Kennametal Inc (KMT) 2012 Q2 法說會逐字稿

Good morning.

I would like to welcome everyone to Kennametal's second quarter and fiscal year 2012 earnings conference call.

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

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

(Operator Instructions) At this time, I would like to turn the conference over to Quynh McGuire, Director, Investor Relations.

Ma'am, you may begin your conference.

Thank you, Nicole.

Welcome everyone.

I am Quynh McGuire, Director of Investor Relations for Kennametal.

Thank you for joining us to review Kennametal's second quarter of fiscal 2012 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 have invited various members of the media to listen into 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 February 26, 2012.

Joining me for our call today are Chairman, President, and Executive Officer, Carlos Cardoso; Vice President and Chief Financial Officer, Frank Simpkins; and Vice President, Finance, and Corporate Controller, Marty Bailey.

Carlos and Frank will provide further explanation on the quarter's financial performance.

After their remarks, we will be happy to answer your questions.

At this time, I would like to direct your attention to our forward-looking disclosure statements.

This 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 8K, 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 8K 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'll now turn the call over to Carlos.

Thank you, Quynh.

Good morning, everyone.

Thank you for joining us today.

I am pleased to report that for the December quarter of fiscal 2012, Kennametal once again delivered strong results.

For the period, our organic sales grew by 14% year over year.

This growth rate reflects strong customer demand and it is impressive, given strong comparisons of 31% from the prior year quarter.

In other key performance metrics for the December quarter, Kennametal's operating margin reached 14.7% with earnings per share of $0.91.

Both of those represented December quarter records for the Company.

Due to continued focus on operational excellence, our probability reflected strong year over year incremental margins of 36%.

In addition, adjusted return on invested capital was 17.3% which is an all-time Company record.

Our top line growth for this fiscal year has been as we expected and it is trending consistently with the fiscal 2012 guidance of 10% to 12% organic growth in a year over year basis.

We continue to believe that manufacturing is leading the economic recovery currently underway.

In addition, our results were attributable to our global team's successful execution of our proven strategies to outperform industrial production and improve our market position.

For the December quarter, global industrial production increased by 2.1%, indicating that expansion is still occurring in a number of end markets.

Along with the positive microeconomic, Kennametal environment -- Kennametal clearly benefited from our own growth strategies and initiatives which resulted in 14% of organic sales growth for the quarter.

For the six-month period ending December 31, industrial production growth was 1.1% while Kennametal realized 16% organic sales growth for the first half of our fiscal year 2012.

Customer demand in industrial markets continued to show strength, particularly in General Engineering, Aerospace, and Transportation.

Infrastructure markets such as energy and mining also reported steady growth, and we expect them to expand further as we move through the economic cycle.

We also saw increased activity across many of our served geographies with the [emerging] markets continue to show the fastest growth.

Currently, our rest of the world markets represent 27% of total sales during the December quarter.

During the period, we continued to implement our channel brand strategy.

For the first half of fiscal 2012, WIDIA Product sales increased 27% year over year, reflecting ongoing strengths.

We'll continue to maximize opportunities to expand our presence in distribution channels and gain market share.

Let's now discuss end market trends.

In General Engineering, customers continued to increase efficiencies in order to lower labor costs.

This should allow capital expenditure programs to grow even though there are some uncertainties related to US specs and regulatory policy.

Overall, the metal-working machinery industry has performed well due to general rise in industrial activity globally, particularly in the US.

We expect this trend to continue for the next several quarters.

In Transportation, sales in the global light vehicle market are anticipated to grow to 103.7 million units.

Key markets that will outperform the global average include South America, China, and South Asia.

According to a November 2011 report issued by IHS Global Insight, worldwide light vehicle sales are higher by 3.6% compared with the prior year despite production and disruption problems related to the Thailand flooding.

IHS forecasts global light vehicle production is expected to grow by 6% in 2012 to reach 81.1 million units, boosted specifically by the recoveries in Japan, Korea, and South Asia.

In Aerospace, the industry is looking for high productivity improvements and innovation.

Commercial airlines are expected to add more planes to their fleet to provide an opportunity to increase future revenues and address high fuel prices.

For example, Southwest Airlines recently announced its order for 2008 of the redesigned and more fuel-efficient version of the Boeing's most popular plane, the 737 model.

Our portfolio offers products for titanium and super alloy machining and other products that support the development of advanced manufacturing processes.

In the Mining market, metallurgical coal prices have stabilized in recent weeks, but the overall outlook for 2012 is for further price decline, driven by softening steel demand resulting from Euro Zone weaknesses and certain US demands and slower growth in BRIC economies.

However, the impact of further price softening is not expected to change investment strategies for major mining firms as 2011 was a record year for mining activity and capacity expansion.

In Highway Construction, activity in Euro Zone and the US is forecast to decline due to government austerity measures and funding issues.

However, shipments for construction machinery through October 2011 increased significantly with order backlogs and new orders also increasing.

In Energy, the US Energy Information Administration, or EAI (sic), expects consumption of natural gas in 2012 to grow in all sectors, particularly in the electric power market.

Those trends are expected to continue into 2013.

North American natural gas inventories are projected to reach record levels as storage injections are high in November according to IHS Global Insights.

In addition, the usual warm winter weather combined with domestic production increases during the year resulted in high storage levels.

Because of continued gas production, natural gas prices are expected to remain stable even with the higher demand during the winter months.

Regarding cost reduction measures, we continue to benefit from savings related to our past restructuring initiatives.

We are realizing annualized cost savings of $170 million.

Those costs have been permanently removed from our structure.

In addition, other initiatives aim at streamlining our business and both strengthening our foundation and improve our operating excellence.

As a result, we are confident that Kennametal can support up to $3 billion in sales without significant additional capital investment.

Our stronger enterprise has also made Kennametal a safer place for our employees.

In November, we were named one of America's Safest Companies by a leading environment health and safety industry publication.

Kennametal's margin performance during the quarter reflected our continued ability to recover inflation costs related to tungsten, our primary raw material.

We continue to execute appropriate pricing actions and maintain our margin disciplines.

As always, we continue to successfully execute Kennametal's growth strategies.

As announced last week, the pending acquisition of Deloro Stellite reinforces our strategy of requiring technologies that strengthen our core business.

In addition, we are leveraging our enterprise structure to gain additional top line growth from cross-selling.

We are increasing our presence in distribution channels to our video branch strategy.

We are showcasing our capabilities in technology and innovation and improving our customer's productivity through new product introductions.

We are expanding our presence in rest of the world markets.

As a result, we are further extending our reach to penetrate new markets, grow market share, and capture new customers.

I will now turn the call over to Frank, 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 December quarter and then I'll move on to our outlook for the remainder of the fiscal year 2012.

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

So let me start off, the December quarter once again illustrated strong progress towards our goal of achieving 15% EBIT and 15% return on invested capital this year.

As we have discussed previously, this is one year ahead of schedule.

Our December quarter highlights included solid top line growth, as evidenced by 14% organic growth; record quarter earnings per share of $0.91 and operating margin of 14.7%; an all-time record adjusted return on invested capital, 17.3%; and included in the release you'll see the actual amount was 16.6%, very favorable.

Raw material costs continue to stabilize.

Our price increases are holding and as Carlos mentions, in January, we entered into a definitive agreement to acquire Deloro Stellite that will strengthen our core business.

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

Sales for the quarter increased $76 million, or 13%, to $642 million and this compared to $566 million in the December quarter last year.

And that is due to 14% organic growth offset by the effect of less business sales.

Our sales growth was achieved despite stronger comparisons of double-digit organic growth of 31% in the prior year quarter.

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

We also continued to benefit from improved balance of our business globally for the December quarter.

55% of our sales are generated outside of North America with Western Europe at 28% and the rest of the world at 27% of sales.

Turning to the business segment's performance, the Industrial segment sales of $410 million increased 11% from the prior year quarter.

This was driven by organic growth.

On an organic basis, sales increased in all served markets lead by strong growth in Aerospace and Defense of 16%; General Engineering of 12%; and a 7% increase in Transportation.

Regionally, sales increased by approximately 15% in the Americas, 13% in Europe, and 1% in Asia.

As many of you know, the growth we experienced in the prior year December quarter was exceptional and strong across all regions, especially the emerging markets.

For comparison purposes, last year, Asia grew 48%, Europe was up 34% and the Americas grew 31%.

Our Infrastructure segment sales of $232 million, increased 18% from the prior year quarter, driven by organic growth of 19%, offset by the effect of less business days.

The organic increase was driven by 25% higher sales of energy and related products and 15% increase in demand for earthworks products.

Regionally, organic sales increased 34% in Asia, 16% in the Americas, and 10% in Europe.

The Infrastructure business also had very strong prior year growth with sales of 24% in Asia and 21% in the Americas, and 12% in Europe.

Now, a recap of our operating performance.

Our reported gross profit margin increased 70 basis points to 36.1% compared with 35.4% in the December 2010 quarter.

Our gross profit improved due to higher sales volume, price realization, and incremental restructuring benefits.

This was partly offset by higher raw material costs.

As I noted earlier, while raw material prices have doubled compared to last year, these costs continue to stabilize.

We will continue to watch for developments with these materials.

Operating expenses remained relatively flat year over year; in fact, our operating expenses increased only 2%, or $2 million.

We remain focused on controlling general and administrative costs and making select investments and selling-related costs.

We are focused on controlling the G&A portion to fund the selling expenses as we discussed at Analyst Day.

Operating expenses as a percent of sales was 21% for the quarter.

And this was down 200 basis points from the prior year percentage of 23%.

Our operating income increased to $94 million compared to $62 million in the prior year quarter.

Absent restructuring and related charges, operating income was $67 million in the prior year quarter.

As Carlos noted, we levered well again with a strong incremental margin of approximately 36% on both an actual and constant currency basis.

Operating margin was the December quarter record of 14.7% and 290 basis points higher than the prior year quarter adjusted operating margin of 11.8%.

Looking at the business segments of operating performance, the Industrial segment operating income was $63 million compared to $42 million in the same quarter of the prior year.

Absent restructuring related charges, Industrial operating income was $46 million in the prior year quarter.

Industrial operating margin increased 290 basis points to 15.3% from an adjusted operating margin of 12.4% in the prior year quarter.

Primary drivers of the increase in operating income were higher sales volume and price realization, partly offset by a higher raw material cost.

The Infrastructure segment's operating income was $33 million and this compares with $22 million in the same quarter of the prior year.

Absent restructuring related charges, Infrastructure's operating income was $23 million in the prior year quarter.

Infrastructure's operating margin increased 260 basis points to 14.4% from an adjusted operating margin of 11.8% in the prior year quarter.

Operating income grew primarily due to higher sales volume, price realization despite significantly higher raw material costs.

Our effective tax rate for the quarter was 17.3% compared to 21.3% in the prior year quarter.

The current year benefited from a $4 million valuation allowance adjustment and from the impact of stronger earnings in our Pan-European operations.

And regarding our bottom line performance, we reported a December quarter record diluted earnings per share of $0.91 compared to the prior year diluted earnings per share of $0.52.

The prior year earnings per share included restructuring related charges of about a $0.05.

Turning to cash flow, our cash flow from operating activities was $71 million compared with $67 million in the prior year.

Net capital expenditures were $33 million year-to-date compared to $14 million in the prior year period.

Free operating cash flow for the six months ended December 31, 2011 was $38 million compared to $54 million in the prior year period.

Subsequently, we had an improved December quarter performance for free operating cash flow compared to the September quarter.

Our balance sheet remains strong.

Our cash position was $129 million and was up from $103 million in the September quarter.

We remain focused on improving our working capitol and DSO and ITO are relatively similar levels in the December quarter compared to the September quarter.

However, we made further progress with our days payable, which increased two days from September to December.

We also initiated actions to better balance our inventory levels and demand for the second half as we discussed last quarter.

At December 31, 2011, our total debt was $308 million, down $5 million from the June quarter and our debt-to-capital ratio at December 31 was 15.9% and that is consistent with the June quarter.

We have been monitoring the bond market in anticipation of refinancing our $300 million, 7.2% Senior Unsecured Notes that are due in June of 2012.

With the public announcement of the Dolores Stellite acquisition and our upcoming 10-Q filing for the second quarter results, we expect to become more active with respect to the refinancing transaction.

When the transaction is executed, we will use the proceeds for debt reduction and general corporate purposes and we expect to retire the June 2012 notes when they become due.

Furthermore, our US defined benefit pension plans remain 100% funded and our adjusted return on invested capital increased to 17.3%, up significantly from 14.8% in June and as we mentioned, represents an all-time high.

As we announced last week, we signed a definitive agreement to purchase Dolores Stellite from Duke Street Capital for EUR277 million, as Carlos mentioned.

And as a refresher, Dolores Stellite has approximately EUR220 million in annual sales, seven facilities and 1,300 employees.

This is an alignment with our growth strategy and positions us to further achieve geographic and [end mark] balance.

The transaction is expected to be accretive in earnings in fiscal 2013.

We plan to fund the acquisition through existing credit facilities and operating cash flow and remain committed to our investment grade ratings.

Regarding share buyback, we were not active during the December quarter due to the ongoing discussions related to the Dolores Stellite transaction.

We will continue to be opportunistic in buying our stock.

To date, we have repurchased 3.5 million shares since the program was approved one year ago.

We have 4.5 million shares outstanding on an existing repurchase authorization and our priority as cash remains consistent, we will continue to evaluate share buybacks, acquisitions, dividends and capital expenditures.

Now I'll turn to our outlook.

As Carlos mentioned, the global economic conditions and industrial production are expected to continue to reflect moderate expansion and this view is relatively consistent with what we provided at the start of our fiscal year.

As such, we have maintained our fiscal 2012 organic sales growth.

Guidance range of 10% to 12% and increased sales growth guidance to a range of 10% to 12% from a previous estimate of 9% to 11%.

Full-year foreign currency impacts are now expected to be offset by the impact of more business days in fiscal 2012.

We have also increased our earnings per share guidance for fiscal 2012 to the range of $3.70 to $3.90 per share from the previous range of $3.60 to $3.85 per share.

Now I'll walk you through the factors of our increased earnings per share guidance from the prior midpoint of $3.72 per share to the new midpoint of $3.80 per share.

The factors include -- one, defective tax rate.

As a result of the December quarter tax benefit of approximately $4 million coupled with a slightly lower overall effective tax rate in the second half, we estimate a total positive benefit of approximately $0.08 per share.

Second, interest expense.

Due to the timing of the bond refinancing, we have concluded it no longer makes sense to offer the [make hold] premium which we originally planned to occur in the December quarter.

As a result, we now expect our full-year interest expense to be favorable by approximately $0.05 per share.

Foreign currency, we anticipate the foreign currencies and in our case, primarily the Euro will become a headwind in the second half of our fiscal year.

The first half of our fiscal year, we benefited from a stronger Euro which averaged about $1.41.

For the second half, we expect the Euro to weaken versus the first half and average in the high $1.20s.

This is anticipated to have an unfavorable impact of approximately $0.03 per share.

Lastly, as a result of our plans to improve to inventory levels in the second half, we are now expecting an unfavorable impact on our margins of approximately $0.10 per share.

However, we will offset a significant portion of this impact through improved productivity and pricing.

And so on a combined basis, this will have an unfavorable impact of approximately $0.02 per share.

Taking all these factors into consideration, they add approximately $0.08 per share to the midpoint of our full-year earnings per share guidance.

Pending the closing of the acquisition of Dolores Stellite, which we expect the impact to our earnings per share fiscal 2012 to be between $0.05 and $0.10 per share unfavorable which includes transaction costs of approximately $6 million.

This impact from the Dolores Stellite acquisition has not been reflected in our current EPS guidance.

And cash flow from operations is expected to be in the range of $330 million to $360 million for fiscal 2012 based on capital expenditures of $100 million.

The Company expects to generate between $230 million to $260 million of free operating cash flow for the full fiscal year.

Now I would like to turn it back to Carlos for a couple of closing comments.

Thank you, Frank.

As we move forward, we are forecasting an environment where demand is expected to grow moderately.

However, we can continue to outperform industrial production by maintaining our strategies and growth initiatives.

Those growth drivers include -- enterprise selling, new product introductions, and merger market expansion, pricing actions, and our indirect channel strategy.

Additionally, the pending acquisition of Dolores Stellite will advance our strategies by further diversifying our customer base, products and end markets and geographies.

We'll also continue our transformation towards becoming a customer-focused enterprise in a market-facing organization that is well-positioned to identifying new opportunities.

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

Those are the strategies that helped us transform Kennametal into a break-away Company, one that is profitable throughout the economic cycle.

Financial flexibility in the current environment continues to be important and we remain committed to maintaining a strong financial position.

As always, we will continually evaluate ways to streamline our cost structure.

Our priority is use of cash continue to include -- reinvesting in our business such as capital expenditures, buying back our stock, increasing our dividends, and making acquisitions.

We will remain disciplined in our capital allocation process to increase shareholder value.

We have repositioned Kennametal to continue delivering improved margins and returns.

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

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

We will now take questions.

(Operator Instructions) Ann Duignan with JPMorgan.

Good morning, it is Mike Shlisky filling in for Ann.

How are you?

Good, how are you doing?

Good.

Thank you.

Just a couple of quick ones for you.

I was wondering if you can tell us how much of your infrastructure business has been benefiting from onshore natural gas drilling?

And maybe what is your outlook for that particular segment?

The gas drilling is a strong portion of our energy business, so obviously we have been benefiting from that, and we anticipate that we'll continue to benefit from those activities.

Okay, thanks.

Also on infrastructure, can you give us a little bit more color about the relative strength we saw in Asia in the quarter?

Just within any particular area, country, business, that you saw strength over in Asia?

It's really all around.

Again, things change in a quarter-to-quarter basis, as we know.

China is focusing on the infrastructure, and building more infrastructure to offset some of the decline in their industrial sector, so there is really not any one particular area.

The only thing I would add to that is we did make some capital investments in the prior year, one in China, one in Australia.

And I think we're starting to see the benefits of our strategies with the top line.

Great, and then finally, a little bit more color maybe on Europe.

I know you had mentioned an FX headwind, but I was wondering -- it seems like definitely a headwind, there's something there, but have your organic growth plans changed or if [petition] has changed for Europe?

Actually, I would tell you that Europe this quarter performed slightly better than we anticipated.

I want to emphasize that every geography for us this quarter grew at double digits.

So, we continue to see strength in the industrial portion of the market in Europe.

Okay, well, thank you so much.

Eli Lustgarten with Longbow Securities.

Good morning.

Nice quarter.

How are you doing, Eli?

I can't complain.

A couple of quick questions.

One, you indicated tax rate in the second half is going to be lower than the first half.

Can you give us -- are we talking a 21% tax rate in the second half?

Eli, as you know, the first quarter was 23%.

I said slightly lower.

It's probably going to be between 22% and 22.5%.

So, it's probably most likely going to be down about 50 basis points from that, and that will get us to the full year a little bit over 21%.

Okay, and the interest charge you said because of your change, you're not going to have the premium.

Are we expecting these charges to basically stay about $5 million, $6 million, between $5 million, $5.5 million for the rest of the year except for the acquisition?

Excluding the acquisition, no, because we'll refinance it and basically have two tranches outstanding.

The interest expense, I would say, it's probably going to be about $28 million for the year.

You're looking at anywhere about $8.5 million in the next two quarters.

There was a big difference between your expectations.

Now, I guess the biggest surprise, if I had to look at the quarter, was the margins in industrial that occurred after the strength in the first quarter, and I guess we didn't expect it to fall off as much as it did.

Can you give us some idea of what should we expect for the rest of the year in the industrial margins, and when you're 17 point in the first and then you drop to 15% plus in the second.

Should we -- are we really looking at a blended 16% to 16.5% for the rest of the year or can you give us some sense of what's happening?

Well, Eli, let me start talking about the top line, and I'll let Frank address the margin in particular.

Again, at Analyst Day, we talked about that we have six drivers, six of the seven growth drivers, and this is why we continue to out-produce the industrial sector.

We had six drivers that were on our control.

Which one of those is the distribution channel.

Again, I emphasize WIDIA grew 27%, while the Company grew at 14%.

So again, we continue to show that we can outpace industrial production, and obviously, that volume helps us all around.

That is not going to stop this quarter.

I mean, we still have a lot of room because this WIDIA brand is addressing whitespace that Kennametal was not playing in before.

So this is the reason why we continue to outpace industrial production by a significant margin.

Frank, you want to talk about the margin?

Yes, from a margin standpoint, Eli, your question -- is industrial going to have a stronger second half to the numbers you mentioned?

Yes, we believe so.

I would say Q1 to Q2, I think the inventory was a little bit too high in my opinion than the first quarter, so we started to ratchet that down in the second quarter.

That volume impact was more pervasive on the industrial side.

So that is the driver.

Now I think we're going to have a better balance going forward.

Okay, and related to that, you talked about bringing inventories down in the second half of the year.

Is that mostly in industrial?

Yes.

And that is where the impact will be.

So, we're going to hold back profitability based on that.

Well, as I said, obviously for the full year, we think we'll be okay.

We got a little bit of benefit in the first half.

But I think we'll be able to offset that with some productivity and some select pricing that we'll get in the second half.

So, it's going to be close.

And final question, can you talk about the margin outlook for infrastructure was still below where we think the more traditional long-term value -- profitability is in that sector?

Yes, we expect that margin to continue to increase from the second quarter.

The second quarter, there is some seasonality factor with the construction period, et cetera, and we -- some of the price increases that we put in the second quarter, we expect the third and fourth quarter to be improved.

One final question, the acquisition of Deloro Stellite -- you gave us a negative impact this year.

You indicated you might give us some guidance for fiscal '13 of what ballpark incremental accretion might it look like.

I think most of us assumed something in the vicinity of $0.25 a share.

Is that an unreasonable number?

Yes, Eli, it's Quynh McGuire.

We're going to have to defer that -- the answer to that question until July when we provide guidance for the fiscal year '13.

Some of that will obviously be part of the planning process.

All right, thank you.

Henry Kirn with UBS.

Congratulations on a good quarter.

Thank you.

I guess, first, was there anything unseasonal in the fourth quarter?

Was there any benefit from either a pull forward in advance of price increases or accelerated depreciation incentives on [after] your customers?

Yes, first of all, let me correct.

It was our second quarter.

We're still on the fourth quarter, but it is our second quarter.

We really don't see -- didn't see anything that was unusual from a [full-length] perspective.

No, I mean, a lot of people were asking -- did the tax reformat have any impact on our pull forward?

We typically don't benefit from that.

We're selling consumables, so we don't have the big capital type equipment stuff.

It was pretty much as expected.

If anything, we may have -- we probably finished the first quarter a little bit stronger in the month of September, but the quarter progressively got stronger November and December, to be honest.

And again, I want to emphasize one more time, we gave guidance in June, we are still -- we are true to our guidance halfway through the year, and our new guidance that we just gave is true to the original guidance that we gave in June for 2012.

So, it shows that our model and forecast does -- is working.

And on the Deloro acquisition, what's been the reaction of the customers so far now?

You're over a week into it in terms of having that out there.

Have you gone to your customers and gotten any initial feedback?

Well, our customers are a little more patient than Wall Street.

(laughter) Our customers realize we haven't closed yet, but obviously the customers where our joint customers and our large customers have reacted positively at this point.

But again, for regulatory reasons, we have to be very cautious and really wait until we close before we start talking to customers in a more detailed basis.

That's excellent.

Congratulations.

Adam Uhlman with Cleveland Research.

I was -- can we dig into the industrial Asia sales growth rate a little bit?

That was pretty flat for the quarter whereas the infrastructure business was up a lot, I guess.

What's the -- there are tough comps obviously, but what is the underlying demand trend looking like there, and how are you thinking about that unfolding over the next couple of quarters?

Yes, I just want to remind everyone that in the industrial side, the comp was 48% growth.

I mean, 48% growth is not going to happen every quarter for the rest of our lives here.

But in a quarter-by-quarter basis, as China manipulates the -- or works their GDP between 8% and 10%.

There are shifts from infrastructure investment versus industrial investment, and I want to tell you that last year was -- during this period, we had a lot of projects.

In other words, a lot of [investment] in factories there are today online producing components.

So, I would anticipate that rest of the year that China will come back and be a -- have a bigger percentage of growth in the industrial side.

And in total is a great story.

I remind everyone, double-digit growth in every geography.

That is one of the reasons why we have this geography balance, some of the reason why we diversify this business is so that we are in this position.

We are going to have one market or one geography that is performing lower, and we'll have one or two or three balancing that, so that is the whole strategy of the Company.

Okay, got it, great, thanks.

And then speaking of growth investments, you mentioned that expenses are up only 2% or so, and a lot of the investments that were made over the past year are helping drive some pretty good growth, like in Asia with the infrastructure business.

I am just wondering conceptually how you are thinking about hiring new sales guys or making other investments to support growth for next year?

Well, we continue to make those investments.

I think that obviously we are, as Frank said in his remarks, we are taking away from G&A to put it in [SAP], so we are offsetting one with the other.

So the fact that we did all this restructuring back during the recession, and we did a fixed cost reduction.

In part of the variable costs, we are continually looking at offsetting to increase our sales and the front-end investments.

And again, I'll remind everyone on the line that we always said that this business has -- is -- we can grow up to $3 billion without major capital investment as well.

So, we have some room to go.

Adam, the only thing I would add to that and I agree with that is, I think we actually have much improved/better visibility to our entire cost structure as a result of SAP, particularly on the SG&A side.

So we're able to look at every single department much better than we have ever had in the past, so we continue to find little things.

There's no homeruns in there, but I think we were talking about this in the past, and we keep getting on base, hitting a single here and there, and over time, they start to add up.

So, I like the visibility that we have, particularly with the structure.

Julian Mitchell with Credit Suisse.

Thanks a lot.

Yes, I just wanted to follow up really, I guess, on the China point specifically.

We saw yesterday Rockwell Automation, obviously seeing sales down slightly in China in the December quarter.

And I guess aside from what the government might or might not do in terms of monetary policy, what are your own direct customers and the distributors telling you how they behave?

Has there been any changed trend in their behavior in recent months?

Because I think on your Q1 earnings call, you had said that when talking to customers and so on, there was evidence that maybe you were nearing a trough in short cycle industrial demands.

Have you seen more or less evidence of that in the interim?

We continue to feel strong about Asia, about China.

I think that if you look at the forecast, [IPI] continues to be in the 9% to 10% for our Q3 and Q4, so again, very, very difficult comps, specifically the comp of this quarter that was just finished.

But we feel all the indication our customers, our distributors at this point reflects, always reflect of our new guidance.

Okay.

So I guess, your new guidance on sales, what trend does that embed for the Asian industrial business for March and June?

Again, that's a flat performance in March, and then a pick-up in the June quarter year on year.

Is that the thrust of it?

We typically don't provide country-specific growth.

Carlos alluded to all businesses were strong.

We're trying to gauge right now, China's just in their -- wrapping up the New Year, so we'll continue to look on that.

But I'll tell you, the second half of our business for the March and June quarter, we typically do better.

So we expect the performance to continue as we originally guided, and whether there's puts or takes, that's embedded in our 10% to 12% organic growth.

Okay, great, and then just a follow-up, I guess for the full year fiscal '12, what would you think the net impact on your earnings from price and input cost dynamics are?

Taking everything together just for the full year as a whole?

Yes, we typically realize 1% to 2%, and obviously, we don't go into a lot of specifics, but I can tell you that our pricing is better than that this year.

Brian Rayle with Northcoast Research.

Good morning.

Thanks.

Congratulations on a great quarter.

Most of my questions have been answered.

The acquisition that you have pending seems like it's going to be accretive.

I know you can't comment that on for next year, but just wondering, does this put you on hiatus from looking at acquisitions for a period of time as you integrate this, or would you still be open to smaller bolt-on acquisitions?

I think that we are, we still have a strong pipeline in the acquisitions.

Obviously, it's very difficult to forecast acquisitions, but we continue to be active.

And this acquisition, as Frank mentioned earlier, is not only accretive for 2012, we think we're going to be able to pay for that within -- in '13.

And so and our balance sheet, the debt-to-equity doesn't change that much.

So it leaves us -- we have a strong balance sheet that leaves us room to make acquisitions further.

Yes, I guess maybe to clarify that question, yes, from a balance sheet standpoint, obviously, you have the dry powder that you need.

I guess from an operational standpoint, what I'm trying to get my arms around is, you guys have made fantastic cuts, cut the costs, but does that leave you with the ability to go -- to handle more than something like this from an operational standpoint?

This acquisition is going to require less integration because it's a new technology and -- than an acquisition that would be a similar technology where we have to close plants and so forth.

So this gives us more room, if you want to put it, more capacity in our organization to handle additional acquisitions.

Yes, Brian, I would add is prior to us taking ownership, they just went through a comprehensive portfolio analysis and restructuring so the best of the coupled businesses that we weren't of interest with and made some rationalizations.

So we'll continue to leverage their footprint as well, and then, as Carlos alluded to, take advantage of back office synergies, purchasing, et cetera, going forth.

Yes, this is a growth play.

This is a growth play.

Absolutely.

Thanks.

Thank you for the time.

Andy Casey with Wells Fargo Securities.

Just a couple of questions, as indicated previously, a lot of questions already asked, but if I could go back to the infrastructure US domestic exposure, could you walk through what you're seeing in both those nat gas and coal extraction demand.

And I -- really, the essence of the question is, I just wanted to make sure I understand the comments that you already made on the two markets.

Do you expect them to be, when you go forward, above last year or more of a flat -- good, but flattening trend?

It will be above last year.

I think that it will be moderate growth, as we talked about earlier.

And we are still excited about the energy, and obviously, as we get this new acquisition that plays a big role in the energy side, we continue to be very optimistic about what we can do.

Okay, thanks.

And then again, a clarification.

It's the last one for me.

You pretty much have been answering a few questions about China.

To be clear, are you expecting demand reacceleration anywhere else?

I don't fully understand --.

I think in response to an earlier question, sequentially, typically you see China get better in the second half versus first half.

You are correct, yes.

Is there any other region, given all the macro news going on, that you would expect that to occur?

I would imagine the US side --.

Yes, and I think that, again, I continue to remind everyone that our biggest market in Europe is Germany, and we continue to see, the markets still continue to be good for us, and Germany is still anticipated to continue to be -- again, it is still [accelerating], but a positive growth.

Okay.

Okay, thank you very much.

Walt Liptak with Barrington Research.

Thank you.

I wanted to ask a follow-on to Eli's question about some of the margins and maybe just talk generally about the gross margin, which was a little bit below what I was looking for.

Was it the similar situation where you brought down inventory, and that is why we saw a little bit lower gross margin?

Yes.

Okay.

And just going further down the income statement, last year you had the costs out already, and your SG&A numbers levered really well.

Can you talk about, is there continued cost out that is happening, and I guess what SG&A -- operating expense could we see for the year?

I mean, the first quarter was probably the peak, Walt, from -- on SG&A because we actually had two shows, both EMO and IMX and then we do our typical granting of stock compensation.

But I would expect it to be 21% for the full year right now, if I had to put a number on it for you -- around that (multiple speakers).

Because like I said, we're watching the G&A very closely.

We did a lot of the heavy lifting, to your point there, so we're planning synergistic opportunities across both businesses.

And we'll continue to drive that concept so that if we have to invest in selective markets, whether it's sales personnel that we're able to do it at a reduced cost because we are finding other ways to offset it, and at the heart of everything as we continue to drive lean as part of our KVBS business model.

Okay, got it.

And if we can go back up to the full year gross margin, and your comments about inventory, so we'll continue to see -- my guess is that we'll continue to see some year-over-year pressure on gross margin.

Is that right?

The margins will be up in the second half, and they're going to be up year-over-year, so let me just put it in that perspective.

Okay.

And then just the last one, the revenue was a little bit light from the consensus and from my revenue number, and you had 15% growth through November.

Did the December numbers slow anywhere in, I guess, specifically in Europe?

How are you getting double-digit growth with Europe teetering, I guess, on recession?

Yes, first of all, Walt, December did not slow down.

And again, we have specific drivers that are controlled by Kennametal.

I talked about that.

WIDIA strategy is the perfect example.

Again, let's not forget 27% growth on WIDIA, okay?

So that is helping us outperform significantly not only the overall Company growth, but obviously the industrial production.

The enterprise selling, we talked about.

By the way, we continue to have more than 40% of our sales coming from new products.

That -- companies, as things slow down, look for more productivity.

They need to address their cost structure; therefore, they are a lot more open to try new products and so forth, pricing, and our continuous expansion in Asia.

We continue to have 27% or 28% of our sales coming from the rest of the world, which Asia is a big portion of that.

Those are drivers, growth drivers, that are above and beyond the global economic expansion.

So, this is why we continue to outperform IPI by a significant factor, and it's not going to change for the second half of year.

We're going to continue to be on this pace.

Walt, the other thing, there's actually over three less work days from the first quarter.

The way the calendar [evolves] this year, last year, there was two less but the market was a lot stronger.

Okay.

This year, it's almost a 1.5 days less of a change on a year-over-year basis but over 3 days from Q1 to Q2.

So that's probably why --.

Okay, that's a good point.

Okay, great, thanks very much for the answers.

Joel Tiss from Buckingham Research.

I didn't think I was going to make it.

How are you doing, Joel?

We would make sure you made it.

Whatever.

(laughter) Anyway, I -- just a quick clean-up, any updates on pension?

We have seen a lot of other companies have to lower their discount rate.

I know you are a different fiscal year, so it might be coming, but can you give us any updates on what you are thinking there or what you are seeing?

I mean, that's to your point.

We'll start looking at our discount rate assumption as we get ready for the fiscal '13 guidance, but as I think I made the comment, our pension fund, because we implemented the LDI strategy a few years ago, has proved to be very prudent.

And we don't foresee any issues for this fiscal year for us, and we get into next year, we'll talk about the puts and takes.

And then any highlights you can give us on incremental restructuring?

Like, what else can you do going forward besides what's already in place, or are you going to just, more optimization of what you've already done?

Yes, we are not contemplating any major restructuring at this time.

However, I'll remind everyone that we practice leaning this Company, and we drive cost reductions every year, significant cost reductions, so we're going to continue to do that.

And by the way, those cost reductions also free up additional capacity.

Great.

Thank you very much.

Nice quarter, guys.

Gregory Macosko with Lord Abbett.

Yes, thank you taking my question.

Just a question regarding WIDIA growth.

Are the margins the same in that business, just overall relative to the Kennametal brand?

Our EBIT margins are the same, so we always talked about the fact that the direct sales has a higher cost to serve.

So, they have a higher margin, and so that is offset by the higher cost to serve, where indirect products has a lower margin but has a lower cost to serve.

We manage this Company through the EBIT margin.

So, no real difference on the operating line is what you're saying?

Exactly.

Okay.

Got it.

And then with regard to Europe, basically you're saying that Germany remains strong and it clearly is, and that is because the 10% organic growth does seem fairly -- sounds very good from a North American standpoint, and just looking at the problems over there.

So you continue to feel that way.

Did you feel that way in December as well?

Yes.

Okay.

We have, again, six of our seven growth opportunities are Kennametal controls.

And finally, the 36% incremental margin.

I mean, is that something -- was there anything that affected that more or less in the quarter?

No, it's relatively consistent, Greg, with what we said that when we gave our guidance in July, we said we would be in the low 30s and we're tracking as anticipated.

Now, the things that will drive some behavior there is if raw materials are higher or pricing is better, but on average, it's been pretty much in line.

Well, thank you.

You guys continue to do it.

Thank you.

Steve Barger with KeyBanc Capital Markets.

Just a couple of real quick ones.

Circling back to China, we have seen some of the emerging markets taking steps towards looser monetary policy to help get growth to step back up.

Typically, how long do you think it takes from a lag effect standpoint, when India or China makes those moves, and what end markets do you think that might manifest in first?

I mean, China is typically very quick, 30 days, 60 days.

I don't have a good feeling for India.

India takes longer, but China is pretty -- they move the economy back and forth pretty quickly.

So, we expect to see a bigger positive in the industrial, obviously.

We'll probably see a little bit of the opposite, not that our infrastructure will decrease that much, but we will see an acceleration of the industrial as a result of their most recent monetary policy changes.

Right.

And since they are more focused on infrastructure right now, I think you said, is that taking the shape of roads or dams or airports or power plants?

Which of those is best for you?

What is the right mix to really drive growth for Kennametal on the infrastructure side?

I think repairing of roads, that type of -- the mining is very positive for us, and obviously, all the electric, the power additions that they are doing is very good for us as well.

And the rail could accelerate.

I think they're getting their [minister] under control there, so they may see some acceleration on that, and that will benefit on both industrial as well as infrastructure.

Holden Lewis with BB&T Capital Markets.

A couple of things.

I'm doing fine, thank you.

First, as it relates to WIDIA, how much -- the 27% growth.

How much of the mix -- what revenue base are you getting that growth off of?

What is the mix of WIDIA business?

I would say there's probably more in the Americas, secondarily probably Asia and third in Europe because WIDIA has been established in Europe.

It's a European brand, so I would probably say we're seeing a lot of it with the Americas, and as we continue to work closely with Fastenal, we hope -- hopefully that will continue to accelerate faster in the future.

Is that 27% that you are seeing broad across the geographies, or is that Fastenal meaningfully driving that number at this point?

Yes, Fastenal is just starting, so they're not meaningfully driving that but the sequences, as Frank said, the most growth is coming from the Americas, followed by Asia and the lastly by Europe, and the reason for Europe being last is not an economic issue.

It's the fact that WIDIA was a European brand and was established in Europe.

Okay.

So the growth potential there is not as high as in the rest of -- in the Americas and the rest of the world where WIDIA has absolutely no presence at one time.

And then what percentage of revenues is WIDIA?

Less than 10%.

Less than 10%.

Okay, got it.

And then a couple of questions at least relative to seasonality.

First, it's seasonally unusual for your Q2 revenues to be below your Q1 revenues.

And I guess I would have assumed is the fact that, that happened during a period of expansion would have suggested some slow down that you don't seem to suggest that's happening.

Could you give some color as to why you had such a seasonally unusual event in a period where it doesn't usually happen that way?

Well, first, actual at actuals.

The first quarter to the second quarter, we averaged just using the euro.

The euro averaged about $1.44 in the first quarter.

The second quarter, it was $1.37 and you know where it's at now.

So the Euro plays in there and believe it or not, last year, the workday decline was only a couple.

This year, it was over -- it was almost 3.5 reduction in days.

So you've got a combination of FX and days and this is relatively consistent with how we built our [plans].

Yes, I also want to emphasize that what we are saying is the growth is decelerating.

We said that when we gave guidance for 2012.

We said that the growth was going to decelerate which is different than the bottom is falling out.

Okay.

And then just one other thing, looking at seasonality.

Just taking your guidance, it does imply revenue growth in the back half of about 3% to 6%, which would seem in line with IP perhaps as opposed to beating it.

And it implies that your earnings should be anywhere from down 1% to up 9% in the second half, which seems reasonably anemic, again, in a reasonable growth environment.

Is that just conservatism or what's behind that?

It is a forecast.

I don't know if you have been listening to this call.

Half of the population thinks that the world is falling apart, and the other half of the population, you being part of that, thinks that maybe some conservatism in our assumptions.

It's the forecast as we see it, there's puts and takes, and that's the best that we can do at this point.

As I said in last quarter, we're damned if we do and damned if we don't.

(laughter)

There are no further questions at this time.

Are there any closing comments?

No, you can go ahead and announce the replay.

There will be a replay of today's conference available from today at approximately 11.00 AM Eastern Standard Time through February 23, 2012, at midnight.

The ID number to dial for the replay is 800-585-8367 or 855-859-2056.

The ID number to access the replay is 3426-4306.

Again, the ID number for the replay is 3426-4306.

Thank you for participating in today's conference call.

You may now disconnect.

This concludes our discussion.

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

Thanks for joining us.