Kennametal Inc (KMT) 2016 Q4 法說會逐字稿

Good day and welcome to the Kennametal fourth quarter and FY16 financial results conference call and webcast. All participants will be in listen only mode.

(Operator Instructions)

After today's presentation there will be an opportunity to ask questions.

(Operator Instructions)

Please note today's event is being recorded. I would now like to turn the conference over to Kelly Boyer, Vice President Investor Relations, please go ahead.

Thank you, Rocco. Welcome everyone and thank you for joining us to review Kennametal's fourth-quarter and FY16 year-end results. We issued our quarterly earnings press release yesterday evening and its posted on our website at www.Kennametal.com.

This call is being broadcast live on our website and a recording of the call will be available for replay through September 2. I'm Kelly Boyer, Vice President of Investor Relations. Joining me on the call today are Ron De Feo, President and Chief Executive Officer; Jan Kees van Gaalen, Vice President and Chief Financial Officer; Marti Fusco, Vice President Finance and Corporate Controller; Chuck Byrnes, President Industrial Business Segment; and Pete Dragich, President Infrastructure Business Segment.

Ron and Jan Kees will discuss our June quarter and total year of operating and financial performance as well as our outlook for FY17 and will be referring to the slide deck posted on our website. After their prepared remarks we will be happy to answer your questions.

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

Also we will be discussing non-GAAP financial measures on the call today. Reconciliations to GAAP financial measures that we believe are most directly comparable can be found on our form 8-K on our website.

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

Thank you, Kelly, and hello everyone and thank you for your interest in Kennametal. I will begin with some overview comments which are on page 3 of the presentation. Jan Kees is going to discuss the specific financial results, and then I'll provide a summary of our outlook and strategy before taking your questions.

The management team is here today to support me on those questions, as Kelly noted. With the management team we now have in place, we've confirmed substantial opportunities to improve our Company, despite, quite frankly, the challenging times that we are operating in.

Simply stated, we've not grown and we have costs that are too high. Both of these issues are being addressed.

To grow, we need to improve our commercial acumen and our sales execution. We relied too heavily on products alone. We have great products and we do have great brands.

We need to add great service, pricing, availability, a balanced channel strategy and better sales execution to our mix. We're making progress in these areas today with more intensity than ever but this is going to take time.

On the cost side, the opportunity to lower costs and improve productivity is immense around here. This will mean substantial improvements to margins, even without growth. Today, nearly 70% of our costs are labor and material based, split about two-thirds/one-third.

So for us to succeed we have to do more with less of these cost components. These changes are also underway. In fact, it started at the top of the Company. Six of the nine members of the management team are new to their positions within the past year, but only two are new to the Company.

We've eliminated over 20% of the top 100 paid positions in the Company in the past few months. We found the talent we need from within the Company. Change happens from the top down. I'll discuss more details about our initiatives to lower costs and improve productivity when I discuss the outlook later on in the call.

With regard to the fourth quarter, noted on slide 4, our adjusted results are as expected. We reported a fourth-quarter loss of $0.83 per share versus fourth-quarter earnings in FY15 of $0.26. On an adjusted basis, fourth-quarter EPS of $0.44 per share was flat versus last year's EPS of $0.44 as well.

The press release details the specific adjustments that were made. Total year results are on slide 5 with a loss of $2.83 per share in FY16 versus a loss of $4.71 per share in FY15. On an adjusted basis, EPS was $1.11 compared to FY15 adjusted EPS of $2 per share.

Slide 5 also details the full-year revenue splits by geography and by end markets for your information.

So now let me turn to the results by business segment regarding our industrial business on slide 6. The adjusted operating margin for the quarter was 12.4%, an improvement over the previous three quarters but still below a year ago. Margins were positively impacted by lower raw material costs and lower operating costs, despite an organic sales decline of 8% which was the biggest negative factor impacting year-over-year margins.

We continue to experience weak end markets, energy, commodities, and general engineering have been weak for over a year. We did some slight -- we did see some slight recovery in the last quarter in some of our markets and we believe that destocking has stabilized. We expect to see some modest improvement in some of our end markets in 2017, however, as I said in our last earnings call whether a slight recovery happens or not, we have a lot we can do on our own to improve.

We also mentioned on our last call our initiatives to build the indirect channel and be where the customer wants to buy. We estimate that our industrial business is now slightly above 50% indirect.

The important point to note here is that we're focused on making this change without sacrificing customer service and support. This is about efficiency, best value for the end-user, and making the right decisions for profitability. Looking to the future, we're positioning ourselves for when the markets recover but even without much growth we know margin improvements are possible.

Turning to page 7 on our infrastructure business, this business improved profits despite an 11% decline in revenue. The adjusted operating margin for the quarter was 3.4% which is above last year's adjusted margin of 1.1% and well above the losses in the first half. This reflects increased commercial success, such as with the launch of the Road King product, for example, continuing progress and cost savings programs as well as lower raw material costs.

Energy and mining end markets continue to be challenged, and while any growth in the next few quarters may not be significant, our focus on profit margin should allow us to improve the results.

Now I would like to turn the presentation over to Jan Kees, who will provide a more detailed financial report. Jan Kees?

Thank you Ron. Good morning everyone. As Ron mentioned, the June quarter experienced continued weakness in end market to market. We're focusing on cost management and cash flow, delivering further reductions in operating expenses and overhead. We here at Kennametal believe the actions that we are taking to achieve margin improvement, even in a no growth environment, will strengthen the Company irrespective of when our markets improve.

Let me walk you through the key components of the income statement, beginning with the quarterly results on slide 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.

Adjusted EPS for both the current quarter and the prior-year quarter were $0.44 per share. This reflects organic sales decline and related negative mix in addition to unfavorable currency exchange offset by lower raw material costs, incremental restructuring benefits and a more favorable effective tax rate.

We recorded a discrete tax charge of $81 million, associated with the valuation allowance with regards to US deferred back taxes. I will provide further detail on this later in my remarks.

The adjusted EPS bridge for the quarter is shown on slide 9. Our June quarter sales were $521 million compared with $638 million in the same quarter last year, an 18% decrease. 9% of that decrease is due to the impacts of the divestiture in the second quarter. The remaining 9% is due to organic decline, driven in part by continued end product weakness.

Prior-year volume purchasing from our customers that did not repeat in the current year and pricing softness in mining and construction sales. Sequentially, sales increased $23 million or 5% from the third-quarter sales of $498 million. On a regional basis, excluding the impact of divestiture and currency exchange, sales decreased in the Americas 13% and in Asia 11%.

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

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

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

Turning to the sales by business segment on slide 10, industrial segment sales were $329 million in the fourth quarter, an 8% decrease from $358 million in the prior-year quarter. We experienced weak demand in energy, general engineering and transportation partially offset by improvements in aerospace and defense. The general engineering market was global was weak globally, but most notably in the Americas, where sales to the indirect channel were lower but in line with end-user purchases.

The global transportation market was mixed. We generated favorable conditions in EMEA and the Americas and offset by lower deliveries in Asia. Aerospace sales grew across all regions with stronger growth occurring in India and Asia. Sequentially, industrial segment sales increased $12 million or 4% from the third-quarter sales of $369 million.

Sales increased sequentially in aerospace and defense, general engineering and transportation while sales remained flat in energy. Compared to the third quarter, fourth-quarter sales increased in all regions, led by Europe, then Asia and then the Americas. Infrastructure segment fourth quarter sales of $193 million, decreased 31% from $280 million in the prior-year period, driven by the investiture -- divestiture impact of 20% and an organic sales decline of 11%.

The energy markets was impacted by continuing weakness in oil and gas end markets, with the US land rig count taking another step down from earlier this year. Additionally, challenging conditions in underground mining continue to drive sales declines, particularly in North America, while highway construction sales showed improvement in conjunction with the road rehabilitation season.

Sequentially, infrastructure segment sales increased $11 million or 6% from the third-quarter sales of $181 million. Sequential increases were driven primarily by earthworks and to a lesser extent by general engineering, offset partially by a decrease in energy. Sequentially, fourth-quarter sales increased in all regions, led by Europe, then Asia and the Americas.

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

Full-year adjusted operating income was $126 million compared to $235 million last year. Adjusted operating income decreased primarily due to organic sales decline, unfavorable product mix, lower fixed costs absorption and unfavorable currency exchange, offset partially by lower material costs, incremental restructuring benefits and manufacturing productivity improvements. Adjusted EPS were $1.11 in the current year compared to $2 in the prior year period. The bridge is on slide 12.

The update on restructuring costs and benefits is shown in detail on pages 13 and 14 on the slide deck. We completed substantially all of phase 1 of restructuring initiatives in the quarter. In total, the phase 1 initiatives delivered FY16 incremental annual savings of $14 million.

Life to date exchange charges of $59 million were incurred to deliver annual run rate savings of $40 million to $45 million. We are also implementing additional restructuring initiatives to align our cost structure with the current operating environment through rationalization of certain manufacturing facilities and to [have time] productions.

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

Combined with the previously announced programs underway, estimated annual savings for these programs are expected to be $75 million to $90 million, with total charges of $105 million to $125 million. These benefits from restructuring and cost savings initiatives are mitigating the impacts of economic headwinds. The full-year incremental savings in 2016 were $44 million.

The year-over-year leverage for industrial and infrastructure segments was 33% and a negative 3% rest activity, contributing to consolidated year-over-year leverage of 8%. The bridges of the effective tax rate are presented in the appendices.

The year-over-year change in the adjusted quarterly effective tax rate is written primarily by favorable jurisdictional, geographical mix of earnings and higher benefits from the RD&E credit in the current year quarter. The year-over-year change in the adjusted annual effective tax rate is driven primarily by a favorable jurisdictional mix of earnings, a favorable impact related to a US provision to return adjustment, and a higher benefit from the RD&E credit. Our outlook for 2017 includes an effective tax rate of 13% to 17%, due to the effects of the recording of the US deferred tax evaluation loans in 2016.

We are in the cumulative loss position in our US legal entity. This cumulative loss was primarily driven by charges for asset impairment, restructuring and loss on divestiture, further worsening with a rolling off a profitable year 2013 from the cumulative computation. A cumulative three year loss is considered significant negative evidence that is very difficult to overcome when evaluating the realizability of deferred tax assets.

We determined that a valuation allowance is required to record our US deferred tax assets at a less realizable value. We recorded a valuation allowance of $106 million, of which $81 million was recorded in the FY06 tax provision and $25 million was recorded for other comprehensive income.

The accounting treatment of this non-cash item has no effect on the ability of the Company to use its tax assets to reduce future cash tax payments. The valuation allowance is subject to reversal upon the Company's return to sustained profitability in the US.

As we have emphasized many times, we believe that a conservative strong balance sheet is an important strength of Kennametal. The balance sheet is shown on slide 15.

Cash on hand stands at $162 million as compared to $105 million last year. Our current ratio was 2.5 as of June 30, 2016, compared to 2.6 as of June 30, 2015.

As shown on slide 16, primary working capital was $648 million as of June 30, 2016, a decrease of $186 million from $834 million as of June 30, 2015. Primary working capital as a percentage of sales decreased 150 basis points from 35.8% as of June 2015, to 34.3% as of June 2016. Strong free operating cash flow has been a consistent strength of Kennametal through the years, through both troughs and peaks.

As shown on slide 17, the year to date free operating cash flow is $115 million, despite the severe economic headwinds that we have faced this year. For FY16, the total year adjusted EBITDA was $247 million versus prior year adjusted EBITDA of $366 million. Adjusted EBITDA for the current quarter was $77 million versus prior year fourth quarter adjusted EBITDA of $86 million. Adjustments for EBITDA are detailed in our earnings release on our form 8-K.

In terms of uses of cash year to date, net capital expenditures were $105 million. We paid out approximately $64 million in dividends and we reduced our gross debt by $51 million to $701 million, as of June year-end. Our conservative capital structure and dividends are of key importance to Kennametal and we continue our commitment to maintaining them.

Our debt and liquidity positions are shown on slide 18. At the end of June our net debt was $540 million. With no current outstanding borrowings on our revolver, we have no significant maturities until 2019. We will continue to prioritize business reinvestment for profitable growth and reduction of cost of sales and operating expenses to drive shareholder value.

Now I will turn the call back to Ron.

Thank you, Jan Kees. Turning to slide 19, a few words about our outlook.

Things are changing quickly around here, we think for the better, but the markets remain hard to predict. Our outlook was developed on the basis of continued improvements operationally with flat revenue. Consequently, we've positioned the outlook with a no-growth view and then added some initiatives to help us deliver or exceed it, depending upon what happens to the revenue.

For our outlook, as mentioned, we are expecting basically flat sales, based on slightly positive end markets through the year with no pricing impact. Built into this outlook already are cost savings programs, Jan Kees detailed a number of them, and another initiatives that continue from prior actions that more than offset the anticipated cost increases for compensation and benefits. With regard to the full-year adjusted EPS, we are projecting a range of $1.10 to $1.40, the midpoint of course is plus 13% versus 2016 adjusted EPS.

Capital expenditures are forecast to be between $100 million and $120 million. Pre-operating cash flow is forecasted to fall between $90 million and $110 million, the effective tax rate is forecast to be 13% to 17%.

So if we step back, and we did, as a management team, and look at this performance, we concluded that this was a solid plan but we felt, frankly, we needed to be more aggressive. So as noted on slide 20 we're executing a growth and cost reduction program which is aided by our new organizational structure announced a couple of months ago. For 2017 we will report three P&L segments -- industrial, infrastructure, and video.

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

Therefore, we've announced the workforce reduction of approximately 1,000 people targeting annual savings of $100 million to $110 million on a run rate basis so we expect to hit that run rate leaving FY17. The estimated cost for this is $80 million to $95 million.

Neither the cost nor the benefit is in our outlook. We are however, almost halfway complete with this recently announced initiative to reduce our workforce.

Perhaps more interesting to investors is that we've also developed a list of productivity and investment programs that are expected to yield $200 million to $300 million in savings over the next two to three years. We expect to have less than two-year paybacks on most of these projects. Later this calendar year we will highlight key programs and projects for investors.

This is part of our fix in place manufacturing strategy. There's a lot to do to improve this Company that's already been identified. We will be going about prioritizing and putting in place teams of people to begin to harvest what is clearly big opportunities for us.

So to summarize on slide 21, we have a solid consumables business with strong free cash flow through the cycle. We expect to maintain our conservative capital structure and dividend policy. And the challenging end markets have driven us to try and make bolder changes within the enterprise, this will improve our franchise for the mid-and longer-term. The challenging end markets aren't going to change but the performance of the Company needs to and that's what we're about.

So Rocco, I'd now like to open it up to questions.

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Ann Duignan of JPMorgan.

Hi, good morning.

Good morning, Ann.

Ron, could you just walk us through your expectations by quarter or maybe first half, back half as we go through FY17? Do we lose a day in Q1 because we gained a working day in Q4? Just talk us through the mechanics of how we should think about modeling? That would be great.

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

That was about what? 48-52 -- is that the way to think about it?

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

Okay. That's helpful. And then if you could talk about industrial versus infrastructure? What specifically -- I know you said maybe destocking is gone, maybe in markets stabilizing -- maybe just a little bit more color by end market?

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

The impact of that, we'll provide looking back more detail, but it will take some business out of our North American area and actually make Chuck's business a little bit more concentrated in Europe than might be readily apparent. And Widia is, revenue-wise, probably in the range of $170ish million, maybe a little bit more, but in that range so for people's perspective.

End-market wise it's really pretty tough out there across the range of end markets. I guess I would say on the industrial side -- aerospace, maybe automotive to little bit of an extent, and infrastructure -- pick your poison. Mining, commodities, the only positives I think are a little bit in the earth works kind of business, some on the construction side. Just general, it's tough to get ahead of the prior-year.

The good news I think, as we look forward, is that we have a little bit easier comps to go against. But you know, one of the concerns we have is that while we're calling our revenue to be basically flat year over year, we are not sure how confident for us to really be on that. So that's in fact one of the reasons why we were a bit more aggressive on thinking about further cost reduction.

Any more comments on end markets, Chuck?

Sure. Ann, thank you for that question. In industrial, we definitely have seen the end of the destocking for four straight months -- March through June -- our sales have been right in line with the point of sale data that we get from our customers. I believe July will be in line, so we do not see any further destocking in our previous four to five months.

For the infrastructure business year-over-year, what we're expecting is this flat sales to some markets slightly down. In oil and gas we have had now several weeks of encouraging news relative to rig counts. We stay cautiously optimistic that we could see some improvement in oil and gas as we go through FY17.

Mining continues to be a challenge for us-- we did see continued [differentiation], second half of FY16 - has somewhat stabilized. We're having to take a number of [matches] in order to maintain competitiveness.

As Ron said, construction did become a very bright spot for us year over year. We did grow about 6%, we have had great success with the new product introductions that you had the exposure to at the Bauma show -- that has continued. And we are very happy with the performance that we got out of that product in our end markets.

Aerospace continues to be a growth area as well, and we saw a slight improvement year-over-year growth there, and we expect to continue with that FY17.

Okay. [Recon's work to detime again], just with the (Indiscernible), oil back down below $40, would that be a negative headwind for you in infrastructure? And I will leave it there thank you.

You know Ann, we're all wondering what's going to happen with the price of oil. Rig counts improved a little bit, price of oil has now gone back down. Yes, it would be negative if rig counts -- if those trends reversed, for sure.

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

Julian Mitchell of Credit Suisse.

Hello good morning. Firstly, on the sort of medium and longer-term -- you've announced these extra restructuring measures today? I guess I just wondered, what percent of the overall sort of current headcount base is that 1,000 people number that you mentioned?

And then related to that, what's the end goal here in terms of medium or long-term profit margins, when you're sort of figuring out how many heads to cut and what the extra cost measures beyond that should be?

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

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

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

I think these reductions are a little bit greater than proportionate, but this should allow us to get our operating margins up to the double-digit type levels which we think they should be at in a fairly no growth environment. But to get us past that we've now identified automation, productivity improvements, things that we can invest in that will drive further productivity within the Company around the globe. And we've identified projects with savings in the range of $200 million to $300 million, with costs that approximate the same level.

And while we're saying paybacks should be two years or better, frankly a lot of the projects we've identified have almost one year paybacks. So a lot of work that can be done by applying capital prudently to our manufacturing operations so that we can really, really improve our efficiency in our manufacturing process. We're a little bit late to the party here, frankly, but honestly this gives us a chance to advance beyond where our competition is -- at least that's my point of view.

Very helpful. And then just one follow-up would be on the shorter term -- just a boring question maybe for Jan Kees?

Looking at that EPS bridge on slide number 12 that you helpfully provided -- if I'm running that forward to FY17, is the right way to think about it that you have about $0.20, $0.25 of restructuring benefit? Maybe $0.10 of tax headwind? So that gives you $0.10 or $0.15 of an EPS growth and then the other sort of five items are fairly neutral? Is that roughly right or there's some things you've called out in those other items beyond restructuring and tax?

First of all, the taxes are going to come in a little bit below what you mentioned. The guidance that we gave is somewhat below. I think we mentioned 13% to 17% guidance.

If you just take the midpoint there, I think its a little bit less than what you gave. And yes there will be restructuring benefits to the level that you indicate. But we're also it will be a little bit more a raw material benefit, not as much as in 2016, but a little bit more. And the rest you are directionally correct.

Very helpful. Thank you.

Eli Lustgarten of Longbow Securities.

Good morning, Eli.

Good morning everyone. Can we talk a little bit about your expectations for operating profitability? I guess we talked last time about the possibility of the tax rate normalizing?

And we're still going to be in the 15%, so we're still 5% to 10% below what would be a more normal tax rate -- how long does that continue? And with the lower tax rate that I think a lot of us expected, your implication is that your operating profitability for 2017 will remain relatively similar, maybe a little bit higher but not much change from 2016? Can you give us some guidance of what you expect operating margins in industrial and infrastructure can look like?

Okay Eli, let me take that. I'm not sure we're going to provide forward views on each segment. Because when we report, those segments are going to look differently, okay?

But in a company -- in the Company overall we expected our forward tax rate to be in the 22% to 25% range, and we expected that until we had to book the valuation allowance in the United States. Because we booked that valuation allowance in the US, it reduces our tax rate going forward. Therefore, the benefit of 13% to 17%, that range, with a midpoint of about 15%.

That will continue until we demonstrate, which we are confident we will, sustained profitability in our US legal entity. That will take a couple of years. So the go-forward profitability from a tax rate point of view will be impacted from a beneficial fairly lower rate.

If we did have a capitalized US tax asset, we'll return back to that 22% to 25% tax rate - so that kind of frames that.

Thank you.

From an operating point of view, we're -- 2017 is a year where we have to recover a substantial amount of cost. We had savings for the wrong reasons in 2016 -- because we didn't pay bonuses, because we were restricted in some of our merit increases, because some of our benefit costs are going up. So we're going to have to recover, in a non-inflation oriented environment, a lot of those costs in planning.

But despite that, we are seeing a fairly meaningful increase in our operating profit, even including recovering some of those costs. Will be like it to be greater? Yes, we would -- so therefore that's why we initiated some of the additional cuts we've made.

Can you give us some idea of what the corporate will costs go up for the year? And is it fair to assume that the operating profitability of infrastructure will basically go up a little bit?

And maybe you can get to the double-digit all-in for industrial and Widia, which looks like has declined a lot? Because it used to be a little over $200 million I believe? Is that operating profitability below the industrial group or above? Can you give us some idea of how to look at this?

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

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

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

So are these headwinds going to be reported in the segments? Or is the corporate number split between? Any idea how we should model that?

It will be in the segments.

Segments. All right, thank you very much.

All right, Eli.

Michael Feniger of Bank of America Merrill Lynch.

Yes, thanks for taking my question. I understand that the UK is only 2% of your overall sales, but within your forecast for flat revenue next year, what are you expecting of Europe in 2017?

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

Sure -- Europe was our top performing unit within industrial for 2016 which was slightly under planned, and we see a flat to slightly down market. Again, there's some currency changes that we haven't planned for Europe that may dampen out the volume delta that we see. Again, the currency is a negative to industrial for 2017 versus what could be in pieces, a slightly higher build rate.

So perhaps a little different than 2016, where we saw Europe at least a little bit positive, and the Americas quite a bit negative. The outlook there is a little bit negative for Europe with perhaps the Americas being a little bit more positive.

But I want to add this, before Pete comments -- we also expect Eastern Europe to be a lot stronger. There's some parts of the East, where either through Widia or some other places we will capture some new business. Maybe there's some offset that will be positive there. Pete?

For the infrastructure business we do expect a year-over-year, some slight growth in EMEA. Most of that is coming from the success we've had in the construction business, as well as expanding into the Middle East -- which we saw the benefit of late in FY16 and we're expecting it to continue in 2017, as well as actions that we're taken to improve our cost base in EMEA with localization of manufacturing and leveraging our Asia manufacturing to support our new sales.

That's great. And then my next question just on -- its encouraging to hear the trends in destocking. But the industrial business is still down organically 8% to 9% and we're hearing comments from some distributors about decelerating trends? I was hoping you can discuss that -- what you're seeing in the business and what you saw maybe through July as well?

Are you sure into the year over year start to close, and are we expecting that to turn positive by-- is it Q2, Q3 to get us that flat outlook?

We're pleased that we continue the second half we sold at the rate that our distributors were selling at. That's counter to our first half, where we definitely saw destocking in our distribution channel. Our sales into the channel were far below what our customers were selling.

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

So I think if you reflect upon the trends inherent in what Chuck said, was our year-over-year organic decline may not be quite as big as it was because I think we shift a little bit more into the channel at the end of last year than we did at the end of this year. But despite any of those kind of readings, what I'd say is -- we're just focused on growth. We want to gain share, even among our distribution partners.

We're aggressive with them, we're talking to our distribution partners in a way they haven't heard Kennametal talk to them. And I think that's positive. So I'd encourage you to ask MSC what they think of Kennametal, ask other partners what they think of the Kennametal of today versus the Kennametal of six to nine months ago.

Perfect, thank you, guys.

Great.

(Operator Instructions)

Walter Liptak of Seaport Global.

Hello thank you, good morning guys.

Hello Walter.

I wanted to ask about the headcount reduction? It sounds like you're pretty far through? I think you called out 50% through that reduction?

And I'd like to know why you did not include that in the guidance? Or is that in there somehow, considering you've got some temporary costs that might be coming back up?

Okay so Walt, we put our plan together, looked at the plan, the plan looked like a reasonable plan but the outcome of the plan was we were working really hard to only get a little bit further ahead. So we took a hard look at what was possible and we said we need to have fewer people and fewer costs within the company and we started at the top of the Company. One of the important comments I made was more than 20% of our top 100 paid people in the Company are no longer with the Company.

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

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

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

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

Okay. Is part of this program -- some of the things you're talking about in the future like fix-in-place manufacturing, some of this automation, is this processes that have been developed already or these homegrown processes that you're putting in place now?

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

Okay. Fair enough. Okay. Thank you.

Steve Volkmann of Jefferies.

Hello, good morning.

Hello Steve.

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

5% at group level.

5%, so I guess the rest of the businesses have to make up that 5% to get you to flat organic? Am I thinking about that the right way?

No I don't think so Steve, because we basically excluded that in our view. The business, if you exclude the piece that JK mentioned is about $2 billion in revenue, versus the $2.1 billion that we reported. So we're looking at about $2 billion in revenue in 2017.

Okay. I get that. Thank you. Just sort of follow-on to the previous question -- and again I just want to make sure I'm thinking about this right -- you talked about this 1,000 people that are coming out, it's going to save you about halfway through that already, I think? I mean if I just do the math that looks like a cushion of upwards of $0.50 a share for 2017 -- that seems like a big cushion.

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

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

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

Great. Okay that's very helpful. That's better for me. Finally, just one sort of bigger picture question, Ron?

Traditionally Kennametal has had some Analyst Days in the fall and sort of laid out a lot of the longer term views of the world and so forth? Is that something you're thinking about or how do you intend to keep us updated on this stuff going forward?

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

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

Great. Thank you so much.

Rudy Hokanson of Barrington Research.

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

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

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

When it is combined with Kennametal, it gets the second child syndrome and we need to have it be a first child and a first player. And if you see this in our competition, you see a number of our competitors have multiple brands with specific value strategies and we think Widia can develop that way. It is a great brand in India, it has a good reputation in the United States, it has a very good reputation on some places in Europe but it's waned in terms of importance and I just think with a little bit more focus we will bring it back to prominence.

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

Okay. Thank you, that was my question.

Okay. Thank you.

George Pika, of Wells Fargo.

Good morning.

Good morning, George.

I'm on for Andy Casey this morning. Can you talk about where you feel like you're strongest end markets are? Because through the course of the call, it sounded like really construction and aerospace are the markets that you feel like are going to be the most stable going forward? Am I reading that right?

Yes. I think you are reading that correctly.

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

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

But that's only a piece of the market it's not the whole market. And for us to be successful across the range of the market, we need to have better sales execution, which means we need to have a really good initiative for the major customers, and great service level for mid to smaller customers. We need to have great product availability. We need to have competitive pricing, and in general we need a service mentality that takes a backseat to no one.

These are areas where intensity and focus and leadership and empowering people closer to the market will make a really big difference. I think Chuck and Pete have already seen specific impacts of where that can happen, where they can make the decisions, or their people can make decisions that historically might have gotten bogged down a little bit in this Company.

So I hope I've answered your question there. You want to comment, Pete?

Relative to product development, and looking at the markets, we've seen in my business in particular migration from the toughest conditions. Certainly, as Ron said, its always going to be a part of our DNA, but we are going to provide solutions. But there's another outstanding portion on the market now that requires something -- some cases are just good enough we've looked at this from a standpoint of developing products that aren't extremely better but are better than what's out there in the market.

But most important, we will produce those in a competitive cost structure and be competitive from a pricing standpoint. We've seen success with that in recent introductions in my continuing that with our new product development plan.

What geography to you feel like you're going to be most supportive of your new product development strategies? Where do you feel like you will get the most headway, geographically?

Geographically, and I'm talking relative to construction now, the most recent product introductions we've had, in FY16, great success in EMEA and North America. Year over year growth in construction specifically, that broken crack that we talked about in Q4 was 18%. Was huge and we haven't even introduced the project in Asia yet.

We are in the process of doing that as we speak and localizing production. I'm so looking forward to having success in Asia.

George this is Chuck, I hope you can come visit with us at IMTS. We have some major new platform launches we'll be announcing at IMTS. There's a new duo-lock turning drilling platform that will launch IMTS' new milling 411 platform.

We'll be announcing a significant expansion of our already successful Beyond Evolution group and cut off platform. And then some exciting new grades in our top-notch grooving platform that will all be rolled out at IMTS, showing significant benefits to customers.

That sounds great. Thank you.

Okay.

Samuel Eisner of Goldman Sachs.

Yes, good morning everyone.

Good morning Sam.

So just on the original cost savings plan -- the phases one through three? Are you guys still on pace to achieve roughly the $115 million to $135 million run rate savings by the end of this year?

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

( Multiple speakers )

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

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

Sam, we typically don't provide the breakout for this. Raw materials are a larger portion.

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

So curious how you guys are thinking about what the right level inventories are going forward? Should we should expect inventories as a percent of revenues are to fall going forward? Just curious how you're thinking on managing the inventory situation.

Well, I think the inventories for the company have improved, we're making progress on our working capital. We've got a little bit more progress to make, but I don't think that's where our today focus is going to be. We've got to get the cost down, we want to make sure our customer services at the levels that they have to be maintained at, and I wouldn't forecast a tremendous amount of change in our working capital.

Maybe just lastly, what were your utilization rates in the quarter?

We don't report utilization rates and frankly I don't think it's -- that's critical for us because depreciation for us is 4% to 5% of our total sales. In fact, they probably should be a higher percentage. Our problem in this Company is that we have underinvested in our fixed plant and equipment. We have too many plants perhaps from a macro perspective, but our depreciation expenses and our biggest challenge.

Got it. Thank you, Ron.

Steve Barger of KeyBanc Capital Markets.

Hey good morning. Ron, you said you're being aggressive with the distributors, the message you're sending is different from the message from six months ago? Question is, how is that conversation different? What is the new message that is so compelling that wasn't being communicated before?

I'm going to let Chuck answer that.

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

So we are continuing to have high fill rates and high availability of product to make it easier for us to do business with. This direct to indirect change has driven a response from our customers, our indirect partners, that we really want to be their partner and we want to stop competing with them. I can't explain how positive that is that our indirect customers no longer think of our salespeople as their competitor, but instead they think of them as their partner.

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

VAR stands for value-added reseller, and I guess what I would say is one of the big customers that Chuck's referring to and I won't mention which one -- when I visited with them they said we have to look at Chuck's card to see whether or not it really said Kennametal on it because he fundamentally understands that we are partners and dedicated to growing our business. And that's an attitude change, and it starts from the top.

So when I think about that new mindset towards the distribution channel -- and you talked about how you need to have really great innovative product, you have to invest in inventory to keep that level high, yet you're reducing headcount by 1,000 people? Presumably that's not coming from engineering but maybe some from sales, but really it's all manufacturing where that reduction is coming?

Steve, its going to come from everywhere in the organization. We have some limitations -- I mentioned India, Asia, and probably the IT finance and HR organizations which were targeted in our business excellence initiatives that were already underway. And let me just say it this way -- you can't take 1,000 people out of an organization and not have various parts of the organization affected.

Certain levels of work has to change. And there's got to be a concentration on the most important things. But at the end of the day, it's probably going to be a preponderance of operational folks with some sales and marketing. But also, let's be clear, a large portion of the costs is coming out of the highly paid.

As Ron mentioned, we changed six people out of nine in DLT. 20% of the highest-paid 100 employees of the company are leaving or have left already, so there's a considerable effort being made to make sure that from the top down, these initiatives are implemented.

Understood. Thank you. Last question is just around free cash flow then? So given the normal seasonal pattern of earnings and the cash restructuring costs that you are undertaking early in the year, should we think the free cash flow is negative in the first half, positive in the back half?

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

In other words, probably neutral in the first half and most of it in the second half.

Got it. Thanks for the time.

All right, Steve. I think Rocco -- I think that probably is it on the call, correct?

That is correct, yes, sir.

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

And thank you, sir. Today's conference has now concluded.

(Operator Instructions)

Thank you for attending today's presentation. You may now disconnect.