Kennametal Inc (KMT) 2011 Q3 法說會逐字稿

Good morning.

At this time I would like to welcome everyone to Kennametal's Third 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 conference over to Quynh McGuire, Director of Investor Relations.

Please go ahead.

Thank you, Tiffany.

Welcome, everyone.

Thank you for joining us to review Kennametal's Third Quarter Fiscal 2011 results.

We issued our quarterly earnings press release earlier today, and you may access this announcement via our website at www.Kennametal.com.

Consistent with our prior 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 May 27, 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 their 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 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 to discuss non-GAAP financial measures during this call in accordance with SEC regulation G, and this 8-K presents GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures, and it provides a reconciliation of those measures as well.

I will now turn the call over to Carlos.

Thank you, Quynh.

Good morning, everyone.

Thank you for joining us today.

We are hosting this call from Sao Paolo, Brazil.

Our Board of Directors and some members of our senior management team recently visited our manufacturing facility located near Indaiatuba.

Kennametal established operations in Brazil in 1999, and we have continued to grow our presence in this region.

I am pleased to report that March quarter results continue to demonstrate that Kennametal's global team is successfully executing our ongoing strategies.

During the quarter, we realized organic sales growth of 25% on a year-over-year basis.

Note that that is against strong top-line comparisons from the same period in the prior year.

In addition, we achieved all-time records with operating margin of slightly over 15% and return on invested capital of approximately 13% for the March quarter, even with sales that are lower than our prior peak.

The macroeconomic environment has been better than our expectations.

Global business conditions remain positive throughout the quarter.

Industrial production continued to show strength around the world, and emerging markets such as China, India, and Brazil remain growth leaders.

Specific to Kennametal, for the year-to-date period we saw 39% of sales increase year-over-year in our rest-of-the-world markets.

Again, this growth is on top of strong comparisons from prior year.

Regarding our served end markets, General Engineering and Transportation continue to expand.

Our strong sales growth reflected higher customer demand in both our served end markets as well as our geographic regions.

From a macro perspective, growth remains strong in most areas.

China and India continue to be very strong, with China taking some measures in the near term to control growth while India is well insulated from external events.

In Brazil, the industrial production rate is expected to remain high.

US manufacturing production is forecasted to grow, and the extra output is likely to show up in exports or added inventory.

In the Euro Zone, growth mainly comes from strong momentum in Germany.

The events in Japan are expected to shrink GDP for the first half of calendar year 2011.

However, during the second half of calendar 2011, we expect reconstruction effort should ultimately boost growth.

While there will be an impact on the global supply chains, it may represent an increase in demand for alternate sources.

For Kennametal we are getting a number of requests from customers across all geographies, including Asia.

So there could be an increasing near-term demand as well as participation in longer-term rebuilding projects.

Moving to the outlook for end markets -- in Transportation, the Japan disaster is impacting global automotive supply environments.

Kennametal does not have a significant penetration of Japanese OEMs, and (inaudible) are direct exposure.

However, we are beginning to see an impact through European and North American OEMs and suppliers.

Currently, this is limited to Electronics and paint colors, which affects model contents rather than production of power train and drive line components.

Also, there may be a higher impact to the tier suppliers that rely more on Japanese high technology inputs, which may affect production in this area.

However, this shortage from Japanese suppliers can be offset by Western sources such as Kennametal.

In General Engineering, global metalworking activity has increased significantly, although still below pre-recession levels.

New orders for machinery continue to grow as exports play a large role in demand growth.

Capital expenditure programs are expected to continue in order to meet customer needs to increase productivity and efficiency.

According to the Association of Manufacturing Technology, consumption has increased significantly from prior year.

Going forward, it is expected that Transportation and Aerospace markets will continue to increase capital spending over the next several years.

In Aerospace, certain programs are poised to start production over the next two to three years for prototypes, certification, and testing.

It is expected that production activity will increase when the Boeing 787 enters commercial service and deliveries are ramping up.

At Airbus, the A320 has been launched with 332 commitments in a few months and expected to reach 500 orders by the Paris Airshow in June.

In Earthworks, commodities pricing, such as coal, remains strong.

Large mining companies continue to consolidate and invest in capacity, which supports strong demand.

Road construction demand trends vary by geography.

Infrastructure maintenance levels are governed by availability of funding in developed economies such as North America and Europe.

Outlook for China, India, and Latin America, road construction activity remains upbeat.

In Energy, oil prices coupled with tight natural gas storage, have continued to maintain a high level of activity.

In North America, the drilling for oil versus gas has shifted from a 20-80 mix to approximately 50-50.

Offshore demand for inland and shale products also continued to grow.

The process industries continued to show improvement, and OEMs have order books filled already for the coming 18 months.

Specific to our Company initiatives, we continue to make solid progress on our Widia strategy to further increase our market presence in distribution channels.

By aligning certain brands under the Widia name, we have built an outstanding product portfolio, improved customer access to those products worldwide, and created a robust distribution brand.

We are continuing to top grade those who represent our brands.

On a year-over-year basis, sales for Widia products increased by approximately 45% from prior year.

Our team is successfully executing this strategy and gaining momentum globally.

The overall favorable customer sentiment has been apparent at major industry meetings and events.

For example, Kennametal recently participated in Con Expo in Las Vegas, and highlighted our most recent innovations in construction products.

At this event, we launched several new products including our new Road Razor ECO road rehabilitation tooling line.

This is an international exposition held every three years to showcase the latest equipment for the construction industries.

This year the event attracted approximately 2,400 exhibitors and 120,000 registered attendees.

Thousands of customers visited our Kennametal booth, and although the outlook varies by state, the commentary was generally optimistic regarding the upcoming construction season.

At another occasion, Kennametal participated in China International Machine Tools show held in Beijing a couple of weeks ago.

The CIMT was a successful event, with representation from 30 countries and approximately 10,000 attendees.

The Kennametal display featured our new product innovation, Beyond Blast and all the products from our Spring Innovations catalog.

Separately, our Widia booth featured its [Vectra] portfolio and sub-brands.

Many customer meetings were held, and outlook for the region continues to support an expanding economy while balancing inflation risks.

During the quarter, we continue to implement price increases across the global customer base.

Additionally, we recently notified customers that we will be adjusting our list price on a variety of products.

Those increases are necessary in an environment of rising raw material costs, particularly tungsten.

We expect our raw material cost increases will continue to impact margins for another one to two quarters.

In the meantime, we will continue to focus in maintaining margin discipline as always.

Kennametal customers include some of the world's largest companies, and they view our products as valuable to their business and often as critical to their manufacturing processes.

Ultimately, we believe that our price increases will be successfully implemented and at a pace that is faster than historically.

In addition, we continue to work toward completing our restructuring initiatives.

At the beginning of the quarter, there were four facility closures in process.

Since then, three of the four manufacturing plants have closed, and the final facility is expected to be completed in the June quarter.

Currently, we are realizing approximately $165 million in permanent cost savings on an annualized basis.

When restructuring is complete, we will have reduced our manufacturing footprint by 20 facilities including divestitures.

However, we have retained much of our capacity using our lean processes to share production to exist in plants.

Today Kennametal has the manufacturing capacity to support up to $3 billion in sales with no significant capital investments.

Overall, we continue to reach higher profitability and return levels due to our continued focus on operating efficiencies.

As evidence of this, adjusted operating margin for the March quarter was slightly higher than 15%, and adjusted return on investment capital was approximately 13%, which are all-time record highs.

Another metric to consider is incremental margin.

For the year-to-date fiscal 2011 periods, incremental margin was 42%.

This is well in line with our expectation of realizing 40% incremental margin over the cycle.

Especially when we consider the impact of raw material costs and when those accomplishments are impressive.

I would like to recognize and thank Kennametal employees for their dedication and commitment to continue to implement our margin expansion goals.

I will now turn the call over to Frank so we 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 March quarter, and then I'll move on to our updated outlook for the remainder of the fiscal 2011 period.

Some of my comments exclude special items, so please refer to the reconciliation schedules that we provided in our earnings release and related Form 8-K.

Let me start off by summarizing the quarter.

We continue to make good progress by executing our strategies as Carlos articulated.

Our organic sales growth was very good, coming in at 25% on top of tougher comparable.

We once again had strong operating results, and we further strengthened our financial position.

And we set a March quarter record for earnings per share of $0.83 and an all-time record for adjusted operating margin of 15.2% and return on invested capital of 12.9%.

And we achieved our fourth consecutive quarterly record for operating income.

I am pleased with our overall performance, especially in light of input cost pressures and the implementation of a new SAP system at the start of the quarter.

Now let me walk you through the key items of our income statement.

Turning to sales, our sales for the quarter increased 25% to $615 million compared to $493 million in the March quarter last year.

Our sales growth was achieved despite stronger comparisons of double-digit organic growth of 11% in the prior-year quarter.

This represents the fifth consecutive quarter of year-over-year organic sales growth.

We also continue to make progress of the better balancing of our business globally.

At the end of the March quarter, 54% of our sales were generated outside of North America with Western Europe at 28% and rest of world at 26% of sales.

Now let me call your attention to the recent events in Libya and Japan and how they may affect Kennametal.

As Carlos stated, both situations are unfortunate and devastating, and our best wishes go to all individuals affected.

The situation in Libya has had very limited direct impact on our business or customers except for the impact of higher oil prices, which we'll continue to evaluate.

In Japan, the issue will be how the supply chain is affected from shipping delays and raw material shortages.

Again, this has had a very limited impact on our business in the March quarter.

We will continue to monitor the situation in Japan and its potential global implications for our business.

As many of you know, we do not have a large presence with the Japanese automotive OEMs.

We'll focus on our American and European transportation OEMs and the possible impact on production schedules due to availability of components.

One item to point out is that we are receiving inquiries globally, including Asia, from end users and distributors who are faced with cutting tool supply constraints from their existing sources.

Some examples include an automotive OEM production line that was at risk of stoppage and requested immediate replacement tools, and a bearing manufacturer that is testing our products after receiving notification of supply interruption.

Additionally, distributors are seeking alternate supply sources to mitigate their risks in general.

The typical distributor carries approximately a few months of inventory, so we anticipate some increased demand in the near future.

From a longer-term view, it is anticipated that Earthworks tools will be needed for rebuilding affected areas after earthquake and the tsunami cleanup.

Now I'll turn to the business segment sales performance.

The industrial segment sales increased 28% from the prior-year quarter, and that was driven by organic growth of 29%, 1% favorable foreign currency effects, partly offset by 2% impact due to fewer business days.

On an organic basis, sales increased in all served markets led, again, by strong growth in General Engineering and Transportation with increases of 34% and 29%, respectively.

Aerospace and Defense also grew slightly up 6% compared to the prior year.

And regionally sales increased approximately 32% in Asia, 29% in Europe, and 23% in the Americas.

The Transportation and General Engineering markets continue to demonstrate the strongest growth.

Globally, these markets performed well including the strengthening of business in Europe --

(audio break)

I'm sorry, everybody, for some technical difficulties.

I'll pick up on the discussion with sales on the infrastructure segment discussion.

As I started, our infrastructure segment sales increased 19% from the prior-year quarter driven by organic growth.

The organic increase was driven by 21% higher sales of energy and related products as well as a 17% increase in the demand for Earthworks products.

Regionally, organic sales increased 20% in the Americas, 15% in Asia, and 11% in Europe.

The Energy business continued to benefit from higher commodity prices, increased capital spending, including higher North America and international rig counts.

And the natural gas and storage is 2% above the five-year average.

Our Earthworks business had a very good quarter and is currently getting ready for the construction season.

As Carlos mentioned, the feedback from Con Expo Show in Las Vegas last month was very upbeat.

Coal prices are stable and up from last quarter slightly as are coal stock prices.

Now I'll hit briefly our operating performance.

Our reported gross profit margin was 37.4%, an improvement of 290 basis points above the 34.5% reported in the prior-year March quarter.

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

Not surprisingly, raw material costs, particularly tungsten, had an unfavorable impact on margin and leverage performance during the quarter.

This was, once again, due to faster-than-anticipated increase in input costs.

So to try to put this into perspective, during the quarter we experienced much-improved price realization compared to the December quarter as a result of previously announced price actions in October and January.

However, raw material costs further increased faster than anybody anticipated, and had our initial assumptions come true, we would have recovered over 100% of these costs.

In fact, the tungsten average market price in the December quarter was approximately $300 per metric ton unit and has continued to increase to its current level of more than $400 per metric ton unit.

Accordingly, we will manage this challenge effectively with further price increases to recoup these costs.

Bottom line, we know the challenge.

We are addressing it, and we are still delivering strong leverage.

Our operating expense increased year-over-year by 15%, or $18 million to $138 million.

The primary drivers of the increase in operating expense were employment costs, including higher incentive compensation due to better operating performance.

OpEx as a percent of sales was 22.5% for the quarter, down 180 basis points from the prior-year percentage of 24.3%.

Our operating income increased to $88 million compared to $26 million in the prior-year quarter.

Absent restructuring and related charges in both periods, our operating income was $93 million compared with $49 million in the prior-year quarter.

We levered well again this quarter with a strong incremental margin of 36.2%, and if you put that on a constant currency basis, we have an additional leverage benefit, and it would have come in at 37.3%.

Our adjusted operating margin reached an all-time record of 15.2%, as Carlos said, despite all the headwinds we had to address.

We are overall pleased with the performance.

Looking at the business segment performance -- the industrial segment's operating income was $54 million compared with $11 million in the same quarter last year.

Absent restructuring related charges in both periods, industrial's operating cost $56 million compared with $26 million in the prior year.

The primary drivers of the increase in operating income were higher sales volume, including price realization, improved capacity utilization and incremental restructuring benefits.

This is partly offset by higher raw material costs and the restoration of temporary cost measures from the prior year.

Industrial's adjusted operating margin increased substantially from the prior-year quarter to 14.3% from 8.6% last year.

The infrastructure segment operating income was $36 million compared with $19 million in the same quarter last year.

Absent charges in both periods, infrastructure's operating income was $37 million compared with $26 million in the prior-year quarter.

Their operating income improved primarily due to higher sales also with price realization, increased capacity utilization and incremental restructuring benefits also offset, in part, by higher raw material costs and the restoration of temporary cost reductions.

And infrastructure's adjusted operating margin increased from the prior-year quarter to 16.5% with 13.8% last year.

Turning to the tax rate, our effective tax rate for the quarter was 19.1%, and this was better than anticipated.

The improvement in the rate was a result of higher benefits associated with our European business model driven by stronger European earnings.

We now expect the full tax year rate to be approximately 22%.

And then regarding our bottom line performance, our reported third quarter fiscal 2011 diluted earnings per share were $0.77 compared to the prior-year diluted earnings per share of $0.12.

On an adjusted basis, we came in at $0.83 compared to the prior-year quarter adjusted earnings of $0.39.

Turning to the balance sheet, our cash position increased to $184 million.

We remain focused and diligent on receivable collection.

Our DSOs and IPOs were relatively flat in the March quarter compared to last quarter.

At the end of the quarter, our total debt was $317 million.

This was also flat from last quarter.

Our debt-to-cap ratio for the March quarter was 16.9% compared to 20.2% at June 30th.

Furthermore, our US pension benefit plans remained over 100% funded, and our adjusted return on invested capital increased to 12.9%, up significantly from 6.4% in the June quarter.

And, as I said earlier, our adjusted return on invested capital is an all-time Company record.

Now let me update everybody on our current outlook.

First, we expect economic conditions, including global industrial production, to remain positive.

We expect our annual organic sales growth rates to be approximately 24% to 25%, which is higher than our previous guidance.

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

We still anticipate that sales volumes and capacity utilization, including restructuring benefits, will yield strong incremental margins and more than offset year-over-year cost increases for merit and pension and incentive compensation.

Raw material costs have increased faster than anticipated, however, we continue to initiate price increases to offset these higher-cost increases.

As Carlos said, our restructuring benefits are in line to reach the $165 million in annual savings, and our effective tax rate has improved due to an improved mix in our business and, as I said earlier, we now anticipate a tax rate of 22%.

Under these assumptions, we expect earnings per share for fiscal 2011 to be in the range of $2.75 to $2.85 per share, excluding charges related to previously announced restructuring and related programs.

And to help put our revised earnings per share guidance into perspective, you should compare this year's expected full-year results to our prior-year record set in year-end fiscal 2008.

If you take the midpoint of our current guidance and compare it to our earnings per share in fiscal 2008, it's a prior peak of $2.76, you will clearly see that we have higher earnings on significantly lower sales.

As a reminder, in fiscal 2008, we had sales of $2.6 billion and earnings per share of $2.76.

The projected results for fiscal 2011 clearly show that our cost structure has been dramatically reduced, and our strategies are working.

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

We are well within reach of our next milestone targets.

We also anticipate cash flow from operating activities of approximately $255 million to $265 million for 2011 based on CapEx of $80 million.

We expect to generate between $175 million to $185 million in free operating cash flow for the full fiscal year.

This is slightly lower than our prior quarter guidance of $180 million to $200 million, and the primary reason is due to slightly higher working capital based on higher sales and higher inventory levels related to recent cost increases.

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

Thank you, Frank.

As we move forward, we continue to build on our enterprise approach.

We are -- we have transformed Kennametal to become a market-pacing organization, aligning our business with our served end markets.

This provides customers with the access to our entire product portfolio, facilitates top-line growth to cross-selling opportunities, and streamlines our costs by improving supply chain and manufacturing efficiencies.

We are positioned to focus more on customers, to gain market share, and to further increase our profitability.

Based on expectations of continued global growth and our ability to maintain strong operating leverage we have, again, increased our guidance for fiscal year 2011.

Our updated organic sales guidance of 24% to 25% for the year demonstrates that Kennametal continues to outperform the forecasted industrial production rates.

Our revised EPS guidance in the range of $2.75, $2.85 per share compared with the previous range of $2.50 to $2.65 per share represents an increase of about 9% at the midpoint.

This increased guidance reflects record operating margin performance, even on sales volume that has not yet reached the prior peak level.

During the recent cycle -- during the current cycle, we expect to achieve higher profitability and prior peak periods due to the structural improvements to our cost base.

We continue to be committed to realizing 40% incremental margin through the cycle.

In summary, we have strengthened our financial position and enhanced our liquidity.

We expect to continue generating strong cash flow.

Our global team remains focused on the next milestone target of 15% EBID margin and 15% return on investment capital.

We believe that we can achieve those goals and advance even further along the path (inaudible).

Enabled by our long-term strategies, we believe our performance validates our ability to achieve a sustainable level of profitability in the high teens' range.

For the past several years, we have taken the necessary actions to further strengthen our foundation and expand our profitability.

We continue to balance our served end markets, business mix, and geographic presence.

Kennametal is a breakaway company that has demonstrated its ability to be profitable through all the cycles.

We will maximize our strong financial position to meet those targets and deliver continued shareholder value.

Thank you for your time and your interest in Kennametal, and we'll now take your questions.

Thank you for listening to this call today, and we would be happy to now take your questions.

(Operator Instructions) Eli Lustgarten, Longbow Securities.

Just one clarification -- the tax rate, you said, this year is 22%.

Is that what we assume for next year also?

Or will it creep up?

I mean, it's sort of an important issue that's (multiple speakers) fixed?

Well, I can't, obviously, get into next year.

We'll provide that in July.

But, yes, the 22% is kind of what we anticipate, as you saw the mix between rest of the world and Europe.

The euro is looking stronger, and as that continues to perform, we should see a deterioration in tax rate or a reduction in tax rate, I should say.

As you know, we -- last quarter we guided 24.

We picked up two points as a result of the strong performance in the second half.

Okay.

And one of the things I was surprised in the numbers is the absence of currency in infrastructure and almost minimal currency versus what we're seeing around other companies in industrial.

Is the currency a bigger factor in the fourth quarter for you at this point?

You gave us the year, but are we looking at more currency benefits in the quarter?

Yes.

Eli, each of the first three quarters, currency was actually negative.

I think it was a couple of pennies negative in the quarter, both transaction and translation.

And the fourth quarter is actually the first time -- and I'm speaking primarily from a euro perspective -- that will actually have a slight benefit end of fourth quarter.

So you're exactly correct.

And the same thing from number of workdays.

I mean, that was a factor that we had -- you had a couple of less workdays in this quarter.

Do we get them back in the fourth quarter?

No.

Compared to last year, the workdays are essentially the same in the fourth quarter on a year-over-year basis.

Okay.

And if we talk about the profitability of industrial, which seems to be lagging.

I mean, it's a big gain versus last year, and it's a decent incremental margin or so, but we're still running in the less than 14% kind of number -- a 14.3%, I guess, number.

In the business, I guess I was expecting to get well over 15% at some point.

Can you talk about what's going on in cost price there?

And can we expect to break 15% in the fourth quarter, and is that a reasonable goal for an average for a year in the near term?

Yes.

I think the performance has been pretty good from a little shy of 12 in the first quarter, then we went a little bit above 12 in the second quarter.

But we saw a nice increase of almost, to your point, 200 basis points of improvement in the industrial operating percent.

So a likely improvement.

Yes, there are some time issues with the cost -- input cost and the pricing.

And there's probably -- we implemented a new system here, so hopefully we can catch up a couple of things here in the fourth quarter.

So to have that type of performance on top of some of the raw material headwinds, putting in a new SAP system at the beginning of the quarter, I'm actually extremely pleased with the performance of industrial.

And I think we're moving in the right direction.

The point that I'll make, as a company, I mean, we are achieving all-time records, and this is one of the reasons we have two segments, and we'll look at two segments.

Sometimes one quarter will perform better than the other.

But (inaudible) is about 15% EBID margin.

As I said, it's still reasonable to expect industrial to get over 15% as a goal at this point?

That's the goal.

And have prices gone up enough, with the way you ran up price increases, that you will essentially recover all your costs in the next couple of quarters.

You sort of hinted that was the case.

But with the new round coming at this point, do you expect to be there by the end of the next two quarters?

Yes.

As we wrap up the fourth quarter, again, based upon raw materials, it's like trying to catch a falling knife sometimes with tungsten the way it's been behaving here.

But we should be able to recover 100% of our costs in the fourth quarter.

Andy Casey, Wells Fargo Securities.

First, on the third quarter corporate expense, a pretty detailed question, but if I'm doing the math right, after adjusting for restructuring, it looked like it came down a couple of million in Q3 from Q2.

First, is that math correct?

And then, if so, what drove the sequential decrease and how sustainable is that?

I would imagine that the third and fourth quarter will be similar.

And it's just watching expense some of the -- I'll call it the SAP implementation cost we implemented in the January timeframe.

So those costs are trending down, as we had anticipated.

So, yes, at this point I would say the fourth quarter should be very similar.

But your numbers are correct.

Okay, thanks.

And then on that -- another detail on the remainder of the year -- those 22% for the full year.

Is that a net number, or does that exclude the restructuring?

No.

That's an all-in number.

Henry Kern, UBS.

You've taken out $165 million in fixed costs.

You're closing the final four facilities.

How do you think of the footprint, going forward?

Is there still any opportunity to do further rationalization and take out even more fixed cost?

Are we sort of at the steady state where things are as good as they can be on that level?

Henry, we believe there is always opportunity.

We have a very strong lean culture.

So every year we take cost out.

The $165 million, obviously, were singled out because it was a big number and required special charges.

Our anticipation is that in 2011, we go back to the pre-recession where every year we have what sometimes is a significant cost reductions through lean savings that we do.

So there are more opportunities, and we will continue to look at those.

Everything hinges around how much growth we expect -- is it above 10% or more than 10%?

But, typically, what we see right now is to go into a pay-as-you-go type of process.

And could you give a little bit of an updated view on your priorities for the balance sheet and what you're seeing in the M&A market right now?

I think that we -- the M&A market is good.

I mean, we have a strong pipeline.

We are very engaged in looking at opportunities.

But, again, we are very, very disciplined about our M&A process, and it's hard to forecast M&A activity.

So we'll continue to be very optimistic about it, and we are ready and have the right balance sheets to take advantage of good opportunities.

Adam Uhlman, Cleveland Research.

Could you talk about the Europe business?

It seems to be holding up a bit better than expected?

Could you get a little bit more granular on the market dynamics there?

Our strength in Europe is because of our mix being filtered into the German market, okay?

And as I've been saying for the last few quarters, I think we've been able to outperform the overall European GBB or IBI as a result of our mix.

I mean, Germany continues to outperform every country in Europe, and it's driven primarily by General Engineering and Automotive.

And it's driven primarily by exports and -- actually, their machine tool business is starting to come back.

And they have strong exports into China and India, and to -- in certain cases, to Latin America.

So I feel very good, and I think the future continues to be good.

And that helps us not only with the top line but as you can see from the results of the quarter, that helps us with the tax rate as well.

Okay, got it.

And then regarding the commentary around the Japanese quake and the order pickup that you folks have seen or quoting activity -- I guess, how sticky would that business be if you were to win over some business that was supplied by Japanese manufacturers previously?

It's really hard to forecast that.

We're seeing the quoting activity going up.

We've seen some of the very little, of the buy yet, because it's only been 30 days, and as you heard from Frank, the distributors -- that's primarily a distribution type business.

The distributors typically carry about two months' inventory.

So if you see when the disaster occurred versus where we are today, it's about two months.

So we anticipate to know more in the next month or so -- more details.

Ann Duignan, JP Morgan.

Can I just ask you about your balance sheet performance?

Inventories and day sales outstanding were a bit higher than last year and last quarter.

Can you just talk -- was that related to SAP implementation or -- just give us some color on what's going on there.

Yes.

There's, obviously, some growing pains there, Ann.

Obviously, the sales are a little bit higher on the receivable side, but it would probably -- we'll try to pick that up here in the fourth quarter.

That's why we didn't change the cash flow guidance.

But as you go through, just kind of learning the applications, and you would expect that at anytime that you implement a new system as well.

Now, if you look at the inventory on a year-over-year basis, you don't have the cash flow there -- probably up to $70 million.

The terms have been flat, but we expect that to start to move in the right direction as the production teams get also used to the system.

Okay, that's good color.

And then, Carlos, maybe -- I'm being a little facetious when I ask this question, but I can totally appreciate Brazil versus Latrobe.

But can you describe the purpose of hosting the board meeting in Brazil and what are your objectives -- your business objectives in Brazil?

We have a practice of taking the board to one of our facilities and have the board meeting at one of our facilities every year at this -- basically, in this period.

And what we do -- and we take them international maybe every third year.

What we do is we take them to places where we have major investments and/or acquisitions after a couple of years.

So that they can really see how the investment our company is deployed and understand the market, and they get to see the benefits of investing.

And that took place here, so we brought the board here.

And we had a very, very, very successful visit.

And Brazil, for us, actually has the highest growth rate of all of our geographies.

Not [by a book] by much, so this has been a very good investment for us.

As I said, we've been here since 1999, so we're kind of a little bit of [light commerce] into this area.

But we've built a new plant here, and we actually made an acquisition here, and we are really leveraging those benefits right now.

I don't know if I answered your question.

Okay.

Yes, no, that's helpful to have the color because it's like maybe a large acquisition was coming down the pipeline or something.

So that's helpful to understand the context.

And just one real final one, Carlos.

It's looking like units -- just given the rate of recovery and revenues and earnings that there's a potential that that $3 billion revenue target could be achieved sooner rather than later.

To what point do you start thinking about having to reinvest in the businesses, to reinvest in capacity expansion, et cetera, and could that put pressure on your 15% ROIC target?

You said it perfectly.

We have talked about this $3 billion target.

Clearly, it's going to come earlier.

I mean, there's already an indication based on our performance that it was at so far that we had in third quarter looking at the fourth quarter.

And basically capital takes about -- to deploy it effectively, it takes about 12 months, okay?

So you will not put the pressure on return of invested capital because you have to build capacity gradually.

And the 3 -- when we talk about $3 billion, it's not, like, we have certain product lines -- we would not be at 90% or close to 90% in all products.

We'll probably be at 90% in certain products where we have to, then, expand those product lines.

But, certainly, I do not anticipate at this point to have a major investment even to go beyond $2 billion or $3 billion.

I mean, I feel very comfortable that we can stay around the depreciation for a while longer.

Walt Liptak, Barrington.

I wanted to ask about the tungsten prices coming up and just get some more clarity on it.

You said that it -- Carlos, in your commentary -- it will be fourth quarter and first quarter, the next two quarters, where you get the cost recovery.

But then you mentioned -- I think Frank mentioned -- 100% cost recovery in the fourth.

Can you explain the difference?

Yes, Walt, again, I think the point there is we were a little bit behind here because of the raw material cost increase, and we're going to cover 100% in the course for the full year.

We're obviously still behind.

And we're still going to be chasing that a little bit in the first quarter of next year.

But, hopefully, with the increases, if they do take a little time, we should get back on track by the first half of next year.

But my comment was just 100% of the cost increases in the fourth quarter.

Did you take up prices already for the fourth quarter?

Yes, they've been announced.

Okay.

In both North America and Europe or just -- ?

All around the world -- globally.

Okay.

And what about tungsten supply?

Do you have access to supplies?

Is supply tight?

No.

From Kennametal's perspective, we have not had any shortage or price in the (inaudible) supply.

It's been the price.

Okay.

Okay.

And you mentioned the earthquake in Japan causing issues for some of your competitors.

Is that in your guidance that you might pick up some share in the fourth quarter and next year because of that?

No.

We just don't have enough details.

We don't change our sales forecast based on quoting activity only.

We certainly (multiple speakers).

Okay, in the full-year guidance, did you use the adjusted EPS number, the $0.83?

Yes.

There are no further questions at this time.

This concludes our discussion.

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

Thank you for joining us and have a nice day.

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