Kennametal Inc (KMT) 2008 Q1 法說會逐字稿

Good morning.

My name is Jennifer and I will be your conference operator today.

At this time, I would like to welcome everyone to Kennametal's first quarter fiscal 2008 earnings call.

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

After the speakers' remarks there will be a question-and-answer session.

(OPERATOR INSTRUCTIONS) I would now like to turn the call over to Quynh McGuire, Director of Investor Relations.

Thank you, Jennifer.

Welcome, everyone.

Thank you for joining us today to review Kennametal's first quarter fiscal 2008 results.

We issued our quarterly earnings press release earlier today as well as an announcement regarding a two-for-one common stock split and increased dividend.

You may access both of these announcements via our website, www.Kennametal.com.

Consistent with our practice in prior quarterly conference calls, we have invited various members of the media to listen to this call.

It is also being broadcast live on our website and a recording of this call will be available on our site for replay through November 23, 2007.

I am Quynh McGuire, Director of Investor Relations for Kennametal.

Joining me for our call today our President and Chief Executive Officer Carlos Cardoso, Vice President and Chief Financial Officer Frank Simpkins, and Vice President, Finance, and Corporate Controller Wayne Moser.

Carlos and Frank will provide details on the first quarter financial performance as well as our outlook for the remainder of fiscal 2008.

After their remarks, we will be happy to answer your questions.

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

The discussion we will have today contains comments that may constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements involve a number of assumptions, risks and uncertainties that could cause the Company's actual results, performance or achievements to differ materially from those expressed in or implied by such forward-looking statements.

Additional information regarding these risk factors and the uncertainties is detailed in Kennametal's filings with the Securities and Exchange Commission.

In addition, Kennametal has provided the SEC with a Form 8-K, a copy of which is currently available on our website.

This enables us to discuss non-GAAP financial measures during this call in accordance with SEC Regulation G.

This 8-K presents GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures and it provides a reconciliation of those measures as well.

I will now turn the call over to Carlos.

Thank you, Quynh, and hello, everyone.

Kennametal's solid performance in the first quarter of fiscal 2008 extends our strong track record and reinforces our reputation as a high-performance company that delivers on its commitments.

Our team made improvements that collectively resulted in a September quarter record for sales and earnings per share.

During the first quarter, we met, made or exceeded our guidance for sales growth and earnings per share, while again generating strong cash flow and also increased return on invested capital.

Our sales for the quarter were up 13% year over year.

We again demonstrated strong operating leverage resulting in an EBIT margin that was 120 basis points higher than last year.

Driven by our ongoing efficiency measures, operating expenses as a percentage of sales decreased 130 basis points from the same period last year, our seventh consecutive quarter of year-over-year decrease.

As a result of those factors, adjusted earnings per share for the September quarter were $1.05, which was a 28% increase over the same period in the prior year.

All of those achievements were made in spite of a challenging market environment in North American economy.

Our global strategies and initiatives as well as our ability to outperform industrial production provide Kennametal with multiple opportunities to grow sales and expand our margins.

As always, we attribute our success to the dedication of our global team, the strength of our operations and our proven customer-focused growth strategy.

We also credit the Kennametal Value Business System, or KVBS, which continues to be a cornerstone of our business.

KVBS is our management operating system which consists of six disciplined processes that guide key decisions regarding our strategy.

An important component of that strategy is to achieve further geographic balance.

We have a goal of eventually generating revenues in equal thirds from North America, Western Europe and the rest of the world, which are the developing economies that offer exceptional growth potential.

We are making steady progress in this front.

At the end of the first quarter, 51% of our sales were from outside North America.

Another example of continuing to balance our geographic mix and serve end markets is the previously-announced marketing agreement with Kyocera.

Through this relationship, we intend to grow the presence of Kennametal products in the Asia-Pacific region.

This exciting agreement encompasses a wide range of sales and marketing initiatives and was a focus at the EMO trade show in September.

This biannual event is a world exposition of machine tools and was recently held in Hanover, Germany, with more than 160,000 visitors over a six-day period.

Our team considered this event to be highly successful and received very favorable feedback from both customers and prospects.

As we announced earlier today, our Board of Directors and our management team are confident in our ability to successfully execute our global growth strategies, so much so that the Board has approved a two-for-one common stock split and increased the dividend by 14% in a pre-split basis.

This action reflects our confidence in Kennametal's future opportunities.

We also believe that this split will make our stock more attractive to a broader investor base.

We also continued to actively communicate our investment story.

We believe that Kennametal has a compelling value proposition.

During this past quarter, we met with members of the financial community in major markets from New York to Milan to London.

In addition, we hosted an annual analyst's day in New York City on September 12, at which we had a very high attendance profile.

In summary, we will continue to execute our growth strategy.

We will continue to apply our targeted capital deployment process, which is central to our growth strategy and instrumental to our success.

We will continue to grow AMSG, our Advanced Materials business, to equal the size of MSSG, our Metalworking segment.

We will continue to acquire companies that complements our existing portfolio.

We will continue to implement our brand channel strategy, which provides many opportunities for customers to buy products directly for Kennametal as well as through distribution.

Most of all, we will continue to adhere to the principles of KVBS, expanding our existing strategies and initiatives to deliver great value for our shareholders.

I will now turn the call over to Frank so he can discuss our financial results in greater detail.

Thank you, Carlos, and hello, everyone.

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

My comments exclude both the current quarter and prior year quarter's special items and please refer to the reconciliation schedules that we provided in the earnings release and related 8-K.

To summarize, as Carlos highlighted, we had another good quarter in terms of overall growth.

We delivered a record September quarter for sales and EPS.

And our overall management team is extremely pleased with our performance for the quarter.

Reported diluted earnings per share for the first quarter of fiscal 2008 were $0.88.

This is a 13% increase over the prior year's quarters' reported EPS of $0.78 and as previously announced, the current quarter EPS included a non-cash special charge $0.17 per share for the impact of a German tax reform bill enacted in July of 2007.

The prior year quarter EPS included special charges that were $0.04 per share related to previous divestitures.

Adjusted EPS was $1.05 compared with the prior year adjusted EPS of $0.82, and that's an increase of 28% and reflects a very solid quarter despite continued challenges in certain of our served markets.

Now I will walk through the key items of our continuing operations in the income statement.

For the September quarter, consolidated sales were $615 million, compared to $543 million in the same quarter last year.

Sales were up 13% over the same quarter last year and included 5% growth on an organic basis, 5% from acquisitions and 3% from foreign currency effects.

The 5% organic growth is consistent with our prior guidance of four to 5% and represents the 47th consecutive month of organic growth.

Our gross profit margin came in at 34.5% and was at a similar level as the prior year quarter despite higher raw material costs, specifically steel and cobalt-containing materials.

These higher costs were offset by the effect of acquisitions, the benefit of some recent price increase enacted for certain products.

Our operating expense during the quarter increased 7%, or $10 million, to $145 million.

The increase is mainly attributable to the impact of acquisitions and foreign currency exchange rate fluctuations and slightly higher increased professional fees.

Operating expense as a percent of sales decreased 130 basis points, as Carlos said, to 23.6% from 24.9 in the prior year quarter.

And this September quarter is the seventh consecutive quarter in which we had a year-over-year reduction in operating expenses as a percent of sales.

Amortization expense for the quarter increased $1 million year over year to $3 million due to the acquisitions we made last year.

Our operating income was $64 million for the quarter.

This represents an increase of $16 million, or 33%, from the prior year quarter reported operating income of $48 million and an increase of $14 million, or 27%, from the prior year quarter adjusted operating income of $50 million.

The current quarter operating margin increased 150 basis points on a reported basis and 110 basis points on an adjusted basis from the prior year quarter.

Other income decreased $2 million from the prior year quarter and that was driven by lower interest income due to lower cash and cash equivalents as a result of the acquisitions we made since last year and higher FX losses realized in the current quarter.

Interest expense was $8 million in the current quarter.

That was up 5% from last year.

This was the result of an increase in average domestic borrowings of $78 million, mostly offset by a lower average interest on domestic borrowings of 6.8% compared to 7% last year.

The effective tax rate for the quarter was 37.7%, which was unfavorably impacted by $6.6 million non-cash special charge for income taxes related to the German tax reform bill enacted in July.

Excluding the special charge, the effective tax rate for the quarter was 26.3%, compared with 31.7 in the prior year quarter, and benefited from increased earnings from our pan-European business strategy.

We expect the tax rate to remain at or slightly above this for the remainder of the year.

Our balance sheet continued to be strong and our cash flow continue to be favorable.

Our adjusted return on invested capital was 11.6.

This compares with 11.5 in the prior year quarter.

Cash and cash equivalents came in at $67 million.

That was up $16 million from June and that was primarily due to stronger positive cash flow from operations, partly offset by capital expenditures and share repurchases.

Our primary working capital was $717 million.

That was up $36 million from $681 million at the end of the year.

This increase was attributable to higher inventory, to increased service levels, lower accounts payable and this with partly offset by lower accounts receivable, as well.

Our cash flow provided by operating activities was $57 million in the current quarter, compared with outflow of $19 million in the prior year quarter.

Free operating cash flow was $16 million in the current quarter, compared with outflow of $41 million in the prior year quarter.

Included in current year free operating cash flow were income tax payments of $5 million, compared to $86 million in the prior year quarter, and that was primarily related to the gain on the divestiture of J&L and cash that we repatriated in 2006 under the American Jobs Creation Act.

So adjusted free operating cash flow, excluding the effective these items, was $21 million, compared with $45 million in the prior year quarter.

Also during this quarter, we repurchased approximately 200,000 shares of Kennametal stock at cost of about $16 million under our 3.3 million share repurchase program.

We have 2.6 million shares remaining to be repurchased under this program and we will continue to build shareowner value by buying back stock on an opportunistic basis.

As Carlos pointed out, we also announced today that our Board of Directors declared a two-for-one common stock split and a quarterly cash dividend increase of $0.03 per share to $0.24 per share on a pre-split basis.

This is a 14% increase on the dividend.

This also is the third consecutive double-digit increase of our dividend.

Turning to our business units, from a geographic perspective, European and Asia-Pac markets remain strong.

The North America market declined slightly and the Indian market had positive growth compared to the prior year quarter.

Worldwide, we continue to see global growth in many sectors, including aerospace, machine tools, distribution and highway construction.

On the other hand, the energy market has moderated considerably from previous levels due to weakening conditions in the North America oil and gas markets.

Regarding business mix, we continue to execute our strategy to balance the portfolio between MSSG and AMSG while growing results of both units.

During the quarter, MSSG delivered 14% topline growth and AMSG deliver to 12%.

MSSG continued to deliver topline growth led by year-over-year expansion in aerospace, machine-tool industry and distribution sectors, coupled with the effect of acquisitions.

And as I previously mentioned, Europe and Asia were very strong.

North America declined slightly and the Indian market had positive growth compared to the prior year quarter.

MSSG sales were higher by 14% and that included 6% from organic, 4% from acquisitions and 4% from favorable foreign currency effects.

Europe and Asia organic sales were up 11 and 18%, respectively, and North America organic sales were flat with the prior year.

India, organic sales was up 2%.

On the operating income, MSSG was up 21% and an increase in the same quarter last year.

The current quarter benefited from organic growth, the net impact of acquisitions and favorable quarter foreign currency effects.

Turning to AMSG, they also continued to deliver topline growth in the September quarter, driven by sales gains in certain markets, effective acquisitions and favorable foreign currency effects.

Strong sales gains were made in the highway construction markets, while more moderate sales gains were achieved in engineered products and the energy markets.

Sales of mining products were somewhat lower due to softening market conditions.

AMSG were up 12 as a result of 3% organic growth, 7% for acquisitions and 2% from foreign currency.

AMSG again delivered organic growth in the current quarter on top of double-digit growth achieved in the prior year quarter.

Mining construction products' organic sales increased by 6% and that was driven by strong construction sales.

Engineered products and energy products' organic sales increased four and 2%, respectively.

AMSG's operating income was up 9% and that was driven by topline growth, while the operating margin was lower than the prior year due to higher raw material costs and the sales mix in the current quarter as well as a production interruption at a manufacturing facility, which should be resolved in the second quarter.

At corporate, the operating loss decreased 14% to $21 million from $25 million in the prior year and that was due to lower employment costs, reduced pension and postretirement benefit expense and, further, the prior year quarter did include the special charges related to the divestiture of J&L.

Turning towards the outlook, we continue to see worldwide market conditions supporting our expectations of continue topline growth.

Based on global economic indicators, we believe that the softness in the North American market will continue to persist.

We also believe that the European market will remain favorable and that business conditions will be strong in the developing markets as well.

We anticipate that many of our end markets will operate at favorable levels for the balance of the year, with moderating growth rates for some regions and sectors.

We expect sales growth in the range of nine to 11% for fiscal 2008, with an organic growth rate of four to six, continuing the trend of outpacing worldwide industrial production rates by two to three times.

We increased our adjusted EPS guidance for fiscal 2008 to a range of $5.60 to $5.70, and that's from $5.30 to $5.50 at year-end, due to stronger international base sales and higher benefits from our pan-European business strategy.

This represents a 23 to 25% growth in adjusted EPS compared with our fiscal 2007 adjusted EPS of $4.56.

Consistent with the historical seasonal patterns, we expect to realize about 60% of our forecasted EPS in the second half of the fiscal year.

In the second quarter, we expect sales growth to be in the range of 11 to 12% and this includes organic growth of four to five and our earnings per share to be in the range of $1.10 to $1.15.

We anticipate cash flow from operating activities of approximately $280 million to $290 million for the year.

Based on anticipated capital expenditures of $140 million to $145 million, we expect to generate between $140 million to $145 million of free operating cash flow for the entire fiscal year.

We have increased our capital expenditures plan over fiscal 2007 spending to further invest in capacity, productivity improvements, manufacturing capabilities and our geographic expansion.

At this time, I will turn it back to Carlos for some closing comments.

Thank you, Frank.

As evidenced by our Board's approval of the two-for-one stock split and a dividend increase of 14%, we are confident in our ability to successfully execute our global growth strategies.

Our updated fiscal 2008 guidance now represents adjusted EPS growth in the range of 23 to 24%.

As you can see, Kennametal is delivering more profitable sales globally through greatly-diversified end markets.

We have a strong business portfolio, a broad geographic presence and numerous platforms for growth.

We firmly believe that our strong operating leverage and our effective cost control initiatives will enable us to deliver growth in terms of EPS, EBIT margins, ROIC and cash flow.

It is very evident that our strategy is working.

We have multiple new opportunities and we believe that we are in greater control of our destiny than ever before.

As we move forward, we will continue to prioritize the development of cash for those investments that increase shareholder value.

To this end, we will be highly disciplined in evaluating additional acquisitions and we will continue to buy back our stock in an opportunistic manner.

Meanwhile, we will continue to strengthen our business by reducing our cost structure, streamlining our manufacturing footprints, implementing initiatives that reduce SG&A expenses and building on our lean-oriented culture.

As many as you already know, our strategy and growth-oriented platforms has allowed us to commit to ambitious set of new goals -- to deliver 15% EBIT margin and 14 to 15% ROIC by fiscal 2009.

We believe that will achieve those next milestones due to a steady topline growth, strong cash flow and continued margin expansion.

In summary, we believe that our collective strengths position us well to achieve our goals and continue to deliver on our commitments.

Thank you for listening to this call today and we will be happy to now take any of your questions.

Thank you.

(OPERATOR INSTRUCTIONS) Terry Darling, Goldman Sachs.

Wondering if we could just understand some of the change in guidance a little bit.

The organic sales growth, four to 6%, has not changed.

In your commentary, you mentioned the stronger international business.

Frank, I am wondering if you could tell us what you're assuming on foreign currency impact for the full year now.

Is that part of the change?

If it is not and it's coming from some of the international acquisitions, maybe you could elaborate there as well.

Terry, you're right on.

The organic growth, given the conditions, we're staying with the four to six.

As evidenced by us hitting the first quarter, we feel good about that, but your point on the foreign exchange, that is exactly right.

That is why we have increased slightly given our strong European-based businesses.

So that is the main catalyst for the sales increase from the prior guidance.

That's terrific.

In the past you have called out for us what the EPS impact from foreign currency benefit in quarters has been.

Can you help us with where you were on that in this quarter and any change in that assumption baked into the new guidance as well?

Yes, in the current quarter I would say we actually had about $0.03 of favorable -- and that is a net benefit, we got the benefit from some translation.

That was partly offset, as I said in the other income, by some losses.

We have an FX hedging program and we put some of the coverage in for our Canadian dollar.

As you know, it had an unprecedented rise recently and we actually had some losses there.

We got about $0.03 in the current quarter related to foreign exchange.

The assumption on the FY -- the full year guidance there, is it $0.03 a quarter versus a little before that previously or is that moving up?

That is a safe assumption at this point because the second half, we don't know how the currency is going to behave.

Okay, and any change on the tax rate assumption on full year?

No, I think the current level in that 26.3 to 26.5%.

I think the sustainability of the pan-European business model is helping us drive some nice benefits there.

So we think we're going to be into that range for the remainder of the year at this point.

Okay, terrific.

Carlos, I am wondering if you could update us with how the work with Kyocera is going and also just broadly how you're feeling about M&A opportunities as we move through the fiscal '08 year relative to sort of the pace of activity that we had last year.

The Kyocera opportunity is going very well.

We are on track with our plans.

The relationship is working very well and both of our teams are very engaged and very excited.

And our customers are giving us a lot of positive feedback.

As we said earlier, this will help us tremendously in establishing a stronger footprint in Japan and Japan is sort of the place that a lot of the machines are tooled and go to develop the economies in other places, so we are very, very excited about that.

The M&A activity is very -- we're very optimistic about that.

We continue to have a number of companies, a strong pipeline if you want to say that, and, again, we always communicate that we wanted do about $150 million worth of sales in acquisitions per year.

I think that we still feel very confident that we can accomplish that.

Okay, on Kyocera, did we have any revenue impact in the quarter from that yet, or is it just too early at this point?

It is too early at this point.

We do not have any.

Okay, thanks very much.

Walt Liptak, Barrington.

The first question I have is about North American.

I was wondering if you could just talk about some of the demand trends during the quarter and how that impacts your outlook and maybe talk about it distribution versus direct customers.

Yes, overall, North America, as Frank said earlier, was slightly down and we anticipate that to be the same for the rest of the year.

Our distribution is actually doing better than we anticipate.

Again, the strategy is working and we are extremely pleased that we entered into this channel branch strategy a couple years ago, because it is definitely helping us right now with the softening U.S.

economy.

Okay, so distribution is up and it is being dragged down by direct?

Yes.

Okay.

Then just a [nit] on the balance sheet.

I wondered about the inventory and the growth in inventory sequentially, what that was a result of.

That was a concerted effort to increase our service levels for our customers, particularly in kind of the higher growth margin -- areas, I should say, Asia-Pac and Europe and, to a lesser extent, North America.

We're trying to get our service levels up for our customers.

That is the primary driver.

The turns, you know, Walt, the turns are essentially unchanged.

However, we continue to look at both on a cash flow that we can try to improve turns, but we felt we needed to get the capacity issues behind us with capital, get the inventory where we needed to be going into the strong second half, as you know.

As you know, Walt, we have a $140 million approximately of projected investment in capital, so we have an opportunity for the second half of the year to make improvements in that area.

Okay, very good.

Thank you.

Andrew Casey, Wachovia Capital Markets.

A question on the short-term guidance for Q2.

If I take the midpoint of the guidance, it looks like you're expecting somewhere around a 20% incremental margin versus the prior year period in Q2.

And if I go back to the prior year period, it was somewhat of a relatively weak comp given some of the realignment activity you were doing.

If I look on a sequential basis from Q1, what -- are you looking for accelerating internal realignment or does that prior inventory question kind of boost up Q1 versus Q2 incremental?

I do not think it boosts up the first quarter profit up at all from a production standpoint.

And then from the guidance and the midpoint, some of the comments that we have talked about, you know, the softer market conditions, which basically, as we expected, are coming to fruition both on the mining and the construction side, and we had little bit of an issue with one of our facilities in the first quarter, late in the quarter, that we're trying to resolve that we had a production issue and we are working through that in the second quarter.

So the margins, that basically was factored in into the second quarter guidance and we'll get that back in the second half as well as the favorable sales mix in some of the mining, construction and automotive sector.

Okay.

Thank you very much.

Joel Tiss, Lehman Brothers.

Just two questions.

One, if I could glue two of these together, two trends that are a little bit unique to you guys, India slowing down to sort of 2% growth and energy flattening, I have not heard that from anybody else.

Could you just give us some color on what is going on behind the scenes there and what you expect for the rest of the year?

Yes, energy, as you know, we do a lot in the gas, oil and gas, so it has been flattening for us.

If you go back into last year or the year before, we had outpaced everyone as far as the growth in the energy area and we anticipate that to begin to change in our second half of our year, to get better.

Relative to India, again, we were four years in a row with 40% type of growth.

We have seen a slightly slowdown in the two wheelers in India.

We anticipate that is going to be a short-term situation.

I think that in the second half of the year, once again, we anticipated that that will get better.

Joel, I think the -- on the North America, it is more on the gas side than the oil side and we're seeing some inventory corrections in some of the bigger accounts.

As Carlos said, there is some softening in automotive, particularly the two wheelers, in India.

Then we have these spikes with some of the machine tools, so that should rectify itself in the next quarter or two.

By no means a trend.

Then second just sort of like earnings quality related, can you talk a little bit about why return on capital, invested capital, is basically fat and the free operating cash flow was down also in the -- quarter over quarter?

You know, the acquisitions coming in late in the fourth quarter are still affecting our return on invested capital.

What was the second part, Joel?

I've got to make sure I pressed the right button or I will cut it off.

The free operating cash flow declining, getting cut in half, basically, in the quarter.

Yes, that was some of the inventory that we talked about earlier on the working capital side.

Great, thank you.

Mark Koznarek, Cleveland Research.

Just to follow-up on earlier question, when can we expect to see material levels of revenue from that Kyocera venture that you are involved in?

I mean, the biggest impact is going to be in '09.

Obviously it is going to start to bring some revenue probably towards the end of the third quarter and fourth quarter, increasing into 2009.

Majority of it will come in '09 and thereafter.

Okay.

Then, could you quantify the impact of price in the quarter?

Price was -- it was relatively small, Mark.

I would say a little bit less than 1%

What about price versus raw material?

Would that be a net positive or a neutral?

No, it would not be a net positive or a neutral.

The tungsten side of the house, that material is flat, but it is the cobalt and steel.

We did to do some additional actions at the end of the quarter on steel, so hopefully we will get that back no later than the third quarter, but we'll see some effect here in the second quarter.

And in cobalt, we're still struggling with that issue.

But we're going out with some increases, but it is just going to take some time.

To price purchase cost was kind of a negative, but you're addressing it?

Right.

So when we look at AMSG margin, when it's down year over year, that is not all acquisition dilution, some of that is the raw material impact?

Well, at AMSG, it is a couple things.

It is the mix of the business with the energy, which is a nice profit margin business there.

The raw materials, to your point there, and then we have one of the manufacturing facilities that I alluded to on the call where we had some production interruption was in the Advanced Materials, which we feel are pretty good to correct in this quarter and we'll get those benefits in the second half.

We had to overcome that hurdle in the first and now second quarter, so that is depressing some of it.

Okay, so there is going to be a bit more of this production interruption headwind in the current quarter.

Correct.

Okay, good.

Thank you.

Steve Barger, KeyBanc Capital Markets.

The Metalworking sales came in at 66% in total and AMSG at 34%, which is basically the same year over year.

Is your inability to kind of change that mix towards AMSG just a result of some of the market slowdowns you have talked about or are you having more trouble penetrating some markets than you had anticipated at this point?

No, it is the first, Steve.

It is the first point you made.

It has to do with interruption, factory interruption, manufacturing interruption that we had.

Okay, well, your full year organic growth guidance of mid single digits, four to 6%, that is against a slower North American market.

Does that make you think differently about how you rationalize your footprint?

Does that give you an opportunity to potentially take some more plants out?

Yes.

Do you think that is something that we'll see in the next quarter or two or how do you think about timing?

Well, we're still working through the timing at this point.

Okay, and just one more then.

When you think about your 15% EBIT margin and the 200 to 300-basis-point swing that you expect to see between AMSG and MSSG, how do you think those margins -- what will they approximate when we get towards the end of FY '09?

Is that kind of an 18% and 15% or how should we think about those margins, where they can go?

You're close, but, again, I think will see the MSSG side continue to accelerate for some of the past actions and some of the capital he put into the business.

Then we're just going to have -- I think AMSG will be a little bit stronger, consistent with our historical patterns, in the second half and once we see a little bit of a pickup in the later part of next year on some of these markets that we serve and we get this one production issue behind us, what we will see -- we should get at least 100 basis points higher and then we will see some of the actions we take during the year if that could even drive it further.

For this point, it is kind of tough with some of the market conditions we're fighting.

I understand, but I guess kind of on a normalized basis, would you expect the spread between the two to be closer to 200 or can you get 300 just when you think seven quarters out?

It is pretty hard for us to see that far and be that precise at this point, Steve.

Again, we feel very comfortable with our objective of reaching the 15% at this point EBIT margin.

Okay, thanks.

Glenn Primack, Broadview.

I was just wondering if you could size the opportunity on the cladding all the components within coal-fired power plants and kind of how that is coming along?

Then the second question, again, within AMSG is outside of North America, do you need more capacity potentially?

I am not sure if Russia and some of these undeveloped, lesser-developed areas in terms of drilling are using the same materials as the counterparts here in the U.S.

The first question of the cladding opportunity, we prefer not to talk about that because of competitive reasons.

We do have a lot of opportunities there and we continue to capitalize on those opportunities and we actually made a major investment last year in India to be able to produce that service in India for India and the Asia-Pacific market and we're just begun.

We're still not getting that much revenue from that yet, so the opportunity is really good.

Relative to capacity, that is one of the reasons why we have a very high, actually probably a record year of capital investment, with $140 million plus, is to really establish and put capacity in developing economies, which would include Russia and central and eastern Europe.

Right, so it is fair to assume that those national oil companies over there want the same technology now that it is being used here in the states.

Absolutely.

It is just a matter of time.

Those things, as you know, take some time.

You have to do -- we have to do one power plants or a portion of the power plant has to be tested and staffed and proven and then we start doing the whole plant after that.

Okay.

Would this, the cladding, be on display over at the big PowerGen show?

I cannot answer that question at this point.

We can get back to you, Glen, if you can call Quynh and we will direct you.

But I do not the answer to that question.

Okay, great.

Thanks.

Steve Volkmann, JPMorgan.

I think most of the questions have been answered, but could you just drill into Europe a little bit for me and just give me a sense of -- I think you said some markets may be slowing and I know that was a separate comment from Europe, but I am just trying to get a sense of what you're seeing in Europe with respect to specific end market conditions going forward and then any market share changes you might want to comment on.

Let me talk in a country-by-country basis, because it is easier.

I think Germany is very strong, continues to be strong and we will -- we anticipate that that will continue.

We have seen some weaknesses in the auto and very, very slight.

Italy is, again, flat, sideways at this point and we do not see any other place where the economy is sideways.

And central and eastern Europe is going to be strong.

The other area that we see some softness is in France, so if you look at France and Italy, those of the two areas where Italy is sideways and France is slightly down due to the automotive slowdown there.

But central and eastern Europe continue to have -- be very, very strong as a whole.

I mean, we feel that we continue to gain market share.

We're growing at a faster rate than the industry, so we feel extremely good about what we have in Europe and what's going on in Europe.

Okay, great.

Just sort of drilling down on margins a little bit in the second quarter, I believe last year in the second quarter AMSG margins were down about 100 bps and I think that was due to some planned shuffling and so forth.

Do we get that back in this next second quarter or do you think margins will still be below those '06 levels?

Yes, I would say I think they will be a little bit below, Steve, until we rectify some of the things I talked about.

The planned closure that I think you're referring to, that actually was in MSSG last year.

Okay.

Good, that's helpful.

Thanks.

Dana Walker, Kalmar Investments.

Simple question, could you talk about the acquisitions that you have made over the last 12 to 18 months as well as the facility consolidation steps that you've taken and how you would describe the productivity benefits of those steps and the acquisition accretion so made compared to where your expectations would be?

Over the last 12 to 18 months, as you know, we did five last year and we're still working through some of the facility consolidation points.

We have not announced anything along those lines, but for the most part, they are pretty much on track.

We had a little issue, as I talked about, some production interruption recently in the first quarter, but outside of that, I think most of them overall are hitting their numbers where we would like.

And as we continue to go forward, we'll look at some additional benefits associated with some of our plans both the domestic and international expansion.

And on the acquisition front, same response?

Correct, yes.

We are pleased with the acquisitions that we have made in the last 12 to 18 months.

What time frame to the degree that this was part of your plan would you expect to benefit from broadened distribution or a smaller business taking advantage of the attributes of the larger company?

Well, like we said, we're doing that with Conforma Clad, as we have talked about in another call.

What we try to do is focus on is not change the face of the customer, initially working on the back office and as we look at some of the acquisitions that we did late in the second half, some of the bigger ones, the Federal Signal cutting tool, the KENCI and the ISA were still in process, just a little bit too early to leverage the infrastructure.

But that is kind of the plans we have going forward.

Typically, our plans are to integrate the back end within the first 100 days and then start integrating the front-end or leveraging the front end at 12 months later so that we understand the business and we understand the processes and we do not lose any customers in the process of leveraging them.

Carlos and Frank, you've talked about trying to gain price based on what's happening in the raw material front.

Would you say that that dialogue is an easier sale today than it might have been at some prior point?

Well, the pricing is coming primarily for the Advanced Materials business because they get the most impact of raw materials going up.

And, with a few exceptions, it is easier to get price in that business than in the Metalworking business, so the answer is the conversations are easier.

I am not sure it is because the timing as much as that our value proposition is very strong.

It is a niche, typically, environment and we have more pricing power there.

Thank you very much.

Terry Darling, Goldman Sachs.

Wondering if you can help us with sort of the year-over-year change in your tungsten cost profile and your cobalt cost profile, sort of how you see that trending going forward.

I know that is a sensitive area and you're not going to tell us exactly what the absolute numbers are, but I am thinking percent changes might be in fair territory there.

Can you help us on that?

Let me get that.

Why don't we deal with that after the call and I could help you with some of the -- I get all the facts on the tungsten, the steel and the cobalt.

Okay, fair enough.

Joel Tiss, Lehman Brothers.

Just a cleanup clarification.

Can you give us a sense of organic growth and acquisition growth that is baked into the '08 guidance?

What we said -- the organic is still four to six.

I would say the acquisitions is about 4% and then we will get a little bit of a currency benefit for the remaining piece.

There are no further questions, Ms.

McGuire.

Any closing remarks?

Yes, thank you for joining us today.

If you have follow-up questions, please contact me, Quynh McGuire, at 724-539-6559.

This call will be available for replay beginning at 1:00 p.m.

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