the additional cuts we've made..

Well, can you give us some idea of what the corporate costs will go up for the year? And is it fair to assume that the operating profitability of Infrastructure will basically go up a little bit and maybe you can get towards a double-digit all-in for Industrial? And WIDIA, which looks like it has declined a lot because it used to be a little over $200 million, I believe, is that operating profitability below the Industrial group, above.

Can you give us some idea of how to look at this?.

Okay. WIDIA is going to be breakeven at best, maybe in that range, but our expectation is to expose it and grow it. The operating profit from Industrial probably will be north of double digits and we expect pretty meaningful increases in our Infrastructure business.

Don't want to quite dimensionalize that right this minute but pretty meaningful increases. The headwinds we're facing are in the range of $30 million to $40 million for those extra costs that I mentioned earlier. So pretty substantial additional costs that we're having to overcome.

So, that's the reason why we got all these basic cost savings programs from the corporation overall but why the profitability isn't going up quite as much as perhaps it should be. But also....

So the operating headwind is it going to be reported in the segments or is it a corporate number or split between it? Do you have an idea of how we should model that?.

It will be in the segments..

And those will be in the segments..

Each segment. All right. Thank you very much..

Thanks, Eli..

And our next question comes from Michael Feniger of Bank of America Merrill Lynch. Please go ahead..

Yes, guys. Thanks for taking my question. I understand that the UK is only 2% of your overall sales.

But within your forecast of flat revenue next year, what are you expecting of Europe in 2017?.

Well, do you guys want to talk about that because, Chuck, you've got probably the biggest European business. I have a view but you're closer to it..

Sure. Europe was our top performing unit within Industrial for 2016 which was slightly underplanned. And we see a flat to slightly down market. Again, there's some currency changes that we have in plan for Europe that may dampen out the volume delta that we see.

Again, the currency is a negative to Industrial for 2017 versus what could be in pieces a slightly higher build rate..

So perhaps a little different than 2016 where we saw Europe at least a little bit positive and the Americas quite a bit negative. The outlook there is a little bit negative for Europe with perhaps the Americas being a little bit more positive. But I want to add this before Pete comments. We also expect Eastern Europe to be a lot stronger.

There are some parts of the east where either through WIDIA or some other places we will capture some new business, maybe there's some offset that will be more positive there.

Pete?.

For the Infrastructure business, we do expect year-over-year some slight growth in EMEA.

Most of that is coming from the success we've had in the construction business as well as expanding into the Middle East, which I think we saw the benefit of late in fiscal year 2016 and we're expecting it to continue in 2017 as well as actions that we're taking to improve our cost base in EMEA with localization of manufacturing and leveraging our Asia manufacturing to support our EMEA sales..

Okay, that's great. And then my next question is just on – it's encouraging to hear the trends in de-stocking, but the Industrial business is still down organically 8% or 9% and we're hearing comments from some distributors about decelerating trends. I was hoping you could discuss that.

What you're seeing in the business and what you saw maybe through July as well? Are you seeing (45:25) into the year-over-year, start to close, and are we expecting that to turn positive by Q2, Q3 to get us that flat outlook?.

We're pleased that we continued in the second half, we sold at the rate that our distributors were selling at. That's encountered to our first half where we definitely saw de-stocking on our distribution channel. Our sales into the channel were far below what our customers were selling.

Our initiatives around direct-to-indirect and focus on our large VARs and our large national chain here in the U.S. have definitely generated some additional activity that we're seeing an increased sales rates in our distribution channel..

So I think if you reflect upon the trends and inherent of what Chuck said, was our year-over-year organic decline may not be quite as big as it was because I think we shipped a little bit more into the channel at the end of last year than we did at the end of this year.

But despite any of those, kind of, readings, what I'd say is we're just focused on growth. We want to gain share, even among our distribution partners. We're aggressive with them. We're talking to our distribution partners in a way they haven't heard Kennametal talk to them. And I think that's positive.

So I'd encourage you to ask MSC what they think of Kennametal, ask other partners what they think of the Kennametal of today versus the Kennametal of six to nine months ago..

All right. Thanks, guys..

Great..

Ladies and gentlemen, Our next question comes from Walter Liptak of Seaport Global. Please go ahead..

Hi. Thanks. Good morning, guys..

Hi, Walter..

Hi, Walter..

Good morning, Walter..

Hi. I wanted to ask about the head count reduction. And it sounds like you're pretty far through.

I think you called out 50% through that reduction? And I'd like to know why you did not include that in the guidance? Or is that in there somehow, considering that you've got some temporary costs that were cut that might be coming back up?.

Okay. So, Walt, we put our plan together, looked at the plan. The plan looked like a reasonable plan. But the outcome of the plan was we were working really, really hard to only get a little bit further ahead.

So we took a hard look at what was possible and we said we need to have fewer people and fewer cost within the company and we started at the top of the company. One of the important comments I made was more than 20% of our top 100 paid people in the company are no longer with the company.

And while any head count program and change like this is painful, frankly, it's necessary and a lot of the head count is also taking place changes at our manufacturing operations, which were becoming inefficient, because the revenue, frankly, was substantially lower.

We didn't include it in our outlook because, at this stage, our outlook includes flat sales. So what happens if our flat sales aren't flat? We'll need to be able to get some of that benefit from other places.

So what we wanted to do is to assure ourselves, and consequently, our investors that we were doing everything we could to deliver the $1.10 and $1.40 EPS range with the potential of possibly exceeding it if the revenue comes in at about the flat level and we can execute that head count reduction program efficiently.

Now, that head count program is going to take a little bit longer in different parts of the world. So while we're about halfway through it, at this stage, we also have a lot of work to do in some of our European operations. And we're really not emphasizing reductions in force in Asia, China and India in particular..

Okay. As part of this program, are you – some of the things you're talking about in the future like fix-in-place manufacturing, some of this automation.

Is this processes that have been developed already or are these homegrown processes that you're putting in place now?.

Many of these are proven automation processes that are readily available and we, for whatever reason, have not implemented over the years. We just approved a $10 million capital investment to automate our packaging. It will take somewhere in the 18-month timeframe for that to be effective but we're on our way on that.

And there are a number of additional programs and initiatives that have been developed by our team for a number of years that we think are pretty proven..

Okay. Fair enough. Okay, thank you..

And our next question comes from Steve Volkmann of Jefferies. Please go ahead..

Hi. Good morning..

Hi, Steve..

Hi, Steve..

Most of my questions have been answered but in case we have some sort of organic headwind in 2017 from the divested business sort of falling over into 2017, isn't that right? How much would that be?.

5% at group level..

5%. So, I guess, the rest of the businesses have to make up that 5% to get you to flat organic.

Am I thinking about that the right way?.

No I don't think so, Steve, because we basically....

Excluded that..

Excluded that in our view. So, the business, if you exclude the piece that JK mentioned it's about $2 billion in revenue versus the $2.1 billion that we reported. So, we're looking at about $2 billion in revenue in 2017..

Okay, I got that. Thanks. And then just sort of following on to the previous question. And, again, I just want to make sure I'm kind of thinking about this right, you talk about this 1,000 people that are coming out. It's going to – you said you're about halfway through that already, I think.

I mean, if I just do the math that looks like a cushion of upwards of $0.50 a share for 2017. That seems like a big cushion..

Well, halfway through isn't halfway through like we're saving money today. It's – we've identified the people that participated in a voluntary separation plan. They will roll off the company's ranks through the first quarter and into the second quarter. So timing, cost, all those things are in process of being worked through.

So in an ideal world, you're right. But I've never seen an ideal world kind of come true like that very crisply. Perhaps we will but right now I'm not so sure..

So, Steve, we will report. Obviously, with the Q1 and Q2 earnings calls, we'll report on the progress..

Great. Okay. That's very helpful. That sizes it better for me. And then, finally, just one sort of bigger picture question, Ron. I mean, traditionally Kennametal has had some analyst days in the fall and sort of laid out a lot of the longer-term views of the world and so forth.

Is that something you're thinking about? Or how do you intend to keep us updated on this stuff going forward?.

I think you might have been in our office yesterday when we were talking about this, Steve. Seriously, this is something we want to do probably late October. We'd love to have people come out to our Technology Center where we can actually show them some of the automation projects that are planned and underway.

And when we can kind of tick and tie in a little bit more detail some of the $200 million to $300 million of productivity improvements that are possible with the enterprise. So we'll keep you posted on that..

Great. Thanks so much..

And our next question comes from Rudy Hokanson of Barrington Research. Please go ahead..

Thank you.

I was wondering if you could speak a little bit more as to what you hope investors gain by the understanding of WIDIA as a separate segment? And also how that's going to help you manage WIDIA better than you would by keeping the current reporting basis?.

Thank you, Rudy, for that question. The reason we're bringing out WIDIA has little to do with what we think investors will gain and a lot more to do with getting greater focus within the enterprise on that brand and on the potential that exists in that brand. The SEC rules are pretty clear. How you manage is how you should report.

So, it is my feeling that WIDIA has been an undermanaged brand for this company for some time. We've owned it since 2003, I believe, and the business has shrunk and it used to be a premier product. We think it can grow, and we think it can return the company a substantial amount of new business over time with focus.

When it is combined with Kennametal, it gets the second child syndrome and we need to have it be a first child and a first player. And if you see this in our competition, you see a number of our competitors have multiple brands with specific value strategies and we think WIDIA can develop that way. It is a great brand in India.

It has a good reputation in United States. It has a very good representation in some places in Europe but it's waned in terms of importance. And I just think with a little bit more focus we'll bring it back to prominence.

If I had had my brothers, I would have done this internally and not separated it out in terms of external reporting because it's kind of small to do that but that's not what the SEC rules allow..

Okay. Thank you. That was my question..

Okay. Thank you..

And our next question comes from Jorge Pica of Wells Fargo. Please go ahead..

Good morning..

Good morning, Jorge..

Good morning..

I'm on for Andy Casey this morning.

Can you talk about where you feel like your strongest end markets are because through the course of the call, it sounded like really construction and aerospace are the markets you feel like are going to be the most stable going forward? Am I reading that right?.

Yes. I think you're reading that correctly..

Yes..

And what is – you're going to have to grow these segments in a declining market, essentially out-innovating your competitors. You obviously are working on the footprint, the cost reduction. What is more the innovation plan that you have going forward, maybe in new products..

Well new products have always been part of the fabric of Kennametal. And we're going to continue to develop proper new products. We're also going to continue to solve our customer's toughest problems. Kennametal is the company people come to when they have tough problems to solve because our engineers know how to get that done.

But that's only a piece of the market. It's not the whole market. And for us to be successful across the range of the market, we need to have better sales execution, which means we need to have a really, really good initiative for the major customers and great service level for mid to smaller customers. We need to have great product availability.

We need to have competitive pricing. And, in general, we need a service mentality that takes a back seat to no one. And these are areas where intensity and focus and leadership and empowering people closer to the market will make a really big difference.

I think Chuck and Pete have already seen specific impacts of where that can happen where they can make the decisions, or their people can make decisions that historically might have gotten bogged down a little bit in this company. So, I hope I've answered your question there.

But do you want to comment, Pete?.

Yeah. Just to add to what Ron said, relative to product development and looking at the markets, we've seen, in my business in particular, migration from the toughest conditions. Certainly, as Ron said, that's always going to be part of our DNA, who we are to provide those solutions.

But there's another expanding portion of the market now that requires something that, in some cases, that's just good enough.

And we've looked at this from the a standpoint of developing products that aren't extremely better but are better than what's out there in the market, but most important, we'll produce those at a competitive cost structure and be competitive from a pricing standpoint.

And we've seen success with that with recent introductions and we're continuing that with our new product development pipeline..

What geographies do you feel like are going to be most supportive of kind of your new product development strategies? Where do you feel like you'll get the most headway geographically?.

Geographically, and I'm talking relative to construction now in the most recent product introductions. We've had in FY 2016 great success in EMEA and North America. Year-over-year growth in construction specifically the Road King product that we talked about in Q4, It was 18%. It was huge and we haven't even introduced the product in Asia yet.

We're in the process of doing it as we speak and localizing production. So I'm looking forward to having success in Asia..

Jorge, this is Chuck. I hope you can come visit with us at IMTS. We have some major new platform launches we'll be announcing at IMTS.

There's a new Duo-Lock Turning Drilling platform that we'll launch at IMTS, a new Milling 411 platform where we'll be announcing a significant expansion of our already successful Beyond Evolution Groove and Cut-Off platform and then some exciting new grades in our top-notch Grooving platform that will all be rolled out at IMTS, showing significant benefits to customers..

That sounds great. Thank you..

Okay..

And our next question comes from Samuel Eisner of Goldman Sachs. Please go ahead..

Yeah. Good morning, everyone..

Good morning, Sam..

Good morning..

So just on the original cost saving plan, the Phases 1 through 3.

Are you guys still on pace to achieve roughly the $115 million to $135 million run rate savings by the end of this year?.

Yes. That's after completion of, materially completing Phase 1. That is still the target, yes..

Thanks. That's helpful..

In fact, let me just state it more directly. I think we want to do better than that, okay. I think we've added additional cost savings programs so we can exceed that..

That's helpful. And then you guys called out roughly $0.19 of raw materials absorption and mix tailwinds for your fourth quarter EPS bridge. I was wondering if you could maybe break out those individual pieces. Just curious what the major drivers were. It's basically the largest bucket of improvement that you guys saw in your earnings this quarter..

Sam, look we typically don't provide the break out for this. The raw materials are a larger portion..

Okay. And then maybe asked a different way, when I look at your inventory as a percentage of LTM sales, you guys are still running pretty close to 22% inventories to sales. And that's kind of slightly up from last year. It's flat from the first quarter.

So curious how you guys are thinking about what the right level of inventories are, going forward, if we should expect inventories as a percentage of revenue to start to fall going forward. Just curious how you think about managing your inventory situation..

Well, I think, the inventories for the company have improved. We're making progress on our working capital. We've got a little bit more progress to make. But I don't think that's where our today focus is going to be. We've got to get the costs out. We want to make sure our customer service is at the levels that they have to be maintained at.

And I wouldn't forecast a tremendous amount of change in our working capital..

And then, maybe just lastly, what were your utilization rates in the quarter?.

We don't report utilization rates. And, frankly, I don't think it's that critical for us because depreciation for us is 4% to 5% of our total sales. In fact, it probably should be a higher percentage. Our problem in this company is that we have underinvested in our fixed plant and equipment.

We have too many plants, perhaps, from a macro perspective but our depreciation expense isn't our biggest challenge..

Got it. Thanks, Ron..

Okay..

Welcome, Sam..

And our next question comes from Steve Barger of KeyBanc Capital Markets. Please go ahead..

Hi. Good morning. Ron, you said you're being aggressive with the distributors. The message you're sending is different than the message from six months ago.

Question is how is that conversation different? What is the new message that's so compelling that wasn't being communicated before?.

I'm going to let Chuck answer that..

Steve, this is the biggest change I've seen in my seven months with Kennametal. We have implemented our direct to indirect strategy, which basically says we're not going to compete with our indirect partners at small direct customers that Kennametal used to hold so close they would never allow indirect partners to participate in those sales.

We also have continued to invest, as Ron mentioned, to address our inventory levels. So we are continuing to have high fill rates and high availability of product that make it easier for us to do business with.

This direct to indirect change has driven a response from our customers, our indirect partners that say we really want to be their partner and we want to stop competing with them.

And I can't explain how positive that is that our indirect customers no longer think of our sales people as their competitor but instead, they think of them as their partner.

I spend a significant part of my time dealing with our VARs globally and with MSC here in North America to find any way we can continue this path where they see us as their partner instead of their competitor..

Yeah. VAR stands for value-added reseller.

And, I guess, what I would say is one of the big customers that Chuck is referring to, and I won't mention which one, when I visited with them, they said we have to look at Chuck's card to see whether or not it really said Kennametal on it because he fundamentally understands that we're partners and dedicated to growing our business.

And that's an attitude change and it starts from the top..

So, when I think about that new mindset towards the distribution channel, and you've talked about how you need to have really great innovative product, you have to invest in inventory to keep that level high, yet you're reducing head count by 1,000 people. Presumably, that's not coming from engineering but maybe some from sales.

But really it's all manufacturing where that reduction is coming?.

Steve, it's going to come from everywhere in the organization. We have some limitations. I mentioned, India, Asia and probably the IT finance and HR organizations which were targeted in our Business Excellence initiatives that were already underway. And let me just say it this way.

You can't take 1,000 people out of an organization and not have various parts of the organization affected and certain levels of work has to change. And there's got to be a concentration on the most important things. But at the end of the day, it's probably going to be a preponderance of operational folks with some sales and marketing.

But also, let's be clear, a large portion of the cost has come out of the highly paid..

As Ron mentioned, we've changed the six people out of nine in the IT (01:08:11). 20% of the highest paid 100 employees of the company are leaving or have left already. So there's a considerable effort being made to make sure that top-down these initiatives are implemented..

Understood. Thanks. So, last question is just around free cash flow then.

So given the normal seasonal pattern of earnings and the cash restructuring costs that you're undertaking early in the year, should we think the free cash flow is negative in the first half, positive in the back half?.

I think most of the free cash flow will be in the latter half of the year but negative are not entirely there yet in the first half..

In other words, probably neutral in the first half..

Neutral in the first half..

And most of it in the second half..

Got it. Thanks for the time..

All right, Steve.

I think, Rocco, that probably is it on the call, correct?.

That is correct. Yes, sir..

So a couple of final comments. I appreciate everybody participating in and their interest in Kennametal today. Obviously, please follow up with questions. Kelly, Jan Kees, myself and other members of management team would love to engage with any of your interests in Kennametal today. Thank you very much..

And thank you, sir. Today's conference has now concluded. A replay of today's event will be available approximately in one hour after the conclusion of today's conference. Please dial 1-877-344-7529 or 1-412-317-0088 and enter code 10071553 to listen to the recording. Thank you for attending today's presentation. You may now disconnect..