Kennametal Inc (KMT) 2009 Q2 法說會逐字稿

Good morning.

I would like to welcome everyone to the Kennametal Second Quarter Fiscal Year 2009 Earnings Call.

(OPERATOR INSTRUCTIONS.) Thank you.

I will now turn today's conference over to Quynh McGuire, Director of Investor Relations.

Thank you, Christie.

Welcome, everyone.

Thank you for joining us to review Kennametal's Second Quarter Fiscal 2009 results.

We issued our quarterly earnings press release earlier today.

You may access this announcement via our website at www.kennametal.com.

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

It's also being broadcast live on our website, and a recording of this call will be available on our site for replay through February 28, 2009.

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

Joining me for our call today are Chairman, 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 quarter's financial performance, as well as our outlook for the remainder of fiscal 2009.

After the remarks, we'll be happy to answer your questions.

At this time, I'd 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 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 represents 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.

Good morning, everyone.

Thank you for joining us today.

As you know, the second quarter of fiscal 2009 was an intensively challenging period for most companies around the world.

As the global recession deepened and credit markets tightened, industrial production and capital spending declined significantly.

At Kennametal, we experienced weaker demand in nearly all our end markets.

Many of our customers utilized all available inventories to avoid additional cash expenditures.

From a geographic perspective, North American sectors slowed dramatically and both the direct and distribution channels were in negative territory year-over-year, while the (inaudible) manufacturing Purchasing Manager Index, or PMI, plunged to record lows signaling the industry's lack of confidence in a near term recovery.

In Asia, growth continued to decline sharply and manufacturing--and the manufacturing sector in India was further worsened.

Those factors collectively contributed to what was a very difficult operating environment in the second fiscal quarter.

Kennametal managed for those unprecedented and challenging market conditions by continuing to execute strategies to help to maintain our financial flexibility and balance sheet strength.

Our main priorities are to maximize cash flow, accelerate our restructuring plans, and right-size our business appropriately.

We accelerated our restructuring plans announced in April 2008 though--to which we are improving our operating efficiencies, applying Lean to our support functions, such as customer fulfillment centers, and streamlining our manufacturing footprint.

Earlier in January, we announced additional actions to reduce our global salaried workforce and right-size our business in order to further adjust to current economic conditions.

Together, those programs involve a reduction in our global headcount of 1,200 positions.

Those actions represent additional structural changes designed to ultimately lower operating expenses and maximize cash flow while minimizing the impact on our customers and remaining well positioned for future growth.

We expect our combined cost reduction programs to result in a charge of approximately $90 million, including 27 million [spend] through the December quarter.

Those measures are expected to drive pre-tax savings of approximately $100 million annually.

Successful execution of our strategies to balance our business across geographies and end markets has enabled Kennametal to effectively weather the current economic downturn over the past several quarters.

However, this economic crisis is deep and global in nature and we expect that challenging times will continue for the next six to nine months.

That being said, we believe that Kennametal is positioned to benefit when industrial productions begin to gather steam either through economic stimulus or natural infrastructure growth requirements.

As a consumables business, our products are required in nearly every manufacturing process in the world.

As always, we are looking to increase efficiencies in our processes, to applying Lean, consolidating support functions, continuing evaluating our portfolio of business, strengthening our brands, and improving the ease of doing business with our customers.

When the economy eventually improves, we'll emerge as a leaner, more streamlined company that is an even better partner for our customers.

In the meantime, we will remain sharply focused on maximizing cash flow and ensuring liquidity and maintaining balance sheet strength.

We'll also continue building our core business, managing our portfolio, and balancing our global infrastructure.

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

Frank?

Thank you, Carlos.

I'll provide further comments on our performance for the December quarter, and then I'll move on to the outlook for the remainder of our fiscal 2009 year.

As always, some of my comments will exclude current special items and that's been posted on our 8K and our press release.

So to summarize the quarter, we experienced a challenging period and quarter.

Sales declined in all major metalworking markets and organic sales were flat in our advanced material business, resulting from a steep and sudden global decline in industrial production.

The lower impact of sales volumes and production levels, as well as the effect of temporary disruption costs from restructuring activities, were offset somewhat by lower provisions for employee incentive compensation, considerably improved price realization, and higher other income.

We continue to implement restructuring actions to further reduce costs and improve efficiency in our operations and we recently announced further cost reduction actions.

Especially in this challenging environment, maximizing cash flow and ensuring adequate liquidity remains our top priority and focus.

For the first half ended December, we generated free operating cash flow of 48 million despite the sharp downturn in sales.

Now, I'll walk you through each of the key items on the income statement.

Sales for the quarter were 569 million, compared with 647 million in the same quarter of last year.

The 12% decrease in sales was comprised of a 10% organic decline and 5% from unfavorable foreign currency effects, partly offset by the net favorable impact of acquisitions and divestures of 2% and more work days of 1%.

The year-to-year decline in organic sales occurred quite abruptly and sharply in the latter part of the December quarter as a result of unusually early and rapid shutdowns of customer plants in combination with swift actions by customers to reduce their inventories.

MSSG sales decreased by 21% during the December quarter, driven primarily by an organic sales decline of 15%, unfavorable foreign currency effect of 5%, and 1% from the impact of divestitures.

On a global basis, industrial production declined in contrast to the prior year quarter.

Demand in most industry and market sectors weakened, and on a regional basis, Europe, India, and North America reported organic sales declines of 17%, 17%, and 16%, respectively.

Asia Pac and Latin America also experienced organic sales declines of 9% and 2%, respectively.

AMSG sales increased 5% during the December quarter, driven by 8% from the impact of acquisitions, partly offset by 3% from unfavorable foreign currency effects.

Organic sales were flat as increased mining and construction sales and higher energy related sales were offset by lower sales of engineered products.

Our gross profit margin was 28.7 for the quarter, as compared to 34.1% in the prior year.

Restructuring related charges of 4 million were recorded in cost of goods sold for the quarter.

Absent these charges, gross profit margin was 29.4%, or 470 basis points below the prior year.

The primary drivers contributing to the declining gross margin percentage were reduced absorption of manufacturing costs due to lower production levels, as well as disruption costs from restructuring programs, and a less favorable business unit mix.

We estimate these disruption costs impacted our gross margin by about 80 basis points for the quarter.

Our improved price realization exceeded the increase in raw material costs for the second consecutive quarter.

The spread has now reached the point to more than cover the overall margin dilution from higher raw material and freight costs.

This favorable impact on gross margin for the December quarter was 40 basis points.

The increase in our raw material costs finally began to slow at the beginning of the December quarter, followed by the sharp line up in these costs that started about a year ago.

In fact, the raw material costs actually started to decline near the end of the quarter, but remained above levels one year ago.

We presently expect the raw material costs to continue to trend somewhat downward over the next few months, although a precipitous decline is not expected.

Our operating expense decreased 12% or $18 million to 130 million from the prior year quarter.

The decrease is mainly attributable to lower provisions for employee incentive compensation programs as a result of the decline in our operating performance, as well as the impact of foreign currency exchange rate fluctuations and other cost reduction actions, offset somewhat by a net increase from acquisitions and divestitures.

Operating expense as a percent of sales increased slightly by 10 basis points to 22.9% from 22.8% in the prior year.

We also recognized restructuring charges of 6 million during the December quarter.

As previously mentioned, we recorded 4 million of restructuring related charges and cost of good sold during the quarter.

As such, total restructuring and related charges recorded in the December quarter were $10 million, which was equivalent to $0.14 per share.

These charges relate to the restructuring plan announced in April 2008, which involves the closure of five manufacturing facilities, as well as other employment and cost reduction actions.

The total restructuring and related charges that we have now recorded so far under this plan amounted to $27 million.

Including these charges and those associated with the additional cost reduction actions we announced earlier in January, we expect to recognize a total of $90 million of pre-tax charged related to our restructuring plans.

The remaining charges are expected to be incurred over the next six to nine months, and the annual ongoing benefits of these actions once implemented are expected to be approximately $100 million.

Operating income was 23 million for the quarter.

This represents a decrease of 46 million or 66% from the 69 million in the prior year quarter.

Absent the impact of restructuring related charges, operating income for the quarter was 34 million and declined 36 million or 52% from the prior year.

The decrease was driven primarily by reduced sales volumes and the [related] lower manufacturing cost absorption as well as the disruption costs in restructuring programs.

This was partly offset by lower provisions from employee incentive compensation plans and higher priced realization.

Turning to the business units, MSSG operating income in the margin decreased significantly compared to the prior year.

MSSG recognized restructuring and related charges of $7 million in the December quarter.

Absent these charges, MSSG operating income decreased 76%, resulting in operating margin of 4%, compared to 14% in the prior year quarter.

The primary drivers are the decline in operating margin, reduced absorption of manufacturing costs due to lower production, and temporary disruption effects related to the restructuring initiatives.

The impact of recent price increases essentially offset the effect of higher raw material costs.

AMSG operating income decreased 29% and the operating margin decreased 410 basis points from the same quarter last year.

During the December quarter, AMSG recognized restructuring and related charges of $3 million.

Absent these charges, AMSG's operating income decreased 18% and the operating margin decreased 290 basis points.

This decline in operating margin was due to unfavorable business mix and lower performance in the engineered products business.

Improved price realization more than offset the impact of higher raw material costs in this business unit as well.

The corporate operating loss decreased by 81% to 16 million--or 16 million and the decrease was driven primarily by lower provisions from employee incentive compensation programs.

Interest expense of 8 million decreased 6% from 9 million in last year's comparable quarter.

The impact of an increase in average domestic borrowings of $195 million was more than offset by a 220-basis point decline in average interest rate on domestic borrowings.

The increase in average domestic borrowings was driven by the first quarter share repurchase and our second quarter acquisition of Tricon Metals and Services in our advanced materials segment.

Other income increased 3.8 million from the prior year, primarily due to favorable foreign currency transaction results.

And the effective tax rate for the quarter was 23.2%, compared with 17.3 in the prior year quarter.

Absent the effect of restructuring related charges, the current year rate was 16.5%, which included a benefit from the recent completion of a routine income tax examination for certain prior fiscal years.

And lastly, reported fiscal 2009 second quarter diluted earnings per share was $0.21, compared to the prior year EPS of $0.64.

Adjusted EPS was $0.35 and this decreased 45% from the prior year quarter reported EPS.

And our adjusted return on invested capital was 10.9 and that was down 140 basis points from 12.3% in the prior year quarter.

Turning to the balance sheet, our balance sheet remains strong and we continue to generate strong cash flows from operations.

At December 31, our debt to capital ratio was 26.5%, which provides us with substantial financial flexibility, and we generated 115 million of cash from operations during the first half of 2009.

Our total debt ended the quarter at 523 million.

That was up 176 million from the June quarter.

And the increase in borrowing since the beginning of the current fiscal year was driven by our first quarter share repurchases and our second quarter acquisition of Tricon Metals and Services.

Maximizing cash flow and ensuring adequate liquidity remain our top focus and priority.

As I mentioned, cash flow from operations for the current six months was 115 million.

This compares with 69 million in the prior year period.

Free operating cash flow for the current period was 48 million, compared with an outflow of 9 million in the prior year period.

The increased generation of cash flow was driven by a strong focus on receivable collection and lower income tax payments.

We had 325 million of remaining borrowing capacity at December 31, 2008, and we do not anticipate--or we do not participate in the commercial paper market.

And our U.S.

pension funds were 100% funded a year ago and they are still 100% funded today.

The strength of our balance sheet, as well as our proven capability to generate strong cash flow from operations enables us to weather tough economic times, such as we have today.

We will continue to remain diligent with our use of cash and capital deployment.

We have no near term refinancing needs and we will continue to take the steps necessary to maintain our solid investment grade ratings and ensure adequate liquidity.

Also announced in our earnings release today, the Board has declared a regular quarterly dividend of $0.12 per share.

Now, I'll turn your attention to the outlook.

The decline in the global economy and worldwide industrial production has been more rapid and severe than most had anticipated.

In addition, there continues to be a great of turbulence and uncertainty in the global banking industry and financial markets despite the considerable intervention by central banks and governments around the world.

We, along with many companies, are striving to gain some sort of visibility as to the anticipated depth and duration of the current economic contraction.

We do not claim to have any better ability to predict the future than anyone else, especially in these unprecedented times.

Nevertheless, we have developed an outlook for the remainder of our fiscal year.

This outlook is based on a set of assumptions for the key market conditions that drive demand for our products.

Some of these assumptions for the remainder of the fiscal year are as follows.

Global industrial production will remain well below the prior year in the relative range that prevailed in the second half of our December quarter.

Automotive production will continue to be among the weakest sectors worldwide.

Energy markets will weaken somewhat from the levels prevailing in the past several months.

Aerospace should continue to have some growth, but at a declining rate.

Foreign currencies will be similar to the average levels experienced in our December quarter.

Bank lending will continue to be constrained, leading to suppressed capital investment and high incremental borrowing costs.

And stimulus efforts by governments around the world will not have much impact until the second half of calendar 2009.

In addition to our assessment of market conditions, our earnings outlook takes into consideration the additional savings that we generate from our announced restructuring programs and cost reduction actions.

Based on our assumptions, we revised our outlook for fiscal 2009 earnings per share to a range of $1.30 to $1.50 per share, excluding charges that occur relating to restructuring actions.

Organic sales for fiscal 2009 are expected to be 14 to 15% lower than the previous fiscal year.

We anticipate the full tax--full year tax rate, excluding the special charges, to be between 21 and 21% and we anticipate the third quarter effective tax rate to be around 25%.

In the third quarter, we expect organic sales to decline by 22 to 25% from the prior year quarter and earnings per share to be in the range of $0.05 to $0.15, excluding restructuring charges that occur related to our previously announced actions.

Given the sharp drop off in global demand that began toward the end of the past quarter, our earnings pattern for this fiscal year will be such that approximately two-thirds of our earnings will have been generated in the first half of our fiscal year.

This is in contrast to our normal historical earnings pattern in which we would have generated about two-thirds of our earnings in the second half of the fiscal year.

To help you better understand our third quarter earnings guidance, a bridge between our second quarter adjusted EPS and the midpoint of our third quarter adjusted EPS is as follows.

The second quarter had a benefit of about $0.15 per share related to an adjustment in provisions for employee incentive compensation plans.

We will not have a similar benefit in our third quarter.

Operating results are expected to be lower by the equivalent of about $0.26 per share as a result of lower sales volumes.

On the other hand, additional savings from our restructuring and other cost reduction actions are expected to be about $0.16 per share.

The effect of a higher tax rate and less favorable foreign currency translation is expected to be essentially offset by lower interest expense and the more favorable foreign currency transaction results.

As previously mentioned, maximizing cash flow is our top focus and priority and we anticipate generating cash flow from operating activities of approximately 170 million to 190 million for fiscal 2009.

Based on anticipated capital expenditures of 110 million, we expect to generate between 60 and 80 million of free operating cash flow for fiscal 2009.

At this time, I'd like to turn it back to Carlos for some closing comments.

Thank you, Frank.

As we advance through the rest of fiscal year 2009, we will take the necessary steps to effectively manage our business through this uncertain market.

This includes an intense focus on controlling costs, maximizing cash flow, ensuring liquidity, and maintaining balance sheet strength to provide us with the financial flexibility.

Our financial strength provides us with a solid foundation for the future, especially in these difficult times.

As always, we'll continue to manage our portfolio and build on our core business.

We remain committed to our proven discipline and principles under our Kennametal Value Business System, or KVBS.

This management operating system guides our enterprise in areas such as strategic planning, product development, sales growth, talent development, portfolio management, and Lean enterprise processes.

In summary, although we recognize there will continue to be challenges, we believe we are prepared to meet the demands ahead.

Thank you for your time and your interest in Kennametal.

We will now take questions.

Thank you.

(OPERATOR INSTRUCTIONS.) Your first question comes from the line of Eli Lustgarten of Longbow Securities.

Good morning, everyone.

Hi, Eli.

How are you doing?

A couple of housekeeping to make sure--Frank, did you say the tax rate for the year will be 20 to 21?

I think you said 20 to 21 (inaudible) if I heard that.

The tax rate for the year will be around 20 to 21?

That's correct.

Okay.

And with the 25% in the third quarter, are you talking about a similar rate in the fourth quarter?

Is that what we're assuming at this point?

No.

It would come down to a little bit lower, maybe around 22 in the fourth quarter.

And it's related to some of the charges that we have to take in Europe.

We don't get a significant tax break given our structure there.

And is this holding to next year or--I know you don't like to talk--but we are moving past '09.

So--.

--Yes, I think it's a little premature to get into that, but--and I think we've said our long-term goal over the horizon is to get a sustainable tax rate in the low 20s.

So it will be the same.

And the corporate charges are going to run in the 16 million quarterly rate.

Is that the new annual rate--quarterly rate for a while?

Well, I mean, as you saw in the corporate operating segment, we have 4 million.

I would say it could be a little bit higher.

It could be that--anywhere from 18 to 20 million, but I would expect to be in the lower part of that at this time.

Okay.

And then, interest charges dropped from--how much--how far down would they go from 8 million?

They'll go down--I mean, I'm looking at it in net--.

--Okay--.

--Net interest income.

It will probably go down a little over $1 million sequentially.

Okay.

Now, can we talk about demand?

I mean, you've given us a very dire third quarter organic drop in the 20s.

What are you assuming--are you assuming the fourth quarter rebounds a bit to, what, a mid-teens drop or something like that, or is that--?

--No, single digits, Eli.

Okay.

We see the quarter rebounding, but the--at a much lower--.

--Much lower decline, to a mid-single digit decline.

And that's just because the businesses are starting to function as opposed to really not functioning in the current quarter?

Yes.

Again, Eli, I think on the third quarter--let me start there, because I can't see much difference third and fourth quarter in this environment.

That's why the numbers are there.

And the reason here, in January we saw a pretty steep drop off in the month of December.

That has obviously not improved in January.

And given the extended shut downs and the visibility being somewhat cloudy, you're looking at January is soft--that's why the guidance is where it is--and then, we'll take it from there.

But it's going to be somewhere in the next few quarters, I think.

So have you basically shut down most of your acquisition activity at this point for the rest of the year?

And are you looking at paring back capital spending from the 110 million at this point?

Capital spending, yes.

I mean, we have pretty much pared everything down that was not committed.

And although we are still looking at acquisitions from an analysis perspective and negotiations, until we have a better visibility of the future, it's very unlikely that we'll do something now.

Yes.

On capital, we spent almost $70 million in the first half.

We will have some carryover from some commitments, but this will get--we'll be running at maintenance levels by the fourth quarter.

And it will probably stay that way for a while until things improve, I assume?

Yes.

Correct.

So next year, you obviously have that impact as well as the disruption cost that will no longer be there as we ramp up the benefits from the plant closures.

And the pension plan stays 100%.

There's no financing requirements in 2009 or calendar 2009, is there at all?

No, that's correct.

The pension, that's a big focus of our ERISA Committee.

And our funding actually improved from the September quarter to the December quarter.

We're still over 100% and our Treasurer did a great job and his team there making sure that we are on top of all the developments in that arena, so that was good, and the refinancing needs - the 2011 and our public debt that comes due in 2012.

And one final question.

Using any price pressure or price erosion in any of your businesses at this point?

Well, I mean, we see customers are trying to put pressure on the pricing.

But we have not seen any price erosion.

As a matter of fact, this past quarter our pricing has improved.

And your competitors are holding the line, too, I assume, at this point?

Yes.

Yes.

All right.

Thank you very much.

Thank you, Eli.

Your next question comes from the line of Walt Liptak of Barrington Research.

Thanks.

Good morning, everyone.

Eli didn't leave us with very many questions.

But I wonder if you could talk about the 39% international decline.

And you may have done this already, but just break it out by the different geographic sectors.

You mean what's in the press release or the breakdown by--?

--Yes, well, the international decline of 39%.

How much did Europe go down?

Europe was down 17% on a net basis - that's volume and price net effect there.

And I would say that Asia Pac was nine and India was also 17%.

Okay.

All right.

And you ran through those numbers already.

All right.

And I guess in this environment can--and going back to the pricing question.

Given the steep declines that you're experiencing right now, is there--are you seeing any signs of price discounting?

Are you going to need to lower prices to try and keep your volumes going?

Well, I mean, we at this point do not anticipate having to--or see prices coming down.

Like I said, our competition has stuck with the prices.

But--and we're not going to trade pricing for volume at this point.

So--.

--Yes.

The only thing I would add is, as you know, Walt, a couple of things in the December quarter, mostly on the MSSG side with the exception of Europe, which on January 1 had the price increases.

As you know, it takes three to four quarters before you fully realize the past prices increases have been in there.

I think the competition has been increasing there.

We keep a keen eye on that.

And we did have a significant product launch vis--vis in the metal working side of the Beyond product, and this is minimum of a 30% productivity improvement.

So the competition--this is just getting out into the marketplace.

And we're having extremely well received results from our customers.

And that's just ramping up at this point.

So that will help us going forward.

It's a magnitude of 3,000 SKUs that we introduced, new products with really good value and acceptability in the marketplace.

And we've just begun to get benefits from that this past quarter.

Okay.

Have--okay.

And then, just on the share repurchase, how many shares were repurchased during the quarter?

Zero.

Zero.

Okay.

Thanks very much.

Thank you, Walt.

Your next question comes from the line of Andy Casey of Wachovia Securities.

A question on the--well, a couple questions on the third quarter guidance.

First, on the margin, if I exclude restructuring and $0.15 related to the incentive adjustment I think you talked about in Q2, it looks like the Q2 decremental margin would have been around 60%.

And then, if I'm doing the math right and take your mid-point for Q3 from the various things, it looks like there's a 45% assumed decremental.

Is that all price increase or are you expecting a little bit better manufacturing absorption in Q3?

Again, in the December quarter, trying to fix production when it falls off really steep, it's tough.

Andy, I think you know that.

And then, I think the pricing is a factor.

But as you'll remember, the restructuring benefits from the cost of service start kicking in a lot stronger in the second half of our fiscal year, particularly in the March quarter for the [CTS].

And then, the recently announced restructuring actions that we talked about in early January will help [sever] that.

So, yes, we're trying to get the decremental margins to--longer term to be less than 40%.

But as production volumes continue to decline and with January starting off slow, the 45% at this point in the mid-40s is kind of our best shot at it at this point.

And we'll continue to look at the temporary--even though we talked about permanent cost reductions, we're obviously looking at the hourly as well.

Obviously, we started to do pay as you go in the beginning of the year.

We announced our restructure pretty early in this environment.

So we'll get some good benefits in the second half of the year.

Okay, thanks for that clarity.

And then, on the top line, the down 20 to a little bit more dramatic decline than that, is that assuming further deterioration on a year-over-year basis in MSSG or just kind of an inversion from the AMSG 5% positive in Q2 to something flat to negative given your comments about energy?

Yes.

I mean, that's--it's continuing from what we've experienced in kind of the end of the December quarter.

Okay.

Thank you very much.

Thank you, Andy.

Your next question comes from the line of Joel Tiss of Buckingham Research.

Hi, Joel.

Joel?

Yes.

Sir, your line is now open.

Hi.

Can you hear me?

Yes.

Oh, okay.

I wonder if you can talk--the inventories and receivables both declined in the quarter.

Is that all seasonal?

No.

I think sometimes in Europe you have some seasonality with the end of the calendar year, but that's been more of a focus globally.

I think kind of a call to arms pretty much across the organization, Joel.

So the receivables are driven by the focus in looking at all geographies.

And inventory--it's tough to really reduce inventories when you feel a sudden decline in volumes.

So on a constant currency, yes, they were down a little bit.

But we're going to continue to look at taking inventory down further in the second half.

Okay.

And then, just a clarification.

How much--what percent of the pension is in equities?

We switched.

We used to--like a lot of companies a standard benchmark is 70% equities and the rest in fixed.

We probably have the inverse of that right now in fixed versus equities.

Okay.

And the distributor inventory levels, any read on that and sort of any conversations you're having with those guys to give us some color on what they're saying and thinking?

Yes.

Joel, as you know, our distributors typically don't carry a lot of inventory.

But my feeling is that towards the end of the year, the heavy ones decrease their inventory.

And again, it's hard to tell when the timing is, but we feel that sooner or later they are going to start processing some inventory.

And then, last question, can you just give us any color on mix changes coming up, say for the next year?

We're sitting here watching [Joy] and Bucyrus and [Manethwok] and all the guys with big backlogs watching their backlogs get cancelled, and I'm sure a lot of those end markets are higher margin for you guys as well.

Can you just give us any sense on how do you bake in the mix changes into your expectations?

I mean, we bake--based on the--what we told you.

I mean, we expect the energy to continue to go down slightly and the same thing with mining.

But we also expect aerospace to get slightly better.

So there's a lot of elements that we're putting into our forecast.

And our current forecast sees the mix as we described it.

Okay.

All right.

Thank you very much.

Your next question comes from the line of Scott Blumenthal of Emerald Advisors.

Good morning.

Hello?

Scott?

Mr.

Blumenthal, your line is now open.

Hello?

Sir, your line is now open.

Yes, can you hear me?

Yes.

How are you doing, Scott?

Okay, fine.

Sorry about that.

Carlos, one of the programs or one of the projects that you've talked about over the last couple of years was SKU reduction.

And you just mentioned the Beyond product line and how we've introduced another 3,000 SKUs.

Have you made any more progress or is that becoming kind of a new focus to kind of ramp that up a little bit more quickly than what you'd expected?

Actually, our focus is still the same.

We're still focusing on reduction of SKUs.

What we try to accomplish is for every new SKU that we bring in, we take that plus the goal that we have to--for reduction.

I don't have--Frank, do you have the number?

I don't have the number at hand on what the SKUs are, but they are getting closer to the 100,000 from the original almost 400,000 a few years ago.

So--and typically, we introduced about 10,000 SKUs per year.

So we've reduced 10,000-plus, so that we can continue to make our progress towards the 100,000.

Scott, this is Quynh McGuire.

We ended up the year at about 158 SKUs.

And I'll follow up with you to get you the number where we are today.

158,000, did you say, Quynh?

At June 30.

At June 30 of '08.

Right.

Okay, that's great.

I'll follow up to get you an update.

Okay, terrific.

Carlos or Frank, can you--would you be able to give us a gauge as to what the overall capacity utilization is at this point across the enterprise?

Yes.

It's really difficult to tell you at this point because of the January and December have come down quite a bit.

Sure.

And as you saw, we have--we are in the process of closing a number of plants per our April announcement.

Okay.

And I guess maybe if I look at this from a different angle, where do you look at capacity utilization across the enterprise with regards to breakeven, Frank?

I mean, are we breakeven at 50%, 40%?

Yes.

I can't--for competitive purposes, I really--I'm going to defer that question.

Okay.

Well, how about this one, then?

Could you--maybe switching to the inventory and raw materials, you reported that raw materials were a little bit higher.

At some point considering the economic circumstances here we should--I hope we should expect them to come down a little bit.

Are you seeing any of that and what are your expectations there?

Yes.

Again, this goes back to even what we said back in July.

We had expected the first half to be up, the second half to start decline.

And we saw that trend, albeit it didn't go down substantially from Q1 to Q2, but we do see the trends coming down.

[But] the particular increase for us would be in steel and cobalt being the main drivers, tungsten being kind of moving sideways a little bit here.

But we expect that to continue to trend down.

Now, we don't pay spot prices or markets.

We do have contracts to protect us on the upside as well as the downside.

But according to our forecasts, we do have some of that built into the second half, lower raw material costs.

Okay, terrific.

Thanks much.

Your next question comes from the line of Steve Barger of KeyBanc.

Good morning.

Steve.

Hi, Steve.

I want to circle back to the Asia Pac revenue.

I think Chinese industrial production came in around 6% for the quarter and they obviously saw a positive GDP.

The disconnect between that and the negative 9% you saw, is that all India or is there something else going on?

No.

I wouldn't say there's anything unusual going on.

It was just--India was a little bit higher than say China, but it was pretty slow across most of the end markets.

Again, Steve, I mean, although we're talking about year-over-year, a year ago those markets were a lot hotter than what they are today.

So it's a decline in year-over-year, but there is still growth in Asia.

No.

Right.

I understand.

I was just trying to get the sense of the difference between industrial production or that growth versus what's happening to your revenues there and trying to get to--again to a market share question.

Yes.

But it all depends upon if we're a little bit stronger in automotive or general engineering, if those customers are shut down.

It's really tough to gauge that, but I mean that's the best I can give you at this point.

Okay.

I can tell you that we're not losing market share in Asia.

Are you gaining market share in the downturn?

I mean, again, it's hard to tell because the changes are so rapidly.

Things are coming down so fast.

Looking at orders that--and bids that we do and quotes that we do, I can tell you that we are in a good position.

Okay.

[Relative] (inaudible) markets.

And just to follow up on the prior question to mine.

Frank, you said that you should--you do have some benefit from lower cobalt and steel built into the back half expectation?

Correct.

Okay.

And were--you were buying ahead on steel a little bit, right?

And has that--has all of that higher priced inventory already gone or you're just expecting it to tail off in the back half?

Yes.

I wouldn't say there's much there.

And we would never buy a significant amount forward--some of the orders we have.

But it's not going to be a major driver or a drag in the second half.

Okay, great.

That's all I have.

Thank you.

Your next question comes from the line of Henry Kern of UBS.

Good morning, guys.

Good morning.

How are you?

Good.

Within advanced materials, mining and construction was still up in the quarter.

Could you give a little more of a breakdown between what you're seeing between the two?

Is mining up and construction down?

Yes, I would say mining was probably a little bit stronger than construction in the quarter, and then construction has a seasonal impact.

So--and I would say mining continues to be a little bit stronger as we head into our third quarter.

Okay.

And in terms of your visibility at this point in the cycle, could you tell us a little bit about how far out you can see today versus maybe six months ago or a year ago?

Yes.

We typically don't see that far.

I mean, again, we--our--we ship our orders pretty much within the month.

So we depend on the models that we have, we depend on the industrial production, and so forth.

So we're not a backlog company.

Okay.

Maybe if I can speak one more in.

If I step back, what signposts are you looking at to say that maybe things could turn around?

What end markets do you think could actually pick up or--?

--I think that we're going to continue to see the energy decelerating.

We're going to continue to see mining and automotive--we'll continue to see that to be there--be down for a while, six to nine months.

I think [of] the industries [that are typically] challenged, engineering comes back first and aerospace has an opportunity to come up first.

Yes.

Henry, I think aerospace will probably be a little sooner, and then stimulus related players will--they'll probably--whether it's some OEMs and as Carlos said, the general engineering, the job shops, we're supporting some of them in the bigger OEMs.

But we'll keep a close eye on them as well.

Okay, thanks a lot.

Thank you.

Your next question comes from the line of Dana Walker of Kalmar Investments.

Good morning.

Good morning, Dana.

Could you talk about the difference in your revenue performance between consumable products and tooling?

Well, we look at it as one and the same.

And I think as we've shared with you in the past, 80% of our business is consumables, so that's the lion's share.

I mean, we'll have some durable good pipe orders on the steel side and we have some different parts of the business on some OEM equipment.

But the lion's share of it is definitely the consumables side.

As you go through this weak period though, are--is the tooling side--is that weaker still or are they roughly equivalent?

They're equivalent.

The company raised its capital expenditure program starting in fiscal '08 and expected to do more so in '09.

Can you talk about having spent that money what that will allow you to do on either headcount or on footprint that you might not have been able to do otherwise?

Yes.

It's actually three elements, Dana.

All--the majority of our capital spend supports new products.

New products have higher value.

We get higher margin on those products.

Okay?

And we get less price pressure on a downturn.

The other portion was for obviously--to reduce our costs and be able to close some of our facilities that we have announced.

So part of our restructuring is taking advantage of that capital that we have invested in.

And obviously, as we move more internationally, a lot of our capital was invested outside of the--outside of the western economy, so that's going to help us to continue to reduce our costs and grow in those geographies.

Frank, your year-end inventory target might look like what?

Lower--lower than today.

I'm hoping to take out another 25 to 50 million at this point.

But it's just going to be dicey as we get a little bit more visibility going forward.

But we're going to continue to focus on reducing inventory.

And a final though, in 2010, or your fiscal 2010, you would expect the full benefit from this $100 million in cost structure reduction or would it be phased?

No.

No, that--we will--we're going to exit this year at a pretty high run rate.

But in fiscal '10, we expect to realize $100 million associated with the cost to serve and the actions announced in January.

So the answer is yes.

And you would think generally or within a range your CapEx in '10 might look like what?

At this point I can tell you less than 100 million until we get in a little bit more detail to see how it goes.

Thanks for your help.

So long.

Thank you.

This concludes our Q&A session.

I will now turn the conference back over to Quynh McGuire for closing remarks.

Thank you for joining us today.

This concludes our discussion.

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

Thank you.

Today's conference will be available for replay beginning at 1:00 p.m.

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