Kennametal Inc (KMT) 2011 Q4 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 Fourth Quarter and Fiscal Year 2011 earnings call. (Operator Instructions.) I would now like to turn the call over to Ms. Quynh McGuire, Director of Investor Relations.

Thank you, Regina. Welcome, everyone. Thank you for joining us to review Kennametal's fourth quarter and fiscal year 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's also being broadcast live on our Website, and a recording of this call will be available on our site for replay through August 29, 2011.

I'm Quynh McGuire, Director of Investor Relations for Kennametal. Joining me for our call today are Chairman, President and Chief Executive Officer, Carlos Cardoso, Vice President and Chief Financial Officer Frank Simpkins, and Vice President Finance and Corporate Controller, 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'd 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 has provided the SEC with a Form 10-K, a copy of which is currently available on our Website. This enables us to discuss non-GAAP financial measures during this call in accordance with SEC Regulation G. This 8-K presents GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures, and it provides a reconciliation of those measures as well.

I will now turn the call over to Carlos.

Thank you, Quynh. Good morning, everyone. Thank you for joining us today. I'm pleased to report that Kennametal, again, achieved strong results for the June quarter of fiscal 2011. During the quarter, we had organic sales growth of 24% year-over-year. This growth was realized on top of 39% organic growth in the prior year period.

In addition, we achieved all-time records on an adjusted basis with operating margin of 17.5% and earnings per share of $1.11 for the June quarter as well as return on invested capital of 14.8%.

For fiscal year 2011, Kennametal has also delivered historical highs for operating margin, earnings and return on invested capital, even with sales that are lower than the prior peak. Incremental margin for the year was 39%. This validates our ability to capitalize on top line growth as well as the permanent nature of our streamlined cost structure to achieve higher levels of profitability.

We are proud of these impressive results, because they demonstrate the progress of Kennametal's transformation, the effectiveness of our initiatives, the ability of our global team to execute our strategies and, above all, our capacity to deliver our promise of premier performance.

During the quarter, industrial production continued to show favorable trends in markets such as General Engineering, Transportation, Earthworks and Energy. Our order rates were strong, reflecting ongoing customer demand on a global basis [with] the emerging markets continue to lead the growth. For the June quarter, Kennametal's rest of the world markets represented 27% of sales and grew 36% from prior year quarter.

We continue to implement our WIDIA brand strategy. For fiscal year 2011, WIDIA product sales increased 37% year-over-year, reflecting strong growth. As evidenced by our recently-announced agreement with Fastenal to be WIDIA's national distributor in North America, there will be additional opportunities to expand our presence in distribution channels and gain further market share.

As we mentioned in prior discussions, price increases are being implemented to recover high raw material costs as necessary, specifically tungsten. Our customers continue to value our products and recognize Kennametal's contribution to improving the productivity of their manufacturing process. We continue to increase prices as needed and will maintain margin disciplines.

During this June quarter, we successful completed our restructuring initiatives, which including -- included reducing our manufacturing footprint by 22 facilities in total, including divestitures. However, we retain much of our operating capacity by shifting production to existing facilities by using lean principles.

The restructuring program resulted in a higher than expected annual cost savings of $170 million. This represents fixed costs that have been permanently removed. The aggressive streamlining of our business, combined with disciplined portfolio management, have generated significantly higher operating margin, earnings and return on invested capital.

From a macro perspective, economic activity in the manufacturing sector continues to expand. According to IHS Global Insight, another soft patch is occurring, but a double dip is not expected. The world's economic expansion is forecasted to gain momentum in the second half of calendar year 2011. Major downside risks facing global economy are uncertainties about fiscal austerity and the sovereign debt. Upside opportunities include stronger spending by consumers and business in US, Northern Europe and Asia, thanks to improved balance sheets.

Let's discuss the outlook in our served end markets. In Aerospace, an increase in production is anticipated in commercial aviation. At the recent Paris Air Show, Airbus surpassed its own previous record at 730 intentions of purchase during this event. Last week, American Airlines announced it [just placed] the largest order in aircraft -- in aviation history, an intent to add 460 narrow body fuel efficient models. The implications on the supply chains are positive, as both Boeing and Airbus are ramping production of their flagship products.

In General Engineering, new orders for industrial machinery are expected to continue to grow. Traditional manufacturers have increased investment spending domestically and internationally, focus on productivity and efficiency to help offset labor costs.

In Transportation, light vehicle sales are forecasted to be more than 12 million units in US according to IHS Global Insights. In addition, it is expected that supply disruptions related to Japan disaster should ease, and sales will reach nearly 16 million units by 2013. On a global basis, light vehicle output is expected to be more than 76 million units in 2011 and grow to approximately 87 million units in 2012.

Going forward, there may be additional growth opportunities related to the lightweightening of cars, with an introduction of carbon fiber reinforced polymer into the body structure. In Earthworks, commodities pricing remains strong, and record high mining capacity expansion investment continues. Central Appalachia's steamed coal and met coal pricing remains strong. China and India's seaborne coal demand continues to increase, along with Japan, in the wake of the spring's nuclear disaster.

Regarding growth construction, demand tends to vary by geography in developed economies of North America and Western Europe. Infrastructure maintenance levels are governed by ability of funding. Overall, funding outlook in developed economies is worsening, due to the fiscal tightening and austerity measures. However, in emerging markets, such as China, India and Latin America, the construction activity is upbeat.

In Energy, North American inventory is just below the five-year average. A warmer than expected summer may cause an uptick in seasonal demand. However, high gas prices may continue and are expected to keep prices at relatively the same level through calendar year 2011. By the end of calendar 2011, the Energy Information Administration forecasts that marketed natural gas production will increase and continue into calendar 2012.

Overall, Kennametal continues to achieve high operating margin, earnings and return levels due to our strong focus on operate efficiencies. As a result, adjusted operating margin for June quarter reached 17.5%, with adjusted EPS of $1.11, and adjusted return on invested capital was [14.8%] which all are all-time records.

In addition, I would like to mention that Kennametal received national recognition for our commitment to excellence. For example, we were recently awarded Delphi's 2010 Pinnacle Award for supplier excellence. The WIDIA products group was honored with the ISA's American Eagle Value-Added Partner Award for showing exceptional documented cost savings or productivity improvements to an end user.

These accomplishments are remarkable, and I'd like to recognize and thank Kennametal employees for their dedication and commitment. I will now turn the call over to Frank, and he will discuss our financial results for the quarter in greater detail. Frank?

Thank you, Carlos. I'll provide some comments on our performance for the June quarter, and then I'll move on to our fiscal '12 guidance for the next fiscal year. Some of my comments exclude special items, so please refer to the reconciliation schedules that we provided in our earnings release and the related Form 8-K.

Let me start by summarizing the June quarter and, in part, the year. Similar to Carlos, I'm pleased to report that for both the June quarter and the full fiscal year, we set records for operating income, earnings per share and return on invested capital. In the June quarter, we again delivered strong organic growth, coming in at 24%, versus tougher comparables last year. We also had stronger operating results, and our capital structure continued to strengthen.

Our restructuring programs have been successfully completed and have yielded higher benefits and lower cost to execute than previously anticipated. I also want to point out that for the full fiscal year, we achieved these records while encountering the implementation of a new enterprise structure July 1 of last year, we upgraded our ERP system on January 3, we dealt with higher raw materials and the effects of salary and benefit restorations, including higher incentive compensation. So, a great year on many fronts.

Now let me walk you through the key items in our income statement, starting with sales. Our sales for the quarter increased $155 million, or 29%, to $694 million. This compares to $539 million in the June quarter last year, and this was due to 24% organic growth, a 6% favorable foreign currency impact, and that was partly offset by the effect of fewer business days.

Our sales growth was achieved, despite stronger comparisons of double-digit organic growth of 39% in the prior year, and this represented the sixth consecutive quarter of year-over-year organic sales growth. As Carlos alluded to, we also continued to further balance our business globally, and for the June quarter, approximately 55% of our sales were generated outside of North America, with Western Europe at 28% and the rest of the world at 27%.

Now, looking at the business segment sales performance, our industrial segment sales of $437 million increased 31% from last year. This was driven by organic growth of 25% and a 7% favorable foreign currency impact, partly offset by 1% unfavorable impact due to fewer business days. And on an organic basis, sales increased in all served markets, but by strong growth in General Engineering and Transportation, with increases of 33% and 19% respectively.

Aerospace and Defense also grew. That was up 8% compared to the prior year quarter, and regionally our sales increased by 32% in Asia, 24% in Europe and 20% in the Americas. As Carlos pointed out, the Transportation and General Engineering markets continued to demonstrate the strongest growth. Globally, these markets performed well, including the strengthening of business in Europe and continued growth in Asia and the Americas.

Our infrastructure segment sales of $257 million increased 26% in the prior year quarter, driven by organic growth of 22% and a 4% favorable foreign currency impact. The organic increase was driven by a 24% increase in demand for Earthwork products and 20% higher sales of energy and related products. Regionally, organic sales increased 29% in Asia, 23% in the Americas and 13% in Europe.

Our Earthworks business had a very good quarter, given the construction season and mining activity. Pricing for Central Appalachia's steam coal is trading at approximately 20% higher year-over-year, and met coal continues to trade around a benchmark of $315 a ton, which support planned mining activity.

And in the Energy market, the US and international rig counts are higher than the prior year by 21% and 3% respectively, and the Canadian rig count is up 6% year-over-year, and natural gas and storage remains at 2.5% below the five-year average.

Now I'll touch on our operating performance. Our reported gross profit margin increased 130 basis points to 38.3%. This compares with 37% in the June 2010 quarter. Our strong gross profit margin was a direct result of higher sales and price realization, increased capacity utilization, higher restructuring benefits and continued cost discipline. Not surprisingly, raw material costs, particular tungsten, had an impact on our margin and leverage performance during the quarter.

Our operating expenses increased year-over-year by 16%, or about $20 million, to $143 million. The primary drivers of the increase in operating expenses were employment costs, including higher incentive compensation due to better operating performance. Our operating expense as a percentage of sales was 20.6% for the quarter, down 230 basis points from the prior year percentage of 22.9%.

I'd like to take a moment to summarize our restructuring program, which is now completed and, as Carlos said, ended with favorable results. As you know, we embarked on this initiative a few years ago to help improve our cost structure and our competitiveness.

The final figures for the restructuring program resulted in total charges of approximately $150 million and, more importantly, annual benefits are expected to slightly exceed approximately $170 million and a combined footprint reduction, including divestitures, was 22 total facilities.

Our operating increase increased to $115 million. This compares to $61 million for the prior year quarter. Absent restructuring and related charges in both periods, our operating income was $121 million compared with $74 million in the prior year quarter. We levered well again this quarter with a strong incremental margin of 30% and, on a constant currency basis, our leverage was even higher, at 34%. Our adjusted operating margin reached an all-time record of 17.5%, despite all the headwinds we had to address, and I'm very pleased with the operating margin performance.

Looking at how the business segment's operating performance happened, the industrial segment operating income was $77 million compared with $32 million for the same quarter of last year. Industrial's operating margin increased substantially from the prior year to 18.7% from 12.8% last year.

And absent restructuring and related charges in both periods, the industrial operating income was $82 million compared with $43 million in the prior year quarter. And the primary drivers of the increase in operating income were the higher sales volumes, price realization, improved capacity utilization and incremental restructuring benefits. This was partly offset by higher raw material cost.

The infrastructure segment operating income was $38 million, and this compares with $31 million in the same quarter of the prior year. Infrastructure's adjusted operating margin was 15.6% in the current quarter. Absent restructuring and related charges recorded in both periods, infrastructure's operating income was $40 million in the current quarter compared with $34 million in the prior year quarter. Operating income improved due to higher sales volumes and price realization, increased capacity utilization, higher restructuring benefits, but offset by higher raw material cost.

Regarding our overall bottom line performance, the [reported] fourth quarter fiscal 2011 diluted earnings per share were $1.04, and this compares to the prior year diluted earnings per share of $0.49. And on an adjusted basis, our diluted earnings per share were $1.11 compared to the prior year adjusted earnings of $0.61 a share. Again, this adjusted earnings per share of $1.11 is an all-time record. And to put this into perspective, we earned more earnings per share in the June quarter than we did all of fiscal 2010.

Our balance sheet remains strong, and we improved our financial flexibility. Our cash position increased to $205 million and remain focused on improving our working capital. Looking at some of the metrics, our DSO and ITL were flat in the June quarter compared to last quarter in the March period. However, we made further progress with our days payables, which increased four days from March to June.

At June 30, our total debt was $313 million, a decrease of approximately $4 million from the March quarter, and our debt-to-capital ratio at June 30 was 15.9% compared to 20.2% at June 30, 2010.

I'd like to point out that our senior unsecured notes are now reflected as current liabilities in our balance sheet, and we are in the process of reviewing financing alternatives. And I'll cover that in a second. Furthermore, our US defined benefit pension plans remain over 100% funded, our adjusted return on invested capital increased to 14.8%, up significantly from 12.9% in the March quarter. And as I previously mentioned, our adjusted return on invested capital is all-time Company record.

Let me turn to the outlook. Our outlook for fiscal '12 assumes that the global economy and worldwide industrial production will continue to reflect moderate expansion and that the overall economic trends will remain in positive territory. As a result, we expect to experience positive growth in all our geographies.

The following are some additional assumptions encompassed in our outlook -- global industrial production is anticipated to be in the mid single digits for the full fiscal year. Sales volumes and related capacity utilization are expected to yield favorable incremental margins and offset year-over-year cost increases. Our net interest expense will increase in fiscal '12 by approximately $8 million. This is largely due to the need to refinance the $300 million of the 7.2% 2002 notes that will mature in June of 2012.

Our expectation is to approach the public market this fall to take advantage of attractive market rates. Proceeds from the new debt transaction can be used to call the existing bonds or be retained on the balance sheet to repay the notes at maturity or for other general corporate purposes.

Our effective tax rate is projected to be around 23% for fiscal '12, and that's based on our anticipated global earnings mix, and our earnings are -- expect to be consistent with our historical seasonal patterns with approximately 40% of earnings occurring in the first half and 60% in the second half.

Taking these factors into consideration, we expect organic sales growth to be 10%, 12% higher than fiscal 2011 and total sales growth to be higher by 9% and 11%. This is in line with our goal of growing at least two times the rate of the increase and global industrial production.

We also expect earnings per share for fiscal 2012 to be in the range of $3.50 to $3.80, and the mid-point of this range represents a 22% increase from fiscal 2011 adjusted earnings per share of $2.98. In addition, fiscal 2012 guidance reflects our expectation of achieving our next milestone target. And that's -- for you who know us, that's 15% earnings before interest and taxes, or EBIT margin, and 15% return on invested capital. And this is one year earlier than previously anticipated.

Our cash flow from operating activity is expected be in a range of approximately $360 million to $380 million for fiscal '12. Based on anticipated capital expenditures of approximately $100 million, the Company expects to generate between $260 million to $280 million of free operating cash flow for the full fiscal year.

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

Thank you, Frank. Going forward, we'll maintain our strong commitment to executing our strategies. We will further balance our served-in markets, business mix and geographic presence. We expect to continue generating strong cash flows and will remain disciplined regarding our capital allocation process.

We'll keep driving our ongoing transformation to be an even more customer-focused enterprise and continue to deliver premier performance. As evidenced by the June quarter and fiscal year 2011 results, Kennametal continues to realize higher operating margin earnings and return on invested capital. We achieved all-time record highs, even with sales, are even lower than prior peak levels.

For fiscal year 2012, our guidance reflects expectations of continued global growth and our ability to outperform industrial production. Our fiscal 2011 EPS guidance, in the range of $3.50 to $3.80 per share, represents a 22% increase from fiscal 2011 adjusted EPS of $2.98 per share at the mid-point.

In summary, our global team remains focused on achieving the next milestone target of 15% EBIT margin and 15% return on invested capital in fiscal year 2012, a year earlier than previously anticipated. Our long-term strategies remain consistent. We will advance even further along the path to premier by maximizing our strong financial position and delivered continued shareholder value.

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

(Operator instructions.) Adam Uhlman, Cleveland Research.

Congratulations on the strong year. Hey, I was just wondering if we could talk about the infrastructure margins a little bit. It seems like the material costs have crept back up there. Can you maybe go through the dynamics of the quarter? And then, also, your outlook for material costs for fiscal '12?

Adam, I'll start. Yes, and I think you hit on it right there. As we said on our prepared remarks, raw materials continue to increase throughout the quarter, and I know you guys follow the APT trends. They went up a little bit quicker than we had originally planned. The good news is, it seems like they have somewhat taken a pause here for a while.

While the pricing was trying to catch up to the raw material cost, they rose a little bit faster than we had anticipated, but we should be able to get that back as we get into the new fiscal year. Our outlook is to get that, and that's embedded in our guidance going forward into fiscal '12.

Okay, I got it. Then, Frank, on the guidance for the year, it looks like you're going to be better than even the 15% goal, if my math is correct. Closer to 16%. I just wanted to check to see if that's correct. Then, secondly, if -- when we should expect some new long-term margin targets, given that you have blown through yours a year early?

Again, Adam, I think, directionally, your math is correct. You're spot-on from that perspective, given where we're at. As far as the next milestone, we're not ready to talk about [it yet]. I think we need to deliver the goal of 15x15, as I said, in New York, no later than '13, which we're going to do next year. Once we accomplish that, we'll revisit and set the next milestone after that.

Yes, this is Carlos. This is a subject most likely we're going to discuss at our September meeting.

Great. Thanks very much.

Eli Lustgarten with Longbow Securities.

Nice quarter. Couple quick questions. Just clarification. Corporate expense turned out to be $0.5 million in the quarter again, I guess. Can you give us an idea of what's going on and what that number would look like for next year?

Yes. Nothing usual. Again, we're trying to -- we look at whether we had a little bit of a benefit last quarter that didn't come through this quarter, but we're winding down some of our initiatives from last year. That's why it tailed down in the second half.

And I -- Eli, I would tell you that next year, it'll probably -- if I had to take a stab at it, it'll be about $10 million for the year. So, roughly $2.5 million a quarter, if you look at it. I would -- it's basically going to be flat.

And your margins -- I mean, [you started touching] that you got much better expected margin industrially, probably just somewhat disappointing margins in infrastructure. Turned out to -- for the year about the same. Can we -- what would be a more normalized rate for industrial next year? I guess I can't believe it's going to stay at 18.7%. And will we get those kind of margins in infrastructure next year, which is sort of more norm?

As far -- we're going to continue to do well. I think some of the restructuring benefits -- most of the benefits were on the industrial side as opposed to the infrastructure, so we're going to continue to watch the discipline. We got some key initiative or some newer products on the industrial side. Particularly, we like the relationship with the Fastenal arrangement, so that's going to help us there. We think -- we don't expect much deterioration at all, from that perspective.

Then, I think we should see a little bit of a benefit on the infrastructure side as we catch up with the price increases and the raw materials.

You were saying the deterioration from the year number? Or the fourth quarter number?

From the fourth quarter.

So, you expect you can keep the margins in the high teens and industrially for early next year on a seasonal basis, [adjusted seasonally] --?

Right. Yes. Correct.

Absolutely. Eli, I remind you that the cycles of the two business are different, so you'll see a time where the infrastructure margins are higher than industrial.

Yes.

But, typically, in the recovery, the industrial margins are better.

Frank, can you talk about the refinancing that you're doing? You said higher charges of $8 million, yet unless something really changes, you're going to save a couple hundred basis points on the debt refinancing. Is that $8 million all frontloaded in the first quarter or first and second quarter because of the cost of finance? I mean, it's hard to believe it's going to go up except for charges associated because your costs will be lower on the same debt.

Yes. Well, you're exactly correct. We will definitely be able to refinance the 7.2 notes much lower than where it's at today, so the strategy really -- and the number's actually the higher interest expense works out whether we do one of two approaches, whether we do the [May call tender], and then you could have a higher charge in one quarter, and then you have much lower earnings. So, you have some seasonality. That'll skew the seasonality a little bit. Or we issue it in the fall, and we keep the cash on the balance sheet and repay it back in June of 2012.

We're going to have the higher carrying costs associated with the debt, so we're looking at couple different ways. What's more advantageous? We'll look it in the fall.

But, should we spread the higher $8 million -- it's $2 million a quarter, effectively, [all over] the four quarters? Or frontloaded in the first half? I mean --.

Yes, I would assume that we would most likely try to do it in the second quarter.

It's -- basically, this -- the $8 million goes in one quarter? In the second quarter? Is that what you're saying? Or --?

No, it -- I would -- there's two different scenarios.

Yes.

It depends on what we do. You can either spread it -- if we do the latter scenario that I talked about, if we would do the May call, you would probably have more on the second quarter and less in the second half.

Okay. Something like that. One final question. One of the benefits in [turning to] -- I mean, the Japanese tragedy also affected the number four to seven suppliers in cutting tools globally. Did you see much benefit of that? Or were you hearing much? Customers wanting to make sure they had supply and [getting] some share? Will that sustain itself?

Yes, Eli, this is Carlos. I mean, it's really hard for us to quantify because most of that would've come from WIDIA replacement. And the -- as you -- as we said earlier, WIDIA, for the year, grew at 37%. So, clearly, we have replaced some of those Japanese suppliers, and -- but, we can't quantify it. I would say that we'd likely keep the majority of it.

Holden Lewis with BB&T.

Are you able to give a sense -- I mean, you've had a number of price increases, both big, broad ones, as well as maybe more targeted, smaller ones. They -- I think they concentrated towards the back half of '11. When you're talking about your revenue growth rate, what are we assuming for price in that? I guess I'm curious about what you achieved in '11. As that carries forward, and you get a full year, what that implies about '12?

Yes, I mean, I'll talk from '12, and Frank can fill in on the '11. But, we typically plan for a 1% to 2% price increase as we start the year. All I can tell you -- that is higher this year for 2012. Obviously, we're not going to get into very specific details for competitive reasons. And Frank, '11?

Yes. Again, I think we -- Holden, we don't want to necessarily give out -- as you know, we do reflect price that's in our organic growth rate, but to Carlos' point, it was above our typical average in the fourth quarter, and that's all I'll comment on it at this point, because the raw material cost increased a lot faster. I know what you're trying to get at, but at this point I'm not comfortable with the price -- giving that assumption out, given the competition dynamics.

Okay. Fair enough. But, on the price cost dynamic, then, looking at the two blended, I think your thoughts were where tungsten was before, that you'd be behind on the margin in the second half of this just-done fiscal year, and then you'd be at or above parody on the margin in the first half of fiscal '12.

Given what tungsten's done and your pricing actions, do you still feel like you've got back to neutral by the time you get into this Q1 period? Or are we -- is tungsten pushed to -- behind that a bit?

It's -- we're close to that. Let me just say it that way.

Then, by year-end, it'll be ahead.

Right. If everything stays the same, obviously.

Okay. I think it's [pushed to the right] a little bit, maybe, but you --?

Correct. Right.

Okay.

Yes.

Okay. Then, last thing, working capital -- it looks like your inventory and receivables went up a fair bit. Any commentary on that?

Well, we finished with the strongest month of the year on the receivables side, so very strong finish on the sales. Then, we had to buy some additional raw materials at higher prices, so temporarily a little bit higher on the inventory side.

But, I like the progress that our purchasing and treasury team have done with the payables, so we got a nice plan to get that back into line. That'll continue to increase as we go into next year, and then it's really focusing on the receivables and, particularly -- or, I should say, more importantly, our inventory turns as we go forward.

Okay.

Julian Mitchell, Credit Suisse.

It's actually [Sheena] on behalf of Julian. A few questions for you. On the incremental margins, I know it was discussed, but they were about 30% in the quarter. I assume some of that was because of -- FX was such a big tailwind for the top line, so a bit of a headwind on the margin. On fiscal '12, that should accelerate, but your guidance implies 30 at the low end, 37 at the high end, so the mid-point is accelerating from the Q4 level. Is that correct?

Yes. To start with your first point there, the difference between the -- I'll call constant currency and actual, we did 30% to -- you point out, and 34%, if you put it on a constant currency basis.

Currency -- when we looked at [with] the euro -- I'll just use one currency, to give you some kind of guidance. We finished this year -- the average euro, as we do it, was about $1.36. When we -- when you do your plan rates, we assumed $1.37 for the full year. Now it's a little bit higher, so you don't obviously lever at all, or very little bit, on the incremental margin.

The way we did our plan, FX shouldn't have a significant impact, given that the euro's our biggest currency, and we're looking at it on a constant currency basis, the $1.36 to $1.37. I don't think, at this point, the way we did the plan and the guidance is going to have a significant impact, but if the currencies get out of line, we'll update at the end of every quarter, as we typically do.

Also, any change in order trends or demand trends from June to July? Can you comment on that?

The --.

Seasonality. I mean --.

Yes, just outside of seasonality, the orders are consistent with our guidance. We --.

Got it.

Feel good about it.

Last question on -- just a quick one. Aerospace and Defense grew 8% in the June quarter. Commentary around the Paris Airshow suggests that this should pick up as commercial aerospace accelerates in fiscal '12. Do you think that's accurate to assume?

Yes, absolutely. I mean, the orders, by the time we ship, take a little longer in the Aerospace market, but we feel very good, and our Aerospace business is starting to do very well.

Yes, I -- the only thing I would add to that is, we had our best quarter in Aerospace in the June quarter. That trends up from March, so you can extract it like that.

Got it. Thank you.

Ann Duignan with JP Morgan.

It's Ingrid Aja standing in for Ann. Was wondering if we could circle back to WIDIA. What kind of growth expectation is in your guidance for WIDIA this year? I guess what percent of that growth is driven by Fastenal building its inventory?

Well, I mean, we are not going to publish how much our growth is expected, obviously for competitive reasons, but we expect WIDIA to continue to outpace all the areas in our business. The Fastenal is, again, really hard to predict. As a matter of fact, this week, we have probably 100 -- close to 170 people here getting training for -- from Fastenal. So, it's really hard to predict.

Our assumptions right now is the growth is going to be small, but we'll see how it goes through year. It's very difficult to predict at this point.

Ingrid, again, that's -- the couple comments there is we like the growth opportunities, particularly with Fastenal driving that in the Americas. And I also like the opportunities we have in Asia. There's -- these are -- this is really starting to gain some traction on all geographies.

Okay, great. That's helpful. Then, just going back to the price increases and offsetting the costs, are you still expecting the 40% incremental operating margin target through the cycle? Or is there expectation around that change at all?

I think we took that into consideration with our guidance here, if you look over the past three years. We think we're pretty much in that because the prior year was very strong. We finished the year right around 40% this year. And as some of the calls earlier -- somebody commented between 30 -- the mid 30s. That put us right where we committed to previously.

Yes. I would expect that by mid-year, again, according to our guidance, we are at a run rate of the peak. So, sales in the past. So, I would say that if you really look at and calculate that, our 40% incremental margin through the cycle, I believe we're going to meet or exceed that.

Thank you.

Walter Liptak with Barrington Research.

Congratulations on the return numbers. I wanted to ask about the seasonality. Frank, I think you commented normal seasonality 40/60?

Yes.

If I -- looking back at this year, there were some issues early in the year with the EPS coming in at, I think, 34% in the first half. I guess what are the puts and takes here? Pricing is probably in better shape than it was last year, but we're -- it looks like some of the industrial regions are starting to slow a little bit. Should we be cautious on the first half?

I think we're a little bit more -- we looked at -- you're right, Walt. The drivers -- obviously, it'll be what price does and what industrial production does on a global basis. That's how we kind of look at it. And like anything else, you put a stake in the ground at the end of the year, we look historically how it's been, we kind of rolled up -- I'm not going to try to get it too precise here, plus or minus on the 40, and some thing with the 60. It could move a little bit higher, it can move a little bit lower, depending on how the second half of the calendar year is, but as you would expect, fiscal '12 or second half of our fiscal year is in calendar '12. So, we get a little bit more visibility, we'll update it as we go forward, but that's our best estimate at this point.

Okay.

Walt, industrial production for IPI for FY '11 was 5.9. Current forecast for FY '12 is 5.2. So, it's going to down from 5.9 to 5.2. My point is, though, I'll be really happy with 5.2 and 13% growth -- 11% to 13% growth on top line.

Okay. Would you expect that, like, in the first, second quarter, that we're going to have equal quarters? Like 20 and 20? Or do you think the first question will -- because of holidays and things like that, will be weaker than the second?

If you take into consideration the debt, I think the second quarter would be a little bit less because of higher interest expense, but on the surface, not exactly 20/20. B--, the second quarter's, on a normal basis, is a little bit stronger than the first.

Okay. Thanks, guys.

Thank you.

Andy Casey with Wells Fargo Securities.

Couple questions. First, on free cash flow guidance, at the mid-point of your fiscal '12 guidance, you're expecting free cash flow as a percent of net income to be about roughly 90%. That's up pretty strongly from this year's performance, not adjusting for the restructuring. What is changing to achieve that, given you're looking for higher CapEx?

Well, I think the inventory growth was the main driver in the prior year. Andy, I don't think we need -- we won't need to increase as much on the inventory side as we did in the past year, so that's -- that was a call -- I don't want to call that drag, but kind of growth with the working capital on fiscal '11 versus '12.

Okay.

We also did some strategic buys on the raw material because the raw material increase quite a bit. You had demand coming in, and the growth in the -- in this 2012, as a percentage of growth, is going to be lower, so we've built the inventory to support FY '12 growth, and we did some strategic buys on the raw material.

Andy, I would add to your point on the CapEx, which is up year-over-year, it's really three facets. It's emerging -- I'll call it market expansion in Asia in a couple areas, the support for some new products that we have here. [The unit guys] would know about Beyond BLAST. And to further drive increased profitability, we also put some equipment in for productivity.

Okay. Thank you for that. Then, if I can turn back on the prior demand questions, clearly I'm sure you've seen other companies have talked about seeing demand soften in some regions. You're really diversified and have above-market growth prospects, but I'm wondering if you're seeing any underlying market demand trend weakening recently in any region?

Oh, I mean, I think that -- I go back to the IPI. I mean, we're going from a 5.9 to a 5.2, so there is what I would consider a little bit of a deceleration, but it's, again, included and implied in our guidance. We really haven't seen any weakness in any particular market at this point.

Okay. Thank you very much.

Henry Kern with UBS.

Wondering if you could talk a little bit about the mix shift from direct to indirect as we go through fiscal '12. Where do you expect to be, as we exit fiscal '12, versus where we are today?

Well, I mean, I think that we believe that we're going to continue to grow or we will grow the indirect faster than the direct. I haven't actually looked at -- from a percentage, we typically say that we're about 60/40. I'm not sure what the impact in the overall percentage is. But, our growth in 2011 -- the indirect grew at a much higher pace than the Company as a whole, and I believe that it's going to be the same case this year, 2012.

Is there a margin impact from that on the operating margin level?

No. If anything, it's positive at the operating margin.

And one final one, if I could. Could you walk through your latest thoughts on M&A?

I mean, we have a healthy pipeline, and we are always in discussions with a number of companies but, as you know, forecasting something is very difficult. So, we are open and would do an acquisition that would make sense, and we're always in talks with some companies.

Okay. Thanks a lot.

Thank you.

Steve Barger with KeyBanc Capital Markets.

As you've gone through some of the sensitivity analysis on your forward look, if you think about a slow to medium growth industrial production environment, given your cost structure and how you're operating now, do you think your EPS growth rate, on a normalized basis, settles in at high teen, low 20% over time? So, not thinking about '12, just on a go-forward basis?

Yes. Yes, absolutely. I mean, we always talked about 15% being our next milestone. We also talked about -- that we believe that this business is a mid-to-high teens EBIT margin business.

No, I'm talking about earnings growth rate.

Right.

Yes, same.

Same thing? Okay. Thinking about the overall goal of growing two times global industrial production, when you put together the current growth forecast, did you -- can you tell us what the implied growth rate is in developing markets versus developed? And then, how you see that kind of shaking out over the year?

Well, I'll give you, I mean, a point of reference. Again, it goes back to the IPI. The Asia Pacific area has an IPI of 8.7 versus NAFTA at 4.1 and versus the European Union at 2.7.

Okay.

The developing economies are going to grow at a significantly higher pace than the developed economies. That's going to continue.

As you look at that higher growth rate in the developed economies -- and I know market share can be hard to gauge in some of those markets, do you have share gain targets? Can you measure that versus just what the cycle gives you?

No. I mean, it's really hard in the -- especially in developing economies, because the data is just not there. But, my view is that if we are growing in -- two to three times the IPI market, I mean we have to be getting some market share, right?

Yes, it stands to reason.

Yes.

Okay. That's great. Thanks. I'll get back in line.

Okay, thanks.

Brian Rayle with Northcoast Research.

Great quarter. Most of my questions have been answered. I guess, given the outperformance on the cost save at $170 million for the plant closures, has it changed, in any way, how you're approaching your thought process? I know you stated in the past that you'd go back to the more normal restructuring through the course of the cycle as demand comes through, but given the outperformance here, does that change how you look at that at all?

No. I mean, I think that we're, at least from what we see for the 2012 guidance and where we see the growth to be, is that we would not do any called-out restructure, if you look at it that way. I mean, we are constantly looking in our -- at our cost and adjusting our cost accordingly, but the difference between the previous estimate and where we came out is two additional plants. I think, at this point, we feel very -- that we are sized properly for our going-forward projections.

Okay. So, I guess, stepping back from, just, 2012 but longer term, you guys had historically closed one to two plants or rationalized facilities, whatever euphemism you want to use. Is that a pace that we should expect to be accelerating, given the success of this program?

Well, I mean, I wouldn't -- at this point, there's a lot of -- as I can sense in the call and the economy, there's a lot of jitters around there, so I -- we probably not going to do that much this year. I think, going forward, our view is that if we continue to have the growth that we think we're going to have, we'll go back to doing something like that going forward. We want to --.

Okay.

Plants, but we would not accelerate that. I continue to remind everybody that it's not a large square footage. These typically are very small plants that have fixed costs that we can eliminate by moving them into other larger facilities.

No, absolutely. Yes, the rationalization makes complete sense. Thank you for the time.

Thanks.

Holden Lewis with BB&T.

Couple things as it relates to profitability going forward. First, with regards to where you feel you're sized to, I think in the past you talked about really not having to make any investments to support growth until you're about a $3 billion kind of business again. Can you comment on that?

Then, secondly, the SAP system that you rolled out -- and I guess you were tweaking that through the March period, or what have you. You should have a quarter now of really trying to run it and get benefits and advantages out of it. Can you just talk a little bit about what we're doing with that and what the expected benefits and contributions should be from that?

Yes. I mean, I'll talk about -- the SAP is really, now, six months that -- we kicked it off in --.

January.

January 3, and I think some of the benefits are already in the 170 that we talked about.

But, going forward, I think we're going to have a better understanding of our customers. We're going to have to -- we're going to have a better understanding of our markets in market share as well as some of our specific costs. I think the visibility is very good.

We haven't really quantified any additional savings. I mean, again, our margin continues to expand. Therefore, the benefits are -- one of the drivers for the expansion of the margin is cost savings that are coming from the SAP and how we run the business.

Relative to the $3 billion is -- we're still looking at that. That is -- we don't have to make any major investments in our infrastructure to get there. Again, our capital is in line around the depreciation, so we plan to continue in that pace.

Okay. And on the SAP thing, I mean, you're not attributing, we think, just broadly, 50 basis points of annual improvement related to things that stem from this system? There's no way to sort of quantify or put a range around what that benefit of farming that could be?

No. I mean, our first priority with SAP was -- and the changing of the organization was that we are going to make sure that the $170 million were fixed, permanent cost takeout, and they weren't coming back. We did things like -- we integrated all the payables into one area and receivables and so forth. All of that -- majority of that was part of the $170 million cost takeout.

What we're going to get forward is the SAP's going to help us with growth because it's going to help us to be more focused and so forth and understand our customers better.

Okay. Thank you.

And this concludes our Q&A period. Ms. McGuire, do you have any further remarks?

Yes. This concludes our discussion today. Please contact me, Quynh McGuire, at 724-539-6559 for any follow-up questions. Thanks for joining us.

Ladies and gentlemen, today's call will be available for replay beginning today at 1:00 p.m. Eastern Time. It will run through midnight Eastern Time on August 29, 2011. The numbers to dial to access the replay are 1-800-642-1687, and for international callers, 706-645-9291. The conference ID number for the replay is 79469605. This does conclude today's conference call. Thank you all for participating, and you may now disconnect.