Kennametal Inc (KMT) 2011 Q2 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to Kennametal's second-quarter fiscal year 2011 earnings call.

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

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

(Operator Instructions)Thank you.

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

Please go ahead.

Thank you, Regina.

Welcome, everyone.

Thank you for joining us to review Kennametal's Second Quarter fiscal 2011 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 is also being broadcast live on our website, and a recording of this call will be available on our site for replay through February 28, 2011 .

I am 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 Marty Bailey.

Carlos and Frank will provide further explanation on the quarter's financial performance.After the remarks we'll 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'll 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 achievement 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 within 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 to discuss non-GAAP financial measures during this call in accordance with SEC regulations G.

This 8-K present 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

Thank you, Quynh.

Good morning, everyone.

Thank you for joining us today.

I'm pleased to report that the second of fiscal 2011 was yet another period of strong performance for Kennametal.

We continue to deliver top-line growth and realize strong operating leverage.

We remain focused on executing our strategies effectively and improving our operating efficiency.

The considered efforts of our global team resulted in organic sales growth of 31% compared with prior-year quarter.

Our adjusted earnings per share were $0.57 compared to $0.14 in the prior year period.

The year-over-year improvement in EPS was driven by increased sales volume and higher incremental margin.

It's worth noting that we realized 11.8% adjusted operating margin for this past quarter.

This is another historical high for any first or second quarter.

In fact, the December quarter represents the third consecutive quarter that Kennametal has achieved record levels of adjusted operating margin performance.

In addition, our adjusted return on invested capital was 10.9% as of December 31, 2010.

Overall, the December quarter represents an all-time record performance for Kennametal.

Our second results benefited from a strengthening global economy, which reflected growth in many of our geographies and end-market search.

Industrial production continued to increase, and Kennametal experienced higher customer demand.

Emerging markets, such as China, India and Brazil remain strong.

Our geographic profile continues to be more balanced.

For the December quarter, we generated 56% of sales outside of North America, with 28% coming from the rest of the world regions.

An indicator of ongoing favorable customer sentiment was reflected at JIMTOF, which I attended last month, an industry trade show held in Japan representing Asian manufacturers.

At this event, Kennametal generated two to three times the number of leads than that of the prior trade show.

This favorable trend is consistent with what we experienced in September at IMPS, or International Manufacturing Technology Show.

Also certain end markets, such as general engineering and transportation again showed the most strength.

Current forecasts shows that global manufacturing activity is expected to continue to grow.

In general engineering, production activities continue to grow and represent ongoing rebound in the manufacturing sector.

As the economic recovery continues, increased demand to replace older equipment and a growing need to upgrade productive capacity and increase resource suppliers will produce the next life cycle.

The transportation production volumes for North America remains strong.

This trend is expected to persist in 2011, and Kennametal will continue to benefit from increased build rates.

In Europe, the majority of the demand is driven by exports.

The outlook is for slight growth in light vehicles; however, we expect an extension in heavy truck markets.

We are continuing to see growth in the mass transit market, with new opportunities from all regions, as there's a new railroad infrastructure is built or expanded maintenance.

In aerospace, the commercial market is experiencing a resurgence of orders.

This is an encouraging indicator that the industry is rebounding.

This is expected to be a growth driver for Kennametal in the intermediate to longer term when key programs increase production.

In energy, US and Canadian rig counts were up year over year by 46% and 16%, respectively.

International rig count was 10% higher than the prior year.

Natural gas and storage was 9% above the five-year average, which is more favorable than a year ago.

In earthworks, recent flooding in Australia is restricting coking coal suppliers, leading to higher prices.

As a result, this creates an opportunity for US coking coal producers to supply demand from overseas.

According to global insight, major commodity prices are forecasted to increase another 5% to 10% from the current level in 2011.

High commodity prices support further investment in mining assets and mine capacity expansion, which increases the addressable market from Kennametal's products and services.

During the December quarter, we continue to focus successfully on the value selling approach of our product portfolio.

Our products continue to bring high value to our customers and represent the critical part of their manufacturing processes.

Although raw material costs have increased, specifically tungsten, we believe those costs will ultimately be recovered as we continue to implement price increases.

In general, we increased prices October 1 for North America and January 1 for Europe as well as some income price increases in selected markets in the November and December time frame.

Two of those price sections, we plan to recover 100% of the raw material cost increases in the second half of our fiscal year.

We are on track for faster raw material cost recovery than in the past, and continue to be disciplined in maintaining our margin performance.

In addition, we continue to implement the remainder of our structuring initiatives, which are winding down.

Production activities have ceased at 4 plants slated for closure, and the process is expected to be finished by March 2011 quarter.

When restructuring actions are completed at the end of the fiscal year, we will have reduced our manufacturing footprint by a total of 20 facilities, including divestitures.

As a result of the restructuring programs, we are on track to realize approximately $165 million in permanent savings on an annual basis.

At the same time, we have retained much of operating capacity by using lean processes share production to existing plants.

As we announced previously, Kennametal has formed an enterprise to be a more customer-centric organization.

This is part of building a breakaway company that is competitive and profitable throughout the economic cycles.

With the recent systems upgrades to SAP 6.0, effective on January 3, 2011, we marked the final milestone of this process.

I would like to congratulate our entire team across the globe on this monumental achievement.

Of course, this is not the end of our transformation, but the beginning of a new chapter, and we'll continue to focus on continued improvements.

Our enterprise approach benefits our business by streamlining our cost structure and retaining our permanent savings.

At the same time, it provides opportunities for additional top-line growth by improving our customers' experience with the Company.

In summary, Kennametal has successfully implemented our near-term strategy to resize the Company, and significantly lower our fixed costs.

This enables us to be profitable at below $2 billion in sales.

Our business, however, is scalable to $3 billion without significant additional capital investments.

Kennametal has achieved higher incremental margins during the current cycle due to our actions to aggressively lower our cost structure.

We remain committed to our goal to realize 40% incremental margins over the cycle.

We are disciplined in our capital allocation strategies.

We continue to be prudent in evaluating uses of cash, which included reinvestment in the business, acquisitions, share buyback and dividends.

As always, we remain committed to further balancing our mix in end-market service, geographic profile and portfolio of business.

We will continue to grow our presence in fast-growing channels with our Widia brand where appropriate.

We'll continue to introduce new products at a market leading pace.

We have strengthened our foundation, positioned Kennametal to benefit during an economic upturn, and place our Company on the path to become a breakaway company.

I'll now turn the call over to Frank so he can discuss our financial results for the quarter in greater detail.

Frank?

Thank you, Carlos.

I'll provide some comments on our performance for the December quarter, and then I'll move on to our updated outlook for the remainder of our fiscal 2011 period.

As usual some of my comments exclude special items, so please refer to the reconciliation schedules provided in our earnings release and related form 8-K.

Let me start off by summarizing the quarter and some of the key takeaways as we saw them.

First, global business environment continues to improve, as Carlos pointed out.

We're beginning to leverage our new operational structure.

We again demonstrated strong operating results, free operating cash flow and we further strengthened our financial position.

We have some headwinds around raw materials, but we have been proactively addressing them, and we again increased our outlook through our December quarter performance, improved visibility in the global recovery.

Our adjusted operating income with the December quarter record coming in at 11.8%.

In addition, as Carlos mentioned previously, we performed a major upgrade of our ERP system, SAP, this quarter with a cutoff date of January 3.

And this was a significant undertaking by the entire Organization, and I would also like to thank all of our employees for their time and effort spent on this implementation.

So, now let me walk you through the key items in the income statement.

For sales, our sales for the quarter increased 28% to $566 million.

This compares to $443 million in the December quarter last year.

Increase in sales was driven by 31% organic growth, partly offset by 2% unfavorable impact in foreign currency effects, and 1% unfavorable impact from fewer business days.

This represented the fourth consecutive quarter of year-over-year organic sales growth.

We also continue to make progress with the better balancing of our business, as Carlos touched on.

Again, at the end of the December quarter, 56% of our sales were generated outside of North America, and both rest-of-world and western Europe grew to 28% of sales.

This is the highest percentage of sales we have reached in rest-of-world due in part to the stronger growth and our focus in these geographies, primarily China and India.

We also had sales of new products introduced in the last five years remain at the 40% threshold.

Turning to the business segment sales performance, industrial had another good quarter.

The industrial segment sales increased 33% from the prior-year quarter.

This was driven by organic growth of 37%, partly offset by unfavorable foreign currency effect of 2%, and a 2% unfavorable impact due to fewer business days.

On an organic basis, sales increased in most market sectors, led by growth in general engineering and transportation with increases of 49% and 36%, respectively.

And regionally, sales increased by approximately 48% in Asia, 34% in Europe and 31% in the Americas.

The transportation and general engineering market sales increased sequentially from the September quarter, while only the aerospace and defense declined slightly.

Our infrastructure segment sales increased 19% from the prior year quarter, all driven by organic growth.

The organic increase was driven by 22% of higher sales of energy and related products as well as 17% increase in demand for our earthworks products.

Regionally, organic sales increased 24% in Asia, 21% in the Americas and 12% in Europe.

The December quarter is typically the slowest period of our infrastructure segment.

That's due in part to seasonality of our mining and road construction businesses.

Now I'll recap our operating performance.

Our reported gross profit margin came in as 35.4%, significantly above the 31.6% reported in the prior year period.

The improvement in our gross profit margin was a direct result of the higher sales and related increased capacity utilization, higher restructuring benefits and ongoing cost discipline.

Again, the business continued to lever well in the quarter.

Raw material costs, particularly tungsten, did have an unfavorable impact on our margin and leverage performance during the quarter.

This was due to a faster than anticipated increase in input costs; however, as Carlos pointed out, we are managing this challenge effectively with price increases to offset these costs.

In the second half of our fiscal year, we expect to recover a 100% of the anticipated raw material cost increases, but the impact will still have a diluted impact on margins.

In addition and a reminder, the prior-year quarter did benefit from temporary cost measures such as salary cuts and the suspension of our 401(k) match, and we previously advised that the impact from the salary reduction was approximately $7 million per quarter and the 401(k) match impact was an additional of $2 million for a total of $9 million.

Our operating expenses increased year over year by 12% or $14 million to $132 million, much below the organic sales growth of 31%.

So, we continue to watch that relationship.

The primary drivers of the increase in operating expenses were employment costs due to the reinstatements of salaries and 401(k) match and merit increases, which occurred October 1, of this fiscal year and also incentive compensation due to better operating performance.

That was partly offset by favorable foreign currency effects, and our operating expense as a percent of sales was 23.3% for the quarter down 330 basis points from the prior year percentage 26.6%.

Our operating income increased to $62 million compared to only $15 million in the prior year quarter.

Absent restructuring related charges in both periods, our operating income was $67 million compared with $20 million in the prior year period.

We levered well this quarter with a strong incremental margin of 38.4%.

Our adjusting operating margin reached 11.8% despite increased incentive compensation, employee salary merit increases and the restoration of salary and other employment related costs that had been temporarily reduced in the prior year.

Looking at the big business segments' operating performance, the industrial operating segment operating income was $42 million compared with $6 million in the same period last year.

Absent charges in both periods, the industrial operating income was $46 million compared to $9 million in the prior year quarter.

The primary drivers of the increase in operating income were the higher sales volumes, improved capacity utilizations, a better product mix and incremental restructuring benefits.

That was offset by the restoration of temporary cost reduction and higher raw material costs.

Industrial's operating margin increased substantially from the prior-year quarter to 12.4% from 3.1% from the prior year.

Infrastructure segment operating income was $22 million.

This compares with $18 million in the same quarter of the prior year, and absent restructuring and related charges in both periods, infrastructure's operating income was $23 million in the current quarter compared with $20 million in the prior-year period.

Operating income improved due to improved sales, increased capacity utilization and incremental restructuring benefits, also offset in part by higher raw material costs and the restoration of temporary reductions.

Infrastructure's operating margin remained relatively flat at 11.8% compared to the prior-year quarter.

Turning to our tax rate, our effective tax rate for the quarter was 21%, and this was slightly better than anticipated, and the driver there was due to the tax impact of the RD&E credit extension of the Tax Relief Act of 2010.

And this included a discrete benefit for us of $1 million in the quarter.

Also driving it was a higher mix of income and lower tax jurisdictions and a cumulative catch-up adjustment due to the change in the annualized tax rate, which now we see around 24% for the full fiscal year.

Regarding our overall bottom-line performance, our second-quarter fiscal 2011 diluted earnings per share was $0.52 compared to the prior year earnings per share of $0.07.

And adjusted, we did $0.57 compared to a prior-year adjusted earnings of just $0.14.

Turning to the balance sheet quick, our cash position increased nicely to $147 million, and we remain focused and diligent on receivable collection.

We further reduced our DSOs by two days during the quarter to 54, and by 11 days versus the prior-year quarter.

And our inventory turns improved to 3.5.

That's up a half a turn from last year at the same time.

We did increase our inventory due to the addition of some strategic raw materials and finished goods inventory to support sales growth and in preparation of the system cutover, which occurred on January 3.

On the CapEx front, our year-to-date capital expenditures were $21 million.

That's slightly higher than what we spent last year of $19 million in the prior year, and capital expenditures net of disposals represented about 2% of sales.

And at December 31, our total debt was $316 million, down $21 million from June 30.

Our debt to capital ratio at December 31, was 17.6% compared to 20.2% at June 30, 2010.

Furthermore, our US pension plan remains over 100% funded, and as Carlos mentioned, our adjusted return on invested capital grew to 10.9% up 210 basis points from 8.8% in the September quarter.

Now, I'll just touch on a couple of factors in our current outlook.

As Carlos touched on, we expect economic conditions, including global industrial production to continue to improve.

And as a result of the strong first-half performance, coupled with better visibility, we expect our annual organic sales growth to be around 21% to 24%, which is better than our previous guidance by 200 to 300 basis points.

And this is in line with our goal of growing at least two times the rate of the global industrial production.

Currency is still going to remain a drag on a year over year basis, and we expect the Europe average in the low $1.30 range versus the $1.40 that we fully realized last fiscal year.

We still anticipate sales volumes and related capacity utilization as well as further incremental restructuring benefits will yield strong incremental margins and more than offset the year-over-year cost increases with the salary restoration merit in pension and incentive compensation.

Just some last factors, as we touched briefly on, raw material costs have increased faster than anticipated; however, we have initiated price increases to realize most of this by the end of the fiscal year.

Our restructuring benefits remain on line to reach the $165 million in annual savings.

And finally, seasonality patterns appear to be in line with our historical ranges, and we still expect approximately 40% of our earnings in the first half and 60% in the remainder of the second half of our fiscal year.

So, factor in these assumptions, we expect our earnings per share for fiscal 2011 to be in the range of $2.50 to $2.65 per share, excluding charges related to the previously announced restructuring programs.

Our fiscal 2011 financial performance will reach levels of profitability never before achieved by our Company, eclipsing our record setting year in fiscal 2008, and I would add that we achieved new records on much lower sales than in fiscal 2008.

We also anticipate cash flow from operating activities to be approximately $260 million to $280 million for the fiscal year, and based on anticipated capital expenditures of around $80 million, we expect to generate between $180 million to $200 million of free operating cash flow for the full fiscal year.

Now I'll turn it back to Carlos for a few closing comments.

Thank you, Frank.

Going forward, Kennametal is now in a better position to benefit from a stronger sales environment and realize substantial margin expansion.

We have weathered the challenging environment of global economic downturn and emerged as a much stronger company.

Our new enterprise structure offers additional growth opportunities.

We are committed to continue our path to becoming a breakaway company, one that can be profitable throughout the economic cycle.

We continue to implement strategies that focus on customers in their respective end markets and grow our top line by serving demand, gaining market share and developing new products.

Based on ongoing improvements in the economic environment and our ability to maintain strong operating leverage, we have again increased our guidance for fiscal year 2011.

Our updated sales guidance of 21% to 24% for the year, reflects that we are outperforming the forecasted industrial production rate at a very strong pace.

Our revised EPS guidance in the range of $2.50 to $2.65 per share compared with the previous range of $2.25 to $2.45 per share represents an increase of about 10% at the midpoint.

This increased guidance reflects record operating margin performance, even on sales volumes that have not yet reached to the prior peak levels.

During the current cycle, we expect to achieve higher incremental margins than in the past periods.

We strongly believe that we can realize 40% incremental margins over the cycle.

Our long-term strategies remain consistent.

We continue to balance our served-in market, business mix and geographic presence.

We continue on our path to premier, which is defined by customer needs and driven by the power of our Organization.

The Kennametal global team is highly focused on achieving our next milestone targets of 15% EBIT margin, and 15% returns after capital by no later than fiscal year 2013.

We successfully managed through an unprecedented market crisis, and repositioned the Company for improved margins and returns.

We refocused our strategic direction with a new operating structure and enterprise approach.

We aggressively managed our portfolio to increase profitability and returns.

We've strengthened our financial position and enhanced our liquidity.

We expect to continue generating strong cash flows.

We will leverage our strong financial position to meet our next milestone targets and deliver continued shareholder value.

Thank you for your time, and your interest in Kennametal.

We'll now take your questions.

Thank you.

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

The first question, just on the corporate charges were $2 million or so in the segment data.

Is there anything going on there, and what's the run rate for the second half of the year?

Yes.

It's probably a little lower.

Obviously with focusing on costs and the cutover for the system allocation, it was probably a little lighter.

So, Eli, it's probably going to be in between that number and what we had in the first quarter going forward.

But just the way it's pulled up there's nothing --

No, there's nothing unusual in the second quarter.

And when we look at the rest of the year, can you talk a little bit about what kind of profitability margins we expect to be able to generate at this point when we go out?

The margins in the first half are a little bit sloppy because of raw material costs.

And the question is, will it get back to mid teen margins across the board by the ending half of the year?

Yes.

I'll start off.

I would not call them sloppy.

I think they're actually pretty good for all time records for the Company.

You're up to a new standard.

You now up to the gold standard.

Come on.

Well, again,, I think we're going to get back there.

I think the infrastructure, we have a little bit of seasonality there.

But I think, Eli, the one issue, we know what it is on the raw material side.

We've been proactively addressing the raw material costs, vis-a-vis the price increases.

And that was the one that probably accelerated faster than we anticipated, and we thought it was going to go up, but it really took a jump in November, December.

We acted accordingly, so we think we're going to get back to our numbers.

And that's why we took to the guidance, and we'll get the benefits of the leverage in the second half just due to the type of volumes we typically benefit from with the capacity in our second half.

And the restructuring benefits continue to remain on track, and hopefully, we'll be a little better on that front as well.

So, at this point, you're expecting easy margin comparisons versus last year, I suspect?

Well, again, the fourth quarter, from an EBIT perspective, was an all-time record for the Company at 14.1%, and I'll remind you the operating income leverage last year, we did over 80% in the third quarter as well as over 50% in the fourth quarter.

So, the comps are tough, but we think we're driving towards the right profitability metrics.

Okay.

Yes.

I'll add that, again, 11.8% EBIT margin, this Company historically has never gone over 12%, and 18.8% in the first half, in particular, is exceptional.

All right.

Thank you.

Our next question comes from the line of Jeff Spector with Credit Suisse.

A question on the raw material costs.

Is there a way to handicap, on a dollar basis, the impact in the most recent quarter?

And I'm just trying to extrapolate what incremental margins could have potentially been, if you didn't have this short-term hiccup?

Yes.

For competitive purposes, we specifically try not to provide that type of information, but, Jeff, we would have been -- we did 38.4%.

But I can tell you this.

We would have been over 40% in the quarter had we not had the anticipated raw material cost increases.

And just to try to give you a flavor, and I think you and I have talked about this, input costs, when you take into consideration, still remain around in the 30% of our costs have been sold, to help give you a little bit of a flavor there.

So it's an impact; but, it's not going to be a significant driver going forward.

Okay.

Great.

Thanks.

And then Carlos, I think you had mentioned earlier in your prepared remarks that this cycle you feel like you're on pace for a faster recovery of these raw material costs.

Is that just your being more proactive with pricing, or what's different this cycle versus the last?

You know, I think that one is we're being more proactive.

We've been anticipating the raw materials to go up, and so number one.

Number two is, because of the environment of growth and so forth, I think it's a little bit easier for us to get priced.

And third, as we spoke, we do have a new system that has very good data that really helps us do the strategic pricing that will not affect our top line.

Okay.

Great.

Thank you very much.

Through the SAP system.

Okay.

Thank you.

Our next question comes from the line of Ann Duignan with JPMorgan.

Just on the revenue outlook, can you just talk a little bit, Carlos, about during the course of the quarter, where have you seen the most incremental upside, by region and by market?

By region, the leading was the rest of the world.

So, think about Asia, China, India, and Brazil.

And by market, with general engineering, and transportation.

A bit more color on the general engineering and the transportation, if you could, please.

What is included in general engineering?

Yes.

In our general engineering, we have a lot of the small shops, with things like valves and pumps, and just general, like medical, and -- So, we lump a little bit more into the general engineering, because it's hard to -- some of the middle small job shops actually produce products for a number of industries from one week or one month to the another.

Okay.

So it's kind of general industrial production.

Is that the way to think about it?

Yes.

But I want to make a point that we are considerably outpacing the IPI index, which is -- we're just not following the industrial growth.

But the new organization, with the focus on the customer, and the new products that we worked on during the economic downturn are actually paying off for us in the top line.

Yes.

I can appreciate that.

And then, in that light, I'm thinking about $165 million in net cost out.

At what point do you think that some of your CapEx spend is going to have to go for capacity expansion?

It looks like end markets are coming faster than you might have expected.

Should we really be thinking that $165 million is a gross savings, not really a net, because you are seeing incremental employment costs, and 401(k) costs, and compensation costs come back in?

Yes.

And we always talked about two cost buckets.

The variable costs which would be $30 million, which that's what we talk about the costs coming back being employment costs.

That's the foremost temporary salary reduction, payments to 401(k) that we didn't make, and so forth.

So, that's what you're seeing coming back.

The $165 million is permanent.

I mean, we've changed the structure.

20 plants are gone.

The cost of those plants will never come back.

We moved the capacity into existing plants.

So, as we get this top line back, that's where we get a lot of leverage.

And we always said that because we did move the capacity of those plants that we closed into existing plants, we have the capacity to reach $3 billion in sales without significant estimates in the capital.

We plan to continue our capital acquisition at the depreciation, more at the depreciation level.

And the only thing I would add to that is, partial to that the SKU reductions that we've gone through over this cycle.

So, we've taken out, particularly in the industrial side, almost 3,400,000 SKU combinations.

Plus with the new product focus, we continue to marry those up and rationalize on top of the line.

And I think with the branding, both with the Widia umbrella as well as Kennametal to have that better structure and focus, we think we're set for capacity for awhile.

So, we shouldn't have to bring back a lot of costs.

And I appreciate all of.

Carlos then, just finally, my question on when could you achieve the $3 billion just looking at how quickly some of these end markets have recovered?

All our assumptions, we gave top-level assumptions of the 15% by 15% by 2013.

Our assumptions are that we will be close to that level by 2013; however, as you said, our top line has grown at a faster rate.

But we haven't really looked at what do we need to do.

Is that going to be different going forward?

We just implemented the SAP 6.0, system.

And so we were very focused on finalizing all of our restructuring and all of that.

And I think, in the next couple of months we're going to be looking at the economic environment, and what does that mean to our previous anticipated projections.

Okay.

So you are going to take a re-look at that in the next couple of months?

Is that what I take away from this?

Yes.

We typically go through our annual plan at the end of the third quarter, beginning of the fourth quarter.

So, I think that's probably where we're going to have a really good view of what's the environment look like, and what is the implications for Kennametal.

Okay, thanks.

I appreciate that, and I know there's a lot going on, and good luck with the SAP.

We're done.

Oh, you're done?

Good.

100% done.

Okay.

I empathize.

(laughter)

Our next question comes from the line of Adam Uhlman with Cleveland Research.

Just a couple of clarifications if I could.

First of all, within the new revenue growth outlook for the year, can you quantify how much of that is expected to be price realization?

Probably a couple points in there, Adam .

Okay.

And then you had mentioned that we're still going to see some margin dilution.

That the price is going to completely offset the higher material costs.

Could you quantify how much margin dilution you've baked into the numbers?

Again, I still think, as Carlos pointed out, we're committed to get back to the 40%.

For competitive purposes, we don't want -- obviously it's more than a couple hundred basis points in any period.

But my point is just on the dilution effect.

If you get dollar for dollar, it just affects the overall percentage there.

From a cost perspective, and again it's anticipated.

So, if raw materials continue to go up or down, we'll adjust accordingly.

But it's tough to give you a specific number at this time.

Got it.

Okay.

Just a last question on working capital.

For the second half of the year, inventories look to be in really great shape relative to where sales are coming in and even with this material cost pressure.

Can you talk about how you expect that to play out in the back half of the year and tie it in with that?

The good problem is the growing cash balance.

Maybe you can talk about the acquisition environment or other uses of cash.

We think we're pretty good from a balancing of the inventory, the right stuff that we need to have in the second half.

I don't think we're planning to grow inventory beyond this level with the better visibility.

It will get better as we go through with the new SAP system.

We like some of the things we're seeing here.

So, I expect better velocity as we exit the fiscal year into next year.

But I can't see inventory going significantly up or down for the rest of the fiscal year.

The M&A environment is getting a little better.

We are and have been active in looking at properties and looking at some relationships in those properties.

But M&A is a really difficult thing to forecast.

So, I think that as you see from our balance sheet, I think we have a strong balance sheet that allows us to be flexible, and we're going to continue to look at it.

Great.

Thanks.

Our next question comes from the line of Henry Kirn with UBS.

As you're able to price faster, could you talk a little about the price discipline in the market as you see it at your competitors?

And if you see yourselves today as a price leader or if the markets generally responding faster than historical?

Yes.

We are the price leader in North America, and we are probably a follower in Europe, and sort of neutral in developing economies.

But the pricing environment, the competitive environment has been very good.

I think that our competitors have followed us in most cases when we have gone first.

And we certainly have followed our competitors when they have gone elsewhere.

I think would say that the environment is -- price increases are always difficult, but I would say, on a relative basis, the environment is okay.

Is it possible to get an update on Widia for the quarter?

Any metrics you can share?

We couldn't hear you, Henry.

Is it possible to get an update on Widia for the quarter?

Any metrics you could share there?

Yes.

All I can tell you is that all of our distribution is growing at a good pace, and we feel really good about Widia.

Thank you very much.

Our next question comes from the line of Chuck Murphy from Sidoti & Company.

Just wanted to talk about the infrastructure real quick.

Can you talk a little bit about the sequential decline?

I think you mentioned the seasonality before.

Was it a particular end market that stood out?

Yes.

It's the highway and road construction.

That's one of those things, when the weather comes, they just shut and go away.

So, it was a little bit earlier than we have seen traditionally in the past.

Got you.

And did that also hit the margins a little bit as well?

It's a combination of the seasonality coupled with some of the higher raw material costs.

Got you.

Okay, that's all I had.

Thanks.

Our final question comes from the line of Walt Liptak with Barrington research.

Hi.

Thanks, guys.

Good morning.

I wanted to ask about -- I don't want to beat a dead horse on the raw material thing, but I'm wondering about hedge positions.

If you guys hold excess inventory, or if you do something in the futures markets?

Yes.

We don't do anything in the futures market.

The tungsten is a very well-traded commodity, and we do have inventory that we look at to help us through that.

But as we said, we are way ahead in our recovery than any one time that I've been with the Company for sure.

And the fact that we're going to be able to recover 100% of the raw materials in the second half of the year just shows you that, again, I don't see that as an impact for the year.

And actually is going to position us well for the next year because we typically don't get priced back.

Okay.

Can you tell us what the overhang or the hit was from the raw material costs during the second quarter in millions of dollars?

We typically don't provide that, obviously.

That's competitive.

Okay.

And what about gross margin?

I might have missed it.

Did you provide gross margin guidance for the next quarter?

No, we don't.

We typically just give the full-year EPS guidance.

And with the increased guidance from the midpoint last time of $2.35 to $2.58 midpoint, it obviously reflects some benefits in the second half with the capacity utilizations on volume, which we typically get that lift on the gross margin line.

So, that's been embedded in our EPS guidance.

Okay.

And what tax rate are you using for the next quarter?

Again, it's probably going to be about the same for the first-half average in the full-year Ex tab around 24%, and that's pretty much where we're seeing it.

It could move a couple basis points here and there, but nothing substantially.

So, given the mix of the business where we have forecasted it, factoring in the RD&A, we had a little bit higher in the first quarter.

We crewed it up in the second quarter.

So, we thought we would start the year at about 25%.

So, probably going to be around 24% for the remainder of the year, and that's basically the next few quarters.

Okay.

All right.

Thank you.

Thank you, Walt.

This concludes our question-and-answer session for today.

I'll turn the conference back over to Ms.

McGuire for closing remarks.

This concludes our discussion.

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

Thank you for joining us.

Today's call will be available for replay beginning at 12.00 pm Eastern Time today, and lasting through midnight on February 28, 2011.

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This concludes today's discussion.

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