Kennametal Inc (KMT) 2012 Q1 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 first-quarter fiscal year 2012 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 first-quarter of fiscal year 2012 results.

We issued our quarterly earnings press release early yesterday; you may access this announcement via our website at www.Kennametal.com.

Consistent with our practice and 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 November 28, 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, and Vice President and Chief Financial Officer, Frank Simpkins.

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 8-K, a copy of which is currently available on our website.

This enables us to discuss non-GAAP financial measures during this call in accordance with SEC Regulation G.

This 8-K presents GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures and it also provides a reconciliation of those measures as well.

I'll 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 delivered strong results for the September quarter for fiscal year 2012.

During the period we had organic sales growth of 17% year over year.

This increase is on top of 34% organic growth in the prior year periods.

In addition to a positive economic environment, we continue to successfully execute our strategies to realize additional sources of growth.

Those initiatives include enterprise selling, new product introductions, immersion markets expansion, pricing actions and our indirect channel strategy which include the WIDIA brand deployments.

With global industrial production at 3.9% for the September quarter we are demonstrating that Kennametal specific strategies drove our revenue growth at a pace that significantly outperforms the industrial production index.

During the quarter we continued to experience growth in customer demand across our served end markets and geographies.

This supports our continued expectations of a manufacturing lab recovery, at least in the United States.

Our expectations are in line with recent data showing that US manufacturers grew faster than expected in September as production and (technical difficulty) increased.

Additionally, there continues to be growth in emerging markets such as China, India and Brazil.

At September 30 our rest of the world markets represented 26% of our total sales.

We are continuing to leverage our indirect channel strategy through the launch of our WIDIA brand.

We are increasing our presence in distribution channels and showcasing our market leading technology capabilities.

WIDIA product sales increased 22% year over year, reflecting continued strong growth.

Clearly we are increasing our addressable markets, moving into more of the white space and gaining share.

Regarding other key performance metrics for the September quarter, Kennametal's operating margin reached 15.4% with earnings per share of $0.88.

Both of those represent all time first-quarter Company records.

In addition, adjusted return on invested capital was 16.2%, which is an all-time Company high.

While the macro environment reflected ongoing growth our business also continued to benefit from proven strategies, as well as aggressive measures to control costs and build a more efficient streamlined enterprise.

Our initiatives have strengthened our foundation and further increase our focus on operational excellence providing Kennametal with the ability to achieve higher levels of profitability, earnings and returns.

From a macro perspective a weaker growth outlook is forecasted, but a recession is not expected according to the IHS Global Insight.

In the Eurozone the GDP forecast for 2012 has been revised lower to 0.9%.

In the US (technical difficulty) many manufacturers are driving and the past two months gains in the industrial production index are not consistent with an imminent recession.

In China inflation is showing early signs of easing, but the Chinese government is expected to maintain its stance on monetary tightening for now.

Growth in (technical difficulty) region is forecasted to slow from 10.3% in 2010 to 9.2% in 2011 and 8.3% in 2012.

At those projected growth levels China remains an attractive market for Kennametal.

Moving to the outlook in our served end markets, in general engineering the future outlook for US exports of machinery remains strong, although growth may moderate in the near term.

Investments in the industrial power and infrastructure sector are expected to continue in emerging markets such as China, India and Latin America.

Exports have continued to be a bright spot, but domestic demand has gained some ground.

In transportation replacement pressures have driven the recovery in commercial vehicles.

However, truck buyers may be somewhat cautious due to the uncertainty in the near term.

According to IHS Global Insights, US light vehicle sales averaged 16.8 million units per year from 2000 to 2007, before declining to 13.1 million in 2008 and 10.4 million in 2009.

Now in 2010 sales increased to 11.6 million units and are expected to grow to 12.5 million units in 2011 and with a forecast to reach 13.5 million units by 2013.

In aerospace commercial aircraft manufacturing activity is expected to reach a seven-year moving average production rate of 1,000 aircraft per year in the next two to three years, twice what it was in 1991.

This production level represents a promising market environment for manufacturers in commercial aero structures, electronics, engines and components and other suppliers in this industry.

In earthworks coal demand in 2011 will grow modestly according to IHS Global Insight.

A strong area for this industry is primarily in export demand.

Consumption is expected to remain relatively flat as the increases in the exports are mostly offset by the decline in electricity generation from coal.

Regarding road construction, the Senate Appropriations Committee recently approved fiscal year 2012 funding for the highway and transit program at the same level as fiscal year 2011, just over $41 billion.

The bill also provides an additional $1.9 billion in emergency relief funding and $550 million for an economic recovery discretionary grants program as well as $100 million for high-speed rail.

As a result we anticipate road construction activity for the next season to be similar to the prior year periods.

In the energy market, US and international rig counts are higher than prior year by 20% and 7% respectively.

Canadian rig count is up significantly, increasing 63% year over year.

North American inventories are on track to hit record levels as productivity gains in the Shale region increases production.

The abundance of low-cost natural gas is expected to boost end-market demand over the next 12 months.

At the same time the global manufacturing picture is mixed and there continues to be uncertainties related to the Eurozone debt crisis.

The lack of clarity has resulted in slower production in parts of the Eurozone.

We realize that there are investor concerns related to the potential for a global slowdown.

However, customer sentiment has been generally favorable according to our recent experiences.

For example, Kennametal exhibited at the imX show in Las Vegas which is an interactive manufacturing experience to provide customers with an opportunity to learn about the latest technologies.

This event took place in early September and it was sponsored by the American Machine Tool Distributors Association or AMTDA.

High-level buyers were paired with industry experts across all sectors to bring together powerful solutions.

Also Kennametal was represented in Germany at the EMO Hannover 2011.

This was a leading international event for the machine tool industry featuring at least the latest machinery for all aspects of metal working with more than 2,000 exhibitors from 41 countries.

At those events customers indicated that they remain upbeat about growth prospects and they expect production levels to continue to expand.

Kennametal's margin performance during the quarter reflects that we are successfully recovering raw material inflation costs related to tungsten.

We are committed to ongoing pricing actions and maintaining our margin discipline.

We also continue to benefit from savings generated from our restructuring initiatives.

We are realizing $170 million of cost savings on an annualized basis.

Those are expenses that we have permanently removed from our cost structure.

Drivers of Kennametal's margin improvement can be attributed to strong top-line growth together with Company specific initiatives such as cost reduction measures related to our restructuring program as well as an ongoing commitment to lean operating principles.

We continue to believe that Kennametal's current footprint can support up to $3 billion in annual sales without any major capital investments.

Overall Kennametal continues to achieve higher profitability, earnings and returns due to our disciplined focus and operating efficiencies.

As a result we achieved first-quarter records of 15.4% operating margin and earnings per share of $0.88.

In addition, our adjusted return on invested capital of 6.2% was an all-time Company high.

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 September quarter and then I'll move on to our outlook for the remainder of our fiscal year 2012.

Some of my comments are non-GAAP, so please refer to the reconciliation schedules that we provide in our earnings release and related Form 8-K.

Let me start off -- the September quarter highlighted our further progress toward our commitments we made regarding our goal of achieving 15% EBIT and 15% return on invested capital this year.

And as you know, this is one year ahead of schedule.

We continue to drive our profitability by continuing our focus on key metrics such as our strategic initiatives, lean productivity as well as realizing the benefits from our restructuring programs that I highlighted recently in New York at our Analyst Day.

As Carlos alluded to, our September quarter was another record quarter and it included -- one, solid top-line growth as evidenced by 17% organic growth; record operating margin, earnings per share and return on invested capital despite uncertain macro conditions and significant raw material cost increases.

We did not have any restructuring charges.

I'd like to categorize it as a very clean quarter.

We strengthened our financial position and enhanced our operational flexibility.

And as I commented on in New York recently regarding our commitment to our priority uses of cash, we purchased 2 million of our shares during the quarter.

Subsequent to the quarter we amended our revolving bank credit facility and we increased our dividend 17% to $0.14 per share or $0.56 a share on an annual basis.

Now I'll walk you through some the key items on the income statement.

Sales for the quarter increased $130 million or 25% to $659 million, this compares to $529 million in the September quarter last year and the increase was due to 17% organic growth, 7% favorable foreign exchange and the effect of more business days.

Our sales growth was achieved despite stronger comparisons of double-digit organic growth of 34% in the prior year quarter.

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

We also continue to benefit from a better balance of our businesses globally.

And for the September quarter 54% of our sales were generated outside of North America with Western Europe at 28% and the rest of the world at 26% of sales.

Turning to the business segment sales performance, industrial segment sales of $418 million increased by 26% from the prior year quarter.

This was driven by organic growth of 17%, favorable FX impact of 8% and 1% increase due to more business days.

On an organic basis, sales increased in all served market sectors led by strong growth in general engineering and transportation with increases of 22% and 14% respectfully.

Aerospace and Defense also grew, they were up 8% compared to the prior year quarter.

And regionally sales increased by approximately 24% in Europe, 19% in the Americas and 7% in Asia.

The general engineering and transportation markets continue to demonstrate the strongest growth.

Globally these markets performed well including the strengthening of business in Europe and continued growth in the Americas and Asia.

Turning to the infrastructure segment, their sales came in at $241 million and increased 21% from the prior year quarter and that was also driven by organic growth of 17% and the impact of foreign currency of 4%.

The organic increase was driven by 19% higher sales of energy and related products and 14% increase in demand for earthwork products.

On a regional review, organic sales increased 25% in Asia, 16% in the Americas and 14% in Europe.

Now I'll touch on our operating performance.

Our reported gross profit margin increased 240 basis points to 38.1% and this compares with 35.7% in the September 2010 quarter.

Our strong gross profit improved due to higher sales volume including price realization, continued cost discipline and incremental restructuring benefits partly offset by higher raw material costs.

Our raw material costs, as you know, particularly tungsten, had an impact on or margin and leverage performance during the quarter.

And on a year-over-year basis tungsten prices have more than doubled.

However, these costs have stabilized recently, although it is difficult to determine which way the trend will go.

Operating expense increased year over year by 17% or $21 million to $146 million and the primary drivers of the increase in OpEx were employment costs including higher sales incentive compensation due to better operating performance, unfavorable FX and strategic initiatives related to trade shows such as EMO and imX, as Carlos touched on earlier.

Our operating expenses as a percent sales was 22% for the quarter, down 140 basis points from the prior year percentage of 24%.

Our operating income increased to $102 million, this compares to $58 million last year.

Absent restructuring-related charges operating income was $62 million in the prior year quarter.

We levered well (technical difficulty) this quarter with strong incremental margin of 31% and currency basis are leverage is even higher at 35%.

Operating margin reached the first-quarter record of 15.4% compared to the prior year quarterly record for adjusted operating margin of 11.7%.

Looking at the business segment operating performance, the industrial segment operating income was $73 million compared with $36 million for the same quarter last year.

Absent restructuring-related charges industrial operating income was $39 million in the prior year quarter.

The industrial operating margin increased substantially to 17.4% from an adjusted operating margin of 11.8% in the prior year.

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

This was partly offset by higher raw material costs.

The infrastructure segment operating income was $33 million compared with $27 million in the same quarter of the prior year.

Infrastructure's operating margin was 13.5% in the quarter compared with the prior year adjustment of 14%.

Absent restructuring and related charges the infrastructure op income was $28 million in the prior year.

Operating income grew primarily due to higher sales and volume which included price despite significant raw materials and incremental restructuring benefits.

On the tax rate front our effective tax rate came in as anticipated at 23%.

And regarding our bottom-line performance we reported a record first quarter with diluted earnings per share of $0.88 compared to the prior quarter diluted earnings per share of $0.42.

And the prior year included restructuring-related charges of a nickel.

Turning to cash flow, our cash outflow from operating activities was $7 million compared with the cash inflow of $26 million in the prior year.

Net capital expenditures were $11 million for the quarter and free operating cash flow for the quarter was an outflow of $18 million compared with an inflow of $16 million last year.

The primary drivers of the outflow in the current quarter were an increase in inventory levels and incentive compensation payments partly offset by higher net income.

Our balance sheet remains strong; our cash position was $103 million at quarter end.

We remain focused on improving our working capital.

DSO and IPO were relatively flat in the September quarter compared to June.

However, we made further progress with our days payable which increased one day from June to September.

At September 30, our total debt was $313 million, consistent with the June quarter.

Our debt to cap ratio at September 30 was 16.4% compared to 15.9% at June 30.

We are also in the process of reviewing financial alternatives related to our $300 million (technical difficulty) senior unsecured note.

Furthermore, our US defined benefit plan remains over 100% funded and, as Carlos talked, our adjusted return on invested capital increased to 16.2%, that's up significantly from 14.8% in the June quarter and represented an all-time high.

More importantly, the reported return on invested capital was 15.3% on a reported basis.

In October we further enhanced liquidity and strengthened our financial position by amending our existing revolving bank credit facility.

The amendment provides additional liquidity and increases the size of our facility from $500 million to $600 million and extending the terms to October of 2016.

The amendment also provides for improved pricing.

Financial covenants and other key provisions remained unchanged.

We also remain disciplined in our capital allocation process to ensure we invest in the highest potential initiatives.

As I said earlier, our capital expenditures were $11 million with a focus on productivity, capacity and internal expansion.

We also purchased 2 million shares under our repurchase program at a cost of $67 million and we have purchased 3.5 million shares since the program was approved one year ago.

And as we also noted, we increased our dividend by $0.02 per quarter effective with the November 2011 payment.

This is in line with our stated dividend strategy.

All these actions are consistent with our capital structure principles.

Now I'll touch briefly on our outlook and then I'll turn it back to Carlos for some closing comments.

Global economic conditions and worldwide industrial production are expected to continue to reflect modest expansion.

As such we have maintained our fiscal 2012 organic sales growth guidance range of 10% to 12% and total sales range of 9% to 11%.

We have increased our EPS guidance for fiscal 2012 in the range of $3.60 to $3.85 per share from the previous range of $3.50 to $3.80 per share.

The increase in earnings per share is primarily due to a lower share count.

Cash flow from operations is now expected to be in the range of $330 million to $360 million for fiscal 2012 as compared to the previous range of $360 million to $380 million.

And based on capital expenditures of approximately $100 million which is unchanged from the previous guidance, we expect to generate between $230 million to $260 million of free operating cash flow for the full fiscal year revised from the previous range of $260 million to $280 million.

Not I'll turn it back to Carlos for some closing comments.

Thank you, Frank.

As we move forward we'll continue to execute our strategies in order to stay in the path to become a breakaway company, one that can be profitable throughout the economic cycle.

We will capitalize on our strong foundation to maximize margins, earnings and returns.

We'll continue to balance our served end markets, business mix and geographic presence as well as manage our portfolio to maintain strategic relevance.

As proven by our September quarter results, our top-line growth continues to outperform the industrial production index.

In addition to benefiting from a positive demand environment we are successfully executing our strategy.

Kennametal is realizing additional sources of growth from initiatives such as enterprise selling, new product introductions, emerging markets expansion, pricing actions and our indirect channel strategy.

In summary, we will maintain a strong financial position to provide enhanced operation flexibility.

Also we'll continue to evaluate further opportunities to streamline our cost structure on an ongoing basis.

We will remain disciplined in our allocation of capital with priority uses of cash to include making acquisitions, reinvesting in our business, paying dividends and buying back shares.

Our global team remains highly focused on achieving our milestone target of 15% EBIT and 15% return on invested capital for fiscal year 2012.

Thank you for your time and your interest in Kennametal.

We will now take your questions.

(Operator Instructions).

Stephen Volkmann, Jefferies.

Curious, are we still supposed to be thinking of this year as kind of 40% EPS in the first half, 60% in the second?

I'll start and then if you have any other questions -- that's a guideline.

Let me start off, that's historically -- that's kind of how we tried to position when we come out in a new fiscal year because we always have the second half coming into a new calendar period.

So, for example, we said last year we expected approximately 40-60, very similar to this year.

The last year ended up 35-65.

So that's just a guideline that we're basically talking about at this point, but it could be higher in the first half this year than the second half or it could revert back to the prior year.

So at this time it's really kind of a guideline and we're going to be in a tight band plus or minus 5% on the side.

Okay --.

That's reflected on our EPS guidance.

Let me just ask it another way then.

If we hew to that rule the next quarter looks like it's down potentially fairly meaningful over this quarter and below I think what the Street is looking for.

I guess I'm trying to figure out if you're trying to send that message or if there's anything we should be thinking about about this next fiscal quarter?

What will be unique in the second quarter was the potential refinancing of the debt and we may have a lot more higher interest expense -- kind of the make wholes that we talked about in the last call.

So that would be something that could skew the -- I'll call it the past patterns.

So that's in your forecast then?

Correct.

Got it, thank you.

And then just real quickly on share repurchase, should I be thinking of that more opportunistically or do you think this is just kind of a slow and steady continuing process?

Opportunistic, Stephen.

I think that obviously we bought 2 million shares because we thought the price was great for us to buy.

You were right so far.

Thanks so much; I'll pass it on.

Henry Kirn, UBS.

Good quarter, but the infrastructure incremental margin was a little light of what we had modeled.

Could you talk a little bit about what you'd expect for flow through in infrastructure over the next few quarters?

Yes, I'll start and then Carlos wants to add on something.

The driver there, as you guys know, is -- the infrastructure has higher I'll call it tungsten content products.

So the driver there is most of the cost on the tungsten goes to the infrastructure side.

So it's kind of a game where we think we're catching up on the price.

We put some pricing increases in the fourth quarter; we tried to position us to catch up to the raw material cost.

Now as I said in the script, the tungsten has temporarily stabilized, but we need to watch that going forward.

From a steady-state now going forward we expect the infrastructure margins to continue to improve particularly with stronger performance in the second half of the fiscal year.

I will also add relative to the margins, the reason we have two businesses is for diversification purposes.

So if you -- those two businesses act differently at different times of the cycle.

So if you look at the low end of the cycle, the decremental margins in the infrastructure were a lot lower.

So the industrial were a lot higher.

So when we come back into the recovery the industrial margins, the incrementals will be higher than the infrastructure.

And that's kind of what -- that's been our five-year strategy is to have two businesses that ideally when one is at the peak the other one can be in the bottom and vice versa so that we can continue to grow our margins.

That's helpful.

And on Europe, how did quoting activity trend over the last couple months especially since your Investor Day?

And how does that tie into your visibility at this point versus what you had a few months ago?

Our quoting activity on the orders are in-line or slightly better than anticipated.

I've mentioned to you that I went to the imX show in Las Vegas, I went to EMO, I just came back from China this past week.

The customers continue to be -- I met probably with about 600 customers in the three continents plus.

I haven't found a customer that is not consistent in their projections of moderate growth in the US and Europe and strong growth in the Asia area.

That's helpful, thank you very much.

Eli Lustgarten, Longbow Securities.

A follow up talk about margin.

You had a terrific margin in the industrial sector in the first quarter.

Now is that sustainable for the rest of the year or is that sort of a -- slows down the rest of the year because it's sort of higher than I think we expected for the year and clearly much higher than anything we've seen in quite a while.

Well, let me go back to what I said, Eli.

We expected in the recovery for the industrial business to have a higher incremental margin.

Obviously as they get to the peak those margins will start to moderate and the reverse on the infrastructure.

If you remember, you and I talked about this during the downturn; people were -- or in the previous cycle -- people were concerned about the industrial margins being low, could we ever recover that.

So this is -- the businesses are operating the way we expect them to behave and the bottom line is that we delivered 16% EBIT margin as a Company, so the strategy is working.

Those businesses will not have the same margin at any one point in the cycle.

I mean that's been our strategy all along with this business and the good thing about this strategy is that we're delivering a higher margin, record margins and the two businesses are in different levels of delivering their potential.

I guess what I'm trying to get at is your profile on the next couple of the quarters.

Is the 17.4% sustainable in the second and third and fourth or do we get down a little bit and then up a little bit because of seasonality?

I mean what kind of profile should we expect in the industrial sector for the rest of the year?

Eli, I would say I think you're pretty much on.

I would expect a little bit of a dip in the second quarter and then the second half just on a pure number of work days because of the seasonality there.

And as you may or may not remember, every October 1 we put merit increases in place so we get a little bit of cost in the second quarter with less work days, we typically have that and that's not unusual compared to our normal past.

And then we'll get the corresponding benefits from the capacity utilization and the benefits in the second half.

Just a clarification -- the number of shares outstanding, your basis is down about 81.5 million or something like that, for the year?

Yes, let me answer that two ways.

As you know in the press release is 81.8 million, I would say the actual shares at the end of the September quarter is probably 1 million less.

So you're a little under 81 million?

Correct.

And you expect that to stay that way for the year or is there some share creep because of stuff or --?

Well, I think as Carlos addressed Steve's question, we'll be opportunistic and we'll evaluate consistent with our priority uses of cash.

We still have a large number authorized from last year.

I mean we got 8 million authorized and I think we've used 3.5 million so far.

So we have tons of flexibility.

And just one final question.

You talked -- Europe is probably the big concern, 28% of sales.

Are you assuming that Europe really goes through effectively very, very slow growth or zero growth as the ISM is indicating by the end of the fiscal year?

Again, if the ISM -- let me go back to the IPI because it's sort of -- if you go back to the IPI, the new projected IPI is in line with our current guidance and with our plan.

The IPI in Europe is about 1.2 forecasted for our fiscal year, just to our fiscal year of 2012.

And again, it is consistent with both our guidance, our plan and our expectations.

Great, thank you.

Ann Duignan, JPMorgan.

Could you quantify the incremental profits in both segments?

At least could you quantify the drag from higher input costs?

Ann, we typically don't put the breakdown between the two functions.

But with the infrastructure being a little bit more skewed with the raw materials they were a lot lower until the price catches in.

And then I'm stating the obvious, but the industrials were much higher on that one.

But I would say in the first quarter at the infrastructure I would put in the low-double-digits and the infrastructure higher to pull it up to the overall 31% range.

But you're not willing to quantify the net negative impact of higher tungsten prices?

No, it's so fluid and from a competitive standpoint we prefer not to.

Okay.

Then my second question really is about TDI.

Could you maybe characterize the 22% sales increase?

How much of that was dealer stocking versus pull through by dealers because of their sales?

It would be good for us to understand what's driving the 22% sales increase.

Is it just stocking the shelves at dealers or is it real pull-through?

We have one distributor that carries inventory, you guys know all of that, he's MFC, they represent 4% of our total sales.

All the other distributors is truly pull-through.

As a matter of fact some of our distributors, a lot of our distributors (technical difficulty) don't even carry any inventory.

The product gets shipped right from our warehouse to the end customer.

So there is really no inventory that we know of in the shelf, there's no pent up.

So, in other words the 22% sales increase or whatever absolute number that is, that it should be sustainable, it's not like we should see a decline as we go through the end of the year?

No, I mean it's just a matter of the (technical difficulty); the growth is there as the comps get harder obviously.

Totally, but the absolute level should remain at these levels?

Again I want to remind everyone that as low as the number, the IPI number, the world number for our fiscal year is 4.0, okay.

We just came out of a quarter that we outperformed by 4X.

So again, even if the number comes down slightly our guidance is still -- we still feel very comfortable and confident about our guidance.

Well, Carlos, that obviously begs the question then why didn't you have the confidence to raise your guidance by more than just the share repurchases?

Because I'm damned if I do and I'm damned if I don't.

So if I raise the guidance then I have to deal with the fact that am I naive, or if I don't I'm dealing with the situation that I'm dealing with now.

So obviously we err on the conservative side, we've always done it and we'll continue to do that.

But again, I don't know what else we can do.

I mean if you go back to every quarter during the recovery, we outperformed the IPI by a significant factor between four and five.

And historically we can outperform that by two to three times.

I can't really give you any more confidence than that.

Adam Uhlman, Cleveland Research.

I guess just first with a clarification on tungsten cost.

The price increases that are out in the field now, are those sufficient to offset the cost outlook that you have for the remainder of the year?

Yes.

We said that in the last -- at the end of last -- at the beginning of the quarter.

Most of our pricing actions had been deployed; it was just a matter of recovery and achieving those.

Okay, got it.

And then secondly, the working capital targets for the year, I might have missed it, but it sounds like you're seeing some inventory creep.

Frank, could you maybe just go through why the cash flow outlook has come down?

Adam, you're spot on, it's inventory.

I want to take that inventory down throughout the rest of the next quarter and that's where I think we'll give some back to the over-performance in the quarter.

But it's solely isolated to the inventory and some of the raw materials that we wanted to take advantage of.

And I will continue to work that down as we get a little bit more efficient with some capital we've put in the fourth quarter as well as leveraging the SAP here for (multiple speakers) back a year ago.

So we're getting a little bit better.

There's still some runway to go, but that's the main driver, it's solely related to inventory and we know what to do on that.

Yes, it is a delicate situation.

Obviously the price of the tungsten is fluctuating.

We have pricing in place and so forth.

Sometimes you have an opportunity to acquire more raw material than we actually need at a good price and we do some of that from time to time and from quarter to quarter we'll see some fluctuation in the inventory.

And then just a quick one, was there any earnings impact from currency this quarter?

Thanks.

The currency impact was about $0.02 from our guidance from the beginning of the year.

Can we move to the next person in the Q&A queue, please?

Sheila Kahyaoglu, Credit Suisse.

Just to elaborate on Carlos' trip to China, ABD said they saw soft orders this morning and some of the other industrials have also highlighted a big slowdown.

What's Kennametal seeing -- what are you seeing in the different end markets in Asia?

If you look at the quarter that we just ended, the order growth, the sales growth in China during the past quarter decelerated a little bit.

However, as I said, I was there just -- I came back actually Saturday, this past Saturday.

We feel that this quarter that we're in, and potentially for the rest of the year, we're going to see an acceleration in the industrial production there.

And we are actually seeing that in our orders -- it's reflected in our orders already this month.

So if you're talking about Q3 that we just ended, we saw a little deceleration in the growth and as we go into this quarter --

Only in industrial.

Only in industrial.

And as we look into the this quarter that we're in we'll see the industrial coming back.

Perfect.

And then on the automotive customers, what have you seen in terms of what your US automotive customers are saying to you?

And then on the aerospace side, just given the strong commercial aerospace number -- OE numbers, are you still projecting an acceleration from the 8% because it's been 6% to 8% for the last two or three quarters now.

Yes, I'll start with the easy one which is the aerospace.

I don't think this year we're going to see an impact on the overall -- I mean we're going to grow in aerospace, but of the other markets are going to grow as well.

So we're not going to see that number change significantly one way or the other.

As the aircraft -- as we produce more composite aircraft going forward then you'll see that number accelerated.

And the 787 is really the big composite of aircraft and they just flew I think yesterday or the day before yesterday.

So we'll anticipate that production is going to start kicking in and we'll see a positive effect on our revenues -- there you can see that number, we changed that number.

Relative to the automotive sector in the US, we continue to feel that there's growth.

And as I said earlier on, the Global Insight figures show continued increase both in 2012 and 2013.

So we continue -- our quoting activity continues to be high, we continue to see new projects for more efficient fuel efficient engines and obviously those are great opportunities for Kennametal.

Perfect.

And then just one last question on balancing hiring needs and just higher compensation costs given the strong order rates.

How are you thinking about that for the rest of the year?

Sheila, I would say it's pretty much -- it will be in line with our plan.

I mean, one quarter may be a little bit ahead of the other, but nothing that I'm worried about.

Okay, perfect.

Thank you so much.

Walt Liptak, Barrington Research.

My question is basically similar to what Ann was talking about with the revenue.

Your organic volumes have been coming through this quarter surprisingly strong and when you -- so your guidance for organic volumes look conservative for the full year.

So you're growing at 4X industrial production, why?

I mean is it the channel strategy?

Is it something competitive with Sandvik or Iscar?

Or is it some other market share benefit that you're getting?

Good question, Walt.

I mean we talked about this and we actually had a chart at our Analyst Day in New York.

So out of the five -- out of the six drivers that we have for growth, one of them is obviously the growth the economic environment.

But one of them was new products -- we're introducing new products at record times -- record numbers and our business is growing as a result of that; we're gaining market share as a result of that.

Is the channel strategy, the brand -- again, WIDIA is going into places, the white spaces that we didn't play before.

So the majority is incremental sales.

We talked about the continued balance of the geographies, again the developing economies continue to drive higher growth, as you've seen by our results in here.

And so, those are -- we have some very, very specific strategies that are driving (technical difficulty) incremental growth through the economic growth (technical difficulty) even with [10] it is the fact that we've been able to get a multiple of the IPI growth and I believe that we'll continue to do that.

Okay, right, those things are in place, they seem controllable.

And so I guess to just address the organic growth for the full year again, it's just basically the damned if you do, damned if you don't.

You're just being conservative, but with the way these initiatives are trending you would expect higher revenue?

Yes.

Just think about December -- this second quarter is a telling quarter because we don't know in December how many plants, if any, shut down and all that stuff.

And again, the debt crisis and all that stuff in Europe.

But the bottom line is the IPI is at 4%, we typically get 2% to 3%, although we've been getting more.

So again, if you go at three times the IPI is 12% and if you go at two times it's 8%.

So we are pretty close.

Okay.

And just a second question, on pricing.

I think it was in May the last time that you raised prices.

Are you expecting a price increase in January or sometime before then?

I think -- yes, I think there was one in North America in October consistent with past practice.

And what we typically do is we'll evaluate the situation in Europe, obviously see what the competition does in January.

That's typically when a number of our competitors go, so we'll watch developments accordingly.

Okay, was the October price increase for across the board or was it North America infrastructure?

More industrial.

Industrial, okay.

All right, thanks very much.

Andy Casey, Wells Fargo Securities.

A couple questions.

On the gross margin -- pretty impressive, 47% incremental.

Would you expect that to start coming back down towards the 40% to 45% range through the year?

You mean the incrementals -- I think I said 30s -- mid-30s?

On the gross margin.

Oh gross margin, yes.

I would think a little bit, Andy, but I wouldn't say too much.

I think it's twofold, now we'll take some inventory down.

But as Carlos talked about earlier, we think with the pricing we have in place that should compensate for it as well.

Was some of the sequential inventory build responsible for that?

You had a similar effect last year.

There's some in there, there's always some in there.

We wanted to make sure that we were opportunistic where we can and obviously we want to make sure that we can service our customers with a focus and then we'll have the normal seasonality, as you know, in the second quarter and then we get the benefits in the second half, but I think you're in the ball park.

Okay, thanks.

And then kind of a hypothetical on the tax rate, given all the macro stuff out of there and your European -- your pan-European strategy, if the growth shifts more toward North America does that cause the tax rate to drift up?

In that scenario that would correct, that would be higher tax jurisdictions.

So that would be exactly correct.

Okay, thank you very much.

Brian Rayle, Northcoast Research.

Congratulations on the great quarter.

When we think about the $3 billion target -- since most of the other questions have been asked -- the CapEx that's going to be required, you said no more CapEx up to $3 billion.

How should we think about as revenue could potentially break that $3 billion revenue level which, again, is a first-class problem, what should we think about CapEx?

Should it stay the same as a percentage of sales, obviously have maintenance CapEx, how should we look at that?

You should look at it as same as depreciation, about $85 million.

But I think, Brian, you're right.

It's, I mean, post $3 billion.

I think we'll be in that 3% to 4% of sales kind of range, that's kind of the -- unless there's a unique opportunity that we can take advantage of in an emerging market or something we want to do specific which we would call out.

But we think that's kind of about the right level to invest back in the business.

So it wouldn't push above your historic range?

No.

Again, it's a first-class problem, but if you went to $3.5 billion using the 3% or 4% range on CapEx would not be anything out of --.

It all depends how fast we get there, right.

Because every year we take about 6% -- 4% to 6% productivity out of our factories.

So that means 4% to 6% freed up space.

So to the time -- if it takes us a little longer to get to $3 billion then we'll have some more free space so we don't have to invest as much.

If we go to the $3 billion overnight then it requires us to invest a little more.

Okay.

But within that 3% to 4% range is not unreasonable?

Yes.

Okay, thank you.

Joel Tiss, Buckingham Research.

Just trying to clarify, there's been a lot of questions about this.

I wonder if you can just help us and cut right to it, the September order.

If you just -- you separated out the month of September and so far the month of October.

Can you give us an idea what that was just so -- because everyone is asking the same question about the trend and I think that would be very helpful.

Joel, this is Quynh.

We typically provide the orders rate on a three-month rolling basis.

So if we would have reported orders this month, it would have been at the 17% organic growth because our order's trend is a very close proxy to our sales trend.

So that 17% of organic growth for sales would be exactly what we would have reported for the orders trend.

But on a rolling three-month basis?

Correct.

So you can't separate it out for us, just September -- and October?

We can't quantify that, no.

Is the tone of peoples' questions that the September order run rate was materially or noticeably lower than what we saw in August and July, is that a fair tone that people have in their voice?

I would say if I would characterize the quarter I would say July was the slowest, it got better in August and September.

Now you would expect that typically with the European vacation in August, September is always better on a daily rate.

So that held true to form.

But the one that was -- I'll say the usual trend is July was a little bit slower and August was much stronger.

So sequentially it got better.

And the follow-through into October still gives you guys confidence?

Absolutely.

Okay.

And then last just quick, Carlos.

Are you -- are acquisitions making more sense here valuation wise or do we still need to be cautious and measured?

No, I think valuations are beginning to look better.

As we always said, we have a strong pipeline, but it's hard to predict or project when things happen.

But I would anticipate that things are getting a little better.

Okay.

All right thanks for taking the time.

Thank you.

At this time there are no further questions.

So this concludes our discussion.

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

And thank you for joining us.

Today's call will be available for replay beginning at 1.00 p.m.

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The conference ID number for the replay is 1278-4135, the number to dial for the replay is 855-859-2056 or 404-537-3406.

This concludes today's discussion.

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