Kennametal Inc (KMT) 2002 Q4 法說會逐字稿

Thank you for standing by and welcome to the Kennametal second quarter earnings conference call.

At this time, all phone participants are in a listen-only mode.

Later, we will conduct a question and answer session with instructions given at that time.

If you should require assistance during the conference, just press zero, then star, and as a reminder, today's conference is being recorded.

I'd like to turn the conference over to the Director of Investor Relations, Beth Wily.

Please go ahead.

Thank you Kim.

Welcome and thank you for joining us this morning to review our 2003 second quarter and our expectations for the remainder of the year.

The media have been invited and in addition, it is being broadcast live on the website at www.Kennametal.com.

I'm pleased to have our Chairman, President and Chief Executive Officer, Markos (inaudible) and Vice President and chief financial officer, Nick Rastleburger joining me for the call.

After some initial comments we will have questions.

Before I turn the call over to Marcus, I'd like to read the forward-looking statement.

This may constitute forward-looking statements, as defined in 1995.

Such forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from the expressed --expressed in the forward-looking statements.

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

With that, I'll turn the call over to Markos.

Thank you.

Good morning, everyone.

Thank you for also for joining us.

I hope you have an opportunity to see our earnings release earlier this morning.

We were pleased with the strong December quarter in a still soft global manufacturing environment.

Our EPS of 27 cents excluding special charges is rising over our guidance.

On an apples to apples basis this represents 13% year over year operational earnings growth on slightly lower sales or 36 cents per share versus 32 cents.

Nick will take you through the detailed reconciliation from 27 cents to 36 cents which include the (inaudible), decreased pension income and the benefit from currency.

Our revenues for the quarter increased 14% with the addition of Vidia sales.

While activity remains sluggish we do believe as we experience the beginning of a muted recovery in the December quarter.

Year over year comparisons improved through each month of the quarter for most of those markets.

In both North America and Europe automotive continued to be the area of strength, while aerospace remained the most depressed end market.

Other investor markets delivered modest improvement including light and heavy engineering and tool and die makers.

The oil and gas and the coal mining and the road reconstruction markets also remained soft.

We were particularly pleased with the 100 basis points improvement in the gross margin, despite the soft environment, this formalization continues to deliver on the parameters within our control.

The improvement is testament to the enduring benefits of our Kennametal value business system which is easily used to manage the company.

I should also note that this margin expansion includes the offset of a 70 basis points negative pressure on gross margins from Vidia operations which was expected.

As usual, the quarter also included continued strong cash generation, prudent management of capital expenditures and tight administration of working capital.

In addition, product innovations continued to generate successes through the ace process.

As we have mentioned in the past, there has deliberately been no reduction in our investment in product development despite very tight -- over our controls in response to the weak macro environments.

Technology and innovations are cornerstones to the market advantage and Kennametal strategy and demonstrated by 40% of the sales come from new products introduced in the last five years.

Our original target date for achieving this condition was the end of fiscal 2003, but I'm proud to say that we achieved this in December and reached 41% of sales from new products.

Moving on to another significant element of our strategy, we have of course sustained our efforts on the Kennametal enterprise.

In the quarter, we have added significant assets to our internal team of lead consultants with the hiring to lead the lean enterprise efforts.

Tommy's expertise will accelerate our advance to the next level of efficiency on our lead journey.

Tommy comes here from Eton Corporation.

He spent ten years learning the Toyota production system, the original lean practice.

He's also a shingle prize winner in recognition of his expertise.

He has hit the ground running and is already a highly valuable addition to our team.

You may also have noticed that yesterday we announced in addition to our board of directors Larry Stein Haner has joined the board.

Yesterday was his first meeting and given his background, and his financial as well as proven assignments with Honeywell will be a very strong addition to the board.

Finally, discussions of the December quarter would not be complete without recognition of the excellent progress made toward completing the Vidia integration.

The Kennametal Vidia team charged with the responsibilities for the integration is doing a fabulous job.

More on that later.

Looking forward to the remainder of fiscal 2003, like most the companies have served similar end markets we did not anticipate a significant recovery in the next six months.

U.S. industrial production is now projected to grow at best 1% in the first half of calendar 2003.

Peter's estimates were between 2 and 2.5% growth.

As importantly, we have also told you that increased capacity utilization drives growth in the use of our consumables without any increase in capital spending.

Capacity utilization currently remains stuck around 75%.

Consequently, our performance is doubly constrained with neither capacity utilization nor capital expenditures improving.

The European outlook is even softer.

While we have always expected Europe to lag the U.S. recovery, the growing range of European economic indicators are quite negative on the near term outlook.

Among other factors, a strength in Euro is reducing exports.

A key economic component, particularly in the important German market.

And finally, of course, geopolitical global tension there is adding considerable uncertainty on the recovery.

This uncertainty is restraining growth in corporate capital spending and negatively impacting consumer sentiments.

The Vidia integration in both Europe and India is going extremely well and is ahead of schedule.

The integration of the European sales and service organization will be completed in February, just five months after closing the acquisition.

We will now be able to speak to our European customers with a single voice under a single name.

This will allow us to provide unprecedented breadth of world leading solutions.

The completion of I.T. systems integration and the leveraging of global purchasing as supply management are already delivering efficiency in cost reduction benefits.

We have also made significant progress in India, of course many areas of integration and we have already achieved targeted reductions.

On the growth side, approximately ten Kennametal branded products have been identified for introduction in the Indian market, while Kennametal Vidia India products are being sold in Asia Pacific.

Also we can finally shift some of the integration details that you have been waiting for.

This will include a global head count reduction of between 650 to 700 positions.

Almost 25% of the head count.

Approximately 80% of which will be completed in fiscal '03.

We will also be closing four manufacturing facilities and two warehouses and are still working on a number of branch and field offices.

In addition, we are aggressively selecting the best products on the collective range.

We'll be rationalizing about 35% of standard SKUs. (inaudible) closing we cannot change the economic or political environments of our climate, due to Iraq and uncertainty, the strongest fiscal quarter which is the current one has significantly higher uncertainty.

Let me just close by summarizing the pluses and minuses from a Kennametal perspective.

On the plus side, we are very confident that we are winning in the market.

Our cost structure is breaking on point is the lowest in years.

We're turning out new winning products at a faster pace than ever before.

We are continuing to strengthen our management team and this year we will spend close to 2% of sales in training and organizational development.

Our gross margins are improving by 100 basis points per quarter versus fiscal 2002.

We continue to generate strong cash flow, reduce debts and our balance sheet is strong.

The integration of Vidia is ahead of schedule and exceeding our expectations.

On the minus side, economic recoveries is much slower than anticipated and we may not even see any perceptible growth in the end markets in the first half of the calendar year.

Secondly, Kennametal's growth is coming from overseas in the next two quarters, particularly Vidia with lower margins and a higher cost structure, which was known and we are fixing and is part of our plan.

But we do need to complete our restructuring.

North America which is our highest margin business is expected to only grow marginally.

The combination of these two, higher emphasis from overseas with Vidia, and a much more muted outlook in terms of the growth we expected in North America result in an income profile that has put margin pressure on our earnings.

If our end markets, particularly in North America, recover at the faster pace, the very substantial leverage we have built in the business will deliver an acceleration in earnings that will be impressive.

Let me turn this over now to Nick.

Thank you, Markos.

Good morning, everyone.

Let's go over the financial performance during the December quarter and then move on to an updated Vidia and the outlook for the remainder of the fiscal year.

For the second quarter of fiscal year 2003, excluding special item, Kennametal earned 9.4 million or 27 cents per share.

Compared to 10 million or 32 cents last year.

A 16% decline in EPS.

Adjusting for Vidia dilution, lower pension income EPS was 36 cents, an increase of 13% on a 1% decline in sales volume.

Consolidated sales increased 14% to 432 million with the addition of Vidia.

Excluding acquisitions and divestitures, sales for the fourth quarter -- second quarter were flat.

However, November and December deliver modest year over year growth.

Notably, the gross profit margin for the quarter was 31.9%, up 100 basis points from last year.

In addition to the factors identified in the release, pricing was modestly negative with the pressure in the energy and electronics units.

As Markos noted, Vidia was 70 basis points dilutive for the quarter.

Consolidated operating expenses for the quarter were flat to last year on a light basis.

That is, excluding Vidia, expenses, foreign currency effects and pension income. (inaudible) excluding special charges was 23.3 million, down 3% from FY '02.

The (inaudible) margin was 5.4%, down from 6.3% for the same quarter last year.

Interest expense increased 16%, reflecting the additional debt associated with Vidia.

Average U.S. interest rates of 5.5% were up 45 basis points versus last year.

Consistent with last quarter's guidance, the effective tax rate for the second quarter was 27.6% excluding special charges versus 32% the same quarter last year.

This reflects the year to date adjustment to the 30% annual rate achieved through successful Vidia tax planning strategies.

On a year to date basis, cash flow was 54 million, consistent with last year.

We've continued to realize benefits from our working capital reduction programs, and prudent capital spending.

As of December 31, 2002, total debt was 617 million.

Debt to total capital declined 610 basis points to 44.9% from the same quarter last year.

I will now move on the a discussion of our individual business units and the top line in EBIT results.

I'll start with the metal working group.

Metal working sale before Vidia were flat the prior year.

In constant currency, Europe declined 6%, and Asia again delivered double digit growth.

North America declined 2%.

Including Vidia, metal working sales grew 26% in constant currency.

The EBIT margin for MSSG declined 8.8% versus 11.3% last year.

The decline is largely due to the expected dilution from Vidia.

We'll continue to expect Vidia to be accretive to MSSG margins and realized over the next 12 months.

Turning to our advanced materials group, sales were flat in constant currency.

Minings and construction were down 3% on continued softness in mining.

Engineer sales were up 27% on very successful market initiatives and energy declined 17% at the U.S. rate count remained well below last year's levels.

Electronics was flat to last year.

Before special charges, AMSG EBIT margin was 10.8%, up from 7.3% last year on benefits from the electronic, restructuring program improved manufacturing efficiencies due to lean and lower raw material costs.

Sales excluding the strong divestiture were flat over the same period in fiscal year 2002.

Special charges, J&L's EBIT margin excluding strong was 4.5%%, up 50 basis points from 4% a year ago.

Full service supply sales decreased 12% in the current quarter versus last year.

Before special charges, full service supplies EBIT margin was minus 1.1% compared to 1% a year ago.

FSS continues to generate strong cash flow of 50 to 20 million per annum as it disengages from accounts that require large capital investments.

Let's move forward to the outlook of remainder of FY '0 3.

First an update on Vidia.

As Markos mentioned, we have made rapid progress on the integration, including completing agreements that, allows to discuss our plans in greater detail.

The estimated financial impact of Vidia is as follows.

Sales for fiscal year 2003 are still expected to be between 200 and 210 million, with EBIT of 8 to 10 million.

Planned synergies remain unchanged with 3 to 5 million in fiscal 2003, 20 to 25 million in fiscal 2004, and 30 million or more thereafter.

Fiscal 2003 associated restructuring charges are 45 to 50 million in cash, and 55 to 60 million in totals.

The EPS impact is now expected to be 10% -- 10 cents dilutive in FY-'03 becoming 10 to 15 cents accretive in fiscal 2004 and 20 to 30 cents accretive thereafter.

As Markos discussed a host of global economic and GEOpolitical indicators point to a further delayed recovery, and we have adjusted our forecast accordingly.

The sales guidance for the third quarter is organic growth of 0 to 2%.

This is preVidia.

And for the full year, it's now flat to down 2.

Including Vidia, for the full year, we're looking at 12 to 14% and in the third quarter, 18 to 20%.

In terms of EPS, we expect EPS excluding special charges to be between 47 and 52 cents in the third quarter and between $1.65 and $1.80 for the full year.

We exclude the dilution of Vidia and the impact of pension income EPS for the third quarter would be 55 to 60 cents, or up roughly 5 to 15% and for the full year $1.91 to $2.06 flat to up 5%.

Free operating cash flow expectation continues to be north of $100 million and likely in the range of 100 to 110 million dollar for the full year.

Additional guidance for the full year is as follows.

A tax rate of 30%, capital spending of 50 to 60 million, depreciation of approximately 80 million, the working capital mark into sale, 27%.

Debt to capital 40 to 42%.

Return on capital of 6 to 7%, and interest expense, up 6% due to the Vidia acquisition debt.

Included in current targets are the following assumptions following outlook by end markets in the next three months.

We now expect flat to low single digit growth in automotive.

Low to single digit growth in tool and die, while light and heavy in general engineering is expected to be flat for the quarter.

Single digit declines are anticipated in heavy engineering with high single digit declines in oil and gas and low and single digit declines in underground coal mining and construction.

Aerospace is expected to decline 10 to 15%.

Electronics is expected to be flat to slightly down.

Over the next three months, we now expect year over year geographic performance as follows.

End markets and North America, flat to up to 1%, Europe to be down 1 to 2%, and Asia to grow 4 to 5%.

We'll now open the line for questioning.

If you wish to ask a question, please press the one on your touch-tone phone.

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We have a question from Joel Tiss with Lehman Brothers.

Hi, guys, how you doing?

Hi Joel.

Can you talk a little bit about the kind of incremental margins that we've -- we may be able to see, you know, looking out a little further when we finally see some volume?

Yes.

I think the incremental margin is between 40 and 50% across the business.

And a very short term, the number's closer to 50% and over the -- let's say intermediate to longer term it's about 40%.

Okay.

Can you also give us a little bit of an update on the competitive landscaping, what's happening with your big competitor in the U.S. and in Europe as well on shore?

Joel, we think we're doing just fine on that, and all the major markets.

And by all measures that we have and let me give you why we think we're doing that.

I believe we are well ahead of our integration of Vidia.

And are beginning to see some of the synergies already.

We think that their acquisition of two entities is significant challenges in the past 12 months operationally certainly the course of destruction.

And we -- as we look at our measures, particularly automotive, light engineering, that is on the metal working side and then on the engineer side, -- you know, when you put that all together, we think we may be picking up about 50 to 1 hundred basis points.

But it's hard to tell exactly.

Okay.

Thank you very much.

Our next question is from Mark Koznarek with Midwest Research.

Yeah, I have a question regard to the margin performance at the metal working business, because it looks like if we were to add back the dilution from Vidia which you said was 70 basis points, you know, we get 6.1%, versus 6.3.

So it seems like on flat sales we still had some margin decline.

I'm a little bit puzzled about that, because we have done all this restructuring over the past several years.

Probably you're getting some raw material benefits, perhaps a little bit.

So I'm wondering what the offsets are here?

Let me make two points, Mark.

The first one, the 70 basis point dilutive impact on the margin for Vidia was just a gross particular gin.

They clearly have as a percent of sales, you know, much higher operating expenses as well.

So if you look overall, the impact would be kind of 2 to 300 basis points overall in the margin.

On the EBIT margin.

Okay?

The second point I would make, and I did say that Vidia only accounts for a portion of the margin decline year over year.

The other portion and Markos touched on this is we have seen in the short term a shift -- a product and market shift within MSSG.

On a market basis as you may know, we tend to have the highest margins in our engineering segments, and in the energy business.

We have been seeing more growth in automotive with the lower margin end market for us.

So there's a -- that's shift there in terms of end market.

Also, within products, we have seen some better performance at industrial products and J&L versus the metal working business.

So there's a product and a market shift there.

Okay.

Are we capturing anything raw material benefits right now?

Is your basket of raw materials down?

Yeah.

On a year over year basis, yes, we are.

And what's that expected to be like in the second half?

It will be favorable year over year.

You mean by a lot?

I'm going to say putting it in gross margin terms, between 25 and 50 basis points.

Okay.

And then finally that comment you made by end market right at the end, are those for the remainder of the fiscal year, or is that just the upcoming quarter?

I think I may have said for the next three months, but I think it's really for the rest of the fiscal year.

Thank you.

Your next question is from (inaudible) Von Carp with Sage Asset Management.

Good morning or good afternoon.

Could you say -- if you did, I apologize, mark, you have been coal mining for coal mining equipment and other energy for your equipment?

Yeah.

As you may know, our focus in mining is really underground coal, and that has been weak and the outlook is for that to remain somewhat weak.

With respect to energy, we tend to track the North American brick counts fairly closely and that brick count as I noted had declined year over year.

Although we expect in the next six months those declines to moderate significantly, we have seen some low double digit declines in our business over the past six months.

: Okay.

Thank you very much.

Appreciate it.

Just to follow up on this, I know you signed off, these segments have been somewhat puzzling, with the cold weather.

We would expect coal mining to go up, because the stockpiles are coming down.

And we have such a big market share that we've always benefited very quickly.

We continue to see some reluctance on the part of the coal producers to replenish their stockpiles or -- we have seen very recently some signs that maybe this is about to end.

So this may change things.

On the energy side, given the high prices of the uncertainty in the oil sector, we had expected that they would be up now.

These are the kind of things that we anticipated as part of the previous forecast and yet we haven't seen that.

And the only explanation we have is that the market hates particularly in the energy sector hates uncertainty and there's so much volatility out there that the -- you know, the investments that is required to restart the oil rigs is not going in.

People are being tentative and it's back to the same old uncertainty we have been seeing for some time.

Both of these sectors could turn pretty quickly in some things began to go in the right direction and could change our forecast, but I don't see anything definitive, of course.

We are taking the prudent course here.

Our next question is from Walt Liptak from McDonald Investments.

Please go ahead.

If you don't want to answer it, don't answer it.

But go back to the metal working margin, can you give us a number just backing out Vidia, what the base margin was?

EBIT margin.

I don't have the exact number Walt.

I believe it's between 2 and 300 basis points.

Okay.

Fair enough.

On the revenue guidance, previously you were looking for 14 to 16%, including Vidia and now 12 to 14%.

How much is that decrease is due to North America versus how much are you taking out for Vidia?

Yeah, the vast majority is North America.

Between the metal working business and the energy business let's say that accounts for about 75% as a reduction.

And the other piece would be our base European business, not Vidia necessarily, but the base European business has the economic outlook that's softened there as well.

So really if you look at the reduction in EPS versus if previous guidance, it's really all derived from the outlook in metal working in North America and energy which is mostly North America, as you know, and our core European business.

Okay.

Great.

And then the capex guidance, I mean, the capex that you're planning for this year looks like it's -- well, you're at previously at 50 to 60 million.

Where is that capex, you know, reduction?

Where are you taking the capex out?

I think a portion of that is that we have looked at Vidia.

We've come back on our capex forecast that we -- Markos mentioned the closing of the facilities and we don't need to spend as much at Vidia as we had thought.

So that would be the majority of it.

But another piece would be certainly across the core business with volumes softening, not having the need to add some capacity that we anticipated.

Okay.

Thanks, I'll get back in queue.

And we have a follow-up question from Joel Tiss of Lehman Brothers.

Please go ahead.

In your press release you mentioned that free cash flow was roughly cut in half for first six months, and but on your comments you mentioned that it was flat.

I just wondered if there's anything in there, and, you know what are you guys going do with the free cash flow?

Okay.

Well, first of all the guide phones the full year just to repeat is north of 100 million dollars, and that includes by the way about 40 million of after-tax cash related to restructuring.

So let's say on a pre restructuring basis, the cash flow is more like 140 to 150.

But it is allocated roughly equally between the first and second half of the year.

First half we generated 54 and it was roughly split equally between the first and second quarters.

The second half of the year we expect to generate about 50 again, and even though the plan is to spend most of the restructuring money in the second half, we are planning to produce in our plants somewhat below the sales rate to take inventories down.

So that's a better inventory performance in the second half of the year relative to first.

I think, Joel, in the release it wasn't just for the quarter, the second quarter.

Last year, the way that the cash flow came through the quarter is it had 2 million in free cash flow of the first quarter of the year and then a bigger hit in the second half of the year.

The 49 that's in the release.

But, you know, it's not the same.

Okay.

And then, you know, if you guys can give us an idea, are you going to pay down debt, are you looking at buying back shares on the cash?

And then a follow-up with that one, too, on Asia, you know, 4 to 5% volume growth seems a little slower than what we have been hearing for a while and I just wondered if Asia is slowing down or if we should, you know, continue to look for decent growth out of there.

Thank you.

Regarding your first question we expect as we have in doing to apply the excess cash flow after dividend payment to debt reduction.

As opposed to share repurchase or at least in the short term additional acquisitions.

On the second point with respect to Asia Pacific, we really haven't seen the organic growth rate in the business decline.

It is kind of high single/low double digit.

The issue we have over the next six months is we had a one-time very large order with the Japanese company last year in Asia Pacific.

That when you take that out, it moderates the growth year over year.

But, no, the expectation is still, you know, high single digit, low double digit volume growth in Asia.

Thank you.

Our next question is from Mark Koznarek with Midwest Research.

Yeah, I have a couple of things.

One is automotive.

Looks like you have picked up some market share in automotive, at least in North America when you listen carefully to the monthly commentary is that true, and can you characterize your proportion of auto now versus what it was a year ago as a percent of sales?

Okay.

Well, yeah, we do believe that we've taken some share in automotive and then December quarter, sales to automotive were up 19% year over year.

A significant improvement.

If you look at the proportion of our sales to automotive, as you know, Vidia has a higher component of its sales in automotive.

So that's been accretive to the overall net.

When you add that that to the market share gains in North America, I'd say from 25% the sales may go up to kind of in the high 20s to 30%.

Take that 19% increase, that includes the impact of Vidia or that's just base growth?

No, that's just actually the base business growth and that's North America.

Wow.

Okay.

So that's got a negative impact on margin, however?

It does.

Okay.

Then the second one I've got is the Vidia plant closures you mentioned four manufacturing facilities.

That would be out of how many and then would give you total how many, cumulative total number of facilities, manufacturing in Europe between Hertel and Vidia, how much?

The total manufacturing facilities were 12 manufacturing facilities.

So we have reduced it by three.

So we'll have -- or four.

So we'll have eight.

Okay.

That would contrast with how many in North America?

On the metal working side, we have about -- about 20 plants of all sizes.

For the metal working business part.

Okay.

So it's not unusually proliferated in Europe versus North America?

No.

In terms of number of plants terms your sales base over there?

No.

All right.

Thank you.

And we have a question from Joanna Shatney with Goldman Sachs.

Please go ahead.

Good morning.

Good morning.

Given the fact that the(inaudible) economic signs are softer for Europe, and the fact that you're rationalizing the significant number of SKUs, why hasn't the sales expectations for Vidia changed that much?

Just you said it was a considerable expectation, or are you gaining share?

What's the offset?

Well, as we noted, we just recently finished the negotiations with the workers council, I guess now where we've fully integrating the sales forces in Europe, between Vidia and Hertel.

So, you know, we don't expect significant benefits still this fiscal year.

Clearly, there are benefits anticipated in '04 and beyond, but we're taking a somewhat cautious approach in year.

Joanna Shatney But I'm confused why it's not going lower.

Because your core European business assumption is down, and then we have the 35% rationalization SKU.

I'm guessing the SKU thing is not new, but just new to me.

Why not moderate the expectations for Vidia since that that is so Germany related and of course European related?

Joanna this is Markos.

Two things.

One is we're much more cautious in outlook regarding the -- of course because of the unknown.

And so we had a very conservative estimate on the table.

We also didn't know how quickly we'd be able to get an agreement from workers council to act on many things.

And there's always a dimension of making sure the cultures get on well when they start.

So that's really what made us very conservative, so we think we've built enough conservatism so we don't need to change that.

The rationalization takes five, because you have to withdrawal draw products in an ordinary fashion in the market.

This will be spread out over a couple of years.

So when I think about the earnings power of Vidia, or the sales power at Vidia, we don't have any sale synergies baked in, at least in the earnings guidance?

You know, is there really some synergies baked in because we see that Vidia remains at X even though we take 35% of the SKUs?

We bake no synergy, we maintain our conservative approach.

We feel a lot better by the way that the thing is coming together.

We may have some upside, but we're not changing that going forward.

And what are the things you're taking out?

Are they overlap?

In some cases they're overlap.

In some cases these were one or the other company has a better technology.

Doesn't have to be exact overlap but, you know, you can have a particular product that can end up doing the job of three products.

So this is really something we do very aggressively in terms of acquisition.

And that over time obviously helps you across the board.

But it's actually a couple of years because we have customers who are used to them you have to convert the number, you have to convert the manufacturing lines.

So the benefit -- although it won't happen this year, but there are going to be substantial.

Frankly, I would not expect it to be able to get such a good reduction overall.

So 35% for me is a pretty good number.

The synergies expectation for this year don't sound like they're changed much either.

I want to make sure that's right.

Have not.

So why is the expect face for dilution of Vidia gone from 15 cents to 10 cents?

Is it cash flow, paying down debt?

No, it's just the math.

It's the fact of the equity offering off the lower EPS face.

As we brought the EPS down versus the previous guidance, of course, we issued 3.5 million shares.

You do the math, it translates into about a nickel less dilution from the equity offering.

Okay.

I'll stop beating the Vidia dead horse now.

One last question.

I know we're profitable on full service supply.

Can you just talk about was that a volume issue?

You talk about walking away from high-end investment contracts that you earned.

What's going on there?

Can you remind what the plan is for full service supplies?

Strategically for full service supplies, we said the --the question for us.

That's a high-volume business, high asset intensity, good cash flow, but low margins, because the competitive arena in the world is not attractive.

What we have done is essentially disengaging from our profit over the business, putting the new processes in place, giving us some volume to pick up better cash flow, low inventory.

So net, I don't have a problem with that line or business because it's smaller business than it was.

And, you know, because I don't want to go into too many pluses or minus, some of that has been offset by the base business.

But it is the way we want to go, so I'm not concerned about that.

As long as it generates cash and we're fixing the operating aspect, that's where we need to be.

Caller: So when I think of the earning power at Kennametal, it's break even or a slight loss?

I think you can see marginal improvement going forward, but without a question as we continue to do improve this.

But for now the short term, that's what we have baked in the next two quarters.

Okay.

Yeah.

Joanna, it should be about a 5% margin business.

And that hasn't changed?

No.

Okay.

Thanks.

Again if there are any additional questions, please press the one on your phone at this time.

We do have a question from Walt Liptak.

Please go ahead.

Yes.

A follow-up to the Vidia integration.

If we can go a little deeper into the four shops you're closing.

Can you mention which countries those are being closed in?

In the European union, I'm not being -

Okay.

I understand.

It's very delicate matters here, Walt, in terms of workers council, worker regulations.

Okay.

That's fair enough.

When it's announced publicly, then we can do it.

But for now, we cannot.

We have agreement sign -- signed agreement for the workers council, but we don't have agreements for public identification.

Okay.

That's fine.

Then secondly, on the inventory levels, inventories came down a little bit sequentially.

What can we expect from inventories going forward given the reduced outlook?

I would expect inventories, Walt in the second half to come down another 20 to 25 million.

Okay.

Thank you.

And we have a question from Mark Koznarek.

Please go ahead.

Hi, thank you.

Can't get rid of me.

I just would like to know, you've got this new initiative in North America where you are going to market in certain regions via distributors rather than solely direct now, and can you give us an idea what kind of revenue those distributors contributed in the quarter and what the outlook is for the full year, how much is embedded in your guidance for the year?

Yeah, Mark, we have to get back to you on that.

I would say that as we've indicated before, we have been very cautious given the relatively direct shift to market strategy.

We have been very cautious with the pace of the transition.

So -- we'll get back to you with the actual numbers.

Would you consider it to be material or it is still very modest in scale?

I would say it's not material.

Okay.

Thanks.

We have a question from Greg Macaso with Lord Abbott.

Please go ahead.

Yes.

Would you talk more on J&L with regard to the expectation and the past quarter?

I believe you're saying that the sales were basically flat and could you just give us some color on the type of customers we're talking of essentially?

Yeah.

J&L was flat in the second quarter.

They actually show year over year growth in November and December.

We're looking for kind of low to mid single digit growth at J&L for the next six months.

Mostly coming from the market share gains.

As they've repositioned that business and I would say that in terms of the various ways they go to market, they have been most successful in terms of the telesales group, as opposed to the direct sales group.

I think we're picking up market share and so forth.

But we're expecting low to mid single digit growth.

At J&L.

Thank you.

Our next question is from Joel Tiss of Lehman Brothers.

Please go ahead.

Sorry.

Just two more quick ones.

One, I wonder if you guys are strong with Volkswagen and the angle I'm looking at is that VW has been very strong in China.

So I'm wondering if there's a strong way in to China?

We have a disposition in Europe and in China, Joel.

Joel Tiss Okay.

Great.

And then last, Markos, I wonder if you can give us whatever the quick version if you're comfortable on what kind of a framework we should be looking at or thinking about for 2004?

I know it's a little bit early and there's a lot of uncertainties, but I think it would help us a lot.

I think what you need to be looking at is what we said before, and this is the breaking even point is at the lowest it's been in years, and the level is significant that growth we can leverage in the short term for every percent of growth, particularly in North America --for every dollar, 50 cents on the dollar.

And the fact -- we talked --reading a crystal ball that will say we pick up in the second half of this year, then you should start seeing that right away.

There's very little time line between our ability to generate profit as soon as the consumable business picks up and putting it in the bottom line.

So capacity utilization, forced capital expenditure second and the leverage -- it stays 50 cents on the dollar going forward.

Right now, the best we can get is second half of this calendar year.

If we get it sooner, if the energy picks up, if coal production picks up, all of this is potential of the business.

Joel Tiss Then as you go around and talk to your customers about your integration and expanded product line, are you hearing any, you know, little more optimism in the voice or anything, you know, stuff is really wearing out or we've pushed it to the bone or anything like that?

You mean in terms of our customers?

Yeah.

Of course the outlook from the customers is the possession we have taken in the market.

We have talked to many of them and that's how we've taken the position that we have.

In terms of performance, and outlook, the inventories continue to be very slim.

They continue to manage the inventory very tightly, and they continue to look for technology that will give them some kind of a competitive advantage which is where we come in.

Where we have begun to make some substantial progress which I believe in the medium so long term going to give us substantial upside is in the meaningful leverage with customers who are moving globally and that is from our side a valued proposition of Kennametal one stock worldwide to support all of their plants.

Particularly now that we have a complete product range with Vidia acquisition.

And this is a supply chain model we're putting in place that is showing some early signs of promise and we don't want to go on too much at this point.

But that is particularly in the case of global customers with facilities in many parts of the world.

Okay.

Great.

Thank you so much.

Our next question is from Joanna Shatney with Goldman Sachs.

Can you guys talk about why you think J&L's kind of flattish with your huge gain in North America and metal working?

Isn't it largely ranked to automotive?

It is Joanna, but it's primarily at the first tier level of all the other spending.

Most of the customers are in the second and third tier.

As you know, as they have been speaking out for automotive they're not pushing that much business down.

If you look at the metal-working piece of the business, they're getting traction now, because the strategy that they're using is to be the only dedicated metal working company.

And that is really what's starting to eventually give them the traction we talked about.

So we should see more penetration of automotive in the next four months maybe?

In the second and third tiers now, then we should.

But I think I'm looking to get more across the board in other places.

Is it lower margin business at J&L as it is for metal work

in automotive?

Yeah.

No, typically this is better .

Just on your pension assumptions, because you guys obviously have a fiscal year end before everyone else and were -- in the middle of changing everything so people for calendar year end.

You guys lowered your expected rate of return to 9.5%.

Can you give us an idea, are you going to stay where you are?

Would you go as low as 8%?

Joanna, we're just having the discussions right now with some of our outside advisers.

I can't really give you any guidance.

I'm sorry to say it's coming down.

The -- the past of the pension fund is a well funded function.

And we still don't believe at this point that we'll need to fund to make contribution to the pension fund for the next one to two years.

Okay.

Great.

Thanks.

We have no further questions at this time.

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