Kennametal Inc (KMT) 2013 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 2013 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 fiscal year 2013 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 in to this call.

It is also being broadcast live on our website and a recording of this call will be available on our site for replay through November 26, 2012.

I'm Quynh McGuire, Director of Investor Relations for Kennametal.

Joining me for our call today are Chairman, President and CEO, Carlos Cardoso; Vice President and CFO, Frank Simpkins; Vice President Finance and Corporate Controller, Marti Bailey.

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

After the remarks, we will be happy to answer 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's 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 provides a reconciliation of those measures as well.

I will now turn the call over to Carlos.

Thank you, Quynh.

Hello, everyone.

Thanks for joining us today.

As we enter the first quarter of fiscal year 2013, we expect to face of economic challenges.

However, political uncertainty in the US, sovereign debt issues in the Euro zone, pending leadership transition in China imploring growth in emerging markets have curtailed demands in many of our served end-markets -- more than we initially anticipated.

For the September quarter, we reported earnings per share of $0.57 on $629 million of sales compared with prior year period of $0.88 on $659 million in sales.

Despite the affects of decreased volume and lower absorption of manufacturing costs, we deliver an operating margin of 10.8% for the quarter when adjusted to exclude the satellite acquisition.

This margin performance is due to our relentless discipline on controlling costs.

Also on an adjusted basis, we maintained strong return on invested capital of 14.6%.

We have contingency plans to further reduce costs and maximize our cash flows.

Although market conditions make organic growth more challenging in the near term, we remain highly focused on cost control to deliver mid-teens EBIT margins for the full-year.

Also, Kennametal consistently generates strong cash flow each year throughout the economic cycle.

As the end-user demand to soften during the quarter, particularly in the month of September, it was further intensified by inventory destocking.

Our customers, particularly distributors, are working down their inventory levels.

We believe that those challenges our near-term in nature, fueled by uncertainty since we expect that it is pent up demand to be realized in the future.

As a consumables business, our products are required in manufacturing processes and must be replaced regularly.

Sooner or later, customers need to replenish their inventories.

At the International Manufacturing and Technology Show, or IMTS, held in Chicago in September, we showcased innovative and new products for both Kennametal and Widia brands.

Registration for the show marked the highest level ever and machine tool builders reported seeing healthy level of customer interest.

We believe those are encouraging indicators for longer-term sentiment.

In the meantime, we'll continue to execute our strategies to maintain high profitability, financial flexibility, and our strong balance sheet.

In addition to further reducing our cost structure, we are deeply focused on maximizing cash flows.

Accordingly, we have scaled back on our planned capital expenditures for fiscal year 2013 from the prior level of $150 million to $125 million to new range of $95 million to $110 million.

At this time, I would like to provide an overview of in-market trends.

In aerospace, IHS Global Insight expects commercial global production to increase of 32% in 2012 and 16% in 2013, which suggests the aircraft production is back on track.

In general engineering, the Institute for Trend Research reports that US capacity utilization has been high and increasing machinery inventories may suggest some over production.

Therefore, manufacturers and distributors may be inclined to decrease inventories as industrial markets reflect a slowdown in the near-term.

In transportation, light vehicle sales in North America have benefited from improved credit conditions but the overall economic growth environment remains continuous.

Vehicle sales in North America are expected to grow modestly through the remainder of calendar year 2012.

In Europe, production is expected to decline in the December quarter and this demand outlook was revised to reflect that 2013 sales are estimate to be lower than 2012.

European production is not projected to return to its 2011 high level for several years.

In China, passenger vehicle production, [as] higher supplied commercial vehicle production, decline year-over-year.

In India, light vehicle production declines, partially due to a local manufacturers plant shutdown due to labor unrest.

Consumer confidence, credit availability, and pent up demands will play key roles in strengthening auto demand.

In mining, the 2012 year-to-date total coal consumption in the US declined by 27% from prior year.

This is primarily due to many utilities switching from coal to natural gas.

Currently, the electricity sector coal stock piles are at an all-time level and coal production has been lower year-over-year.

China and Australia also have an oversupply situation; however, there is modest growth projected in South Africa, which is forecasting 3% year-over-year growth of imported coal.

In the oil and gas markets, there has been measurable slowing in drilling activity with world rig count decreasing by 5% year-over-year.

Historically, colder weather in the Northern Hemisphere during the winter months helps to deplete source levels and encourage an increasing drilling activity.

Overall, we are staying the course to build a global portfolio to generate revenues in equal terms from North America, Western Europe and rest of the world markets.

Also, we will continue to diversify our mix of served end-markets to reduce volatility and mitigate down size exposure in cyclical sectors.

We continue to make progress with strategic growth initiatives to increase our addressable markets and gain share.

For example, our distribution exclusive Widia brand strategy increases our market presence and provides innovative solutions specifically generated with customers that buy through the indirect channel.

In addition we further increased our value proposition to the marketplace by consistently introducing new technologies and developing new products to improve customer productivity.

Kennametal has successfully managed through economic headwinds in the past.

We have never been a stronger -- in a stronger position than we are now, having effectively executed our strategies to increase operating efficiencies and deliver improved profitability.

By executing our Company's specific initiatives, together with our strong balance sheet, we will continue to position Kennametal well for future growth.

I will now turn the call over to Frank who will discuss our financial results for the quarter in greater detail.

Frank?

Thank you, Carlos.

I will provide some comments on our performance for the September quarter and then I'll move on to our revised outlook for the remainder of fiscal 2013.

Some of my comment are non-GAAP so please refer to the reconciliation schedules provided in our earnings release and related Form 8-K.

Let me get straight to the point.

The September quarter was a challenging quarter, given the macro environment, fueled by uncertainty in the US and Asia as well as fiscal concerns in Europe.

We experienced weaker than expected demand in most markets, especially in our general engineering and earth works businesses.

September, which is typically our strongest month in the quarter, broke from past patterns.

The month started off fine but deteriorated quickly as destocking continued and demand levels from transportation customers in Europe weakened further.

In addition, there were further underground coal mine shutdowns and energy customers pushed out orders.

These factors led to a weaker than anticipated September.

And another headwind was foreign currency; however, that was as we expected.

On the other hand, as Carlos pointed out, positive in the quarter was that prior restructuring programs and cost containment measures helped deliver double-digit adjusted operating margin of 10.8% for the base business despite all the commercial challenges of the quarter.

We have initiated cost containment actions and all functions and are managing the business to market conditions while staying focused on our long-term strategies.

Now I will turn through the income statement.

Sales for the quarter were $629 million compared to $659 million in the same quarter last year.

Sales were down by 4% driven by a 7% organic decline, 5% unfavorable foreign currency effects, and 1% from fewer business days, partly offset by the acquisition contribution of 9% from the Stellite business.

Looking at the individual segments, our industrial segment sales were $353 million and they declined by 15% in the prior year quarter.

This was driven by a 9% organic decline and a 6% unfavorable effect from currency exchange.

On an organic basis, sales declined 15% in general engineering and 1% and transportation, partly offset by sales growth of 7% in our aerospace and defense unit.

General engineering was unfavorably impacted by lower sales to the indirect channels due to continued inventory destocking as a result of the slowing macro environment.

Our expectation was that destocking at distributors would end in August, especially in the United States.

However, distribution inventory levels grew in September and distributors continued to reduce purchasing activities in an effort to burn down their inventory.

Transportation was also impacted by higher unit inventory levels at dealerships, the big three inventory levels were at 67 days in North America compared to a normal level of around 60.

In Europe, Germany and Southern Europe slowed and implemented extended shutdowns.

Many European customers implemented short-term work programs given the weakening demand rates.

And on a regional basis, our sales and industrial segment decreased by approximately 13% in the Americas.

7% in Europe, and 1% in Asia.

We believe that there is pent up demand in the indirect channel sales can re-accelerate quickly once there is more certainty in the overall macroeconomic outlook.

Our infrastructure segment sales were $276 million, and they increased 15% from the prior-year quarter, driven by the Stellite acquisition contributing 25% growth.

This was partially offset by a 5% organic sales decline, 4% unfavorable foreign currency, and 1% fewer business days.

On an organic basis, sales declined by 6% in both earthworks and energy.

Earthworks continues to be impacted by weak underground coal demand in North America.

Although we saw an improvement in the sector in August, many major US underground coal companies idled mines and announced additional closures in the middle and latter part of September.

This negative outlook was reinforced at the recent mine expo show in Las Vegas.

Energy is being effected by lower global demand as customers have temporarily postponed orders and have also been destocking inventory.

However, they are now forecasting an improvement in the March quarter.

And regionally, our sales decreased by 11% in the Americas, 7% in Europe, and Asia sales were 5% higher.

Now a recap of our operating performance.

Our gross profit margin was 33.1% compared to 38.1% last year.

The decline was due to lower sales volume, lower absorption manufacturing costs, and the inclusion of Stellite in the business.

However, the prior-year gross margins benefited from strong organic growth and pricing as well as favorable absorption of manufacturing cost, hence the challenging comparison.

Operating expense continues to be good story and they declined 7% year-over-year.

Overall, lower employment and related compensation cost, favorable foreign currency, were partly offset by the Stellite acquisition operating expenses.

Operating expenses as a percent of sales was 22.1% for the quarter, down 10 basis points from the prior year of 22.2%.

And amortization expense was 5.1% for the quarter, and that's up from 3.5% last year due primarily due to the Stellite acquisition.

Operating income was $64 million compared with $102 million last year.

Operating income included $3 million of Stellite operated income contribution for the quarter.

Operating income decreased as a result of lower sales volume, lower absorption of manufacturing costs, and unfavorable foreign currency impact.

Our operating margin for the September quarter was 10.2%, and adjusting for the Stellite acquisition, our base business operating margin was 10.8%.

The industrial segments operating income was $35 million compared with $73 million in the same quarter last year.

Industrial operating income decreased due to lower sales volume, lower absorption of manufacturing costs, and unfavorable currency impact.

Industrials operating margin was 10% compared with 17.4% in the prior year.

The infrastructure segment operating income was $32 million compared with $33 million in the same quarter of the prior year.

Infrastructure operating income benefited from the Stellite operating income of $3 million, which were more than offset by the affects of organic sales decline and lower absorption and manufacturing costs.

Infrastructure's operating margin was 11.5% for the September quarter compared with 13.5% in the prior year.

Interest expense increased approximately $0.5 million year-over-year in the September quarter to $6 million due to higher debt levels attributable to the Stellite acquisition, partly offset by lower bank revolving borrowing costs and the lower bond coupon rates.

The effective tax rate was approximately 21% compared with 23% in the prior year quarter.

The current year rate reflects a net benefit from the affect of the settlement of an income tax audit in Europe, partly offset by the impact with stronger earnings in the United States where the income tax rate is higher.

Regarding our bottom line performance, we reported September quarter diluted earnings per share of $0.57 compared with $0.88 in the prior year.

And the September quarter earnings per share included acquisition related contribution of $0.01.

Turning to cash flow, our cash flow from operating activities was $3 million compared with the cash outflow of $7 million in the prior year.

Net capital expenditures were $15 million compared to $12 million in the prior year.

Free operating cash flow for the quarter was $12 million, or an out flow compared with an outflow of $18 million in the prior year.

We remain committed to our priority uses of cash.

During the September quarter was purchased 706,000 of our shares and we continue to be highly disciplined in our capital allocation process to ensure that we invested in initiatives of the highest shareholder returns.

Our balance sheet remains strong.

Our cash position was $111 million and we remain focused on improving our working capital and our DSL, ITL, and DPO were at relatively similar levels in the September quarter compared to June despite the substantial decline in economic activities.

This demonstrates that our operating model has become more adaptable to the dynamic market environment.

Inventory increased approximately $32 million from June.

The increase is almost entirely attributable to raw material purchase commitment.

This is related to the sales decline in the September quarter.

And as we have previously stated, we still remain committed to reducing our inventory by $60 million for fiscal 2013.

At quarter end, our total debt was $601 million, up $35 million or 6% from June, due primarily to share repurchases of $26 million and a free operating cash flow -- outflow of $12 million, partly offset by lower foreign exchange.

Debt was up $280 million versus the prior year due to the Stellite acquisition and our debt-to-cap ratio at September 30 was 26% compared to 25.3% at June 30.

Our US defined benefit pension plan remains 100% funded and a return on adjusted capital was 14.6%.

Now I will give you quick update on our acquisition of the Stellite.

The integration of Kennametal Stellite continues to proceed well with focus turning towards further alignment of business processes with Kennametal's standards.

Most noteworthy, is the project to implement SAP, our integrated business operating system which was launched last quarter.

This project will further enable the efficiency and growth synergies between our organizations.

The integration team reports that 49% of all work streams are complete at the quarter, slightly ahead of our plan.

During the quarter, Stellite experienced similar weaknesses in its core-end markets, particularly the construction market in Asia as well as automotive softness in Europe.

Cost control measures have been implemented to mitigate the short-term effects of the weaker commercial environment.

We remain committed to our aggressive integration plan and our cost control measures will not impact initiatives critical to achieving synergies in fiscal 2013.

In the first quarter, Kennametal Stellite sales were approximately $60 million and Stellite contributed $0.01 per share to that Kennametal results.

Now I'll turn to the outlook.

When revising our guidance for fiscal 2013, we took into consideration the affects of the global uncertainty as well as the potential for additional inventory destocking by our customers.

We believe the customers are waiting for better clarity pending the outcome of the US elections and decisions regarding the fiscal cliff situation, the ongoing fiscal and monetary changes in the Euro zone, and finally the position that China's new leaders will take on any new economic stimulus.

While underlying fundamentals suggest the resumption of growth beginning in calendar 2013, particularly in the US in Asia, we have revised our expectations with the more conservative scenario.

In addition, we remain focused on cost reduction initiatives that are within our control.

In response to these many factors, Kennametal has lowered its fiscal 2013 total sales growth range from 3% to 6% to a flat to negative 3% organic sales from the previous sales growth of 7% to 10% with organic sales growth of 5% to 7%.

As a result of the lower sales now expected, we have reduced our earnings per share guidance for fiscal 2013 to a range of $3.40 to $3.70 from the previous range of $4.10 to $4.40.

We expect to generate approximately 35% of earnings in the first-half and approximately 65% of earnings in the second half of the fiscal year.

Included in this revised earnings outlook are the following assumptions.

First, the accretive contribution of Stellite acquisition still expected to be the range of $0.15 to $0.25 per share net of integration costs.

Second, foreign currency is still forecasted to be a significant headwind compared to the prior-year and will have an unfavorable impact on operations estimated in the range of $0.10 to $0.15 per share.

And lastly, our effective tax rate for fiscal 2013 is expected to be approximately 25% due to the year fully included Stellite as well as unfavorable jurisdictional mix and the combined effects, which are now expected to be 20% to 25% per share lower than the prior year.

We now expect to generate cash flow from operations in the range of $320 million to $385 million for fiscal 2013 versus the previous range of $425 million to $475 million.

Based on lower than anticipated capital expenditures of approximately $95 million to $110 million, we expect to generate between $225 million and $275 million of free operating cash flow for the full fiscal year, down from the previous range of $300 million to $350 million.

We continue to expect our free operating cash flow to approximate net income and our incentive compensation metrics continue to include free operating cash flow as a factor.

In summary, we have demonstrated in the past that we have successfully navigated challenging economic times.

We are confident that we will weather the soft patch and continuing our path to premier financial performance.

At this time, I'll turn it back to Carlos for closing comments.

Thank you, Frank.

As we move forward, we will execute the same strategy that will have transformed Kennametal into a Company that can deliver profitable growth throughout the economic cycle.

We will continue to meet the demands of our customers by further balancing our served end-markets, business mix, and geographic presence.

We will continue to adhere to our cost control strategies, maintaining our reduced cost structure and further driving business efficiencies.

In addition, we will continue to capitalize on our strong balance sheet to increase shareholder value.

We will remain disciplined in our capital allocation process with priority uses of cash to include stock buyback, acquisitions, capital expenditures, and dividends.

In summary, we will continually evaluate changing economic conditions around the world.

We have always acknowledged the risks related to the macro uncertainties.

We will make tough decisions as needed related to the capital expenditures, manufacturing production, and headcount.

In the meantime, we will continue to focus on maintaining operational excellence with every area of our business.

Thank you for your interest in Kennametal.

We will now take questions.

(Operator Instructions)

Your first question comes from the line of Stephen Volkmann with Jefferies & Co.

Hi.

Good morning, guys.

A couple of quick things, if I may.

It sounds like things really did sort of step down pretty meaningfully in September.

We have heard that from some other companies, as well.

I guess the first question is, is that continuing into October as far as you can see?

And I'm curious how long you think this destocking kind of lasts?

And I guess that is the first question.

The yes, Stephen, I think that you are correct.

Things kind of -- especially in the last two weeks of September, really declined unexpectedly.

And it is really too early relative to October.

A lot of activity, just like in September, the last two quarters were the quarters that surprised -- the weeks that surprised us.

It's too early to tell in October.

It is definitely not getting worse, but too early.

Relative to destocking, we did a look at this last quarter and typically in the US, we thought that our distributors were carrying about 60 days worth of inventory.

I mean this was an educated guess -- I mean Europe about 90 days.

And that was at the rates that -- at the growth rates that we have projected.

So, with the lower growth rates, we probably add a month to each one of those areas.

And again, this is another educated guess.

So I would say that we probably have, starting in September, probably had about three months with the new growth rate in the US channel and maybe 120 in Europe.

So that is kind of the best guess we can have at this point.

Okay.

All right.

That's helpful.

And I guess, given the sort of the down shift across what sounds like most of the Company based on your comment, Carlos, about end-markets, do you change your view of cash utilization at this point?

Does share repurchase become more or less interesting, given the uncertainty?

Do the acquisitions get tougher to do?

Do you sort of try to sit on your cash for little while and make sure things get worse or am I thinking about it the wrong way?

All of the above (laughter).

I think the acquisitions are now going to get tougher.

I mean I think that this is a -- we haven't seen really a change in sort of in the mood and in the space of the acquisitions.

Certainly, again, as we said we have a strong balance sheet.

We have committed to doing 2.5 million shares of purchasing this year.

And we have, as you know, we expanded our authorization.

So we are willing and capable of doing more if that is the best interest of the shareholders at this point.

Yes, Steve, I would add -- we have the balance sheet, as you know, to handle both buyback as well as acquisitions.

And stock buyback could become more of a priority if the acquisitions -- if we can't tie them right, so we will continue to be aggressive with both.

Okay thanks, Frank.

Eli Lustgarten, Longbow Securities.

Good morning, everyone.

Just some clarification on the tax rate at 25% for the year.

So we've seen 25% from every quarter or are you going to average 25% and therefore you've got to be back 26%, 27% somewhere out there?

Yes, I -- to make it easy for right -- it will be 25% for the year and it will probably be, as best we know, 26% for the quarter -- two to four, based upon the mix that we have right now.

So that is why it basically stayed at 25% despite the benefit in first quarter.

Okay.

And how big was gain -- the adjustment that you got, net settlement, in the quarter?

About $3 million.

About $3 million.

Now can you help us a little bit on your organic growth outlook as you interpreted?

And the first quarter was not exactly pretty, down 7%, but yet real ugliness in industrial -- I guess the industrial was way down, 15%, I think it was.

Can you give us some idea of the segments -- how you see the organic growth unfolding for the next couple of quarters?

I mean I assume the second quarter will be a little bit better than the first quarter in industrial but not -- still probably down double digits.

Is that sort of the way we should think about this thing?

Yes.

I would think the second quarter -- it actually also has one more work day year-over-year but, sequentially, it is almost on one to two days the way the calendar fell this year.

So, yes, I would expect a slight improvement.

And that is why we looked at that 35%, 65%.

But when you really take into consideration, we expect a little more growth in the second half and that is due to some of the things we talked about -- Vidia, construction kicking in in the March quarter.

We don't think destocking will go past December.

There may be some -- I don't want to call it restocking -- but we think that cycle will be worked through.

The US should pick up a little bit in a couple of other sectors, particularly with the aerospace and defense.

Stellite will have is a stronger second half.

They start flipping into the organic growth numbers.

And then we expect the cost controls we have put in place, lower raw material costs, as well as the lower interest expense across the board, to help us drive particularly stronger earnings in the second half.

And can you also maybe give us some help on operating profitability?

If you want to make the mid-teens EBIT with the second quarter probably being, again, a little bit better than the first quarter as we're looking, we are talking about over -- north of 15% in both sectors in the second half of the year.

Is that sort of the way the focus of the cost cutting will be?

Yes.

And by the way that is normal.

If you look at our previous year -- years, the percentage margin grows every quarter sequentially.

The worst -- the lower percentage is always in the first quarter and the highest percentage is always in the fourth quarter.

It is historical.

Yes.

And another thing I'll add to that too, Eli, particularly in the fourth quarter this year, we actually have two additional workdays.

So we will get some additional benefits as sales slowly pickup will get some additional absorption benefits in the fourth quarters.

So the fourth quarter will be a little bit better profitability wise/margin.

And my final question, has pricing been held up throughout this whole process?

Are any pricing issues taking place as we go through the weakness in the marketplace?

Absolutely staying.

The pricing has stuck.

Pricing is flat?

I mean there's no change in pricing at this point?

No.

Ann Duignan, JPMorgan.

Hi.

Good morning.

Can you talk a little bit about where exactly, both by end-market and by region, where you so the greatest surprise in decline in demand as we went through September?

So by region, the highest decline was North America followed by Europe and we actually had slightly positive in Asia.

By end market, the worst decline was the general engineering followed by earthworks and then energy and transportation.

And aerospace is actually positive.

Okay.

And, Carlos, we are now in October 23 and just to follow-up on Steve's question, it doesn't seem like we are too early in October, given that you get daily order rates.

Why do feel like it is too early to tell how October is looking at this point?

Because in September, we experienced the largest decline in the last two weeks of the month.

So that would -- we would have a better idea if there was not this destocking phenomenon going on.

So, as Frank said, we think that sequential the second quarter is going to be better.

It is not getting worse.

But I am hesitant to talk about knowing that just in September -- actually when we started the September month, we were -- our indicators are still showing us that we were not going to be too far from where we needed to be.

Okay.

And just as a follow-up to that, given that you have excess raw material inventories, your customers are destocking and your decrementals were quite weak.

How should we think about modeling the detrimental by segment going forward?

I think the decrementals will be more pervasive in the industrial side.

But I don't think, Ann, we will have as much of destocking as we expensed in the industrial sector in the September quarter.

It should start subsidizing in the December quarter.

But we don't get the big benefit on the infrastructure side given the larger material content product.

But when we have the volume, I would say it's a little bit stronger in the industrial side, particularly for the whole year compared to what we have in the first quarter if things don't improve.

And we're looking at cost cutting across the organization.

And with a little volume, given our restructuring programs that we did, we should see a quick turnaround if we get a little bit of a benefit.

Again, I continue to emphasize that at the current levels that we deliver -- sales levels in the quarter, which was very well, we still were around 11% EBITDA margins.

And the first quarter is always the lowest quarter -- the lowest margin quarter.

Yes.

But, again, the issue is that going forward you are compounding the problem of having excess inventory.

Is most of the inventory in the industrial sectors since that's where you saw most of the destocking?

Yes.

Okay.

I will get back in line, just in the interest of fairness.

Thank you.

Thank you.

Julian Mitchell, Credit Suisse.

Hi.

Thank you.

So just to follow-up on the point on industrial decremental margins and thinking about the incremental in the second half, so I guess you did a 58% decremental or something in industrial in Q1.

If we think about Q2 it sounds like sales will be down but the decremental is maybe more like a 40% because the under-absorption related to inventory destocking is less severe as a headwind.

And then you're looking at kind of 30% plus incrementals for the second half as sales start to rebound.

Is that a reasonable view of what your expectations are for the industrial business?

I don't think it is unreasonable, to that point.

But you can get the guidance numbers right where we took down.

You can see the sales.

So it was a pretty big hair cut from where we're at, but it should improve particularly in the second half.

Okay.

But I guess the key point here is -- I mean you are saying that that 58% decremental -- I mean it is a function of a lot of under-absorption because of destocking.

And also I guess the cost cutting measures haven't started to come through yet.

I mean, did you start to take cost out measures in the September quarter itself?

Or are those the things that you are mulling over now to in place in the next six months?

Yes, they really started -- I would say late in the September quarter -- starting to gain some traction.

Okay.

Got it.

And then just in terms of the -- I guess the regional expectations, you've given your organic sales growth outlook for the year globally.

Could you just give a little bit of color on each region?

Do you know -- just very top-down -- I guess Americas, Europe, and Asia.

Okay, so I will give you directionally for the year.

We expect North America to be slightly positive for the year.

We expect Europe to be negative.

And we expect Asia to actually have mid-single digit growth.

Okay.

And I guess just a final follow-up.

You talked about the slowdown was pretty severe, obviously particularly in US general engineering to the subsegment in the second half of September.

And you know, the drop off, I guess, there was nothing obviously from the outside that you could see.

I mean the issues in Europe and China have been going on for sort of 6 to 9 months.

The PMIs in the US have taken a leg down already back in July.

So could you -- what sense did you get from the distribution channel as to why suddenly the second half of September something changed?

Well, I mean -- again, 80% of the orders that we get in the month we ship within the month.

So it just gives you an idea that we really don't have -- other than the leading indicators in the models that we have.

I think everyone was surprised, as you heard the earnings from the calls already that took place.

So, I don't know how to explain it any other way that the orders, as a result of destocking, people just got really nervous and it they'll go out -- they'll go down and they'll up at the same speed, actually.

That is why it is hard to tell how quickly.

We believe there is pent-up demand.

The question is, is it going to come this quarter?

Is it going to come next quarter or what?

All the indicators that we see is that things will come back in the second half of the year.

Probably not very strong but --

Andy Casey, Wells Fargo Securities.

Good morning, everybody.

I want to follow up on a component of some previous questions, specifically the gross profit contribution margin.

If I am correct, and I am going back a couple of years, but I think you provided a longer-term incremental gross profit margin target of about 40% for both up and down demand environments.

And the reported quarter number was basically a little more than triple that, but there was a lot of stuff going on in the quarter.

So if we adjust currency acquisition and destocking out of the performance, what was the core gross profit incremental?

I would say it is north of 35%.

I would have to go back and factor in the currency impacts on a couple there.

But still, I would add over 100 basis points itself and the destocking is always tough in the quarter because of the European holiday in the month of August.

So this quarter is a little bit unusual on a stand-alone basis.

But it would be north of 35%.

It probably would be 200 to 300 basis points better, off the top of my head.

Okay.

And then on the cost control actions, I am just curious how you're going about it given you have the within your guidance, you are expecting kind of another weak quarter in front of us and then some improvement in the second half.

What sort of cost control actions are you putting in place?

Well the first thing that you do is you take direct label, right?

Because it's -- you man for the volumes that you have.

So that is the first thing that you do.

And we have done.

So we have adjusted.

We are adjusted to the current forecast that we have.

And then you do things like all the controllable expenses, you look at it and reduce those.

Those are pretty straightforward to do.

And I would include hiring freezes, moving investments, postponing, looking at all the discretionary stuff within your control and then longer term, looking at the structure of the business.

Okay.

And then lastly, I don't mean this in an overly negative way, but given the choppiness of the environment right now, I'm just curious as to why you didn't do what some other companies did and just assume no improvement for the fiscal second half?

Well because, I mean, we have our models, Andy.

And our models work 95% of the time.

So, we just can't go out and do what the other companies are doing.

We have got to do what our models are telling us to do.

Okay.

So, we have very robust models.

And, again, you can question the models didn't work for this quarter.

But generally speaking, we are on 95% of the time.

So we've got to continue to obviously improve those models, but stick with the models that have worked for us.

Okay.

Thank you very much.

Adam Uhlman, Cleveland Research

Hi.

Good morning.

I would like to address the industrial segment sales decline maybe a different way to try to better understand the destocking that you're seeing.

Is there any way to divide the decline that you saw between the sales decline seen as direct customers versus the distribution channel?

Yes.

We really don't have that broken down.

I mean it's hard to tell from the -- we don't get all of that data from our distributors, to be honest with you.

And I guess you know your sales into the distributors so was is it something that the distributors were off 20%, 30% and the direct customers were down only less than half of that?

Well I think --

We know the distribution was down higher.

I don't know what their number is.

Okay.

And do you have what the Vidia performance was in the quarter?

Yes.

The Vidia performance was mid-to-high single digits growth.

By the way, it proves that our Vidia strategy continues to be good.

And then just to get back to the inventory question.

I guess Thomson is down quite a bit in the stock market and it looks like you guys ramped up your raw material inventories a lot.

How should I think about the earnings contribution from that as you start to work through those inventories?

Well we have -- I mean it's not that we -- we have purchase commitments that we have to honor with our suppliers.

There is the life-blood of our manufacturing organization.

But we try to factor in our $60 million reduction that was in our original plan.

And that was more focused on the finished goods and the whip.

Raw material doesn't go bad.

And over time we don't pay for what the market price is immediately.

So if our lag was on quarter in the past, maybe it's one to two quarters as we work through the raw materials.

And by the way, the raw materials -- we're going to have a tail-end of the raw materials from a lower cost in the second half.

That -- I would think that would have offset the -- or more than offset any inventory reduction that impact.

Okay.

Got it.

Thanks.

Walt Liptak, Barrington Research.

Hi.

Thanks.

Good morning.

I wanted to ask about the guidance and the 65% second half, 35% first half.

So it looks like you are thinking that this is going to be the low EPS quarter for the year and that we continue to move up on EPS basis second quarter and then the back half.

Correct.

Okay.

And the inventory destocking, is something changed from -- you know, we saw destocking back in '09 too that was pronounced.

Is this the same sort of a phenomenon or do you think something's changed with the way that distributors and OEs are stocking and looking at their cutting tool inventory?

Well, I think that our -- the supply chain always -- after recession always gets more efficient.

So, I think there is less inventory in the supply chain.

But, I think that one of the things that is different now versus 2009, 2009 was just a -- was a recession driven by consumer and all that stuff and financial crisis and so forth.

I think that there's a lot of uncertainty now.

So, I think there is pent-up demand.

So, once the elections are over, and we are probably going to see some positive coming back starting in 2013.

But, again, everyone has an opinion and that is our view.

And, Walt, on the destock, I think we also had an unusual quarter.

Let me say, one of our large key distributors bought a lot last year because of the acceleration.

We were removing some private label so some distributors had to take that into consideration.

And some had to deal with the transition out of the Vidia brand.

So on a year-over-year basis, that largest distributor -- I think we had a large and unfairly comparison year-over-year, which we don't expect to recur as we go out.

So we know that that destocking should flush itself through.

Okay.

I understand.

But in general, you think the -- maybe starting in the third -- second quarter and probably in the third quarter we start to see inventories build back up?

That is what is in your model?

Correct.

Yes.

Okay.

All right.

Thank you.

Brian Rayle, Northcoast Research

Good morning.

Most of my questions have been answered, but I guess if we can go through the process of, obviously, you guys lowered your cost structure in the first quarter.

Where that is -- is that -- are we almost done with that or are we going to see that carry into the second quarter?

And then I guess on the optimistic side, how quickly can that ramp up?

What kind of parameters exist for orders going either positive or negative on how you can ramp your overall production base?

Yes.

We have not reduced physical capacity.

Okay.

So we took our -- we have laid off hourly people.

And obviously if things -- if demand starts coming back in January, we bring those people back.

So, capacity is there so we can ramp up.

And we don't intend or have plans to reduce capacity at this point.

So, we would be very flexible and be able to ramp up pretty quickly.

Yes.

And all the discretionary items on a previous question -- we started it in the first quarter.

They will continue to gain momentum as we go on the out period.

And if we need to add people because business comes back, that is a relatively easy comparison.

Because the key thing is here, we did not let our cost creep back into the organization with restructuring.

We did take out the fixed costs that are permanent.

And if you take out the Stellite acquisition, our headcount is basically where it was at the end of 2009.

So, we purposely cautious on adding people back so we don't have the same situation that we went in past cycles.

So, we think the cost control, the discipline we have now, will pay dividends as we go out.

Okay.

Great.

Thank you.

Steven Stone, Sidoti & Co.

Hello.

Just a quick question.

Most of my questions have been answered.

But as far as the Vidia, how large of a percentage of revenues is that?

About 10%.

And the relationship with Fastenal, how is that progressing according to plans?

Did this destocking -- any of that change in this?

No.

It's going the other way.

It's actually above our expectations.

Okay.

Steve, on that -- as Fastenal, they had a pretty good first quarter if you look at the numbers and they continue to focus on the vendings.

And we have a good relationship there as well.

As they continue to grow faster, there will be definitely a pull-through.

And I think to Carlos point, it was a little bit faster than we had anticipated.

So, that is a positive as we go forward.

Okay.

Any plans on more distribution with Vidia -- pushing it out -- Fastenal increasing that relationship?

Anything with that?

Yes, that is the plan.

We have both Fastenal and Kennametal together have very aggressive expectations for the future.

I think we have a lot of runway left.

Okay.

Thank you.

Steve Barger, KeyBanc Capital Markets

Good morning.

Did you give the September monthly order number?

Sorry for missed it.

Yes, we did not provide the standalone September number.

But it is a high single-digit decline.

High single-digit decline.

And that is the rolling three, right?

Or is that standalone?

That's a standalone which contributed to the negative 7% organic decline.

Got it.

And just to go back to that growth, the negative 7% another way.

It was -- I know it is hard to quantify, but was half of that end-market decline versus destocking?

Or is there any way you can frame up the magnitude of the two kind of buckets?

Yes.

I think we would be speculating at this time.

It is really hard to quantify.

I mean, I'll tell you that 40% of our sales as a Company goes through distribution and the destocking took -- was higher in the distribution side of the Business.

Right.

And just one last one, you have a target of growing in 2 to 3 times global IPI.

As you plug the numbers into your model at the end of the quarter, what was your estimate for global IPI in your 1Q?

Just to get a sense for how much you underperformed in the sense that that might be mean reverting?

I would say in the first quarter we basically had very low single-digit growth.

Very similar to the fourth quarter.

That's how we had our plan build for our organic one.

We basically were up pretty much the same point in the first quarter.

And then we hit the -- what drove the overall business down is obviously what happened, as we said on the call with the earthworks side, particularly the underground coal mining and the destocking, particularly at one of our large customers.

So hopefully that will dissipate as we go forward.

Right.

But do you have an estimate for what global IPI itself was?

I mean obviously industrial production comps were positive in the US in the first quarter.

How are you thinking about what the total IP number was?

We were just looking at those numbers.

I don't have the (inaudible) global insight yet.

Yes, when we look at that -- when we developed the plan, it was on average between 2 to 3 global IP.

And that's how we got to the 5 to 7 for the year.

But we don't have the actual for the quarter yet.

Okay.

I'll circle up with you later on then.

Thanks.

Samuel Eisner, William Blair

Good morning.

Thanks, everyone.

Just had a couple quick questions here.

Could you maybe tease out what your utilization rates were, either on the corporate whole or at least across the two segments?

Yes.

I would say in the low 70's.

And how did that compare, I guess, to where they were last quarter?

On the fourth quarter, we have a lot more work days.

I would say they were in the high 70's.

All right.

And then when -- if I look at kind of your mid-teens even margin target for the year, is there a way to kind of parse out how much volume recovery is embedded in getting there from the 10% that you have -- or 10% in change that you have right now.

How much is price?

And I would say, how much would be internally driven?

Price will be not much.

On average, I think we said at the beginning of the year maybe 1% and then it will be volume as the main driver, and then our cost discipline and actions we initiated.

Look, there's certain inerrant costs that happened in the first quarter that did not take place in the rest of the year.

Got you.

And then just --

We'll look at historicals and you'll see the natural gains from sequential quarter-to-quarter.

Got you.

And then just lastly, on the cost programs that you -- I guess you put in place towards the end of this quarter, how much would you say would be fixed versus variable?

Or is everything variable where it would come back upon volumes coming back?

Everything is variable at this point.

Okay.

Great.

Thanks so much.

Holden Lewis, BB&T.

Great.

Thank you.

Good morning.

I just wanted to ask about a couple of items that -- sort of their impact.

Was there any sort of purchase accounting or integration expense that was unusual related to Stellite in the quarter?

No.

I mean when we provided the 15 to 25 net of some of the integration costs, that was in that program.

Everything is going pretty much on track.

To your point, they will subside.

They will get lesser in the second half.

That's why we have Stellite stronger earnings contributions, two half versus one half.

But we're going through the purchase accounting and it's pretty much done.

The amortization is there, the step up in inventory has been burned through.

But the only thing you really have left is amortization and the integration costs, which are pretty much on plan at this point.

Okay.

And then I wanted to ask about, you kept the guidance for Stellite's accretion the same, yet it was I think a $0.01 in the quarter and you did note that perhaps the revenues were coming in less that expected.

Was there just some conservatism built in there to overcome the revenues or are you doing less in terms of not being as aggressive from a cost standpoint given the environment?

How do we maintain it?

Well, on the high-end of the range, we would have -- with the volumes that we were anticipating, we would have been potentially north side of that.

But we've done some good restructuring things in the fourth quarter that are paying some benefits here going forward.

And as we start to rationalize the ERP system with the better visibility, we think there's further cost benefits in the second half that are going to come in.

So we've compensated this top-line softness with a little bit of head on the synergies going through the business.

Okay.

And then the second piece was sort of the -- you anticipated reducing inventories in this quarter.

That was the original goal.

Obviously it went up.

It looks like work in progress more than anything ever -- raw materials more than anything else.

But has this kind of -- has the dynamics in your inventory since you still want to cut but didn't make progress in Q1 -- does that mean that we sort of pushed out the negative effects on production?

So now instead of maybe even first half of the year it's going to drag throughout the year?

Is this -- is that how that dynamic is going to work?

I don't think it's going to have a major impact.

As Carlos said, if the prices are down, we'll get a little bit more benefit on that side.

But the raw materials of the entire -- I said it's almost entirely raw materials.

So what we factored in before, I think still holds true.

Okay.

Great.

Thank you.

Eli Lustgarten, Longbow Securities.

All right.

Just a quick follow up, guys.

And it goes back to the inventory -- taking out inventory at the firm.

How much below sales do expect to produce in the second quarter or the rest of the year, or could you give us some idea of what the impact will be, why you've taken inventory out?

Because it's quite a program and it does have an impact on absorption.

Eli, I don't have that number off the top of my head.

We'll have to get that offline for you.

Okay.

Thank you.

Tim Buie, Third Avenue Management

Hi.

Could you please address the facts rate issue?

How long can you keep it at 25%?

Will it go up in the future years?

Based upon the structure and the model we have today, we think 25% -- I'd like to say it's higher over time.

As Europe comes back that will drop it down.

We have other components in our portfolio like Stellite that's not included in the model, which will help as we get out to fiscal '14 and beyond to help mitigate any potential weakness there.

But we feel pretty confident based upon the mix of our business portfolio that worst case -- mid-20's is a reasonable number.

So 25% is on the high end.

We anticipate it to be lower than that.

Thank you.

Adam Uhlman, Cleveland Research.

Hi.

My question was answered.

Thanks.

Stephen Volkmann, Jefferies & Co.

Hi, guys.

My follow up -- I think you've gotten two thirds of the way there.

But I was just trying to get a sense of the cost cutting benefits in the second half.

And I guess we haven't really put any numbers around that yet.

Is that something we can do?

We haven't provided that, Stephen.

We typically don't.

I mean this is just normal -- like Frank said, we don't travel as much -- all that stuff.

We adjust the cost to the level of business there.

That's why it's indirect costs.

We feel really good about our fixed costs and, again, this is another thing -- our fixed cost is driving.

Stephen, you know that before, at this level of sales, we would never be able to add double digit EBIT margin.

And that is a testimony to our fixed cost, so we feel good about the fixed cost.

And the variable cost is variable cost.

I mean, it's adjusted to the level of sales.

So --

Fair enough.

I've got it.

Thank you so much.

At this time, there are no further questions.

This concludes our discussion.

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

Thank you for joining us.

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