Kennametal Inc (KMT) 2016 Q2 法說會逐字稿

Good morning.

I would like to welcome everyone to Kennametal's second quarter FY16 earnings call.

(Operator Instructions)

Please note that this event is being recorded.

I would now like to turn the conference over to Kelly Boyer, Vice President of Investor Relations.

Please go ahead, ma'am.

Thank you, Denise.

Welcome, everyone, and thank you for joining us to review Kennametal's second quarter FY16 results.

We issued our quarterly earnings press release earlier today.

It is posted on our website at www.Kennametal.com.

This call is being broadcast live on that website and a recording of the call will be available for replay through March 3.

My name is Kelly Boyer and I have joined Kennametal as Vice President of Investor Relations.

I'm very happy to be part of the Kennametal team and I look forward to meeting investors and analysts of Kennametal in the coming weeks and months.

Joining on the call today are Don Nolan, President and Chief Executive Officer; Jan Kees van Gaalen, Vice President and Chief Financial Officer; and Marty Fusco, Vice President Finance and Corporate Controller.

Don and Jan Kees will discuss the December quarter's operating and financial performance as well as our updated outlook, and will be referring to a slide deck which is posted on our website.

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

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

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

Such forward-looking statements involve a number of assumptions, risks, and uncertainties that could cause the Company's actual results, performance, or achievements to differ materially from those expressed in or implied by such forward-looking statements.

These risk factors and uncertainties are detailed in Kennametal's SEC filings.

In addition, we will be discussing non-GAAP financial measures on the call today.

Reconciliations to GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures can be found on our Form 8-K on our website.

With that, I would now like to turn the call over to Don.

Thank you, Kelly.

Hello, everyone, and thank you for joining us today.

First, let me take a moment to welcome Kelly to the Kennametal team.

I know she will add great value to our investor relations effort going forward.

I would also like to take this opportunity to thank all of Kennametal's employees around the world for their hard work and dedication.

This is a time of change and challenge for Kennametal, our industry, and our end markets, and I am very proud of their achievements during this turbulent time.

The second quarter of 2016 for Kennametal was a continuation of the work began in earnest several quarters ago.

The economic environment remains very difficult and conditions continue to worsen during the quarter.

However, we are making great progress in the items that we can control and remain steadfastly focused on them.

Jan Kees and I will provide detail on those progress points on today's call.

First, let's talk a bit about the current operating environment.

The global industrial operating environment continues to be very challenging.

We are being impacted by the three C's, China, commodity markets, and currency.

Developments in China and the US are weighing down the manufacturing activity around the world.

China's economy has continued to decelerate, especially in the heavy industries and mining sectors.

In the US, industrial production is being negatively impacted by the persistent and severe decline in oil and gas prices.

In addition, industrial goods tied to exports have been impacted by the strong US dollar.

It is becoming more apparent that we are in an industrial recession in the US.

Getting a little more granular on some of our key end markets, US oil and gas rig counts are down 61% year-over-year and declined 22% during our fiscal second quarter.

This was a greater decline in we had previously anticipated.

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

Within aerospace, manufacture and activity has been tempered during the last two quarters in North America where growth was flat while in Western Europe the market was much stronger, expanding at a rate close to the 4%.

In this harsh environment, we continue to focus on our strategy.

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

We are having success in several areas.

First, as previously announced, we completed the divestiture of non-core businesses which yielded $61 million on a net basis after working capital adjustments and transaction fees.

This is a key step in our portfolio simplification efforts, dramatically reducing our complexity and enabling us to concentrate our efforts on the businesses where we can truly add value.

This transaction encompassed 18 total facilities, 11 manufacturing facilities, and seven smaller facilities.

We are very pleased with the result and looking forward to focusing on the efficiencies that results from the simplified portfolio.

Second, we continue to focus on cost saving initiatives and are on track to accomplish the goals we set in phases one through three of our restructuring.

We have now achieved run rate savings of approximately $80 million and we fully anticipate continued progress going forward.

We estimate that we will achieve a run rate of $113 million in FY17 from phases one through three.

These restructuring programs and portfolio realignment will position us well when our end markets recover.

Third, as we have mentioned in the last couple calls, we have meet good progress reducing our working capital and we continue to focus on this area.

Our goal is to be the range of $600 million to $640 million by FY16 year end.

Lastly, we continued to fortify our management team and commercial teams.

During the second quarter, in addition to Kelly, Chuck Burns also came on board as leader of our industrial segment.

Some of you met Chuck during our analyst day in December.

Chuck brings a wealth of knowledge of more than 30 years experience in the metal components industry.

We are very pleased to have Chuck as part of the Kennametal team.

In terms of the financial results in the second quarter of FY16, Kennametal reported sales of $524 million versus $676 million the second quarter of FY15.

Our organic sales decreased 12% of that total 22% decline.

Adjusted earnings per share in the second quarter was $0.14 compared to $0.52 in the second quarter of last year.

These results reflect the strong headwinds on our end markets, as we discussed.

Year to date we generated $103 million of operating cash flow and $46 million of free operating cash flow primarily driven by working capital improvements, which Jan Kees will go into detail on later in the call.

Now, to look at our operations from a segment point of view.

First, let's take a look at our industrial business.

Regardless of the cyclical ebbs and flows and the near-term macroeconomic challenges facing the space, we really like the long-term potential of our targeted global industrial markets.

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

We continued our Feet on the Street initiative, adding both technical and commercial resources to win competitive conversions at the end user.

Our initiative is already bearing fruit and this is a critical and ongoing initiative for Kennametal.

As discussed during our second quarter, we saw continuation of recent trends.

Weakness in commodity markets, particularly oil and gas and coal, and a strengthening US dollar and deceleration in China.

We've also seen the reduction in oil and gas activity spill over into the broader industrial economy.

These macroeconomic forces have clearly affected our sales, bringing significant pressure on our energy and general engineering market sales, particularly in the US.

Further, we believe the recent destocking trends continue in the US and China across our customer base but particularly in our indirect channel.

Our customers reduced their purchases to support their lower sales, but they also brought down inventories to align with lower sales expectations and we believe destocking will continue in the second half of our FY16.

We did not fully benefit from the relatively strong US auto structure in the second quarter.

However, we expect to see better results in our US auto business over the next months as a result of renewed investment in the area.

It is important to point out that while we were experiencing a challenging industrial environment in the US and parts of Asia-Pacific, we believe that we outpaced the overall market growth in several emerging markets.

This validates an important premise on our focus on execution.

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

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

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

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

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

In terms of the breakdown of our current infrastructure business by end market, an estimated 25% of our sales is directly or indirectly tied to global oil and gas markets.

Process industries and general industry represents another 25% and global mining accounts for approximately 20% of our infrastructure business.

Construction accounts for approximately 15% and the remainder is other.

Of the 25% of total infrastructure sales linked to oil and gas, approximately two-thirds is sold directly to oil and gas customers and one-third to the tier 1, tier 2 suppliers of the oil and gas market.

As discussed earlier, this sector has been hard hit.

We are working closely with the key markets in this -- key players in this market on innovative solutions to their most challenging wear and cutting problems and have been successful in maintaining and in some cases growing market share despite the downturn.

Of the 20% total which is linked to global mining in our infrastructure business, US coal mining represents approximately half of that.

We remain a market leader in this space, delivering high-performance tools designed to excel in the most difficult operating conditions, such as those in central Appalachia.

As the price of coal has decreased, higher cost mines have closed or shut in, so we have shifted our US mining strategy to regain market share in geographies outside of central Appalachia, focusing on customers we believe will be long-term winners in US mining.

The other half of our global mining business presents significant opportunities given a relatively low market share in these huge markets.

For example, we currently hold less than 10% of the market share in China, which produces over 70% of the global coal.

In addition to China, other international areas of focus will be Australia, South Africa, and Poland.

We have very strong technical solutions and proven technologies that are highly applicable to these growth markets.

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

We realized 5% growth in the second fiscal quarter, largely from new projects outside the US, and we are positioning new product launches to take advantage of what we believe will be and improving market environment globally for road construction projects.

A great example of such a product is our new Road King Conical products for road rehabilitation.

The product is being launched this season and will be featured at the Obama trade show this April.

It's design significantly increases the life and performance of the tool and also helps to extend the life of the customer's equipment.

The size of the highway systems worldwide is approximately 64 million km and it is estimated that at any particular time 20% to 30% of all highways are in maintenance.

We are excited about the global potential of this product launch.

With the completion of the non-core business divestiture, lower raw material costs, and crisp execution of our strategy, we expect the profitability of our infrastructure business to improve significantly in the coming quarters.

With regard to the outlook for the balance of FY16, we expect the challenging macro environment and strong US dollar conditions to continue.

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

Consistent with the expectations that we communicated in December, adjusted earnings per share for FY16 is forecast to be in the range of $0.85 to $1.05, a 41% decrease midpoint to midpoint, and FY16 organic sales are expected to decline in the range of 10% to 13%.

Our full-year CapEx is expected to be in the range of $125 million to $135 million.

This represents a slight deferral in our capital spending program and is both a reflection of the progress of our capital programs the first half as well as prudently managing through a difficult economic environment.

A strong balance sheet as well as investment-grade ratings are of key importance to Kennametal and we are committed to maintaining them.

I will now turn it over to Jan Kees for a detailed review of our financials and outlook.

Thank you, Donald.

Good morning, everyone.

As Don mentioned, the December quarter experienced further weakness in end market demand.

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

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

Now, let me walk through the key components of the income statement on slide 6 through 8.

Remember that I will be at times referring to non-GAAP measures.

Please, see our Form 8-K and press release for the reconciliations to GAAP.

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

By comparison, last year same period adjusted EPS was $0.52 per share.

The $0.14 per share includes a $0.04 per share tax benefit.

Our December quarter sales were $524 million compared with $676 million in the same quarter last year, a 22% decrease.

The decrease reflects a 12% organic decline, a 6% unfavorable impact from foreign exchange, and a 4% decline due to the divestiture.

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

Excluding the impact of foreign exchange and divestiture, sales were down in all of our served end markets with declines of 33% in energy, 12% in general engineering, 18% in earth works, 5% in transportation, and 1% in aerospace and defense.

Our adjusted gross profit margin in the current and prior periods was 27.2% and 29.9% respectively.

In line with the reduction in our sales, the decline in our margin was due to lower organic sales resulting in lower cost absorption.

In addition, we experienced unfavorable currency exchange in business mix, partially offset by lower raw material costs and restructuring benefits.

Adjusted operating expense as a percentage of sales was 22.9% for the current period and 19.8% in the prior year.

Adjusted operating expense declined $14 million year-over-year, primarily due to favorable currency exchange of $8 million and restructuring benefits and effective cost reduction actions totaling $8 million.

Turning to the sales by business segment on slide 8. Industrial segment sales decreased to $311 million in the second quarter, a 16% decrease from $372 million in the prior year quarter.

We experienced weak demand in all end markets, particularly in the Americas and Asia.

The general engineering end market weakened considerably where we believe there was a destocking in the indirect channel, particularly in the Americas and Asia.

Infrastructure segment sales of $213 million decreased 30% from $304 million in the prior year period.

Sales were lower year over year due to persistent weak demand in oil and gas, general industry, and US underground mining.

As Don mentioned, we continue to make progress with our current restructuring programs, phases one through three, and realize benefits of approximately $19 million in the December quarter.

In the prior year December quarter, we realized benefits of approximately $6 million.

For more complete updates on restructuring costs and benefits, please see slides 9 and 10.

The bridge of the affected tax rate is presented on slide 11.

The FY16 difference between reported and adjusted is primarily due to the divestiture and the asset impairment charge.

The tax rate in the FY16 is a reflection of the geographic shift in earnings and the impact of the permanent extension of the R&D tax credit in the current year, extenders as well as (inaudible) provisions.

The balance sheet is shown on slide 12.

We believe that a conservative strong balance sheet is an important strength of Kennametal.

Cash on hand stands at $139 million as compared to $105 million at June month end.

Our current ratio stayed constant at 2.7 as of December 30, basically level compared to 2.6 as of June 30.

As shown on slide 13, primary working capital stands at $659 million, a decrease of $175 million from $834 million at June 30.

We continue to focus on inventory and receivables.

Primary working capital as a percentage of sales stayed relatively constant at 35%.

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

In terms of uses of cash, we paid out approximately $16 million in dividends during the quarter and total expenditures, capital expenditures were $24 million.

Total CapEx for FY16 is projected to be $125 million to $135 million.

As I mentioned, we have always maintained a conservative balance sheet and we believe this is particularly important in the current economic environment.

Our debt profile and maturities are shown on slide 15 and 16.

We continue to reduce debt.

At the end of December, net debt was $568 million and we only had $5 million outstanding on our $600 million revolving facility.

Our debt-to-capital ratio was 38%, slightly up from the last quarter's level of 36%.

As shown on slide 16, we had no significant debt maturities until 2019.

Our investment grade ratings and dividends are of key importance to Kennametal and we are committed to maintaining them.

We are split rated now as Moody recently downgraded us by one notch to Baa3 citing the macroeconomic headwinds that we currently face.

We remain committed to our conservative capital allocation principles and will continue to prioritize business reinvestment for profitable growth to drive shareholder value.

Turning to the outlook for the remainder of FY16 on slides 17 and 18.

Consistent with our December announcement, we have reduced our FY16 outlook.

This reduction is driven by a number of factors.

We are experiencing what we believe to be a US industrial recession as well as a deceleration and economic activity in China, the extent to which was not anticipated in our prior guidance.

Both of our operating segments have been impacted by these factors.

Specifically related to the industrial segment, our expectations for general engineering and energy end markets have declined by more than 5% for the fiscal year from prior guidance.

This is in part driven by the US and China slowdowns but also due to the primary and secondary exposures these end markets have to oil and gas.

On a regional basis, the majority of the decrease from prior guidance is within the Americas.

Related to our infrastructure segment, our expectations overall are also impacted by the US industrial end environment and to a lesser extent this China slow down.

From an end market perspective, oil and gas and power generation expectations have fallen approximately 20% due to the factors that Don previously mentioned.

We have also reduced our expectations around the process industries and our general engineering and market by approximately 15% from our prior guidance.

These are due primary and secondary exposures to energy.

We now expect FY16 total sales to decline in the range of 20% to 23% and organic sales to decline in the range of 10% to 13%.

Previously, total sales decline was projected to be in the range of 10% to 14% with organic sales decline of 6% to 10%.

The divestiture impacted the total sales range by approximately 6% from the prior guidance and had no impact on our organic expectations.

Organic decline within our industrial segments are expected to be approximately 8% and 13% at the midpoint of our consolidated organic sales range respectively.

We understand we need to reduce our G&A costs and we're focused on accelerating our cost reductions in the second half.

With the decline in our US earnings expectations and the impact of the permanent extension of the research and development tax credit, our effective tax rate, excluding special charges for FY16, is now expected to be in the range of 11% to 13%.

Our EPS guidance for FY16 is now expected to be in the range of $0.85 to $1.05.

This represents a decrease of approximately 40% from the previous guidance at the midpoint.

Side 18 highlights the key factors underlying the change in our guidance midpoint to midpoint.

As shown on the side, the primary factors are expected decreases in organic sales, absorption and mix partially offset by raw material cost reductions and taxes.

Our free operating cash flow for FY16 is expected to be in the range of $90 million to $110 million.

Free operating cash flow expectations have been negatively impacted by the reduction in earnings offset partially by better than expected working capital improvements and our decision to defer capital expenditures for the second half of the year.

I will now turn the call back over to Don for closing comments.

Thank you, Jan Kees.

I will wrap up by saying several quarters ago we outlined our plan to position the business to deliver improved performance and we are executing to that plan.

Despite very challenging macroeconomic conditions, we are doing what we said we would do on that count.

We took aggressive actions to simplify our business, including streamlining our manufacturing footprint.

We are making good progress in factors that we can control, focusing on the productivity of our core businesses and reducing costs.

We continue to deliver world-class safety and have improved our service levels to our customers around the world, and we have fortified our leadership team with several key additions.

Our free cash flow remains strong and we are committed to maintaining a strong balance sheet.

We believe the actions we have taken and our focus on executing our strategy will focus -- will position us to take share in accelerated growth in the future as the economy and our cyclical end markets recover.

We look forward to continue to serve our customers and shareholders and thank you for your interest and support today.

We will now open it up for questions.

Thank you, Mr. Nolan.

(Operator Instructions)

Stephen Volkmann of Jefferies.

Good morning.

Hello, Stephen.

A bunch of questions.

Maybe I'll just go big picture and leave the details for later.

Don, you have been there a year, a little bit more than that now, and we've been through quite a bit of this.

I guess I'm trying to figure out what you think this business can do once it gets to a better state with regard to your restructuring and cost savings and so forth?

I think you alluded to infrastructure profitability improving significantly in coming quarters.

Is this a business that can earn its cost of capital at something like where we are now, which I assume is sort of bottomless cyclish-type end markets?

Or do you have a view of what type of profitability we can drive down the road?

Or what you are managing to internally?

And I guess, corollary to that -- sorry for the long question -- but have we completed what we need to do with the restructuring?

Or is there more to do here?

Because clearly the returns really haven't turned yet.

Sorry for the long question, but whatever insight you can get there would be great.

Sure.

A lot in there, Stephen, as you pointed out.

First, can each of the segments earn the cost of capital?

Absolutely.

We're happy with the divestiture.

We think that is a key step in getting us positioned so that infrastructure can get to that cost of capital, and we would target the cost of capital at the trough and improved returns at higher operating levels.

That's certainly our goal.

The plan that we laid out on Analyst Day -- in that plan, we laid out how we would expand our margins by 400 to 500 points over the coming quarters, and we're committed to that.

We continue to focus on delivering that.

Phases 1, 2, and 3 were a significant part of that, but we also have mentioned in the past that we anticipate continued restructuring and, dare we call it, phase 4. So, yes, there's still opportunity for us to get costs down.

We will continue to focus on that 400 to 500 margin point expansion.

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

So I guess I was thinking maybe we would certainly hear something more about this phase 4, let's call it.

Is it just too early?

Or how do we think about the cadence of that?

Very focused right now on executing phases 1, 2, and 3. As we have talked about, phase 1 was a lot about integration of acquisitions.

Phase 2, a lot about footprint reduction.

Phase 3 was a combination of footprint reduction and G&A cost reduction.

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

Okay.

That's helpful.

Thank you.

And then just a quick followup if I may.

Your new CapEx budget is a little bit lower, but just by quick math it is still 6% or 7% of revenue; seems kind of high.

How much of that is tied to restructuring and moving things around?

What should we be thinking about as sort of a sustainable CapEx rate?

So, almost none of that is tied to restructuring, that capital.

We see terrific opportunities to invest in our core.

Opportunities to drive productivity or to invest in production of new products for growth.

That's what the capital is all about and we felt that the increase in investment year over year was warranted because of the returns that we were getting on productivity.

And quite frankly, we are just deferring.

Those projects are still there, still offer tremendous returns, but we think at the lower volumes that we're running right now it makes sense to defer those investments until next year.

Okay, thank you.

I will pass it on.

Thank you.

Ann Duignan of JPMorgan.

Good morning.

I appreciate the color you gave us on the end markets and also where you think some of the opportunities are.

Could you give us a little bit more color?

Focusing on growth, coal mining in China seems a little more aspirational.

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

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

First of all, we think that the markets we participate in also offer opportunities.

Certainly the US market, where we have high share, we continue to see opportunities to take share there despite the decline in the market.

The mention of China, and some of the external international markets outside the United States, we think represent significant opportunities.

We have a sales force in place, so it's not as if we don't.

Part of this is our regional manufacturing strategy.

We're going to be moving production in region, and enables us to be competitive from a cost standpoint.

Also, quite frankly, from a service and delivery standpoint.

Sometimes, it's just simple, Ann.

Okay, thank you.

I appreciate the color.

On your comments on the automotive, I think you said you didn't benefit from strong US automotive production in the quarter, or maybe in the recent quarters.

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

I think we've mentioned for a couple quarters now that we have opportunities in North America.

We think that in this past quarter, although it's not time to celebrate because the region is shrinking, but we believe that we are holding our own as far as share goes now in North America; and part of that is some of our investment we've made in the commercial team in automotive and in other areas to support our automotive business.

So we expect that to continue to improve over coming quarters and we will keep you posted.

Okay, I will leave it there and get back in line.

Thank you.

Julian Mitchell of Credit Suisse.

Hello, Julian.

Welcome to Kelly.

Just a first question, really on the infrastructure business.

I'm assuming your guidance embeds, gets back to a positive EBIT in the second half.

Maybe just confirm that, that is the case?

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

I will start that.

Jan Kees can answer your second question.

Yes, we will certainly expect the business to be EBIT-positive in the second half.

So no doubt there.

And then, on the divestiture, of course -- that's, as we said, earnings per share neutral.

Do you want to comment on that, Jan Kees?

The divestiture in terms of EBIT didn't have an impact.

In terms of infrastructure, for the second half of the year, we are really looking at volume, productivity to improve the numbers.

Thanks.

And then just a follow up on the industrial business, where you've had a similar rate of overall revenue decline the last three quarters around the mid teens.

The decremental margin seems to get larger even with the cost-cutting.

Is that because of the destocking that is underway, that is putting a lot of pressure on your own production?

Is there something happening on price or mix behind that?

Certainly, oil and gas -- we have a higher proportion of oil and gas than many other players in this market, so it has certainly impacted us, I would say more than most.

So, when it comes back we would expect significant impact, too.

As far as the decremental margin, Jan Kees?

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

Okay, thank you.

Ross Gilardi of Bank of America Merrill Lynch.

Thanks.

Good morning.

Don, can you give a little more color on the implied second-half ramp which basically has your earnings doubling versus the first half?

And why assume that volume is going to improve in the infrastructure business in the second half of the year?

On the improvement in earnings as we look at the second half, one of the key drivers is going to be taking advantage of low raw material costs.

We know that we are going to see a significant impact on our second half, significantly more than the first half.

So that's a key driver.

Ross, I have already touched upon them.

In terms of industrial we are looking at improvements in volume, mix, and productivity; and for infrastructure, volume and productivity.

Basically, a better outlook in terms of the decremental.

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

I guess I understand the productivity initiatives.

The volume -- can you just give us a little bit more?

Are you seeing any type of order improvement to count on?

Any volume improvement in the second half of the year?

Or is this share gain tied to strategic initiatives and things like that?

Yes, incremental tied to strategic initiatives, but most of this is all about cost reduction.

Let's just call it.

This is about some of the things we have already announced around taking out G&A and removing cost of manufacturing.

All of this has really come to routes in the third and fourth quarter.

And then raw materials, the impact of raw material costs coming down.

Those are the two big drivers.

Okay, got it.

Can you talk a little bit more about the balance sheet and cash flow prioritization?

I thought you said your main priority was to continue to reinvest for growth?

And I don't know if I heard that right, but I was surprised to hear that.

I was curious to where debt reduction fits in the pecking order.

And if you can just comment on the safety and confidence in the dividend?

I will tackle the capital and leave the rest for Jan Kees.

As far as investing in the business, I feel very comfortable with some of the deferred capital investments that we have announced.

We have lower volume, so when you have lower volume moving through your plants, the productivity and the returns are not quite as high.

So we have deferred those investments that are incremental in that regard and we will come back to them in the first quarter of 2017.

The rest, what we are investing will deliver significant productivity or position us well as we roll out new products around the world.

And in terms of debt repayment, we have continued debt repayment in the first half of the year, as I have discussed, compared to the June year end.

And we will continue to make some progress on that either on a net-debt basis by building up a cash balance, and we will make sure that we get as much of the cash back to the US as we can.

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

I think the other thing, on the same topic, we're committed to continuing to drive our working capital down.

We see continued opportunities not only in the second half of this fiscal year but continuing into FY17.

And just the dividend?

Thoughts on the dividend?

We are committed to it.

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

Let me just say that we are on track with the forecast that we put together.

So the forecast that we have put on the top line, January looks in line with what we expected, so we have no reason to think that our expectations won't be met.

Thanks a lot.

Eli Lustgarten of Longbow.

Just one quick question on the tax rate.

With the credit in the second quarter, are we looking at a low teens tax rate for the third and fourth quarter?

And, more importantly, does the tax rate go back to normalizing into the low 20s next year?

Or does it stay down at these levels?

I think that question in terms of the 2017 tax rate we will discuss at the time of providing you 2017 guidance.

It depends to some extent as to what the sources of earnings are, geographically.

Some of the new tax law that was implemented in the back end of 2015 is permanent, so that will help.

And in terms of the other elements, (inaudible) provisions, et cetera, we see if those are, how do you say, beyond the year 2016.

The second half of the year will be in the low teens?

It will be in the low teens, yes, correct.

There's nothing structurally that would get you -- you should be expecting a more normalized tax rate next year versus this year, all things considered, because you don't have all this other --

Eli, that's correct.

Yes, as far as looking out in the second half of the year, can you give us some feeling for what you expect profitability-wise in both industrial and in infrastructure?

Industrial, you have a 7% operating margin in the quarter.

Can we get back to double digits by the end of the year?

And as we originally expected, mid to single digits in the infrastructure in the second half of the year in operating profitability -- are those reasonable targets?

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

Okay.

One other question about China -- I know you highlighted that about coal.

The Chinese government just banned the opening of any new coal mines for the next three years.

With that kind of environment, is it more the investments in your strategy, there, just to be able to just hold your own in China?

Because it has got to be a very competitive market if they can't open any more coal mines?

It plays to our strength, because there are lots of estimates out there about how many coal mines are in China.

I have heard anywhere from 7,000 to 9,000 coal mines out there.

What we expect to be happening is consolidation.

So that plays right into our hands.

I don't know if you know this, but the largest coal mine in China, they remove as much coal from that mine as all the coal that is mined in the United States.

That's just one mine, one owner of mine.

You can imagine what this will look like as it consolidates in the top 10 coal miners in China.

So it plays into our hands.

We're very good at working with large customers, and we've got some great technology that we continue to improve on.

So, we think that the time is right for us to expand in China.

One final question.

Inventory liquidation, which you cited.

Do you think the channels have gotten relatively clean?

Or with declining volume in the second half of the year, I assume there could be some more inventory liquidation, but more end-market related as opposed to just pure inventory liquidation?

Is that a fair outlook?

Destocking has always been difficult for us to see the magnitude.

We hear from our customers, quite frankly, but difficult to put numbers around.

I would expect destocking to continue through the next quarter, and beyond that I just couldn't comment.

What happened that you had negative automotive sales in the second quarter or so?

Was that lack of share?

Was it model specific?

What caused that to happen?

That was sort of a surprise, that you would lose share in automotive in what was a pretty strong production quarter.

I hate to point out, Eli, but that's actually pretty consistent with where we have been, unfortunately.

Our external report last quarter was similar.

We've mentioned this before.

This is a target area for us, significant opportunity, and we are on it.

All right.

Thank you very much.

Walter Liptak of Seaport Global.

Just to follow up on the last question on auto.

You have talked in the past about market share losses.

Is that primarily automotive?

Or is it across the board in the different sectors of North America?

Yes, we haven't actually discussed that in detail, Walt.

But I think in automotive it's pretty fair to say that automotive is growing and we are not, so we need to get on that.

Okay.

And as you're talking about Feet on the Street, I wonder if you could talk about just the numbers of new hires, incremental costs from new hires, et cetera, and when do you expect to start seeing benefits from the Feet on the Street?

We're already seeing benefits.

We're not in a position to talk about number of people or where or how.

We consider that competitive strategy, but I can tell you it's already having an impact and we are continuing to -- this will be a key initiative for some time to come.

A lot of our focus is in North America.

We think that there is some significant white space there where we can win; and a few other emerging markets.

Okay.

If I could switch gears to the working capital accounts.

Your inventories -- are you expecting to bring the inventories down further in the back half of the year?

And by how much?

A lot of our focus thus far has been on raw materials and [whip], and as we reduce complexity in our feeds.

So now going forward a lot of the focus will be on finished goods.

And, again, reducing complexity, focusing on line simplification -- a little more difficult, but certainly something that we are good at, and it will be a focus for many quarters to come.

Okay.

Kind of related on accounts receivable -- what kind of shape are your receivables in, in terms of, are you seeing an increase in any bad debts related to oil and gas?

Or any stretching of some of those terms?

No, we're not seeing increases in bad debts.

Typically, many of the people that we sell to in the oil and gas sector are investment grade and they pay us on the dot.

Okay, thank you.

Rudy Hokanson of Barrington Research.

Thank you.

I have a question on your oil and gas business globally.

As expectations are that the US service sector and oil and gas activity are certainly in a rapid decline, and when they will recover is questionable.

There are thoughts that the price of the commodity will see a pickup by the end of the year and into next year, in large part because of the US is falling off.

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

Just maybe a little color, Rudy, around how we think about it.

The oil and gas business for us is particularly large in the United States because of the fracking that has gone on here.

There's a tremendous pull, because of the equipment that is utilized in fracking versus more conventional drilling.

So for us, the big balance would be a comeback in the US of drilling.

Right now, I think we said 60% of the rigs are offline.

To get those back online would have a really nice impact on our business.

Globally, the cuts that we have seen around the world as units come offline -- nothing has had as high an impact is what we have seen in the United States.

For us, higher oil prices would be great and we would love to see United States put more of those rigs to work.

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

No, we do a lot of business in the Middle East, actually.

Much of that is done through the United States, where service equipment is shipped, actually, from here to there.

It's a very strong business for us and directly in that region.

It's a good business for us.

We have very strong share.

We have a very strong share around the world, but the larger volumes are in the United States.

Okay, thank you very much.

Joel Tiss of BMO.

Hey, guys.

How's it going?

Hello, Joel.

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

We heard a couple of little highlights, but I just wondered where you are in that process, and what you have discovered, and maybe -- not giving us numbers, but just an idea if there are more pieces that need to be divested?

Or you think the business is pretty much what's going to be there going forward?

I think running through the two segments -- the industrial segment I am very pleased with what I've found.

Some great markets.

We have some great technology.

We have got some work to do, which we already talked about on the commercial side.

So I think it's clearly core to Kennametal and right in our sweet spot.

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

Joel, when it comes down to it, we have got a great game plan laid out for us to expand our margins and put ourselves in a position where we can deliver outstanding earnings on the recovery.

So that's our game plan.

I don't see any significant divestitures in the near or distant future.

And then, one for Jan.

Just wondered -- the way that you have the guidance for the second half and the way you're thinking about the business, is it more that the end markets are just flat with where we are, with the run rate that we are at now?

Or is there further deterioration or improvement baked into some of those trends?

Thank you.

We're seeing some similar run rates, Joel.

At this point we're going to continue to see -- in fact, as I mentioned, January we saw exactly what we expected, what was in our forecast.

We are on track.

Great, thank you so much.

Thanks, Joel.

Andy Casey of Wells Fargo Securities.

A couple questions around price cost, with the sustained dollar strengthening -- meaning it has been strong for a while now -- and the weaker end market conditions that you continue to run into -- are you seeing or do you expect any deflationary pressure during the second half in any of your businesses?

I think deflationary being price pressure, just to be clear, Andy -- we're seeing some price pressure.

Some of our contracts are tied directly to raw material movements.

So we have some of that built in to our business, but I have got to tell you, for the most part we are not experiencing significant profit pressure from that price pressure.

Okay.

Thanks, Don.

And then I guess it was kind of a lead into the performance gap between industry and your auto growth that you're not seeing any competitive pressure there?

Or it's just product mismatch?

What's going on?

I will just leave it as I think right now we have the products; we have certainly the capabilities, the engineering capabilities; and we are executing much better as we sit today than we were a year ago; and I expect to see that business improve over the short to medium term.

Okay.

Thank you very much.

Thanks.

Schon Williams of BB&T Capital Markets.

Good morning.

Just a little bit of housekeeping.

I was a little confused in the press release.

You actually -- look like the estimated savings for phase 1 had ticked down.

Generally in the past it had been $50 million to $55 million.

It ticked down to $40 million to $45 million, yet you had already realized $52 million.

Any clarity there?

Schon, that is the effect of taking the Venture Savings out.

That was the divestiture that we referred to.

Okay, that makes sense.

I just noticed the completion date on phase 2, I guess, was pushed out two years as of the -- that was actually updated last quarter.

Just a little clarity on why was that extended so much farther into the future?

Originally, the date was --

Schon, this is Marty.

I will take that one.

We have a large manufacturing project in there that the timing got extended just a little bit beyond where we were last quarter; and, to your point, we did update that.

Okay, so you are saying this one project extended the timeline by two years?

That's correct.

Okay.

Thanks, guys.

I'll get back into the queue here.

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