Kennametal Inc (KMT) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Kennametal Fourth Quarter Earnings call.

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

Later, there will be an opportunity for questions.

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 Beth Riley, Director of Investor Relations.

Please go ahead.

Thank you, Cathy.

Welcome and thank you for joining us this morning to review our fiscal 2004 fourth quarter and our outlook for fiscal 2005.

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

I'm pleased to have our Chairman, and President and CEO, Markos Tambakeras, and VP and CFO, Nick Grasberger joining me for the call.

After some initial comments, we will ask for questions.

Before I turn the call over to Markos, 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 and uncertainties is detailed in the company's Security 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 8K to the SEC, which is also now available on our website at www.kennametal.com.

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

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

Thank you, Beth, and good morning everyone.

Personally, I'm very pleased with our results for the fourth quarter and for total Fiscal '04.

The geo impact of recovering markets and solid execution of good strategies has resulted in delivering good value for our shareowners, while Kennametal is in the best position it has been for many years.

In the fourth quarter, we delivered record sales of $542m, 80% EPS growth, and almost 300 basis points improvement in operating margins, all in 12% organic sales growth.

Those results were driven by broad-based, good performance by all businesses and across most of our end markets.

For the full year, we delivered 50% EPS growth, which was at the high end of our original fiscal year '04 guidance on 5% organic growth, helped by improving economic environment, but also coping with headwinds of rapid escalation in raw materials and benefit costs.

These results also contributed to a nearly 200 basis point improvement in return on invested capital.

While Europe was the one laggard, North America rebounded nicely, and we are leveraging our number one market share positions very strongly.

We continue to implement the fixed processes of the KVBS, or Kennametal Valued Business System, which is becoming well engrained in our culture; lean benefits, mitigated inflation and pressures and cost increases across the board.

Global expansion is well on track with excellent results in all developing regions, in particular India, Latin America, China, and Central and Eastern Europe.

We continue to invest heavily in the development of our people.

Once again, we spend approximately 2% of sales in training and development.

On the acquisition front, video integration was on schedule and delivered the expected accretion of $0.29 year-over-year, while the acquisition of Conforma Clad has gone very well.

As we entered fiscal year '05, our balance sheet is strong and the debt to capital ratio is down to 33%, the lowest since 1997.

Turning to FY '05, we believe that the recovery in our current market is somewhere in the third inning, and we have set very credible goals for fiscal '05, with top line growth in high single digits, EPS up 25 to 35%, and a further 200 basis point improvement in return on invested capital.

All of these very much in line with our long range plan.

Let me turn it over now to Nick Grasberger, who will give you more details.

Thank you, Markos, and good morning.

I'll provide further comments on our performance for the June quarter and the past fiscal year, and then move on to the outlook for fiscal 2005.

There were no special items in the June quarter.

My comments will exclude the special items from the June quarter of last year for a better comparisons of results.

For the fourth quarter of fiscal 2004, Kennametal earned a net income of $29.9m, or $0.81 per diluted share, up more than 80% compared to $15.9m or $0.45 last year.

For the full year, EPS was $2.15, up over 50% versus last year, and at the high end of both our current guidance and our original guidance provided one year ago.

The anticipated hockey stick development of earnings growth throughout the year actually did materialize when the industrial recovery took hold in our March quarter.

EPS for the second half of our fiscal year was up over 75% versus last year, after increasing 15% in the first half.

For the June quarter, consolidated sales increased 17% to $542m.

The sales increase was driven by volume growth of 12%, and included a 3% benefit from foreign currency.

Gross profit margin improved 180 basis points to 34.3%, despite a $5m or $0.10 per share negative impact of raw material prices.

Gross margin benefited from continued cost reduction from our lean programs, improved capacity utilization, better pricing, and favorable currency effects.

Operating expenses increased $14m or 12% to $134m.

The increase is primarily due to unfavorable foreign exchange, inflation, and employee benefit programs, and charges associated with the reorganization of our global marketing function and the dissolution of a prior full service supply relationship.

These charges totaled $4m or $0.08 per share during the June quarter.

EBIT was $50.4m, up about 60%, and the corresponding EBIT margin was 9.3%, up 240 basis points versus last year.

Interest expense of $6.4m decreased 30% over the same quarter last year on reduced debt levels and lower interest rates.

Interest rates on domestic borrowings of 4.4% were down from 5.2% last year.

As expected, the effective tax rate ford the June quarter was 32%.

The prior year rate was 30%.

ROIC was about 7%, nearly two points higher than last year.

Free operating cash flow for the quarter was about $50m, bringing the total for fiscal year 2004 to $125m, at the top end of our previous guidance.

Free operating cash flow over the past five years exceeded $700m, and our debt balance now stands at $440m.

Debt to capital declined nearly 900 basis points to 33% from June of last year, the lowest number since 1997.

And debt to EBITDA is now around 2x.

OK, so turning to our business units, and all of these comparisons of sales will be in constant currency.

MSSG delivered strong growth in nearly every business and every geography.

The business leveraged market recovery in North America and strong markets in India and China, with innovative marketing, discipline sales, and a record number of new products.

In this one example, the fall production out on [KEMKIP] and [MILL1] new products achieve extraordinary sales results in the released markets.

Video sales synergies were launched with large orders for video automotive crankshaft [milling] products, secured within Kennametal accounts.

The focus on improving value provided to our customers resulted in finding an enterprise productivity partnership with Tyco.

In IPG, our high speed still business, also had an outstanding year, with sales growing faster than their market, and double digit operating margins more than double last year's margins.

In the June quarter, Metal Working sales were up 8%.

North American, excluding High Speed Steel, was up 16%, High Speed Steel up 15%, Europe declined 5%m and the Rest of World grew 31%.

On 8% volume growth, MSSG's EBIT was up 37%, and the EBIT margin improved by 250 basis points to 13.6%.

The Advanced Materials group had a very strong year across the board.

Mining and Construction achieved record performance in 2004, driven by new products and penetration into new markets.

These results were achieved despite flat year-over-year underground coal production in North America, continued uncertainty in U.S. highway funding, and stagnant markets in Europe and other key global mining economies.

Energy grew sales in excess of the strong growth in the North American oil and gas markets through innovations like the new corrosion resistant grades for controlling the flow from oil and gas wells.

New products also drove engineering sales, including the introduction of a new spiral coolant haul line.

In FY 2004, electronics benefited from the global recovery of the crippled circuit board industry.

Fourth quarter was the best quarter in over three years and the growth was augmented by many significant new business wins, including being named the sole source of carbide PCP drills to a large, multinational conglomerate.

AMSG sales for the quarter grew 21%.

Mining and Construction was up 10, engineered sales were up 17, and energy grew 28.

Electronics increased 2% against last year.

AMSG's EBIT grew 56% versus last year on the 21% sales growth, and the EBIT margin improved over 300 basis points to 14.8%.

J&L had an outstanding year, growing significantly faster than the market, as their efforts to push through industry paradigms and take the business to a new level began to pay dividends.

Of particular note, this growth was achieved without the benefit of the GSA contract, which is ramping at a much slower rate than originally expected.

Our strategy to go to market through multiple channels continues to pay off.

Highlighted [unintelligible] success in e-commerce, which now counts for 20% of sales.

J&L's fourth quarter sales increased 23%, grabbing a 7x growth in EBIT.

J&L's EBIT margin was up 850 basis points to 10.3% versus a year ago, as price optimization programs and higher operating efficiencies generated strong leverage.

Full service applied growth was accelerated by the launch of 18 new customer programs, including programs at General Motors, Goodrich, DKN, FMC, and Raytheon.

Customer cost saving commitments were exceeded at several major FSS customers, and a concurrent focus on lean and cost reduction delivered positive operating income of 800,000, up from break even in fiscal 2003.

For the June quarter, FSS sales were up 26% and the EBIT margin increased to 2.4%.

OK, moving ahead to our outlook for fiscal year 2005.

The forecast is driven by broad-based optimism on the global economic environment, including confidence and the return to growth of our European business.

Continued strong readings from leading indicators, such as the ISM index and the Manufacturers Alliance Composite Index, support the view, as do the consensus estimates of 3 to 4% growth in global industrial production.

These forecasts, coupled with our expectation of further market penetration, yield the forecast of 7.9% volume growth-- 7 to 9% volume growth at Kennametal during fiscal year 2005.

For the first quarter, we are anticipating volume growth of 9 to 11%.

In terms of EPS, the first quarter guidance is $0.50 to $0.60, up 50 to 75% versus last year.

And for the full year, EPS of $2.65 to $2.85.

This increase of 25 to 35% is consistent with our previously stated objective for earnings growth over the next few years.

Free operating cash flow for the full year is anticipated to be in the range of $110 to $140m.

And ROIC should improve another two points to about 9%, also consistent with our previously discussed financial model.

Like most companies, our outlook includes significant headwinds from increased raw material costs.

We expect an approximate $25m increase in raw material costs for FY '05.

We anticipate offsetting approximately 70% of this through a combination of price increases and surcharges.

The outlook for pricing also includes a 50 to 100 basis point improvement across the portfolio.

Additional guidance for the full year is as follows.

The effective tax rate for the full year is anticipated to be 32%.

The 32% rate includes discreet benefits related to the execution of a certain tax planning strategy, therefore the rate will not be flat at 32% for all four quarters.

The most likely outcome is a lower tax rate in either the first or second quarters, with the rate in the other three quarters somewhat higher.

Once fully executed, we expect to realize benefits in our effective tax rate in future fiscal years.

To be clear, the EPS guidance for the first quarter assumes a 32% tax rate, which could change.

Capex we expect to be approximately $70m to $80m, up about 30% from FY '04, driven by a significant investment and capacity in both India and China.

Depreciation or amortization should be about $65m.

Primary working capital for sales should be in the range of 22 to 23%, down another 300 basis points from FY 2004.

Debt to capital should decline further to about 25%, and interest expense we expect to be up about $2m as the impact of higher interest rates more than offset the impact of lower debt levels.

Included in our sales guidance are the follow assumptions concerning our end markets for the next three months.

We expect 3 to 5% growth in most of our major end markets, including automotive, heavy machinery, light engineering, and coal mining.

In addition, we expect the energy sector to begin to level off and road construction and airspace to gradually improve.

On a geographic basis, we expect industrial production in North America to remain strong, up about 3 to 4%, and we look for gradual improvement in Europe, up 2 to 3%.

In addition, demand should remain strong in Asia Pacific and Latin America, each up 5 to 7%.

I'll now open the line for any questions.

Thank you.

Ladies and gentlemen, if you'd like to ask a question, please press star, then one on your touchtone phone.

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And our first question comes from Joel Tiss with Lehman Brothers.

Go ahead, please.

How are you doing guys?

Hi, Joel.

Hi, Joel.

Can you give us a sense of, in the corporate expense up $1m over the third quarter and 5 from a year ago, and also give us a sense of the trend that you expect in that for '05?

Yeah, there are only two items there, Joel.

The first would be, as we've discussed before, the increase in pension income year-over-year.

And the other issue would be an increase in incentive compensation in the fourth quarter, given the performance of the company.

And in terms of the current going forward, we're looking for corporate expenses to be up about 5% in FY 2005.

OK.

And can you also give us a sense of the currency impact in 2004 and what's implied in the outlook for '05?

Thank you.

Yeah, OK.

Currency in the fourth quarter has upped earnings by about $0.06, $0.06 to $0.07, and I believe it was about $0.25 for the full year.

Looking forward to '05, we actually don't expect much impact in currency at all, based on the current spot rates, about 120 for the year.

OK.

Thank you very much.

Thank you.

Our next question is from Walt Liptak with [C Bank McDonald].

Please go ahead.

Hi, thank you.

Under raw material costs, what was the total hit for raw materials in 2004 and what was the percentage of [inaudible]?

Well, on a net basis, I think we indicated that the hit from the market quarter was about $3m.

In the June quarter, it was also about $3m.

So, $6m net, net of pricing for fiscal '04.

As I mentioned, about $25m gross of raw material impact in FY '05 and net of the price recovery, down a few million.

But on top of that then, again, we would expect 50 to 100 basis points in pricing across the business.

So we're looking at realizing about 70% of that $25m in FY '05 and, on top of that, what would be a normal price increase for a recovery year.

OK.

And I'm not sure if this is a good question or not, but the reason that it's only 70% is did it catch up, or is it just conservative?

I mean, is there a chance you can get to 100%?

Well, sure.

There's a chance.

I think looking back historically, both at Kennametal and throughout the industry, there's roughly a 70% realization.

OK.

And on the increase in your capital spending, are you putting in new facilities and what kind of-- you know, could you talk a little bit about the investment that you're making in India and China?

Well, as you know, we have the number one business in India, following the [Vidia] acquisition and we have significant infrastructure there.

That business we expect to grow at about 50% in fiscal year 2005.

So, we are adding significant capacity to the infrastructure that we have, more so than in China, but also adding capacity in China.

OK.

OK, thank you.

Thank you.

We'll now go to the line of Joanna Shatney with Goldman Sachs.

Please go ahead.

Hi, you guys.

It's [Marcetta] Garcia here.

In terms of '04, '05 incrementals, I was wondering if you could help me with a couple of things.

The first one is acquisitions, Conforma Clad.

How much it added in '04 and how much are you expecting in '05?

And I was wondering if you could also break out for us both the benefits, the pension and the incentive comp as an incremental year-on-year?

OK.

Well, as we have indicated previously with Conforma Clad, it is accretive and, as Markos mentioned I believe, it's very much on track.

But, we just don't view this material to EPS, either in '04 or '05.

In terms of the impact of benefits and incentive comp and so forth, pension in sum for the year in '04 was about a $10m to $15m hit.

We expect that to be just a little worse in '05, maybe up another $1m or $2m.

But as you may recall, we've made some structural changes to our pension funds and interest rates have gone up, which helps that dynamic.

So, pension income up $1m to $2m in '05 versus '04.

In terms of incentive compensation in the fourth quarter, that was up, I believe, $3m to $4m versus FY '03.

And what is it-- what are you building in your current forecast for '05?

Well, incentive comp would be inline with '04.

OK.

The last question here.

Can you give us some-- can you give us some update on how you are thinking about uses of cash?

I'll take that.

This is Markos.

As you know, we have had consistently over the past few years kind of a [inaudible] list where we wanted to get our debt down to the comfort levels of 35 to 45%.

We are well within that.

And obviously, that's linked to our desire to preserve our investment grade rating.

We feel very comfortable with that.

Our next priority is to look at accretive acquisitions, both in terms of the top line as well as the bottom line in ROIC.

That now would move much more into [inaudible] stage.

And then, going forward beyond that then, if we see that we have-- we don't have attractive opportunities in that area, then we're certainly looking at returning cash to the shareholders in one form or another.

Great.

Thank you.

thank you.

Our next question is from [Jay Aston] with Neuberger Berman.

Please go ahead.

Hi, guys.

Great quarter.

Hi, Jay.

Thank you.

A great year, actually.

As far as use of cash, just a follow on that question with regard to acquisitions.

Should we be thinking more domestically, internationally?

And should we be thinking more-- I mean, you've talked, at least going back over the last year or so, talked really a bit more about acquisitions and growing the AMSG business, but would you just delve down a little bit further into what we should be thinking about, both geographically as well as segment line?

Yeah.

I think the way to look at it is strategically.

The primary emphasis is around what we call the engineer components within [inaudible] materials.

And that will not be driven by geography, but by the opportunity itself.

And that's really the primary consideration here.

With respect to metal working, we think of it more in terms of [inaudible] on acquisitions, which may have a geographic element to it and, if that's the case, it's likely to be more in the developing economies.

But, our primary effort is within the AMSG arena and it is driven by the selection criteria I talked about before, not the geography.

OK.

And then also with regard to investment in India and China, is the capex being done on your own?

You doing this with partners?

Is there any development, particularly in China, with regard to partnerships?

Let me just-- it is that, certainly in India, given the position we have of mix there, this is our own investment in our own company.

With respect to China, we certainly keep our options open.

And so, I wouldn't exclude any possibilities.

But, whatever we do in China, as we do in India, our strategy will always be to have control, management and financial control.

OK.

And the types of capacity that's being built in China is to produce what?

It could be to expand our existing capacity there, primarily in standard product that will be utilized for local production, for the local markets.

So, we're looking at high volume production for inserts, the metal working business and high volume work product for the engineered components.

And as I said, essentially for the Chinese market.

OK.

And last question with regard to raw material costs.

I think earlier this year there was some confusion among some about the impact of certain raw material costs.

And if you would just speak briefly about what assumptions you're making with regards to the cobalt prices and the other components of raw material costs so we can track it throughout the coming year.

OK, Jay, I'll take that.

It's Nick.

Again, we spend about $150m a year on these raw materials, and that breaks down roughly as follows.

Tungsten and tungsten related products are about $70m, cobalt's about $30m, and steel, for high speed steel, it's about $50m.

And collectively, we're looking for those to increase about 20%, 20 to 25% year-over-year, more in cobalt and less in steel, but that's the average.

Now, what we've seen recently is that those prices have softened a bit, but we expect them in the fall to pick back up again and that's what we've assumed in this guidance.

So, that $25m negative impact year-over-year assumes that prices begin to move up again in the fall and then reach the levels where they were in the more recent past.

Towards the high end.

OK.

Thank you, guys, and again, congratulations on a great quarter.

Thank you.

Thank you.

And for any further questions, please press star, one now.

We do have a follow-up from Walt Liptak.

Please go ahead.

Thanks.

The operating leverage for the total company, it looks like it was about 27% during the fourth quarter.

How are you thinking about total company operating leverage I guess going forward?

Well, I can comment on the leverage in '04 and the fourth quarter.

First of all, as we've indicated, when the dollar is weak because of the margin that you get on the incremental sales due to currency, it actually dilutes the incremental margin overall.

So that affect by itself is about 5 points to incremental margin.

And then we also had in the fourth quarter the raw material issue, which is, as you might expect, somewhat dilutive to incremental margin.

And then the distribution businesses, as you've seen, which have lower margins, have been growing faster than the rest of the business.

So, if you account for those factors, we are-- actually, we're the high end of our standard incremental margin of 35 to 40%.

So, that's how that would reconcile for the June quarter.

For FY '05, the reported leverage here would be about 30% and the-- what's pulling that down is the raw material issue, and that accounts for about 10 points of incremental margin, so that would take us, again, back up to the high end of 35 to 40%.

So, as you know, we're very sensitive to incremental margins.

We analyze them very closely and we feel comfortable in this '05 plan that, excluding the raw material impacts, incremental margins are quite high.

OK.

OK, thanks very much.

Thank you.

And we also have a follow-up from Joanna Shatney.

Go ahead, please.

Can you give us an update on what you are seeing in Europe and what you are thinking for '05 in terms of end markets?

[Marcella], we think that Europe is on a slow recovery path.

We expect to see that pick up through the next four quarters.

The kind of sense we're getting from Europe is that industrial production will go up about 2 to 3%.

We feel very good about where we are in Europe in terms of having completed the integration of [Vidia], having a new head of our European operations and a new sales leader, and being able to take advantage of the upturn.

Most recently, the [inaudible] index from Germany also was up about 100 basis points, I think July versus June or the most recent comparisons available.

So, actually, we're feeling better about Europe now that we have focus on time and I think we'll be very well positioned there to leverage the [Vidia] acquisition.

Thank you.

Is that all, Ms. Shatney?

Yep.

OK.

Thank you.

Then we have no further questions.

Please go ahead with your closing remarks.

All right, well thanks, everybody, for joining us this morning.

And certainly look forward to speaking to you over the course of the day with follow-up questions.

Have a good day.

Thank you.

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