Kennametal Inc (KMT) 2004 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Kennametal first quarter earnings conference call.

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

Later we will conduct a question-and-answer session.

Instructions will be given at that time.

If you should require assistance during the call, please press star, then zero.

And, as a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Director of Investor Relations Beth Riley.

Please go ahead.

Thank you, Lois [ph].

Welcome and thank you for joining us this morning to review our fiscal 2004 first quarter and our outlook for the remainder of the year.

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 website at www.kennametal.com.

I'm Beth Riley, Director of Investor Relations for Kennametal.

I'm pleased to have our Chairman, President and Chief Executive Officer, Markos Tambakeras, and Vice President and Chief Financial Officer, Nick Grasberger, joining me for the call.

After some initial comments, we'll 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 and implied by such forward-looking statements.

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

In addition, to be able to discuss non-GAAP financial measures during this call, in accordance with SEC Regulation G, the company has furnished a Form 8-K to the SEC, which is also now available on our website at www.kennametal.com.

The 8-K presents GAAP financial measures that we believe are most directly comparable to those non-GAAP measures, as well as a reconciliation thereto.

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

Thank you, Beth, and good morning.

On balance, our business performed as we expected during the September quarter and we were pleased to deliver earnings near the high end of our guidance.

EPS of 34 cents, excluding charges, represents a 6% year-over-year growth in earnings on slightly lower sales.

We believe market conditions support continued cautious optimism regarding the recovery in North American markets, as evidenced by growth in many key end markets during the month of September.

Three consecutive months of growth in the important light engineering segment is also encouraging.

However, as most other industrial companies have noted, the recovery is not yet consistent across markets and the strength of any recovery in North America is not yet apparent.

In contrast, the markets for our products continue to grow rapidly in the developing regions of Asia-Pacific, India and South America.

We believe we continue to outperform in these markets as we commit an increasing amount of human and financial resources to our base operations.

Turning now to Europe, through the September quarter and for the near-term outlook, Europe is under performing our prior expectations, especially in Germany and France.

Broad softness in European industrial markets is exacerbated by particular weakness in automotive, a segment to which our exposure was increased with the Widia acquisition.

However, the Widia integration continues to progress as we anticipated and Widia became accretive to earnings in September.

The integration is now largely complete and we anticipate remaining charges will be recorded during this quarter.

Notably, all the debt incurred to pay for the acquisition has been repaid.

For the balance of FY-2004, our guidance remains unchanged as global market developments on a consolidated basis remain within the range of our expectations.

Our earnings forecast is based on modest organic growth assumptions that are consistent with both the macro and seasonal trends, augmented by the Widia synergies and the new distribution contracts with J&L and FSS.

This is the basis for our sustained confidence.

Now to the specifics.

For the first quarter of FY-2004, excluding special items, Kennametal earned net income of $12.1m or 34 cents per share, compared to $11.2m or 32 cents last year.

Widia added 2 cents of earnings versus the first quarter of last year.

Consolidated sales increased 10% to $445m.

Widia contributed 8 points of the growth and currency 4 points.

Organic sales declined 2%.

Gross profit margin, excluding special charges in both periods, was 33.1%, an increase of 70 basis points compared with the first quarter of fiscal 2003.

The gross margin benefited from manufacturing efficiencies, currency and lower depreciation, partially offset by slightly lower pricing and higher pension expense.

Reported gross profit margin of 32.4% was flat versus last year's first quarter.

Operating expenses increased 15% to $120m, excluding charges.

Operating expense declined slightly, excluding two additional months of Widia operating expense and the negative impact of foreign currency.

Reported operating expense is $121.2m or 16% over the prior year.

EBIT, excluding special charges, was $25.4m, flat to prior year.

The corresponding EBIT margin was 5.7%, down from 6.3% for the same quarter last year.

Interest expense at $6.6m decreased 22% over the same quarter last year on reduced debt and lower interest rates.

Interest rates on domestic borrowing of 4.3% were down 130 basis points versus last year.

As expected, the effective tax rate for the September quarter was 32%, flat to prior year.

Cash earnings for the quarter were in line with the prior year.

Free operating cash flow was $2m versus $28m in the prior year, as anticipated.

The year-over-year variance included an incremental $20m in tax assessed due to a refund in the prior year.

Higher cash restructuring charges account for most of the remaining variance to last year.

As of September 30th, 2003, total debt was $520m and debt-to-capital declined 100 basis points to 40.5% from June 30th, and is down 500 basis points from the same period a year ago.

I'll now move on to a discussion of our individual business units, starting with the metalworking group.

Metalworking sales grew 7% in constant currency.

Before Widia, sales were 3% below prior year.

Europe declined 7%.

North America, excluding high-speed steel, declined 1%.

High-speed steel declined 9% and the rest of the world grew 22%.

EBIT margin for MSSG increased against the prior year at 10.6% versus 10.1%.

Turning to our advanced materials group, sales grew 8% in constant currency.

Before Widia, sales were up 2% in constant currency.

Mining and construction was up 2% on a modest recovery in mining and market penetration in construction.

Engineering sales were down 9%, energy grew 17%.

Electronics increased 4% in constant currency against last year.

Before special charges, AMSG's EBIT margin was 12.8% versus 13.5% last year as pricing continues to affect the electronics business.

The margins in the other AMSG businesses were higher versus a year ago.

J&L sales declined about 1% over the same period in fiscal year 2003, but earnings were higher.

J&L's EBIT margin of 5.6% was about 1 point higher than a year ago as Lean benefits and higher operating efficiencies continued to generate good results.

Full Service Supply sales were flat to the prior year.

Before special charges, the EBIT margin was about break-even, slightly lower than a year ago, due to the upfront investment in the new contracts.

For the full year, we expect FSS's margins to be about 200 basis points higher than last year.

Now to an update on the remainder of fiscal year 2004, including expectations for the second, December, quarter.

In terms of sales for the year, we are still expecting core volume growth of 1% to 2%, plus an additional 1% to 2% from the new contracts with J&L and FSS, for total volume growth of 3% to 4%.

Including currency and two additional months of Widia, sales for the full year are expected to grow at 6% to 8%.

For the second quarter we are now anticipating volume to be flat to down 2%, with sales growth of 3% to 4%, including currency.

In terms of EPS, excluding charges, full-year guidance remains at $1.90 to $2.20 per share, an increase of 35% to 55%.

Our earnings guidance for the December quarter was 27 to 32 cents, flat to up 18% versus a year ago.

These numbers include approximately 12 to 15 cents of benefit from Widia for the full year and about 3 cents for the quarter.

On a year-over-year basis, Widia will add 27 to 30 cents per share of benefit.

As anticipated in the acquisition plan, Widia will be modestly accretive to margins and ROIC and free operating cash flow for the full year is still anticipated to be in the range of $100m to $125m.

To complete the Widia integration, we expect to spend approximately $30m of cash on a pretax basis during the remainder of FY-04, bringing total free cash to cash spend to just over $60m, in line with our original estimates.

Total charges for the remainder of FY-04 are expected to be in the $3m to $4m range, bringing the total to just under $60m, which is modestly below original expectations.

As previously noted, all charges will be completed in the December quarter.

Additional guidance for the full year is as follows: tax rate is 32%, up from 30% in fiscal year 2003; cap ex between $60m and $70m; deprecation and amortization about $70m; working capital below 35%; and interest expense below $25m.

The outlook for the December quarter is based on the following assumptions.

Demand for metalworking products in North America should be roughly level to last year.

We expect the gradual recovery in North America to continue in the current quarter, with accelerating sequential and year-over-year growth in the second half of the fiscal year.

Demand for metalworking products in Europe is expected to be down 5% to 10% due to continuing weakness in the automotive industry, European exports and general machinery projects.

Management expects the European market to lag the U.S. recovery, but European demand should improve, beginning in the fourth quarter of this fiscal year.

Demand is expected to remain strong in Asia and South America, fueled by strong market growth in Brazil, China and India.

Automotive is expected to decline 3% to 5% on a global basis, with Europe weaker than North America.

Aerospace is expected to decline 2% to 4% globally.

Light engineering is conservatively expected to be flat, but heavy engineering should improve 2% to 3%.

Energy remains strong and is expected to grow 20% to 25% and mining and construction is expected to increase 1% to 2%.

In closing, we continue to feel very good about fiscal 2004 and our guidance is based on very modest and realistic volume growth and we expect Widia to deliver a material boost to earnings versus last year, despite the continued weakness in Europe.

We are introducing new winning products at a faster pace than ever before.

We're continuing to strengthen our organization through substantial investment in training and development.

The introduction of aggressive new sales and marketing programs will gain momentum throughout the year.

We expect to invest an incremental 10 cents of earnings this year into the rollout of key training and our components of KBDS [ph] such as talent development, Lean and the customer acquisition process.

Finally, and perhaps most importantly, we continue to generate strong cash flow and reduce debt.

Finally, if our end markets, particularly in North America, recover at a faster pace, the very substantial operating leverage in the business will deliver incremental growth in earnings.

I will now open the line for any questions.

Thank you.

Ladies and gentlemen, if you wish to ask a question, please press star then one on your Touch-Tone phone.

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Once again, if you have a question, please press star, then one, at this time.

Our first question is from Steve Volkmann with Morgan Stanley.

Please go ahead.

Hello.

Just Daniel Cummings at Morgan Stanley covering for Steve.

Just this question on the European business specifically.

Your guidance was minus 5% to 10%.

I have guidance from European competitors, such as a [inaudible], which is flat to up.

Could you comment whether this is due to share loss or a difference in the mix?

I noted that you said net minus 9% for high-speed steel.

Could you sort of confirm what that mix is in Europe?

Yeah.

I suspect the issue here is one of mix, probably not so much product mix but end-market mix.

The exposure that we have to automotive with the Widia acquisition is substantially higher than it was.

Automotive in Europe was down about 22% in the month of August and actually about half of our sales in Widia go into automotive.

So I think it's a mix issue.

But to answer your direct question, no, we do not feel that we're under performing in Europe.

OK.

Thank you.

Thank you and our next question is from Walter Liptak with McDonald Investment.

Please go ahead.

Thank you.

You mentioned what Widia's auto exposure is.

Did you say 20%?

No, it's about 50%, 50%.

OK.

Thank you.

My question is foreign currency, what it added to EPS during the quarter?

It was about 3 cents-- 3 to 4 cents.

OK.

And on the gross margin improvement, you mentioned things like foreign currency and manufacturing efficiencies.

Last quarter I recall that you slowed production to try and reduce your inventories look well again.

What are you doing with production schedules in the coming quarter?

In the coming quarter?

In the December quarter, it'll be more of a seasonal issue.

Generally in the December quarter the holiday shutdowns would lead to lower production volume sequentially versus the first quarter and, of course, we're also very intent on reducing inventories and we will again in the December quarter.

OK.

And can you comment on pricing during the quarter?

Yeah, during the September quarter pricing was down about 40 basis points.

Again, as we've indicated before, driven mostly by electronics, as well as the high-speed steel in North America.

And that's 40 points sequentially or year-over-year?

That's year-over-year.

OK.

OK.

Thank you.

Thank you and once again, if you do have a question, please press star, then one at this time.

We do have a question from Michael Hayden [ph] from BBT Capital Markets [ph].

Please go ahead.

Good morning.

I just-- I have a question.

I know your tone is certainly a lot more optimistic here, but also at the same time you guys are aware that we've seen several kind of head fakesin the past and so that's, I guess, why you're saying you're still cautious.

So one thing I'm noticing that hasn't changed and I'm curious as to why it hasn't changed is that you are seeing some strength in the light and heavy engineering, yet your actual engineered products is off almost double-digits.

Why is, I guess, one end market product strong, but then actual products are not-- are actually pretty weak.

Well, the end markets for the engineered products group would sell into would be quite different than the light engineering segment.

Just for example, last year there was significant sales into governmental ordinance contracts and so forth out of the engineered products group that are not recurring this year.

I would add that also there's a bigger exposure this year in engineering in Europe, for example, the Widia acquisition, than we had before.

It was primarily a North America business.

So the comments that applied to the overall economy in Europe come into play here for the engineered business, where most of the optimism in light engineering in general is in the North America market for the metalworking business, which is the second and third tier supplies, which tend to represent the general manufacturing environment.

Sure.

That was getting to-- going to be kind of a follow-up.

So you are starting to see some work being pushed out to these second and third tiers, which kind of lends you some confidence, I guess, as to perhaps the breadth of this recovery?

Yes.

That would be true.

OK.

Thank you.

Our next question is from Gary McManus from J.P. Morgan.

Please go ahead.

Hi, guys.

It's actually Mike Manzo.

How are you?

Hi, Mike.

Your full year, even if we take the low end of your full-year guidance, it assumes a pretty hefty pickup in the second half.

Can you make us feel comfortable with that?

I know we have some seasonality.

There's probably an increase in the Widia acquisition accretion.

There's also the two contracts, J&L and FSS.

Can you just kind of elaborate a little bit and make us feel more comfortable?

Well, that's really three to four components.

I'll just go through them again.

The seasonality -- typically, the second half would be about 3% in sales higher than the first half of the year.

That would be the first component.

The second component you mentioned the contracts at J&L and FSS, which we've indicated we expect them to ramp up, particularly in the second half of the year.

That's an incremental $25m to $30m of sales in the second half versus the first.

Widia -- the accretion from Widia does improve throughout the year.

It's, I believe, about a nickel of earnings higher in the second half of the year.

And the last piece would be growth in the business relative to a pretty flat to slightly down first half on a year-over-year basis, we expect to see 3% to 4% core value growth in the second half of the year.

So if you add all that up and apply historic incremental margins, that should give you some confidence that the guidance is appropriate.

OK.

And one follow-up.

The lowering of the Widia accretion, is that all market related or is that--

It's driven by the market, but it's offset by better synergies than we expected and also the Indian business continues to do extraordinary well.

India in the September quarter grew over 30% organically.

And so even though we've seen softness in Europe, India is acquiring, as well as better cost synergies than we anticipated.

So we have been saying 15 cents or so of accretion.

We're now ranging it 12 to 15 cents.

OK.

Thanks, guys.

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

Please continue.

All right.

Well thank you everyony for joining us, I'll be available all day for follow-up questions.

Thank you.

Ladies and gentlemen, this conference will be available for replay until 3:15 today through November 5.

You may access the AT&T Teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 702261.

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