Kennametal Inc. (KMT) Q2 2015 Earnings Report, Transcript and Summary

Good morning. I would like to welcome everyone to Kennametal's Second Quarter Fiscal Year 2015 Earnings Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Quynh McGuire, Director of Investor Relations.

Thank you, Denise. Welcome, everyone. Thank you for joining us to review Kennametal's second quarter fiscal 2015 results. We issued our quarterly earnings press release earlier today. You may access this announcement via our website at www.kennametal.com. Consistent with our practice in prior quarterly conference calls, we've invited various members of the media to listen to this call. It's also being broadcast live on our website, and a recording of this call will be available on our site for replay through March 1, 2015. I'm Quynh McGuire, Director of Investor Relations for Kennametal. Joining me today for our call are Chairman of the Board, Bill Newlin; President and Chief Executive Officer, Don Nolan; Vice President and Chief Financial Officer, Frank Simpkins; and Vice President, Finance and Corporate Controller, Marty Fusco. Don and Frank will discuss the December quarter's financial performance. After their remarks, we'll be happy to answer your questions. At this time, I'd like to direct your attention to our forward-looking disclosure statement. The discussion we'll have today contains comments that may constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve a number of assumptions, risks and uncertainties that could cause the company's actual results, performance or achievements to differ materially from those expressed in or implied by such forward-looking statements. Additional information regarding these risk factors and uncertainties is detailed in Kennametal's filings with the Securities and Exchange Commission. In addition, Kennametal has provided the SEC with a Form 8-K, a copy of which is currently available on our website. This enables us to discuss non-GAAP financial measures during this call in accordance with SEC Regulation G. This 8-K presents GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures, and it provides a reconciliation of those measures as well. I'll now turn the call over to Don.

Thank you, Quynh. Hello, everyone. Thanks for joining us today. First, let me say how excited I am to be here. Kennametal is a company with a rich 77-year history, a well-respected global brand, a sound business model and most importantly, a loyal customer base. I joined Kennametal because it's a great organization with enormous potential. As attractive as our future may be, Kennametal also faces some serious challenges. We have missed investor expectations the last several quarters. We've underperformed versus our internal targets as well as versus some of our peers. So this morning, I'm going to focus on the new game plan, immediate steps we're taking to address the challenges we face and ultimately drive organic growth. Then I'll touch on our current quarter results, and lastly, I'll share our outlook on the second half for the year. Looking at where we are today, we can do better, and we understand that we must do better. So we're developing a new game plan. I'm in the process of reviewing all the strategies for our business. Our priorities are clear. First, we need to enable and drive organic growth. Second, we need to get our cost structure right. We need to get our portfolio right. We need to improve efficiencies, like working capital management, to deliver better free cash flow. And lastly, we need to drive an accountable, customer-focused culture. We're moving on immediate actions to streamline our cost structure. Those of you that are familiar with my background know that I'm a hands-on operational leader. I aim to establish a culture of execution. In the short term, we're focusing on the factors that we can control, such as manufacturing and operating efficiencies and working capital. As you may know, we've already committed to a first set of restructuring initiatives, which I'll refer to as Phase 1, to integrate our Tungsten Materials business. These initiatives are underway and on track to generate an estimated $50 million to $55 million of annualized savings as promised. To build on that, we're now implementing a broader Phase 2 restructuring across the enterprise. We aim to achieve another $40 million to $50 million of annualized cost savings in this initiative. Phase 2 will deliver a more streamlined manufacturing footprint as well as reduce our general and administrative expenses over the next 12 to 24 months. Combined, we expect Phase 1 and Phase 2 restructuring programs to deliver $90 million to $105 million in savings annually. It's also critical that we get our overall portfolio right and to sort out what is core to Kennametal and what is not. This is especially important as it relates to our Infrastructure segment. There are businesses in our portfolio that have great potential to grow profitably, and we will continue to invest in those core businesses. We're also in the process of reviewing all businesses in our portfolio. We are looking deeply into those businesses that are not delivering results to determine if they are a good fit for Kennametal. In some cases, there may be a better owner for some of these underperforming units. We're looking at our product [ph] portfolio with a tighter lens, focused on performance not tenure. There are no sacred cows in our analysis. We're using 2 key criteria to determine what belongs in our core. First, it's a matter of fit. We're looking for complementary materials and products that enhance our competitive position. And second, we're using an EVA-based framework to evaluate each business in the portfolio. As we consider portfolio decisions, our forward actions will likely include further cost reductions beyond what we've announced today, and we'll continue to look for ways to improve our performance by eliminating activities that don't create value. We are committed to maintaining Kennametal's investment grade ratings and pay down debt in the near term. Our capital allocation process will be disciplined regarding investments in the business, including restructuring. Also, in addition to our debt reduction of $100 million in the first half, we're targeting $200 million reduction for the full year. We view this as consistent with our investment grade goals and current business demands. Excess capital generated from reductions in working capital or business divestitures beyond our debt reduction goals will be returned to shareholders through dividends and stock buybacks. We believe that there will be opportunities to generate additional cash as we align the portfolio. At this time, acquisitions are not in our plans as we seek to maximize the profitability and return on the assets that we already have. We're also looking at our operating expenses. Prior goals suggested that 20% of sales is the right level. Early indications are that we can do better and still deliver a powerful value proposition to the market. In the coming months, our team will be reviewing our portfolio and our strategies. We've already begun the diagnostic work and are focusing on execution. First, execution requires a clear game plan, the right priorities, realistic expectations and a disciplined approach with clear accountability. Beyond the initial measures I've outlined today, it would be premature for me to comment on our long-term strategy at this point. I'll have more to say about Kennametal and our future objectives during our next quarterly earnings call. Additionally, we'll schedule an Analyst Day event for some time later in calendar 2015. Moving on to December -- our December quarter's performance. Clearly, the results were a disappointment. Our sales fell short of expectations as organic sales declined 2%. A couple of our end markets weakened significantly in the quarter. The coal market continued to deteriorate, driven by oversupply and lower demand. And overall, our infrastructure segment declined 8% organically. The market changes and commodities make it even more important that we move with a great sense of urgency over the coming months. Frank will discuss the specifics of the quarter, including the infrastructure impairment charge reported for this period. While one quarter is not a trend, we did make progress on reducing our inventory levels. Total working capital reductions generated $36 million in cash flow in the quarter and will continue to be an intense area of focus for the team. Our immediate focus is to address our business portfolio, our manufacturing footprint, our G&A costs and working capital and cash flow generation. Looking forward, through the reduction -- although the reduction in our fiscal 2015 guidance is significant, it appropriately reflects the recent changes and uncertainties in the commodities market and in currency. While our end markets remain challenged, it is essential to highlight the fact that we have several ongoing initiatives that will generate significant returns for shareholders. Our restructuring efforts, Phase 1 and Phase 2, are expected to total annual savings of $90 million to $105 million. As I said earlier, this is a journey that has multiple milestones. We'll be proactive in seeking organic sales opportunities as well as recalibrating our portfolio and cost structure for profitable growth. We'll reach each milestone through disciplined and process-oriented action plans. Kennametal is on a new path forward. We believe that the only way to transform Kennametal into a company that delivers for customers, employees and shareholders is through transparency and disciplined investment processes. We're looking forward to taking Kennametal to that next level of performance. I will now turn the call over to Frank, who will discuss our financial results in greater detail.

Thank you, Don. As with prior discussions, some of my comments are related to non-GAAP metrics. As Don mentioned, the December quarter was disappointing and more challenging than planned, as certain served end markets further weakened, coupled with an abrupt change in the global energy market. Those of you who follow our monthly published order rates have observed this trend. Some additional comments before I go into further detail. Our industrial segment was in line with our forecast despite some headwinds in the European market. However, our infrastructure segment performance was below expectations due to continued weakness in mining and a slower energy sector. Our adjusted earnings per share for the quarter was $0.52 compared to $0.50 in the prior year. The current year adjusted earnings per share excluded the asset impairment charge of $382 million or $5.28 per share related to our infrastructure segments as well as restructuring and related charges of about $13 million or $0.13 per share. The TMB acquisition that we acquired a year ago is now fully integrated. We are progressing with the Phase 1 restructuring program, which generated benefits of approximately $6 million pretax or $0.07 per share in the quarter. The Phase 1 restructuring pretax benefits are projected to be $50 million to $55 million on an annualized basis, and pretax charges are estimated to be $55 million to $60 million. To further rightsize our cost structure, we also announced another restructuring, as Don pointed out. The new restructuring program, referred to as Phase 2, is expected to deliver pretax annualized benefits of an additional $40 million to $50 million. We will incur $90 million to $100 million of estimated pretax charges, and we expect that to be completed in 12 to 24 months. Total expected restructuring pretax benefits for both Phase 1 and Phase 2 programs range from $90 million to $105 million, with total charges expected to range from $145 million to $160 million. We also continue to employ specific and targeted actions to maximize cash flow and liquidity, and this resulted in strong free operating cash flow of $82 million year-to-date. I also want to point out that we will change our monthly order reporting practice beginning in fiscal 2016. Kennametal will no longer provide orders data during the quarter. However, sales trends by geographic regions and end markets will continue to be presented in our quarterly earnings announcement. This decision to move away from reporting monthly orders for our next fiscal year is consistent with the industry and our business strategy, which is focused on long-term initiatives. Now I'm going to walk through the key items in the income statement. Sales for the quarter were $676 million compared with $690 million in the same quarter last year. Our sales decreased 2%, reflecting a 4% unfavorable impact from currency exchange and a 2% organic decline, partly offset by a 3% increase from the TMB acquisition and a 1% favorable impact due to more business days. And as a reminder, the prior year quarter had 2 months from the TMB acquisition, whereas the current quarter has 3 months of activity. Looking at sales by business segment. The industrial sales were $372 million, and that remained flat compared with $371 million in the prior year due to increases of 2% from organic growth, 1% from net acquisition and divestiture and 1% due to more business days, offset by the unfavorable currency effect of 4%. Sales increased 3% in our general engineering market and 2% in transportation, while aerospace and defense remained relatively flat. General engineering increased due to sales in the indirect channel and to tier suppliers in the Americas and the transportation market increased due to new project tooling packages in the Asia region. Our regional sales increased 14% in Asia, 3% in the Americas, offset by a decrease of 1% in Europe. In the Americas, sales in the indirect channel were up 8%, partly offset by a weaker performance in Latin America. Overall, choppy end market performance in Europe was offset by strong growth versus the prior year in Eastern Europe, which was up about 18%. In Asia, sales growth was driven by strong end market performance, particularly transportation, in both China and India where vehicle production was up 7% and 5%, respectively. Our infrastructure sales came in at $304 million. This was a decrease of 5% from $309 million in the prior year. The decrease was driven by an 8% organic sales decline and a 3% unfavorable currency exchange, offset by a 5% increase from the acquisition and 1% due to more days. Sales decreased 6% in earthworks and 3% in energy. Earthworks sales declined from persistently weak underground and surface mining globally, particularly the U.S. and Asia, combined with reduced demand for road rehabilitation tools and infrastructure development activity in China. Energy sales decreased due to lower activity in power generation projects, while our oil and gas sales were flat year-over-year in the quarter. In addition, the prior year included sales related to surface finishing projects that did not repeat in the current year. And looking at the sales regionally, sales decreased 14% in Europe, 9% in Asia and 2% in the Americas. Now our operating performance recap. Our gross profit margin was 29.5% compared with 30% in the prior year. Our adjusted gross profit margin in the current and prior periods were 29.9% and 31.1%, respectively. The decline in our margin was due to decreased volumes and unfavorable business mix and lower absorption of manufacturing costs due to our inventory reduction efforts. We reduced finished goods and work-in-process inventory by $17 million, which impacted our margin by 50 basis points. This was partly offset by benefits from our restructuring programs. And as some of you know, the prior year included the inventory step-up from the TMB of about $8 million. Operating expense as a percent of sales was 20.3% compared with 21.5% in the prior year. Adjusted operating expense as a percent of sales for the current and prior periods was 19.8%, and 21.3%, respectively. Operating expenses declined $11 million year-over-year due to continued disciplined -- or continued discretionary spending, restructuring benefits as well as lower employment and related costs. Cost reduction actions are in place, and we will continue to align our cost structure with the realities of the current market conditions. As part of our ongoing cost discipline, at minimum, we are committed to keeping our operating expense at or below 20% of sales for fiscal '15. Our operating loss came in at $334 million compared with $50 million in the same quarter last year. Our adjusted operating income was $61 million in both the current and prior periods. Adjusted operating results in the current period were driven by restructuring benefits and lower employment cost, offset by organic decline and an unfavorable mix in our infrastructure segments and an unfavorable currency exchange. Adjusted operating margin was 9.1% in the current period compared with 8.9% in the prior year. Now I'll touch briefly on the impairments. As Don pointed out, because of the recent abrupt change in the global energy market that is currently -- is expected to continue into the foreseeable future, coupled with the severe and persistent decline in the earthworks markets, we made an interim assessment of the possible impairment of the goodwill and other intangible assets attributable to our infrastructure segment. As a result of this assessment, we recorded an estimated noncash pretax goodwill and other intangible asset impairment charge of $377 million or $5.24 a share. Evaluation will be completed in the fiscal third quarter. We also recorded a noncash impairment charge of $5 million or $0.04 per share for a infrastructure technology asset related to our mining business. The goodwill impairment will not have any impact at all on our bank covenants. And approximately $266 million of goodwill remains on the books for our infrastructure segment as of December 31. Given the significant impairments in the infrastructure segment, it will be the initial focus of our portfolio actions. Looking at operating income by business segment. The industrial segment operating income was $42 million compared with $33 million last year. Our adjusted operating income was $48 million compared to $40 million in the prior year quarter, benefiting from organic growth, restructuring benefits and lower employment costs. Also during the quarter, we completed the closure of the TMB's Gland, Switzerland facility. Industrial's adjusted operating margin was up 190 basis points to 12.8% compared with 10.9% in the prior year. The infrastructure segment's operating loss was $372 million compared with operating income of $19 million in the same quarter of the prior year. As previously mentioned, we recorded noncash pretax impairment charges of $382 million. Our adjusted operating income was $15 million compared to $23 million in the prior year quarter. Adjusted operating income decreased due to lower organic sales, coupled with an unfavorable mix and lower fixed cost absorption related to reduced demand in earthworks and our energy product lines, partly offset by the benefits of restructuring and lower employment cost. Infrastructure's adjusted operating margin was 5% compared with 7.3% last year. Our adjusted effective tax rate was 17.7% in the current quarter and 23.8% in the prior year. The decrease was primarily driven by the extension of the credit for increase in our research activities contained in the Tax Increase Prevention Act of 2014 as well as jurisdictional mix. Turning to cash flow. As a result of our cash flow initiatives, we generated strong year-to-date operating cash flow of $135 million and were $51 million above the comparable prior year period in December. Year-to-date, we generated $82 million of free operating cash flow, an increase of 125% compared with $36 million last year. We delivered the strong cash flow after investing $55 million in capital expenditures. We remain confident in our continued robust cash flow generation and committed to our capital structure principles. Our liquidity remains strong, supported by our $600 million revolving credit facility that's due in April of 2018, of which $423 million was available at December 31. We have ample cushion under our financial covenants and attractive debt maturity profile as our nearest debt maturity is not until November 2019 when our $400 million, 2.65% senior unsecured notes come due. Our cash balance was $146 million at December 31, which resides mostly overseas. Through a prudent and balanced debt facility structuring, we are favorably positioned to deploy cash flow from overseas operations for debt reduction. We believe we are uniquely advantaged in this regard, thereby providing additional flexibility if needed. We enjoy investment grade ratings from all 3 agencies and remain committed to maintaining them. Our credit ratings were recently affirmed by all 3 agencies who acknowledge our strong liquidity and favorable debt reduction since the TMB acquisition last year. Our fiscal year-to-date debt reduction is $100 million, and we are targeting a full year debt reduction of $200 million. We will achieve this significant debt reduction in spite of the reduction to the fiscal '15 outlook through enhanced working capital performance and liquidity management. Our debt-to-cap ratio at December 31 was 38.6 compared to 35.1 at June 30, with the increase being driven by the infrastructure impairment charge. We remain vigilant in the management of our pension plans and continue enjoying the benefits of our adoption of a liability-driven investment strategy over 8 years ago. As a result, our U.S. defined benefit plan remains over 100% funded. Now I'm going to turn to the outlook. Due to the current high levels of uncertainty in the global economy, visibility is very limited regarding demand in some of our served end markets and ultimately will affect our sales, earnings and cash flow. For fiscal '15, we revised our outlook to reflect the weaker economic environment for the remainder of our fiscal year. Based on the revised forecast, we're reducing our earnings per share guidance for fiscal '15 to the range of $1.90 to $2.10 compared with $2.80 to $3 previously. Our fiscal '15 revised outlook is based on the following assumptions. We now expect fiscal '15 total sales to decline in the range of 6% to 7% and organic sales to decline in the range of 4% to 5%. Previously, we have projected total sales growth ranging from 2% to 4% with organic sales growth of 1% to 3%. The primary driver for the change in earnings guidance relates to a further reduction to the infrastructure segment sales due to a rapid decline in the oil and gas markets as well as continued weak demand from the mining industry. We are assuming infrastructure sales for fiscal '15 will be down 10% to 15% from the prior forecast. This, combined with an approximate decremental margin of between 35% and 40%, translates to about $0.55 to $0.65 per share. The industrial segment is also expected to be negatively impacted by further weakening in the Eurozone. We are estimating industrial sales for fiscal '15 will be down by 2% to 4% from the prior forecast. When coupled with an approximate decremental margin of 45% to 50%, the estimated EPS impact will be $0.25 to $0.35 per share. In addition, foreign exchange is expected to be a notable headwind, estimated to be $0.10 to $0.15 per share from our prior forecast, and this is related to the recent currency fluctuations, particularly the U.S. dollar to the euro exchange rate. Our goal remains to maintain operating expenses at 20% of sales. Restructuring benefits from Phase 1 are expected to be approximately $25 million pretax in fiscal '15. The restructuring benefits of Phase 2 will begin to show, and approximately $5 million pretax will be realized in fiscal '15. Our effective tax rate, excluding special charges for fiscal '15, is forecasted to be approximately 23% to 24%. And we will continue to look for ways to balance our geographic presence and to minimize our tax. And based on these factors, we expect earnings per share to range from $1.90 to $2.10 for fiscal '15. As discussed on our -- earlier on today's call, we will continue to take aggressive actions to reduce costs, including streamlining our manufacturing footprint. In implementing these actions, we expect to recognize the remaining $20 million in special charges related to Phase 1 restructuring initiatives over the next 6 to 9 months. While near-term conditions are challenging, we are in the process of developing a path forward that will result in improved shareholder returns. We have a renewed focus on managing what we can control, and we'll continue to sharply focus on cash flow. We expect to generate cash from operating activities ranging from $270 million to $295 million in fiscal '15 versus the previous expectation of $280 million to $310 million. We anticipate capital expenditures of $110 million to $115 million, and we expect to generate between $160 million and $180 million of free operating cash flow for the remainder of the fiscal year. In addition, we're evaluating opportunities to repatriate $40 million to $50 million of excess cash from cash overseas. We also believe that we'll be able to generate additional cash flows from our portfolio review process. We'll utilize these proceeds, along with working capital reductions, primarily for the purpose of debt reduction, and we'll also look very strongly at redeploying those proceeds into what we believe is a very attractive opportunity in Kennametal stock. At this time, I'll turn it back to Don for a few closing comments.

Well, thank you, Frank. We can and must do better than we've done in the past. The entire Kennametal team is dedicated to unlocking the value of Kennametal, and we will be very transparent as we make progress and move down this path. Our path forward includes a lot of hard work, but the team is rising to the challenge. We have a good reason to be optimistic about our future. We have a long history of outstanding products and technologies. Our customers are loyal, and they recognize that Kennametal value proposition. Our global workforce is dedicated and committed to our mission. Reiterating our new game plan that we're driving with a clear sense of urgency, we're reviewing our business strategies to enable and drive organic growth. We're getting our cost structure right. We're getting our portfolio right. We're improving efficiencies, like working capital management, to strengthen our free cash flow, and we're driving an accountable, customer-focused culture. And all that we do will be highly focused on creating value for shareholders. We will take execution to the next level and achieve better performance. I'm honored to be the Kennametal CEO, and I look forward to meeting and working with all of you. We'll now take your questions.

[Operator Instructions] The first question will come from Julian Mitchell of Crédit Suisse. Julian Mitchell - Crédit Suisse AG, Research Division: Just a question on the Infrastructure portfolio actions. I understand that you feel that there are a lot of assets in there that are maybe not beneficial for longer-term returns. How do you square the urgency of divesting those with the knowledge that you'll be selling them at pretty -- at a pretty weak time for the end markets in infrastructure? So the value you realize will be a lot lower than maybe if you wait or...

Yes, Julian, thanks. Look, there's 2 sides to that coin. First, we're looking for opportunities to improve the performance of the businesses as they stand. So -- and that includes structural opportunities. So to be clear, it's not a fire sale. When we find pieces of the portfolio that we feel don't fit for the long term, we're going to divest at a rate that makes sense. So it's a combination: improve the performance of the businesses as they stand; and see if we can find the rightful, better natural owner for each of those businesses. Julian Mitchell - Crédit Suisse AG, Research Division: And then when you were talking about the -- obviously, debt reduction is a near-term focus for the second half at some point, I guess, depending on the timing of divestment proceeds, you mentioned the buyback. How are you thinking about the optimal leverage ratio for the company, so we can sort of figure out what you view as the right level of cash to have and therefore, what is excess cash that can be returned?

Yes, Julian. I think a couple of things. We feel very comfortable with the $200 million debt reduction. I think we are uniquely restructuring. We'll take a look at potentially redeploying some of the cash that's outside the U.S. at a nominal cost. I think that would be very prudent. And then, the portfolio, it's obviously tough to time a sale of one of these properties. So we'll -- obviously, that will factor in when those happen. We'll look at our capital structure principles, how we redeploy that. And then from a leverage perspective, we want to also maintain our investment grade rating, and that's always been a debt-to-cap ratio of 35 to 45, in that range, but sometimes, it's a little bit higher when we make acquisitions. But as we continue to focus on cash and debt reduction, that'll come back down, and then we'll decide at that point when we get to the right levels that we're comfortable with from an investment grade rating, we'll redeploy excess cash back in towards Kennametal stock, with the overall arching ability to even do better in working capital. We think we'll be able to generate some additional opportunities as we embark on a new game plan going forward. Julian Mitchell - Crédit Suisse AG, Research Division: And then just one last quick one. The restructuring charges in the fiscal Q2 seem to be pretty well balanced between the 2 segments. But the end market outlook the next 12 months looks a lot worse in infrastructures. So should we see the balance of the Phase 2 related restructuring costs for almost entirely the infrastructure? Or do you think a balance is needed because the industrial sales outlook is also pretty weak?

It's balanced. Again, as Don said, there's no sacred cows. We're looking at all areas where we can get the best and quickest returns we're going to focus on. We want to make sure that we can turn around some of the business in infrastructure. But I wouldn't say it's necessarily directionally one way or the other. The portfolio will speak for itself. We're also looking at how we can improve our effectiveness and efficiencies in the back office as well. So some of those costs will get allocated. So indirectly, they'll go to both businesses. But I would keep it the same for now, and as we go further into the process, we'll provide you an update.

The next question will come from Ann Duignan of JPMorgan. Ann P. Duignan - JP Morgan Chase & Co, Research Division: I guess my question is around just the size of the restructuring program. Can you talk a little bit about the risks that are inherent with undertaking such a large restructuring program, whether you have the team in place, if you're using outside help? Or how do you keep the organization focused on the day-to-day, while all of this other activity is going on? If you could just talk about some of that.

Sure, Ann. This is Don. I think one of things that Kennametal has done well for many, many years is the ability to restructure and keep their eye on the ball. So I'm actually very comfortable with what I've seen in my first 74 days here. That the team is extremely well-organized around footprint adjustment and making that happen in an orderly and quite frankly, they execute very, very well. I think some of the new areas that we're going to be exploring over the next 12 to 24 months will be end-to-end processes in the G&A area. And in that area, we have asked for some outside help. And we have a number of people in the company who have been through this process in earlier parts of their career. So we have plenty of experience, both borrowed and hired, and looking forward to making -- to executing quite well in that area also.

Ann, I would add one thing, to give you comfort on this. I mean, clearly, we're focused on a lot more -- or a lot fewer items. We do have the past experience, as Don pointed out. And this is very similar -- particularly in the infrastructure side, it's very similar to what we experienced in the industrial prior to the Great Recession. A lot of acquisitions, we closed a lot of plants, we divested a lot of businesses. So we do have a lot of experience, and we feel pretty good we have the right people and the right teams to execute this. Ann P. Duignan - JP Morgan Chase & Co, Research Division: Okay, that's helpful. And then, 72 days in, maybe you could give us an idea of what has been the most pleasant surprise, if you like, and I don't know if you'd be willing to tell us what maybe the most negative surprise you've seen in the organization. Just your first impressions, I guess.

Overall, I mean, for sure, the passion. This is an organization that's extremely passionate about markets, about customers and about success of the organization, long tradition, long history of making things happen around the world. And I've had the opportunity to visit with customers and had several town halls on 3 continents, and it's consistent around the world, that passion. I think the other thing that I would say was a bit of a surprise, everybody understands the opportunities we face. There's no changed management here in helping people to see that we have some great opportunities in front of us. In some cases, to manage things like working capital in a different way and free up cash for better uses, and in other ways, things that -- ways that we can take the innovation that we're introducing -- that we have introduced for the last 12 months, and it's coming out in the next 12 months and have a much bigger impact on market. So I think, quite frankly, I've been pleasantly surprised is the best way to put it, on all fronts. Thanks for the question.

The next question will come from Eli Lustgarten of Longbow Securities.

A couple of things. One, as you revised your outlook and we talk about the kind of expected performance you expect from each of the 2 sectors -- I'm speaking specifically, you've done a very good job in industrial market. You still have double-digit operating margins, 12.8% in the quarter, I think adjusted. Your expectation that you'll be able to hold double-digit operating performance despite reduced forecast, particularly from Europe. And as far as from the infrastructure side, you -- 5%, you're making a little bit of money, and oil and gas is now first starting a big part of the drop, I suspect. Can you just give us some idea about the drop of oil and gas, if you're sort of embedding in your forecast and whether you can stay profitable at all in that sector? Or should we expect it to be slightly in the red?

No, I think your comment first with the industrial side, yes, we expect that to remain at the double digit. We are doing further restructuring. A lot of the programs will accelerate some restructuring benefits. Another area where we haven't seen the benefits yet, given our lag with raw material cost, is with the APT. Now we typically lag. So as the contract starts to roll off, we should see also a little bit better input costs from raw material. And with some of the markets they're dealing with, they're doing okay in the Americas. The indirect channels appears fairly good, as well as Asia, with the real soft spot being kind of the Eurozone and some transportation. But overall, given what we're focused on from a restructuring and some input costs, I feel fairly good as far as the industrial side. The challenge, obviously, is with the oil and gas markets, but it's a little bit broader than that. The oil and gas, probably direct, is a couple hundred million dollars for us on an annualized basis, just that we know directly on the drilling side. But we also sell a lot of powders, which goes into the general engineering and the infrastructure side, and we have a little bit higher exposure in the powders now that we acquired TMB last year. So for example, APT, when it's coming down short term, it puts a little bit pressure when we're selling blanks and components in an area there. So when you combine those 2, it's having a significant impact on the second half, coupled with the mining business that we've talked about. I think you're familiar with U.S. and China, as well as we had some good projects with iron ore manufacturers in Australia, given what's going on there. That's pulled up back, so we factor that in. And then just some general power generation softness related to the Stellite business in Europe, but when we're all done, we're all doing restructuring as well on the overall Kennametal side, which benefits will go to infrastructure. We expect that to maintain kind of a low, low single-digit performance for the year.

And if we step out a little bit and step back to the big restructuring that went out of Phase 2 in 12 to 24 months, what kind of target normalized margins are you looking for to get out of Infrastructure? You were able to get to low double digits in the industrial side, and that -- with volume, we understand that, but you've been able to, even in a difficult environment, maintain that. What kind of target are you setting for the infrastructure side when you -- as you go through this process? And I assume that you're looking to get to a least low double digit, similar to industrial at that point. Is that fair?

Well, I mean, we haven't set a target yet. I think, as we said in the call, we'll be talking about that in the near term. But part of that, really, it depends. Going back to what Don reiterated, it's about cost structure and the portfolio. So in the past, I know where we've been, so clearly, we're driving towards higher returns. Right now, we think the restructuring benefits will be additive, and the portfolio focus will help us drive a lot more. But at this point, we're not ready to come out with a specific number.

Yes, just to build on that Eli. I think the first decision is what's core. And we're doing a review of our strategies for each one of the components, certainly of infrastructure. And once we're clear in what that portfolio strategy looks like, then it would be time for us to think more clearly around what is our goal, then, on margins and quite frankly, the size of the business.

The next question will come from Stephen Volkmann of Jefferies.

I'm wondering if we can just think about this portfolio restructuring a little bit. I'm trying to get a sense of the magnitude of what you're looking at, and I'm trying to figure out whether we're going to be selling off sort of onesie, twosies maybe around the edges, but mostly kind of focusing on the cost side or whether there might be a more significant portfolio restructuring happening. And maybe the way to think about that might be, if you have sort of some ballpark figure about what percentage of your businesses might not be hitting, I think, Don, you said you used EVA target as you review these things. And granted, some of them will not be sold, some of them will be fixed, but just if there's any way to sort of size what's coming down the pipe for us on this portfolio restructuring.

Yes, Steve. It's just a little early for that. The one thing we will say is that there are no sacred cows. We're looking at everything. But we're just not ready to -- it's just wouldn't be prudent to comment at this time.

Okay, fair enough, I'll ask you again next quarter. How about, Frank, can we talk a little about the rate of the write-offs on the goodwill impairment? Which businesses were those specifically associated with? Which one of the recent acquisitions, I guess? Or was it kind of all of them? Or is there any color there?

Yes, I'll give you a high level. But you're right, it's all infrastructure. We do test the impairment at the segment level. And given the downturn and the forecast, you've got to look at what's going on from a market industry considerations, which we did, i.e., oil and mining. We look at the financial performance. We look at what -- the stock, and we look at the portfolio going on there. And as a result of the $375 million, I would tell you that a significant portion relates to the Stellite acquisition from a few years ago, and then some remaining oil and gas acquisitions and some legacy stuff that's in the infrastructure was the rest of it. But the biggest piece of that was related to the Stellite business.

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

You presented some of the top line trends, but also mentioned that the visibility is weak. And I wonder if you can provide us with a little bit more color about how you came up with the back half revenue targets. And did you make a big enough cut to the expectations so that we can hit a few numbers going forward?

Yes, remember, we have -- there's 2 quarters left. So the first half of the year, obviously, the performance in the second quarter was not where we had anticipated. But we're -- like the biggest driver in the oil and gas stuff is we expect CapEx to be down about 30%. So we're assuming they're going to be down 30%. Now that's covering for the next 6 months. We think that's in line from everything that we've heard from Baker, from Halliburton, Schlumberger, the cuts that you're reading, and we see the rig count dropping 60 a week or so. So we feel that we've taken the right approach from both the bottom line, what our sales force is seeing to put it in, and that's the biggest driver there. And we're not seeing any pick-up in any of the mining business as we -- and they're both profitable businesses. So that's why I think the decrementals are a little bit higher. So not only we have the top line, but the mix within the business is also driving some of the performance. So we think we've -- the best knowledge we have, talking to our customers, it's a pretty significant decline in the Infrastructure sales from last quarter for the remaining 6 months, coupled with some currency impacts. So -- well, we try to take it in driven by the energy, that's the best I can give you.

Okay. And then, yes, getting to the next question on the decrements. Could you repeat those decremental margins and explain why those are so -- is it inventory that's coming out, some production getting cut, why are the decrementals so high?

Walt, we actually outlined that in Frank's formal remarks. So in the interest of time, could you and I do that offline later today?

Sure. Okay, no problem. Can you comment, Frank, on the type of inventory you'd like to exit 2015 at?

Well, I think we're going to try to continue to take -- I don't want to put a number on it, but I'd like to see a similar performance in the next few quarters of what we had in the quarter. It's going to be challenging, that's why I don't want to specifically give you a number because as the sales come down, it gets a little bit more challenging. But we're also trying to reduce both raw materials as well as our WIP and finished goods. So we're going to focus on it. That's what's in the cash flow guidance at this point. And if we can do better, we'll provide an update next quarter.

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

Can we start back with -- could you talk about what you're seeing in terms of pricing for the infrastructure segment currently? And then what's embedded in the second half outlook? And does that match the falling materials prices that you alluded to with APT? Or is that going to be more of a headwind?

That's why it's in there from an overall pricing. We do have some contractual agreements with energy providers that follow APT, as you remember from years ago when it was going up. This is a catalyst for us to get price. And when it comes down, we have to give some back. The challenge there for us, and that's why we built it into the decrementals, is it comes a little bit quicker versus us getting the lower price from our contracts. So it is reflected in there. I don't think there's any short-term impacts on it that we haven't considered in the reduction to price as it relates to the infrastructure business.

Okay, got you. And then, Frank, you had mentioned the -- you sized the direct exposure to oil and gas drilling for us, and you obviously cut the outlook for the industrial business segment. But I'm wondering if you work through the numbers, how much indirect exposure you believe you have on the cutting tools business and your expectation of softening with the sales of the energy industry there.

Let me say it this way. It's in there. But when you're selling to general industry side, on the tooling side, these are going to job shops, as you know, from your MSC guys. Some days, 1 week, they're working on aerospace parts; one day, they're working on energy. So these guys will flip between where they can make money, whether it's transportation, aero or energy. And we don't have point-of-sale reports for every single location. So the bottom line is there's -- it's factored in, but I can't give you specific number.

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

A couple philosophical questions, Don, for you related to your future vision. First, and this is really related to the answer you provided to Steve Volkmann's earlier question about how we should frame the portfolio investigation potential impact. Do you have a time frame in mind as to when Kennametal will be able to provide more detail around that?

I'm on day 74 here, Andy, and my intention was to certainly take the next quarter and to make sure that we have a clear understanding of what might fit or what might not fit and be in a position to talk with more definition about our strategy going forward, the next call. So that's my current timing.

Okay. And then second, related to the release comments about Kennametal's underperformance versus expectation and then adding the perceived limited visibility, generally, of the business given the short lead times, can you help us understand any internal changes that either have been or will be made and the approach to providing guidance for future performance?

Can you give me a little help on that, Andy? The internal changes in regards to...

Sure, sure. In the past, some of the top line was based on multiple or global industrial production and so forth. I'm just wondering if that is still in place, or alternatively, maybe a more conservative approach is being employed.

Yes. Right now, Andy, we're doing a bottoms-up and a top-down at this point. So to try to get any correlation to a GDP industrial production, excluding stuff, it's -- the relationships don't make sense right now. So we're going to the other approach.

The next question will come from Steven Fisher of UBS.

I'm not sure if I missed this, but how would you expect to see the $90 million to $105 million of benefits be realized over the next few years in terms of a timing perspective.

Yes. So you have the original Phase 1 and the Phase 2. I would imagine the $40 million to $50 million, we'll get a little bit towards the end of fiscal '15, but then, for budgeting purposes, I would split it half in '16 and half in '17.

Okay, that's helpful. And what are your expectations for U.S. highway construction season this year, if you have any at this point?

Well, obviously, it depends on the Highway Bill, and I think some of the contractors are being conservative. And we saw a little bit of softness in the quarter. But seasonally, we typically have -- the fourth quarter is a pretty good season for us. I think it's a little premature right now to try to figure out what's going to happen in the construction. I don't think there'll be significant year-over-year change, but it really depend what'll happen with the funding and what some states are doing as far as raising their own. Like in Pennsylvania, they put additional gas tax, which hopefully will spur some business. But I would say, the U.S. will be better. And once the U.S. sorts out its infrastructure issues, we're doing a little bit worse in Asia, and Europe should hang in there relatively quick. But it's a little bit early at this juncture to feel what the road contractors are anticipating, given that the bill expires in May.

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

Earlier, Don, and it was alluded to in one of the questions, but you did mention that EVA was going to be the principle that you are going to rely on. And I was just wondering, with, again, so many moving parts and how you see EVA being the -- maybe the primary principle rather than just one of many tools that you'd be using, why you emphasized EVA and how you see that falling into place with a company like Kennametal?

Why I think EVA -- I outlined 2 areas that we're going to look at. First, complementary materials and products, really looking at how each of the businesses may or may not support other parts of our portfolio, making sure that we have a clear understanding of that. And then secondly, EVA, I think, is a great measure whether or not it creates value for us as a company, looking at each unit. And that's going to be the measure.

The next question will come from Steven Barger of KeyBanc Capital Markets.

I'm trying to just work through some of the guidance revisions. Operating cash flow came down $10 million to $15 million, net income came down more like $60 million or something. Is working cap basically the entire bridge there?

Yes, pretty much. I mean, obviously, we'll watch CapEx as well. Receivables, they declined. We'll drain those a little bit quicker, and we'll probably focus on some days there. And obviously, the swing is the remaining working capital. So you're spot on.

Got it. Okay. And then given the exposure that you have to mining and oil and gas, and Don, you talked about needing to drive organic growth, what end markets do you really intend to focus on? Where can you go to stem some of the weakness that you're seeing in other parts of the portfolio?

I think first of all, we have a tremendous portfolio of innovation pipeline. We've launched a lot of innovative products over the past couple of years. We see significant opportunities to continue to take share with those products. You've heard over the last years about a number of products on automotive and aerospace. And quite frankly, we have plenty of opportunity. I mean, I can't emphasize how many on the industrial side. And then last piece is, even in infrastructure, where you have markets that are shrinking, we actually see opportunities to take share and with some very innovative approaches with our product technology. So I think, for us, it's back to basics. I think a clear focus and prioritizing what we do really well and doing more of that is really the key. I think some of the, I would call it, the portfolio additions that have been made that haven't created EVA, taking that away as a distraction allows us to focus on the things that we do really, really well. So I think that's it.

And just a follow-up. Some of the products that you talked about, as you mentioned, have been rolled out over the last year or 2. Is this really something that you can implement quickly to where you can go to the sales force and say, this is the targeted area that we need to go to in order to kind of kickstart that? Or is that a longer process in terms of a product review before you can really go and start taking that share?

No, I -- NOVO Sphere is a case in point. This is a technology that's been introduced now for a while, and it's garnered quite a bit of support. There's a number of customers out there that love it, and we'll be looking to take that technology to a much wider group of customers, and we think that can help us significantly in the industrial market.

Our final question will come from Ross Gilardi of Bank of America Merrill Lynch.

Just a couple of last ones. I don't think you guys talk much about pricing. Can you address that? And in this weak demand environment, have you seen the pricing environment get a little nastier? And is that contributing at all to your guidance revision? And then I have a follow-up.

Yes, as far as, first, with infrastructure, yes, it has been negative, it's getting negative, given the correlation with the APT prices dropping. So we'll have the short-term squeeze, and as I commented on before, that is factored into the decrementals. And then, on the Industrial side, very similar to our key competitors, Sandvik, ISCAR, et cetera. Everybody went out with price increases here in January. It's not an across-the-board. It'll depend on some of the newer products where we have a significant advantage or where we can could prove to the customer we have the productivity savings. But it's going to be a challenge. We're not expecting much in price in the industrial for the rest of the year as well.

Okay. And then one of your larger mining customers, I think, is talking more about more in-sourcing on parts and components. And is that accounting for any meaningful portion of your -- the weakness you continue to see in mining? Or is it -- do you think it's just solely end market-driven?

Yes, I think it's mainly end market-driven. Talking to our guys, we feel that both underground and the surface as it relates to our products, that we've increased share.

And we're the clearly the market leader in share.

At this time, we will conclude the question-and-answer session. I would like to turn the call back over to Don Nolan for his final words.

So thank you very much for attending our earnings call. As you heard, the Kennametal team is taking immediate steps to address our performance challenges and to drive organic growth and improve shareholder returns. So I look forward to updating you, all, on our progress on our next quarterly call. Thank you.

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