Good morning. I would like to welcome everyone to Kennametal's Second Quarter Fiscal 2023 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Kelly Boyer, Vice President of Investor Relations.

Thank you, operator. Welcome, everyone, and thank you for joining us to review Kennametal's second quarter fiscal 2023 results. Yesterday evening, we issued our earnings press release and posted our presentation slides on our website. We will be referring to that slide deck throughout today's call. I'm Kelly Boyer, Vice President of Investor Relations. Joining me on the call today are Chris Rossi, President and Chief Executive Officer; and Pat Watson, Vice President and Chief Financial Officer. After Chris and Pat's prepared remarks, we will open the line for questions. At this time, I would like to direct your attention to our forward-looking disclosure statement. Today's discussion contains comments that constitute forward-looking statements, and as such, 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 statements. These risk factors and uncertainties are detailed in Kennametal's SEC filings. In addition, we will be discussing non-GAAP financial measures on the call today. Reconciliations to GAAP financial measures that we believe are most directly comparable can be found at the back of the slide deck and on our Form 8-K on our website. And with that, I'll now turn the call over to Chris.

Thanks, Kelly. Good morning, and thank you for joining us. I'll start the call today with a review of the quarter and some recent strategic wins as well as an example of the game-changing innovation we are bringing to our customers. Pat will then go over the quarterly financial results and the outlook. And finally, I'll make some summary comments before opening the call for questions. Beginning on Slide 2 of the presentation, we posted strong year-over-year organic sales growth in the quarter and continued the successful execution of our strategic initiatives despite ongoing macroeconomic headwinds, such as high inflation, foreign exchange and COVID-related disruptions in China. Sales increased double digits year-over-year at 11% organically, offset by negative foreign exchange of 8% and business days of 1%. As expected, price continues to be a significant part of the sales increase. On a constant currency basis, all regions and end markets grew year-over-year, the Americas and EMEA both posted double-digit growth. It's worth noting that the EMEA growth rate includes the negative effect of approximately 300 basis points due to our exit from Russia in Q3 of last year. The growth rate in Asia Pacific was 2% in the quarter and was negatively affected by approximately 550 basis points from COVID disruptions in China. The growth rates, however, in all other Asia Pacific countries remained strong. By end market, aerospace, transportation and earthworks, all reported double-digit growth, while energy and general engineering grew mid- to high-single digits. So overall, our end markets continued to demonstrate resiliency despite the unpredictable macroeconomic environment, and we expect this to continue through fiscal year '23. Of course, we recognize there are still risks in the global economy. However, as I said last quarter, we believe we are well positioned in all our end markets despite…

Thank you, Chris, and good morning, everyone. I will begin on Slide 6 with a review of the second quarter operating results. Before I begin, please note that like last quarter, we did not record any non-GAAP adjustments this quarter. Therefore, adjusted numbers are not presented for the current quarter and for today's discussion, year-over-year comparisons will be against the prior year's adjusted results. The quarter's results show that we continue to execute our initiatives in the face of significant headwinds from inflation, foreign exchange and the effects of COVID in China. Sales increased by 2% year-over-year with 11% organic growth, offset by headwinds due to foreign currency and workdays of 8% and 1%, respectively. As Chris pointed out, price remains a large portion of the sales numbers. On a sequential basis from Q1, sales were approximately in line with our normal Q1 to Q2 seasonal pattern of 1% to 2%. Operating expense as a percentage of sales decreased 60 basis points year-over-year to 21.3%. EBITDA and operating margins were 13.7% and 7.1%, respectively, versus 16.2% and 9.2% in the prior year quarter. The year-over-year decrease in operating margin was mainly due to the following factors: First, as discussed last quarter, we were aggressively raising prices in the prior year ahead of experiencing the full effect of higher tungsten prices. In Q2, for the Infrastructure segment, however, the favorability of price over material cost is now negligible as raw material costs reflecting the current market cost is flowing through the P&L. We expect raw material costs to be relatively steady for the balance of the fiscal year. Versus total cost inflation, overall higher pricing substantially offset higher raw material costs, wage and general inflation in the quarter. Further, there was a higher-than-anticipated mandated inflation bonus in Germany for all workers…

Thanks, Pat. Turning to Slide 13. Let me take a few minutes to summarize. Overall, we're pleased with the strong organic growth and free operating cash flow in the quarter. Although the operating environment remains challenging, we're encouraged by the continued resiliency of our end markets and the improvements that we are seeing in the supply of materials, which allows us to draw down safety stocks. And we look forward to margin improvement in the second half as we move past the inventory reduction actions we took in the quarter. Looking beyond fiscal year '23, we're encouraged by our strong market position. We're poised to benefit from the megatrends affecting our end markets and the opportunity we have to extract even greater operational efficiency from our modernization investments, and we're confident in our ability to continue to return cash to shareholders while investing in our strategic initiatives for growth and profitability improvement. And with that, operator, please open the line for questions.

[Operator Instructions]. Our first question comes from Stephen Volkmann from Jefferies.

Maybe just on the guidance here. Maybe start maybe big picture. The range that you guys have for the year is pretty broad, and I might have thought you might have narrowed that a little bit as we get into the second half. But maybe just talk about what your view is of sort of the book ends there. What has to go right to get to the top end and what would have to happen to get to the bottom end, just so we can think about how to level set there.

Sure, Steve. I would say at the high end, what we would need is a very strong recovery in China. We're expecting some kind of recovery more at our midpoint. So we'd have to have a stronger recovery in China. And we'd also have to sort of be operating at kind of the high end of our normal sequentials. And then, of course, we sort of need FX to stay about where it is. I'd say on the low end, it's one of our risk areas, and we just don't know. There's a lot of uncertainty just given the sheer number of absenteeisms. And now with the Chinese New Year, even greater absenteeisms, it is possible that there could be a weaker China recovery. I don't think anybody knows for sure. We've tried to pick sort of a middle-of-the-road view of that, but it could certainly be weaker. And then we could also be just naturally at the low end of our sequentials. So that's how I would look at it.

Okay. And maybe I think you talked about the interest margins getting back to kind of where we started by the fourth quarter. How should we think about metal cutting margins kind of sequentially?

I think, Steve, when you think about metal cutting, coming off of Q2, moving into Q3, you're going to see some positive volume pickup there. currency should be a help quarter-over-quarter. And obviously, metal cutting has most of our foreign currency exposure. And also, we'll just see some stabilization in the cost structure. So overall, quarter-to-quarter, should be up slightly.

Our next question comes from Julian Mitchell from Barclays.

This is on for Julian. I just wanted to ask on the guide for Q3 and the fiscal year. It looks like there's a step-up in terms of margins in Q4 versus Q3. And I get there's a step-up with infrastructure there. Are there any other swinging items that we should be aware of improving Q4 versus Q3?

Yes. A couple of things to think about there. Number one, absolutely, the absorption will go away in terms of that drag in the fourth quarter. And then I would say, normally, when you think about infrastructure margins, Q3 to Q4, that's generally a better, more profitable mix quarter for us going into Q4.

Got it. That's helpful. And then just one follow-up for me. I know you said price realization was a large portion of organic sales in the quarter. Do you have the breakdown of price versus volume in Q2, just so we can kind of see what's embedded for volume for the back half.

That was a Q2 -- Q3 question?

I think it was Q2

Q2, we're on our expectations in terms of where the price came in, in Q2 versus our outlook.

Our next question comes from Tami Zakaria from JPMorgan.

So I wanted to understand the EBIT guidance for the quarter a little bit better. So sequentially, your sales are going up, call it, $30 million to $35 million-ish. But then for your EBIT, you're guiding to at least 40 and up. So can you sort of help me understand why EBIT would only go up by about $5 million? Like what's sort of the bridge from 2Q to 3Q for the EBIT guide?

Yes. So if we work from Q2 to Q3, a couple of things to think about there. Number one is we will have an uptick in volume. We have some favorability in FX coming in from Q2 to Q3. You could think of that number probably in the $15 million range. Part of that will be, some additional price realization, of course, the cost structure will go up just a little bit as well. So those are your main bridging elements between Q2 to Q3.

Got it. Okay. Okay. Understood. And then just following up on the previous question, does the low end of your guide for the year assume China seeing negative year-over-year? Or do you still expect growth in China but could be at a slower pace than what you are currently expecting?

Yes. The low end of the guide from a China perspective would assume that China in the back half is down year-over-year. And if you think about the total growth number that where our guidance from a year from a volume perspective and for the quarter, that's a significant chunk of that low end in terms of what the negative is there for the negative to positive, too.

Our next question comes from Mike Feniger from Bank of America.

Just can you help us understand, you made some comments about customer inventory adjustments at year-end. I think it was energy comment. I don't know if it was more broad-based with other verticals, but hoping you kind of flesh that out what you're kind of seeing there on the inventory adjustment.

Yes. I think just sort of broadly, in general, we're not seeing much restocking or destocking. But what we talked about in our opening remarks was really related to oil and gas services company. And it's their fiscal year-end and they were, I think, managing their inventories down. They still believe and we talk to their leadership as part of our S&OP process. They still believe that the long-term trends are there, and they want us to continue to support them. But they did pull back on inventory a little bit, and since we are doing these planned shutdowns anyway, it gave us the opportunity to extend those and try to draw safety stocks down, which we were planning on doing anyway, but this gave us certainly impetus to do it in the quarter.

And how do you feel about your inventory levels with distributors on the distribution side and at the company level today? Are you going to be producing in line with demand? Are you producing lower maybe than demand to try to draw down some of your own inventories? I'm just curious about how Kennametal feels currently with its own position there?

Yes. I think from a customer inventory perspective, they've been distributors, in particular, I think they've been cautious to not get out over their skis. So that's why we don't think there's going to be a significant destocking or increase in stocking. For us, we believe we can largely based on our outlook produce in line with demand. And beyond that, normally in metal cutting, for example, we did carry a little bit more safety stock just because of supply chain disruptions. But that's the kind of thing that based on the current outlook, we feel we can bleed down, and we're not expecting to see a kind of a major absorption hit like we just did in infrastructure because we literally shut down processing plants.

The next question comes from Steve Barger from KeyBanc Capital Markets.

I want to start with volume growth guidance of basically flat for the year versus the 2Q recap, which says you're winning share of wallet with existing customers, securing new ones and driving share in underserved geographies. My question is, if all that's happening, but volume is flattish, does it mean other customers are rolling off? Or why isn't unit volume up more than 0% to 2% for the year?

I think, Steve, just to talk about, again, some more on Russia and China. If we think about those 2 drags, those 2 drags alone for the full fiscal year are probably 200 basis points of growth based on where we think our current outlook is. So you kind of got to think about that because those 2 things are relatively idiosyncratic. Chris, you have anything to add?

Yes. And I would also say that as I think Steve pointed out on the first question, we do have quite a large range there. There is a lot of uncertainty. And so we may be a little bit conservative on the low end of the sales range there. We do have moderating demand in the Americas and EMEA. So there could be some conservative at the low end, Steve, just to cover ourselves for things that we can't really control, and there is still some uncertainty around those things.

Got it. So for the parts of the business where you are having success in new customers and wallet share, can you compare unit volume changes through direct sales versus distribution or digital if that's become more meaningful? I'm just trying to understand where you are growing units and what's happening there that's different versus other channels where there's less unit growth?

Yes. I think the unit growth for sort of the direct sales force, these project bids, that continues to be strong, especially in transportation, EV and also aerospace, which is no surprise because that's where we have a targeted initiative to focus on there. And the distribution channels, that is driving some volume. We are seeing increase in volume there. So I think it's kind of coming from both, but there are 2 different animals. The project stuff is definitely a focused effort, mostly in transportation and aerospace. And then I think also even in the infrastructure business, we've been in business a long time as Kennametal, but there's still many regions and even customers that have more of a global presence that we have a good share of in the U.S. But for example, oilfield service customers, a lot of activity is happening now in Saudi Arabia, and we're leveraging our relationships with those oilfield service companies in the U.S. to start to gain traction to share in that part of the world.

I guess if I can get a quick follow-up. I think part of your transformation process was scaling up the sales team for lack of a better word, maybe helping them understand areas to target or where you have it maximize the opportunity. Where are you in that process?

Yes. I think that was definitely part of the simplification effort. And so for example, we've done a much deeper dive in segmentation of, let's say, general engineering. And what we found is that over half of that business is small machine shops, companies with less than 50 to 75 people. And we weren't necessarily reaching those folks, Steve, with distribution and certainly not direct sales. But that was the impetus to start to make our investments in our digital customer platform. And we're still improving that platform, and we've done a lot of investment over the last few years, and we're starting to see the fruits of that. I think also, we've done a lot of sales training and a lot of detailed strategic marketing analysis on where to target growth and to focus those resources where we got the best opportunity for profitable growth. And as I always tell my presidents of both metal cutting and infrastructure, the sales force is an investment just because it's an expense each quarter, we look at it like a capital investment, and it needs to generate a proper return. So that's the way we're running that business. And so I think in terms of our journey, I'm now in my sixth year here. I think if I could use a baseball analogy, we're in the sort of late innings in terms of that. And I look forward to that sort of revved up sales organization and processes generating more growth in the future.

Our next question comes from John Joyner from BMO.

All right. So just following up on Steve's question. Chris, you talked a lot about share gains and definitely gave nice detailed examples. I guess what do these wins mean for Kennametal's top line and margin potential longer term? I mean maybe I can't wrap it around my head. But I mean, I guess, how has your addressable market expanded since embarking on your modernization journey and these kind of commercial excellent initiatives? Any color there would be helpful.

Yes. I think we're very cautious about taking business just for the sake of growth. And I think there was a little bit of that in the old Kennametal, where, for example, in transportation, we were picking up share, but I remember when I came into the company, I'm not sure that some of that business we were making much money at. So we're very careful about the business that we are taking that's got the right profitability. Just to comment on some of these EV projects, customers are not in full production yet. So a lot of these projects are the initial sort of setup and prove out. So they'll generate more revenue maybe a year from now as they start to ramp up their production lines. And then certainly, they generate a consumable tooling spend after that. So aerospace is a little more immediate effect. As we win more share and greater machining percentage on these large projects, it means that as the Boeings of the world and Airbuses ramp up their production and their supply chain constraints start to abate, we look forward to more growth coming from those opportunities. So it's like we're kind of setting the stage with some of these major wins. And then as the customers' volumes pick up, that's going to certainly be a benefit for us.

This concludes our question-and-answer session. I would like to turn the conference back over to Chris Rossi for closing remarks.

Thanks, operator, and thanks, everyone, for joining us on the call today. I think this quarter is another data point that demonstrates our ability to advance the strategic initiatives and definitely position ourselves for future growth and secure that market-leading position. And I am confident in the full year outlook. There still is uncertainty out there. But as we talked about on the phone, I think we've got the proper ranges out there, and we feel good that we're going to be able to execute to that outlook. So with that, if you have any questions, please follow up with Kelly, and have a great day.

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