Kennametal Inc (KMT) 2006 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the Kennametal, Incorporated, second-quarter results conference call.

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

After the speakers' remarks, there will be a question and answer period. (OPERATOR INSTRUCTIONS) At this time, I would 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 this morning to review Kennametal's second-quarter results and outlook for the remainder of this 2006 fiscal year.

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

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

I am pleased to have joining me for the call Executive Chairman Markos Tambakeras;

President and Chief Executive Officer Carlos Cardoso;

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

Markos, Carlos, 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 the remaining time.

At this time I would like to direct your attention to our forward-looking disclosure statement.

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 reconciliation thereto.

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

Thank you, Quynh, and good morning, everyone.

As our second-quarter results have shown, we are on track to achieve our goal of becoming a consistent top-tier performer.

We had record sales, earnings, and return on invested capital for a December quarter.

I am particularly pleased that we reached the 10% ROIC milestone this quarter.

This represents a year-over-year improvement of 140 basis points and reflects a new high for our Company.

So in summary, we continue to grow globally, gain market share, and deliver strong financial results.

As expected, the transition of the CEO role to Carlos Cardoso has been conducted in an orderly and seamless manner, consistent with our well-established succession planning process that is part of the Kennametal Value Business System or KVBS.

I have full confidence that Carlos and his team will continue the transformation of Kennametal into a high performing premier global Company.

Finally, as Executive Chairman, I remain closely involved with Kennametal's transformation and look forward to continuing to work with executive management on the strategic direction of the Company, portfolio management, as well as provide support in any way that I am asked.

I will now turn the discussion over to Carlos.

Thank you, Markos.

Good morning, everyone.

I'm pleased to be here in my new role as President and CEO of Kennametal.

As Markos stated, our second-quarter performance was outstanding.

It reflects continued strength across our end markets and geographies, despite difficult comparisons to the prior year.

We have a competitive advantage.

We provide superior value to customers through our game-changing technology, end-market diversity, and global presence.

Our customers recognize Kennametal for extraordinary contributions to their value chain.

Each of our three business groups, Metalworking Solutions and Services, Advanced Materials Solutions, and J&L Industrial Supply, are showing strong performance.

For Metalworking, we continue to see solid orders in North America and dynamic growth in developing economies.

Advanced Materials consistently reports very robust activity across the board in energy, mining and construction, and engineered products.

J&L, our distribution business, also reported healthy results.

We will continue focus on profitable factors to diversify the markets we serve and gain additional share.

Overall, we believe Kennametal continues to outperform the manufacturing industrial production activity in the major markets.

Thanks to the efforts of our more than 14,000 dedicated and fully engaged employees around the world, we continue the road to success.

We have worked diligently to establish a global presence and currently have approximately 50% of our sales coming from outside of North America.

We are on track to realize our ambition of having one-third of our sales from North America, one-third from Europe, and a third from the rest of the world.

As global demand increases, we continue to see significant growth in developing economies.

We have already made substantial investment in those regions and have a strong infrastructure in place to capitalize on those opportunities.

Another key part of our core strategy is to continue balancing our portfolio while preserving our leadership position in metalworking.

Building on our materials science knowledge, both through our R&D efforts as well as through acquisitions, will add to Kennametal value proposition and benefit our customers.

All of our M&A activity is conducted according to a disciplined process that is part of the Kennametal Value Business System or KBVS.

We believe we can deliver our growth targets based on the fundamental strengths of our business model.

The Kennametal team is focused on stepping up the intensity and accelerating growth through key strategic initiatives.

We continue to expect solid earnings growth driven by sales, strategic pricing discipline, and operating cost efficiencies.

At this time, I will turn the discussion over to Cathy, who will review the details of this quarter's performance.

Cathy?

Thank you, Carlos, and good morning, everyone.

I will provide you further comments on our performance for the December quarter and then move on to our outlook for the remainder of our fiscal year.

Kennametal earned net income of $31 million compared to $28 million last year.

Earnings per diluted share of $0.79 is up 7% over last year's $0.74.

This includes $0.07 for the combination of extending stock options due to FAS 123, and the increase in our domestic pension expense, and a benefit of $0.05 related to the release of a deferred tax valuation allowance.

For the December quarter, consolidated sales increased 5% to $585 million, a new December quarter record.

The sales increase was driven by organic growth of 8%, offset by unfavorable foreign currency of 1% and 2% reduction due to the net acquisition -- net of acquisitions and divestitures.

Gross profit margin increased 150 basis points to 34.1%, due mainly to price realization and improved product mix, offset by significant raw material price increases.

As we have previously stated, our goal is to limit SG&A expense to no more than one-third of our top-line growth.

Operating expense increased $6 million or 4% to $145 million.

This increase is primarily attributable to increased employment cost, stock option expense resulting from FAS 123, and pension expense.

These increases were offset by favorable foreign currency.

Excluding stock option and pension expenses, operating expenses increased 2% on sales growth of 5%, consistent with our goal of limiting SG&A.

Adjusted earnings before interest and taxes was $54 million, up 27%.

The corresponding EBIT margin was 9.3%, up 160 basis points.

Adjusted return on invested capital, or ROIC, was up 140 basis points to 10%, as Markos mentioned, a new record for us.

Interest expense increased $2 million to 8 million in the December quarter.

Interest rates on domestic borrowings of 5.2% are up from the 4.7% last year; and average domestic borrowings increased $45 million from last year.

The effective tax rate for the December quarter was 31.5% compared to 20% in the prior year.

Net cash from operations was $55 million compared to $51 million in the prior year, reflecting another strong quarter.

Now turning our business units, all comparisons of sales will be in constant currency.

MSSG continued to deliver strong growth despite difficult comparisons to the strong quarter last year.

Growth in metalworking business continued to outpace the growth in its addressed market, demonstrating the effects of further market penetration and price realization.

In the December quarter, MSSG sales were up 6%.

North American cemented carbide and high-speed steel grew 12% and 7% respectively.

Europe's sales were constant.

Rest of world grew 13%.

North American consumer products declined 12%.

MSSG operating income was up 2% on 4% sales growth; and the operating margin of 12% was constant.

I am pleased to note that once again AMSG delivered significant top-line growth in the current quarter, also despite difficult comparisons to the prior year.

The underlying markets in mining, construction, and energy remained strong for Kennametal.

Electronics is the only market showing year-over-year declines.

Despite this challenge, our overall Advanced Materials segment continued to report considerable growth.

Market share penetration and price realization are primary factors to our overall results.

AMSG sales grew 41%.

Mining and construction was up 16%; energy sales increased 43%; and engineered sales grew 32%.

Electronics decreased 2%.

Our acquisition of Extrude Hone also contributed to the AMSG sales growth.

Operating income grew 110% versus last year on 41% sales growth, with the operating margin increasing 590 basis points to 17.2%.

J&L sales also grew 7%, and operating income grew 8%.

Operating margin of 9.7% was up 10 basis points versus the prior year.

Now we will look ahead to the remainder of 2006.

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

For the markets that we serve, developing economies are expected to grow, delivering -- are expected to continue delivering growth in the range of 20% plus.

For fiscal 2006 we continue to expect organic revenue growth in the 7 to 10% range, consistently outpacing worldwide industrial production growth by 2 to 3 times.

The outlook for our end markets for the remainder of the year remains positive.

We anticipate the majority of our end markets to continue operating at high levels but moderating growth rates, the exceptions being aerospace and light engineering, which should continue to be robust, while automotive is expected to show modest growth globally.

As we have previously discussed, a major challenge for the industry in fiscal year 2006 continues to revolve around raw material costs, especially tungsten.

We have demonstrated the ability to meet this challenge through our disciplined strategic pricing process and expect to continue doing so.

As announced in our press release, we have revised our projected fiscal-year 2006 guidance.

Reported EPS for fiscal year 2006 is now expected to be at $3.70 to $3.90, 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 domestic pension plan.

This revised earnings outlook represents an increase from previous 2006 EPS guidance of $3.50 to $3.90.

In addition to continuing to narrow the earnings guidance range, the revised outlook reflects an 18 to 25% increase from prior-year reported EPS of $3.13.

The growth that we expect to achieve represents best-in-class performance.

Organic sales for the third quarter of fiscal-year 2006 are expected to grow 7 to 10% despite tougher comparisons.

Market conditions support our expectations of continued top line growth in the third quarter, consistent with full-year guidance.

We anticipate some continuing pressure on raw materials prices.

Reported EPS for the third quarter is forecasted to be in the range of $1.00 to $1.10, consistent with historical seasonal patterns and reflecting confidence in our ability to maintain the momentum of the first half.

Operating margins and ROIC are expected to continue improving for the remainder of the fiscal-year 2006.

ROIC is expected to be in the 10 to 11% range for our fiscal year.

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

We anticipate cash flow from operations to be $210 million to $230 million, reflecting an increase from our prior guidance of 200 million to 220 million.

As a result, we expect free operating cash flow of 130 million to 150 million, and capital expenditures of approximately $80 million.

In summary, we are solidly on the path to meet our targets for fiscal-year 2006.

We continue to maximize growth by managing our product portfolio, maintaining operating expense discipline, and achieving price realizations.

We are on track for another strong performance.

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

Operator, we're ready now ready to take questions.

(OPERATOR INSTRUCTIONS) Walt Liptak with KeyBanc Capital Markets.

My first question is regarding raw material costs.

Where would you say we are with price realization?

Last quarter, we saw gross margins expand; and there was some moderation during the quarter.

Can you talk about price realization in the U.S. versus in other parts of the world, and especially with regard to the metalworking sector?

Yes, you know, Walt, we are continually pleased with our pricing execution; and our price realization remains at the higher end of our expectations.

As you know, tungsten was a little higher in the December quarter than it was in the September quarter, and we expect those costs to remain high.

Okay.

The other question I have is on tax rate.

What is the expectation for the second-half tax rate?

Consistent with our previous guidance at 35%.

Okay, okay.

Thank you.

Joel Tiss with Lehman.

I wonder if you could give us a sense of how much of the operating margin improvement in the quarter came from acquisitions in AMSG.

Yes, we did have a little bit of improvement in the gross margin, consistent with our strategy for our acquisitions, that they need to be accretive.

So we did get a little bit of improvement both from the acquisition as well as the divestiture of FSS.

So Joel, our M&A and portfolio management is working according to our strategy that we have been conveying all along.

All right, so you can't give me any -- all right, forget it.

Okay.

Thank you very much.

Brendan Browne with Caris.

Can you give me -- can you go over one more time where the strength and where the weakness is coming from in Metalworking Solutions?

Sure.

We were very strong in metalworking in North America, specifically cemented carbide.

Carlos will talk a little bit more about that.

But we grew at 12% this last quarter there, and our high-speed steel grew at 7%.

Europe was constant quarter over last year.

Rest of the world grew 13%.

And a little bit of weakness in our consumer products as you would expect.

Okay, can you also give me the organic sales growth rate for Advanced Materials?

Yes, it was 41%.

And that is organic?

No, that was reported.

Is there an organic number?

Hold on; sorry, that was organic.

Yes, that is organic.

41% is organic in Advanced Materials?

I'm sorry.

When I say organic that does include the effects of Extrude Hone in there, though, too.

We're not pulling that out separately for you.

Okay, okay.

I see.

I think that is it.

Thank you very much.

Gary McManus with JPMorgan.

The $0.05 tax benefit in the second quarter, is that in your full-year guidance or should we strip it out?

In other words, are you using $0.79, the reported number, or are you using 74 ex the tax rate benefit?

No, our full-year guidance contemplates the actuals from the first two quarters.

So that would be included.

Okay, all right.

I just wanted to make sure on that.

The 35% tax rate you expect both in the third and fourth quarters, right?

Correct, consistent with our outlook for the tax rate.

Following up on this metalworking question, you say North America is up 12%.

That has got to be a big chunk of the segment, and reported sales are only up 4%.

So I am still mystified on why revenues were up 4% with North America up 12 and high-speed steel up 7, rest of world up 13, and Europe flat.

I don't see how it gets to 4% overall.

It has to do with the rest of the world still represents a small percentage of our total metalworking.

North America and Europe metalworking are about the same size business.

Yes, and Gary, just a little bit of apples and ducks there.

The 4% is reported; 6% is organic; and the numbers, all of the pieces you gave are all organic.

So a little bit of FX, negative FX as well.

Okay, so the numbers you threw out there exclude currency effects?

Correct.

Okay.

And the reported 4%, you must be getting that in pricing.

Let's say it is 6% organic; that suggests very little volume growth.

And you were saying you outgrew the end markets.

It just seems to me that the end markets should be growing faster than 3% volume growth.

No, we did get a fair amount of pricing, as you can imagine.

But we also did get the volume growth as well in that mix.

Is the 6% organic?

How would that break down between volume and pricing?

I would assume it is more weighted towards pricing?

Just slightly; but we are not going to provide the details, as you can imagine, for competitive reasons.

Okay, let's just say it is 3% each or something like that.

Then you think you outgrew the end market?

The end markets grew less than 3%?

Yes.

Okay.

The margins were down a bit in Metalworking.

Is there anything going on in that?

It sounds like you're expecting better both organic revenue growth in Metalworking and margin improvement in the second half of the year.

Yes, to answer your question, it was 30 basis points down; and it was primarily driven by FX, a little bit of it, and then raw material.

As you can imagine, you get a little bit of margin dilution with the cost increases.

Okay, but do you expect better -- you expect margin improvement in Metalworking in the second half of the year?

Yes.

Yes, and on a year-to-date basis, there has been improvement.

Just this quarter you saw a little bit of a blip.

Yes, but FX is going to be a problem in your second half too, I assume.

Yes, I should mention though, in this growth, in our EPS growth that we have for the quarter, 7%, on a like-for-like basis if you take out the tax events -- that we had a fairly large tax event in the second quarter of last year, and then the tax event we had this year -- on an apples-to-apples basis we grew 30% in EPS.

In that, we offset $0.05 of negative headwind for FX this quarter.

Okay, one last question.

Do have a capital spending number for either the second quarter or first half?

No, we are just maintaining to our guidance of 80 million for the full year.

Okay, thanks.

[Adam Allman] with [Midwest Research].

Just a follow-up on this currency issue, do you have a full-year outlook as to the earnings impact from the negative currency.

Then also, your outlook for the top-line impact from negative currency?

The outlook or estimate is included in our guidance range, so in the $3.70 to $3.90 we have included the impact of FX.

As I said, we offset some of that this quarter.

In addition in our top-line growth of 7 to 10% we have included the impact there.

Okay, but the negative impact from currency for the full year, is that going to be more than what you had forecast last quarter?

Not substantially at all.

Okay, so it is a similar rate? (multiple speakers) Okay, so it was $0.05 for the current quarter; and then going forward presumably there will be additional pressure.

Yes, you know, we had an average Euro $1.20 or $1.21 versus last year $1.28 this quarter.

So.

Great.

Then on the J&L business, I was wondering if you might have an outlook for the remainder of the year regarding revenue growth and margin performance.

Because it seems like revenue has just kind of decelerated here to a mid single digit range, and the margin improvement has slowed over the past couple of quarters.

So do you have any expectations regarding the second half for that business?

We're going to continue as planned to increase the top line and the bottom line consistent with our 7 to 10% guidance and in the top line.

So we are expecting continuously growth in the J&L business.

Okay, I guess another way to look at it, would you expect revenue growth in J&L to return to the double-digit rate that it had been previously?

Should we expect this single digit type revenue growth for the remainder of the year?

We have not broken out guidance by segment, but they are consistent with our range of 7 to 10%.

Okay, the last question I hade here was just jumping back to this price realization topic.

At the beginning of the year the expectation was that price realization for the year would be somewhat lagged as we rolled through the quarters.

I am wondering if the full level of the price increases that were put into place at the beginning of the year have been fully realized.

Or is there still a lagged effect here into the third quarter and the fourth quarter?

Do you expect incremental improvements in price realization as we go forward?

Yes, relative to the price realization, we are right on plan.

We do have strategic pricing deployment.

We have not gone and increased prices to every product, every market, at the same time.

So we are on track and expect price realization to continue at the same pace that we have had in the first half of the year.

To continue through the second half.

Yes, you're going to see some continuous momentum there as we get fully implemented across the globe.

Okay, so there is still more to be realized as we move into the second half?

Yes.

Okay, great.

Thank you.

(OPERATOR INSTRUCTIONS) [James Moore] with Goldman Sachs.

It's James Moore from Goldman Sachs in London.

I just wanted to ask a quick question if I could on your Metalworking division, as to what the mix is now between cemented carbide and high-speed steel; and also on a geographical basis, how that looks in the U.S. and Europe and your rest of world piece.

We don't break down the high-speed from cemented carbide.

All I can tell you is that high-speed is a very small percentage of our total business.

What was your second question?

I'm sorry.

I was then trying to get the mix of that in Europe, as to whether it's the same sort of mix as it is in the U.S.

Yes, again in Europe it is very small as well.

I wondered if I could just ask a bit about the flat growth in Europe, as to whether there are any differing trends in Europe depending on different end markets; and whether cemented carbide grew a lot faster at the same differential as it did for you in the U.S.

The outlook for Europe has been consistent from the beginning of the year.

We have been talking about having flat to modest growth.

You always can be -- will continue to see a small transition from high-speed into cemented carbide.

That has been happening for the last few years;

I think will continue; it is hard to predict the rate.

Thank you.

That trend has been going on for some time, we know that.

But within that, presumably there is a headwind from the more difficult European automotive market.

What I was trying to get a feel for is to whether the nonauto markets in Europe were showing any greater positive momentum as you went through the calendar year.

Yes, we see the automotive market in Europe to be flat.

We have seen it being flat the first half of the year.

We expect that to continue.

And no signs of improvement in some of the other end markets?

The other end markets?

We see some improvement in some of the other end markets in Europe.

General engineering, we see some improvement; and in the energy we see some improvement as well.

So why is the European business flat?

If auto is flat, you've got other parts growing, what is the negative side of the European business?

If you've got pricing at 3%, where is the negative volume?

Parts of the automotive have come down, and parts of the automotive are flat.

I talked about the energy;

I was talking about the total Company.

We actually are -- our Advanced Materials we have grown in the energy.

We basically have seen puts and takes from country to country relative to each end market.

But overall, we see the European market flat to a slight increase.

Okay, thank you very much.

Andrew Casey with Prudential Equity Group.

I'm had a question;

I guess it goes back to Adam's question.

I am still a little unclear how the sales growth is expected to reaccelerate, given you went from down to 5% in your second quarter.

Is the full year still looking for 7 to 10%?

But remember we did 8% organic; so when we give you our guidance we always talk about organic to be consistent.

So for the remainder of our outlook for the third quarter we expect 7 to 10 as well as for our full year.

Okay, (multiple speakers);

I'm sorry.

Go ahead.

In a typical trend, we do have our third quarter and fourth quarters are typically stronger than the second quarter and first quarter.

Historical pattern.

Thank you.

At this time there are no further questions.

Are there any closing remarks?

Yes, thank you again for participating in our call.

In closing, we're extremely pleased with our second-quarter performance.

As reflected by our revised earnings guidance, we feel confident of continuing this momentum into the second half of the fiscal-year 2006.

Our current guidance range now reflects an 18 to 25% increase over the prior-year reported EPS of $3.13.

On a like-for-like basis, excluded the $0.25 negative impact from the combination of stock options and pension expenses, our current FY '06 guidance range reflects a 26 to 33% increase over prior-year EPS.

We believe that our expected growth represents best-in-class performance.

We continue to relentlessly focus on winning in the marketplace, achieving price realization, and managing costs through [lean].

Through the consistent deployment of our Kennametal Value Business System, or KVBS, we are positioned to accelerate growth and deliver outstanding value to customers and shareowners.

This concludes our discussion.

Please contact me, Quynh McGuire, at 724-539-6559 for any follow-up questions.

Thank you for joining us today.

This concludes today's Kennametal, Incorporated, second-quarter results conference call.

You may now disconnect.