Kennametal Inc (KMT) 2015 Q3 法說會逐字稿

Good morning.

I would like to welcome everyone to Kennametal's third quarter FY15 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.

(Operator Instructions)

Please note that this event is being recorded.

I would now like to turn the conference over to Quynh McGuire, Director of Investor Relations.

Thank you, Denise.

Welcome, everyone.

Thank you for joining us to review Kennametal's third quarter FY15 results.

We issued our quarterly earnings press release earlier today.

You may access this announcement via our website at www.kennametal.com.

Consistent with our practice in prior quarterly conference calls, we've invited various members of the media to listen to this call.

It's also being broadcast live on our website and a recording of this call will be available on our site for replay through June 5, 2015.

I'm Quynh McGuire, Director of Investor Relations for Kennametal.

Joining me for our call today are President and Chief Executive Officer, Don Nolan; and interim CFO, Vice President Finance and Corporate Controller, Marty Fusco.

Don and Marty will discuss the March quarter's financial performance.

After their remarks, we will be happy to answer your questions.

In addition, FY15 third-quarter presentation slides are available on our website as well as in our Form 8-K filing.

At this time, I'd like to direct your attention to our forward-looking disclosure statement.

The discussion we'll have today contains comments that may 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.

Additional information regarding these risk factors and uncertainties is detailed in Kennametal's filings with the Securities and Exchange Commission.

In addition, Kennametal has provided the SEC with a Form 8-K, a copy of which is currently available on our website.

This enables us to discuss non-GAAP financial measures during this call in accordance with SEC regulation G. This 8-K presents GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures and it provides a reconciliation of those measures as well.

I'll now turn the call over to Don.

Thank you, Quynh, and hello, everyone.

Thanks for joining us today.

In the March quarter we made significant progress in accelerating our cost reduction measures.

We delivered adjusted earnings per share of $0.46 and year-to-date operating cash flow of $143 million -- both metrics above our expectation for the March quarter.

That said, there were challenges in several end markets including a continued global decline in energy.

We have targeted three key initiatives to further Kennametal's competitive and financial position.

These actions will drive improved performance and more effective capital deployments.

Our focus is on cost reductions, portfolio management and working capital improvements.

We also intend to adjust our cost structure to reflect certain declining end markets.

First, we're launching a phase 3 restructuring initiative and I've identified an additional $25 million to $30 million in cost savings, which we expect to be complete by March, 2017.

Secondly, our portfolio management review indicates that there's a potential to divest a combination of businesses in the range of $150 million to $400 million in annual sales.

And thirdly, based on our footprint review, we believe that we can reduce our manufacturing footprint by roughly 20% to 25% over the next several years.

For the March quarter, consolidated sales declined 9% from the prior year on an organic basis.

Sales were lower by 5% from the December quarter with 3% of the decrease due to foreign currency exchange rate.

On an organic basis and by segment, industrial sales were slightly lower with a decrease of 2% while infrastructure sales declined 16% compared with the prior year.

Q3 was dramatically impacted by lower oil and gas drilling activity and a continued slowdown in mining.

Approximately 8% to 9% of Kennametal's total sales are related to the oil and gas sector, not including those customers who may indirectly serve this market.

Looking at the bigger picture, 20% to 25% of our sales are to energy and related markets.

In addition to the challenging macroeconomic environment, our sales were negatively impacted by 6% due to foreign currency exchange.

Marty will discuss the specifics of the March quarter, including the additional infrastructure impairment charges recorded for this period and the related decline in its outlook.

We are working hard to overcome the market uncertainties by identifying ways to improve our business.

Our passionate global team of employees is delivering great service and innovation that truly matters to our customers.

I remain committed to taking a fresh look at every aspect of the Company, and while the assessment is not complete, we are fixing problems in execution in overall performance.

While we are reducing costs in many areas, we are also investing in capabilities to better serve our customers and support growth.

These are our top priorities to maximize profitability and improve shareholder returns.

We are mapping our path forward and we will share a longer-term plan at our analyst day event in December of this year.

Regarding our capital allocation process, we will be disciplined and prioritize our capital investments to drive margin enhancements in our business.

We remain balanced in returning cash to shareholders through dividends and, over the longer term, share repurchases.

As we realize restructuring program benefits, we expect to be comfortably within financial metric thresholds of our current credit rating.

Also, proceeds from divestitures will provide funds for further debt reduction and restore capacity for share repurchases.

We remain committed to maintaining our investment-grade ratings.

For FY15, we produced debt by $158 million.

And in addition, we are planning to utilize overseas cash for further debt reduction in the range of $50 million to $100 million.

At this time, it really doesn't make sense for us to consider acquisitions.

There are much better investment opportunities that exist within our core businesses.

We have defined the following priorities for margin expansion.

First, we must continue to identify opportunities to accelerate our sales growth.

We have distinctive technologies and capabilities and we will continue to invest in innovation that matters to introduce new products that help us win in the marketplace.

We remain committed to our historic pricing discipline, which reflects our value as a full solutions provider.

We are prioritizing research and development efforts, piloting new projects with a focus on velocity to increase the speed at which our products come to market.

All the while, we are capitalizing the strengths of our well-known brands -- powerful brands like Beyond, WIDIA, Hanita and, of course, Kennametal -- and leveraging our successes worldwide.

Customers appreciate our quality and performance as validated by the recent Silver Supplier Performance award, which we received from Boeing.

Second, we will be improving earnings and cash generation by implementing a more effective cost structure and reducing the complexity our business.

We are taking a granular view of our SG&A spending and using a disciplined, return-driven decision making process, redeploying some savings to areas with the greatest potential for growth.

We also increased our efforts related to cash generation by managing everyday costs and taking a close look at improving inventory levels and other aspects of working capital.

Through our phase 1 and phase 2 restructuring programs, we realized $21 million in savings so far.

To date, we have closed four facilities and divested one facility as part of phase 1. We are identifying additional opportunities through our phase 3 restructuring initiatives, estimated to achieve an additional $25 million to $30 million of annualized savings.

These actions represent an enterprise-wide cost reduction program as well as the consolidation of certain manufacturing facilities.

While the size and magnitude of each restructuring program varies, we continuously look for ways to streamline our business and expect more to come.

Combined, the current restructuring actions are estimated to generate total savings of $115 million to $135 million on an annualized basis by March 2017.

Over the long term, we believe that we can reduce our manufacturing footprint by roughly 20% to 25% from the current level, including a piece from the portfolio realignment.

In addition, we expect to implement more actions to reduce administrative costs when the portfolio review process is completed.

We are strengthening Kennametal's culture, reinforcing a mindset of improved execution and clear accountability.

We are measuring our success through improvement in sales, margins, earnings and free cash flow.

Finally, we are streamlining our portfolio to determine what offers the best EVA metrics to improve profitability and allow us to focus on our core.

We define our core as those businesses that have the technology and manufacturing processes that enable Kennametal to bring value to our customers.

As mentioned earlier, we believe there is potential to divest a combination of businesses in the range of $150 million to $400 million in annual sales.

These businesses have margins significantly lower than the corporate average.

Additionally, we want to be clear that our portfolio review will be ongoing and not a one-time effort.

To accomplish our goals we created a transformation team that is led by one of my direct reports to ensure executive-level focus.

We are closely tracking key metrics and each area is reviewed on a weekly basis.

We will provide an update each quarter so that you can measure our progress.

Regarding FY16, we will provide guidance and related assumptions during our next quarter's earnings call.

While we can't provide specifics at this time, we can provide a high level perspective.

We are not anticipating much improvement in the current market trends.

Also, we would like to remind investors that while restructuring savings will accelerate, there will be substantial headwinds in the form of foreign currency exchange as well as difficult comparisons in the energy markets, particularly in the first half.

These factors lead us to view FY16 as a year in which we will adjust our cost structure and position the Company for future margin expansion, improved cash flow and better returns.

My confidence in Kennametal's future is driven by the strength of our innovation focus, our market-leading brands and our geographic reach.

I will now turn the call over to Marty who will discuss our financial results for the quarter in greater detail.

Think you, Don.

Some of my comments are related to non-GAAP metrics so please see the non-GAAP reconciliations filed with our Form 8-K and in our press release.

As Don mentioned, the March quarter presented additional challenges as certain served end-markets further weakened coupled with a more severe downturn than previously expected in the global energy market.

Those of you who follow our monthly order trends have seen this trend.

Up-line challenges were offset by additional cost reductions during the quarter.

Our adjusted earnings per share for the quarter was $0.46 compared to $0.75 for the prior year.

Current year adjusted EPS excluded the following: asset impairment charges of $0.90 per share related to our infrastructure segment; restructuring and related charges of $0.12 per share; and tax expense of $0.02 per share related to a planned cash redeployment.

We are progressing with the phase 1 restructuring program, which generated pretax benefits of approximately $8 million in the quarter compared to $1 million in the prior-year period.

Phase 1 restructuring pretax benefits are projected to be $50 million to $55 million on an annualized basis.

The pretax charges estimated to be $55 million to $60 million.

Also, we're making progress with our phase 2 restructuring program, which was announced last quarter, and generated pretax benefits of approximately $1 million in the quarter.

This program is part of the efforts to further right size our cost structure and is expected to deliver pretax annualized benefits of $40 million to $50 million with $90 million to $100 million estimated pretax charges and we expect to complete this by the end of calendar 2016.

To further enhance operational efficiencies through an enterprise-wide cost reduction programs, as well as the consolidation of certain traditional manufacturing facilities, we also announced another restructuring program.

This program, referred to as phase 3, is expected to deliver pretax annualized benefits of $25 million to $30 million, incur $40 million to $45 million in estimated pretax charges and be completed over the next two years.

Total benefits for all three programs are expected to range from $115 million to $135 million and total charges are expected to range from $185 million to $205 million.

We continue to employ specific and targeted actions to maximize cash flow and liquidity with a key focus on improved working capital management.

This resulted in strong free operating cash flow of $143 million year-to-date.

Now let me walk through the key items in the income statement.

Sales for the quarter were $639 million compared with $755 million in the same quarter last year.

Sales decreased by 15% reflecting a 9% organic decline and a 6% unfavorable impact from currency exchange.

Turning to the sales performance by business segment.

Our industrial segment sales of $355 million decreased 11% from $400 million in the prior year quarter due to unfavorable currency exchange of 8%, organic decline of 2% and 1% from divestiture.

Excluding the impact of currency exchange, sales increased approximately 2% in transportation, general engineering decreased approximately 1% and aerospace and defense decreased approximately 6%.

On a regional basis, sales increased 12% in Asia, offset by sales decreases of 6% in Europe and 4% in the Americas.

In Asia, sales growth was driven by new project tooling packages in the transportation market.

In Europe, we saw a broad end-market softness.

In the Americas, sales declined primarily due to weakness in the energy and general engineering markets.

Overall, general engineering was impacted by weaker global demand, which included lower activity related to the energy markets.

Infrastructure segment sales of $284 million decreased 20% from $356 million in the prior year.

The decrease was driven by 16% organic sales decline and 4% unfavorable currency exchange.

Excluding the impact of currency, sales decreased by approximately 23% in energy and by approximately 15% in earthworks.

Energy sales were impacted by an accelerated decline in demand for oil and gas products in all regions.

Extended weakness in mining activity, particularly in the US and Asia, together with decreased US road rehabilitation tool demand and reduced project spending globally, led to lower earthworks sales.

On a regional basis, sales decreased 18% in the Americas, 15% in Asia and 11% in Europe.

Moving to our consolidated operating performance, our gross profit margin was 31.2% compared with 31.6% in prior year.

Our adjusted gross profit margin in the current and prior periods was 31.3% and 32.7% respectively.

The decline in our margin was due to the organic sales decline, unfavorable business mix in the infrastructure segment and unfavorable currency exchange, partially offset by restructuring benefits.

The reduction of finished goods and work in process inventory impacted margin by approximately 50 basis points.

Operating expense as a percentage of sales was 21.6% compared with 20.2% in the prior year.

Adjusted operating expense as a percentage of sales was 21.5% for the current period and 19.9% in the prior year.

Adjusted operating expense declined $13 million year-over-year due to favorable foreign currency exchange impacts, restructuring benefits and containment of discretionary spending.

Cost reduction actions are in place and will continue to align our cost structure with the realities of the current market conditions.

Operating loss was $120 million compared with operating income of $77 million in the same quarter last year.

Adjusted operating income was $56 million compared with $90 million in the same quarter last year.

Adjusted operating results in the current period were driven by organic sales decline, unfavorable mix in infrastructure and unfavorable currency exchange, offset partially by restructuring benefit.

Adjusted operating margin was 8.8% in the current period compared with 11.9% in the prior-year period.

During the March quarter, we finalized the non-cash pretax impairment charge related to an infrastructure trade name.

As a result, an additional non-cash pretax charge of $7 million, or $0.05 per share was recorded.

We also completed our annual impairment test of goodwill and indefinite lived intangible assets.

The test resulted in a non-cash pretax impairment charge of $153 million, or $0.85 per share, in our infrastructure segment due to the decline in the future energy market outlook being more severe than previously anticipated.

Combined impairment charges in the quarter of $160 million will not have an impact on our bank covenants.

Approximately $112 million of goodwill remains on the books for infrastructure as of March 31.

Given the significant impairments in the infrastructure segment, it continues to be the focus of our portfolio review.

Looking at the operating income performance by business segment, the industrial segment operating income was $35 million compared with $51 million in the prior year.

Adjusted operating income was $44 million compared to $59 million in the prior year quarter.

These results were driven by organic sales decline, partially offset by restructuring benefits.

Industrial adjusted operating margin was down 240 basis points to 12.4% compared with 14.8% in the prior year.

The infrastructure segment operating loss was $153 million compared with operating income of $28 million in the prior quarter of last year.

As previously mentioned, we recorded non-cash pretax impairment charges of $160 million.

Adjusted operating income was $14 million compared to $33 million in the prior year quarter.

Adjusted operating income decreased primarily due to lower organic sales, coupled with unfavorable mix of sales and lower fixed cost absorption related to reduced demand levels in earthworks and energy product lines, partially offset by the benefits of restructuring.

Infrastructure adjusted operating margin was 5% compared with 9.3% in the prior year.

Our effective tax rate was 64.4% benefit on a loss in the current quarter compared with 24.1% provision on income in the prior year quarter.

Excluding the impact of special charges, the adjusted effective tax rate of 23.1% decreased primarily due to jurisdictional mix of incomes.

Turning to cash flow, as a result of our working capital initiatives, we generated strong year-to-date operating cash flow of $220 million and we are approximately $66 million above the comparable prior year-to-date March period.

Year-to-date, we generated $143 million of free operating cash flow, an increase of 110% compared with $68 million in the prior-year period.

We delivered this strong cash flow after investing $76 million in net CapEx.

We remain confident in our continued cash flow generation and committed to our capital structure principles.

Our liquidity remains strong, supported by our $600 million revolving credit facility, which is due April 2018, of which $486 million was available at March 31.

We have ample cushion under our financial covenants and an attractive debt maturity profile as our nearest maturity is in November 2019 when our $400 million, 2.65% senior unsecured notes are due.

Our cash balance was $146 million as of March 31, which mostly resides overseas.

Through prudent and balanced debt facility structuring, we are favorably positioned to deploy cash flow from overseas operations for debt reduction.

We believe we are advantaged in this regard, thereby providing additional liquidity flexibility if needed.

We enjoy investment-grade ratings from all three agencies and remain committed to maintaining them.

Our credit ratings were affirmed in the December quarter by all three agencies who acknowledged our strong liquidity and favorable debt reduction since the TMB acquisition last year.

Our fiscal year-to-date debt reduction is $158 million and we are now targeting full-year debt reduction of $250 million to $300 million.

We will achieve this significant debt reduction through enhanced working capital performance, liquidity management and use of overseas cash.

Our debt to capital ratio at March 31, 2015 was 39.2% compared to 35.1% as of June 30.

The increase was driven by the infrastructure impairment charges.

Turning to the outlook, we refined our outlook to reflect one remaining quarter in FY15.

We are tightening our interested EPS guidance to a range of $1.95 to $2.05 compared with previous guidance of $1.90 to $2.10, maintaining the midpoint at $2 per share.

Our FY15 outlook is based on the following assumptions.

We expect FY15 total sales to decline in the range of 7% to 8% and organic sales to decline in the range of 5% to 6%.

Previously, we had projected total sales decline ranging from 6% to 7% with organic sales decline of 4% to 5%.

We increased the organic sales decline by 1%, driven by infrastructure, which will be offset by accelerated expected restructuring benefits and cost reduction efforts.

Our effective tax rate, excluding special charges for FY15, is forecast to be approximately 22% to 23%.

We will continue to look for ways to balance our geographic presence and minimize our tax rate.

Based on these factors, we expect EPS to range from $1.95 to $2.05 through FY15.

As discussed earlier today, we continue to take aggressive actions to reduce costs, including streamlining our manufacturing footprint.

In implementing these actions, we expect to recognize the majority of the remaining charges related to phase 1 restructuring initiatives over the next three months.

While near-term conditions are challenging, we are in the process of developing a path forward that will result in improved shareholder return.

We have a renewed focus on managing what we can control and will continue to sharply focus on cash flow.

We expect to generate cash from operating activities ranging from $295 million to $320 million in FY15 versus our previous expectation of $270 million to $295 million.

With anticipated capital expenditures ranging from $115 million to $120 million, we now expect to generate between $180 million and $200 million of free operating cash flow for the fiscal year.

To facilitate an acceleration of our debt reduction commitments to lessen the impact of are projected decline in operating income, we are planning a cash redeployment of approximately $50 million to $100 million from overseas.

We expect to complete this redeployment in the June quarter.

We recorded tax expense in the current quarter of $2 million, or $0.02 per share, related to this anticipated redeployment.

We also believe we will be able to generate additional cash flows from our portfolio review process.

We will utilize these proceeds along with working capital reductions, primarily for the purpose of debt reduction in the near term.

Over a longer term, our capital allocation process will continue to include disciplined capital investments in the business as well as returning cash to shareholders through dividends and share repurchases.

At this time, I would like to turn the call back over to Don for his closing comments.

Thanks, Marty.

My confidence in Kennametal's future stems from the strength of our people, our great products and our geographic reach.

We continue to develop innovative technologies and nurture great talent within our organization.

While there certainly is a lot of work to be done, we are making progress.

Our key priorities are to simplify our portfolio, align our cost structure with the realities of the market and invest in the business to deliver core growth with an accountable, customer-focused culture.

These are all essential to developing our path forward to drive organic growth, maximize profitability and generate improved shareholder returns.

As we achieve these near-term priorities, we will continue to build a strategic road map to define our future and frame the long-term picture for Kennametal and our shareholders.

We will now take your questions.

(Operator Instructions)

Our first question will come from Ann Duignan of JPMorgan.

Please go ahead.

Hi.

Good morning, everyone.

Good morning, Ann.

Don, I don't know if I harped on this the last quarter, also, but I'm curious -- why do we have to wait till December for the analyst meeting?

Given the size of this restructuring and given the importance of this restructuring -- and I think it's important that investors have confidence in the team's ability to pull it off.

And I think we would like see more details sooner rather than later.

Well I think, Ann, it's really important.

Right now we have a focus on the initiatives as we described.

Our focus is on optimizing our portfolio, making sure that we're really clear on what is core and what isn't.

And our focus on working capital clearly needs to be the center of our attention.

And what attention we have left after those initiatives is focused on making sure that we have a successful and we're aligned on a long-term strategy.

So this purely prioritization.

And is it your expectation that you will be out meeting with investors before December?

Yes, absolutely.

Okay.

That's helpful.

Thank you.

And then turning back to businesses, I don't think you gave guidance in the release by segment.

Could you provide revenue guidance by segment?

Hi, Ann.

This is Marty.

We don't provide guidance on top line by segment.

I could talk a little bit about sort of end-market outlook as far as industrial goes.

I would say in total, we expect similar levels as we did in Q3.

And from an infrastructure standpoint, we are continuing to experience the current trends within oil and gas and energy as well as a little bit softer construction season than we were expecting at this point as our customers are waiting to see what might happened with funding for the highway bill.

I will say, just to build on that, we are on through April -- we are on track to achieve our forecast for the quarter.

Okay.

That's helpful.

I'll get back in line.

I appreciate it.

The next question will be from Julian Mitchell of Credit Suisse.

Please go ahead.

Hi.

Thank you.

Just wanted to follow up on the industrial business and the demand trends within that.

I guess a lot of companies seem to see demand particularly soften in sort of February and then maybe get a little bit better in the last month or two.

I just wondered if you saw that within industrial?

And maybe what's happening in Europe and that business?

Is there any sign at all recently of pickup there?

I would say, Julian, we were pretty much on track with our forecast for the quarter.

I would say no particularly significant surprises.

And I would say we're on track to -- on the industrial side, certainly, we are on track to achieve our forecast this quarter.

So my take is over the six months, pretty much as expected.

Not seeing any significant changes.

I would say the only area where we are continually watching was infrastructure, as Marty mentioned.

We fell a little bit short of what we expected in the last quarter.

And this quarter we are pretty much on track with what we expected.

Thanks.

And then just a follow-up question around pricing dynamics.

I think one of your main cutting tool competitors talked about how the currency moves would not really affect pricing strategies as they saw it.

Have you seen any shift in pricing, either through currency moves or demand driven in oil and gas?

Have not seen -- I just speak philosophically -- I don't think currency is a key driver in the short term.

I just -- I don't think certainly not for us.

We continue to focus on the value added portion of the market.

And we think we create considerable value for our customers and priced accordingly.

We haven't seen anything.

And I would just add to that, Julian, that reminding everyone we did go out with some general price increases in January that we talked about last quarter.

And from a pricing perspective, all of the pricing impacts within our strategy are reflected within the current guidance.

Thanks.

And then just a very quick last one.

The cost savings from phase 1, 2, 3, any sense of the waiting of those three across infrastructure versus industrial?

Is infrastructure sort of 70% to 80% of that?

I would say that now that we have added phase 3, it's pretty consistent with what we have seen in the first two phases.

I estimate probably in the 50/50 range -- an estimate.

Great.

Thank you.

The next question will come from Stephen Volkmann of Jefferies group is go ahead of

Hi, Stephen.

Good morning.

Just a couple follow-ons if I could.

Don, you're starting to sketch out what this turnaround is going to look like.

And I'm curious the divesture of $150 million to $400 million in annual sales -- sort of a wide range.

And I guess I'm curious what those businesses look like now.

Do you think they are divestable in their current condition?

Do you have to do some work on them first?

And is that just sort of a waypoint towards something bigger?

I think you mentioned a footprint reduction, ultimately, of 20% to 25% but I can't do the math that fast.

Does that mean the numbers will be bigger as we go down the road?

No.

At this point I think $150 million to $400 million is the right range and, as I said in the last call, this is not a fire sale.

We have, I would say, some businesses that may have better natural owner's, people who add value, organizations that would value these businesses.

And we think we're not in a hurry but, on the other hand, these are businesses that we don't think are good for the long-term success of the Company.

Sorry.

Would you expect to have these sort of in other hands by the time you do this analyst day in December?

Is that part of the idea?

I don't think I could really specify timing right now.

As you know, when you think about divesting a business, it's a balance on timing and cost or part timing and price.

And I would say that this is something I would rather do sooner than later, but I'm not a fire sale of that.

Okay.

Yes.

Fair enough.

Thanks.

And the since you opened the door a crack on 2016, I'm just going to take a shot at a couple things here.

Restructuring benefits in 2016, you should probably have a decent idea assuming end-markets are kind of flattish.

What does that look like?

Yes.

We're just not prepared at this point.

At our next earnings call we will be giving a little bit more definition around what we are thinking about 2016.

As you mentioned, I just wanted to crack the door bit.

We are thinking hard about it and we will be prepared to talk more at our next earnings call.

And, Stephen, I would add to that that phase 1, the range of $50 million to $55 million in benefits -- estimating about half of that in 2016.

Phase 2's benefits are say you're going to get a majority of them within 2016 and phase 3 likely near the end we will start to realize a chunk of those benefits from phase 3.

Okay.

Great.

That's helpful.

And then just finally, I couldn't tell from the tone, but is there potentially a phase 4 as well?

Well I think what we have said is that we're going to continuously look carefully at where it is, what we need to accomplish as part of our strategic plan.

Most assuredly, there's more to come as we divest portions of the business.

As we mentioned, the $150 million to $400 million.

There will be opportunities to realign around that.

So not sure I want to announce much more but there has to be more to come, yes.

Great.

Thank you so much.

The next question will come from Adam Uhlman of Cleveland Research.

Please go ahead.

Hi, guys.

Good morning.

Good morning, Adam.

I'd like to follow-up on the businesses that are being evaluated for sale.

You had mentioned that the margin profile of that business was lower than the average.

I'm wondering if you could put some meat on the bone on that?

Are they profitable?

Is it like 1% to 2%?

Just a little extra color there would be helpful.

Yes, at this point we just can't provide much color on that one.

As we make progress down that path, we will certainly give you some illumination.

But right now we just can't comment.

Okay.

And then related to the restructuring savings that were being mentioned earlier in your prepared remarks, Don, you had mentioned that you thought that FY16 you were seeing some volume headwinds.

And I think you managed that you'd be positioning for EBITDA margin expansion in 2017.

I'm wondering if that means that the volume environment is going to offset some of these restructuring savings that we're looking at for 2016 and, therefore, the margins would not be expected to grow next year.

Is that what you're trying to telegraph?

Well, I think we will certainly have more to talk about when we meet after next quarter in July.

What I will comment on, the significant headwinds -- we have currency headwinds, which many companies are facing right now.

And certainly the impact of the energy sector, which as I mentioned, is 20% to 25% of our revenues.

And we just don't see that trend changing.

So as we prepare and head into our next fiscal year, making sure that we have the right cost structure in place for that size is important.

And then, quite frankly, position ourselves for the upturn.

We are confident that eventually these markets will come back and we want to be very well-positioned for that upturn.

Look more to come when we talk in July.

Okay.

I guess just to round it out, your expectations for -- what currency impact to earnings for this year -- Martha, could you update us on that, please?

Sure.

We have some significant headwinds from a euro perspective.

I will tell you that I would say within the guidance in the forecast that we've provided, we're expecting a similar euro exchange rate as you would see today.

For the full year, it's pretty consistent where we had it in the guidance.

It's not that significantly different from the guidance that we had provided on currency last quarter.

Our next question will come from Walter Liptak of Global Hunter.

Please go ahead.

Hi.

Thanks.

Good morning, everyone.

Good morning, Walt.

I wanted to ask -- take a shot at 2016 too and understanding currencies of the headwind and energy too.

I wonder if you would comment on if there's anything about Europe or some of the other geographic regions that worry you about 2016?

Or is it anything in North America that's of major concern as you look into 2016?

Yes, I think I'll take the obvious path here, Walt.

Industrial certainly looks better than infrastructure heading into 2016.

And I think that right now we're thinking about similar trends as far as China.

We are quite happy with our industrial business in Asia overall right now.

We think we are growing faster than the marketplace.

And that's important because that marketplace is not growing as fast as it has in the past.

And we probably -- we'll see the same trend next year.

In Europe, certainly it continues to be challenging.

But the good news is, we are very well-positioned in Germany, which is one of the strongest economies in Europe.

So that has certainly benefited us.

And right now we don't see significant upturn in Europe as we head into next year.

Is that helpful, Walt?

Yes, it is.

Thank you for that.

And then kind of another question, just on the manufacturing footprint, I wonder if you could clarify for us how much of the footprint has been kind of either reduced -- plans taken out so far -- that 20% to 25% that's in phase 1 or 2 or in 3?

And how much -- and is any of that 20% to 25% footprint reduction related to the divestures?

Yes, so the 20% to 25% will include the portfolio realignment, but it's going forward.

It's plants that haven't been closed yet.

So much of phase 1 we've already done.

So this will include portions of phase 2, phase 3 and unannounced changes and closures.

Okay.

So it is going to be a fair amount of, I guess, heavy lifting on changes to the factory floor?

How does that impact the outlook for volumes?

I think one of the things that we do very well, quite frankly, are these transitions.

We've been at it for a few years now.

We've got an accomplished team.

We're very good at doing the things that you need to execute well in order to manage these transitions.

We are committed to making sure that we continue to deliver to our customers and not have an impact on their service levels.

Okay.

Great.

Okay.

Thank you.

The next question will come from Sean Williams of BB&T Capital Markets.

Please go ahead.

Hi.

Good morning.

Good morning, Sean.

I wonder if we could maybe still maybe dive in a little bit more on the European commentary.

I am a little surprised to see Europe take another leg down, especially on the industrial side.

Can you just talk about -- do you think you're down 6% -- do you think that is in line with the market or is there some pricing effect that's that taking effect there?

Maybe if you can just give a little bit more color on what specific end-markets within Europe or maybe the biggest headwinds.

And then I know it's a smaller piece of the business but could you just comment on the aerospace and defense trend?

Down against a pretty soft comp -- I'm just trying to get some color on maybe what's happening there.

Thanks.

Yes, so I'll pick up the aerospace.

I think in aerospace we actually made one particular customer that we decided to let go.

We decided that the margins weren't attractive enough and that's impacting our topline in aerospace, certainly.

I think overall in Europe, we have -- I think we're holding our own.

I'm happy with our industrial business overall.

I think we are holding share or may be even slightly getting share in Europe.

So I feel pretty comfortable there.

I think we will continue to be challenged.

I think Europe, the market in general, I don't see anything on the horizon.

I would say it is getting better.

So we're going to have to continue to do all the things we do even better to earn our new business as we had down the road here.

What about maybe European auto specifically?

You talked about that maybe being a headwind in the past -- European sales starting to accelerate here.

Could that be a modest tailwind for you going forward?

More cars -- definitely better.

But I think -- I don't see it -- I certainly don't see it in Q4.

Okay.

That's helpful.

And then maybe one more if I could just sneak it in.

Any update on the CFO hunt at this point?

We continue a very disciplined approach and will be keeping you updated as we make progress.

But nothing to report right now.

Okay.

Thanks, guys.

The next question will come from Michael Feniger of Bank of America.

Please go ahead.

Hi, guys.

I know there's been a lot of questions on 2016.

And I appreciate that you don't provide guidance, but can you help us understand the seasonal pattern of the business now?

Historically, it's always been more second-half weighted.

Should we be looking at 2016 as is the first half going to be much lower than the second half?

How should we be thinking about the seasonal pattern of the business now?

Yes, Michael.

We'll be in a much better position to comment on that in July.

I think, to be frank, on that particular question, we'll especially be watching this quarter.

So I'll defer that question til July.

Fair enough.

And we talked about -- we heard you guys talk about inventories.

How much more inventory do you stock and do you guys have to do internally?

Is that going to be weighing on the margins at all?

And how do you feel the inventory is with the distribution and distribution channel right now?

Yes, Michael.

From an inventory perspective, and I won't put numbers around quantifying the amount of inventory reduction because we do have a lot of moving parts, but I will say we are focused on not just with [unfinished] goods inventory, which will impact the margins, but also from a raw materials perspective, some inventory restrictions there in Q4.

And I would think similar margin impacts in the quarter for Q4 as we experienced in Q3.

So roughly 50 basis point is in Q3.

Thanks.

And then I guess just my last question, guys, you did take down your organic growth guidance on the back of oil and gas.

But I think you made a comment to you not seeing any pricing pressure.

How is that -- how's the conversation going with customers right now in that market?

It seems like demand continues to trend lower and below expectations.

Well, I think what I said was that we're going to continue to focus on the high end of the market.

We continue to focus on customers who really value the expertise and the solutions that we provide.

And in that end of the market, quite frankly, demand is high and we find opportunities.

Thanks, guys.

Thanks.

Our next question will come from Samuel Eisner of Goldman Sachs.

Please go ahead.

Yes, good morning, everyone.

Good morning, Sam.

I'm going to try one more time on FY16.

Based on you current views of end-markets and the cost restructuring programs that you have already in place, do you feel as though you can grow earnings next year?

Yes.

I'm sorry, Sam.

I just have to defer that question to July.

We still have some homework to do and will be ready to talk about that when we get together for earnings call after this quarter is complete.

On the phase 3 initiatives, can you talk specifically about what you are actually targeting for cost savings?

Are you closing facilities in Europe?

Is it more headcount instructions?

Just want to understand what specifically those are.

Yes, we're going to have similar to what we said on phase 2. Phase 3 will be a mix of administrative reductions.

And I want to emphasize that this is a structured program where we are changing processes.

We brought in an outside consultant to help us through this change process.

And so it's structured and disciplined with milestones.

And so that is certainly a significant portion of what we're going to go through with phase 3. The second key driver here will be continued footprint restructuring.

So it will be a mix similar to phase 2.

The $160 million charge that was taken, the asset impairment or the intangible asset impairment, what specifically was that for?

Can you talk about which transactions, historically, that was for?

Yes, Sam.

This is Marty.

I'll put it this way, the ending balance of goodwill on the infrastructure segment of $112 million is lower than the goodwill that we added through the Tungsten Materials acquisition.

So you can read into it that way.

Our next question will come from Steve Barger of KeyBanc Capital Markets.

Hi.

Good morning.

Morning, Steve.

I'm just trying to think about mix from a high level.

As you've gone through your product and segment reviews, can you tell us what percentage of your revenues coming in below say a 10% operating margin?

And what percent might actually be losing money right now?

Yes, Steve.

That isn't usually something that I think we ever shared that kind of detail on our product line.

I can tell you that the one thing we have shared is that we -- the portion of the business that we are looking at divesting, we certainly -- that's well below the average profitability that we have in the business.

So it will be a net improvement going forward.

That's on the entire $400 million at the high end of the range of divestable revenue?

Yes.

Okay.

But, look, we are very competitive in many markets.

And there's a range that we've never talked about what that ranges is and where.

Yes, I guess I'm just trying to get a sense for if you can divest that $400 million, how much of the jump that gives you in terms of getting back to -- just call it a double-digit operating margin.

Would that put you there?

Or would there still be additional work to do?

Yes, that would be something that we would cover as we divest.

So we will give you some indication as we head down that path.

As you can imagine, it just depends on the pieces, right?

Okay.

Thanks.

That's all I have.

Thank you.

The next question will come from Stanley Elliott of Stifel.

Please go ahead.

Hi.

Good morning.

Thank you for taking my question.

Quick question when we think about kind of the growth rate on a go-forward basis.

Industrial production used to be kind of 2 times plus [that], but with a smaller footprint I'm assuming you guys can be divesting some of the slower growth product as well as deemphasizing slower growth products.

Is it possible that we could actually see that multiple expand 2.5 times industrial production or something of that magnitude with a little bit of market tailwind behind you?

I think first, Stanley, it depends on where in the world.

So certainly in some areas in emerging markets you can get a multiple on industrial growth.

But in areas -- infrastructure certainly not.

And certainly in, I would call it the mature markets, where we have -- where you have continuous productivity gains, you're probably not going to see the kind of factors -- those kind of factors.

Because people get more and more productivity out of the tools that the use.

So I just don't see that.

And then as thinking about working capital as a percent of sales, historically it's run pretty high for the Company.

But with the divestures and fewer SKUs out there, where kind of should we be able to bracket that as a percentage sales kind of once some of these restructurings take hold?

Can you rephrase that, Stanley?

I'm not sure I understood question?

Yes.

So working capital as a percent of sales has been historically very high for Kennametal, but with divestures and then also deemphasizing a certain number of SKUs -- you can have smaller SKUs out there -- so really, where can the working capital go as a percentage of sales when we're thinking about cash flows for the Company several years down the road?

Okay.

So first of all, we certainly see opportunities for improvement.

And I mentioned in my last call, and certainly we mentioned this several times, it's one of our top three priorities.

We're just not quite yet in a position where we can lay out what is the endpoint.

Our goal is to lay that out with our strategic plan when we lay that out at the end of the year.

I will say, though, it's tied to these -- the portfolio realignment.

We need to get that behind us in order to be clear on what our working capital goals will be.

So first step is portfolio realignment and we'll be in a better positioned to talk about what's possible.

Okay?

That sounds good.

Well thank you very much and best of luck.

Thank you, Stanley.

At this time, we will conclude the question-and-answer session.

I would like to turn the call back over to Quynh McGuire for closing comments.

This concludes our discussion.

Please contact me, Quynh McGuire, at 724-539-6559 for any follow-up questions.

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