Kennametal Inc (KMT) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by -- and welcome to the Kennametal's second-quarter earnings conference call.

At this time, all lines are in a listen-only mode. (Operator Instructions).

As a reminder, this conference is being recorded and replay information will be given at the conclusion of the call.

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

Please go ahead.

Thanks, Kathy.

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

As Kathy mentioned, I am Beth Riley, and I am pleased to have our VP and CFO, 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 would 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 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 financial measures as well as a reconciliation thereto.

With that, I will turn the call over to Nick.

Thank you, Beth, and good morning, everybody.

We were pleased to exceed our December quarter guidance for both organic sales growth and earnings in the December quarter.

This is Kennametal's best quarterly performance in over three years and we certainly viewed the December quarter as an inflection point to strong sales and earnings growth in the second half of our fiscal year.

I'll just touch on a few highlights before I review the specifics of the second quarter and our forecast for the balance of the year.

We believe our overall performance in the quarter was consistent with, or slightly better than, the change in industrial production -- excluding technology -- on a global basis.

Although many forward-looking indicators such as the ISM index are quite bullish, actual production increased only 50 basis points in the U.S., declined by 50 basis points in Europe, and rose about 5 percent in Asia.

The Frank (ph) of the ISM index, which we generally lag by about nine months, gives support to our second half forecast of mid single digit volume growth.

We expect quite strong performance in the second half of our fiscal year with volume growth of 5 to 7 percent, against global investor production X-technology forecast of about plus 2 percent.

Most of our businesses are well positioned to perform better than the market, and we will begin to see the incremental volume from the new contracts in our distribution businesses.

EPS should increase over 50 percent in the second half.

We're maintaining the low end of our full year EPS guidance, but have reduced the top end by 10 percent -- 10 cents -- due to continued weakness in Europe and higher than expected raw material prices.

We believe this is prudent since we spend 10 to $15 million per annum on cobalt, and prices have doubled in the last several weeks.

Cash flow generation was again strong and the balance sheet is healthier than at any time since the Greenfield acquisition in 1997.

Debt to capital should be about 33 percent by year end, and debt to EBITDA around to 2X.

We completed the Widia integration during the quarter, and Widia became accretive to earnings during September.

The total cash spend related to the integration was just over 60 million, consistent with our original estimates.

As anticipated, all special charges associated with the Widia acquisition were completed during the quarter, and we do not anticipate further charges of any kind for the balance of the fiscal year.

Now for the specifics of the quarter -- for the second quarter of 2004 excluding special items, Kennametal earned net income of 12.3 million, or 34 cents per share -- compared to 9.4 million or 27 cents last year.

The current quarter included 4 cents of accretion from Widia.

Consolidated sales increased 7 percent to 461 million, excluding currency effects; organic volume growth was 1 percent.

Current profit margin, excluding charges, was up slightly, at just over 32 percent compared to the prior year quarter.

Gross margin benefited from manufacturing efficiencies, currency and lower depreciation, partially offset by price mix and higher pension expense.

Reported gross profit margin of 32 percent was essentially flat versus the prior year.

Reported operating expenses for the quarter increased 8 percent to 125 million.

Excluding charges, operating expense increased 8 million or 7 percent to 122 million. $8 million increase is attributed to over 7 million of unfavorable currency effects, and inflation in employee benefits and pension costs.

We continued to spend well above last year's levels in marketing and employee training and development programs.

Reported other income was 3.9 million, up from 1.7 million in the prior year quarter.

The increase is attributed to the gain of the sale of the Toshiba investments, offset by certain losses on foreign currency contracts that hedge into Company cash flows.

EBIT excluding special items was 25.2 million, up 2 million to the prior year quarter.

The corresponding EBIT margins was 5.5 percent, up slightly from 5.4 percent last year.

Interest expense is 6.5 million decreased by about 3 million over the same quarter last year, due mainly to lower debt levels.

As expected, the effective tax rate for the quarter was 32 percent -- the prior year rate was about 28 percent excluding charges, which included a year-to-date adjustments to the 30 percent annual rate.

Free operating cash flow for the quarter was in-line with expectations and exceeded the prior year by 35 percent.

Improved earnings and reduced inventories account for the increase.

As of December 31, 2003, total debt was 481 million.

Debt to capital had declined 420 basis points to about 37 percent.

From the end of FY '03.

Turning to the individual business units -- and all of these sales figures are in constant currency and the EBIT figures exclude special items.

For MSSG, sales were down 2.6 percent.

North American, excluding high-speed steel, grew 1 percent.

High-speed steel in North America remained essentially flat with last year.

Europe declined 12 percent, due to primarily unfavorable and market and customer mix, and the rest of the world grew 15 percent.

The EBIT margin for MSSG increased against last year at 9.2 percent versus 9 percent.

Turning to the advanced materials group, sales grew 8 percent.

Mining and construction was up 9 percent on a modest recovery in mining, and continued market penetration and construction.

Engineered sales were down 5 percent and energy grew 27 percent on the strength of fire, oil and gas activity.

Electronics increased 17 percent.

Sales growth delivered improvement in AMSG's EBIT margin to 12.5 percent versus 10.2 percent last year.

J&L sales increased 4 percent over the same period last year, and their EBIT margin was 8.6 percent against 4.5 percent a year ago, as lean benefits and higher operating efficiencies generated strong operating leverage.

Full Service Supply sales were up 4 percent versus last year, and the EBIT margin was about breakeven compared to about -1 a year ago.

For the full year, we expect FSS's margins to be about 200 basis points higher than last year, as we overcome the upfront investment in the new contracts.

Okay, so let's discuss our outlook for the remainder of FY '04.

In terms of sales for the year, we are forecasting core volume growth of 2 to 4 percent.

If you include currency and two additional months of Widia, sales for the full year are expected to grow between 9 and 11 percent.

For the third quarter, we anticipate core volume to increase 4 to 6 percent and total sales growth of 10 to 12 percent, including currency.

In terms of EPS, the third quarter guidance is 50 cents to 60 cents, and for the year $1.90 to $2.10.

These figures include about 2 cents of Widia accretion in the third quarter, and 12 to 15 cents of accretion for the full year.

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

As anticipated in the acquisition plans, Widia will be moderately accretive to margins in our ORC.

And finally, free operating cash flow for the full year is still expected to be in the range of 100 to 125 million.

Additional guidance for the full year is as follows, and remains largely unchanged from last quarter.

The tax rate for the year will be 32 percent.

Capital spending will range between 50 and 60 million.

Depreciation and amortization will be about 70 million.

And interest expense will be just below 25 million.

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

Demand for metalworking products in North America is expected to be up 2 to 3 percent from last year.

Management expects the recovery of North America to accelerate in the second half, with most key markets improving except for aerospace.

Demand for metalworking products in Europe is expected to be about flat versus last year.

With weakness in automotive offset by gradual recovery during our fourth quarter.

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

In terms of end markets, automotive is expected to grow slightly in North America, but at the decreasing rate, and decline moderately in Europe.

The year-over-year declines in aerospace are narrowing, but the segment should still be down low single digits for the balance of the fiscal year.

Light and general engineering is expected to grow 4 to 5 percent, with heavy engineering increasing 2 to 3 percent.

As you know, growth in these segments is very encouraging to Kennametal given the high operating leverage and our strong market share positions.

Energy remain strong and is expected to grow 5 to 7 percent off the high levels of a year ago, and mining and construction should increase 4 to 5 percent.

In closing, we continue to feel very good about fiscal year 2004.

Our growth is returned to most of our key markets, and we expect earnings growth of between 35 and 50 percent.

In addition, Widia has been successfully integrated and our balance sheet is strong, and will support future growth opportunities.

We also believe we have a winning management team in place, and with the recent changes in the metalworking business, a combine with innovative new products and aggressive new sales and marketing programs, we have confidence that we will outperform the industry in the second half.

I will now open the line for questions.

(Operator Instructions).

Gary Mcmanus, J.P. Morgan.

Nick, you talked about I guess a weak European automotive -- I'd don't know, is it the end markets that is weak and expected?

Or something going on specifically with your operations over there?

Can you elaborate a bit on how that operations are performing rather than expectations?

Yeah, well, we continue to see automotive production in Europe down.

Kind of low to mid single digits, year-over-year.

We also have a customer mix issue within automotive -- I think we have discussed before that Volkswagen is our principal automotive account.

And you may have seen that they continue to be underperforming the industry.

So the issue in Europe for us is primarily mix and then markets and customers, but I will also acknowledge that we do believe that we have lost some modest market share in the transition during the Widia acquisition.

Just as we have gained share in North America, and we also believe in the rest of the world, we do believe that we have lost a little bit of market share in Europe to the Widia transition.

Now, certainly, no one here views that as permanent, and we are very confident in the management team and the plans in place.

And in fact would view that slight loss as something that would be somewhat typical integration of the scale of Widia.

Okay.

Secondly -- you mentioned higher raw material costs negatively impact you.

Can you kind of quantify to what degree, was it getting worse as the quarter went on?

Do you expect to get worse going forward?

And are you raising prices perhaps to offset the higher raw material costs?

Yes.

This was a real surprise to us.

Throughout the month of December, cobalt prices, which are key ingredients to our carbide powders, increased significantly.

In fact, they doubled since the levels in the September quarter.

So, as I indicated we spend between 10 and 15 million a year on cobalt.

And if you assume the spot rate continues for the second half of the year, that's about 5 million of risk to EBIT.

Now, certainly, there will be an attempt to pass some of that on -- history would indicate in the short-term, that does not happen.

As quickly as we might like it to.

But, it's really not other raw materials -- it's strictly this cobalt issue.

And perhaps we're being a bit cautious here to assume that the spot prices are going to continue with this level.

There may well be a bubble that will burst here in the second half.

But our forecast assumes that the stock prices will continue with this level.

Okay.

And just one last question -- how much did foreign currency favorably impact earnings per share?

In the December quarter, it was about 5 cents.

And going forward -- the second half of the year, we are looking helping us by five to 7 cents for the whole second half, given that we are beginning to lap some strength from the euro last year.

And I assume you're just holding currency is constant.

Yes.

Okay, great, thanks.

Adam Almand (ph), FTN Midwest Research.

I was wondering if we could dig into the metalworking margins a little bit during the quarter.

They seemed a little bit weaker than, at least, we were expecting.

So I was wondering if you could kind of just lay out what the pluses and minuses were here in the quarter.

Okay, well, metalworking margins -- were, I will say, a bit soft versus expectation -- I will acknowledge that.

We have indicated that we believe what we're taking some market share in North America.

The issue with margins was principally a North America issue.

We have been a selectively, and with discipline, reducing prices to gain some share in some accounts.

Certainly, we feel that we have taken share in accounts where we have not had to move on price.

So, there has been -- I will say about a 50 basis point impact of price on the MSSG margins.

It's principally in North America.

Is there any end market that is this is particularly focused on?

Is it automotive or --?

I think it's really more product specific, as opposed to end market specific.

There's some new products that we're launching, and product areas that we're trying to increase our penetration -- it's not so much by end markets.

Okay.

And then, I was wondering if you could give us some color on metalworking in Europe.

What the performance there was in the quarter?

Well, I guess I will just repeat a few of the comments that I made to Gary's question.

I think that performance there is driven largely by mix issues, both in end markets and in customers.

And we continue to think that the European recovery's lagging the one in the U.S. -- obviously, we have seen some very positive forward-looking indicators in Europe that would perhaps indicate that we will start to turn positive here in the next six months or so.

And maybe I missed it -- how much was sales down in Europe in the metalworking segment?

I think we said sales were down about 12 percent.

12 percent.

Okay.

Great.

Thanks.

Mercedes, Goldman Sachs.

Yes, it's Mercedes here, I apologize if somebody asked the question before, but I missed a little bit of the call.

What is giving you so much confidence that Europe is going to look much better in the second half versus the first half?

Okay.

Well, again, the assumption is that Europe will be about flat with last year as you intimate -- Europe was down, say, 10 percent or so in the first half.

The comparisons are becoming certainly easier for us in the second half of the year.

The Widia integration really took effect February 1st of last year.

Europe began to turn down.

We had a few weak quarters as the market did in Europe in March and June last year.

So we believe the comparisons are getting significantly easier year-over-year.

I would like to ask the same question for North America.

What is taking North America from flattish levels now to growth in the second half?

Well I will tell you what we're seeing in the marketplace.

We finished the December quarter very strong.

The month of December was quite strong.

The order rates are quite good.

The entire North America, the organization, feels very optimistic about both the markets prospect and our loan prospect in the second half of the year.

So, this is not what I would call wishful thinking.

We're seeing in the marketplace today.

This is a housekeeping question.

How much was R&D for the quarter?

I don't have that offhand.

Beth, I don't know if you can --

Will pull that and get back to you Mercedes.

okay.

I think I'm all set.

Thank you very much.

Walt Liptak, McDonald Investments.

My question is about Widia and the accretion you're keeping at 12 to 15 cents.

Why not bring that down or what offset that?

You said Europe is weaker than expected.

It was there synergies or some additional costs or something that gives you the same kind of accretion?

Yes.

There are two things.

I think we mentioned this last quarter as well.

We have seen synergies above what the expectations were at the beginning of the year with the guidance -- so we continue to see better synergies than expected.

And that coupled with the strong performance in India -- Widia India -- really, to some extent, offset the weak market conditions of Widia in Europe.

So I think it's fair to say that in that range of 12 to 15 the accretion will likely be at the lower and.

But we still feel that is going to be within that range.

Okay and the synergies that you are referring to -- these are operational synergies?

Yes.

The CapEx -- I had in my notes, previously, that you were at 60 to 70 million.

Now it looks like you are at 50 to 60 -- was that brought down?

It was brought down by about 10 million -- just looking at our run rate for the first six months.

And this has been somewhat traditional here, that the units as the year progresses just don't put forth as much capital spending requests as they believe they would.

It's partially a function of lean savings and other items.

So we have brought it down 10 million.

Okay good.

And the operating leverage that you had during the quarter was, I think, below your targets.

Can you tell us again what you think the operating leverage is for your business?

And what kind of organic growth you would need to achieve that?

Yes, the operating leverage in the business, depending upon the mix of course, because the distribution businesses are somewhat lower than the manufacturing businesses.

But we would look -- I'm trying to say -- steady state basis for incremental margins to be in the 35 to 40 percent range.

Across the Company.

Of course there are many things that effect that.

Including currency and other trends -- but in general, we look for that to be about 35 percent.

Now, in the second half of our fiscal year it's going to be a bit lower, given some of these big distribution contracts that we've talked about as well as actual currency.

Because, the sales from -- the intercompany sales from Europe to North America are putting some pressure on margins.

Because of strength of the euro.

So currency and the distribution contracts are pulling down that incremental margin in the second half of the year to somewhat below what we would typically expect.

Do you do any hedging on those contracts?

Yes we do -- but we hedge within fairly broad ranges.

So, the currency is floated to the top of the range in most of our contracts.

And therefore, in a year-over-year basis, those incremental sales from Europe to the U.S. are pressuring margins.

Okay.

Thank you.

Joel Tiss, Lehman Brothers.

Why was the corporate expense up about $4 million?

In the quarter?

On a year-over-year basis you're saying?

Yes.

Yes, it's mostly pension.

And the other issue is -- this quarter last year we were not matching the 401(k) and we have reinstated that.

But it's mostly pension.

So, this is a better run rate going forward?

Yes.

And then also, mining and construction -- it sounds like up 4 to 5 for the year -- it sounds like a deceleration from where it has been recently.

Can you just give us a sense of what you're thinking there, or what you're seeing in that business?

Yes, in that business we saw -- we actually had a relatively weak September quarter.

It was up just 1 percent, this past quarter was up about 9.

I think we expect to see the markets maybe about 5 to 6 -- but the internal forecast -- we believe we're going to be a little bit higher than that -- you know maybe 7 to 8 percent.

Okay, so there isn't anything to read into that -- that you expect to see a deceleration in the second half?

No, there are actually some onetime items that bumped up the growth rate in the second quarter.

Basically, snowplow blade sales and those types of things.

But in the core mining and construction business, I think we are at a run rate year-over-year of 5, 6, 7, 8 percent, something like that.

Alright, thank you very much.

Douglas Carson, J.P. Morgan.

Over the next two quarters, it looks like we will generate about 80 million in free cash flow, is that still slotted for debt reduction?

Which would bring you down to about 400 million and leverage it two times and then going forward -- what's a comfortable leverage target for the Company to operate at?

Certainly for the foreseeable future -- the excess cash flow will be applied to debt reduction.

And you're right, we will be about two times leverage at the end of the year.

I think if you look at a target in terms of debt to EBITDA, something between 1.5 and 2.5 times will probably be a steady-state target.

Debt to capital of 35, 45 percent, something in that range.

Would be reasonable targets.

Okay.

Obviously those would be very much influenced by opportunities in the marketplace in terms of acquisitions or any divestitures.

But I think that in general, we see ourselves as a weak investment-grade company.

Right, perfect, thank you.

J. Astin (ph), Newberger and Bermin (ph).

When I was up there -- or down there, Marcos made a comment with regard to RSPs, we're talking about -- this kind of goes back to the question of sustainability of -- in the comfort with the sustainability of recovery.

And one of the comments he made was that the RSPs-- certain RSPs were bigger than you all had seen in a very long time and suggestive of corporate mentalities becoming a little bit looser with their wallets and really in coming out of the bombshell and looking forward.

Can you elaborate on that?

Is that the case and are those projects moving forward?

Yes I think that's absolutely true, what Marcos indicated.

Obviously, those types of projects are a longer lead time.

What we're seeing now is growth just based on the, at least this point, somewhat slight increase in production levels.

But, yes, we do look at those contracts and those quotes, bids, as leading indicators for the business and, again, that is another indicator of that would support our second half volume assumptions.

Okay.

And then the second question had to do with Asia.

And again, kind of going back to the November, December, time-frame you all finally had what Marcos seemed to qualify as your real pointman on the ground there.

Could you talk about any sort of developments in the short period of time thus far that make you all either more or less enthusiastic about development or the speed of development in Asia and the speed of growth over there?

Particularly now that you kind of have your pointman in place, so to speak?

Well, I guess my comments would be mostly focused on what we have done in terms of building out infrastructure in China to prepare us to capture the growth that we expect of the next several years.

I don't think there have been any significant changes in the past few months in terms of the outlook for Asia-Pacific.

Again, our focus has really been putting a strong senior management team in place and laying that groundwork.

And looking at a number of opportunities in the region.

Okay.

But opportunities have not necessarily increased thus far, as far as having an individual who kind of adds access over there, so to speak?

Well, I think the individual that we hired in the business does add access clearly.

And the people he has brought along with him -- the team that he has built -- I would echo the same --

But we don't have -- there aren't actually certain examples to cite at this point of winds over there or business that you may have won in the last couple of months that are a direct result of that?

Yeah, J., there could well be -- I know we have in India, for example, won some major new contracts in the past few months.

In China -- I'm just not aware of any.

Okay.

Thanks very much.

(Operator Instructions).

We have no further questions.

Please go ahead, sir.

Closing remarks.

All right, well, thanks everybody for joining us for the call, and as always we'll certainly all be available all day for follow-up questions and I look forward to speaking to you.

Thank you.

Okay.

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