Kennametal Inc (KMT) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Kennametal third quarter earnings conference call.

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Later there will be an opportunity for questions.

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And as a reminder, this conference is being recorded.

I would now like to turn the conference over to Beth Riley (ph) , Director of Investor Relations.

Please go ahead.

Thank you Kathy.

Welcome and thank you for joining us this morning to review our fiscal 2003 third quarter and our expectations for the remainder of fiscal '03.

Consistent with prior calls, members of the media have been invited to listen to this call, and the call is being broadcast live on our web site at www.kennametal.com.

I'm Beth Riley (ph) , Director of Investor Relations and I'm pleased to have our Vice President and Chief Financial Officer, F. Nicholas Grasberger lll, joining me for the call.

After some initial comments, we will ask for questions.

Before I turn the call over to Nick, I'd like to read our forward-looking disclosure.

This discussion contains statements that may constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

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

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

In addition, to be able to discuss non-GAAP financial measures during this call in accordance with new SEC regulation G, the company's filed today a Form 8-K with the SEC, which is also now available on our Web site at www.kennametal.com that present GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures as well as a reconciliation there too.

With that I'll turn the call over to Nick.

Thank you Beth and good morning.

Before I start through this specifics of the March quarter and the June quarter outlook, I'd like to highlight a few key points.

For the March quarter we were pleased to exceed our forecast that we reduced last month as demand softened during the strongest period or our fiscal year.

The earnings performance on flat sales reflects our unfavorable business mix expected dilution from Widia and difficult year-over-year comparisons with certain expenses such as pension.

The integration of our Widia acquisition continues to proceed in line with our original expectations, with the integration costs and benefits within our previously disclosed ranges.

Cash flow and balance sheet performance continues to be strong.

The internal focus on the associated metrics has never been higher with Kennametal.

We are maintaining our cautious outlook for the balance of the fiscal year.

While we are certainly hopeful for even a gradual improvement, the experience of the last several quarters has shaken our confidence in a near-term rebound.

The June quarter earnings performance will also reflect an unfavorable business mix and a comprehensive effort to reduce inventory through production cuts.

And finally we remain highly confident in the substantial operating leverage that we've created in our business.

The visibility of the $100 million of cost reduction over the past three years has been shielded by the impact of declining volumes that will become evident when volume returns, when volume growth returns.

Now I'll turn to the specifics of the March quarter.

Excluding special items, Kennametal earned net income of 13.3 million or 38 cents per share compared to 16.7 million or 53 cents per share last year, a decline of 28 percent, versus the prior year of the current quarter included negative pressures totally 17 cents, including eight cents of Widia dilution, four cents of lower pension income, and five cents in compensation components that were cut in the prior year quarter as part of a temporary cost reduction effort.

As we discussed last year, these included a freeze on merit increases, selected salary cuts, and a suspension of the 401K match, all of which was subsequently reinstated.

Consolidated sales increased 17 percent versus the prior year to 459 million with the addition of Widia.

Sales increases from the prior year included 12 percent from net acquisitions and divestitures, four percent from foreign currency and one percent from an additional work day.

Excluding special charges, the gross profit margin for the quarter was 33.1 percent, up 40 basis points from last year.

In addition to the factors identified in the earnings release, pricing was modestly negative with the pressure in the J&L (ph) , energy, and electronics units.

Widia was 10 basis points diluted for the quarter.

Consolidated operating expenses for the quarter were slightly above last year on a like basis, excluding Widia expenses, foreign currency effects, and pension income.

EBIT, excluding special charges, was 28.7 million, down 12 percent from FY '02.

EBIT margin was 6.3 percent, down from 8.3 percent the same quarter last year.

Interest expense increased 21 percent, reflecting the additional debt associated with the Widia acquisition.

Interest rates on domestic borrowings of 5.2 percent were up 55 basis points versus last year.

Year-to-date free operating cash flow was $81 million, on track with last year.

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

As of March 31, 2003, total debt was 580 million.

Debt to capital declined 600 basis points to just below 43 percent versus the prior year quarter.

I'll now move on to a discussion of our individual business units and their top-line and EBIT performance.

I'll start with the metalworking group.

Metalworking sales before Widia were three percent above prior year in constant currency.

In constant currency, Europe declined two percent, North America excluding high-speed steel declined one percent, high-speed steel in North America grew double-digit, and the rest of the world grew five percent in constant currency.

Including Widia, metalworking sales grew 25 percent in constant currency.

EBIT margin for MSSG (ph) declined against the prior year at nine percent versus 12.7 percent excluding special charges.

The decline is largely due to lower volumes and the expected dilution from Widia.

We continue to expect Widia to be accretive to MSSG (ph) margins as the synergy benefits are realized over the next six to twelve months.

Turning to our advanced materials group, sales were up four percent in constant currency.

Mining and construction was flat as a modest recovery in mining offset a delay in the start of the construction season.

Engineered sales were up 17 percent in constant currency on very successful market initiatives, and energy declined three percent as U.S. rig (ph) counts below - remain below last year.

Electronics increased 11 percent in constant currency against the prior year.

Before special charges, AMSG (ph) EBIT margin was 12.4 percent versus 10.3 last year on higher sales benefits in the electronic restructuring program, stringent cost management, and lean and right-sizing programs.

J&L (ph) sales, excluding the Strong Tool divestiture from last year, were flat over the same period fiscal '02.

Before special charges, J&L (ph) 's EBIT margin was 4.1 percent against 6.1 percent a year ago.

Full-service supply sales decreased 18 percent in the current quarter versus last year.

Before special charges, FSS and EBIT margin was essentially breakeven compared to 1.7 percent a year ago.

FSS continues to generate strong cash flow of approximately 15 per annum as it disengages from accounts requiring large capital investments, particularly in working capital.

Let's move forward to now look at the remainder of fiscal year 2003.

First an update on Widia.

Plant energies also remained unchanged with three to five million in fiscal 2003, 20 to 25 million in fiscal 2004, and 30 million or more in each succeeding year. fiscal 2003 associated restructuring charges are 35 to 40 million in cash, and 70 to 75 million total.

The EPS impact is expected to be 15 cents dilutive in FY '03, becoming 10 to 15 cents accretive at FY '04, and 20 to 30 cents accretive per year thereafter.

On a consolidated basis, the remainder of FY 2003 is expected to be as follows; in terms of sales volume growth, flat to down two percent in the fourth quarter, and down two--down four percent for the year.

Including currency and acquisitions, sales for the fourth quarter are expected to be up 15 to 18 percent, and for the full year up nine to 11 percent.

In terms of EPS, excluding special charges the fourth quarter, guidance is 38 to 43 cents, and for the year $1.35 to $1.40.

Excluding the pension impact and the Widia dilution, those numbers for EPS would be 44 to 49 cents for the fourth quarter, and $1.67 to $1.72 for the full year.

Free operating cash flow continues to be anticipated for the full year in the range of 100 to 110 million.

Included in our current target are the following assumptions regarding outlook by end market for the next three months, and I would expect low single-digit declines in automotive, low to mid single-digit declines in light and general engineering, while tool and die is expected to grow low to mid single-digits for the quarter.

Low single-digit declines are anticipated in heavy engineering, while underground coal mining and construction is expected to be approximately flat, and oil and gas is anticipated to grow low to mid single-digits.

Aerospace is expected to decline five to 10 percent and electronics is expected to grow modestly.

Over the next three months we now expect year-over-year geographic performance as follows; end markets North America flat to down one percent, Europe to be down five to six percent, and Asia to grow four to five percent.

I'll now open the line for questions.

Thank you.

Ladies and gentlemen, if you'd like to ask a question, please press the 1 on your touch-tone phone.

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Our first question comes from Joel Tiss with Lehman Brothers.

Please go ahead.

Hey, guys.

How you doing?

Hey, Joel.

Hey, Joel.

Can you give us a sense of why there's such a big range of potential charges in the fourth quarter of 2003?

Yes, the--again, the charges in the fourth quarter are consistent with what we've been saying for the full year, but they have been pushed a bit into the fourth quarter, but they are consistent with what we have been saying for the full year.

OK.

And if I'm doing the math right, I get about 15 or 15 cents of addition from currency in the quarter.

Is there any--can you give us any sense of where the mix has really fallen off and, you know, why organic revenues were up a little bit and there was such a big drop-off in the margins?

You're speaking about the March quarter or the June quarter?

The March quarter.

The March quarter the currency impact was actually about seven cents.

For the full year currency will benefit the company by about 16 cents, but the March quarter number is seven cents.

Yes.

And in terms of the margin as we've discussed, there are a number of contributing factors.

Foremost, would be the business mix.

We're continuing to see softness in North America, the core North America metal working market as well as the European business.

But beyond that, two other high margin businesses, the mining construction business and energy, have also been soft.

The growth that we've been seeing leads to the flat performance overall, or in lower margin businesses like the high speed steel business, the electronics business and so forth.

So that would be the largest single factor in terms of getting the margin pressure.

But, of course, we've also mentioned the impact of pension income year over year.

The dilution from Widia, and the reinstatement of some contemporary cost programs that were executed last year that we reinstated January 1.

So all those items together really contribute to the EBIT margin decline.

OK.

Thank you very much.

Thank you.

If there are any further questions, please press one now.

And we do have a question from Mark Koznarek with Midwest Research.

Please go ahead.

Hi.

Good morning.

Hi Mark.

Hi Mark.

Can you help me dissect the margin performance of the metal working group and if we can split the volume impact versus the Widia dilution?

You know, did Widia actually make some money in this quarter, you know, can you help me with that?

And then, you know, the impact of foreign exchange in there.

It's just a lot of complicating factors.

Yes.

Widia, I'll say was effectively break even at the EBIT line in the March quarter.

We have begun to realize some of the synergies, as you know, we integrated fully on February 1 and we have been taking out some costs.

So there has been, when you include synergies, some EBIT contributed by the business.

But overall, Widia certainly is diluted on a margin basis to the entire business.

And I'll say on an EBIT margin basis, that will be about 20 basis points.

Of metal working alone?

That would be overall.

It would be, I'll say, 50 to 75 basis points for metal working overall.

OK.

And does the way your revenue versus costs work, does the pick up of the substantial foreign exchange revenue increment, does that affect margins at all or are costs and revenues pretty balanced?

No.

There is a currency - a favorable effect of currency on margins.

At the cost of the entire company for the quarter, I believe it was about 30 basis points.

OK.

Then let's see, just a couple other things.

The receivables are up pretty sharply, and I'm wondering if you can comment on that?

Yes.

That would be typical, as you know, the March quarter versus the December quarter is traditionally and certainly this year as well, a good bit stronger in terms of sales volumes.

So the increase in receivables would be in line with that and really consistent with expectations.

So really for the year-ago, fell into the third, from the second, it was virtually unchanged.

So I didn't if you're, if there's some program on, or if you're offering terms of something like that in order to boost sales.

No, I don't know if you're looking at the balance sheet, but certainly there's an impact of currency on receivables in the balance sheet, that is we translate euro denominated receivables into dollars.

OK, yes, I guess that makes sense.

All right.

And then final one Nick, did you mentioned the rig count is down, and I just happened to be looking at yesterday and noted that North American rig count at least land rigs are up 22 percent year to date, and so I'm wondering, do you guys, do you guys sell only to a specific sector of the market or specific, you know, type of rig that is performing poorly, because that's, you know, puzzling disconnect, a lot of the oil service guys are starting to report good news from rig activity now.

Rig activity has been improving sequentially for a number of months Mark.

The comment was a year-over-year comparison.

Yes, that's what I'm talking about too.

It's up 22 percent year-to-date.

Year-to-date or year-over-year?

Year-over-year, to date, you know, four months versus four months a year ago is up 22 percent.

The number that we looked at is total North American rig count and I'll give you the numbers in the stores offline.

But we do see that sector improving, in fact our outlook for the fourth quarter, we have growth in oil and gas.

OK, but I mean, the original question, do you market across the board, the oil and gas or is there just a specific niche that might still be somewhat soft?

No, it's across the board and if you're just looking at U.S. brand, Canada has softened and that's a seasonal impact.

So while the U.S. portion has been increasing, Canada has softened, and Canada is a very big market for us.

So in aggregate, the rig counts were down year-over-year.

OK.

Thanks a lot.

Thank you.

Our next question comes from Maria Forsinski (ph) with WDUU News (ph) .

Please go ahead.

Hi, I was just wondering if you could explain what exactly do you, you mentioned that the high-speed steels grew better [Inaudible] last year, could you just explain what exactly that industry, what skill, what industry that steel would [Inaudible] ?

Yes, the end markets that would supplied in high-speed steel, would be consistent with those of our core business, the core carbide business.

The reason we've seen stronger performance in high-speed steel is they sell to a different channel.

They sell to a distribution and what we've seen is that some of the big distributors are beginning to restock, and that certainly helped that business over the past quarters.

We expect that to flatten out a bit going forward, now that we've seen some of the restocking.

But just for your benefit, it is generally a more commodity-like business than our core business, the carbide business, but the distinction really is beyond that the channel through which it's sold.

OK, thank you.

Thank you.

We'll now move on to Joanna Shatney with Goldman Sachs, go ahead please.

Hi it's Maris Garcia (ph) sitting in for Joanna.

Can you give us a sense of why the surfboarder ended up being a little bit better than the previous guidance?

Well as you recall, perhaps when we pulled down our number late in March, we had seen significant softening versus the expectations at that point.

But I would just say that the last few days of the month which generally are quite strong were a bit stronger than we were expecting at that time.

So it's clearly a revenue issue.

OK.

And it was modest.

And also, what is happening in Widia in the fourth quarter because we are basically moving from an eight cent (ph) dilution to one or two cents dilution or have you guys been able to show the [Inaudible] that we have in March?

Can you give us some color?

Well, yes, those issues have been resolved, but the real reason for the reduced dilution in the fourth quarter is as I mentioned earlier we restructured the business and integrated fully on February 1.

So we'll have a full quarter of the cost synergies in June.

And we only had, you know, a month or so of those synergies in the - in the March quarter.

And my last question here - you mentioned in the press release that [Inaudible] going to do a study [Inaudible] in metalworking.

Can you give us some color about the - some color about the specifics of that?

What should we be expecting, some kind - what kind of programs, and ...

Well, I'm not sure that I would say he'll be addressing problems.

I mean he's coming in at a time when we are at the - hopefully the bottom of the economic cycle here and we need to prepare the business to grow.

And we've been doing that, and if you look at this background and his success, clearly we have a lot of confidence that he'll be able to do that.

So, I wouldn't say he's come to the company to fix problems.

He's helping to prepare us to grow the business.

OK. [Inaudible] thanks a lot.

Thank you.

We now have a question from Gary McManus with J.P. Morgan.

Please go ahead.

Hi, Nick and [Inaudible] .

Hi, Gary.

A couple things - one, you know, I think when you pre-announced a month ago, you were assuming that the weak conditions you were seeing in March would continue in the fourth quarter.

Is that still the case, or who does April look in terms of relative to your expectations?

Yes, I would say April to date is consistent with the forecast that we've put out here.

And consistent with our thinking of a month ago, as well.

Is April like running better than March or able the same?

I would say it's about the same.

OK.

It's just - you may have said this, and I apologize.

But you said fourth quarter sales are up 15 to 18 percent.

Did you break that out on how much is, you know, base sales versus currency versus acquistions?

Yes, the guidance for the organic volume in the business is flat to down two.

Currency I believe would be another 300 basis points or so, and the balance would be the Widia acquisition.

OK.

All right.

And have you, I mean - you know, over the past month, have you become, you know, let's say a bit less pessimistic or more optimistic on the auto site considering how, you know, it looks like all their sales are, you know, running pretty healthy rate in April.

Are you - are you being a bit more optimistic there?

Or do you still see pretty, you know, weak conditions there?

Well, we're expecting let's say a flat to slightly down performance in automotive.

Again, that's consistent with the expectation of a month ago.

So I would say that the view is unchanged with respect to automotive, as well.

OK.

And just one last thing - you know the accretion you expect in Widia I think you said - what? - about 20 cents or so next year?

Yes.

Is that - is that evenly weighted throughout the four quarters of fiscal '04 or would you expect it to, you know, be kind of a back-end loaded accretion?

Yes, I would say it would be somewhat back-end loaded, although, again, much of the cost on a run rate basis has been taken out and so we should see that immediately as we are in the June quarter, early enough Y'04.

So there will be some ramp-up, but really will not be what I'd say notable.

OK, thanks.

Thank you.

We now have a follow-up from Joel Tiss.

Go ahead please.

Yes, just two more quick ones.

One if you could give us any sense of restructuring charges for 2004, and also if you have just a ballpark figure on what kind of pension headwind you might be expecting in '04 as well?

Thank you.

Yes, first of all, the, in terms of restructuring, it's only Widia, right, we're done with the restructuring in the rest of the business.

We've indicated that consistently.

Most of the restructuring for Widia let me say 75 percent or so of the charges and the cash, probably more of the cash, were taken in '03, and we will be finished by the September quarter.

So they'll be an incremental, 10, '15 million of charges perhaps in the September quarter.

OK, and then on the pension?

Yes, on the pension, I think we're looking at, certainly another difficult year, on a year-over-year basis, probably an incremental eight to $10 million negative delta on pension income.

So another 15 to 20 cents, negative comparison year-over-year on pension.

OK, thank you very much.

Sure.

Thank you.

Our next follow-up comes from Mark Koznarek.

Please go ahead.

Yes, on Widia, now that you've, you know, executed a restructuring and are doing the integration, what actually have you done in terms of you know, physical facility reduction, staff reduction, et cetera?

Well, we've, we have closed or are in the process of closing I believe four plants.

We've taken out overall, what, about a third of the head count in the combined business.

Those would be the notable items, certainly we've closed other facilities, distribution facilities, sales offices and so forth.

You're right to say that the integration is still underway, but the decisions have been made and they're in the process of being executed.

Nick, these four plants would be out of how many combined in, you know, across the European sector?

Yes I believe it's about eight.

Well we had 12, and I believe now we're down to eight.

OK, and then finally any kind of comment on raw materials trends in the quarter and outlook for the fourth quarter?

I would say nothing notable Mark.

They continue to be modestly positive year-over-year, but the trend has been consistent here for the past few quarters.

OK, great.

Thank you Nick.

Thank you.

We now have a question from Greg Micasso (ph) with Lord Abbott.

Go ahead please.

Yes, thank you.

Just to follow-up on Mark's question, with regard to steel, are we seeing any sequential change in the pricing here?

What's your expecting there?

Well again, Greg (ph) , I would say nothing notable on steel prices.

What are your assumptions with regard to the pension, return on assets and discount rate and when do you change that, when will you adjust that?

Yes.

Currently the assumption for return is 9.25 percent.

I'm sorry, 9.5.

And the discount rate is 7.25.

And we will change that effective the beginning of our fiscal year '04, which is July 1.

So July 1 you would be adjusting that then?

Yes.

And, again, what we're saying with regard to the current quarter, kind of what you've seen so far in April really does not make you - in other words, you're saying it's no different than when you had your pre-announcement?

Yes.

Unfortunately that's correct.

Even though things improved, sort of in March to what you had expected in the pre-announcement?

Yes.

Certainly when we pulled the number down we were quite cautious and conservative and so the performance versus our forecast at that point, I'd say, was not all that surprising because we were quite cautious.

OK.

And with regard to Europe, you know, you were talking about expectations negative growth going forward in the fourth quarter.

With regard to the competitive environment, kind of, what are you seeing from, you know, some of the competitions, Stanvick (ph) , and some of the others?

So, first of all, if you look at the allocation of our business by geography we tend to have a higher concentration than some of our competitors in Germany.

And, of course, Germany has been quite weak even comparing to some of its peer countries.

So, we would say overall in Europe and in North America we believe that our performance has been consistent with that of our peers and the market overall.

So, really no kind of incremental share changes - market share changes?

No.

OK.

Thank you.

Thank you.

Thank you, and we have no further questions at this time.

Please continue.

All right.

Thanks everybody for joining us and certainly I'll be available for calls later in the day.

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