Kennametal Inc (KMT) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the second-quarter results 2005 conference call.

At this time, all participants are in a listen-only mode, and a brief question-and-answer session will follow the formal presentation. (Operator Instructions).

As a reminder, this conference is being recorded.

It is now my pleasure to turn the floor over to your host, Ms. Beth Riley.

Ma'am, you may begin.

Thank you, Megan.

Welcome everyone, and thank you for joining us this morning to review our fiscal 2005 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 Megan mentioned, I'm Beth Riley, Director of Investor Relations for Kennametal.

I'm pleased to also have our Chairman, President and Chief Executive Officer, Markos Tambakeras, Executive Vice President and Chief Operating Officer, Carlos Cardoso, and Corporate Controller and Chief Accounting Officer, Tim Hibbard joining me for the call.

Markos and I will provide detail on the quarter's operational and financial performance and then update for the second half.

After these remarks, we will ask the questions.

Before I turn the call over to Markos, 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 the reconciliation thereto.

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

Thank you, Beth, and good morning, everyone.

We're very pleased to announce another quarter of top quartile financial performance.

As you know, we exceeded our original guidance for the December quarter, driven by the highest sales for any quarter in Kennametal's history, even though this is traditionally the second slowest quarter of our fiscal year.

The earnings were also a record for the December quarter.

Some highlights now for the quarter -- first, every business unit in every geography delivered double-digit sales growth.

The growth was driven by robust market growth in excess of our expectations and by gains in market share, particularly in North America and in Asia.

Europe's growth accelerated as the region's markets improved modestly, and the new leadership team is hitting its stride.

We are increasingly confident in Europe's potential to contribute to our expected further growth.

Our profit margins and return on capital metrics reflect the operating leverage in the business, despite significant increases in raw material costs.

Compared to last year, are EBIT margin increased 220 basis points, and ROIC increased over 300 basis points.

We remain confident that these metrics will reach double-digit levels, on track with our outlook over the next two to three years.

As you've seen, we have again improved our earnings guidance for the full fiscal year by another 7 percent to a range of now $3.05 to $3.15, reflecting better-than-expected performance in the second quarter and modestly increased growth expectations for the second half.

We've raised our second-half sales growth outlook from mid single digits to high single digits.

This is a significant further increase when viewed on top of the strong organic growth of 10 percent which was realized in the second half of last year.

The increase in earnings expectations needs to be viewed in the context of further incremental headwinds from raw material costs.

Fuel costs, in particular, have continued to rise beyond our earlier or anybody's earlier expectations.

However, as reflected in the guidance, we expect that earnings leverage should continue to improve throughout the fiscal year as price increases close the gap to inflation in raw material costs.

We're also very pleased with our continuing steady and significant improvement in balance sheet metrics.

With debt-to-capital driven below 28 percent for the first time since 1997, which is before the Greenfield acquisition.

Our working capital ratio-to-sales also declined to a new low.

Inventory turnover reached a new high, and cash flow generation continues to be strong.

Of course, we remain committed to investment-grade rating, and debt reduction continues to be high priority for use of funds from operations.

Finally, as further evidence of our continuing commitments to profitable growth, we also announce today the exciting acquisition of Extrude Hone.

The acquisition of this market-leading materials and process technology company is a very good fit with our focus on engineering components and is consistent with our previously announced strategy to pursue strong players in niche markets of materials technologies.

Extrude Hone has high margins and 2 to 3 times the revenue growth rate, compared to are based business.

The Company utilizes proprietary technology to provide high-value added component solutions, which improve the performance of customers and products.

Extrude Hone's strengths include leading marketshares and global footprints, with 50 percent of sales outside the U.S., just like Kennametal.

The acquisition will expand our reach into attractive new segments, including diesel engines, food, medical and pharmaceutical.

And finally, the acquisition will immediately be modestly accretive to margins and earnings, while having no material impact on our debt covenants.

Despite the acquisition, we anticipate still reducing debt-to-capital below 30 percent by the end of fiscal '05, which is June 30th of this calendar year.

So, overall, we feel very good about our performance, about the outlook for the second half, and potential of the Extrude Hone acquisition.

I will now turn the call back to Beth for a more detailed examination of the numbers.

Thank you, Markos.

I will provide a few additional details on our performance in the December quarter and the outlook for the second half.

As a reminder, there were no special items in the December quarter, and my comments will exclude the special items from the December quarter of last year for a better comparison of results.

For the quarter, Kennametal earned net income of 28 million or 74 cents per diluted share, up 118 cents, compared to 12 million or 34 cents last year.

Consolidated sales increased 21 percent, to 556 million.

The sales increase was driven by organic growth of 16 percent, 3 percent from foreign currency and 2 percent from acquisitions.

Gross profit margin increased 40 basis points to 32.6, due primarily to a modest price recovery, improved capacity utilization, and favorable currency effects, partially offset by the continued negative impact of raw material costs, which increased about 9 million versus last year.

Operating expense increased 17 million or 14 percent to 140 million.

On a constant currency basis, operating expense increased 10 percent on an organic sales increase of 15 percent.

EBIT was 43 million, up about 70 percent.

The corresponding EBIT margin was 7.7, up 220 basis points versus last year.

Interest expense of 6 million decreased 7 percent over the same quarter last year on reduced debt levels.

Interest rates on domestic borrowings of 4.7 were up slightly from 4.3 percent.

The percentage of our debt, subject to variable interest rate, declined to 55.6 from 63.6 last year.

Consistent with previous guidance, the effective tax rate for the December quarter was 20 percent, compared to 32 percent in the prior year.

The reduction in the effective tax rate is due mainly to the implementation of an international tax planning strategy as previously discussed.

As you know, this tax rate was included in our original guidance for the quarter.

So let me reiterate that the improved earnings performance is driven entirely by operational performance and not by changes in the tax rate.

ROIC was 8.6 percent, up more than 3 points over last year.

Free operating cash flow for the quarter was maintained at the prior year level of 34 million.

Debt-to-capital declined nearly 900 basis points to 28.4 from December of 2003.

Annualized debt to EBITDA is about 2 times.

Turning to our business unit, again, all comparisons of sales will be in constant currency.

MSSG delivered growth in every segment and in every geography, with nearly every business producing double-digit growth.

In North America, December marked the 10th consecutive month where sales were at least 8 percent higher than the prior year.

In the December quarter, total MSSG sales were up 14 percent.

North America, excluding high-speed steel, grew at 16.

High-speed steel also grew at 16, Europe at 10, and the rest of world at 19 percent.

On the volume growth, EBIT was up 66 percent, and the EBIT margin improved to 360 basis points to 12.8.

AMSG also realized significant sales growth across its businesses, although profitability remained dampened by increased raw material costs that were only partially offset by pricing.

In total, AMSG sales grew 26 percent with mining and construction contributing 23 percent, energy 28, engineered 13, and electronics declining 9.3 percent, versus the prior year.

The sales growth impact, as I previously mentioned, on EBIT was dampened, as price realization lagged continued increases in tungsten and steel.

EBIT grew 11 percent, versus last year, on 26 percent sales growth, with the EBIT margin declining 180 basis points to 10.7.

Again, that was attributable to the raw material price increases and to the previously disclosed plant disclosure.

J&L has continued strong performance through the December quarter.

The execution of a multichannel go-to-market strategy continues to drive above market growth, highlighted by the success in e-commerce, which now accounts for 27 percent of sales.

In the quarter, sales increased 21 percent, and EBIT grew 36.

EBIT margin of 9.6 was up 100 basis points.

FSS sales were up 12 percent for the quarter, and EBIT margin increased 2 percent.

Moving ahead to our outlook for the second half of 2005, the outlook is driven by continued broad-based optimism for the global manufacturing environment.

The strengthening of the ISM index to 58.6 in December and consensus estimates of 3 to 4 percent growth in global industrial production support this view.

In Europe, we continue to expect modest growth but expect to do better than the market.

These forecasts, coupled with our expectation of further market penetration, yield an improved forecast of 11 to 13 percent organic growth at Kennametal during fiscal 2005.

For the third quarter, we are now anticipating an organic growth of 8 to 10 percent as we begin to lay out more difficult comparisons in the prior year.

In terms of EPS, the third-quarter guidance is 80 to 85 cents, up 20 to 30 percent.

This guidance includes two noteworthy items.

As discussed in our first-quarter earnings call, and included in this morning's release, a structural change in our European business, as well as the impact of tax planning, will result in fluctuations of the tax rate from quarter to quarter.

Consistent with this previous guidance, the effective tax rate for the year continues to be about 32 percent.

However, the rate for the third quarter is now expected to be between 36.5 and 38, which is a modest increase from previous expectations of the 35 percent rate.

This roughly translates into about 2 to 4 cents of earnings being shifted from the third to fourth quarter.

As Markos previously mentioned, raw material prices are increasing faster than our previous expectations, with steel now the primary driver.

As a result, we have not yet been able to close the gap with price increases.

We now estimate the net negative impact on the third quarter to be 3 to 4 cents higher than our prior prior expectations.

For the full year, therefore, EPS is now expected to range between 305 to 315, up 40 to 50 percent.

Free operating cash-flow is anticipated to again be in the range of 115 to 135, and ROIC should improve 2 points to about 9 percent, consistent with our previous guidance.

Like most companies, our outlook includes significant cost pressure from increased raw material prices, particularly tungsten and steel.

We now expect a $40 million increase in raw material costs for the year.

This compares to our previous expectation of about 30 million.

We expect to offset approximately 55 percent of these cost increases through a culmination of price increases and surcharges.

Additional guidance for the year is as follows -- CapEx should be approximately 70 to 80 million, up about 30 percent from FY '04, driven by a significant investment in capacity in India, China, and equipment for manufacturing of new products in North America and Europe.

Depreciation and amortization of about 65 million.

Primary working capital, with sales down to 22 percent, was down another 300 basis points from '04.

Debt-to-capital was below 30 percent, including the impact of Extrude Hone, as I previously mentioned.

This ratio would've been below 25 percent, excluding the acquisition, and interest expenses expected to be about level with prior year.

Included in our sales guidance are the following assumptions concerning our end markets for the next 3 months.

On balance, we expect to 3 to 4 percent growth in most of our major end markets, including heavy machinery, light and general engineering, energy, highway construction and coal mining.

In addition, we expect aerospace and defense to accelerate and automotive to remain weak.

Consistent with our overall strategy, we expect to grow faster than the market by focusing on total customer satisfaction, product innovation, and engineering solutions.

On a geographic basis, we expect industrial reduction in North America to remain strong, up about 3 to 4 percent, and look for modest growth in Europe of 1 to 2 percent.

In addition, demand should remain strong in Asia-Pacific and in Latin America, each up about 5 to 6 percent.

And with that, I will now open the line for questions.

(Operator Instructions).

Gary McManus, J.P. Morgan.

Can you talk a little bit about the acquisition in a little more detail, in terms of what's the revenues?

What's the profit?

You said they have high margins.

You said that revenue growth has been 2 to 3 times as fast as Kennametal.

Can you tell me what the 5-year revenue growth has been? -- cost saving opportunities.

And just go through the math on how you see this deal being modestly accretive.

Similar to the Conforma Clad acquisition, although this is a very strategic acquisition for us, it is not material to our consolidated financials.

So, we're not disclosing any of those details.

I would say that the sales growth is well in excess of base Kennametal and margins well above also.

Okay.

Can you talk about how this deal came about?

Was this something that you pursued?

Was this done in an auction process?

Who owns this?

Was this in a private company?

Just a little more detail in that regard.

It is a private company.

It is headquartered in western P.A. and basically came about from both Kennametal and Extrude Hone realizing the great fit of the two companies coming together and the benefits to the customer going forward.

We feel that we can deliver a lot more value to the customer if we work together going forward.

And can you comment -- the likelihood of additional deals of this nature -- is this like a new platform?

You would make other acquisitions in this area?

Do you think the climate out there makes it likely for additional acquisitions of this size?

Absolutely.

We have signaled that.

We are very focused on making acquisitions in niche markets in the engineered components material space, which would expand our advanced materials leg, if you will, in the Company to become a larger piece of the overall Kennametal pie.

The Conforma Clad acquisition that closed in March last year was an example of that.

Extrude Hone is another.

These are all small to medium-sized companies that, as you've heard from Beth and Carlos, have high underlying growth rates and command premium pricing because they have differentiating technologies.

They are very close to the customer, and they compete in niches that don't necessarily attract a whole lot of potential suppliers and competitors.

But we feel we can add a lot of value to those through our knowledge of technology, through manufacturing know-how, and most importantly, through global distribution, which we can leverage, as Carlos was saying.

So, this is very consistent with the strategy.

We've been talking about this for some time.

I do expect that as we go forward, we will be looking at more of these, and it's a good time for me to reiterate that we're very disciplined in the process that we follow.

We're very focused.

We really look for accretion to margins and then, over time, to ROIC in these acquisitions.

Joanna Shatney, Goldman Sachs.

I just want to get some clarification -- just from the positive preannouncement a couple of weeks ago.

Can we just talk about how -- just using the midpoint as a range, as you were at 290 before, and now you're up to 310.

What has, on the margin, been the driver of the 7 percent upward revision?

Is it just North America?

It sounds like Europe is a little bit better than you had initially forecasted.

Can you just break it apart?

Joanna, I would say it's very broad-based.

Europe certainly, North America doing better, and Asia as well.

I would say it's across our markets, both metalworking and advanced materials.

Okay.

When you guys talked about -- I don't think we talked about the tax rate specifically every single quarter, and I know that the press release talked about the tax rate being 37, 38 percent, which was higher than I had initially forecasted.

There's no change in the year.

Can you just walk us through why the third quarter goes higher and then the fourth quarter goes lower, just so I can understand that?

Yes.

I think we weren't sure.

We knew that the year would be lumpy, as we initially guided you to.

We didn't have good visibility into the second half by quarter.

So, our original assumption was that it would be flat at 35, both the third and fourth quarter.

But with discrete items as they fall, there is something that will hit in the fourth quarter, taking it down to about 32 percent, and that's what results in the increase in the third quarter.

Okay, if we go back to the 290 and the 310, was the upward revision 10 cents in each quarter versus your old guidance or was it more fourth quarter loaded?

Well, as it turns out, it was a little more fourth quarter loaded, both because of a shift in the tax that shifted, as I said, 2 to 4 cents from the third to the fourth quarter and the price realization trying to catch up with the increase in steel costs.

Okay.

My last question.

I will get back in queue.

I think in the last call, you talked about shutting down the UK factory that was going to cost 6 cents in the second quarter.

Did that occur?

The closure did occur.

About 3 cents of the 6 were actually incurred.

The remaining 3 cents are included in our outlook for the third quarter.

So, that 310 is actually 313?

No.

No.

Still six cents for the year -- just, it hit second and third quarter rather than all in the second quarter.

Joel Tiss, Lehman Brothers.

Can you give us a sense on the second half of the year -- the raw material cost increases -- if they are going to impact the margin progress at MSSG or AMSG a little bit more?

Certainly, there will be some hits.

I haven't looked specifically at those calculations.

But we're looking at about 11 million in raw material cost increases in the third and fourth quarter versus 9 in the second quarter.

So, there is a step up there.

We are now, for the year, expecting to offset about 60 percent of the 40 million versus 70 percent offset we originally expected.

Okay.

That's helpful.

Can you also talk a little bit about market share gains and give us a sense of where the gains have been and maybe what opportunities there are in the future?

Sure, sure.

And I think you'll find that this is very consistent with what we have been talking about.

First, geographically, I would point to North America and Asia Pacific and then kind of breaking that down into end markets and businesses -- mining and construction and energy have both had good success moving into adjacent markets and taking share that way, as well as with new products.

Milling and drilling applications in MSSG -- the aerospace market, which is beginning to pickup, has also been a good area of opportunity for us.

And also clearly, J&L is performing well above their market.

Just to provide a little bit on the margin, I think it's necessary to point out here that, in fact, the leverage in MSSG, which has the lowest steel content in the December quarter already, was hitting the 40 percent.

And so, as we look ahead, we are confident we're starting to really get that leverage, and we're getting about 100 to 150 basis points of pricing.

The biggest challenge in raw materials is more on the AMSG, as Beth said, because they are the higher content of raw material in their products and especially steel.

So, they are getting leverage as well.

We're just not getting it as much and as fast as we had hoped for.

But, there is a ramp-up in the leverage going forward.

So, on a consolidated basis, we actually are quite confident we'll be getting up to 35 percent in the third quarter and moving on towards the high 30s, as we had said.

So, I think it's important that we clarify that.

Yes.

The margin progress has been excellent.

Can you last talk about the corporate expense?

It was up 6 million in the quarter.

Can you just give us a sense of what is in there?

Thank you.

Yes, Joel.

There were two primary components, one being employment costs kind of across-the-board and the other being compliance -- Sarbanes-Oxley costs and increased audit fees.

Walter Liptak, KeyBanc Capital markets.

Nice quarter, good leverage.

In your comments, you mentioned that raw materials were impacted you by 9 million increase -- was that net or was that the amount that raw materials were up during the quarter?

That was the amount that raw materials were up and we had about 6 million in price, partially offsetting that.

Okay.

And could you review for us -- I guess your estimate of what your total cobalt purchases will be during 2005 in dollar terms?

You know, I don't have that number off the top of my head.

I want to say -- I don't even want to guess at it.

I will get back to you, Walt.

But cobalt is not the driver.

Let me reiterate.

That was the driver in '04, but that has stabilized.

Tungsten was the primary headwind in the first half, and now steel is taking over as the primary driver in the second half.

Okay.

Perhaps we can go offline and talk about those other two as well?

Absolutely.

Are either of these -- are you having anything in short supply?

No.

And then, the CFO search that is going on -- how is that going?

Are you looking internally and externally, and does your lack of a CFO impact -- obviously with the acquisition announced today, does that impact your acquisition strategy at all?

Walt, this is Markos.

No, it doesn't affect our strategy.

We have the strategy, and we're executing.

The search is going fine.

Being that we announced Nick's departure in December, we had the holidays.

So, we're picking up steam now in the first quarter of the new calendar year, and we are looking both internally and externally.

And I'm highly confident that we will have a very good CFO in the not-too-distant future.

Okay.

And then I will ask you a last question.

It doesn't sound like you're going to answer.

You said that the acquisition wasn't material, but it was a fairly good size.

Could you tell us, on an EPS basis, the accretion that you might get from that?

Well, I will not tell you the accretion on it on an EPS basis.

It's not material because of we're going to end up somewhere around $2.2 billion this year.

Then on a reported basis, in terms of sales and earnings, it is not material if you apply materiality to it.

But it is, for us, both strategic -- and its a good one.

And it will be accretive to both our margin rates and our EPS, starting with immediately the June quarter.

Okay.

What is the hurdle for materiality?

Is it 10 percent?

It is 5 percent.

5 percent?

Okay (multiple speakers)

Of sales.

Of sales, right?

Of sales?

Yes.

Chuck Harris (ph), Saranac Capital.

Question on pricing.

Should I wonder whether you're not being aggressive enough in pushing pricing into the marketplace?

I guess there is a fine balance between marketshare, customer relationships and pricing, but there are other industries.

Your industry, in particular, has always been pretty good in pricing historically.

I would think that if one player went, everyone would follow fairly happily.

Chuck, I will take this one.

I would say you should absolutely not be concerned that we're not being aggressive enough.

I think, as you've heard us talking about how we're approaching the market now versus in the past, we're applying a lot more discipline and strategic focus, and certainly, pricing is one of those areas.

The issue has been that raw material costs continue to kind of run ahead of our expectations but for AMSG for example, they have, in some cases, gone out with multiple rounds of increases as they've had to cover raw material costs, and for the quarter, we did realize 150 basis points and expect to continue to do that in the going-ahead quarters.

Well, I mean, yes.

But on the other hand, you are clearly still not recapturing everything.

So, is it -- do you feel that -- is there a goal in mind, by the end of this fiscal year, to more or less achieve some type of catch-up?

Sure, sure.

Or, is that where you're headed?

So that when we talk about next year, there is no negative raw -- assuming raw material basically -- for argument's sake, is flat in fiscal '06.

That is absolutely the target.

That is the goal?

Right.

And in fact, we had expected to achieve that earlier.

We expected to have achieved that this year if raw material costs had leveled when we expected them to early in the year.

But, that's absolutely the goal, and it's just a matter of a lag between the increases in our ability to recapture.

And then the final question on the same topic is that is there any thought about, instead of discussing parity with raw materials is getting ahead of it -- because thus far, virtually everybody who has been in any business has been expecting some raw material costs to ease whenever and consequently haven't been quite as aggressive as they should've been maybe in retrospect -- and to really be more preemptive in getting ahead of the curve, so that pricing effectively generates margin rather than just as an offset.

It's right on.

That's why we essentially have pushed through price increases and not surcharges.

We have had very little surcharges, more in terms of transportation costs.

But, the lion's share of the increases have been price increases exactly to this point.

And I just want to stress, since you brought up the subject, that this is one company that has always focused on price -- getting pricing and that's never going to change.

So, the only issue is, as Beth said, the raw material increases are coming -- are continuing to come, and it's a question of keeping up with the raw material price increases.

Everyone thought they would level off at the end of last year, and they went up again.

So we have to institute other price increases.

But we have very high capacity utilization so our sales forces are very disciplined in terms of managing customers and pricing.

Okay, so this is an issue that is going to go away, you feel (multiple speakers).

As soon as raw materials stabilize, which they will, then it will go away.

Absolutely.

And if they continue to go up?

We will continue raising prices.

The other side of raw materials, as you know, going up means that some of it's high demand, which is a pretty good environment.

Oh, I know.

I understand.

It's that you see just a lot of these intermediary companies or converters of raw materials into finished products.

Everyone seems to be getting squeezed, and the question is how long does this squeeze last?

Some companies have gotten out of it faster than others.

I think we've done pretty well, actually.

No.

No argument there.

When you consider where we are.

It's hard to guess.

You raise a good point.

Nobody expected that some of these would continue to go up the way they have.

The best we can tell -- the best we can hear in the market is those should stabilize by the middle of this year.

Okay.

So that's sort of where your pricing is?

And that's where our assumptions are.

Right.

Joanna Shatney, Goldman Sachs.

I just have two quick follow-ups.

One is housekeeping.

Beth, can you just give us the breakdown of operating expenses between R&D and SG&A?

R&D was 6.4.

Okay.

And then, Markos, now that you (indiscernible) today, you've got the strong free cash flow, and you've closed on -- I know not hugely material -- but at least a decent-sized deal, are you rethinking about the stock repurchase options, dividends, other things besides acquisitions?

We are always looking at that.

The priorities have not changed, Joanna, which is maintaining our debt-to-capital below 30 and focusing on investment-grade ratings and deploying cash to good acquisitions.

And if we can't find something good, then always be ready to return some money to the shareholders.

We are about the median of our peer group in terms of our payout ratio.

We keep benchmarking that.

And so, we will continue to look at the positive.

If we're going to do something, it will be more of a one-time rather than something that is permanent, unless we move out of the median range on the dividend side.

So I don't have any problem giving back to the shareholders if I don't find a better use for the cash, and that's been our consistent approach.

Stephen Volkmann, Morgan Stanley Dean Witter.

Most of them have been answered, but just on the currency -- given that one of your real big competitors obviously has a currency issue right now, what are you seeing out there?

I guess I'm kind of echoing Chuck's sentiment.

This would seem like a good time to kind of get a little extra pricing, given the strength in the cycle of the currency issues and so forth.

Can you just touch on that?

Yes.

We've talked before about our manufacturing strategy and the way that we deploy throughout the world, but I don't want to talk too much about this, except that we're very confident in our gain in marketshares that you've heard about.

And I think we are pretty good at leveraging any advantage we may have.

Okay.

Are you gaining share in Europe as well?

It looks like if you're up double digits there, you may be gaining some share there?

We want another quarter to go by before we can be more clear on Europe, but we feel very good about what we did in the last quarter.

So we'll hold on and then decide after another quarter.

Without a question, everywhere else, we think we're really doing well, and its a combination of many things.

It's not the climate alone.

It's the absolute focus we've had on technology and innovation and the 41 percent of our sales coming from new products now for the last two years.

It's the deployment of new processes that we have taken globally.

It's differentiation on focusing more to delivering financial benefits to our customers, rather than only competing on applications.

It's really everything we do as a company to reposition ourselves to deliver better value.

And I do think it's paying absolutely dividends.

Okay.

When we talk about marketshare gains, are we kind of taking share from the fragmented smaller players in the market or would it be one of the other major players do you think?

Well, we think there are two major players in our industry if you're talking metalworking, and we do think we are taking share from everybody else.

We consider everybody else to the second or third tier.

In the advanced materials business, we tend to be typically the market leader in the segments we compete in.

We just think we're continuing to gain marketshare from everybody.

Okay.

And then finally, I know you have a fairly balanced manufacturing strategy, but I'm guessing there are some net exports from the U.S. to other regions.

Am I correct, and can you give us a sense of what that might be -- some kind of number around that?

There are net exports, but I don't have a number right now.

Adam Uhlman, FTN Midwest Research.

Just a couple of clarifications.

First of all, price was 150 basis points in advanced materials.

Well, that was consolidated, although certainly the majority of it was in advanced materials.

Okay, and then how much was in metalworking then?

Just a little bit, it sounds like.

Yes, a modest amount.

Okay, and then, we were talking about capacity utilization earlier.

I was wondering if you could put some color around where we're running right now in each of the segments and then if you could expand on the capital spending plans for the year a little bit?

Yes.

Overall, we're running at about the high 80s, and certainly there are pockets where its higher, particularly around new products that are selling very well.

And certainly, part of the increase in capital expenditure is focused on increasing that capacity for new products, both in North America and in Europe.

In addition, as we discussed previously, we're going to be spending an incremental 10 million roughly in India for increased capacity and a modest bump as we build up in China as well.

Chuck Harris, Saranac Capital.

One other question that just impressed me on your commentary is given the strong cash flow of the Company and the improved balance sheet that we've seen that continues to get better over the past several years, at what point do we stop the focus on debt-to-total capital and the balance sheet.

You say you want to get below 30 percent, but it's not clear to me why 30 percent or below 30 percent is the right goal for this company versus 35 or 40 or, frankly, where you are right now as being -- you are okay.

Chuck, I'm glad you asked the question so I can clarify.

When I said 30 percent, I was thinking of where we would be this year.

Our goal has been, as we've stated before, 35 to 45 percent.

We're very comfortable being in that range.

We don't feel a need to go below that.

We are obviously watching our investment grade rating.

That's very important to us, but beyond that, I'm comfortable going up to 45 percent.

We were there after the acquisition of the Widia.

Very quickly, we moved below that because of our cash generating capability, as you said.

So, I think at the end of the 35 to 45 percent, as well as investment grade rating and then deployment of cash, based on where it makes more sense -- and clearly as we've shown, niche acquisition strategy is important.

Well, but following up on Joanna's point then, if you continued to deliver the Company, at what point do we have the -- can we come back to you and say, Markos, you are at 25 percent.

You're at 20 percent.

You are at some level which the financial metrics make no sense?

When can we come to you with that and say what are we really going to do with the money here?

Well, you can come anytime you want, and as I have said to you, at that point, I'm very willing to return some money to the shareholders.

That's not an issue.

Okay.

Well, we're pretty much almost there, aren't we?

Well, now with the Extrude Hone acquisition, we're going to move up a little bit again, and we do have capital plans in terms of expanding in Asia, as we've said.

We're starting to wrap up in India and China.

So, we're very consistent.

But I understand what you're saying.

I don't have a problem with the basic idea.

But it all hangs together.

I'm sure it does.

Jay Aston, Neuburger & Berman.

Congratulations on another great quarter.

Markos, can you elaborate a little bit?

You just mentioned China and spending in China.

Could you just elaborate just a little bit strategically on what you accomplished in calendar year '04 in China and what you hope to accomplish in the coming year over there?

Good question.

What we accomplished in '04 in China is we have had two factories already in China for the last few years.

What we have seen -- '04, we focused primarily on establishing our infrastructure on the ground in terms of solid management -- putting in good processes.

This is an area where you want to make sure you do that -- that you have an organization that's reliable and management that understands what you're looking for, and we focus more on training and development of our people and optimizing our existing manufacturing operations.

We also used that year to -- calendar '04, to validate our market assumptions, to understand the competitive landscape a little better.

And we feel we are now at the right point and well prepared to accelerate our localization, and by that, I mean manufacturing capacity on top of local market infrastructure going forward.

And that is what you're going to be seeing calendar '05 and '06.

In India, we're further ahead primarily because we've made the acquisition of Widia just over two years ago, and we inherited capacity and an organization.

We have built on that, and therefore, we are investing in terms of capacity faster.

So, we're very methodical in China.

I spent three or four years over there.

We have management that's seasoned in that part of the world, so we think we have a well-articulated strategy and we will step up execution going forward, kind of.

I hope that answers your question.

It does, and just one small piece, as far as accelerating that and really having spent last year kind of getting all your ducks in a row to accelerate the expansion, is that -- obviously you have some CapEx plans for China.

In looking at that market, are their opportunities to make acquisitions over there as well or is this really a home-grown approach?

I think primarily home-grown, but you always keep your eyes open.

That's an evolving market.

We've constantly tried to understand the dynamics there in terms of local capabilities.

There are no further questions in queue at this time.

I do want to say just some final comments here before we close up then, if I may.

I think a quick way for everybody to look at the third quarter is in terms of our 80 to 85-cent range, which we feel is very strong and very bullish because it needs to be seen in the context of good, solid, high single-digit growth on top of last year's 10 percent growth.

And then the 80 to 85 cents includes compensating for the headwind of raw materials of about 3 to 4 pennies, the tax rate stepping up another 2 to 4 pennies, completing the manufacturing rationalization of the plant in the UK, which is another 3 pennies, and then, there is even a little more diluted stock outstanding that adds another 2 to 3 pennies.

So, compensating for all that, 80 to 85 is a very strong range, we feel.

All right.

Thank you everybody for joining us, and I look forward to speaking to many of you during the course of the day.

Thanks.

Thank you, ladies and gentlemen, for your participation in today's teleconference.