Kennametal Inc (KMT) 2006 Q1 法說會逐字稿

Good morning.

My name is Shan and I will be your conference facilitator.

At this time I would like to welcome everyone to the Kennametal, Inc. conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks there will be a question and answer period.

If you would like to ask a question during this time, simply press star then the number 1 on telephone key pad.

If you would like to withdraw your question press star then the number 2 on telephone key pad.

Thank you.

At this time, I would now like to turn the call over to Ms. Quynh McGuire, Director of Investor Relations.

Ms. McGuire, you may begin your conference.

Thank you, Operator.

Welcome and thank you for joining us for this morning to review Kennametal's first quarter results and outlook for the remainder of the 2006 fiscal year.

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

I'm Quynh McGuire, Director of Investor Relations for Kennametal.

I'm pleased to have joining me for the call our Chairman, President and Chief Executive Officer, Markos Tambakeras;

Executive Vice President and Chief Financial Officer, Cathy Smith; and Corporate Controller and Chief Accounting Officer, Tim Hibbard.

Markos and Cathy will provide additional details on the quarter's operational and financial performance as well as our outlook for the remainder of the 2006 fiscal year.

After these remarks we will answer your questions in remaining time.

Before I turn the call over to Markos, I would like to direction your attention to our forward-looking disclosure statements.

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 assumption, risks and uncertainties that could cause actual results of 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 according with SEC Regulation G, the Company as furnished a Form 8K to the SEC which is also now available on our website via www.kennametal.com.

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

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

Thank you Quynh.

Good morning.

Let me apologize to everyone, I have a bad cold so my voice is going to be a little bit difficult at times to understand.

I certainly feel a hell of a lot better than I sound.

We are very pleased with our performance for the first quarter fiscal 2006.

While the sales growth came in at the top end of our organic growth forecast, earnings strongly exceeded our expectations due to favorable sales mix, raw materials costs up appreciably over last year, but lower than anticipated and better than expected price realization.

The reasons for the successful quarter, I believe, are the following: number 1, our sales initiatives continue to bring success in the marketplace; number 2, we have disciplined execution; and number 3, the ability to deliver superior value to customers through our leadership position and technology and innovation which is focused on helping customers improve their competitiveness.

Companies producing everything from air frames to coal, from medical implants to oil wells, from turbochargers to motorcycle parts recognize Kennametal for delivering extraordinary value to their operations.

We are, in fact, pervasive throughout the manufacturing sector.

Also the globalization of Kennametal continues.

We worked hard at achieving this.

This we have now approximately 50% of our sales coming from outside of North America.

And as we said before over the next five years, our ambition is to have about one-third of our sales from the America's, one-third from Europe, and one-third from the Asia-Pacific region.

This diversity in geography is also contributing to our success.

We are also focusing on balancing our portfolio while preserving our leadership in metal working.

The divestiture of full-service supply a few months ago and the acquisition of Extude Hone, also helped our margin expansion.

I am particularly pleased that our return on invested capital ROIC was just shy of 10%.

This is a year-over-year improvement of 230 basis points and reflects the best quarterly performance in our Company's history in what is usually generally a weak quarter because of summer slow-down in manufacturing production.

We believe that we can continue to deliver in our business model going forward.

And looking ahead we expect sustained earnings growth driven by top line, maintaining pricing discipline, and getting the value of operating cost efficiencies.

Each of our three business groups, the Metal Working Solutions and Services, Advanced Material Solutions, and J&L Industrial Supply, are showing strong results in most of their end markets and geographies.

In Metal Working we continue to see strong orders in North America and in the developing economies while in the Advanced Materials business, we report robust activity worldwide in energy, in mining, in construction, and in engineered products.

J&L our distribution business also reported a strong increase versus prior year.

Overall we believe Kennametal is outperforming the manufacturing industrial production activity in all the major industry sectors we participate in.

Our performance in the first quarter and the global market outlook give us optimism for the remainder of fiscal 2006.

Basically we're going to continue to execute a clear consistent strategy using the Kennametal value business system, or KBBS, through diversifying our product portfolio, balancing the end markets we serve, expanding our global infrastructure, focusing on technology and innovation, and as always, the aggressive management of our cost structure.

Thanks to the efforts of our more than 14,000 dedicated and fully engaged employees around the world, we are delivering above-market performance and expect to continue to do so.

I'll now turn the discussion over to Cathy who will review the details of this quarters performance and talk about the remainder of the fiscal year.

Thank you Markos.

Good morning.

I'll provide further comments on our performance for the September quarter and then move on to the outlook for the remainder of the fiscal 2006.

Kennametal earned net income of $28 million compared to $23 million last year.

Earnings per share of $0.72 per diluted share is up 18% over last year's $0.61.

This includes $0.09 for the combination extending stock options due to FAS 123, and the change in the discount rate for our domestic pension expense which would make comparable earnings of $0.81 for a growth of 33% compared to last year.

For the September quarter, consolidated sales increased 7% to $569 million.

The increase was driven by an organic growth of 9%, a 1% benefit from foreign currency, and a 2% reduction due to net acquisitions and divestitures.

Gross profit margin increased 250 basis points to 35.1% due, mainly to the record level sales, sales mix, price realization, and the divestiture of FSF.

Operating expense increased $17 million or 13% to $148 million.

This increase is primarily attributable to new accounting with FAS 123 related to stock option expense, foreign ex-change, increased pension expense and professional fees associated with compliance.

Actual employment cost increase was only 2.4% on organic sales growth of 9% consistent with our goal of keeping SG&A expenses to no more than one-third of our sales growth.

Adjusted EBIT was -- earnings before interest and taxes was $52 million up about 20%.

The corresponding EBIT margin was 9.1% up 90 basis points.

Return on capital, as Markos mentioned, or ROIC, was up 230 basis points to 9.9%, a new high.

Interest expense increased $1 million to 8 million in the September quarter.

Interest rates on domestic borrowings of 5.2% are up from 4.6% last year.

The effective tax rated for September quarter was 34.3% compared to 36% in the prior year.

Net cash flow from operations was $27 million compared to $32 million in the prior year.

Okay, turning to the business units, all comparisons of sales will be in constant currency.

MSSG continued to deliver double-digit growth despite difficult comparisons to a strong quarter last year.

MSSG growth continues to outpace the growth in their addressed markets demonstrating the effects of further market penetration and volume leverage.

In the September quarter MSSG grew up organically 8%.

MSSG operating income was up 19% on 8% sales growth and the operating margin improved by 80 basis points to 11.7%.

I'm pleased to note that AMSG delivered significant top line growth in the current quarter, again, despite difficult comparisons to last year's first quarter.

The underlining markets in mining, construction, engineered and energy remain strong.

Electronics is the only market reflecting year-over-year decline as expected.

Market share penetration and price realization are also contributed to our overall results.

AMSG sales grew 33%.

Mining and construction was up 18%, energy sales increased 29%, and engineered sales grew 23%, while electronic decreased 10%.

Operating income grew 61% versus last year on 33% sales growth with the operating margin increasing 260 basis points to 14%.

J&L sales grew 6% and operating income grew 20%.

Operating margin of 10.5% was up 130 basis points versus prior year.

Now let's look ahead to the remainder of 2006.

Economic indicators project continued growth through fiscal 2006 in North America and the rest of the world markets and its flat to modest growth in European markets.

We expect developing economies to continue to deliver double-digit growth.

For the fiscal we continue to expect organic growth in the 7 to 10% range outpacing worldwide industrial production growth by 2 to 3 times.

The outlook for the end markets for reminder of the year remains positive.

The majority of our end markets should continue operate at high levels but at moderating growth rates.

The expectations being Aerospace and light engineering which should continue to be robust while automotive is expected to continue declining primarily driven by the Big Three.

As many of you know, the industry is experiencing unprecedented volatility in the key raw material Tungsten.

The major challenge for fiscal year 2006 continues to revolve around Tungsten cost.

We have demonstrated the ability to meet this challenge and expect to continue doing so for the remainder of year.

As announced in our press release, we revised our projected fiscal year 2006 guidance reported earnings per share for the fiscal year is now expected to be in the $3.50 to $3.90 range, including an approximately $0.25 negative impact from the combination of expensing stock options due to FAS 123, and the effects of the reduction in the discount rate applied to our pension plans.

This revised earnings outlook represents an increase from previous 2006 EPS guidance of $3.30 to $3.80.

In addition to narrowing this earnings guidance range the revised outlook establishes a lower range that reflects a 12% increase and a higher range that reflects a 25% increase from the prior year earning per share of $3.13.

Organic sales second quarter fiscal year 2006 are expected to grow 6 to 9% by tougher comparison.

We are expecting our top line growth to moderate slightly in the second quarter due to the collective impact of a rising interest rate environment, sustained higher energy costs, and effect of the recent hurricanes in North America.

Our outlook for the rest of world remains unchanged.

In addition, we anticipate continuing pressure on raw material costs.

Reported earnings per share for second quarter of fiscal 2006 is forecasted to be in the range of $0.68 to $0.73 consistent with the seasonal patterns and reflects confidence in our ability to maintain the momentum of first quarter.

This earnings guidance range represents a 13% to 22% increase over last year's EPS of $0.60 when normalized for a tax rate adjustment.

As reminder last year's tax rate of 20% verse 35% this year.

Operating margin and return on invested capital are expected to reflect continued improvement for remainder of fiscal 2006.

We will maintain our strong focus on our balance sheet and cash flow generation.

We project cash flow from operations to be 200 to 220 million.

Free operating cash flow of 120 to 140 million and capital expenditures to be at approximately $80 million.

In summary, we have credible targets for fiscal year 2006.

We know what we need to do.

We have to exploit growth opportunities, maintain operating expense discipline, and pursue price realization.

We're on track for another strong performance.

At this time we will be happy to take your questions.

Operator we'll be taking questions at this time.

At this time I would like to remind everyone, if you would like to ask a question, press star then the number 1 on your telephone key pad.

We'll pause to compile the question and answer roster.

Your first question comes from Walt Liptak, KeyBank Capital Markets.

Congratulations on the nice quarter.

Thanks Walt.

The first question I have you mentioned the hurricane impact.

I wonder if you could quantify that at all and do you make up for any lost business in outquarters?

Hard to quantify, Walt.

We're just being a little cautious.

First of all let me highlight this is a collective caution, not only the hurricanes but collecting environment related to you know energy prices and rising interest rates, and only for North America.

Everything we see and hear and expect is that there'll be a modest slow down in the December quarter but a pickup again in the third and fourth quarter for us meaning the March and June quarter.

It's hard to quantify.

We don't think it's very large.

It may have in terms of moderating our expectations if it wasn't there we may have gone for 7 to 10% we've gone for 6 to 9%, that's pretty good but not major.

The issue is in oil gas sector?

Actually we don't see any moderation in oil and gas.

We feel pretty good about that.

This quarter you raised your forecast and reported a nice quarter because of the price realization.

I wonder if you could talk about how the price realization came through sooner than expected and if you -- you know, how much more of that price realization do you expect in the second quarter or later on in the year?

I think what I can say is that we had essentially budgeted price realization in the 70 to 90% and we ended up getting closer to the upper end of that.

And we expect to be able to sustain that.

I just -- just to make sure everybody understands though, our raw materials did go up very significantly.

And so if you look at Tungsten ore, in the September quarter Tungsten ore went up about 75% versus the June quarter and APT, which is the other raw material we use, went up 138% in the September quarter versus the June quarter.

So we had substantial increases, which is what made forecasting a little harder for us.

But what were we able to accomplish, and feel good about, is the price realization closer to the higher end of our estimates rather than the more conservative lower end.

We expect to continue this.

The other thing we should note is that if we talk about the mix of the business, we had very, you know, very strong performance from the advanced material business.

If you look at sectors that outperformed mining, energy, construction, and engineered, this is where we got most of the sales mix benefit.

So the price increases did come in they were very high.

Our price realization that we were about to get was higher than we thought, but still you know.

You still have the headwind going forward.

We still have the headwind, which I think is putting things in perspective.

All right thank you.

Your next question comes from Joel Tiss with Lehman Brothers.

Hey guys how you doing?

I wonder if you could--you mentioned you expect auto to decline for the year.

Could you give us a sense what sort of decline you have baked into your numbers?

The -- for ore?

Auto.

The North American number is 15 million.

We expect automotive to decline modestly.

What we have baked in is flat for us because we have won a number of major programs both here and in Europe.

A modest decline this the automotive sector flat for us.

To complete the answer automotive for the September quarter for us was down 14% of sales.

Down to 14% from 17.

On the inventories, I notice they were up 8.7% and I just wondered if you took out the price increase from that?

I don't know if you have this or not.

It's just a question.

Would the real inventory number be closer to flat?

Yes.

Yes, it would.

Okay, that's really good.

Could you give us an estimate of the share count the fully diluted share count for the year including all the options.

That's it I'm done.

At the end of the September quarter?

No for the whole year all of fiscal 2006.

It will be the end of the year, Joel, that's in our plan.

We're going to be buying back to avoid the dilution.

About 39 million.

Yes just at 39 million.

Thank you so much.

[OPERATOR INSTRUCTIONS] Your next question come from Adam Oleman [ph] with Midwest Research.

Good morning.

I have a question on the pension and option expense.

You know the guidance for the year is $0.25.

We've already absorbed $0.09 in the quarter, so is it safe to assume that it's going to be about $0.05 per quarter going forward, or is there another large slug to come here in the second quarter?

No we did see a disproportionate in the first quarter just due to the timing of options being issued and stuff.

But we still expect the forecast for the full year to be around $0.25.

At the annual meeting, you know, you highlighted some incremental investments that were for marking and productivity programs that were going to be made here in the first quarter and then it was going to trail off through the end of the year.

So it was supposed to be front-end loaded.

Could you update us on the timing of this expense?

Did it hit the first quarter?

Should we expect some further pull through through the back half of the year?

The timing is about the same, as we said.

It's -- those investments are related with the integration of North American sales force with the establishment of the European structure and also a shared services capability in India for outsourcing.

So the spreading out is about the same as we expected and total amount is about the same.

Okay.

Great.

And then, you know, the final question that I had here was, you know, you beat your initial outlook here for the first quarter by about $0.27 at the mid point versus the guidance.

How would you divide that out amongst the reasons that you gave earlier in the call?

You know the sales look like they came in at the high end of your range, but between the high--lower than expected raw material costs and then the pricing, how would the remainder of that kind of break out?

I'd rather not go into that kind of a breakdown.

It's--it really is the collective.

We picked up in all of those as I said.

But I don't want to go into the mix between price realization and raw material pricing.

That's the kind of information that we don't want competition to have.

Okay, understood.

But I can tell you that, you know, we feel good about all of those.

Okay, great, thanks.

Okay.

At this time there are no further questions.

I would now like to turn the call over to Mr. Tambakeras for closing remarks.

Just to bring it all together.

Obviously, we're very pleased with the first quarter performance, we expect to continue this momentum into the second quarter and the full year.

I do think that it is when you look at our second quarter guidance, we're looking at the 13 to 22% increase like for like in earnings per share.

When you consider somewhat continuing output pressure on raw materials and a slightly modest second quarter in December, that reflects our confidence in our ability to continue to win in the marketplace.

I want to stress the fact that we are winning the marketplace in the costs associated with price management.

If you look at our total year, EPS growth is 12 to 25%, but if you actually adjust for the stock option expensing and pension that's 20 to 33% year-over-year on top of last year's 50%, on top of the year before 50%, we think that's pretty darn good.

Not many companies can sustain this kind of a growth momentum on their earnings's side.

This is Quynh.

This concludes our discussion today.

Please contact me at 724-539-6559 for any follow-up questions and thank you very much for joining us today.

Thank you for participating in today's Kennametal, Incorporated first quarter results conference call.

This call will be available for replay beginning at 1 p.m. eastern standard time today, through 11:59pm eastern standard time on Wednesday November 9th, 2005.

The conference ID number for the replay is 130644.

Again, the conference ID number for replay is 130644.

The number to dial for the replay is 1-800-642-1687 or 706-645-9291.

You may now disconnect.