Kennametal Inc (KMT) 2010 Q3 法說會逐字稿

My name is Carrie and I will be your conference facilitator today. At this time I would like to welcome everyone to Kennametal's third quarter fiscal year 2010 earnings 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 session. (Operator Instructions). At this time I would like to turn the call over for Quynh McGuire, Director of Investor Relations. You may begin your conference.

Thank you, Carrie. Welcome, everyone. Thank you for joining us to review Kennametal's third quarter fiscal 2010 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 and 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 May 29, 2010.

I'm Quynh McGuire, Director of Investor Relations for Kennametal. Joining me for the call today are Chairman and President, Chief Executive Officer Carlos Cardoso, Vice President and Chief Financial Officer, Frank Simpkins, and Vice President, Finance and Corporate Controller Marty Bailey. Carlos and Frank will provide further explanation on the quarter's financial performance. 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 uncertainties is detailed in Kennametal's filings with the Securities and Exchange Commission. .

In addition, Kennametal's provided the SEC with a Form 8-K, a copy of which is currently available on our website. This enables us a to discuss non-GAAP financial measures during the call in accordance with SEC regulation G. This 8-K represents GAAP financial measures that we believe are most directly comparable to the non-GAAP financial measures and provides a reconciliation of those measures as well.

I will now turn the call over to

Thank you, Quynh. Good morning, everyone. Thank you for joining us today.

I am pleased that we have seen marked improvement in the global economic environment, a strengthening that was evident across a number of manufacturing and other industries. During our fiscal 2010 third quarter we saw a rebound in many of our industrial end markets as well as continuing growth from developing markets, ongoing recovery in North America and some improvement in Europe. We experienced sequential quarterly revenue growth. Revenues grew by 11% on an organic basis from the December quarter, the third consecutive quarter of sequential growth. We also saw year-over-year organic growth of 11%.

We are encouraged by the positive macro trends. The economic recovery seems to be gradual but increasingly broad-based. Our customers have began to rebuild their inventories, although still conservatively. As always, we continue to focus on our value selling approach. The products in our portfolio are designed to provide customers with higher productivity, and this value position is recognized in the marketplace.

Our adjusted earnings per share of $0.39 for the March quarter reflect a sequential improvement of $0.25 from the December quarter. The sequential improvement in EPS was driven by higher sales volume as well as strong operating leverage.

As a result of our aggressive cost takeouts we continue to realize further benefits related to our restructuring programs. Those represent permanent savings and they are increasing in momentum. Our restructuring initiatives are on track to yield $155 million to $160 million of permanent savings annually, driven primarily by a significantly smaller manufacturing footprint and lower operating expenses.

For the March quarter our restructuring savings were approximately $144 million on an annualized basis. In addition, we continue to generate solid cash flows as shown by free operating cash flow of $66 million to date this fiscal year.

I would like to thank our employees for all their hard work. As of April 1 we have restored salaries for our European locations. This is sooner than originally anticipated, but justified due to the region's improved operating performance. At this time, employees at all of our locations now have their salaries restored to prior levels. We remain vigilant with cost controls while preparing to the improving economic conditions.

From a macro perspective I would like to discuss our view of certain end markets served. In transportation, the industry is expected to keep trending towards hybrid and more fuel efficient models. In addition, alternative materials are more and more being viewed as possible replacements for current materials such as steel. Kennametal can leverage our product portfolio expertise in those nontraditional materials in order to minimize both investment and time to market. Along with continued global emphasis on hybrids, OEMs need to provide a high volume, cost efficient powertrain that can be leveraged across platforms. In this area, Kennametal is focused on providing our customers with highly competitive manufacturing technology.

In energy, active US grid counts have increased significantly. For example, the rig count improved 40% on a year-over-year basis. However, the international rig count, which represents approximately 40% of the global rig counts, has remained flat year-over-year. Natural gas in storage is 8% above its 5 year average after temporary increase in withdrawals due to the extremely cold temperature in January and February. Historically, a high level of inventory off the winter month indicates lower drilling activity in the summer months.

In the mining market, thermal coal stockpiles have been reduced to about 51 days of supply. Also, metallurgical coal prices are relatively high at approximately $90 to $95 per ton, primarily due to demand from overseas. Those factors are key drivers in maintaining demand for Kennametal products in the underground coal mining.

In the road construction, the recently passed legislation for the USA HIRE Act signed in March will make federal funds available for highway construction through December 2010. This legislation is expected to have a favorable impact in the industry as it represents confirmation of the normal and planned work in many regions of the US.

In aerospace, consolidation within the industry is expected. The need to update airline fleet is not expected to be impacted. However, there may be delayed timing due to financing issues. Some key OEMs are expected to re-engine their models and this is expected to translate to increased activity for Kennametal within the next 18 months.

Regarding our near term strategies, we have achieved our goal of operating profitably at the $2 billion in annual sales and be capable of delivering double digit EBIT margins at $2.1 billion to $2.2 billion in sales. As a reminder, we expect that our manufacturing footprint will be reduced by 20 facilities in total when restructuring initiatives are completed and including divestitures. However, we have maintained much of our operating capacity by continuing to implement lean practices. Therefore, we strongly believe that our existing manufacturing infrastructure as the ability to accommodate sales volume of up to $3 billion in sales without having to make significant additional investment.

Overall, I'm pleased that sales, operating results and earnings per share increased again on a sequential basis. Our global team has been disciplined in its efforts to streamline our business and lower our cost structure. The strong operating leverage reflected in our March quarter performance is consistent with our strategies to reposition Kennametal to fully maximize our growth potential.

Moving forward, we remain focused on generating strong cash flows, maintaining a solid financial position, managing our portfolio and growing our business. We will continue to further expand our profitability which will help differentiate Kennametal as economic conditions continue to improve.

I will now return the call over to Frank so he can discuss our financial results for quarter in greater detail. Frank?

Thank you, Carlos. I will provide some comments on our performance for the March quarter and then I'll move on to the outlook for the remainder of the fiscal year. Some of my comments will exclude special items so please refer to the reconciliation schedules we provided in our earnings release and related form 8-K.

Overall we had a solid March quarter. The quarter's performance was vastly different than one year ago. In terms of our performance, we exceeded our expectations for sales, earnings per share and free operating cash flow driven by better than anticipated sales, benefits from our restructuring actions and ongoing cost discipline.

Both business groups reported strong results and very good incremental margins. Our sales increased year-over-year by 11% on an organic basis and we were slightly above the high end of our guidance of 5% to 10%. Additionally, sales improved sequentially by 11% compared to the December quarter representing the third consecutive quarter of sequential growth.

Our adjusted earnings per share for the March quarter were $0.39 driven by higher sales growth, increased capacity utilization, higher permanent savings from our restructuring action and continuing cost control. We also delivered free operating cash flow amounting to $66 million year-to-date driven by our operating performance and continue to focus on the balance sheet.

Now, I will walk through the key items in the income statement. Sales for the March quarter of $493 million, this compares with $424 million in the March quarter last year. This change represents a 16% year-over-year increase driven by 11% organic growth and a 5% favorable impact from foreign currency effect. As I previously mentioned, sales from the March quarter up sequentially from the December quarter by $50 million, or also 11%. Improvement to sales was driven by continued expansion in industrial activity in the majority of our markets and all geographies.

Turning to the business group sales performance -- MSSG sales were up 19% from the prior year quarter, driven by an organic growth of 13% and favorable foreign currency effects of 6%. Regionally, MSSG experienced improved trends in all markets, and all geographies and had organic growth. On an organic basis, India sales increased 64%. Asia Pacific was up 45%. And North America, Europe and Latin America each reported organic increases of 7% compared to the prior year quarter.

Key segments driving the growth in the quarter in order of contribution were transportation, as Carlos talked about, which is clearly the strongest segment, followed by general engineering, aerospace, which continued its recovery, and energy which displayed significant recovery for the unit. We know there was some inventory rebuilding benefits in our numbers but as you know it is difficult to quantify.

MSSG sales increased sequentially by 12% from the December quarter. Sales gains were made in all locations and the majority of locations experienced double digit sequential growth. This is the third consecutive quarter of sequential sales growth for MSSG.

AMSG sales were up 13% from the prior year quarter, driven by 9% organic growth and 4% favorable impact with foreign currency. The organic increase was primarily driven by a higher sales of mining construction products as well as increased demand for energy related and engineered products. Sequentially AMSG sales increased by 11% from the December quarter. All of the units within AMSG posted sequential growth except for the capital equipment sector.

Now, I will recap our operating performance. Our reported gross profit margin was 34.5%, up for the quarter as compared to 24.1% in the prior year March quarter. Our gross profit margin also improved sequentially 290 basis point compared to the second quarter of fiscal 2010. Compared to the prior year, we experienced strong improvement in our gross margin due to good leverage on sales volumes, increased capacity utilization, benefits from our restructuring initiatives and other cost reduction actions. Further, we were able to restore salaries in all locations within the quarter except for Europe which was restored in April and we also resumed the company 401(k) plan match in the month of March.

We have very strong incremental margins both year-over-year and sequentially including the effects of furloughs and compensation action. On a sequentially basis, incremental margins of 58% the same as in the prior quarter. But I will point out in the current quarter we maintained our incremental margin of 58% while absorbing a portion of our temporary cost action. Our margin performance validates our restructuring initiatives are delivering real permanent cost saving.

Our operating expense increased year-over-year by 13% or $14 million to $120 million. This increase is mainly attributable to foreign currency rate exchange fluctuations, higher incentive comp, higher spending on professional fees to implement long-term strategic projects in the IT area, and increase in restructuring and related charges and other miscellaneous increases, offset some what by lower employment costs as a result of restructuring and cost management activities.

Our restructuring actions are performing as expected. During the quarter we achieved benefits of $36 million, while incurring costs of $23 million. An additional item worth mentioning is that the combined total pretax charges are now expected to be $160 million to $165 million, a slight increase from the previously announced range of $155 million to $160 million, and this increase is due to recent legislation retroactively extending the period for benefit coverage under COBRA for certain previously terminated employees. So to summarize we are on track to deliver the permanent cost reductions from the combined restructuring programs of $155 million to $160 million annually.

Another topic of interest has been the recent healthcare legislation signed into law and the tax deduction related to the Medicare Part D subsidy which has been eliminated. The change in legislation caused us to recognize approximately $200,000 of expense in the current quarter, a very small amount.

Operating income increased to $26 million in the March quarter compared to an operating loss of $150 million last year. Absent the restructuring reported in both periods and the asset impairment charge reported in the prior year period, operating income $49 million compared to an operating loss of $6 million in the prior year quarter. Excluding charges we achieved 10% operating margin for the quarter, a key milestone for the fiscal year. The year-over-year improvement was driven by the sales increase, increased capacity utilization, our restructuring benefits and ongoing cost discipline. As I have noted previously, our incremental margins were very strong above the year-over-year and sequential basis and the current quarter includes salary incentive compensation restoration.

Looking at the business group operating performance, MSSG's operating income was $31 million compared to an operating loss of $39 million for the same quarter one year ago. Absent the restructuring and related charges in both periods, MSSG's operating income was $36 million, compared with an operating loss of $14 million in the prior year quarter.

We are pleased to note in the March quarter MSSG returned to double digit operating performance despite absorbing partial salary restoration and related matters. The primarily drivers of the performance were the higher sales volumes, better capacity utilization, cost savings from the restructuring programs and also cost containment. MSSG's operating margin improved sequentially from the December quarter by 870 basis points or 3.6% to 12.3%. And compared to the December quarter, MSSG's operating income increased $26 million on a sales increase of $30 million.

Advanced Materials -- their operating income was $25 million in the current quarter compared to an operating loss of $103 million in the prior year quarter. Absent restructuring and related charges and asset impairment in the both prior period, Advanced Materials' operating income was $37 million in the current quarter compared to $18 million in the prior year. The year-over-year increase in operating income was primarily due to also higher sales, increased capacity utilization and efficiencies, cost savings from restructuring, and cost discipline. AMSG again achieved a strong double digit operating margin of 18.4% in the quarter, which was also higher than the 10.1% last year and sequentially higher than the December quarter at almost 17%.

Corporate operating loss was $30 million compared to $9 million in the same quarter last year. Absent restructuring and related charge in both periods, the corporate operating loss was $24 million compared to $10 million in the prior year. The year-over-year change was primarily due to increased incentive compensation, higher professional fees for the implementation of our long-term strategic projects of an IT nature, and higher employee benefits primarily related to the discretionary 401(k) contribution. Lastly, our fiscal 2010 third diluted earnings per share were $0.12 compared to the prior year loss of $1.90 and adjusted earnings per share were $0.39 compared to the prior year adjusted earnings per share of $0.01.

Turning to the balance sheet -- We continue to place a lot of focus on driving work and capital improvements, and we remain focused and diligent on receivable collection. We further reduced the DSO during the quarter by five days to 60, and only slightly increased inventory level despite relatively higher increase in sales. Specifically during the quarter inventory increased 1% on an 11% sales increase.

Our capital expenditures were $30 million for the first nine months of fiscal 2010 compared to capital spending of $93 million in the same period one year ago. Year-to-date capital expenditures net of disposals were $26 million representing approximately 2% of sales.

At March 31 our total debt was $336 million, down $150 million from the June year end. This was driven by the application of the proceeds from our equity issuance in July, the proceeds from divestitures around improved free operating cash flow. Our debt to capital ratio at March end was 19.7% compared to approximately 28% at June 30, 2009. Lastly, our US defined benefit pension plans remain well over 100% funded.

Cash flow from operating activities for the current nine months was $93 million and as I previously mentioned free operating cash flow in the current period was $66 million year-to-date.

Looking at the outlook, as a result of better visibility across our business we have notably improved the outlook for adjusted earnings per share and free operating cash flow.

We had previously taken a conservative view given the uncertainty in the markets but now feel more confident and our served end market. Therefore, as a result of better than anticipated global sales including some effects of customer inventory rebuilding we expect our organic sales growth to be 37% to 40% higher in the June quarter compared with the prior year period. This will result in our fiscal 2010 organic sales that are 7% to 8% lower than last year.

Under these assumed conditions, we are increasing our earnings per share guidance for fiscal 2010 from a range of $0.65 to $0.75 per share to a range of $1.03 to $1.08 per share excluding restructuring actions and divestiture. The increase in earnings per share guidance also takes into consideration the final salary restoration for all locations and a slightly higher effective tax rate due to anticipated journal mix of earnings.

Our cash flow from operations expected to be in the range of $145 million to $155 million for fiscal 2010 based on net capital expenditures of approximately $55 million, the free operating cash flow range was increased from $40 million to $50 million to a range of $90 million to $100 million for the remainder of the fiscal year.

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

Thank you, Frank.

Today, Kennametal is better positioned than ever to serve our customers. Thanks to the dedicated efforts of our global workforce. We have a great team of employees across the world, they have gotten us through the challenging times. We have made difficult decisions over the last two years to reposition our company, streamline our cost structure, manage our product portfolio and maximize opportunities of profitable growth.

The strong operating leverage reflected in our March quarter performance is consistent with our strategies. In addition, we have generated solid cash flows and maintain a strong balance sheet. We believe that the current fiscal year will contribute -- will continue to benefit from the gradual recovery on the topline growth.

At this time we believe that there is adequate visibility to provide our base case as guidance for the remainder of 2010. As always, we will take advantage of the operating leverage that will result from permanent cost savings. We will maximize all opportunities to realize strong incremental margins, grow our business and drive earnings growth.

At our current sales level, we are operating profitably and are now highly scalable. We can support up to a $3 billion in sales without substantial addition in capital investment.

In the meantime, our long-term strategies remain consistent. We remain focused on continuing to balance our geographic presence, business mix, and served end markets. We believe that our strategies will continue to serve us well. We have a strong foundation and we continue to have a reputation of bringing technology and innovation to our customers. Kennametal's significant strengths provide us with the confidence to say that we are capable of achieving our next milestone of 15% EBIT margin and delivering superior value to our shareholders.

Thank you for your time and your interest in Kennametal. We will now open and take questions. Thank you.

(Operator Instructions). Your first question comes from the line of Eli Lustgarten of Longbow Securities.

Good morning, everyone. Very nice quarter.

Thank you, Eli, good morning.

A series of specific questions on financial stuff and then general questions. One, tax rate you are applying for the fourth quarter is also 27% and idea for the tax rate for next year. Does it go down or does it stay similar?

Eli, I would say it is closer to 28% in the fourth quarter.

It was 27.6% in this one I calculated ex adjustment. Is that correct?

The effective tax rate was a little over 26% in the quarter. It will go up a little bit given the mix of earnings. And at this point it is a little bit early but hopefully we will be able to bring that down in fiscal 2011.

Back down to the 25% level that we were expecting. Is that sort of a reasonable expectation?

At this time, probably.

And corporate expenses you said were $24 million. Is that the new ongoing rate for awhile? For the fourth quarter and for next year, the quarterly rate I mean?

I would say that that is probably fair in the fourth quarter. The $24 million. Obviously we will see if we have some further reductions going forward but I think that is a safe modeling assumption at this point.

And do we just annualize that for next year and going to go up or have any feel for a direction of that number next year?

I wouldn't imagine that changing much going forward.

Okay. Foreign currency assumption -- it looks like, you know, you had very good foreign currency results in this quarter but with the change in currencies are we looking at any foreign currency benefit in the fourth quarter?

If you take the euro, we probably average $1.40 Euro in the third quarter probably obviously down 4% sequentially so a slight drag particularly on the currency.

We should assume that currency is roughly a break even at this point in the fourth quarter?

Yes, break even. It could be slightly negative but nothing major.

Okay. Next can we talk a little bit about the impressive margins in Advanced Materials and the double digit margins in metalworking and obviously the question of sustainability of these margins as you go forward from not only the fourth quarter but particularly for 2011. Is it fair to say that we can hold the margins in Advanced Materials at this point through even fourth quarter and into next year?

I will say that, again, we are still in the planning process, Eli at this point for 2011. We are focused really on finishing this year. But I would say that we are in the Advanced Materials going to be trying to maintain that level of margin.

And more importantly in metalworking, I assume it is fair to assume that we should see further growth in the profitability of that business not only in the fourth quarter but into next year.

I think that is right and you see all the industrial indicators the right way. So we feel good about metalworking and from Advanced Materials I think that mid teens, to set a floor is the right way to look at it going forward.

Sort of a little above in Advanced Materials on a full year average, I'm not talking any one quarter, is what you are indicating, is what that what you mean by that the mid teens?

You are on the right path.

And one final question. Raw material costs are now beginning to surge all over. When do you have some effect on raw materials impact on your business and what are you doing about pricing? I assume that is more of a 2011 problem than 2010 problem at this point but talk about the impact and how you handle that with pricing.

Again, we are still just in the midst of putting the plan together for 2011. All I can say is that we have demonstrated over the years that we can recover raw materials. So, at this point we don't think that raw materials are going to go through the roof. I think there is a broad base of thinking up there. I don't think the demand is going go to the high levels of the 2008. Until the demand gets up there, I don't believe that we going to see the same level of commodity pricing that we saw in the 2008 and 2009 time frame.

Your next question comes from the line of Ann Duignan of JPMorgan.

HI. Good morning, guys.

Hi, Ann.

A lot of my questions have been answered. Maybe talk about the trends you are seeing in April now that we are almost through April versus what you saw through the end of March. Are you seeing a continuation in the acceleration and market demand? And you also emphasized a few times I thought that your are still seeing some restocking. Can you talk a little bit about what you are seeing that and whether it is a concern to you or not?

Yes, Ann, I would say that, you know, to date our orders are in line with our guidance and, you know, again the stocking has been -- is very conservative. I mean I think our customers continue to buy only what they need when they need it. I mean our fill rates are very good in the high 90s. So, we have -- we really don't have a concern that this point relatively to any environment that would be overstocking.

Okay. And then just a follow-up on pricing. Would you anticipate any pressure on pricing as you see the recovery take hold in particular from European competitors who may be more at an advantage because of the weakness in the Euro. Would you anticipate any kind of pricing pressure as we come out of the downturn in any of your segments?

No, because I mean I think that everybody has been rational in the marketplace pricing with our competition. We just don't see that big of a change.

Okay. That's helpful. I'll get back in line, thanks.

Okay.

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

Good morning, guys.

Hi, Henry.

Hi, Henry, how are you?

Good. Congratulations on a good quarter.

Thank you.

I was wondering if you could chat about the end market application balance today as it differs from how the application balance ended in fiscal 2009?

I'm not sure -- from what perspective, Harry?

Sure, in terms of what percentage of your sales went to the various categories by end market. Is there any way to break down through has changed today versus where it was a year ago?

I'll start and then Carlos can -- obviously I think transportation is number one as I alluded to particularly with some strength in the metalworking side. Energy is starting to come up. Last year it was a very challenging time, I think for our business so we are seeing an uptick on the energy side. And the mining is kind of flat. We will start to see the sequential change for construction as the season started in mid May. And then we are seeing broadly across all geographies, general engineering, kind of the stuff that would go into the tier 1, tier 2s we are seeing that pretty much across-the-board be up. The only other one I think is down is the capital equipment in some area but nothing notable.

It has been very consistent since the beginning of the year with our expectations. Motor vehicles being the leading and we are seeing some metalworking which is the general industry coming back very strong. Pumps and all that small equipment out there.

Thank you. And is it possible to just aggregate with you expect for organic sales between the segment's fourth quarter and maybe give what you are baking if for the currency effect?

We gave the organic numbers, you know, as you know, 37 to 40, I would say that MSSG will grow slightly faster on the Advanced Materials side but we technically don't break out the organic by business unit.

And on the currency side?

Currency will be sequentially from the third quarter to the fourth will be negative given the strengthening of the dollar. So as I think I answered with Eli we will have a slight, you know, negative but nothing significant in the fourth quarter. Maybe 3% negative topline at that.

Anything to the bottom line?

No, it really -- really it doesn't have a significant impact one way or the other.

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

Good morning, everybody.

Hi, Andy.

In past conversations -- a couple of questions more long-term because most of the quarter and near-term outlook interest been covered. If we look at this recovery being similar in past conversations you kind of talked about it being similar to a mid 1980s type of recovery. Is that still the case or are you seeing more acceleration than you would have thought a couple of months ago?

It is still the same.

I think that this is going to be a steady, you know, broad-based, you know, slower recovery.

Okay. Thanks. And then I mean the incremental margin performance in the quarter was quite impressive even if you X out, you know, restructuring permanent benefit and the compensation stuff. If we look at, you know, how we should kind of view the core incremental margin improvement and how that might play out into the future, if you look past kind of the Q4 and I know you haven't gone through your entire planning process for, you know, fiscal 2011 yet but kind of directionally if you exclude remaining restructuring expense, any future commodity inflation and then the puts and takes kind of more near term and compensation furlough, you know, would you expect the incremental margins to remain above the 40% through 2011 or is it too early to tell?

I think it is a little early, Andy, as we are going through this because as you know we will have some additional restructuring benefits that come into the following year. And, you know, when we get to the fourth quarter we are fully loaded now so the fourth quarter will be clean meaning those salary reductions are all back in so the fourth quarter on a stand alone basis is a normal type quarter. But I would think we would from a floor perspective expect to achieve at least 40% as we get into the next year. And then obviously we've got to add back some of the temporary measures even though the fourth quarter is fully loaded we have to go back from the first half and add some of them in. We will need to pull them out to give you guys a better understanding. But directionally, I think that is where we are head.

Our expectation is that we get 40% incremental margin due to the cycle.

Okay, thank you very much.

Your next question comes from the line of Adam Uhlman of Cleveland research.

Hi, guys, good morning.

Hi, Adam.

Hi.

Just to start first with the metalworking margins. They are exceptionally strong compared to last quarter. Sequentially sales were up $30 million and earnings up $26 million. So I'm wondering if there is any one-time type of items in there or if you could talk about the impact of customer mix or what would drive the conversion rate so high?

First of all, you got to -- in the big scheme, you know, the restructuring benefits were up sequentially now, $36 million compared to about $30 million last time and I think we discussed this, the entire program on this -- the 155 to 160, 65% of the benefits go to MSSG. So we are really seeing a very good leverage on the investments that we have made on that. The plant closures as we talked about, we had some divestitures where we removed some underperforming businesses. And then it is the ongoing cost discipline and the mature markets coming back where Europe was lagging and North America was lagging so they are both up sequentially double digits. So we are leveraging extremely well given the efficiencies and the actions we have taken in consideration. So we feel pretty good about it.

Along those same lines you have taken a lot of capacity out, a lot of personnel. I'm wondering if you are starting to experience any growing pains yet?

Yes, Adam, we have been very, very consistent. We did not take any capacity out. I mean again, our -- as I said in my -- earlier this morning, our intention during this -- all this restructuring is that we move the capacity from the plants that were closing into larger plants so that we can absorb and grow up to $3 billion without major capital equipment investment. So we feel really, really good. We are very well positioned to continue to deliver in the upturn.

Okay. And then just lastly on the metalworking business down in Latin America. The growth rates there some what tepid compared to other emerging markets and I just wondered if you could talk about what you are hearing down there. Any kind of competitive issues that is unfolding or just comparisons?

Just comparisons. Again, Latin America is driven a lot by the North America, especially in the transportation area. So, and, you know, you have months there you have good impressive growth rates and you have months that are not as impressive. But we feel overall pretty good about the growth and the opportunity in Latin America.

Great, thanks.

Your next question comes from the line of Holden Lewis of BB&T.

Good morning, thank you.

Hi, Holden.

How are you?

Fine, thanks. Since you seem increasingly confident to talk about that 15% margin number, is your confidence any greater in talking about the timing either with respect to, you know, perhaps the approximate year or I guess more relevantly maybe where the revenues are to get there?

Yes, we are hoping that we can do that when we do our annual analyst meeting after we give guidance for the FY 2011.

Okay.

So we need to finish the planning and we are still working on dates for that meeting we really need to finalize our FY 2011 first.

Regardless of the timing -- I guess if I look at the simple math here, if you are looking to sustain the AMSG margin kind of at that 17%, you know, where you might sort of come in ballpark this year, and then if corporate is going be a 400 to 500 basis point drag, MSSG kind of has to make up the difference and that suggests that MSSG must be, you know, north of 15%, well north of 15% to achieve that. I mean is that right? Is that -- are you kind of envisioning that MSSG business being a high teens kind of margin business?

You know, Holden, that was pretty much the big reason we did a lot of the restructuring with some of the facilities there because as I said earlier, you know, a big chunk of that restructuring benefit, 65%, give or take a couple of points there, are going towards MSSG so the trajectory that we see on MSSG is to have very strong performance.

Okay. So yes, I mean high teens type margins, I mean that is kind of what you are envisioning for that business in the wake of all these cost cuts?

Yes, and if you look at from a stamping perspective, you know the business how they perform -- Seco, and the high teens they have and there is no reason we shouldn't close that gap.

With respect to the gross margin, I mean gross margin increased quite a bit. And as you noted your inventories really didn't move a whole lot. Can you speak to, you know, to production rates? I mean did inventories stay flat just because you did raise production and get that leverage, it is just the demand ran so quickly that you weren't able to build your own inventories? Or, you know, was production not ramped up all that much to keep inventories down and therefore the gross margin came from some place other than the net absorption?

I think it is probably a little bit of each one there. We have been pretty much focused on realizing the benefits from our SKU reductions and some of the messages we had last year. Inventories were up 1% I think I said in the call there and we are going to continue to manage that closely, you know, if a cash flow perspective. So to your point there is no significant benefit built in from my inventory build. We try to manage it. We think we have our fill rates in the right area. We think we have a better mix of business and I think you are seeing the restructuring benefits and the volumes vis--vis the efficiencies in the plants in both businesses.

Did production go up in the quarter?

Absolutely, yes.

It was just all flowing out with demand.

Yes, yes.

You did get that absorption effect. Last thing, just also your SG&A dollars were pretty flat I think sequentially as well despite a pretty good step up in revenues. You know, again, is that just reflecting, you know, not -- you had to add some costs back in obviously. I guess that is just, you know, whatever you are adding back in on the front door you are taking out of the backdoor with the restructuring costs and that is kind of neutral. When does that line cross and you begin to see SG&A dollars go up again with volumes?

Probably in the beginning of next year. We may see a slight pickup in the fourth quarter. But we still have some actions that have happened during the quarter so we will still get some incremental restructuring benefits going forward on both SG&A as well as cost build. I think it is more into next year.

Your next question comes from the line of Chuck Murphy of Sidoti.

Just wanted to ask a little bit more about kind of potential for your long-term margins. If I were to assume that you guys could in a few years get back to that $2.7 billion in sales you did in fiscal 2008, could I then just add back that $155 million to $160 million in cost savings to get to a new operating profit level?

Yes, I think that is directionally what we have been saying all along.

Okay. That's all I had. Thanks.

Thank you, Chuck.

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

Thanks, guys.

You're welcome.

You're welcome.

I wanted to ask some questions, too, about the leverage because it is really impressive. I wonder, you know, when I calculate it I'm coming up with year-over-year 60%. And as someone else mentioned, you know, it was closer to 100% quarter over quarter. You know, at one point does it leverage down -- does the leverage go down to that 40% because it seems like you are being conservative saying 40% through the cycle, you know, could you continue with like the 60% for, you know, the next few quarters and then what costs are coming back?

Well, Walt, from a fourth quarter, I expect, you know, embedded in our guidance is -- and if you would take into consideration the salary restorations for Europe which was the final straw of bringing back the costs, you know, the real numbers are in the mid 40s, high 40s at that point. If you take these other costs into consideration you are back into the same levels that we had in the March and June quarter. Now, you know, as we discussed last quarter we had a couple of other manufacturing plants close in the March quarter, start seeing those benefits sequentially. So we should be able to maintain short-term higher levels and then slowly creeping down towards the number that Carlos talked about, the 40% over the cycle.

The 40% we think about in a three year period and/or until we get to a rate of equal to that we were in 2007, a sales rate, a volume rate of that.

Okay.

So from now to then.

Okay. And the --

We will be higher in the beginning and then obviously trend down as we get closer to the historical levels.

Okay. You mentioned -- I may have missed this but the restructuring charge that you took this quarter, what is that for? Did you give us detail, people, plans, region?

We had two facilities in the quarter and the rest was on headcount reduction. And I would say it was probably split maybe 60% the last quarter in Europe and the rest all over the world. And we had the closure of the Netherlands which was two big manufacturing plant there.

Okay. And I know you probably don't want to go into too much detail but the restructuring that you alluded to for 2011, is that North American based, European based, how should we think about that, and the size?

About equal.

North America and Europe.

Yes, they are the main -- I mean that is where the facilities are.

Okay. Thanks, guys.

Thank you, Walt.

Your next question comes from the line of Terry Darling with Goldman Sachs.

Thanks, good morning.

Hi, Terry.

Hi, Terry.

Just wanted to get a couple of clarifications here first on the restructuring. Did you call out, Frank, what that savings number in the fourth quarter that would comp to the $36 million this quarter? Did you call that out or maybe I missed it?

We didn't provide that but we should continue to see slight improvements and we will be at the 155 to 160 run rate next year.

Okay. So trending towards the $40 million a quarter type of level?

Right, about that.

And this other, you know, additional 11 restructuring would be on top of that?

No, I don't know where you got that number, Terry.

From Walt's last question. I think you alluded to some additional restructuring in 2011 but maybe that is in the current savings plan?

Yes, that's just a -- by the end of the year, I would imagine costs to wrap up the program's existence, probably $20 million of costs that will fall into 2011, predominantly in the first half and more so in the second and first quarter with an increase in additional benefits in the 20s as well next year.

Year-over-year carryover benefits in fiscal 2011 of about $20 million.

At least, yeah.

That's helpful. And then the 15% margin target, just to be clear, talking about at the segment level or inclusive of the corporate expense.

That would be all in.

Operating income EBIT level.

Yes.

Got it. Okay. Just on CapEx, I think the number for the full year implies a move up in 4Q but I wasn't clear, is that a $20 million implied number for 4Q or a $30 million implied number for 4Q?

Actually, right in the middle, Terry, about $24 million.

And in terms of, you know, the 2011 thought process at this point, is that a run rate or do you think you would be building from there?

When we come out -- I would say next year we will probably be about 3% of sales.

That is helpful. And then interesting commentary, Carlos, on some of the rig count discussion earlier. I wonder if you could update us on of your drill bit related business. Where is that mix between international and domestic right now? And on the domestic side, where do you think that is oil versus gas right now for Kennametal, not the market?

The majority of our drill bits are into gas. We really cannot break internationally because we sell to the Schlumbergers and the Schmidts, and then they sell outside of the US. Do you follow what I'm saying? We don't sell that much directly outside of the US.

So you are selling -- I mean you know -- I guess wouldn't you know that some of our international plants are selling that product into them?Or is that all into their US facilities and then they distribute from there?

It is at least two thirds North America and maybe a third globally.

Okay.

So two thirds we would know for sure because we sell to companies that ship them internationally.

Okay. And Carlos, with the debt to cap coming down and the outlook for free cash flow improving can you tell us where you are in the process of maybe evolving back into some focus on M&A?

Well, I think again if the FY 2011 plan is going to come out as I anticipate, I think that we are in FY 2011 are going to go back to the same use of priorities of cash, of which is M&A is number one and, you know, obviously returning some, you know, dividends and so forth. But we are going to have -- we have been engaged with companies throughout the down cycle, and we have quite a few companies in the pipeline and when we feel comfortable we can make some return back to making some nice acquisitions hike we have in the past.

And just lastly, Frank, I know you said it is tough to calibrate what the inventory restock benefit was. I wonder if you have any stab at that one for us at all. Are you anticipating that the pace of that continues at the current level into the June quarter or tails off or any additional color there would be helpful. Thank you.

That is a tough one. I don't know if I can give you a specific number. It could be equal or flat to the March quarter into the June quarter. You know, we had an unusual March in that January was a little bit buff and then we had some of the weather so I think people bought a little bit more. March was strong and then as far as the fourth quarter from what we are hearing, no significant change one way or the other but give a specific number with all the different customers we have, it varied.

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

Hi, guys, how is it going?

Hi, Joel, how are you?

All right. I wonder if you could break down the international a little bit and give us geographically how much is Europe and the emerging markets. What I'm trying to dig a little more to -- I know you have enough capacity to get to $3 billion, but the recovery feels a little uneven, not through your numbers I just mean in general, and maybe some of your emerging market plans might be a little more stretched than stuff in more developed markets?

Yes, I mean if -- I'm just taking a stab at that. North America is about 47% to 48%. And the European -- the western Europe is in the 30s. Low 30s.

A little less.

28 maybe.

Yes.

The rest of the world everything else.

The rest of the world everything else. And we still, you know, I continue to remind you that we do have four facilities in China, for example, which is, you know, where a lot of the growth is going to come from that have a lot of capacity. And we do have still a lot of capacity left in India. And India actually is where the highest growth is going to come from. Number one, India. Number two, China. And then the US and Europe. So, from a geography mix, we don't anticipate the capacity issue as well -- as a matter of fact, we just opened up a new plant in China a few months ago for the mining business.

And so out of that rest of the world, sort of Asia including India would be about two-thirds of that? Is that a fair guess?

Yes, we are trying to be in the big piece. China, India and to a lesser extent I would call it Israel, kind of Middle East.

Okay. Okay. And then I think somebody was asking a little bit about this before but the peak operating margin potential on the AMSG business it looks -- it already is almost back to where it peaked in the last cycle and you have made a lot of structural changes. Think we can get into the -- is there some sort of a longer term target maybe to get into the mid 20s or low 20s at some point? Or is that just too much?

Well, I mean we really -- we really haven't looked at -- we have focused around the 15% EBIT margin for the company, Joel. We haven't -- you know, we really need to look past the -- FY 2011 is going to be our first normalized year in really in two years. So we really need to understand that a little better so before we will commit to something that is out there. There is a lot of potential.

Okay.

But we need to look at it.

Okay. I just figured if you looked at other companies like doing some benchmarking -- is that unheard of that have other companies gotten in that direction and I can follow-up offline. Thank you.

I think the issue with Advanced Materials, that is one of the great things about that business, that is why it is a great business is that we don't compete as advanced materials. There is not another company out there, we compete at the different segments with different companies so.

Your final question comes from the line of Ann Duignan with JPMorgan.

Hi guys. I just had one quick follow-up. I was just curious. Your days payables was lower than your days receivables. And I'm just curious, you know, is that a policy you have in place to pay suppliers before you get paid by your customers? Or is there an opportunity there to close that gap as you go into the cycle?

Ann, it is more the latter than the former.

It is an opportunity?

Correct.

And is it something that you are working on?

Absolutely.

Okay. Because it is curious that most other companies have through the past cycle closed that gap.

Right.

And just one final follow-up. The IT investments, when are those complete?

They go through part of the first half of next year and then maybe through the third quarter.

And they show up in the segment or they show up in --

That is in corporate.

Corporate. Okay, good. Thank you. I just wanted to make sure that I had that, correct. That's it. Thanks, guys.

Ladies and gentlemen, that concludes our question and answer session. Are there any closing remarks?

Yes. This is Quynh McGuire. This concludes our discussion today. Please contact me at 724-539-6559 if you have any follow-up questions. Thank you for joining us.

Thank you for participating in today's Kennametal third quarter fiscal year 2010 earnings conference call. This call will about be available for replay beginning at 1 PM Eastern Time today through eleven fifty-nine PM Eastern Time on May 29, 2010. The conference ID number for the replay is 62135463. Again the conference ID number for the replay is 62135463. The number to dial for the replay is 1-800-642-1687. Or 1-706-645-9291. Again, thank you for your participation. You may now disconnect.